Last night I listened to President Obama’s address to the nation and to Governor Jindal’s response on behalf of the Republican Party. The difference between the two was so dramatic that it hardly needs to be elaborated upon. While the president reaffirmed his mantra, “Yes we can,” the governor seemed to be saying “No we can’t, but that is the way it should be.” Jindal was defining the two parties: The Democrats are a party that believes government can solve problems, while Republicans believe government is the problem. I do not object to those characterizations.
In order to illustrate his point, the governor told a story about how a sheriff and he were frustrated after Katrina when government bureaucrats tried to stop private citizens from rescuing their neighbors by using their boats without first showing proof of insurance. It was a mind boggling example of government incompetence. What he failed to point out was that the Bush administration was running the government at the time of the Katrina disaster.
Governor Jindal and other Republicans know what they are talking about when it comes to government incompetence. The past eight years have demonstrated just how incompetent a government can be. But I do not think that the example they set is how government has to be. While the wars and the economy took center stage in the election, I think the incompetence of the Bush administration in governing both is what led voters to vote for change. As much as we hate the war in Iraq, I think the American people would have been fine with it had it actually been waged for a good reason and in a reasonably efficient way that would not have required a surge. Tax cuts for the rich, and deregulated markets would have been fine with most of us if they had actually delivered what was promised.
Now, Democrats also have had their failures. Jimmy Carter is a man I admire greatly, but his presidency was not a great success. But when we look for what Carter accomplished we can see the Camp David Accords, but when we look for what the Bush Administration did right we mostly get “The Surge” that bettered a mess of its own making. It was sad to hear Governor Jindal point to the New Orleans schools as one of his own great successes!
So the Republicans feel that the government can not get anything done, and they have an eight year record to prove their point. I think that the change we all voted for was not about growth in government, socialization, or higher taxes, but simple competence. We want a government that works. I am heartened by the air of competence that President Obama exudes, and the management skills and organization he is bringing to Washington. Everything he has done, from listening to his adversaries to bringing transparency to the budget and government spending shows that change has come to Washington. Competent and effective government comes directly from competent and effective leadership.
The choice we face is not quite the one that Governor Jindal put forward last night: Democrats for more government, Republicans for less. The real choice is effective and competent government, or more of the same ineffective and incompetent government we have had for the last eight years.
Our nation has begun implementing a nearly 800 billion dollar Economic Recovery Plan. This money is on top of the 750 billion dollar TARP, and as we frequently hear would cost over two trillion dollars in total if they were paid for by conventional issuance of treasury bonds. The stated goal of both programs is to head off economic collapse, raise the bottom of the downward trough of the business cycle, and restore the economy to a rational marketplace. Those goals for the economy are our hopes, but we hold back our faith in those hopes because we know that government is a notoriously inefficient spender, and we suspect that corrupt practices and special interests will divert the investment funds into foolish and pointless directions. Experience tells us this is true, so we would be foolish to place our faith in the latest economic theory, or our wise leadership in Washington, or the captains of industry. After all, it was pie in the sky economists, dogmatic politicians and greedy, irresponsible businessmen who put us into the situation we are in. We cannot seriously trust these guys to fix this mess, can we?
Placing our trust in mankind can only lead to disappointment; the Marxists already tried that. While I personally did not spend the wealth that was created for me in the housing bubble, that wealth is now gone, and I have nothing to show for it although I am also not in debt. I did hope we would eventually see a Dow 30,000, and placed my hopes and retirement funds in the stock market, and now much of that money is gone. I guess I can only conclude that I cannot place my hope in my own wisdom. Nevertheless, we live in a deterministic society that believes in the laws of science and nature. Perhaps it is time we stopped gaming the fundamentals of economics to project the disappearance of the business cycle and deal with what the fundamentals of the economy really are. If the wealth I theoretically had when my house was worth the most at the peak of the housing bubble was not real, then what is the worth of a dollar today? The worth of a dollar is the fundamental element that can explain how we can spend our way out of the current economic depression/recession, and the key to how we are going to pay for it.
Since 1973 the value of a dollar has been tied to our nation’s Gross National Product, or GNP. Before that, we were on the gold standard which meant that dollars were tied to the value of gold, or actually had something solid behind them. I was 12 when we went off the gold standard, so I really do not remember being on it, but I don’t see how that was really a big change. The value of gold was tied to how many goods and services could be purchased with it, so it strikes me that the dollar was still worth a percentage of our economic output or GNP. A dollar’s worth today can be described as the fraction 1 over the total number of dollars in the system, and the number of dollars in the system is equal to the value of the goods and services that our economy produces. To simplify this further, if there are 100 dollars in circulation and you have one of them, then you can buy 1% of our GNP with it. The worth of a dollar is determined by the number of dollars in circulation, and the value of the goods and services produced by our economy.
So what has happened to those two variables in the last year? First of all, the collapse of the housing and stock bubbles greatly reduced the number of dollars that were in circulation. Some of that money, like the value of my house and the retirement funds that I did not borrow against, was in unrealized gains, and so was not an actual part of the active money supply, or M1. Much of it, however, was borrowed against and so was in the active money supply. The disappearance of all of that money, in theory, should make the remaining dollars more valuable. In the previous example a dollar was worth 1/100 of the GNP, well if we are now down to 95 dollars in the economy, my dollar should buy more since it is now worth 1/95 of GNP. It is this contraction in the money supply that has made it difficult for banks to lend. The dollars that they had have disappeared!
Another problem that we face in determining the worth of a dollar is that GNP has also been falling. To use the 100 dollar economy as an example, if the money supply fell by 5 dollars, but GNP also fell by 5% then the dollar would still buy the same amount of goods and services. There would neither be inflation nor deflation, just a lot of miserable people who have largely been kicked out of the economy since they have neither a job, nor any assets that they can spend.
So, what is a dollar worth today as compared to last year? The unsettling thing is that we really do not know. We know that the economy is contracting, and we know that the money supply has contracted, and continues to contract. Beyond that, we can see that there is an insufficiency of money supply to allow “normal” borrowing to take place. This uncertainty is the root cause of the volatility in world markets, and no argument about “moral hazard” is going to bring certainty. Since our economic problems are now rooted in both the GNP and money supply, it follows that we need to increase both.
Politically, our two parties fall into camps that each address one or the other of these problems, although Republicans have recently started to advocate a hands off approach. Republicans want to stimulate the economy through tax cuts, which basically gives free dollars to the beneficiaries since no corresponding reduction in government services is planned. This is the same as “printing” money to increase the money supply.
The Economic Recovery Plan seeks to expand GNP by creating demand in the marketplace. Right now, the only entity with money to spend is our government since the contraction of GNP makes investment by businesses undesirable. By spending money on fixing roads or building buildings we create jobs that would not otherwise be there, and those workers can then spend that money at the coffee shop, grocery store, or Wal-Mart. So, one dollar invested by the government in that sort of spending hopefully produces many more dollars in spending by the private sector, which increases the GNP. In economics, this concept is called “velocity.” Remember velocity because we will get back to it later, but understand that the velocity of money spent in the economy is likely to be greater than that of money saved in a tax cut. Beyond that, you have to have a job to get a tax cut.
Let us assume for a moment that the government, using either or both approaches, essentially prints the money to pay for this stimulus, since I have no idea who has the money to lend it to us. If every dollar we “print” creates two or three dollars in economic stimulus, then we actually raise our GNP numbers by more than we do our money supply, and a dollar actually gains in value! If we take the 100 dollar money supply, and “print” 10 more dollars, the economy would have to grow by 10% to keep the buying power of that dollar constant. If GNP grows by 20% on a 10% growth in money supply, the dollar is worth more! Now, this sounds like “pie in the sky” type economics!
The reason that this type of approach can be used now is two fold: we have a contracted money supply, and we have a contracting economy. If this approach were used in near full employment economic times, the money that the government spent would actually compete with the money the private sector had to spend and we would not see growth in GNP but would see growth in money supply. That would lead to inflation. Money supply increasing while the economy is stagnant or continues contracting will lead to the type of run away inflation that Germany experienced before the rise of Hitler. The key to a noninflationary increase in money supply is expansion of GNP, and that cannot happen if we are truly at full employment. (It can happen in full employment if worker productivity is increasing, but that is another subject.) The keys here are that we are not at full employment, and the money supply has definitely contracted. The difference between the contraction in money supply and the contraction in our economy is the amount of money we can literally print. We are in a window before the economy has contracted too much. We still have an opportunity to spend, but if the economy collapses, that opportunity will be gone. That is why we must act now!
So, we can print noninflationary money now, but will we ever have to pay the piper? Of course we will. Eventually it is hoped that the economy will recover and grow under its own momentum. At that time, the Fed will lose a lot of control over the money supply as stocks recover and housing values potentially begin to recover. At that time the economy will be “printing” its own money through velocity. (I told you we would get back to it.) When velocity increases the government must decrease money supply or new bubbles, like the ones that did us in this time, will occur. Essentially there are three ways that the government can do this:
1) Reduce spending. Fortunately, the new money created in the ERP has time constraints. Both the tax cuts and the projects will expire. While this does not actually take money out of the money supply, it at least stops pumping more money into it. Further cuts will probably be desirable, but I doubt politicians have the courage to make them.
2) Raise Taxes. If I doubt politicians have the courage to cut spending, I know they do not have the courage to raise taxes. Nevertheless, raising taxes to pay off our debts would reduce the money supply and counter the final option.
3) Inflation. This is the cruelest tax of all, and will eventually lead to another economic down turn. If velocity increases while economic output stays constant, money supply increases while GNP stays the same. A dollar will no longer buy as many goods as it did before the money supply increased. The Fed can counteract this by raising interest rates, but in essence that amounts to the same thing as inflation.
In the final analysis, some spending will expire, some taxes will be raised as tax cuts expire, and some inflation will inevitably occur. The mix of those paybacks will largely be determined by the economic policies we follow at that time.
Does this mean that we are placing our hope in politicians that we have not even elected yet? I guess that it does, and that is not a place I want to place my hopes for a fulfilling life. Nor do I want to trust the latest fad to come out of economic academia, and I have already said that I demonstrated a poor ability to perceive economic reality before this crash happened, so I am not a good place to deposit my own hopes. There must be something greater in which we can entrust our hopes. Maybe if we make wealth a means rather than an end we can escape the trap of measuring our lives against the economy. Forget about what a dollar is worth, what are you worth, and to whom? If we begin the search for those answers, maybe we will resist buying houses that we cannot afford and bidding up the prices of stocks. Both Karl Marx and Adam Smith agreed that the economy would function better if there were better people in it; Smith, however, unlike Marx, did not put forth a plan to accomplish that goal, since he already knew that one existed.
In speaking with people about the president’s Economic Recovery Plan, a common question from both supporters and detractors is: “Has the government ever succeeded in something like this?” As a person with degrees in both Economics and History I can state confidently that there have been several times in recent history where something like the current plan has succeeded in reversing our country’s economic fortunes. Perhaps the one example that best illustrates the point is the post World War II example of the Servicemen’s Readjustment Act of 1944, or GI Bill.
As World War II was drawing to a close President Roosevelt and many of our nation’s leaders faced a daunting challenge: what will happen when more than 15 million soldiers, sailors, and airmen get laid off from their jobs at a time when demand for the industrial goods produced by war time industry collapses? The country had faced a similar crisis after World War I, and lack of action had led to the veterans’ “Bonus March” of 1932, and contributed to the depth of the Great Depression. Social upheaval and economic collapse were a very realistic fear!
Harry W Colmery, a former Republican National Committee chairman, was one of the earliest proponents of a government program to mitigate the effects of the war’s end on the economy. Warren Atherton of the American Legion greatly influenced the content of the bill, and Arizona Democratic Senator Ernest W McFarland guided the legislation through Congress. So, the bill had initial support by the minority party, was greatly influenced by a “special interest group,” and was championed by the majority party! The Economic Recovery Plan also enjoyed initial support from Republicans, but largely managed to escape special interest input because the speed in which it was passed, and ended up having to be passed by the Democrats with little support from the minority party.
The main parts of the bill were provisions for college or vocational training, and one year of unemployment benefits for returning service men. So, it invested in our future by creating a more educated and skilled work force while deferring many people’s entry into the work force, and provided immediate help to the unemployed. Subsequent legislation, after the war including the Employment Act of 1946, and various programs aimed at making home ownership a practical goal for most families also had a stimulative economic effect. The Marshall Plan, with its buy American provisions did as much to bolster our economy as it did to rebuild Europe.
While our challenges after World War II were brought on by different circumstances, they were similar to the problems we face today: industry that needs to be retooled, a collapse of world wide demand caused by the inability of consumers to pay, a surge of suddenly unemployed workers, all of which is happening after years of deficit spending by the federal government. The actions that the United States took spurred demand across our economy by directing government spending into programs that created long lasting value for our nation. The Economic Recovery Plan has exactly the same goal.
Our country’s reaction to the economic challenge that it faced after World War II was hugely successful and can largely be credited with creating the middle class that became, and remains, the main economic driver in the U.S. economy. Our country eventually had to stop deficit spending, and bring forth a balanced budget when the economy got to a stable point, but it can be said that government fiscal (spending) policy has a long and mostly successful history as a tool for dealing with economic hardship. President Obama’s Economic Recovery Plan, like the GI Bill, is aimed at solving a problem BEFORE it gets out of hand. History says that it can work, and it is worthy of our enthusiastic support.
