Running faster… in the wrong direction

Steve Saville
email: sas888_hk@yahoo.com
Nov 9, 2010

Below is an excerpt from a commentary originally posted at www.speculative-investor.com on 31st October, 2010.

A Neat Summary

A neat summary of what the US government and central bank have accomplished over the past two years:

"...the government seized Fannie and Freddie, thereby effectively nationalizing a large portion of the entire US housing market; the Fed nationalized AIG; the treasury secretary told everybody that he needed $700 billion pronto to patch up the financial sector or the world would end; the treasury secretary then proceeded to partially nationalize the US financial sector; the federal government took over two of the Big Three car companies and threw traditional creditor rights out the window; the Fed more than doubled the monetary base in six months' time; the new Obama administration borrowed almost $800 billion to spend on "stimulus"; the federal government has taken a giant leap forward to socialized medicine; and just for kicks, the federal government also banned offshore drilling (though the rules are yet again undergoing revision)." - From Robert Murphy's article "Putting Austrian Business-Cycle Theory to the Test"

The above summary leaves out a lot, including the $8000 tax credit and other subsidies designed to encourage greater spending on houses, the "Cash For Clunkers" program designed to encourage greater spending on cars, the push for "Cap and Trade" and other legislation designed to address the imaginary hobgoblin that was originally known as "Global Warning" and is now known as "Climate Change", and the altering of accounting rules that miraculously transformed insolvent, loss-making banks into highly profitable enterprises. It does, however, paint an accurate picture of a raging bull market in government interventionism.

If the problem is that you are running in the wrong direction, the solution isn't to run faster.

Ramping up government spending will make the economy less productive, so it should be no surprise to logical economists that the "Keynesian" response to economic downturns has a very poor record. It should, however, be a big surprise to Keynesian economists, and yet they never seem to be surprised by evidence that their policy prescriptions didn't work as advertised. Instead, they usually claim that the prescriptions would have worked had they been applied more aggressively.

For example, according to Paul Krugman (today's "poster child" for Keynesian economics), the huge fiscal and monetary stimulus of 2008-2010 hasn't led to a meaningful rebound in the US economy because it simply wasn't huge enough. Apparently, the US economy would now be on much stronger footing if the Fed had created, and the government had spent, a lot more money.

The analysis of post-1990 Japan is another example. Japan has attempted one stimulus package after another for almost 20 years, in the process racking up a direct federal government debt that amounts to 200% of GDP. The result of the longest and most concerted modern-day application of Keynesian economics has been a long period of economic stagnation, but rather than acknowledge a problem with the underlying theory the Keynesians tell us that Japanese policy-makers didn't stimulate enough.

A third example worth mentioning involves the interpretation of what happened during the Great Depression of the 1930s. In 1939, after about 8 years of what would now be called a Keynesian response by the federal government to the economic weakness of the time, there were roughly as many unemployed people in the US as there had been at the 1932 depression trough. But rather than acknowledge the failure of a large increase in government spending and intervention to generate sustainable improvement in the economy -- an eminently predictable failure given that greater government spending generally results in the less-efficient use of resources and intervention creates uncertainty -- today's advocates of similar policies claim that the 1937-1939 return of a full-fledged depression was due to the 1936-1937 reduction in government/Fed stimulus. In other words, they claim, in effect, that the depression would never have returned in full force if the government and the central bank had continued to "stimulate" indefinitely.

One of the most remarkable things about economics is that failed theories can remain popular for generations. It seems that if an economic theory meshes with the goals of the politically powerful then it will never be completely discredited until its relentless application helps cause total devastation. [Editor's note: Highlighting is mine]

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Steve Saville
email: sas888_hk@yahoo.com
Hong Kong

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