This column is a response to remarks posted on yesterday’s column by Bill Woolsey, whose contributions I greatly respect and admire. While he does not suggest that my column is ‘vulgar Keynesianism’ he surely suggests that one of my sources for the column is. I cannot read the mind of the investment analyst concerned. But I certainly can read my own. So what follows is my understanding of the issues that underpin the sluggish economic recovery from the financial crisis of 2008 and that under-score my contempt for the behavior of the Bush and Obama administrations, the Republican and the Democratic-controlled Congresses and the Greenspan and Bernanke-chaired Federal Reserves.
The financial crisis of September 2008 was caused by the poor economic policies pursued by President Bush, three Congresses (two-Republican and one Democratic) and two Federal Reserve Board chairmen (Greenspan and Bernanke) over the period 2001-2008. A mixture of vulgar Keynesian fiscal policies and crude money supply over-expansion flooded the U.S. economy with large fiscal deficits and loose money, while promoting an unsustainable binge in consumer spending, significantly on housing and its ancillary markets. The Peoples’ Republic of China unwisely supported this binge by buying up U.S. Treasury notes and by supplying commodities cheaply to the U.S. market-place. Excess capacity in the Rest of the World protected the U.S. economy from the inflationary consequences of loose money policies.
However, the protection was far from absolute. Inflation surged into the U.S. stock market and into the U.S. housing market, driving prices upwards in focused bubbles. Both bubbles burst, first in the housing market in the third quarter of 2006 and then in the stock market in April 2008. Few analysts noticed or cared, until their portfolios were ripped apart in the aftermath of the justified failure of Lehman Brothers, when CEO parasites, like Lloyd Blankfein of Goldman Sachs, Kenneth Lewis of Bank of America, and Richard Wagoner of G.M., began to creep around the Treasury Secretary, Henry Poulson, bleating for socialism and the termination of laissez-faire capitalism in America.
The policy reactions of Bush and then Obama, and of the Fed and its acolytes truly were a mixture of Lenin-type socialism, Keynesian indulgence and banana-republic politics. In every significant respect these policies were recovery-retarding and unemployment creating.
The problem started in the housing market. Self-evidently, recovery would begin only when the price bubble was completely eradicated, when households unable to maintain their mortgage payments were back in rental accommodations, and when a lower-price equilibrium had restored market balance between the supply and demand. Instead, government policy was driven by an unachievable desire to keep house prices high, avoid foreclosures, and compound the problem. No one apparently had read their history to learn that this was the essence of Herbert Hoover’s reaction to the small downturn in 1929. By 2008-9 I am not even sure that presidents and Fed chairmen could read or write. If they could, surely they did not do so on any policy-relevant dimension.
The agents of the house market bubble, the GSEs and the banks, in many cases were themselves insolvent. The market solution is to allow such failures to move swiftly into bankruptcy, so that new banks and mortgage lenders can emerge unscathed by any overhanging burden of toxic assets. Instead, the government and the Fed expropriated taxpayers’ wealth to shore up the excrescences that created the housing market debacle. So the market does not clear, and the banks do not lend, and private property investment does not play its customary role in leading an economic recovery.
The financial crisis usefully exposed the flawed position of union-dominated big business in the United states, most notably, but far from exclusively, in the automobile industry. Those struggling corporations should have been left to live or die by their own efforts. Instead, the Bush and the Obama administrations rushed to aid the losers, nationalizing two of the three leading U.S. automobile producers, and thus crippling entrepreneurship in that sector for generations to come. The signal to the market-place of America was as clear as it was disastrous. If you mutiliate yourselves sufficiently, then we will throw charitable dollars into your begging bowls. The ancient Chinese mutilation begging- model is now center-stage throughout the U.S. economy.
Oh, yes! and those non-performing banks! Their stress-tests were rigged to show them all as sturdy, when they surely were and are not. In such circumstances, they dare not take risks by pursuing their traditional function of supplying entrepreneurial capital to small business. Instead, they are allowed to suckle on the Fed’s nipple, borrowing at zero interest rates and purchasing low-paying but safe Treasury notes, their primary activities all focused within the socialist sector of the economy, while they avoid marking to market their toxic mortgage assets. Oh what a commercial disaster that ray of sunlight would be, as it illuminated the true nature of their musty vaults!
Not surprisingly, the U.S. economy stagnates in such an unwelcoming environment. The construction industry is all but dead, because the existing housing and commercial pproperty markets are not allowed to clear. Small firms cannot secure bank loans save on the basis of 100 percent collateralization. So they do not pursue profitable ventures. Large firms build up cash reserves, instead of investing, because they fear the oncoming crisis when the federal government can no longer ignore the size of the national debt. Households wisely save because they know that government subsidies typically go to the well-organized concentrated producer groups, not to dispersed interests. The lame-duck, Democratic-controlled government will not legislate in a disastrous election year, even to clarify the January 2011 tax status of anxious U.S. citizens.
In such circumstances, the Chairman of the Fed decides to go for QE2, to flood the U.S. economy with yet more high-powered money. He does not understand that velocity is down because of the insolvency of the banks, not because of a diminished demand for money. The U.S. economy does not confront a liquidity trap. Bernanke is an unthinking Keynesian, who listens to moribund Keynesians, not a Friedmanite.
Once the supply problem eases, as it surely will once the banks have suckled enough socialist milk, and once velocity is restored, inflationary expectations will return with a vengeance. And the instruments available to a the Fed to bring down those expectations – open-market operations to the limit of its now largely toxic assets, buttressed by bribing the banks to hold onto high-powered money – will jolt the economy into stagflation, while the long and variable lags work their way through the economy.
That is my understanding of the current economic situation. I do not believe that it is Keynesian in nature.