Posts Tagged ‘Deflation’

The absolute craziest convention on Wall Street, at the Federal Reserve, and among academic economists is simply to ignore economic history before the Great Depression. It’s particularly wacky to do so as the Federal Reserve, which was billed as a means of avoiding economic dislocation after the Panic of 1907, was established in 1913. In other words, the Great Depression happened on the Fed’s watch.

What’s happening now to the economy: the bankruptcy of overly leveraged institutions, falling prices, a general sense of uncertainty, and calls for high levels of government spending and control are hardly unprecedented. We heard such rhetoric throughout the 70s. And this shift took place once before, in Europe, in the late 19th Century in response to the “Long Depression” of the 1870s and the associated anemic recovery.

For Christmas, I received among other books Norman Rich’s The Age of Nationalism and Reform, 1850-1890. This book might seem obscure and irrelevant to all but the most die-hard history buffs. But consider the following passage, and ask yourself if you think anyone at Lehman Brothers or on Bernanke’s staff like has had much familiarity with this episode and whether it might have been useful:

The 1873 crash set off an economic depression which was to continue for another two decades in the form of a slower rate of growth, rising unemployment, and a general feeling of economic insecurity. This depression appears to have been caused primarily by overspeculation and overproduction. There was a decline in the rate of railway building, and a consequent drying up of this immense market for goods and materials. At the same time European agriculture was depressed by the competition of cheap agricultural products from the interior regions of Russia, America, and Australia, to which the railroad had given access.

During the depression years there was an actually an increase in the real wages and a rise in the standard of living of many Europeans as a result of a steady fall in the prices of agricultural and manufactured products. The fall in prices, however, which brought hardship or outright ruin to many economic enterprises, together with the increase in unemployment and the overall sense of economic insecurity, aroused a widespread feeling of dissatisfaction with existing government economic policies and anger at the threat of foreign competition. The liberal doctrine of laissez faire was discredited as industry, agriculture, and labor alike clamored for protective tariffs and state aid. And everywhere in Europe, with the notable exception of England, the state responded to these pressures. The 1873 depression thus inaugurated a new period of state intervention in economic affairs which was to increase steadily to he present day. It also contributed to the growth of an economic nationalism which was to strengthen the burgeoning forces of political and ideological nationalism.

I used to feel somewhat sorry for Obama for the crises he must now manage, a good many of which were not of his making. But then I realized: he likes this situation and this is good for his personal goals, even though obviously quite bad for the country. Crises, real and imagined, allow someone like Obama to aggrandize power, push through the most radical and spendy proposals, and–like FDR–will make a great many people worship him even more without regard to results, so long as he manages his own image carefully. Far from feeling sorry for Obama, I feel sorry for my future children and grandchildren. It’s a scary time, and we have an immature and untested demagogue at the helm, whose historical loyalties are tribal, whose background is in the cesspool of Chicago politics, and whose outlook is replete with various artifacts of 1970s cracker-barrel liberalism.

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The Federal Reserve has just lowered interest rates to, in effect, zero.  Obama promises to spend perhaps $850 billion in a very dubious infrastructure program, as if filling potholes and repairing bridges that were too expensive to repair in good times, can now be gold-plated in times of austerity, and that, by some alchemy, spending money we didn’t absolutely have to spend will lift our collective fortunes, even though those ill fortunes have been planted, as we all know, on far too much private debt.

It is hard to see how hyperinflation won’t rear its head before long.  The wealth-generating economic activity to back our fiat money is not there, and enhancements in productivity are slowing down.  Instantaneously doubling the supply of money won’t make new wealth-creating activity happen.  Nor will the dubious infrastructure projects, which have real very slim theoretical and historical support. Consider, just by way of analogy, how Bush’s spendy combination of two wars, new entitlements, low interest rates, tax cuts, tax rebates, a modest regulatory climate, and the like only succeeded in pouring money down various dead-end bubbles, particularly housing, that could not sustain themselves as soon as the money needed to be collected.

Now, the problem will get even worse, with government (instead of speculators and home-buyers) deciding how to spend the dollars under the Roosevelt-style stimulus that Obama has proposed.  Of course, government can’t easily figure out where that money should be best spent. It will always be lumberously investing in last year’s model, giving us state of the art high definition CRTs, while real entrepreneurs risking their own money, are inventing plasmas.  Consider how goofy scenes of the future look in older movies.  That’s the government’s “investment” strategy:  unimaginitive, trend-following, unmoored by profit, slowed down by bureaucracy, and laden with nonmarket considerations, such as the cronyism that infects all government contracting and hiring.

Even if it does something well, these government investments will be too costly.  Government can’t help but gold-plate.  It may make a few nice parks, arenas, and the like, but this is not the same as real wealth creation.  Real wealth creation involves a profit.  Supplying something to someone he would pay more for if necessary at less than its cost to produce. We can never easily tell if we’re spending 2X, 3X, or 10X the real economic value of the projects as measured by willingness to pay in the arena of government spending.  By way of illustration, I’m always struck by something I once saw in the former Soviet Union.  I was walking down a railroad track and noticed that all of the ties were concrete.  The ties were quite a bit sturider and more robust looking than the treated timber ties in America.  The Soviets were surely proud of these tracks.  But the Soviet Union, lest we forget, was a corrupt basketcase, characterized by an order of magnitude difference in consumer wealth than the United States.  How do we know that everything from houses to cars to Ipods are valuable in the US?  How do we know, when designing something for oneself or others, whether it should last 10, 20, or 1,000 years?  The great information sorting power of market prices.  Markets rely on the profit and loss mechanism to make these decisions.  Of course, we’ll probably get some sharp-looking projects under Obama.  But we’ll spend too much to get it, and the collective impact won’t save jobs.

In an ideal world, government should be treated like the accounting department of a large company:  unglamorous, necessary, and a cost-center that should be stripped of all that is superfluous or costly, in particular majesty, expense, or the prospect of excessive power. As in accounts payable, it’s a task that needs to be done, and it should be done honestly and well, but we shouldn’t forget that it’s the handmaiden for the real society and its real important activities.  Instead, as it’s grown in size, government has become the preferred venue for the absent spirituality of people like Obama, Hillary Clinton, John McCain, and other “dreamers.”  They see in it not as the accounting department or the meter maid, but Change We Can Believe In, Country First, and the Audacity of Hope!!!  A great many fetishists of big government can’t imagine a worthy life in business, the ministry, or even private charity.  Lacking any sense of God or the eternal, they see that government alone can do mighty and seemingly eternal things such as the Hoover Dam or the Atom Bomb.  Of couse, some people make a similar fetishization of things like science, health care, or money.   But unlike government, these spiritual substitutes do not rely on taxes and can’t, if run amuck, destroy an entire civilization within a generation.

It’s no coincidence that the Greeks equated their gods with their city-states, often “establishing new gods” and temples in their honor upon the founding of a new regime.  Without the illumination of Christian truth, civil and political life is the closest analog to philosophical and spiritual life.  But there is another lesson they can teach us:  vanity, worldliness, fascination with splendor, and loose public morality cannot last, and their biggest harbinger is a lack of physical courage (as evidenced in our time by the offensive phrase “jobs American’s won’t do”) and the devaluation of the currency, as evidenced by. . . well . . .  everything.

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