It Will All End Badly

What I like about numbers is that when they are not jockeyed, jerked around, and falsified they tend to tell the truth. Looking down the road the numbers do not work. Allen H Meltzer is viewed by many economist as America’s foremost expert in monetary policy, Meltzer is the author of the three-volume “A History of the Federal Reserve.” For over 25 years he was the chair of the Shadow Open Market Committee, a group that meets regularly to discuss the policy of the Federal Reserve. At 85 his mind is clear, but his mood cloudy. “We’re in the biggest mess we’ve been in since the 1930s,” he recently stated. “We’ve never had a more problematic future.”

People have been forced into riskier assets because of low interest rates.When interest rates rise, as they will have to do at some point, the value of these risky investments will decline, and these investors will be hurt. Making things worse is the fact that interest payments on the public debt will rise increasing the budget deficit which has grown by well over a trillion dollars a year for the past four years. It is clear that prices in some sectors of the economy  have been rising rapidly and major distortions exist within the market place. When the large "to big to fail" banks like Goldman and bank of America report they made profits in the market on roughly 95% of trading days in 2012 we have to raise an eyebrow. This is an indication that the game is manipulated as no trader is that good.

Peter Schiff says, printing money is to the economy what taking drugs is to a drug addict. In the short term it makes the economy feel good, but in the long run it is much worse off. What was once the "long run" or "distant future" may be getting very near. Soon the dollar and the American economy will be nearly dead. I recently reviewed a book I read years ago, in his book "A Time For Action" written in 1980 William Simon, a former Secretary of the Treasury tells how he was "frightened and angry".  In short he was sounding the trumpet about how he saw the country was heading down the wrong path. Looking back, it is hard to imagine how we have made it this long without addressing the concerns that Simon wrote about so many years ago. Back then it was about billions of dollars of debt, today it is about trillions of dollars.

It appears Meltzer has not been a fan of recent economic policy for some time, in a Wall Street Journal opinion piece on June 30, 2010 titled "Why Obamanomics Has Failed" Meltzer wrote about how uncertainty about future taxes and regulations was the biggest enemy facing future economic growth. He goes on to say that the administration's stimulus program has failed. Growth is slow and unemployment remains high. The president, his friends and advisers talk endlessly about the circumstances they inherited as a way of avoiding responsibility. Two overarching reasons explain the failure of Obamanomics. First, administration economists and their outside supporters neglected the longer-term costs and consequences of their actions. Second, the administration and Congress have through their deeds and words heightened uncertainty about the economic future.

Meltzer goes on to say that most of the earlier spending was a very short-term response to long-term problems. Part of the money financed temporary tax cuts, this was a mistake because it ignores the role of expectations in the economy. Economic theory predicts that temporary tax cuts have little effect on spending. Unless tax cuts are expected to last, consumers save the proceeds and pay down debt. Another large part of the stimulus went to relieve state and local governments of their budget deficits. Transferring a deficit from the state to the federal government changes very little. Some teachers and police got an additional year of employment, but their gain is temporary. Any benefits to them must be balanced against the negative effect of the increased public debt and the temporary nature of the transfer.

The Obama economic team have ignored history. Meltzer says the two most successful fiscal stimulus programs since World War II took place under Kennedy-Johnson and Reagan, both took the form of permanent reductions in corporate and marginal tax rates. Economist Arthur Okun, who had a major role in developing the Kennedy-Johnson program, later analyzed the effect of individual items. He concluded that corporate tax reduction was most effective. Another defect of Obamanomics was that part of the increased spending authorized by the 2009 stimulus bill was held back. Remember the often repeated claim that the spending would go for "shovel ready" projects? That didn't happen.

In his January 2010 State of the Union address, President Obama recognized that the United States must increase exports. He was right, but he has done little to help, either by encouraging investment to increase productivity, or by supporting trade agreements, despite his promise to the Koreans that he repeated in Toronto. Export earnings are the only way to service our massive foreign borrowing. This should be a high priority. Isn't anyone in the government thinking about the future?

Mr. Obama has denied the cost burden on business from his health-care program, but business is aware that it is likely to be large. How large? That's part of the uncertainty that employers face if they hire additional labor. The president asks for cap and trade, that's more cost and more uncertainty. Who will be forced to pay? What will it do to costs here compared to foreign producers? We should not expect businesses to invest in new, export-led growth when uncertainty about future costs is so large. Medicaid, is an excellent example, the new Medicaid spending mandated by Obamacare comes at a time when states face large deficits and even larger unfunded liabilities for pensions. All this only adds to uncertainty about taxes and spending.

Meltzer also finds other aspects of the Obama economic program are problematic. The way the auto bailouts ran roughshod over the rule of law with Chrysler bondholders given short shrift in order to benefit the auto workers union was very troubling. By weakening the rule of law, the president opened the way to great mischief and increased investors' and producers' uncertainty. That's not the way to get more investment and employment. Almost daily, Mr. Obama uses his rhetorical skill to castigate businessmen who have the audacity to hope for profitable opportunities. No president since Franklin Roosevelt has taken that route. President Roosevelt slowed recovery in 1938-40 until the war by creating uncertainty about his objectives. It was harmful then, and it's harmful now.

That's what the U.S. needs now according to Meltzer in not major cuts in current spending, but a credible plan showing that authorities will not wait for a fiscal crisis but begin to act prudently and continue until deficits disappear, and the debt is below 60% of GDP. He points out that plans have been put forth, like the one offered by Rep. Paul Ryan (R., Wisc.) but the administration and Congress ignored it. The country does not need more of the same. Successful leaders give the public reason to believe that they have a long-term program to bring a better tomorrow. Let's plan our way out of our explosive deficits and our hesitant and jobless recovery by reducing uncertainty and encouraging growth.

In 1980, Meltzer had the privilege of advising Prime Minister Margaret Thatcher to ignore the demands of 360 British economists who made the outrageous claim that Britain would never (yes, never) recover from her decision to reduce government spending during a severe recession. They wanted more spending. She responded with a speech promising to stay with her tight budget. She kept a sustained focus on long-term problems. Expectations about the economy's future improved, and the recovery soon began. High uncertainty is the enemy of investment and growth.

The point of this post is to make clear that just because we have muddled along putting band-aids on our economy does not mean that we have done anything but postpone the day of reckoning, and in many ways we may of made it far worse. The time the Federal Reserve has bought for the country to come to terms with its many problems has been squandered at a great cost. While many people say the economy is getting better others like me who are involved in business on Main Street all across America say this is not true and that an ugly reality is only being masked by the easy money and deficit spending policies we have today.


Footnote; This post dovetails with many of my recent writings. Other related articles may be found in my blog archive, thanks for reading, your comments are encouraged.