Politics and Job-Creation Policies – Disagreements and The Theories Behind Them

Blogging time has been in short supply lately.  To compound things, I’ve had a bunch of inter-woven ideas bouncing around in my head that I want to explain, but  I’ve been struggling to figure out how to do it.  I’ve been stuck in the “can’t explain this until I explain that which in turn needs this explained” circle.  Uggh.  So I’m going to just start taking a shot at it and write some posts that all relate one way or other.

What I want to talk about is why there’s so much disagreement among economists about policies, particularly when it comes to macroeconomic policies.

Few people, regardless of political ideology, dispute the idea that the U.S. economy needs to create more jobs.  It’s obvious to nearly all that persistent unemployment rates over 9% and an economy that month after month fails to create enough net new jobs to keep pace with population growth is problem in need of solution. Likewise, few dispute the idea that the solution will rely upon some sort of policy change.  Even the far-right wing, conservative economists and Austrian school economists argue for policy change. Virtually nobody argues that current policies are ideal.  The issue, then, is how to change policy.  In what direction should policy change so that the government can encourage job creation?

Like many things in political economy, there’s a range or spectrum of recommendations.  I personally don’t like the simple “right vs. left-wing” or “conservative vs. liberal progressive”* terminology. I think things are more complex and positions are richer than that.  But, for purposes of exposition here, I’ll go with it today.

If there are n politicians, there are probably at least n+1 different specific proposals of what to do to change policy to encourage job creation.  But today I’m not looking at specific proposals. Today I want to look at patterns, types, or categories of proposals.  I’m interested in the essence of the logic and economic models/ideas behind the proposals, the thinking that leads people to believe they’ll work.

Right now let’s say there are 4 different categories or generalized views, ranging from what might be called extreme right-wing or libertarian views through conservative views through mildly progressive views and finally a more radical or activist progressive view.  Let’s look at each one, the types of policies advocated and some comments on the economic thinking behind them.  I’ll offer my views afterward.

First, let’s take what we can call the far-conservative view or libertarian (economic libertarian, not necessarily social libertarian).  In the U.S. today, this is represented by the Tea Party positions.  The view here is that it’s  government interference with the free market, private property, and private wealth that causes unemployment in the first place.  Therefore, what’s needed, they argue, is for minimal government with minimalist taxes and as little regulation as possible.  They argue that only the private economy creates jobs at all and that the government cannot by it’s nature create any jobs.  Their proposals will typically take the form of calls for tax cuts, government spending cuts, and repeal of regulations. They will oppose any government programs they see as “welfare” or “redistributionist” such as Social Security or Medicare. Their rhetoric will typically include phrases about “unleashing the private sector”.  In terms of economic theory, supporters of this view find support from what we call Austrian-school economists and the more strict Neo-classical macroeconomists (think University of Chicago school).   These schools of macroeconomics in many ways aren’t about macroeconomics at all.  The theories are heavily based on microeconomics, in particular, the models of pure utility-maximizing rational people interacting in unrestricted markets.  Much of this view in macroeconomics has been called rational expectations schoolefficient markets theory and real business cycle theory.

Next is a the conservative view.  Until the last few years, the milder conservative view was what was espoused mostly by Republican candidates such as both Bushes and Reagan.  In more recent years the Republicans (in general) have moved further toward the far-conservative/libertarian view.  The conservative view is likewise grounded in traditional microeconomic-based neoclassical models.  In many ways, the conservative view is very similar in thinking to the far-conservative libertarian.  They both derive their conclusions from a reliance and embrace of pure-utility maximizing rational micro models of markets.  Both will tend to advocate tax cuts, especially for high-income earners and for corporations. The idea is that high-income earners and corporations would normally create enough new jobs but that taxes discourage them from creating jobs by making business and investment look unprofitable.  The assumption is that if you eliminate or reduce the taxes, investment will naturally look profitable and attractive.  Private sector investment spending will then drive growth in the economy.  This view has also been called supply-side economics. The conservative view typically relies upon rational expectations, efficient markets, and real business cycle theory also, but it also takes a lot from the monetarist views of Milton Friedman and his disciples.

The major point of disagreement between regular conservatives and the far-conservative/libertarian views is really in the area of monetary policy.  Far-conservatives or libertarians dislike central banks (seen as government agencies) and often call for a return to some form of commodity-based money such as gold.  The regular conservative view instead believes that an independent central bank, like the U.S. Federal Reserve Bank, if it follows anti-inflation policies, can usually manage monetary policy and interest rates to encourage growth when needed.  In effect, far-conservative/libertarians believe that no type of government or central bank actions can achieve high employment and high growth by policies.  In effect, recessions are simply events we have to live through -they can only be made worse, not better by government policy.  Regular conservative-types favor using monetary policy, in particular interest rates, to manage the economy. And, if monetary policy is ineffective, then they advocate using tax cuts to stimulate the economy.  They have a strong bias against government spending, or at least spending that is used to stimulate the economy (spending for military and wars is usually OK though).

Next we move to views that owe a greater heritage to John Maynard Keynes, though Keynes is far from the only theorist contributing to the views.  We’ll call the next group of policy recommendations Keynesian.  Not surprisingly, this view owes a lot to Keynes.  But Keynesian theory and models have evolved a lot since Keynes’ time.  Some historians of economic thought have argued that, were he alive today, Keynes might not agree with what much of what today’s “Keynesians” argue.  Nonetheless, standard Keynesian models/theories differ from classical/neo-classical/supply-side theories (the ones that conservatives like) in that it focuses on aggregates in the economy like total demand and total spending.  Keynesian models also try to explain why in aggregate, the total economy doesn’t always behave as if it were a simply made of purely rational micro-markets.  Keynesian theory allows for more situations where markets don’t behave rationally all of the time.  Even more significantly, Keynesian theory observes that if we simply assume the economy is the sum of whatever happens in a bunch of micro-markets, we can commit the fallacy of composition.  Keynesian theory points out the cases where the paradox of thrift takes over or when monetary policy is not likely to be effective.

Despite the allegations of many critics, standard Keynesian theory allows for monetary policy to be effective.  But typically standard Keynesian theory says that when the crisis is big or when interest rates are very, very low, then only fiscal policy, increased deficits, will do the job.  Those deficits could be created by either tax cuts or increases in government spending. But, they won’t be equally effective in creating jobs. Basically what’s needed is more spending (demand for goods) in the economy. People need to be motivated to spend more money.  Tax cuts provide money for households and firms to spend, but they do so weakly.  First, people might not spend all the tax cut – they might save some.  Increased savings won’t increase total demand and therefore won’t create the need for new jobs. Further, firms will only spend if they expect future increases in demand.  They won’t spend and invest just because they have more cash in their hands.  Since we have no assurance that a tax cut will result in enough new spending in the economy, Keynesians are more likely to argue for increased government spending because government spending directly creates demand for goods and services.  Contrary to critics’ claims, Keynesian policies are not based upon any ideological desire for socialism or government control.

So what do Keynesian policy proposals for creating more jobs look like?  Increased government spending is the answer.  In particular, while any spending will help, the most desirable forms of spending are public goods, things like infrastructure and schools, and also on social safety nets, things like unemployment compensation, social security, and Medicare. If a proposal calls for more infrastructure spending or extensions/increases in unemployment compensation, it is clearly inspired by theories/models with Keynesian roots.

Finally, there’s proposals that are inspired by the most progressive branches of modern macroeconomics.  Let’s call these proposals the Progressive proposals. Proposals in this area would involve would build upon the ideas of Keynesian group, but go further.  The spending would be greater and on a larger scale. Proposals in this area would call for programs where the government doesn’t just fund projects and buy goods, it actually creates programs that directly hire the unemployed.  Typically such programs are proposed to be temporary or designed in a way to only hire when the private sector won’t (see Bill Mitchell & Randy Wray’s Jobs Guarantee proposals).  These are not socialist or communist proposals.  That’s a whole different thing.  Often Progressive jobs-creation proposals include having the government initiate and fund large-scale infrastructure projects during periods of high unemployment.   This group, which has little popular voice among modern U.S. politicians, is inspired by what’s called Post-Keynesian and Modern Monetary Theories.   In many ways, the original Keynesian proposals for dealing with unemployment are closer to this group than to what we call Keynesian today.  Today’s Keynesians are actually pretty conservative when compared to historical policies.

So there we have it.  Four schools of thought and proposals for how to create jobs in the economy.

Despite the labels attached and misused by politicians, the reality is that the political discussion and policy recommendations of today, the ones with supporters in Congress or the White House, are actually quite conservative.  Franklin Roosevelt and the New Deal in the 1930’s was actually rather Progressive.  In the 1950’s, 60’s, and 70’s, the dominant thinking in Washington was Keynesian.  In fact  a”centrist” politically in that era would have still been somewhat Keynesian on our scale above.  In the 1980’s though today, the “center” of mainstream politics has increasingly moved towards conservative thinking.  Today, for example, President Obama is actually pretty conservative.  He is certainly more conservative than the Republican Richard Nixon was in the 1970’s.

Let’s look at the latest proposal from the Obama administration for stimulating the economy to create jobs. It’s actually quite conservative and it’s not very Keynesian at all.  In fact, of the proposed $447 billion effort, less than 1/4 involves more spending for infrastructure or unemployment benefits.  That’s less than 1/4 of the proposal is basic Keynesian.  Instead, it’s overwhelmingly focused on tax cuts and business tax credits/incentives.  These are the policy proposals of a conservative.  Even the original 2009 “stimulus bill” was heavily oriented towards tax cuts and tax incentives.  Despite what critics said, less than half of it was traditional Keynesian stimulus. It’s a sign of how the U.S. political dialogue has shifted towards the conservative/far-conservative end that the Obama proposals have been challenged as “Keynesian” and Obama himself accused of being “socialist”.

* The word “liberal” is particularly problematic. The positions argued by today’s “conservatives” in the U.S. are in fact the positions that were historically identified as “liberal” going back to the 1800’s.  In the 1800’s “liberal” meant anti-government and pro-free market.  Yet, thanks to the power of talk radio and Republican presidential campaigns since the 1980’s, the word liberal has come to be used an epithet to describe opponents of conservatism.  I’ll stick with progressive to label this more left-wing end of the political spectrum to avoid the emotional taint that liberal carries these days.

The Mean and the Median Tell Two Different Stories

Averages, if you’re not careful, can as easily mislead as enlighten.  It matters a lot which statistical measure of the “average-ness” that’s used.  A good example comes in the case of the U.S. long-term trend of economic growth.  What we’re interested in is to what degree the amount of GDP the average household has available has increased over time.  It’s the prime way economists measure whether not living standards are improving.  GDP, of course, is the measure we use to count output in the economy.  GDP is the total market value of all goods and services produced for final demand in a year.   Real GDP is the inflation-adjusted version of it so we can compare GDP from different years.   But of course, just because total GDP, or even real GDP, is going up from year to year is no assurance that living standards are generally increasing.  After all, if real GDP grows by 1% per year but the population grows by 2% per year, there’s less per mouth each year.

So we need to adjust the real GDP measure to account for population growth. We want a measure of average GDP per person or average GDP per household.  Those readers who didn’t fall asleep in statistics class might recall that technically “average” isn’t a statistical measure.  Instead there are several different ways of calculating what statisticians prefer to call “central tendency” instead of “average”.  The two most common calculations in economics are the mean and median.  And there’s a huge difference between them.  The mean is  what you probably learned in primary school as the “average”.  To calculate it we take the total and divide by the number of people in the population.  When economists cite GDP per capita, we are, in fact, calculating the mean Real GDP per person.  The mean, the real GDP per capita for the U.S. over the last 34 years has grown at around a 1.9% annual rate.  That might not sound like much, but remember the power of compounding means that at 1.9%, mean real GDP per person will double in less than 40 years – one working lifetime.  Sounds good, right?  Sounds like the American dream in action, right? Wrong.

Real GDP per capita when looking at the U.S. is highly misleading because most of the growth only goes to the top 1% income folks.  The vast majority of Americans, the other 99% of us, haven’t experienced anything like that growth.  To see the difference let’s consider real income of the median household.  Remember Gross Domestic Income is the same as Gross Domestic Product.  It’s just counted differently by counting income available to spend instead of actual spending.  Long run, they are the same.  Now let’s quick review what the median is. The median is the middle observation. It means that there’s as many observations with a lesser value as there are with a greater value.  In this context it means that there are exactly as many households with a smaller income as there are households with a larger income.  It’s another way of looking at the average.  In this case we’re looking for the most typical household.  Statistics note:  mean will equal median if both sides of the distribution are identical, but in income this isn’t true – millionaires, billionaires, and rich households are a lot richer than the $49,700 median income but the poorest households can only $49,700 poorer at most.

In the U.S. over the last 34 years, the median household income has only grown at less than 0.5% per year despite increases in education.  So real GDP per person grows at 1.9% per year, but real median income only grows less than 0.5% per year.  At 0.5%, it will take 150 years for income to double.  End of the American dream of doing a lot better than your parents. What accounts for the difference?  It’s the upper 1% of the income distribution, the rich folks, millionaires and billionaires, that have skimmed off the 65% of all of the GDP gains for 34 years.

Princeton economics professor Uwe Reinhardt explains in the NYTimes Economix blog:

So if an American macroeconomist — a specialist who tends to think of nations as people — or high-level government officials or politicians mimicking a macroeconomist boasted on a television talk show that “average family income grew by 3 percent during 2002-7, more than in most European economies,” about 99 percent of American viewers, reflecting on their own experience, would probably scratch their heads and wonder, “What is this guy talking about?”

The third chart, below, exhibits the growth path of real G.D.P. per capita in the United States over the period 1975-2009 and the corresponding path of real median household income. The data show that over the 34-year period, real G.D.P. per capita rose by an annual compound rate of 1.9 percent. Those data come from the Economic Report of the President to the Congress (Tables B-2 and B-34).

Sources: Economic Report of the President to Congress (G.D.P.); Census Bureau (income)

According to the Census Bureau data (see Table H-6), however, median household income in the United States rose by less than 0.5 percent a year. Other than national pride in league tables, that 1.9 percent average economic growth does not mean much for the experience of the median household in the United States.

Income Distribution Does Matter. It’s Wrong Now and Stopping Growth.

When people think about “income distribution” there’s a tendency to think of it only in terms of what different people or households have available to spend.  In other words, we focus on the fairness or equity of whether some households should only have a small amount of money to live off of vs. others who get a large amount of money to live off of.  The debates then often deteriorate into whether or not the households put forth effort (“worked”) for their income and therefore “earned” it.

But there’s more to the issue of income distribution.  A household’s income is not just determined by how much “effort” it’s willing to make or how much “investment” it’s made in the past.  So a household’s income isn’t just how much you work and what education/qualifications you have.  The general level of wages matters too.  And that’s determined at the macro level by institutional arrangements in society.

The nature of production is that it requires both capital and labor.  The joint product is then sold.  This is called productivity.  Part of the income distribution question is “how is the value from joint productivity split up between payments to capital and payments to workers”.

In the U.S. during the Golden Era, the period of World War II until the mid-1970’s, the social contract and institutional arrangements were that the benefits of increased productivity were split evenly between both capital and labor.  Both benefitted.  Starting around 1980 that deal was cancelled.  The social contract has increasingly moved to all gains from improved productivity going to capital and none to labor.  As a result, labor’s share of national income has consistently declined.  The Great Recession was a major blow.  It’s this change in the social contract that is the root source of the frustration and pain felt by so many households.

Garth Brazelton at Economics Revival explains why this matters now.  He explains why we are still in a recession, or at least why the 90% or so of us that work for  a living as opposed to living off of interest and profits are still in recession:

Who cares about double-dip. We never left. Why? because you can’t get out of a recession without consumers/labor income growth. While productivity has grown over the last few years, labor’s share of national income continues to plummet. This implies that others (capitalists / profit-makers) are ‘out of their recession’ but consumers and laborers are not.

The BLS has a nice publication here.

Ordinarily a low cyclical labor share isn’t necessarily a problem because firms can use profits to invest in new business ventures a eventually lower the unemployment rate and provide more compensation in a recovery. The problem here of course is that firms are too busy paying off past debts from poor decisions made a decade ago, or two skittish to do anything substantial with their profits at the moment. So that, in combination with the low labor share of income is like a double-whammy for consumers and laborers who see the haves continue to have and the have-nots continuing to have nothing.

It’s the Political Economy That Must Change.

Peter Dorman at Econospeak has an excellent post on the real challenges facing the U.S. today.  It’s the political economy that must change.  It no longer serves the interests of the vast majority of Americans. We need more discussion and action at these levels>

It’s the Political Economy, Stupid!, by Peter Dorman: Sometimes living in the world of ideas makes it harder to understand the real one. If you happen to be an economist, and the time is now, that is true in spades. Take Paul Krugman, for instance. After bemoaning the terrible policy choices of the last two years, he writes, “I’m still trying to make sense of this global intellectual failure.” It’s as if the core problem is that political leaders didn’t learn their macroeconomics well enough.

But Keynes was wrong about the power of “academic scribblers”. Idea-smiths provide language, narratives and tools for those in control, but the broad contours of policy depend on who the controllers happen to be. We are not living through an epoch of intellectual failure, but one in which there is no available mechanism to oust a political-economic elite whose interests have become incompatible with ours.

This is not some sudden development, much less a coup d’etat as is sometimes claimed. No, the accretion of power by the rentiers has been systematic, structural and the outcome of a decades-long process. It is deeply rooted in modern capitalist economies due to the transformation of corporations into tradable, recombinant portfolios of assets, increasing concentration of and returns to ownership, and the failure of regulation to keep pace with technology and transnational scale. Those who sit at the pinnacle of wealth for the most part no longer think about production, nor do they worry very much about who the ultimate consumers will be; they take financial positions and demand policies that will see to it that these positions are profitable.

The rapid and robust global restoration of profits post-2008 was not an accident. Public funds were used to bail out exposed creditors and shore up asset values, while the crisis was used to suppress wages and postpone meaningful regulatory reform. Indeed, I can predict with some confidence that many of the profits, particularly in the financial sector, that have been reported in official filings and blessed by the accounting firms will later be found to be illusory—but not before those who have claims on the revenues have cashed in to their own personal advantage. The institutions will be decimated, but those who owned, lent to or bet on them will be rich. This is not a failure, at least not for them.

You could make a case that, collectively, the interests of the financially endowed ultimately require a rescue of the real, nonfinancial global economy. Surely, when we take our painful plunge into the second dip of the Great Recession, their wealth will be at risk. But the ability to see it at a system level presupposes either a system-level organization of the class or the existence of individual interests that are transparently systemic. Neither appears to be the case today. From what we (you and me) can see from our vantage point, the ruling demands are to make sure my bonds are serviced, my counterparties pony up, the markets I invest in stay liquid, and expenditures for public welfare (i.e. the losers and chiselers) are slashed.

The first principle of political economy is that the scope of democracy depends on the range of views and interests (typically tightly linked) of the owning and controlling class. Genuine public debate and decision-making extends only to those issues on which the elites are divided. In what country today is there a significant division among political-economic elites over core economic questions? How would our situation be different if Obama, Cameron, Merkel, Sarkozy et al. had been on the losing side of their elections?

So, the current mess is not the result of a failure by intellectuals—although clearer, less ideologically-driven thinking by economists would certainly be a good thing and might make a small dent at the margin. As long as there are even a few economists who proclaim the virtues of austerity and deregulation, however, their views will dominate. They haven’t won a battle of ideas; they are simply the ones who have been handed the microphone.

The real problem is political, and it is profound. Unless we can unseat the class that sees the world only through its portfolios, they may well take us all the way down. Unfortunately, no one seems to have a clue how such a revolution can be engineered in a modern, complex, transnational economy.

There were also some excellent comments in the discussion:

PQuincy said…

I’m a historian, and I think the past confirms your assessment of elite behavior and priorities, not only in the last 2 centuries of mass-based polities, but since the rise of large-scale states altogether. Political contention is almost always limited to a narrow range of issues on which those with power disagree, meaning that significant change (and there has been significant change in the political sphere, as well as the economic one) generally results from elite conflicts, not from ‘popular’ pressure. In fairness, elite contention does open gaps for genuinely ‘progressive’ change, and that’s an important lever for intellectuals to remember…but as you say, academics, thinkers, et al. are as a rule never in a position to have more than a marginal effect.

It’s not a promising situation now, structurally: a series of positive feedback loops in the political sphere are actually concentrating the influence of what I am forced to call a “reactionary clique”, at a time when the policies pursued by that clique are, at least on a larger time-frame, seriously destabilizing. But the narcotic effects of power are such that those who drive the dynamics of elite conflict rarely see the larger picture — behave, for all practical purposes. as though they were incapable of seeing the larger picture (call it, if you like, discursive hegemony), and those who believe they see a larger picture are structurally excluded from bringing about changes in response to their perception.

And…

Re-Considering …. said…

Thanks for the very well thought out reasoning in you post.

While you correctly identify the problem and its solution (current “ruling class” and its unseating), you are shy in suggesting how a solution might come about. While I do not advocate violence, history has shown us that fundamentally there are two ways by which subjugated classes improve their position. A traumatic way and less traumatic one.

Revolutions (most egregious examples are the French, Bolshevik, Chinese, and Cuban revolutions), whereby the ruling class, along with its interests, are eliminated by the subjugated classes. A traumatic event indeed, but, in my opinion, not sustainable in the long run unless the entire world adopts those political and economic paradigms.

Less traumatic and, more sustainable in the long term, are the outcomes of strong labor and student movements like the ones that took place in Europe in the 60s and 70s. Those movements made sure to convey to the ruling classes the message that a more equitable wealth distribution and effective social safety net were needed to avoid the extremes and dispossession that a revolution would involve. Reluctantly, the ruling class complied and the social safety nets and income distributions typical of Western Europe emerged.

In the same light, one must interpret the recent unrests in Western European countries (UK, Greece, France) (and most recently in Israel) as a response to the austerity measures taken by conservative governments of these countries to protect rentiers and capitalists. The austerity movement is trying to undo at least some (ideally, all) of the achievements of the 60s and 70s and redistribute wealth away from the “ruled classes”, when it is clearly the “ruling class” that should bear most of the cost of its disastrous, reckless, and self-serving policies. While the current message in Western Europe is still not of the same intensity of the 60s and 70s due to a current better wealth distribution than that of the 60s, the message is similar in content and direction. Its intensity may increase if the rentiers and capitalists will insist with their policies.

So, why the US labor and student movements do not materialize or are active to the same extent of the ones in Europe? The answer is very simple… while in Europe the “ruled classes” realized a long time ago that there will never be cooperation between them and the “ruling class”, in the US people still believe and pursue the American dream, which is fueled by the once in a while admission of few “mortals” on Mount Olympus. Let’s also not forget that constant sense of guilt passed on by the Pilgrims that, somewhat, it is exclusively the individual’s fault if his/her life is not better… and, maybe, the Pilgrims they were right given that US citizens keep electing the same (type of) people over and over to lead them. After all, wouldn’t you rather have a beer with a nice guy from Texas or Hawaii than protesting in some square?

And…

TheTrucker said…

I stand fittingly chastised for my indictment of the economists.

The Tea Party may well have hit upon a method to overcome the current problems. A constitutional convention to propose particular modifications to federal government structure might seem to be the way out. But that is a holdover from the time when people rode a horse to the nation’s capital in order to be seated in the discussion chamber. The problem is best resolved buy an incorruptible on line polling system of direct democracy in which various policies are proposed and tested for consensus. I do not trust the pollsters and I do not feel that they ask the right questions. At present we have the “super committee” approach which goes in the wrong direction totally. This election of Dems or Pugs who then decide what is the best way to maintain their own power has got to go.

I know that the public is easy to fool. The Republicans prove it every day. Yet there is no acceptable substitute for self governance. When we look at the polls we find that taxing the rich is the majority opinion and that social welfare is a high priority. Yet there is no way to act upon this consensus because the rich own the government. That must change, and it cannot change from the top. Surely there must be a peaceful means of revolution.

If a policy and polling system can be created that is impervious to tampering and corruption then it is entirely possible to supplant the current system or to dramatically improve the current system’s performance. I see no other way.

Learning From the Past – Or Maybe Not.

It looks like we are going to repeat the past.  In this case, it’s 1937.  In 1937 the general discussion in U.S. politics had turned to concerns about debt and deficits.  The conservative view that opposed  both the New Deal and efforts to alleviate the Great Depression began to get the upper hand.  Keep in mind that the economy had not fully recovered from the Great Depression and Great Crash of 1929.  But the economy had been growing some in 1933-36 due largely to the New Deal and government deficit spending.  The spending effort was too weak though and the economy struggled to grow.  By 1937 it still hadn’t recovered to pre-crash levels.  But politicians began to claim that deficits were bad and that all that was needed was “belt-tightening” by government.  The result was disastrous.  The economy plunged downward again and only began to resume a growth path once Europe went to war and started placing orders for food, equipment and materiel.

Sound familiar?  We had a great crash three years ago.  We stopped the downward spiral in 2009 due largely to a federal government stimulus program.  But the program was too small relative to the size of the recession. Worse  yet, the stimulus was 40% made up of tax cuts which in a financial crisis are no help.  Even worse, the federal increase in spending barely offset the decline in state and local government spending.  Result: we stopped the crash. We ended the decline. But there hasn’t been enough true stimulus to really recover.  Now in 2011 the stimulus spending is being withdrawn and government spending is declining.  Government employment is dropping significantly every month, putting a severe drag on aggregate demand.

Even the central bank appears to have lost the history lessons.  Reuters ran a story recently called “That 1937 Feeling All Over Again” (bold emphasis mine):

(Reuters) – Federal Reserve Chairman Ben Bernanke, an expert on the Great Depression, once promised that the central bank would never repeat its 1937 mistake of rushing to tighten monetary policy too soon and prolonging an economic slump.

He has been true to his word, keeping interest rates near zero since late 2008 and more than tripling the size of the Fed’s balance sheet to $2.85 trillion. But cutbacks in government spending may end up having a similarly chilling effect on the economy, and there is little Bernanke can do to counter that.

Back in 1937, the U.S. economy had been growing rapidly for three years, thanks in large part to government programs aimed at ending the deep recession that began in 1929.

Then the central bank clamped down hard on lending, and federal government spending dropped 10 percent. The economy contracted again in 1938. The jobless rate soared.

“Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again,” Bernanke said back in 2002 at a conference honoring legendary economist Milton Friedman’s 90th birthday.

Bernanke convenes the Fed’s next policy-setting meeting on Tuesday, facing growing concern that the United States may be slipping into another recession while Europe staggers toward a deeper debt crisis. Standard & Poor’s decision on Friday to lower the U.S. credit rating adds yet another element of uncertainty.

His options are limited.

Nigel Gault, chief U.S. economist at IHS Global Insight, said the Fed could promise to keep interest rates near zero or its balance sheet swollen for even longer than investors anticipate. Or it could buy even more U.S. government debt.

“It is hard to see any of these options as ‘game changers,'” Gault said. “The Fed would be doing them not because it could be sure they would make a huge difference, but because it would feel the need to do something.”

Gault put the odds of another recession at 40 percent.

“Having said that, there are still plenty of headwinds, like Europe. I am also very encouraged to see the upward revisions to the previous months. This report pulls us back from the ledge a little bit.”

HITTING A POTHOLE

Full employment is one of the Fed’s prescribed goals, and it is clearly falling short. Government spending cuts are making matters worse. Friday’s employment report showed a net loss of 37,000 government jobs last month.

State and local governments with balanced budget rules had little choice but to cut jobs in order to make ends meet. The federal government has no such restriction, but its spending outside of defense fell at a 7.3 percent annual rate in the second quarter, crimping economic growth.

Michael Feroli, an economist with JPMorgan in New York, said he had held out some hope that Congress would approve some form of additional fiscal support in the coming months, but the debt ceiling fight showed lawmakers dead set against that.

“It now looks likely that growth could hit a pothole early next year,” Feroli said.

 

And as we all witnessed with the debt-ceiling debate fiasco, both parties in Washington D.C are battling to see who can be seen as the budget cutter.  It’s 1937 all over. Let’s

Fracking Can Contaminate Drinking Water

We should have learned from decades of lying by tobacco companies, but we don’t.  Oil and gas companies have been lying about the “safety” of hydraulic fracturing, “fracking”, of oil and gas wells.  From the The New York Times:

“There have been over a million wells hydraulically fractured in the history of the industry, and there is not one, not one, reported case of a freshwater aquifer having ever been contaminated from hydraulic fracturing. Not one,” Rex W. Tillerson, the chief executive of ExxonMobil, said last year at a Congressional hearing on drilling.

It is a refrain that not only drilling proponents, but also state and federal lawmakers, even past and present Environmental Protection Agency directors, have repeated often.

But there is in fact a documented case, and the E.P.A. report that discussed it suggests there may be more. Researchers, however, were unable to investigate many suspected cases because their details were sealed from the public when energy companies settled lawsuits with landowners.

Current and former E.P.A. officials say this practice continues to prevent them from fully assessing the risks of certain types of gas drilling.

“I still don’t understand why industry should be allowed to hide problems when public safety is at stake,” said Carla Greathouse, the author of the E.P.A. report that documents a case of drinking water contamination from fracking. “If it’s so safe, let the public review all the cases.”

This is another example of how very large corporations, with very deep pockets, can use lawyers, lawsuits, the courts and regulators to their advantage and our disadvantage.

The Market Shrugs Off Rating Downgrade, Market Is Worried About Real Economy.

It’s now Monday morning, Aug 8.  It’s been roughly 60 hours since S&P downgraded the rating on U.S. government bonds.  In that 60 hours the media, particularly TV talking head channels, have been breathlessly awaiting what they felt was a certain market panic on Monday. Clearly interest rates would go up they said.

They were wrong.  The early results are in.   U.S. government bond prices have  gone up this morning!  That means government bond yields (interest rates) have actually gone down!  The 10 year bond actually dropped from 2.6% yield on Friday’s close to 2.48% at 9:30 am ET on Monday.

It’s really no surprise if you pay attention to real economic events and not listen to the TV media types who think talking in serious tones is a substitute for actually understanding economics.  First, serious investors, the ones who vote with their money in the market already know everything that S&P knows.  In fact, they know S&P has a really bad track record. So the rating doesn’t mean much to them.

What does matter is what choices or alternatives they have for investing their money.  Right now, the signs from the real economy in both the U.S. and Europe are grim.  Europe is struggling to achieve any growth outside Germany with several major economies actually declining due to their governments’ embrace of budgetary austerity.  The U.K. is on the ragged edge of another recession, again due to government cutbacks. The U.S. is barely registering postive growth with only 0.8% growth rate in the first half of 2011.  It’s clear, too, from the debt ceiling debate that the U.S. won’t be seeing much stimulus anytime soon and likely will join the Europeans in austerity budget cutting. Cutting that will only slow the economy further and possibly drive another recession.  So what theses investors know is that economic growth isn’t likely and that’s bad for stocks.  Stock markets aren’t the place to be now.

Further, Europe is continuing it’s slow-motion debt default crisis issues.  In the past week or so the crisis has spread beyond Greece, Ireland, and Portugal. Now it’s Italy and Spain too.  Even AAA-rated France is finding it’s bonds trading at significantly raised interest rates.  Now the debt crises in Europe are real problems because the nations inside the Euro zone don’t have control over their own currency, they don’t have a central bank, and they borrow in some other currency (Euro) rather than one of their own.  This is unlike the U.S.  The problem is the uncertainty the debt crises in Europe are creating.  The global financial and economic system is once again showing great signs of weakness, fragility, and uncertainty – just like 2007 and 2008.

When uncertainty abounds and about the only sure thing is that growth will be weak at best, it’s time to put your money in something safe and wait it out.  The safest thing in the world (in any volume) is still U.S. government bonds.  So what we have is investors moving into U.S. government bonds because they don’t want to be in anything else.  Everything else is too risky.  So we get increased demand for U.S. bonds and that lowers interest rates on those bonds. This is what financial analysts and economists call a “flight to safety”.