April 27, 2009
Can Layoffs, Bankruptcies and Scared Consumers Bail Out Obama?By Mikiel de Bary
FDR's dictum "The only thing we have to fear is fear itself" may have been the 20th century's most inadequate piece of economic analysis. Did you ever wonder how acting on such a fantastic premise halts a financial collapse? Or exactly how refusing to be concerned about the financial condition of banks causes them to be solvent?
We can safely assume other factors rescue us from recessions and depressions. But what are they? The Obama team tells us the keys are "fiscal stimulus," aggressively easy monetary policy, and more robust regulation. Their argument is rather simple: when we have reacted to past economic downturns with these policies, we have always emerged with higher "real GDP" than before.
On the other hand, some supporters of free markets counter that the best policy for government is: Do nothing! Let the free market work things out! Yet, they can offer little statistical proof of this, given that the last administration that tried a hands-off policy was that of the scorned Warren G. Harding. (But that policy succeeded, too, apparently, since "real GDP" subsequently climbed.)
Why do government anti-recession measures (known as "doing something") meet with a chorus of approval, but few experts have the temerity to advocate benign neglect? Perhaps this is because most of us are not really sure how the free market cures cyclical economic distress.
To my mind, Pepperdine University economics professor George Reisman has recently clarified how recessions -- when free of government interference -- are (1) self-limiting, (2) do not turn into depressions, and (3) end quickly. (I urge everyone to read his article in full.)
His argument requires two assumptions. First, we must grant that businesses seek profits when possible. Second, we must assume that the money supply neither collapses nor soars. (True, we cannot rule out either of these devastating monetary events under a system of fiat money and central banking. But that is another story.) Given these two assumptions, only government interference can prevent certain characteristic features of a cyclical downturn from themselves creating a rebound. They do this by increasing the ability of businesses to make profits. Perhaps best of all, they bring about recovery in a non-inflationary way-something the current kamikaze Federal Reserve policy cannot promise-and without requiring taxpayers to support make-work schemes such as those financed by "stimulus" spending.
The free market mechanisms of recovery include:
Layoffs of workers. Firing unnecessary employees leads to two good results for the economy. The first is rather obvious: it enables many distressed businesses to survive the downturn. By cutting business costs rapidly, it limits losses or preserves profits.
The second good result of layoffs is that they dampen aggregate consumer spending. (This, of course, is contrary to the Keynesian doctrine followed continuously by our government beginning with the Hoover Administration.) A reduction in consumer spending, whether caused by unemployment or by rational caution, means an increase in savings in the system, i.e., an increase in the funds available for investment in productive enterprise. Crucially, this increase is real, being accomplished entirely without monetary inflation. It is an increase without an expansion of money and credit by the central bank that would then bring about either a bogus "recovery" in the form of a new asset price bubble, or no recovery at all but merely a depreciating currency.
Even if the reduction in total wage payments does not translate immediately into new investment (that is, if it is neutralized by "fear itself"), layoffs would still lead to an increase in profit margins and return on capital, thus spurring recovery in the economy. The reduction in total wage payments could do this since it would not reduce aggregate profits for the simple reason that any resulting reduction in aggregate business sales to workers would be matched by reduced costs in aggregate employee compensation, leaving net profits unchanged. But with total business sales and costs lower, profit margins would be higher -- i.e., more alluring to potential investors.
Parenthetically, it is true that reductions in wage rates during the downturn would likely lead to the employment of more workers than before. So they might easily fail to lower total wage payments and consumer spending. (Neither Hoover nor FDR realized this and, instead, campaigned against wage cuts, leading to unnecessary unemployment.) But since this would preserve sales commensurately with costs, it would neither harm a recovery in spending aggregates nor hurt aggregate business profits.
Business bankruptcies. Business failures, since they lead to "fire sales" of assets, also lead to improving profit margins for surviving businesses and in this way contribute to recovery. The survivors acquire the assets at bargain prices. In the aggregate, this reduces the amount of capital invested, meaning that returns on capital would improve since any future earnings would be compared to a smaller capital base. Also, future depreciation charges would be lower, increasing profits. Even troubled businesses that manage to avoid bankruptcy but suffer significant "write-downs" would likewise benefit from lower ongoing depreciation charges.
Consumer Hoarding. Eventually, even the Keynesian nightmare -- namely, everyone, both workers and "the rich," refusing to spend -- must lead to an increase in the rate of profit, thereby spurring recovery. Hoarding contributes to widespread price declines that, in turn, have two positive effects. For workers they soften the blow of reduced wage payments, and they help businesses to reduce costs. Only the initial effect of hoarding is a reduction of business sales and profits. The subsequent effect is reduced costs that result in increases in the rate of profit and, therefore, in both the ability and the willingness of businesses to raise capital for expansion.
It is important to realize that a bugbear of both the Bush and the Obama economic teams (see Ben Bernanke's obsessive discussion in 2002), namely "deflation," is one of the most crucial elements of any economic recovery from cyclical recession or depression. By "deflation" they mean widespread falling prices and wage rates. As George Reisman points out, a downturn's widespread price and cost declines enable the return to production and sale of normal quantities of goods. Without prices and costs declining to realistic, post-bubble levels, resumption of normal levels of physical production cannot begin. Thus, in addition to the salutary free market mechanisms discussed -- layoffs, bankruptcies, write-downs, and hoarding -- a requirement of recovery is the general fall in prices and costs and that accompanies them.
The Obama Administration economic policy continues the Bush Administration's. Its tacit foundation, as it were, is the rejection of any impulse to fault government management of our money and banking system. To the contrary, the Obama team wanders down the path of de facto nationalization of banking and of what might be the final and full politicization of credit markets and money in America. The superstructure of its economic policy is the thwarting of free market adjustments at every turn, and so it operates as the enemy of recovery. Administration policy initiatives explicitly attempt to undercut or delay precisely those mechanisms described above as pro-recovery. An accurate description of the specific aim of any Obama economic measure could be that it must prevent layoffs, bankruptcies or the reluctance to spend. The goals of policy in Obamanomics are to "create or save" unnecessary jobs, preserve failing companies, and boost consumer borrowing and spending.
The current offensive against free market recovery mechanisms promises to be extremely costly to the American people, not just from its widely noted cost to taxpayers but also from its potential to broaden and prolong a paralysis of the economy. Will future historians compare the clumsy Bush-Obama subversions of economic recovery to those of their Great Depression predecessors?
Mikiel de Bary works in the financial services industry and is a freelance observer of macroeconomics in contemporary society.