March 18, 2010
No Reason for Economic OptimismBy Earl A. Thompson
Compared to all earlier post-WWII U.S. recessions, the current recession is quite exceptional. It was brewing for a long time.
First, the Asian growth miracles began to exert immense demand pressure on the world's natural resources around the beginning of the millennium, especially once the U.S. had recovered from its earlier recessions of the 2001-2004 period. The prices of U.S. oil imports nearly quadrupled from 2005 to mid-2008.
Absent offsetting monetary or tax policies, the corresponding jumps in operating costs in U.S. manufacturing and service industries were then bound to decrease outputs and employment in these key U.S. industries. Indeed, previous jumps in oil import prices, in 1973-1974 and again in 1978-1979, caused substantial recessions because our Federal Reserve Bank leaders refused to obey their legislative mandate to offset these cost increases with price level-increasing monetary expansions.
But these past downturns were soon mitigated by wisely designed congressional tax cuts, whose fortunately inflationary effects soon allowed ordinary U.S. manufacturers to correspondingly pass on their higher energy costs to their customers, thereby permitting timely recoveries in '74-'77 and again in '81-'85. Bernanke's late-2008-2010 Federal Reserve Board -- after perversely decreasing the relevant money supply in early 2008 to initiate our stock and commodity crash and corresponding financial crisis in mid-2008 -- similarly failed to ever raise the money supply above its long-term trend (ibid.).
But our recent, big-spending Congress refused to substantially cut tax rates despite the fact that earlier, wiser, Congresses had successfully done so under very similar circumstances. Thus, in view of the almost complete absence of curative governmental policy responses, the jump in oil-import prices alone would have sufficed to create a severe 2008-2010 U.S. recession.
But the steady bursting of our real estate bubble since mid-2006 created a second, nearly simultaneous, increasingly recessionary shock that induced drops in demand for goods all over the U.S. economy, very similar to the joint effect of recessions following the burst of the dot-com bubble in 2000-2001 and the post-9/11 collapse of the U.S. tourism and air travel industries. While Greenspan's Federal Reserve Board similarly failed to counter these contractions in aggregate demand with expanded money supplies, congressional tax cuts again moderated the recessionary years from 2001 through 2004.
In sharp contrast, the much more recession-threatened 2008-2010 period yielded neither monetary nor significant tax relief to cushion the double-barrel recessionary shocks of the mid-2006-mid-2008 period.
We have not seen anything like this effective policy paralysis since the Hoover years of the Great Depression, when the best that that president could do, foreshadowing Obama, was expand government spending programs, save a few large companies from justifiable liquidation, and perversely "contribute" to worker optimism and correspondingly unrealistic wage demands.
Some Common Economic Errors
Most economists and U.S. leaders believe that the U.S. has significantly responded to these recessionary shocks through government spending programs. They believe that the Feb 2009 Stimulus Bill, the "American Reinvestment and Recovery Act," has created an auspicious beginning to a recovery from the recession. For most economists, following Keynes, believe that deficit-financed government expenditures can substantially ameliorate recessions.
But they are wrong. They fail to acknowledge a long series of empirical studies that demonstrate the insignificant effect of such spending programs on GDP. Even the scintillating 1933-1936 recovery during the Great Depression was due to Roosevelt's inflationary monetary policy rather than his spending programs, which did not substantially take effect until the later -- nevertheless re-recessionary -- period from 1937 to 1939. The reason is that government spending programs are not monetary policies: Government spenders have to go out and borrow their money from private lenders, most of whom would have otherwise lent their money to private spenders.
Moreover, although conventional economics has people consuming more because of the income created by an increase in government spending, such economics fails to recognize that rational people correspondingly consume less because of the equal increase in future taxes collected to finance the larger national debt ("Debt Instruments in Both Macroeconomic Theory and Capital Theory," American Economic Review, Dec 1967, pp. 1196-1210). The actual source of our partial recovery in 2009 is something else entirely.
Late 2008's plummeting short-term interest rates -- the largest since our Great Depression -- generated a delayed, steady 2009 fall in the international value of the dollar. The corresponding partial recovery in U.S. commodity prices -- from 35% to 55% of their mid-2008 levels -- has given many economists a kind of blind confidence that we are on a road to recovery. But this international adjustment was completed before the end of the year, after which the dollar has risen in the international money markets while U.S. output prices have correspondingly fallen back to about half of their mid-2008 level. With money wage demands even higher than their mid-2008 level, it should be no surprise that we remain mired in an exceptionally severe recession.
A major monetary policy to fight the recession was announced at the March 18, 2009 Federal Reserve Bank's Open Market Committee (FOMC) meeting. This policy announcement appeared to be finally forcing Fed officials to buy up to a trillion dollars' worth of bonds in the free market, thereby finally injecting fresh money into a U.S. economy that had such an injection for or over a year. That is, some such monetary expansion was needed in early 2008 in order to prevent the recession in the first place (See my Sept 24, 2008 American Thinker blog post, "No Bailout Necessary"). Indeed, early 2008 stock and commodity speculators confidently bid up prices in the justifiable expectation that Bernanke would create a jump in the money supply by mid-2008 in order to intelligently avert a severe recession. However, in exactly the same way that Hoover irrationally punished early 1929 market speculators, Bernanke perversely contracted the early 2008 money supply in order to punish the intelligent market speculators who were betting that the Fed would run a loose monetary policy in order to avoid an otherwise inevitably severe recession.
The only kind of paper that the Fed officials purchased was the junk owned by troubled banks. The policy was thus largely a simple replacement for the Troubled Asset Relief Program (TARP), a new program that did not come along with the TARP's executive compensation restrictions. While a few undeserving bank-executives were surely helped, the economy was not, as the extra liquidity created for their banks was used simply to replace their onerous TARP loans and bolster their sagging balance sheets. Once again, sadly, no above-trend jump ever occurred in the relevant money supply.
Obama's unwise reappointment of banker-loving Bernanke -- based on the absurd thought that Obama's constituents preferred enormous banker bailouts and years of serious recession over a one-shot inflation and immediate economic health -- pretty much sealed the president's fate, and ours as well. We are now going to have to wait in hope of a big expansionary shock to hit the economy, something that jars us back to a neighborhood of the upper equilibrium we had enjoyed since 1946. Absent such a fortunate shock, we will wait a number of years for money wage rates to finally fall to where normal U.S. profit and employment rates are restored.
Earl A. Thompson is Professor of Economics at UCLA.