Page 2 of 3 It all comes down to Keynes
By Julian Delasantellis
I am reliably informed that there are some students in Professor Taylor's class
who regularly read this column. If this is being read by one of those who does
not, I can't help but paraphrase Will Hunting (Matt Damon) in the put down of
the Harvard preppie in 1997's Good Will Hunting by saying that you are
wasting $150,000 on an education that you could have for the $4.99 in the
Starbucks wi-fi charges it would have cost you to regularly read Asia Times
Online.
The core point in the deficits-as-danger crowd seems to be that, at some
catastrophic point in the future, present, or, if it's already believed to have
occurred, near past, US government borrowing in the credit markets will reach
and surpass some decisive point of critical mass that all will be lost and an
utter catastrophe will be
unavoidable. The iceberg will be clearly seen to be "right ahead", and even
though everyone will be able to see it, the frightful momentum of doom will
have sealed America's fate and nothing will be able to be done to stop the
nation from foundering.
It's interesting that Ferguson chooses as his penultimate insult to brand his
detractors as Keynesians. This is roughly comparable to prelates in the
Vatican's College of Cardinals conducting a smear campaign against a rival by
calling him a devoted follower of Christ.
Before the time of early 20th century British mathematician, economist and
civil servant John Maynard Keynes, what we now know as macroeconomics, the
study of looking at economic affairs through the lens of the entire economy
rather than just through the operation of individual markets, didn't exist.
Time magazine named Keynes as one of the 100 most influential people of the
20th century, and even in this century, no matter how many new ideas come
hand-delivered on cocktail napkins or espoused by the guy who delivers your
pizza, when governments get into trouble, as George W Bush did in 2007 and
2008, it's Keynes, now dead 63 years, who gets the 911 call first.
Previously, economic thinkers had posited that, as long as everything was
working well in all of the economy's individual markets, be it for corn, labor,
or the eternally furtive widget, everything would be OK with the economy as a
whole.
The Great Depression of 1929 raised questions about the inherent
self-rectifying and regulating nature of modern capitalism and prompted Keynes
to turn on its head the question of how economies work. Gone would be "Say's
law", which that stated that demand would always equal supply, that, in effect,
demand was a derivative function of supply. Keynes looked at demand, what he
called "aggregate demand", in and of and by itself.
Both Princeton University economics professor, New York Times columnist and
blogger and most recent winner of the Nobel Prize in Economics Paul Krugman and
I learned our trade at about the same time. That was in the idyllic, Elysian
late 1970s, back before the twin plagues of HIV and Ronald Reagan took all the
fun out of life for us graduate students seemingly destined for careers using
the Keynes rulebook to oversee the economies of the West from out on the
ramparts of their commanding heights.
What accounted for the millions of unemployed in the 1930s, all across the
capitalist world? Obviously, there was not enough aggregate demand for whatever
product, be it Chevrolets or cummerbunds, that the workers were producing.
What was aggregate demand, as a whole, for the economy? Keynes defined it with
the equation C+I+G, that is: private consumption plus investment plus
government spending, later to include net exports. If you were a 70s-era
macroeconomics grad student, the only thing that mattered more to you than
C+I+G was the phone number of your Quaalude supplier.
What was a depression or steep recession? It was measured through aggregate
demand, AD, composed of C+I+G, being well below the level that the economy
could support without generating inflation. Inflation was just the opposite -
too much AD, too much C+I+G.
In the late 1970s, the Keynesian inflation cure, cutting back on AD through
getting legislatures to pass unpopular tax raising measures that squelched
consumption, was always problematical, but in the 1930s, just as in the
present, with an economic slowdown pressing down hard on AD, the solution
seemed clear. Raise AD, put people back to work.
Early in 2008, President Bush and Congress attempted to goose up private
consumption with $170 billion in tax rebate stimulus checks, but the
stimulative effects of the checks disappeared soon after the checks were
cashed. Tax cuts to spur investment were pushed by the right-wing, supply-side
crowd, but with American factories running at about 70% operating capacity, one
couldn't see how business was going to buy new plant and equipment that would
immediately sit idle besides the old equipment.
Promoting net exports was difficult in a world governed by trade rules that
forbade the so-called "beggar thy neighbor" policies of the 1930s. If someone
was going to boost AD, it was the G, government, of C+I+G that would have to do
the trick.
The real glory of Keynesianism is the belief that it can do the trick, that
C+I+G are, at least in the short term, infinitely fungible. In the fourth
quarter of 2008, real final sales of US product fell 5.1%, the greatest fall in
28 years. Krugman contends that, what with stock and real-estate price
declines, US households are worth $12.3 trillion less than they were just two
years ago, even before the effects of the almost 4 million jobs the US has lost
in the first five months of 2009 fully wind their way through the economy. If C
has dropped the ball, can't G just pick it up and head towards the AD endzone?
In a recent entry on his New York Times blog, one to which he applies a
"wonkish" warning label (oh, how horrible - actual facts and data in a US media
opinion piece!), Krugman makes this argument as to why budget deficits, at
least in the short term, will drive up neither interest rates nor inflation:
In
effect, we have an incipient excess supply of savings even at a zero interest
rate. And that's our problem. So what does government borrowing do? It gives
some of those excess savings a place to go - and in the process expands overall
demand, and hence GDP. It does NOT crowd out private spending, at least not
until the excess supply of savings has been sopped up, which is the same thing
as saying not until the economy has escaped from the liquidity trap. Now, there
are real problems with large-scale government borrowing - mainly, the effect on
the government debt burden. I don't want to minimize those problems; some
countries, such as Ireland, are being forced into fiscal contraction even in
the face of severe recession. But the fact remains that our current problem is,
in effect, a problem of excess worldwide savings, looking for someplace to go.
Going back to C+I+G, Krugman here is saying that currently, so much more money
that used to be consumed in C is being saved, but, with investment and business
capital spending demand so low, the extra funds are not being turned into
investment spending, I, to support AD. Therefore, it's all up to the government
- G.
On Tuesday, FT columnist Martin Wolf tried to mediate between Ferguson and
Krugman, but ended up siding with Krugman, saying that "The exceptional
policies used to deal with extreme circumstances are working." In response, on
Friday, in a letter to the editor to the Financial Times, Ferguson gives Wolf a
thrashing the likes of which has not been administered by an Oxford don since Tom
Brown's Schooldays.
Sir, I am glad to have furnished grist to
Martin Wolf's mill. But hyper-Keynesian fiscal policy on top of a large
structural deficit is going to cause bigger problems in the future than he
allows. Mr Wolf blithely writes: "Historically well-run economies are certainly
able to support higher levels of public debt very comfortably." His favorite
macroeconomics textbook may make this claim. But the annals of history provide
very few cases of economies with public debts in excess of 100% of gross
domestic product that were either well-run or very comfortable. To judge by Ben
Bernanke's warning this week about the need for "fiscal sustainability", the
Fed is less insouciant than your columnist."
Wanna' know how
you can tell if a high-class, well-educated Brit is extremely irritated? If he
drops the "I" bomb, "insouciant", on you, you can pretty much assume he is.
So is that it, a clear victory for Krugman and big deficits? Perhaps, but,
still, there are just a few facts that don't fit all that neatly in the pie.
It is absolutely true that in the past 12 months the American economy has seen
a decline in consumption not seen in decades - from an annualize rate of $8.341
trillion in the second quarter of 2008, to $8.187 trillion at year's end.
That's about a decline of about $155 billion. True, that hasn't been seen since
1980, but is $1.8 trillion in deficit spending really needed to counteract $155
billion in reduced private consumption? Beyond the simplicities of "government
spending bad - private sector spending good" that Ferguson-Taylor tries to
avoid but frequently falls back on, this issue, the awesome extent of the
stimulus versus the as yet more limited extent of the crisis, can't be so
easily explained away by Krugman's introductory explanatory macroeconomics.
A concept called the GDP multiplier states that changes in GDP component
amounts will bleed through to final GDP using a "multiplier", a number that you
multiply the change by to determine the final effect on GDP. No one knows the
exact multiplier until after the effect, but it's believed to be in the
vicinity of four or five. At five, the decline in consumption would only
translate to about $775 billion in reduced GDP - still less than half this
year's deficit.
Probably the best explanation for how the deficit got run up so fast is the
fact that this crisis originated not in the "real" economy, but in the cloud
cuckoo land of leveraged finance/funny money that took over the economy in the
final years of the boom. Here, the numbers were huge, and, since, in the final
analysis, they bore little relation to reality, they were always destined to
fail. It was only when, starting with the rescue of Bear Stearns in March 2008
and the declaration that many, actually a whole lot, of the institutions that
had engaged in the fantasy were now too big to fail, that the make-believe
numbers of the money fever became real live obligations of US taxpayers.
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