Catastrophe (6 page)

But the more the economy stagnates despite Obama’s medicine, the more he will sap his own credibility. The more unemployment data pile up and jobless claims grow week by week, the more the president’s ratings will plummet.

And the more likely it is that we can turn things around in the election of 2010!

FIGHTING THE RECESSION: WHAT OBAMA SHOULD HAVE DONE

So what
should
Obama have done?

The classic conservative answer, revealed as on tablets from Mount Sinai by the economic giant Milton Friedman in the 1980s, held that money supply and monetary policy were the key. Friedman warned against looking to Keynesian economics to stimulate demand; the more government borrows, he reasoned, the less is available to the private sector, which actually has to create the jobs. And any short-term effect of massive deficit spending will be obviated by fears about the inflation it will cause.

Instead, Friedman said, use monetary policy—interest rates—to increase the supply of money and credit. Work on the supply side, not the demand side, of the economy. Give businesses the low interest rates to borrow the capital they need to expand, and get government out of the way.

But the problem is that interest rates today, as in Elton John’s song, are already “too low for zero.” Faced with the onset of the recession, the Federal Reserve Board has cut them as close to zero as you can get. Yet the recession
has only deepened. And the deeper it gets, the more prices drop. After all, when no one wants to buy, prices go down. But with prices dropping by 3 or 4 percent a year, even a 0 percent interest rate is really 3 or 4 percent! (If money is worth 4 percent more each year—because prices have fallen by that much—why borrow money at 0 percent interest? Even at that price, it means you can’t take advantage of the rising value of the currency.)

Cutting interest rates has done little to solve the recession. Credit has continued to dry up. And with confidence in the economy at historic lows, no one wants to borrow anyway.

So if Keynesian demand stimulation won’t work and Friedman’s monetary policy was ineffective, what
will
work? In the years since Keynes, economists have developed what’s known as the Theory of Rational Expectations. Simply priming the pump—and hoping for the water to flow—clearly doesn’t work on its own, they reasoned. Beyond that, you have to convince people that the future is bright—that they
can
afford to buy that new car or flat-screen TV after all.

Without that confidence, those who get the stimulus money will just thank their lucky stars and use the money to pay down their credit cards or student loans or mortgages or car loans or home equity lines of credit. After all, who knows if a windfall like that will ever come again? And none of these uses for the money will do the slightest to stimulate the economy.

The need was not for a one-shot stimulation of the economy but for some long-term basis for rationally buying into the idea that the economy was recovering.

That’s the key: it all comes down to confidence. If you’re afraid you’re going to lose your job, you save your money and don’t spend anything you don’t have to. That makes the economy drop even more—and only increases the chance that you might actually lose your job!

If Obama had offered the prospect of a real change in the economic environment, rational people would have responded. A short-term rise in sales due to a stimulus or a tax cut wouldn’t be enough to encourage discerning businessmen to invest in new plants or equipment. But how about a cut in the capital gains tax? Or a cut in the income tax? If you knew that in the future you would have to pay only 10 percent—not the current 15
percent—in capital gains taxes on your investment earnings, wouldn’t that encourage you to invest? If you knew you’d have to pay only 30 percent of your income in taxes—not the current 35 percent—wouldn’t that encourage you to spend more?

One-shot tax refunds are as useless as one-shot spending increases. But permanent tax cuts, which can encourage long-term growth, send a real message to rational people that better times are coming.

Anxious to use the crisis as a pretext to expand government, Obama criticized the idea of permanent tax cuts, particularly for the wealthy, saying that it was just this sort of policy that got us into the current mess. He was determined, he insisted, to break with the “failed approaches” of the past.

But it wasn’t George W. Bush’s tax cut that caused the recession. His tax cuts pulled us out of the recession of 2001–2002, which hit us right after Osama bin Laden flew a plane into the global economy and knocked it down. Largely because of these tax cuts, the economy grew for five years.

The Bush tax cuts didn’t cause the budget deficits of the first decade of this century either. Even though Bush cut taxes for the rich (the top 10 percent of earners), their share of total tax payments rose from 64.89 percent in 2001 to 70.79 percent in 2006.
⁴⁹
In total, the richest 1 percent of the nation actually paid more money overall because of Bush’s policies—an amount rising from $301 billion a year in 2001 to $408 billion in 2006.
⁵⁰
In fact, it’s precisely because the drop in tax rates stimulated the economy that the lower rates brought in more revenue than the higher ones had.

But Obama wouldn’t let all those inconvenient facts get in the way. He wasn’t about to give up his big chance to use the crisis as an excuse to grow the government. And he certainly wasn’t about to use it to shrink it!

OBAMA TRASH-TALKS THE ECONOMY

Even with top-heavy majorities in both houses of Congress, Obama couldn’t be absolutely certain that he’d manage to get his big spending legislation passed. In the House, of course, he could do whatever he wanted: His majority there would pass anything, and the House Republicans—the best-dressed hostages in the world—could only sit back and watch the legislation sail through.

But the Senate was a different story. There, too, he had an ample majority, but there were still forty-one Republicans that stood in his way. To bring his proposals to a vote, he needed sixty senators—and that means he couldn’t do it with Democrats alone.

So Obama needed to heat up the sense of crisis. He had to make his stimulus program a do-or-die proposition. “Pass this plan or you’ll plunge us into the abyss” became the administration’s daily message. In one speech, Obama used the word “crisis” more than twenty times. Intent on raising the level of anxiety for political purposes, he was seemingly oblivious to the effect his words were having on the economy. What little consumer spending that survived the crash of the last quarter of 2008 dried up; business pulled in its horns.

The president said the sky was falling, so everybody looked up.

Here’s a sample of the language Obama has used to describe the economic crisis to the American people—language that has only increased our collective sense of fear and deepened the recession.

This was good politics but rotten economics. The more Obama described the economic situation as the “worst financial crisis since the Great Depression,” the more he fanned the very flames his stimulus package was supposedly meant to extinguish. He was yelling “FIRE!” in a crowded theater, stampeding an already damaged economy into a panic-driven recession.

Didn’t he know what he was doing? Of course he did. It’s the fundamental mission of the president to keep Americans looking forward, energized, optimistic. But Obama needed to pass his radical big spending package. Curing the recession was not his end; it was his
means
to the end. The end was bigger government.

But Obama’s insistence on the negative, and the harm it has done to the economy, is really a classic case of shooting oneself in the foot. His every pessimistic comment delays the time when the economy will rebound—and makes his eventual political defeat more likely.

INFLATION: THE REAL COST OF OBAMA’S POLICIES

The Obama spending package (aka the stimulus plan) won’t just increase the national debt and burden every subsequent generation with massive interest payments. In the next few years it is also likely to cause runaway inflation.

Indeed, inflation, not the recession, may be the true economic catastrophe of our times.

Most economists agree that Obama’s spending programs will cause huge inflation—particularly because they are to be funded by borrowing (or printing) money.

The economist Barry Elias, for example, believes that inflation may come in the next two to three years. Here’s why.

According to the Federal Reserve Board, from October 2008 through February 2009 the supply of money in circulation (plus that held in reserve by financial institutions) grew by 271 percent.
⁵⁸
That’s right—it almost tripled. Yet car sales didn’t triple. Home sales didn’t triple. Consumer spending didn’t triple. In fact, mostly they dropped.

So what happened to all that extra money? Where is it?

It’s parked on the sidelines of the economy, in the equivalent of economic parking garages, waiting to come out. Right now, the economic weather is still too bad to go out driving. With layoffs on the rise and sales on the decline, no one dares to spend what money they have. People are paying down their debts or putting their money into Treasury bills.

But when the sun comes out, so will the money—and all at once.

Anthony Karydakis, a contributor to CNN, explains the danger in a graphic way:

Right now, an awful lot of Americans are following the Posturepedic Savings Plan (PSP)—that is, stuffing cash under their mattresses. But when the economy improves, all that money is going to come out at once, as consumers head out to buy new goods and services. All those purchases they’d deferred—a new car to replace their cranky old one, new furniture for their
threadbare living room, a new house for their growing family—all of these pent-up consumer desires will come out at once.

And too much money will be chasing too few goods, leading to huge inflation.

The financial community clearly expects inflation. That is why long-term interest rates are now so much higher than short-term rates. Investors are pretty confident that inflation won’t be a problem as long as the recession rages. There’s more likely to be deflation. But once it ends, they can see inflation coming a mile away.

So even though interest rates on very-short-term Treasury bills are only one quarter of one percent, the Treasury has to pay 2.94 percent to get people to lend it money for ten years.
⁶⁰
And the average mortgage interest rate for a 15-year loan (at fixed rates) is 4.61 percent.
⁶¹
Why? Because we expect to be hit with inflation.

Because banks aren’t lending no matter how large their reserves are, the stimulus money remains parked on the sidelines. But when the banks decide the climate is right to start lending, huge inflation will be the likely result.

As Karydakis notes, “The Fed is acutely aware of the need to start mopping up that excess liquidity, very quickly after the economy starts showing signs of making a gradual comeback.”
⁶²

But inflationary psychology can be a hard habit to kick. Once consumers see inflation, they start demanding higher salaries, even asking their bosses to put cost-of-living wage adjustments into their compensation package. Employers, desperate to meet the new demand for their company’s services, don’t have time to argue. They can’t fire their workers, because once unemployment starts dropping there’s too much risk that they’ll have to scramble to find replacements and end up falling behind their competitors in market share. So they give in—and the inflationary wage/price spiral takes over.

Karydakis mentions the need to “start mopping up that excess liquidity” as soon as the economy improves. What would probably happen in such a circumstance is that the Fed would try to buy up the extra money in circulation. To do that, however, the Federal Reserve would need to sell debt—Treasury bills—in the open market. The T-bills would soak up part of the money in circulation, keeping it from being spent and causing more inflation.