Promoting a revamped Keynesian economic theory — one without any guarantee of job growth — is the equivalent of selling a lifetime subscription to a revamped Playboy: one without any photos. It's a tough sell. Yet this is what Keynesians are facing today. This will be fun to watch.
In the last few days, we have begun to see reports from mainstream Keynesian forecasters and economists who are talking about the possibility of a double-dip recession.
For a year, we have been assured by experts that double-dip recessions are rare. They surely are. The last one was in Carter's final year, 1980 — which is why it was his final year — and Reagan's first year, 1981. As far as the National Bureau of Economic Research has reported, that was the only double-dip recession. The NBER is the unofficial arbiter of each recession's chronology.
A few forecasters a year ago predicted the ever-popular V-shaped economic recovery. They are all hoping that no one remembers. There is no one left standing who predicts anything like this. The economy has barely grown over the last year, and the most recent report from the government is that growth was slower than initially reported for the second quarter of this year.
This remains the mainstream consensus: no double-dip recession, but weak economic growth and slow job growth. A few forecasters have said that unemployment will in fact increase. I have, but I am not in the mainstream.
The mainstream says that we are in a jobless recovery. But this assessment does not convey the uniqueness of the last 12 months. The Federal Reserve Bank of Minneapolis has posted an interactive chart that lets us compare the job non-recovery of the recession that began in late 2007 with all of the post-World War II recessions. We can click a box and get a different colored line for each recession-recovery. Only the double-dip recession of 1980—81 was worse in terms of the duration of unemployment.
In another sense, we are in the mother of all jobless recoveries: median unemployment longer than 27 weeks. As of July 2010, the number of unemployed Americans was 14.6 million, according to the Bureau of Labor Statistics. Of these, 45% had been unemployed for over 27 weeks: 6.6 million people. This figure is unprecedented. Remember also that "unemployed" refers to people without jobs who are still looking for jobs. Those who give up and stop looking are no longer counted as unemployed.
Until the most recent meeting of the Federal Reserve System's Federal Open Market Committee, the press releases began with an affirmation of the increasing strength of the economy — slow but visible. The press release for August 10 began with this uncharacteristic pessimism: "Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months."
In response to this intra-day press release, the Dow Jones Industrial Average recovered from a negative 120 to a negative 55, as the result of a meaningless statement that the FOMC will re-invest net payments from Fannie Mae and Freddie Mac bonds in Treasury bonds. This meant, at best, no change in the monetary base. The media greeted this as a major change in FED policy. It wasn't. The next day, the Dow fell 265 points.
SEEDS OF DOUBT
The financial media are beginning to report statements from Establishment forecasters who are saying that a double-dip recession is looking more likely. One of the most prominent of them is Yale economist Robert Shiller. He is the co-creator of the Case-Shiller monthly report on the residential housing prices in 20 American cities. He also coined the phrase "irrational exuberance." He now thinks the odds favoring a double dip are above 50—50. He says that the job market is the problem.
He is a Keynesian. So, he calls on Congress to spend lots more money on another deficit-funded stimulus. He says that the Federal Reserve is "out of bullets." Economists rarely say this about the FED. When they do, it indicates near-panic. He assures us that "If we focus on creating jobs, it's not as expensive as you might think."
First, who are "we"? Congress? Second, did the 2009 stimulus of $787 billion focus on creating jobs? If so, where are they? Third, how does Federal spending create jobs? Hiring part-time census workers, yes. Creating a few thousand "shovel-ready" make-work jobs that cost small fortunes per job, yes. But sustained job recovery? It isn't happening.
David Stockman, who was briefly Reagan's budget director before he resigned, recently wrote an article on the gargantuan size of the Federal deficit. He made an important but neglected observation. Ever since the third quarter of 2008, the nation's nominal GDP has increased by a tiny $100 billion, but the Federal debt has increased by 25 times the GDP increase.
This means that the hoped-for stimulus has not worked. It has taken $25 of Federal deficits to produce $1 of GDP growth. This marks a major anomaly for Keynesian economic theory. The justification for government deficits in Keynesian theory is that government spending restores economic growth. Money spent by the private sector does not increase economic growth in a recession; government spending does. This has never made any economic sense, but now the non-response of the economy is exposing this original nonsense for what it always was: nonsense. The Federal deficit is skyrocketing, but the economy has barely increased, statistically speaking, and is now slowing.
Lest we forget, the NBER committee which retroactively determines when a recession began and ended met in early April. The committee postponed an announcement regarding the end of the recession which it said began in December 2007. Such an announcement, the committee said, would be "premature."
This indicated that the economic data were so mixed that no clear recovery is evident. The Federal Reserve and other organizations have adopted spring 2009 as the end of the recession. This appears on Federal Reserve charts. But the organization that is unofficially the arbiter of such matters is not equally confident.
At this point, the conventional forecast regarding a double-dip recession is that it is unlikely to happen. In contrast, the Austrian School view is that the recovery itself may turn out to have been a statistical anomaly. We are not facing a double-dip recession, only because we have not gotten out of the 2007 recession. We are now facing a more rapid decline of an economy already in decline.
The statistics so far do not point to a full-scale recovery. This was the NBER committee's view in April. The statistics point to something unique: a supposed economic recovery in which commercial banks are reducing their lending, the overnight bank loan rate is close to zero, and long-term unemployment is at an historically high level. To produce this minimal recovery, if it really is a recovery, the Federal government is running a 2010 deficit in the $1.5 trillion range. Meanwhile, Social Security payments now exceed FICA tax revenue, so the general fund must make up the difference, thus adding to the on-budget deficit. Social Security has ceased to be an accounting cash cow for the government. It has become an accounting liability.
Rex Nutting writes for MarketWatch. He is not a famous economist. He is a columnist who spends his life summarizing economic events and data that come in over the wires. But, on August 11, when the Dow opened down by over 200 points and was not rebounding, he wrote an editorial. It reveals the despair of a Keynesian whose confidence in the restoration of economic growth has faded.
The Federal Reserve is pushing on a string, he said. It has gone about as far as it can go. It is therefore time for Congress to reassert leadership. Nutting has had great hope in the creativity of government spending. The government can borrow trillions of dollars, which can be spent by Civil Service-protected government bureaucrats who cannot be fired. His faith is fading. An overly conservative Congress is just too cautious and reluctant to spend more money, he thinks.
It doesn't take a poet to know what happens to a dream deferred. Sometimes, it explodes. If the Fed's hands are tied, are we doomed to a lost decade of deferred dreams?
Happily, no. There is one group that's still able to borrow: the federal government, which could fill the gap temporarily by directly employing idle people to fulfill some of those deferred dreams. They could teach the children, heal the sick, build the infrastructure, discover new drugs, and invent new technologies.
Unhappily, it's not going to happen.
The projected Federal deficits are in the range of a trillion dollars a year for the next decade. Not enough! Too cautious! Woe, woe, woe!
The optimists are saying that the double-dip recession will not happen, but job growth will be minimal. A jobless recovery is the new normal. This is the abandonment of Keynesianism. This is loss of faith on a paradigm-changing scope. The old Keynesian formula is no longer working. Huge deficits have not led to a V-shaped recovery, or maybe any recovery. The Keynesian multiplier is barely even adding. The Federal Reserve is pushing on a string. But so is Congress. The deficits are not working.
What's a Keynesian to do?
Call for more spending, of course. Call for even larger Federal deficits. Call for bailouts of deficit-plagued state governments, which cannot get loans from Asian central banks.
THE KEYNESIANS' FAITH
The Keynesians have only one solution: deficit spending. That is all they have had since 1936. Keynes baptized deficit-spending policies that all governments had begun several years before. He was John the Baptist for his generation. He called on old school economists to repent and be baptized in the logic of deficits. He converted most of the young economists. The old ones slowly died off, although some of them saw the error of their youth and converted.
But today the old Keynesian deficit-spending policy is no longer delivering the promised goods. The old formulas are not providing the old magic. The level of Federal debt is so great today that the percentage of each new annual deficit in relation to the total debt that has to be rolled over every five years is declining. Deficits no longer have the same "punch."
In fact, the old punch had to do with transferring resources from the private sector to the government sector. This transfer made the government sector grow and the private sector contract, compared to what would otherwise have prevailed. Government spending is counted as being the same as private spending. Government spending is considered part of the GDP. Keynesians assume that money collected by means of badges and guns is far more efficient in producing economic growth than money invested in terms of a hoped-for prospect of a positive rate of return. Keynesianism rests on faith in the following:
1. Badges and guns
2. Government IOUs
3. The wisdom of government
It is based on a lack of faith in the following:
1. Voluntary exchange
2. Private investment
3. The wisdom of entrepreneurship
We are now seeing the fruits of this view of economics. The deficits, while unprecedented, represent a declining percentage of the IOUs outstanding, both to investors and the Social Security, Medicare, and Federal pension "trust funds": accounting devices that count government IOUs as legal claims against future taxpayers. Each new deficit adds to this pile of IOUs. No one in the Establishment expects these to be paid off. Everyone expects these debts to be rolled over at low interest rates forever. There is no sense of alarm.
The Tea Party voters are beginning to sense that this is an impossible dream. Yet voters who are approaching age 65 also believe that they have a legal claim on lifetime support. They believe that these claims will be met. They believe that, since they are special, the Federal government can and will deliver on its promises to them. In short, they know they are being conned, yet they insist that the retirement Ponzi schemes will go on forever. In short, tens of millions of voters are schizophrenic.
Two groups of voters are not schizophrenic: the optimists and the pessimists. The optimists think that the promises will be kept, the Federal government can be relied on, and the system will hold. The pessimists believe that the promises will be broken, they will be stiffed in their old age, and the government is headed for a huge default.
Presumably, you are in the second group. Therefore, you are not a Keynesian. You do not believe that endless Federal deficits can continue. You do not believe that deficits will save the economy.
This raises a question: What are you doing to hedge your future against the optimists and the schizophrenics, who will resist any major spending cuts?
RUNNING OUT OF TIME
The Democrats are likely to lose control in the House next year. Their ten-vote edge in the Senate will disappear. Republicans will be able to filibuster any spending bill. This will end House Democrats' hope that voting in favor of a new spending program will get through the Senate. They will ask: "Why risk my slender base back home on a suicide vote to increase spending? If it passes, it will be killed in the Senate."
The Republicans will play the spoiler. Obama will get no new big spending programs passed by Congress. He will be able to blame Congress, just as he has blamed Bush. But if the economy does not visibly recover, and if the unemployment rate does not fall below 6%, he will take the heat. That is what the Presidency is for: taking credit or taking blame.
The government will move to gridlock next year. It will remain there for two years. The deficits will remain high. The economy will stagnate at best, or fall into a decline. There will be no major recovery that persuades voters that they are safe, that the economic future is bright.
We are seeing a loss of faith. It is all-pervasive. The voters see that Congress is impotent. The Keynesians see that the FED is impotent. The economists as a profession have rushed to the Keynesian pump to keep the ship from sinking, but the ship appears to be taking on water despite their best efforts.
Gridlock will end the prospects for a new round of spending. The Republicans will be busy campaigning for 2012. They will hold the line against major new spending projects. The deficits will continue, but the Republicans will blame Obama, the way that Obama blames Bush. "Obama saddled us with these deficits. We did not have the votes to stop him. Now we do. You can't hold us responsible for what Pelosi and Obama did." The voters, always disappointed, will respond in hope.
You can see why I have registered this domain:
"Double dips sink ships." The prospect of a double-dip recession threatens the Keynesians, just as it threatens Obama's hopes for re-election.
The Keynesians have far more at stake. Obama is limited to two terms by law. The Keynesians must keep the faith in deficits alive permanently. If their policy prescription fails, and the deficits accelerate without job growth and income growth, then they have no fall-back position. They can tell us that in the long run, the deficits will finally turn the economy back up, and things will go back to the pre-2007 normal. But if things do not return to the pre-2007 normal, then non-Keynesians will cite Keynes in their defense: "In the long run, we are all dead."
So is Federal solvency.
August 14, 2010
Copyright © 2010 Gary North