A Final Note on a Softer Economic Policy

There is a famous joke about the tendency of economists to consider their chosen field akin to the natural sciences: a physicist, a chemist, and an economist are stuck on a desert island.  A can of beans washes up on the beach.  The physicist devises a mechanism using twigs and rocks to attempt to force open the can, but after several hours with no results, during which the economist sits and smugly smiles, the physicist gives up.  The chemist attempts to extract some sort of substance from plants on the island to melt the can.  The economist continues sitting and smiling arrogantly as the chemist also fails in his efforts.  “What?” the physicist and chemist say, “do you have a better plan?”  The economist stands and walks proudly towards the can on the beach: “Let’s assume we have a can-opener.”

This joke is often told by economists to economists at economic conventions or by economics professors to economics students during economics class, which was where I first heard the joke.  Yet the same economists who make this joke forget their own lack of hard science credentials when they make predictions; and non-economists seem to forget the incorrectness of the last prediction when they hear the next prediction.  In times of trouble, the poor track record of economists at predicting the future is never called into question, and political leaders often blindly surrender national sovereignty to “experts.”

I undoubtedly believe that central economic planners are capable of coordinating and herding hundreds of millions of people to some greater economic purpose by simply printing money and increasing government spending, but I also believe that the negative consequences of these policies usually outweigh their beneficial effects.

As Joe points out in his article, an active central bank policy did indeed cause the Great Depression.  F.A. Hayek, Keynes, and Milton Friedman all acknowledge this.  Fed Chairman Ben Bernanke and Friedman suggest the tight money policies of the central bank which caused the Great Depression be met in kind with a loose money policy, which caused (and “cured”) several recent financial crises.  Hayek, on the other hand, suggests the loose money policies of the central bank which caused the bubble economy of the roaring 20s to explode in the Great Depression be met in kind with the abolition of the central bank, and the exultation of the market’s self-rule.

Keynes suggests the Great Depression was caused by “sticky wages”, that is, wages not responding properly to the greater changes of 1929 and putting the economy even further out of equilibrium.  The solution is to increase the supply of money and/or increase government spending to create an artificial plug in the economy and restore equilibrium.  

People who support Keynes or Friedman tend, for obvious reasons, to become government economic planners.  Ben Bernanke is right that the Fed will never cause the Great Depression again.  It will err way way in the opposite direction, time and time again, by keeping the interest rate artificially low, encouraging Americans to take on massive amounts of debt, and financing the government takeover of corporations instead of allowing the failures of lemons like Chrysler and Citibank.  Gradually, government spending “plugs” in the economy will become the economy.  This is all an alternative to allowing the market to function in its role as a signaler of prices, and was the crux of Hayek’s “Road to Serfdom”. 

Another thinker, Vladimir Lenin, saw a chronically inflationary economy as the nemesis of capitalism: by destroying the value of money, a government could effectively destroy the bourgeoisie, replacing them with a distasteful class of speculators that would get rich on the public dole and incite the proletariat.   

The people shouting "socialism, socialism" at President Obama are wrong.  So are the people shouting "Laissez Faire, Laissez Faire".  We have neither capitalism nor socialism.  We have some sick, hybrid system where there is capitalism for the gains and socialism for the losses.  Such a system creates a permanent underclass massively in debt both by its own decisions and its government's dangling of an inflationary cheeseburger in front of the economic treadmill. 

The choice is a tradeoff.  We can continue to finance false growth with huge mal-investments such as Fannie Mae based on the calculations of a bunch of stuffy suits with Princeton degrees, or we can allow people access to crucial information stored in prices so they can make their own decisions which are best for them, and don’t necessarily involve the maximization of net worth.  

I am no ideologue, and I am not suggesting that it is prudent to completely abandon the Federal Reserve policy of expanding the money supply, merely that further intervention is unwarranted at this point.  My article was intended to highlight the pros and cons of a policy encouraging long-term artificial inflation versus a liberal policy acknowledging the futility of central planners to manipulate society into an economic utopia.  My main contention was that deflation is modest and we should use this opportunity to switch to a consumption-tax based system to encourage the savings - not more debt - that are necessary for real - not false - growth, just in case Ben Bernanke and Milton Friedman are in fact not infallible.

Steering markets may be justifiable sometimes, such as, for instance, to correct an externality; but, as always, the law of unintended consequences prevails: a loose money policy encourages millions of people to borrow money they shouldn't for businesses or purposes that will fail; this creates more aggregate problems.  We rode the high crest of a false boom for far too long, and now we must create another false boom to prevent the perils of the bust.  In a free society, to organically determine which businesses succeed and which fail is the province of the bust; it is not the province of central planners playing whack-a-mole with taxpayer dollars. 

The makers of this video subtly compare Keynesian ideas to alcoholism or drug addiction.  I feel the metaphor is apt: cocaine may increase productive efficiency, but the inevitable down can only be cured by more cocaine, which creates an inevitably even worse down in the future.  An economy which relies on cocktails of uppers and downers to function is destined for long-term problems.

I believe the Modern Synthesis of Friedman and Keynes, which attempts to stuff all of human behavior into a box called the business cycle, is a lot like alchemy, and by that I mean that alchemy eventually became chemistry after hundreds of years of rigorous application of the scientific method, empiricism, and general dissent to the hard core.  F.A. Hayek’s theory, like the atom of Democritus, is the foreseeable endgame, and sleeps, waiting to be rediscovered and refined by a less arrogant future generation.

Comments

[Kevin Breaux]

good piece Carr, solid improvement over the last couple articles on same topic