The Old Order Changeth, Alas

Just when economists thought we had begun to understand how to develop policies that might keep the US economy on an even keel, reality bit. Start with inflation. When the economy reaches full employment, wages will begin to rise and push up prices, triggering inflation at an annual rate higher than the 2% the monetary policy gurus at the Federal Reserve Board are targeting. So raise interest rates.

Really? We have a fully employed economy, wages are heading up, and yet a spurt in inflation is nowhere in sight. Our assumption about the relationship between growth, wages and inflation is in need of review.

Then there are federal budget deficits and debt, once a concern of many policymakers. No longer. Until now, a sober Republican Party, the defender of the dollar, the hard (in more ways than one) men in the board rooms of the banks and on the golf courses of the nation’s country clubs, were known as budget hawks.

Then along came Trump to take over the Party, build his own more, er, glitzy country clubs, and proudly proclaim himself the King of Debt. The budget hawks abandoned their nests, and moved into the empty nests of the departed doves, while their President poured red ink all over the national accounts.

The Democrats have had a long flirtation with inflation-producing cheap money, at least since their three-time presidential candidate (1896, 1900, 1908) William Jennings Bryan claimed that gold-backed money was crucifying mankind on a cross of gold. Modern-day Democrats, no longer constrained by Republican deficit-worriers, and led by Larry Summers, Bill Clinton’s treasury secretary, first argued that budget deficits are a good idea because the economy is facing a threat of “secular stagnation,” a situation in which demand for goods and services is inadequate to create jobs for all those who want them. When demand proved to be robust, rather than inadequate, they moved on to another reason to run deficits. Interest rates are so low that the government can borrow to invest in projects that will have high social returns – education, infrastructure, health care. New justification for an old preference – budget deficits.

Economists of the further left, especially those converting socialist Bernie Sanders’ predilections into economic theory, developed MMT – not a disease, at least not of the body, but a defense of perpetual deficits in countries that borrow in their own currencies. “Wrong,” says Fed chairman Jay Powell. And a step too far for such as Summers, “Although politicians shouldn’t make the debt their top priority, they also shouldn’t act as if it doesn’t matter at all….[Deficits] will have to be fixed at some point.” He would be made prudent, but not yet.

These Republican and Democratic deficit doves have nothing on Alexandria Ocasio-Cortez, the charismatic young congresswoman who is leading the Democratic charge on the old order. She believes that the trillions needed to fund her Green New Deal – no airplanes, no natural gas plants, no vehicles running on gasoline, electricity produced from the wind and the sun, all homes and buildings to be rebuilt to reduce emissions, no methane-producing cattle (hence no burgers and steaks) – can be manufactured on the Fed’s printing presses and by government-created banks that will provide all the credit needed. No worries about the deficits created.

Not all of these deficit doves want to bring down the capitalist system, although Bernie Sanders, who understands what “socialism” really means, and Ocasio-Cortez, who does not, might not mourn its replacement by a government so grand as to make it unnecessary for it to seize ownership of the means of production. And although the Trump/Republicans and the Summers/Democrats would not want to destroy the system that has brought them fame and a modicum of fortune, they might find a conversion from dove to hawk too little and too late to avoid a currency collapse. Vladimir Lenin is reported[*] to have said that “the best way to destroy the capitalist system [is] to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

As with deficits, so too with free trade, once considered a key to lasting prosperity by most economists. Indeed, so powerful was support for free trade in the Republican Party that it was able to hold off protectionist threats from Democrats and their trade union allies. Then the King of Debt granted himself another title, Tariff Man. Forget Adam Smith and all that talk of division of labor – every country doing what it does best, and freely trading their way to prosperity. Proclaiming “I love tariffs,” the President decided that our national security is threatened by steel imports from Canada, automobiles from Mexico, and billions of dollars’ worth of goods we buy from China. And levied tariffs on those imports, claiming the tariffs would be paid by the exporting nations rather than American consumers, a theory he feels compelled to tweet and re-tweet in the hope of explaining it to less enlightened critics. Lo and behold, the predicted cataclysm predicted by the free traders is nowhere to be seen, to which the stodgy, clinging to their copies of The Wealth of Nations, would add “yet”.

Reality has also dealt a heavy blow to another theory, widely shared by both parties. Democrat John F. Kennedy assured us in 1963 that “A rising tide lifts all boats.” The Republicans have a variant: the rich will spend their tax cuts on factories and in Tiffany, and the cash will trickle down to the middle classes and the poor. Alas, it ain’t so. The American economy has barreled along for almost ten years, this year at a 3% rate, and the yachts have risen, while many cannot even afford to own a row boat. The so-called one-tenth of one percent have done better than the 1%, which has done better than the 99%, and so on. We have become less certain of the benign effects of rising tides and trickles than we once were.

Nor can we be as certain of Americans’ support for capitalism. Especially among the young: 52% of millennials would prefer to live in a socialist (46%) or communist (6%) country than in a capitalist country according to YouGov pollsters. In part this is due to the mistaken belief that “socialism” merely means better health care and more equal distribution of wealth and income, as in Sweden, which in fact began rolling back the state decades ago.

In sum, we economists find ourselves in the same position as the King of Siam in the Rogers and Hammerstein musical, “There are times I almost think I am not sure of what I absolutely know, Very often find confusion in conclusion I concluded long ago. … Is a puzzlement.” Indeed.

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[*] The reporter was no less than John Maynard Keynes. Scholars are divided. Some guess that Keynes heard this remark by a Russian attending the Peace Conference after WWI, and attributed it to Lenin, others that Keynes made this up to make a point in his best-selling The Economic Consequences of the Peace. No matter, the phrase captures the effect of extreme use of the printing press to cover deficits, which in more modern terms has set the economy on “an unsustainable fiscal path”, according to Fed chairman Jay Powell.