A featured article in this month’s issue of Mother Jones is entitled “Rich People Create Jobs! And five other myths that must die for our economy to live.” If rich people don’t create jobs, where do they come from? Hmm… You can see where the argument is going. The gist of the piece is that we need big government, with all its wise bureaucrats and legislators who apparently share none of the weaknesses of lesser mortals, to save us from ourselves. Particularly ironic is the fact that in order to supposedly debunk certain supposed “myths”, the author, Kevin Drum, repeats certain other myths. It’s worth having a look, because the article is representative of broadly popular kinds of thinking on matters of the economy that pose a serious threat to our future.
“Myth #1: The Stimulus Failed.”
The stimulus worked, Drum insists, while asking, “So why is our economy still in such bad shape?” Oh. So it didn’t work so well, huh? His answer to his own question is simple. It’s because “It just wasn’t big enough, or long-lasting enough.” His proof is that “things would have been worse without the stimulus”. How do we know? A lot of really smart guys have “concluded that it increased economic growth, reduced unemployment, and put millions of people back to work.” One needn’t get too much into the details. Just look at history! The argument for “tighter money and lower spending” is “exactly the same mistake we made in 1937.”
What happened in 1937? Well, “Franklin Roosevelt tackled the Great Depression” during his first four years “with inflation, easy monetary policy, and government spending.” But then he reversed course, cutting spending and tightening up the money supply, which had “disastrous results”. GDP and industrial production plummeted (it’s important to note that the capital goods industries were hit harder than consumer goods, a point we’ll return to), and it was only in 1938, when “the austerity program was abandoned”, that “the economy started to grow again.” So, obviously, history teaches us that increased government deficit spending and monetary inflation are good for the economy, and such a policy, as every enlightened person knows, is the way out of recession.
Except that the cause of the Great Depression was the Federal Reserve’s inflationary monetary policy. The boom of the roaring ‘20s was largely illusory, based not on savings and sustainable investment and growth, but on the unsustainable expansion of credit, debt, and malinvestment. But wasn’t it was the Fed’s deflationary policy that caused the depression? Actually, no, that’s a myth long since debunked by Austrian economists. As Murray N. Rothbard observes in his study, “America’s Great Depression”, it is true that the money supply shrank. Demand for money increased and people drew down their deposits, thus reducing the base upon which banks could pyramid and with the magic of fractional-reserve banking inflate the money supply. Confidence in the banking system was also shaky, so banks fearing potential runs held onto extra reserves. Thus, the deflationary tendency was the result of market forces moving towards healthy equilibrium and sustainability.
But the Fed tried to fight the market and inflate, including by monetizing government debt. Interest rates were kept artificially low, leading to a misallocation of resources and malinvestment—not unlike the case of the housing bubble that precipitated the 2008 financial crisis, only in this case it resulted in entrepreneurs taking advantage of the artificially low cost of money to invest more heavily in capital goods rather than labor. The Fed’s inflationary policy is evident in the fact that even while the money supply decreased, prices remained stable. With advancements in technology allowing for goods to be made cheaper and with a falling money supply, prices should have fallen as well, but they didn’t. This was a consequence of the Fed’s inflationary policy. The depression was the market’s cure for the disease of government interference that caused the distortions and malinvestment.
Now, back to 1937. Actually, government spending was less in 1935, during Roosevelt’s supposed recovery, than in 1937, as Jonathan M. Finegold Catalan points out. During the time Roosevelt was supposedly tackling the depression, from 1933 to 1935, spending peaked at $6.5 billion in 1934, while it was at $7.6 billion in 1937, down from $8.2 billion in 1936. It’s true that the deficit was much lower in 1937, the lowest since 1933, at $2.2 billion, down from $4.3 billion the previous year. But, then, the following year, when Roosevelt supposedly came to his senses and put aside his foolish idea of cutting the deficit, the deficit was actually slashed considerably further, down to just $89 million. The relatively modest cut in spending in 1937 translated into a huge reduction of the deficit because tax revenues were much higher that year than in any previous year during the depression. And the “tightening” of the money supply refers to the enacted policy of increasing in the required reserves of the banks, but the effect of this on the money supply was diminished since cautious banks were already keeping excess reserves instead of fully loaning up. The cause of the 1937 recession was the inflationary policy that preceded it—along with an inflow of gold from Europe that added to reserves upon which the banks could pyramid—and not from the “tightening” that accompanied it.
The supposed recovery that preceded the 1937 recession was illusory. Like treating the drug addict who starts going into withdrawals by injecting more heroin into his system, the response by both Hoover and Roosevelt to the market’s attempt to readjust and liquidate the malinvestment caused by government intervention and the Fed’s inflationary policy was to double down on the very policies that had caused the depression in the first place, thereby making it “Great”. 1937 was another period of “withdrawal” as the pace of credit expansion slowed and the malinvestments began to reveal themselves, with the envisioned profits induced by easy money proving illusory, being undercut by the high cost of wages. Productivity fell and unemployment rose. As Drum himself points out, hardest hit were the capital goods industries.
As Catalan puts it, “Roosevelt’s Recession” of 1937 was not a mistake but “a necessary readjustment period after the boom of the period 1935-1936…. It is evident that the recession of 1937 was not a product of low government deficit spending or contractionary fiscal policy on the part of the Federal Reserve. It was, instead, a product of expansionary monetary policy and heavy government regulation.” John Lott similarly concludes in the Wall Street Journal that “The real lesson from the 1937-38 is that government made the situation much worse by always trying to fix things.”
“We have tried spending money,” Roosevelt’s Secretary of the Treasury Henry Morgenthau despaired in 1939, after the president has supposedly realized his “mistake” of cutting spending and unemployment rose above 20%. “We are spending more than we have ever spent before and it does not work…. I say after eight years of this Administration we have just as much unemployment as when we started…. And an enormous debt to boot!”
So much for Drum’s “myth”-busting on that count.
“Myth #2: The Deficit Is Our Biggest Problem Right Now.”
This is a “myth” because the government is able to borrow money at little to no interest. If the situation was “really at dire and unsustainable levels”, then “nervous investors would be driving up interest rates on federal borrowing”, yet “just the opposite has happened”. Real treasury yields are at or below zero, Drum observes, concluding, “Apparently, the financial markets think we’re a pretty good credit risk.”
Except that it isn’t the free market that has kept interest rates so low. On the contrary, it is the Federal Reserve that has acted to artificially zero interest rates by buying up treasury securities. Drum cannot possibly be unaware of this, but he nevertheless seems completely oblivious to its implications. The appearance of confidence in the dollar and the U.S. economy Drum speaks of is illusory. Obviously, if interest rates were so low purely because of investor confidence, then the Fed wouldn’t have felt it necessary to intervene to monetize government debt with the express purpose of lowering interest rates. Drum adds that “only an idiot turns down free money.” Perhaps, yes. But only an idiot could call it “free money” when the Federal Reserve buys up treasuries and destroys the purchasing power of the dollar through inflation, a hidden tax on the American people, or when the government otherwise borrows money under deficit spending that can only be repaid in the future either through raising taxes or further devaluing the dollar.
Not that any of this necessarily leads to the conclusion that the deficit is the “biggest” problem. One could definitely argue that this is a myth. For instance, one could make a compelling case that our biggest problem is the Federal Reserve system itself. So Drum might still be on to something calling this a “myth”, just not in the way he intended.
“Myth #3: Lower Taxes Are the Best Way to Grow the Economy.”
Here, Drum first argues that there’s “virtually no correlation” between lower tax rates and economic growth, and then that higher taxes can stimulate an economic boom. After all, in 1993, President Clinton raised taxes and “the economy boomed.” The conclusion is that “high tax rates don’t hinder growth, and low tax rates don’t stimulate it.”
Except that this argument is self-contradictory. How can it both be true that there is “no correlation” between lower tax rates and economic growth and also true that there is a positive correlation between higher tax rates and growth? And Clinton’s 1993 economic plan also cut spending and implemented “fiscal austerity” to reduce the deficit, which is supposed to be bad for growth, remember? And what about Clinton’s 1997 tax breaks on capital gains in real estate that has been credited with contributing to the housing boom? Here, if one wanted to argue against tax cuts, a strong case could be made that they should never come in the form of government incentives aimed to create growth in a favored sector of the economy and so to distort the market. But, then, that would concede that lowering taxes does stimulate growth. Turning again back to the Great Depression for some historical guidance, it’s interesting to note that Hoover raised tax rates, and yet the depression only deepened, causing government revenue to decrease.
Also, it is useful to observe that the logical corollary of the argument that cutting taxes can never help the economy while raising them can is that everyone should just give all of their money to the government so that bureaucrats can in their infinite wisdom direct resources so much more efficiently in order to grow the economy for us. And if that doesn’t sound quite right to you, then maybe cutting spending isn’t the problem after all, and all the Nobel Prize winning wise guys really don’t have the slightest idea what they’re talking about.
Which shouldn’t really surprise anyone. Fed chairman Ben Bernanke was ostensibly oblivious to the housing bubble, assuring Americans that the economy was sound right up until the artificial boom went bust. The great Milton Friedman praised the inflationary policies of Alan Greenspan and Bernanke, and hadn’t the foggiest clue that the bubble even existed, just as his mentor Irving Fischer assured two days after the peak of the bull market in 1929 that the turnaround in stock prices “will not be hastened by any anticipated crash, the possibility of which I fail to see.” Paul Krugman recognized the housing bubble and criticized the Fed for taking it too far, but only after he had in the first place lauded the suggestion that the Fed create a housing bubble as a new boom to “remedy” the bust of the dot-com bubble.
Yet students of the Austrian school of economics, such as Ron Paul, who understand that genuine economic growth comes from savings while credit expansion leads to boom and inevitable bust, had been warning about the housing bubble and railing against the policies that led to the 2008 financial crisis for years. In like manner, Freidrich Hayek warned of the impending crash of ’29 because he understood that “you cannot indefinitely maintain an inflationary boom. Such a boom creates all kinds of artificial jobs that might keep going for a fairly long time but sooner or later must collapse.”
Perhaps we should be listening to the guys who actually predicted and warned against the consequences of inflationary and interventionist policies, instead of the guys who were clueless? Just maybe?
Again, this is not to say that cutting taxes is “the best” way to grow the economy, just that it’s not such a bad idea as Drum would have readers believe. Also that perhaps the biggest myth around today is that Keynesianism is grounded in sound economic reasoning.
“Myth #4: Regulatory Uncertainty is Clogging the Economy.”
The gist of this one is that business owners are not really “paralyzed by fear of a tidal wave of new regulations”. Drum cites a McClatchy article and a survey of “small-business trends”, which, he says, show that businesses aren’t too concerned about regulation hurting their profit margins. Rather, “lack of demand” is their primary concern, “beating out taxes, regulations, inflation, and everything else.”
Except that both sources actually dealt with the question of existing regulations, not hypothetical future ones. Turning to the McClatchy article cited, the title is, “Regulations, taxes aren’t killing small business, owners say” (emphasis added). Not far into the article, it notes that the criticisms of excessive regulation harming business “weigh much more heavily on big corporations than on small business.” While Drum quoted a couple of the small business owners interviewed for the article saying regulation was not a problem for them, he didn’t quote guy who said, “My biggest problem is the current status of the banking system and how it’s being over-regulated”.
Turning to the survey cited, of small business trends, it’s worth noting that it actually argues in favor of cutting government spending—which Drum, remember, thinks is bad—and concludes, “It seems for all the activity in Washington, D.C. they have done nothing but create a sizeable helping of anxiety, exactly what we don’t need.” Drum kind of left that part out. And it does not follow that since the primary concern of small business owners is lack of sales volume that they don’t also feel that government regulations are hindering their growth. In fact, the second most cited reason was increased costs, which included labor costs (thus brining minimum wage regulations into play), taxes, and—gasp—“regulatory costs”. Oh my.
“Myth #5: Obama Is Debasing the Dollar.”
Here Drum argues that the Federal Reserve has not debased the dollar. This, he proclaims, is “not true”, much to his dissatisfaction, because “we’d be better off if it were.” He says the “usual measure for the strength of the dollar”, called the “trade-weighted value”, has “stayed steady under Obama”. So there is “just no basis to the claim” that the Federal Reserve during Obama’s administration has “debased the currency.” This is most “unfortunate”, Drum laments, because if the dollar was debased it would “get our national savings rate up and our long-term budget deficit down” by “fixing our massive trade deficit.” With “a weaker dollar”, the U.S. would “import less and export more”.
Except that a devaluing dollar wouldn’t encourage savings but spending, for the obvious reasons that low interest rates wouldn’t attract depositors and households wouldn’t want to hold onto Fed notes that would buy less tomorrow than they would today. And, hey, if you’re all for robbing old ladies and pensioners of their wealth, devaluing the currency is really a fine idea. And the “trade-weighted value” refers to the foreign exchange value of the dollar. With the dollar acting as the world’s reserve currency, it should come as no surprise that as the U.S. runs the printing presses, so do other nations. It’s practically a race to the bottom as countries inflate and float their currencies against the dollar and thus devalue their currencies together. So pointing to this measure to say the dollar isn’t being devalued is perfectly meaningless. Right now, the dollar is looking stronger again compared to the euro. But that’s not saying very much.
True, consumer prices have risen only modestly, but they have risen, and it must be understood, as Mark Thornton points out, that the Consumer Price Index isn’t a very good measure of the full impact of monetary inflation (John Williams at Shadowstats.com notes that the methodology for calculating CPI has changed “away from being a measure of the cost of living needed to maintain a constant standard of living” and that according to the older methodology, the rate of inflation is much higher), that inflation can impact different sectors of the economy (e.g., the housing bubble), and that the impact of monetary inflation takes time (most of the money hasn’t even entered the economy yet, as banks are keeping excess reserves).
Most of the world operates on the same fiat, fractional-reserve system, with the U.S. dollar acting as reserve currency. Until 1971, the U.S. dollar was backed by gold, but Nixon effectively announced bankruptcy and took the dollar off the gold standard completely (Roosevelt had taken the U.S. off the gold standard domestically in 1933, though foreign nations could steel redeem in gold). Thus, the principle restraint against inflation was removed. The dollar had until then been defined as 1/35 an ounce of gold (that is, gold was set at $35 an ounce). Once Nixon removed the dollar from the gold standard, gold was allowed to float, and has increased in value against the dollar—or, rather, the dollar has decreased in value against gold—ever since. If you want a measure of how much the dollar has depreciated during the Obama administration in the judgment of the free market, you might be able to get a better idea by looking at the price of gold.
And what about the argument that we should debase our currency, so that our exports will look more attractive to foreign countries? Heck, why not just get those printing presses running, and depreciate the dollar even more, so other countries will want to buy more of our stuff? The weaker our currency, the better? Somehow, that doesn’t sound quite right. Shouldn’t we desire a strong currency, a dollar with a lot of purchasing power? Wouldn’t it be more desirable to pay less for stuff rather than more? After all, the loss of purchasing power means that that not only imports, but also domestic consumer goods become more expensive. And, sure, a sudden massive devaluation of the dollar would mean goods set at today’s prices would look cheap to foreign nations. But prices for exports would rise over time, just as they would for domestic goods. Any perceived benefit to the U.S. trade deficit by making American exports more competitive would be temporary, unless the devaluation continued persistently and at an ever-accelerating rate, which, of course, would ultimately mean runaway inflation. And inflation would mean a reduction in real wages, so the expense would just be passed on to the workers, or prices on exports would have to rise to keep up with rising wages racing to keep up. And do we really want to rob the elderly of their retirement savings? And foreign nations would be likely, judging by the current trend, to just follow suit and devalue their own currencies in the race to the bottom, resulting ultimately in the complete destruction of all monetary systems. But, hey, that’s where the logic takes us, isn’t it? The weaker the dollar, the better? It’s brilliant, right?
Even Keynes recognized that “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.” Not that he was totally against this idea. Of course, the other way to solve the trade deficit and make exports more competitive would be to maintain a strong dollar, encourage savings and investment, and actually increase production to better meet demand, thus actually sustainably lowering costs rather than just attempting to create an unsustainable illusion of lower costs of both domestic goods and exports. This goes back to the nonsense about “free money”. Sounds lovely, but you actually have to work for it, one way or another, and pretending that it’s “free” is only postponing the accounting and destroying our children’s futures.
And picking on old women and children really isn’t a very nice thing to do.
“Myth #6: If You Unshackle the Rich, They’ll Rev Up the Economy.”
We return to the “myth” that rich people create jobs. Now, here, Drum makes an excellent point. He argues that we should not “bail them out”. Amen! But this obsessiveness about corporate bailouts that benefit the rich, Drum attributes to “Republicans”, which is quite odd, given the fact that Obama also supported the bailouts, that there was absolute continuity of policy in that regard between him and his Republican predecessor. Drum argues we shouldn’t “lower their taxes”. But why not? It’s inequitable, certainly, when the super-rich pay less than the rest of Americans. But it doesn’t necessarily follow that taxes should be raised on the rich. How about lowering taxes on the rest of us, the 99%? Oh, that’s right, that would mean cutting government spending, which, we already learned, is a very, very bad thing to do, because government bureaucrats obviously know best about how to direct our nation’s resources most efficiently. I mean, just look at the brilliant job they’ve done so far.
But the rich don’t create jobs. So, Steve Jobs never created any jobs? Entrepreneurs who invest their own capital to produce goods to meet consumer demand don’t create jobs? Drum appears to be using some kind of Jedi mind trick on his readers. Rich people don’t create jobs. These aren’t the ‘droids you’re looking for. Kidding aside, Drum does acknowledge that rich capitalists do create jobs, but only when “the economy is growing”—which we may go ahead and stipulate—“and they have customers for their businesses.” Oh, right, there actually has to be demand for their products. And if real demand doesn’t exist—that is, if people’s time-preferences changes and they start saving so as to put off consumption into the future, with resulting lower interest rates and incentive for businesses to invest in means of production, which is where real growth comes from—the government bureaucracy must wave its magic wand and create it. So, “the key” to creating that demand, Drum concludes, “is to focus like a laser on more stimulus, easier money, higher inflation, and a weaker currency.” Because God knows that if the government didn’t intervene in the market to create consumer demand for goods, nobody would ever want to buy anything. Obviously, the solution is to devalue the currency, reduce the purchasing power of the dollar, create artificial demand, distort the market, etc. If we don’t do this, Drum warns, we will “relive 1937 over and over and over again.”
Which is to say that we must persist in the same kind of thinking that caused the 1937 recession—and the Great Depression itself, for that matter—in order to prevent its recurrence, that we must persist in the same kinds of policies that caused the 2008 financial crisis in order to cure it. And if you think that sounds lunatic, you must be delusional, or have succumbed to all kinds of nonsensical “myths” about how the economy works.
Or perhaps you are just too senseless to understand that robbing old ladies and destroying our children’s future is what enlightened societies do in order to create economic growth.