Recently, as the mainstream media pounded away in its coverage of the subprime mortgage “crisis” and the political class scrambled to “do something”, I looked back to the most recent replay of such moments, the 9/11 and Enron scandal induced, pre-tax cut recession of 2001. At that point, just as Federal Reserve Chairman Alan Greenspan rendered his judgment that the recession had run its course and expansion was well underway, the then Republican controlled Congress gave us an economic stimulus plan whether we needed one or not. Of course, none of this had any impact on the economy until the Bush tax rate reductions of 2003 put us on the growth track that has persisted until this very day.
“We are all Keynesians now” is a quote that has been variously attributed to Milton Friedman, who says he was quoted out of context, and Richard Nixon, who threw in the towel on fiscal and monetary policy discipline in 1971 and ended the Bretton Woods accord on the gold-backed dollar while resorting to wage and price controls in a disastrous attempt to control inflation. Actually, the British economist John Maynard Keynes would be appalled at much of the irresponsible monetary and fiscal policy that has been pursued in his name, and once said “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency”. Yet here we are, almost seven decades later, resorting to demand-side stimulus plans for feel good solutions to economic slowdowns that have nothing to do with demand-side problems. For Keynes would be the first to say that we can’t consume what we don’t produce and the idea that government can deliver something for nothing is a pipe dream.
We have such short memories. Remember when Ronald Reagan took office in 1981? The national psyche at the time was that stagflation was embedded in the national economy, that industrial planning was the order of the day, and that the Phillips Curve mandating an inverse relation between inflation and unemployment was inviolable. Then two things–the Reagan supply-side tax cuts and the monetary policy of the Paul Volcker Federal Reserve–changed the mindset. Was there pain? Sure there was, but the pain was a necessary price to pay to squeeze moral hazard out of the market and send the message to our risk analysts and our foreign investors, including central banks, that the U. S. was serious about breaking the inflation cycle and preserving the value of the dollar.
For about 15 years we maintained fealty to this discipline. Then, beginning with the Rubinomics of the Clinton administration in the late 1990s (devotees of the Phillips Curve) and the Alan Greenspan Federal Reserve, we ”fell off the wagon” and allowed the money supply to grow too rapidly and rates to remain too low for too long, feeding an overinvestment in high risk assets, devaluing the dollar to the detriment of our credibility with foreign central banks and investors, and defaulting in our discipline in maintaining price stability.
To turn things around, we need an immediate change in course. The Federal Reserve should announce that henceforth it will have as its top priority the enhancement and preservation of the value of the dollar and it should abandon its short-term management of the overnight Federal funds rate and allow the rate to float, while focusing on reducing the money supply and lowering the price of gold to reverse the inflationary psychology that is creeping back into the commodity markets and the mindset of investors and foreign central banks. Then we need real stimulus in the form of the permanence of the Bush tax cuts, accelerated depreciation of capital expenditures, and reversal of the most onerous provisions of the Sarbanes-Oxley regulations that are stifling capital formation and sending American business to foreign capital markets for their investment banking needs.
A recession is not inevitable. With responsible and determined policy changes, it can be avoided. Not without pain, but with the re-establishment of our credibility in foreign markets and the avoidance of a return of the inflationary mindset and undermining of the currency, which should have the highest priority.