The Economic Prognosis is Not Good in the U.S., China or Europe

Posted by PITHOCRATES - April 22nd, 2012

Week in Review

For those of you who think the U.S. economy is picking up don’t get your hopes up.  The same goes for the Europeans.  And anywhere governments actively interfere with market forces.  They can provide a little succor.  But their efforts provide only temporary relief from reality.  And what is that reality?  That Keynesian economics and state capitalism do not work.  And that government meddling makes things worse in the long run.  Which is no secret.  Investors know what’s going on.  And aren’t fooled by the self-congratulatory praise the politicians heap upon themselves (see Analysis: Spluttering economies to curtail earnings horizon by Mike Dolan posted 4/18/2012 on Reuters).

Exuberant global markets have taken a reality check this month on chronic U.S., Chinese and European growth concerns, and investors should hold companies’ relatively rosy profit outlooks up for scrutiny too…

Macroeconomic hopes hinge on a U.S. recovery gaining more traction, a soft landing of Chinese growth to about 7.5 percent from the double digits of the past decade and a resolution of euro zone’s systemic sovereign debt and banking problems.

All three of these, however, were in doubt again in April and the anxiety knocked some 5 percent off MSCI’s world equity index from their March peaks. That leaves stocks still up 8 percent on the year but, just like last year, the price momentum and direction seems to have stalled.

Even though bouts of central bank money-printing and cheap lending in the United States, Europe and elsewhere periodically offer a fillip, as the European Central Bank’s money flood did again spectacularly in the first quarter, the effect on the real economy and market prices tends to fade fast…

What’s more, ThomsonReuters data shows that margin gains from cost-cutting in jobs, pay and other expenses was a significant part of the U.S. profit recovery since 2009 but that this route to bottom-line improvement is reaching its limits.

The major economies aren’t improving.  All of those government fixes didn’t fix anything.  Printing money just put more inflation into the pipeline.  And increased prices.  You ever notice the boxes of cereal getting smaller?  The bags of chips getting smaller?  They’re getting smaller because of inflation.  Unable to raise prices anymore because people can’t afford them they’ve held prices steady.  And shrunk the portion size.  Making consumers spend more in the long run to buy the same quantities as before.  Or simply go with less.  This is the result of all that money printing.

In business you don’t solve problems on the cost side.  You solve them on the revenue side.  For healthy revenue can pay for anything.  Even the worst cost management.  That’s why during good economic times the focus is on revenue.  Not cost cutting.  During good times companies hire people and expand production.  To grow revenue.  It’s during recessions when they lay off people and cut costs.  Temporary provisions to make it through the recession.  And when they emerge from these recessions they start hiring people and expanding production again.  To grow revenue.  So when margin gains are due to cost-cutting and NOT revenue growth you’re still in a recession.  No matter what the numbers say.  And no one is optimistic about the future economy.  Businesses.  Or investors.

Now would be a good time for governments everywhere to acknowledge their failures.  And let the Invisible Hand take control of the economy again.  For the longer they wait the harder it will be for the Invisible Hand to do its magic.  And the longer and more painful the recovery.  It’s time we drop the ‘state’ from capitalism.  And replace it with ‘free market’.  And trust in the free market.  Like we did during the Industrial Revolution.  Like we did when we abandoned FDR’s New Deal during World War II.  And like Margaret Thatcher and Ronald Reagan did during the Eighties.  All periods of incredible economic growth.  That no period of state capitalism ever equaled.


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The Invisible Hand

Posted by PITHOCRATES - April 16th, 2012

Economics 101

A Command Economy Reduces the Overall Economic Output because those Managing the Economy don’t Understand It

Command economy?  Or free market capitalism?  Which works better?  Well, let’s find out with a little experiment.  Let’s go back in time.  Say ancient Mesopotamia.  Just after they developed mass farming.  And produced some of the first food surpluses.  Allowing the rise of a middle class of artisans.  Now let’s look at what could have been the first two of these artisans.  A potter.  And a winemaker.  Who probably weren’t the first two artisans.  But will suffice for our little experiment.

The winemaker needs some pottery vessels to store and sell his wine in.  And the potter enjoys drinking wine.  They each have something the other wants.  And because we’re so far back in time there is no money yet.  We’re still only bartering at this time.  Trading the goods we make with each other.  But in our experiment the high priest of the civilization is also the economic planner.  This priest communicates to the civilization’s gods.  And guides the civilization in pleasing their gods.  Which he is very good at.  For he knows all of the old teachings and rituals.  But he doesn’t know a thing about pottery or winemaking.  But he looks at an empty pottery vessel and a pottery vessel full of wine and sees that the vessel volume equals the volume of wine.  And deems the price of one pottery vessel is the amount of wine one pottery vessel holds.

Well, the potter is quite happy with this price.  Because he is skilled.  And can dig up some clay.  Throw it on the potter’s wheel and knock out vessel after vessel.  Glaze them and fire them in the kiln.  Even working by himself he can achieve some economies of scale.  By repeating this process every day.  Something the winemaker isn’t quite able to.  For he makes wine by the batch.  Because each step in the process takes a lot of time.  Maintaining his grape vines.  Then picking the grapes.  Carrying them back to his winery.  Putting them into his winepress.  Squeezing the juice out of the grapes.  Putting the grape juice in large vats to ferment.  Monitoring the process.  When he determines the process is complete he fills the small pottery vessels with wine.  When it was finally ready for ‘sale’ and consumption.  Considering all the work it took him to make one vessel of wine the winemaker was not at all happy with the price the high priest set.  And instead builds his own potter’s wheel and kiln to make his own vessels.  Greatly increasing his workload.  And reducing his winemaking output.  While the potter loses a potentially large customer.  Thus reducing the amount pottery he makes.  Reducing overall economic output in the command economy.

The Invisible Hand makes sure we use our Limited Resources Efficiently to Make the Things People want Most

In this command economy the civilization suffered a deadweight loss.  Economic resources went unused.  They could have created more economic benefits with the available resources.  They could have made more pottery.  And made more wine.  Perhaps even creating some jobs to help with the economic output of efficiently using the available resources.  But they didn’t.  Because of the fixed prices economic resources went unused.  Thus creating a market equilibrium lower than where it could be.  Hence the deadweight loss.  Now let’s look at the same example with only one difference.  The high priest does NOT set prices.

In a barter economy people agree to trade the goods they make.  And now the potter and the winemaker are free to determine what they think is a fair trade.  That is, they set the price of pottery in wine.  And the price they agree on is one they find mutually acceptable.  Where the potter agrees to trade an amount of his pottery for an amount of wine.  And the winemaker agrees to trade an amount of his wine for an amount of pottery.  Everyone wins.  For the potter gets an amount of wine he values more than the pottery he traded for the wine.  The winemaker gets an amount of pottery he values more than the wine he traded for the pottery.  And the civilization wins because at this mutually agreed upon price both the potter and the winemaker increase their production.  Providing the civilization with more of their goods.  The potter and the winemaker may even hire people to help them produce more goods to meet this higher demand.  Thus increasing the level of happiness in the civilization.  By increasing the amount of economic activity.  Moving the market equilibrium to a higher level of economic output.  And thus reducing the deadweight loss.  By using the available resources in the most efficient manner.  As determined by these mutually agreed upon prices.

This is the Invisible Hand in action.  An economic concept put forth by Scottish economist Adam Smith (1723-1790) in his The Wealth of Nations (1776).  In a competitive market place where traders set the price for their economic trade (not a command economy) two things happen.  First, resources flow to where we demand them most.  That is, to the buyers willing to pay the highest price.  Second, because of the competitive market place only those companies that sell at the low prices the market demands stay in business.  Which means that they have to use those resources as efficiently as possible.  Especially when they’re paying the highest prices for them.  And all of this happens because of the Invisible Hand. 

History has Proven that no Government Bureaucrat can do a Better Job than the Invisible Hand

Those who favor a command economy (or more government intervention into market forces) say the economy is too complex for us to leave it to its own devices.  That without a smart government bureaucrat managing this complex thing we cannot reach a market equilibrium that maximizes economic output.  Whereas Adam Smith says it is because the economy is so complex that no one is smart enough to manage it.  Just as a high priest doesn’t understand pottery or winemaking a smart government bureaucrat cannot hope to understand all the intricacies of a complex economy.  Nor can they ever hope to understand what millions upon millions of consumers want to buy most.  But the beautiful thing is we don’t have to.

The multitudes make individual decisions just like our potter and winemaker.  Where everyone is looking to maximize their own value.  And when they agree on a mutual acceptable price all parties in the trade win.  While making sure our resources flow to where they are demanded most.  And that we use these valuable and limited resources most efficiently.  Thus maximizing overall happiness in our country.  Reducing deadweight losses to a minimum.  And obtaining a market equilibrium that maximizes economic activity.  All of which happens with no one in charge.  As if an Invisible Hand guides us in the market place to make all the right decisions to maximize this economic output.  And our happiness.

So which is better?  Command economy or free market capitalism.  Well, if you’re being honest you have to choose Adam Smith’s Invisible Hand and free market capitalism.  For history has proven that no government bureaucrat can do a better job than the Invisible Hand.  Not the Soviets.  Not the Chinese Communist (under Chairman Mao).  Not the Cubans.  Not the North Koreans.  Even the Americans failed when their government actively intervened in the private economy.  Something that President Jimmy ‘one-term’ Carter knows only too well.  So based on our hypothetical Mesopotamian example, and history in general, free market capitalism is, and always has been, and always will be, better than a command economy.


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The Left still attacks Free Market Capitalism and the Invisible Hand despite the Left’s Record of Economic Failure

Posted by PITHOCRATES - April 14th, 2012

Week in Review

No matter how many times their policies fail those on the left never give up.  The free market capitalism that gave us the Industrial Revolution was not as good as the mercantilism it replaced.  The free market capitalism that won World War II was not as good as Nazi Germany’s National Socialism.  The free market capitalism that won the Cold War was not as good as the Soviet Union’s communism.   No, any economic system that doesn’t place smart people in the government (and from our most prestigious universities) in charge is an inferior economic system.  At least, according to those on the Left (see There Is No Invisible Hand by Jonathan Schlefer posted 4/10/2012 on the Harvard Business Review).

One of the best-kept secrets in economics is that there is no case for the invisible hand. After more than a century trying to prove the opposite, economic theorists investigating the matter finally concluded in the 1970s that there is no reason to believe markets are led, as if by an invisible hand, to an optimal equilibrium — or any equilibrium at all. But the message never got through to their supposedly practical colleagues who so eagerly push advice about almost anything. Most never even heard what the theorists said, or else resolutely ignored it.

Interesting.  Using the economists of the Seventies as the authoritative position for government interventionism into the economy.  Why, that would be like having the captain of the Titanic being the authority on how to miss icebergs in the North Atlantic. 

The Seventies were the heyday of Keynesian economics.  Where the government was aggressively intervening into things economic.  And the results of their policies were so bad that we had to create new words to describe it.  Like stagflation.  A heretofore unheard of phenomenon.  And something that just wasn’t supposed to happen when the Keynesians used inflation to lower unemployment.  But it did.  Even though you weren’t supposed to get inflation and high unemployment at the same time.  Stagflation.  Like we did.  In the Seventies.

Believing far too credulously in an invisible hand, the Federal Reserve failed to see the subprime crisis coming. The principal models it used literally assumed that markets are always in instantaneous equilibrium, so how could a crisis occur? But after the crisis exploded, the Fed dropped its high-tech invisible-hand models and responded with full force to support the economy.

The subprime mortgage crisis was a government-made crisis.  Precisely because government refused to allow the Invisible Hand to guide the market place.  Instead they stepped in.  Forced lenders to make risky subprime loans to people who couldn’t qualify for a mortgage.  With tools like the infamous Adjustable Rate Mortgage (ARM).  And then they had Fannie Mae and Freddie Mac buy those risky mortgages.  To get them off the lenders’ balance sheets so they would make more risky loans.  Then Freddie and Fannie chopped up these risky loans and repackaged them into ‘safe’ investments to unload them to unsuspecting investors.  Getting these toxic mortgages off of their balance sheets.  (In case you don’t know, Fannie and Freddie are Government Sponsored Enterprises (GSE).  Which are for all intents and purposes the government.)  This house of cards imploded when the Fed raised interest rates.  After keeping them below what the Invisible Hand would have set them at for far too long.  The government created the real estate bubble.  Then blew it up when those higher interest rates reset all the AMR mortgage payments beyond the homeowner’s ability to pay.

There are many economists in the world.  And the consensus of economic thought tends to be one that supports large government intervention.  Which proves the economic consensus is wrong.  For if history supported this consensus the Soviet Union would have won the Cold War.  East Germany would have absorbed West Germany.  China would not be experimenting in ‘Invisible Hand’ capitalism.  And Cuba wouldn’t be experimenting with a little capitalism themselves to fix their broken government command economy.

All these market failures economists like to point to aren’t market failures.  They are the unintended consequences of government intervention into the market.  As the subprime mortgage crisis clearly proved.  Which never would have happened in the first place if the government didn’t try to be smarter than the Invisible Hand.


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FUNDAMENTAL TRUTH #39: “Socialism is easier said than done.” -Old Pithy

Posted by PITHOCRATES - November 9th, 2010

Capitalism vs. Socialism

Socialism as a political/economic theory is pretty involved.  With an involved history.  And if you’re suffering insomnia one night I recommend reading some of it with a glass of warm milk.  Should put you right to sleep.

Let me simplify it a bit.  To begin with, by ‘socialism’ I mean any form of collectivism (socialism, communism, fascism, statism, social democracy, etc.).  They’re all similar.  Just variations on a theme.  And they all suffer the same defects.  Three of which I summarize here:

  • Public (instead of private) ownership of the means of production, distribution, and exchange
  • Put the common good before individual wants or desires
  • Equality of outcomes

That’s not everything.  But it’s the 3 big reasons why socialism fails.  Basically, socialism is the opposite of capitalism.  In fact, socialism was created to defeat capitalism.  The East-West rivalry during the Cold War was the final showdown between the two systems.  And we know how that turned out.  (In case you don’t, capitalism won).

Public (instead of private) ownership of the means of production, distribution, and exchange

Mikhail Gorbachev asked the great Margaret Thatcher how she fed her people.  Her reply stunned him.  She did nothing.  The Soviet Union was struggling to feed her people with their socialist command economy.  And they couldn’t do it.  They who had great tracts of some of the most fertile farmland in the world.  And yet they still had to import grain from their arch nemesis.  The United States.  To keep famine at bay.  The free markets of capitalism didn’t have to struggle to feed her people, though.  The United States had food to spare.  And even though Great Britain is an island nation that had to import much of her food, there were no famine fears in Great Britain.  The socialist just couldn’t understand how that was possible.

One of the problems with socialism is that it ignores market forces.  And perverts the economic decision making process.  In a free market, market forces maximize the use of scarce resources that have alternative uses.  The market does this through the laws of supply and demand.  And prices.  Things high in demand but low in supply have high prices.  This ensures there is enough of that supply available for those who really need it.  Anyone who pushed a car to the gas pump during the gas shortages in the 1970s understands this.  When the Nixon administration kept prices artificially low, everyone bought and used gas until the supply ran out.  If we had let prices rise to their true market price, those who didn’t absolutely need gas would have cut back on their purchases, leaving gas available to those who really needed it and were willing to pay a high price for it.

When the state takes over the economy, politicians make economic decisions for political reasons.  They ignore the ‘invisible hand’ of the market place.  In the Soviet Union, the state boasted about its industrial output and filled stores with tractor parts no one wanted to buy.  Meanwhile, people stood in line for hours in hopes of buying soap or toilet paper.  And no matter how hard they tried they just couldn’t increase the yield of some of the world’s most fertile farmland.

Put the common good before individual wants or desires

Doing what’s best for the common good sounds noble.  And easy to do.  We all agree our children should be safe.  And should have enough to eat.  And that our schools should serve them breakfast each morning.  And teach them about contraception.  Well, okay, it’s not that easy to do.  Because different people want different things.  And different people think different things are better for the common good.

This is the problem of putting the common good before our individual wants or desires.  Few can agree on what the common good is.  We know our own wants and desires.  But we have no idea what other people want or desire.  Unless we ask them.  But does that even help in determining the common good?  Get a group of your friends and family together.  Make it at least 10 people.  Now get the ten of you to agree on a movie to see.  You know what will happen?  First of all, you’ll waste a lot of time saying, “I don’t care.  What do you want to see?”  Then people will start suggesting movies.  And for every one suggested, someone will vote it down.  This will go on until you finally arrive at a movie that no one wants to see.  But because it’s the movie everyone hates the least, everyone’s willing to settle for it.

Now imagine that little exercise with a thousand people.  The agreeing process will be even more difficult.  In fact, it may be impossible.  It is very unlikely that one thousand people will agree to anything.  And if they try they will waste an enormous amount of time in the process.  No.  Someone will have to decide for the group.  Someone will have to weigh everyone’s opinion and decide what is best for the common good. No matter how many people disagree with this one person’s decision.  F.A. Hayek wrote a book about this.  The Road to Serfdom.  He said socialism ends in dictatorship.  Because there’s no efficient means to determine what’s best for the common good.  He predicted this would happen in Germany with their creeping state socialism.  And Adolf Hitler proved him right.

Equality of Outcomes

If a business has a good year, they tend to be more generous at the holidays.  Let’s say a business owner wants to give out some Christmas bonuses to thank her employees for all their hard work.  She goes to her accountant.  Asks what’s the maximum she can give out without giving herself any cash-flow problems at the beginning of the new year (taxes, insurance, etc.).  The accountant crunches some numbers and says $50,000.  If she has 15 employees, that’s about $3,300 each.  Which should make for a pretty Merry Christmas.  Now, let’s say she has 125 employees.  That works out to a $400 bonus per employee.   Which won’t be quite as merry.

The lesson learned?  The more people included in the getting of something, the less each one gets.  And so it is with socialism.  The only way to get equality in outcomes is to give everyone less.  Sure, we can afford to give Congress people a Cadillac health insurance plan.  But we could never afford to give the same coverage to everyone.  To be able to give coverage to all the people, each person will have to get less.

And they will continue to get less.  As costs go up, it is difficult to maintain the same level of government benefits.  Eventually, they’ll have to raise taxes to cover the higher costs.  And when they can’t raise taxes anymore, they’ll have to reduce the amount of benefits.  Or, in other words, they’ll have to ration benefits.  A bureaucrat will have to decide who should get what.  Which could easily turn health care into politics.  A political opponent needs an expensive cancer treatment?  So sorry.  We’ve already reached our quota this year.  Try again next year.

Socialism is Slavery

What it comes down to is this; socialism really fails for one reason.  It goes against human nature.  It only works when we sacrifice our wants and desires so that others may have their wants and desires.  It’s not trying to keep up with the Jones.  It’s helping the Jones get ahead of you.  It’s living your life to serve others.  And there’s another word for that.  Slavery.  Hence the title of Hayek’s book.  The Road to Serfdom.  For socialism to work, the state must become a dictatorship.  And we must become its slaves.  But few willingly volunteer for servitude.  So, given the choice, we will ultimately choose to make socialism fail.


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LESSONS LEARNED #27: “Yes, it’s the economy, but the economy is not JUST monetary policy, stupid.” -Old Pithy

Posted by PITHOCRATES - August 19th, 2010

WHAT GAVE BIRTH to the Federal Reserve System and our current monetary policy?  The Panic of 1907.  Without going into the details, there was a liquidity crisis.  The Knickerbocker Trust tried to corner the market in copper.  But someone else dumped copper on the market which dropped the price.  The trust failed.  Because of the money involved, a lot of banks, too, failed.  Depositors, scared, created bank runs.  As banks failed, the money supply contracted.  Businesses failed.  The stock market crashed (losing 50% of its value).  And all of this happened during an economic recession.

So, in 1913, Congress passed the Federal Reserve Act, creating the Federal Reserve System (the Fed).  This was, basically, a central bank.  It was to be a bank to the banks.  A lender of last resort.  It would inject liquidity into the economy during a liquidity crisis.  Thus ending forever panics like that in 1907.  And making the business cycle (the boom – bust economic cycles) a thing of the past.

The Fed has three basic monetary tools.  How they use these either increases or decreases the money supply.  And increases or decreases interest rates.

They can change reserve requirements for banks.  The more reserves banks must hold the less they can lend.  The less they need to hold the more they can lend.  When they lend more, they increase the money supply.  When they lend less, they decrease the money supply.  The more they lend the easier it is to get a loan.  This decreases interest rates (i.e., lowers the ‘price’ of money).  The less they lend the harder it is to get a loan.  This increases interest rates (i.e., raises the ‘price’ of money). 

The Fed ‘manages’ the money supply and the interest rates in two other ways.  They buy and sell U.S. Treasury securities.  And they adjust the discount rate they charge member banks to borrow from them.  Each of these actions either increases or decreases the money supply and/or raises or lowers interest rates.  The idea is to make money easier to borrow when the economy is slow.  This is supposed to make it easier for businesses to expand production and hire people.  If the economy is overheating and there is a risk of inflation, they take the opposite action.  They make it more difficult to borrow money.  Which increases the cost of doing business.  Which slows the economy.  Lays people off.  Which avoids inflation.

The problem with this is the invisible hand that Adam Smith talked about.  In a laissez-faire economy, no one person or one group controls anything.  Instead, millions upon millions of people interact with each other.  They make millions upon millions of decisions.  These are informed decisions in a free market.  At the heart of each decision is a buyer and a seller.  And they mutually agree in this decision making process.  The buyer pays at least as much as the seller wants.  The seller sells for at least as little as the buyer wants.  If they didn’t, they would not conclude their sales transaction.  When we multiply this basic transaction by the millions upon millions of people in the market place, we arrive at that invisible hand.  Everyone looking out for their own self-interest guides the economy as a whole.  The bad decisions of a few have no affect on the economy as a whole.

Now replace the invisible hand with government and what do you get?  A managed economy.  And that’s what the Fed does.  It manages the economy.  It takes the power of those millions upon millions of decisions and places them into the hands of a very few.  And, there, a few bad decisions can have a devastating impact upon the economy.

TO PAY FOR World War I, Woodrow Wilson and his Progressives heavily taxed the American people.  The war left America with a huge debt.  And in a recession.  During the 1920 election, the Democrats ran on a platform of continued high taxation to pay down the debt.  Andrew Mellon, though, had done a study of the rich in relation to those high taxes.  He found the higher the tax, the more the rich invested outside the country.  Instead of building factories and employing people, they took their money to places less punishing to capital.

Warren G. Harding won the 1920 election.  And he appointed Andrew Mellon his Treasury secretary.  Never since Alexander Hamilton had a Treasury secretary understood capitalism as well.  The Harding administration cut tax rates and the amount of tax money paid by the ‘rich’ more than doubled.  Economic activity flourished.  Businesses expanded and added jobs.  The nation modernized with the latest technologies (electric power and appliances, radio, cars, aviation, etc.).  One of the best economies ever.  Until the Fed got involved.

The Fed looked at this economic activity and saw speculation.  So they contracted the money supply.  This made it hard for business to expand to meet the growing demand.  When money is less readily available, you begin to stockpile what you have.  You add to that pile by selling liquid securities to build a bigger cash cushion to get you through tight monetary times.

Of course, the economy is NOT just monetary policy.  Those businesses were looking at other things the government was doing.  The Smoot-Hartley tariff was in committee.  Across the board tariff increases and import restrictions create uncertainty.  Business does not like uncertainty.  So they increase their liquidity.  To prepare for the worse.  Then the stock market crashed.  Then it got worse. 

It is at this time that the liquidity crisis became critical.  Depositors lost faith.  Bank runs followed.  But there just was not enough money available.  Banks began to fail.  Time for the Fed to step in and take action.  Per the Federal Reserve Act of 1913.  But they did nothing.  For a long while.  Then they took action.  And made matters worse.  They raised interest rates.  In response to England going off the gold standard (to prop up the dollar).  Exactly the wrong thing to do in a deflationary spiral.  This took a bad recession to the Great Depression.  The 1930s would become a lost decade.

When FDR took office, he tried to fix things with some Keynesian spending.  But nothing worked.  High taxes along with high government spending sucked life out of the private sector.  This unprecedented growth in government filled business with uncertainty.  They had no idea what was coming next.  So they hunkered down.  And prepared to weather more bad times.  It took a world war to end the Great Depression.  And only because the government abandoned much of its controls and let business do what they do best.  Pure, unfettered capitalism.  American industry came to life.  It built the war material to first win World War II.  Then it rebuilt the war torn countries after the war.

DURING THE 1980s, in Japan, government was partnering with business.  It was mercantilism at its best.  Japan Inc.  The economy boomed.  And blew great big bubbles.  The Keynesians in America held up the Japanese model as the new direction for America.  An American presidential candidate said we must partner government with business, too.  For only a fool could not see the success of the Japanese example.  Japan was growing rich.  And buying up American landmarks (including Rockefeller Center in New York).  National Lampoon magazine welcomed us to the 90s with a picture of a Japanese CEO at his desk.  He was the CEO of the United States of America, a wholly owned subsidiary of the Honda Motor Company.  The Japanese were taking over the world.  And we were stupid not to follow their lead.

But there was no invisible hand in Japan.  It was the hand of Japan Inc.  It was Japan Inc. that pursued economic policies that it thought best.  Not the millions upon millions of ordinary Japanese citizens.  Well, Japan Inc. thought wrong. 

There was collusion between Japanese businesses.  And collusion between Japanese businesses and government.  And corruption.  This greatly inflated the Japanese stock market.  And those great big bubbles finally burst.  The powerful Japan Inc. of the 1980s that caused fear and trembling was gone.  Replaced by a Japan in a deflationary spiral in the 1990s.  Or, as the Japanese call it, their lost decade.  This once great Asian Tiger was now an older tiger with a bit of a limp.   And the economy limped along for a decade or two.  It was still number 3 in the world, but it wasn’t what it used to be.  You don’t see magazine covers talking about it owning other nations any more.  (In 2010, China took over that #3 spot.  But China is a managed economy.   Will it suffer Japan’s fate?  Time will tell.)

The Japanese monetary authorities tried to fix the economy.  Interest rates were zero for about a decade.  In other words, if you wanted to borrow, it was easy.  And free.  But it didn’t help.  That huge economic expansion wasn’t real.  Business and government, in collusion, inflated and propped it up.  It gave them inflated capacity.  And prices.  And you don’t solve that problem by making it easier for businesses to borrow money to expand capacity and create jobs.  That’s the last thing they need.  What they need to do is to get out of the business of managing business.  Create a business-friendly climate.  Based on free-market principles.  Not mercantilism.  And let that invisible hand work its wonders.

MONETARY POLICY CAN do a lot of things.  Most of them bad.  Because it concentrates far too much power in too few hands.  The consequences of the mistakes of those making policy can be devastating.  And too tempting to those who want to use those powers for political reasons.  As we can see by Keynesian ‘stimulus’ spending that ends up as pork barrel spending.  The empirical data for that spending has shown that it stimulates only those who are in good standing with the powers that be.  Never the economy.

Sound money is important.  The money supply needs to keep pace with economic expansion.  If it doesn’t, a tight money supply will slow or halt economic activity.  But we have to use monetary policy for that purpose only.  We cannot use it to offset bad fiscal policy that is anti-business.  For if the government creates an anti-business environment, no amount of cheap money will encourage risk takers to take risks in a highly risky and uncertain environment.  Decades were lost trying.

No, you don’t stimulate with monetary policy.  You stimulate with fiscal policy.  There is empirical evidence that this works.  The Mellon tax cuts of the Harding administration created nearly a decade of strong economic growth.  The tax cuts of JFK were on pace to create similar growth until his assassination.  LBJ’s policies were in the opposite direction, thus ending the economic recovery of the JFK administration.  Ronald Reagan’s tax cuts produced economic growth through two decades. 

THE EVIDENCE IS there.  If you look at it.  Of course, a good Keynesian won’t.  Because it’s about political power for them.  Always has been.  Always will be.  And we should never forget this.


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