Jimmy Carter, Malaise, Ronald Reagan, Austrian Economics, Morning in America, Barack Obama, Keynesian Economics and Great Recession

Posted by PITHOCRATES - September 4th, 2012

History 101

It was Morning in America again because Ronald Reagan reduced the Misery Index by 42.7%

Ronald Reagan was a supply-sider when it came to economics.  Of the Austrian school variety.  In fact, one of his campaign promises was to bring back the gold standard.  A very Austrian thing.  The Austrian school predates the Keynesian school.  When the focus was on the stages of production.  Not on consumer spending.  These policies served the nation well.  They (and the gold standard) exploded American ingenuity and economic activity in the 19th century.  Making the U.S. the number one economy in the world.  Surpassing the nation that held the top spot for a century or more.  Perhaps the last great empire.  Great Britain.

Following the stagflation and misery (misery index = inflation rate + unemployment rate) of the Seventies Reagan promised to cut taxes and governmental regulations.  To make it easier for businesses to create economic activity.  Easier to create jobs.  And he did.  Among other things.  Such as rebuilding the military that the Carter administration severely weakened during the Seventies (it was so bad that the Soviet Union put together a first-strike nuclear option.  Because they thought they could win a nuclear war with Jimmy Carter as president).  During the 1980 campaign Reagan asked the people if they were better off after 4 years of Jimmy Carter.  The answer was no.  Four years later, though, they were.  Here’s why.  (Note:  We used so many sources that we didn’t source them here to save space.  The inflation rate and unemployment rates are for August of the respective years.  The dollar amounts are annual totals with some estimates added to take them to the end of 2012.  The debt and GDP are not adjusted for inflation as they are only 4 years apart.  Gas prices and median income are adjusted for inflation.  There may be some error in these numbers.  But overall we believe the information they provide fairly states the economic results of the presidents’ policies.  (This note applies to both tables.))

Reagan entered office with some horrendous numbers.  The Carter administration was printing so much money that inflation was at 12.9% in 1980.  Added to the unemployment rate that brought the misery index to 20.6%.  A huge number.  To be fair Carter tapped Paul Volcker to be Fed Chairman and he began the policy of reigning in inflation.  But Carter did this far too late.  The only way to cure high inflation is with a nasty recession.  Which Volcker gave Ronald Reagan.  But it worked.  By 1984 inflation fell 8.8 points or 66.7%.  Even with this nasty recession the unemployment rate fell 0.2 points or 2.6%.  Which shaved 8.8 points off of the miserable index.  Or reducing it by 42.7%.  This is why it was morning in America again.  The Left to this day say “yeah, but at what cost?” and point to the record deficits of the Reagan administration.  Saying this is the price of tax cuts.  But they’re wrong.  Yes, the debt went up.  But it wasn’t because of the tax cuts.  Because those tax cuts stimulated economic activity.  GDP rose 12.6% by 1984.  And tax receipts even increased with those lower tax rates.  Because of the higher GDP.  By 1984 Reagan’s policies increased tax revenue by 28.9%.  And on a personal level the median income even increased 0.4%.  And this following a very bad recession a few years earlier.  Finally, gas prices fell 22.2%.  And the way Americans feel about rising gas prices this was truly morning in America again.

To Top off the General Malaise of the Obama Economy Gas Prices Soared while Median Income Fell

Barack Obama is a Keynesian through and through.  A believer in pure demand-side economics.  To that end his administration focused everything on increasing consumer spending.  Tax and spend policies.  Income redistribution.  Deficit spending.  Anything to make America ‘more fair.’  Raising taxes on the rich so the poor can spend more money.  With the Keynesian multiplier they believe this is the path to economic prosperity.  Just doing everything within their power to put more spending money into the hands of poorer people.  Increasing government regulation, fees and fines as well as taxes to bring more money in Washington so they can redistribute it.  Or spend it directly on things like roads and bridges.  Or solar power companies.  Even paying people to dig a hole and fill it back in.  Because these people will take their wages and spend them.  Creating economic activity.

So President Obama put Keynesian economics to work.  Beginning with a $787 billion stimulus bill.  Investments into green energy and the jobs of the future.  Like a Department of Energy loan of $528 million to the now bankrupt Solyndra.  Which was only one of many loans.  The bailout of the UAW pension fund (aka the auto bailout).  The government poured $528 million into GM.  And President Obama touted the Chevy Volt, boasting that GM would sell a million each year bringing his green goals to fruition (GM is struggling to sell 10,000 Volts a year).  A lot of malinvestment as the Austrians would say.  But a Keynesian sees any government expenditure as a good investment.  Because if all the people who receive this government money spends at least 80% of it (while saving only 20%) the Keynesian multiplier will be five.  Meaning that the net gain in GDP will be five times whatever the government spends.  So how has that worked for the president?  Well, here are his numbers:

The government spent so much money that the federal debt increased by $5.4 trillion.  Trillion with a ‘T’.  That’s over a trillion dollar deficit each of the president’s 4 years in office.  And his last year isn’t even a whole year.  Unprecedented until President Obama.  And what did all of that federal spending get us after about 4 years?  An unemployment rate 2.1 points higher.  Or 33.9% higher than when he took office.  Inflation fell but it did nothing to spur GDP growth which grew at an anemic 3.1%.  Which is less than a percentage point a year.  Which is why the Great Recession lingers still.  Meanwhile the Chinese are having a bad year with a GDP growth of 7.8%.  So all of that spending didn’t help at all.  In fact, it made things worse.  The economic activity is so bad that even tax receipts fell 2.2% after four years of President Obama.  Which has many in his party saying that we need to raise tax rates.  Contrary to what Ronald Reagan did.  And to top off the general malaise of the Obama economy gas prices soared 107.6% under his presidency.  While the median income fell 7.3%.  One has to look hard to find any positive news from the Obama economy.  And there is one.  Inflation did fall.  But even that really isn’t good.  As it may be an indicator of a looming deflationary spiral.  Giving America a lost decade.  Like Japan’s Lost Decade.

The Flaw in Keynesian Thinking is that it Ignores the Layers of Economic Activity above the Consumer Level

So there you have an Austrian and a Keynesian.  Both entered office during bad economic times.  Although things were much worse when President Reagan took office than when President Obama took office.  The misery index was 20.6% in 1980.  It was only 11.6% in 2008.  About half as bad for President Obama than it was for President Reagan.  It came down 16.4% under Obama.  But it came down 42.7% under Reagan.  Which is why it isn’t morning in America under President Obama.  Reagan increased tax receipts by 28.9 % by the end of his first term.  They fell 2.2% under Obama.  Adjusted for inflation Reagan averaged annual deficits of $348 billion.  That’s billion with a ‘B’.  Obama averaged $1.324 trillion.  That’s trillion with a ‘T’.  Or 280% higher than Ronald Reagan.  Gas prices fell 22.2% under Reagan.  They rose 107.6% under Obama.  Median income barely rose 0.4% under Reagan.  But it fell 7.3% under Obama.  In short there is nothing in the Obama economic record that is better than the Reagan economic record.

And why is this?  Because Obama’s policies are Keynesian.  While Reagan’s policies were Austrian.  Reagan focused on the stages of production to improve economic activity.  Cutting taxes.  Reducing regulatory compliance costs.  Creating a business-friendly environment.  A system that rewarded success.  Whereas Obama focused on consumer spending.  Tax, borrow and print (i.e., quantitative easing).  So the government could spend.  Putting more money into the pockets of consumers.  Which stimulated only the last stage in the stages of production.  So while some consumers had more money it was still a business-unfriendly environment.  Where tax, regulatory and environmental policies (as well as the uncertainty of Obamacare) hindered business growth everywhere upstream from retail sales.  From raw material extraction to industrial processing to construction to manufactured goods.  Where these Obama’s policies punish success.  For the bigger you get the more you pay in taxes and regulatory compliance costs.

The greatest flaw with Keynesian economics is that it looks at aggregate supply and demand.  With a focus on consumer spending.  And ignores the layers of economic activity that happens before the consumer level.  The Austrian school understands this.  As did the British when she became one of the greatest empires of all times.  As did America during the 19th century.  No nation became an economic superpower using Keynesian economics.  Japan grew to be a great economic power during the Fifties and Sixties.  Then went Keynesian in the Eighties and suffered their Lost Decade in the Nineties.  Some Keynesians like to point to China as an example of the success of Keynesian economics.  But they still have a fairly restrictive police state.  And their economic policies are hauntingly similar to Japan’s.  Some have even posited that it is very possible that China could suffer the same fate as Japan.  And suffer a deflationary spiral.  Resulting in a lost decade for China.  Which is very plausible considering the Chinese practice state-capitalism where the state partners closely with businesses.  Which is what the Japanese did in the Eighties.  And it hasn’t been great for them since.  As it hasn’t been great in America economically since the current administration.

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Keynesian Multiplier

Posted by PITHOCRATES - September 3rd, 2012

Economics 101

At the Heart of Keynesian Stimulus Spending is the Keynesian Multiplier

Key to Keynesian economics is spending.  That’s the reason why governments everywhere embrace it.  Because Keynesian economics say government MUST spend money.  And that’s the kind of economics politicians like.  “I must spend?  Well, okay.  If you say so.  Forgive me, my constituents, for spending money I don’t have.  But it’s not me.  It’s our Keynesian economists saying we must spend.  And they’re smart.  Real smart.  They even have Ivy League degrees.  So who are we to question them?”

And it’s not just any kind of spending.  Well, actually, it is.  There’s nothing special about it.  You could pass a trillion dollar stimulus bill to pay people to dig holes with a shovel.  Fill them back in with the dirt they just shoveled out.  And then repeat.  Again and again.  Accomplishing nothing beneficial with these efforts.  But a Keynesian economist will approve of this spending and call it a good thing.  Why?  Because of trickle-down economics.  But of the Keynesian kind.

At the heart of Keynesian stimulus spending is the Keynesian multiplier.  That’s the ‘trickle down’ part.  But before we get to that we must discuss one other thing.  Savings.  Keynesians hate it.  They call money that leaks out of the economy into savings accounts wasted money.  Just as if you flushed it down the toilet.  This brings up another Keynesian concept.  The marginal propensity to consume (MPC).  Note the word ‘consume’.  This is what all that government spending is about.  Consumption.  Consumer spending.  Which is why Keynesians hate savings.  Because if people save their money they’re not spending it.  And not creating economic activity.

Politicians prefer Government Spending over Tax Cuts because People may Save Part of a Tax Cut

Now back to the multiplier.  When people receive money they do two things.  They save some of it.  And spend what they don’t save.  This is where the MPC comes in.  An MPC 0f 80% means that people will spend 80% of an amount of money they receive (paycheck, government benefit, etc.) and save 20% of it.  So they use 80% of that money to generate economic activity.  By spending it.  But it doesn’t end there.  Because what they spend other people receive as money.  And these people then save some of it.  And spend what they don’t save.  And so on.  At a MPC of 80% if a person receives $100 they will spend $80 and save $20.  Those who receive that $80 will spend $64 and save $16.  Those who receive $64 will spend $51.20 and save $12.80.  And on and on until people are only spending pennies.  In the end that original $100 will create a total of $500 in new economic activity.  Or five times the original amount.  So the Keynesian multiplier is five.  Or, mathematically, 1/(1-MPC) where MPC = 0.80.

Think of the multiplier as a pyramid of champagne glasses at a wedding.  As you pour champagne in the top glass it overflows into the next layer of glasses down.  When these glasses fill they overflow into the next layer of glasses below them.  The multiplier is kind of like that.  Starting by pouring into one glass.  By the time the champagne bottle is empty champagne fills many glasses.  And spilt champagne represents savings.  Or leakage.  That’s how the multiplier works.  Trickle down.  And the less champagne spilled the more champagne fills glasses.  As shown by the multiplier formula.  The larger the MPC is (as in the more people spend) the larger the multiplier.  In fact if they spent all of their money (an MPC = 1) the formula reduces to 1/0.  And what happens when you divide by zero?  You get infinity.  That’s right, according to the Keynesian multiplier equation if everybody spent all of their money and saved none there would be an infinite amount of economic activity.

In the Keynesian world it doesn’t matter what the money is spent on as long as it’s spent.  Even digging worthless holes is good enough to make this miracle of economic activity out of nothing work.  That’s why their advice is always for the government to tax, borrow or print money to spend.  Because spending is good.  And they prefer government spending over tax cuts to stimulate private spending.  Why?  When the government spends money that top champagne glass will have an MPC of 1.  The government will spend it all.  Less the administrative costs, of course.  Whereas an equivalent amount of money given to the people via a tax cut (letting them keep more of their earnings to spend) will not have an MPC of 1.  Because these people may do something foolish like save their money.  Or pay down debt.  Which is leakage.  Leakage reduces the multiplier.  And a lower multiplier reduces economic activity.

Governments Embrace Keynesian economics because it tells them to Always Spend More Money

It all seems too good to be true.  And there’s a reason for that.  Because it IS too good to be true.  And the proof is in the pudding.  The Seventies was the decade of unrestrained Keynesian economics.  And it didn’t work.  They spent like there was no tomorrow in the Seventies.  But all that Keynesian spending failed to pull the economy out of recession.  All it did was create high inflation.  So there was high unemployment AND high inflation.  Something that was impossible in the Keynesian universe.  But it happened.  Why?  Because they make a lot of assumptions to make their formulas work.  Like that MPC.  And their war on savings.  Their thinking is flawed.  Because savings ARE spending.  Someone’s savings is someone else’s investment.  And investments are spending.  Ever see It’s a Wonderful Life when the people were asking for their deposits back?  The savings and loans had some money.  But they didn’t have everyone’s money.  Then George Bailey (Jimmy Stewart) told his depositors where their money was.  And he ran down a list of all the new houses their savings built.  Thanks to their loans to those new homeowners.  Building those houses generated a lot of economic activity.  So savings are good.  They’re not leakage.  They cause real economic activity.

Let’s return to that pyramid of champagne glasses.  Let’s say it takes 3 bottles of champagne to fill all the glasses in the pyramid.  If you pour the champagne back from the glasses into the bottles you will not have three full bottles of champagne.  Because of all that spillage.  Or leakage.  This is the same with Keynesian stimulus spending.  Stimulus money has to come from somewhere.  Whether government raises it with taxes, borrows it or prints it.  And like that champagne it just moves from one place in the economy to another.  With no net change in economic activity.  Higher taxes mean we have less money to spend.  If they borrow money they reduce private investment.  Because investors are buying government bonds instead if investing in businesses or entrepreneurs.  If they print money they cause inflation.  Which makes our money worth less and prices higher.  Which buys us less after the inflation than before it.  So whatever government spends there is a corresponding reduction in economic activity elsewhere in the economy.  Worse, when the government redistributes this money there is leakage.  Like the spillage of champagne.  For administrative costs.  Because politicians and government bureaucrats don’t work for free.

Printing money is especially harmful to the economy.  For it can cause a short-term boom in economic activity.  But by the time that new money works its way through the economy prices begin to rise.  Raising the cost of businesses.  Who have to raise their prices.  As they do their sales fall.  And they have to lay people off.  So the Keynesian stimulus spending to end a recession results in a new recession.  Which tends to be more painful than the first one.  So eventually a recessionary bust follows the artificial boom in economic activity.  Which brings those artificially high prices back down to normal market prices.  The greater the stimulus spending the higher those prices go.  The farther they have to fall.  And the more painful the recession.  Making the multiplier nothing but smoke and mirrors.  But governments still embrace Keynesian economics.  Because it is the only economic system that tells them to spend more money.  And they are always looking for something to justify more spending.

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