I discussed last week how Federal Reserve chairman Ben Bernanke's easy-money
policies could be reversed should Mitt Romney win the presidency and wish to
reverse them. It is only fair, therefore, to discuss the other possibility:
should Barack Obama be re-elected and (ignoring his fiscal and regulatory
policies, which in any case would be modified by congress) allow Bernanke to
run free with US monetary policy for another four years.
In modern history, since Bernanke's policies are unprecedented, we have no easy benchmark by which we can measure this outcome. As in many cases however, Adam Smith, writing before economic growth was taken to be universal and inevitable, has an admirable template for our future in a Bernanke-driven United States, in his analysis of the declining fortunes of 18th century Bengal.
In "Chapter VIII - The Wages of Labor" of his Wealth of Nations, having discussed the flourishing economies of Western Europe, the American colonies and the static but wealthy China, Smith turns his attention to the problem of decay: "But it would be otherwise in a country where the funds destined for the maintenance of labor were sensibly decaying," he begins.
That is of course precisely the situation in which the United States finds itself after nearly seven years of Bernankeist monetary policy, which followed 11 years of monetary over-expansion under Alan Greenspan. A decade or more of balance of payments deficits in excess of US$500 billion annually, accompanied by interest rates that have depressed the US savings rate far below the capital needs of the economy and four years of $1 trillion plus budget deficits, have hollowed out the US capital base.
Historically the US economy has been noted for its gigantic readily available stock of capital, giving every US worker the knowledge that he had the world's largest pool of capital behind him. This is no longer the case; a recent Congressional Research Services study shows that the US has the lowest manufacturing fixed capital formation of any major economy of the 34-member Organization for Economic Cooperation and Development.
This is having the same effect in today's United States as it had in Smith's Bengal. Median US real household income has declined by $4,000 in the last decade, and the decline is accelerating.
As Smith put it of Bengal, "Every year the demand for servants and laborers would, in all the different classes of employments, be less than it had been the year before. Many who had been in the superior classes, not being able to find employment in their own business, would be glad to seek it in the lowest. The lowest class being not only overstocked with its own workmen, but with the overflowings of all the other classes, the competition for employment would be so great in it, as to reduce the wages of labor to the most miserable and scanty subsistence of the laborer."
If that's not a description of many people's experience in the US economy of 2009-12, I don't know what is. So far, the social safety net, food stamps and so forth have prevented utter destitution, while minimum wage legislation has substituted unemployment (or more usually, withdrawal from the workforce) for plunging wage levels.
However, the qualitative description is sound, and four more years of severely negative real interest rates, hollowing out the US capital base still further, will make it ever more accurate. While nominal benefit levels may be maintained, at enormous cost to the declining number of solvent taxpayers, rising inflation will doubtless reduce real wage and benefit levels, producing an ever more realistic alignment with the Bengal of 250 years ago.
Reading Smith makes it quite clear that, however much the Obama administration may wish to shift the burden of economic difficulties to the rich, the adverse effects of the Obama/Bernanke policies will fall mainly on the working poor.
"The liberal reward of labor, therefore, as it is the necessary effect, so it is the natural symptom of increasing national wealth. The scanty maintenance of the laboring poor, on the other hand, is the natural symptom that things are at a stand, and their starving condition, that they are going fast backwards."
If we regard Bernanke's loose monetary policy as immovable before 2017 (or January 2018, when Bernanke's 2014 term will end) then the economic management problem becomes clear. Economic managers, whether in a possibly Republican congress or those appointed by Obama in his second term, will need to stem the loss of capital from the US economy. Ultra-low interest rates, by depressing US savings rates and encouraging excessive leverage and speculation, will make this very difficult, but there are nevertheless some steps that can be taken.
First, the $500 billion annual US balance of payments deficit must be lowered. The best way to do this is to lower the dollar against the currencies of US trading partners. "King Dollar" policies will only hasten the outflow of capital and inflow of imports. Protectionism, which would slow the latter, runs the risk in the current global recession that it would lead to retaliation from US trading partners.
It would also wreck the World Trade Organization, which has played a valuable if modest role in discouraging the world from lapsing into Smoot-Hawleyism in the global downturn. World trade in 2011 recovered to a level above that of 2007; given the depth of the recession that is a remarkable achievement, incomparably better than the 65% collapse of world trade in the 1930s.
Bernankeism, by printing far more dollars than can be absorbed by world demand, tends to weaken the dollar in any case; this tendency should be encouraged, and exports should be encouraged by any means possible.
Secondly, in a situation in which Bernankeism is tending to de-capitalize the US economy, reduction of the Federal deficit becomes a top priority. The Republicans in congress will be seen as more or less powerless; they should take advantage of this to cave to the Obama administration on taxation, allowing a large tax increase, as far as possible achieved by closing loopholes rather than raising rates. A value-added tax, while a dangerous instrument to leave in the hands of greedy legislators, would have the virtue of shifting taxation from income to consumption, thereby encouraging saving and reducing imports and the payments deficit.
Conversely, congressional Republicans should adopt the "root-canal" approach on spending, forcing massive reductions in discretionary spending, entitlements and even defense in return for their flexibility on taxes. A long-term solution of the medical financing problem along the lines of the Paul Ryan Plan, in return for a modest VAT, would be worth it on balance, provided overall spending was kept on a sufficiently tight leash.
Politically, congressional Republicans should be able to shift most of the blame for both tax increases and spending cuts onto the Obama administration, while any loss of the United States' international position as a result of the defense cuts could also be blamed on Obama's foreign policy.
The objective should be the smallest possible government, financed as far as possible from current revenues; this will reduce the cash outflow from the depleted US savings base. Any unpopularity from root-canalism will on balance redound to the GOP's benefit in 2016, but, more important, the long-term budget problem will be solved, and the drain of capital from the US economy will be minimized. US middle class living standards will continue to decline, but not as quickly as they would have without the "root-canal" policy, and the seed-corn of growth will be preserved for future generations.
There is of course the possibility that Bernankeism will collapse of its own accord before 2017. The most likely form such a collapse would take is a sudden upsurge in inflation. Given Bernanke's "quantitative easing" policy and the extreme nature of his interest rate policies it's likely that an inflation burst, if it occurred, would come suddenly, rather than gradually as in the 1970s. Alternatively, an uncontrollable surge in commodity and energy prices could cause an economic downturn, as was partly the case in 2008.
In either of these cases, policies of a weak dollar combined with extreme austerity in budget policy would make the danger of a Weimar or Great Depression scenario less severe. In the event of a collapse, policymakers should concentrate on using it to ensure the removal of Bernanke, reducing the damaging period during which his monetary policies are in effect. In this respect a weak dollar policy would be helpful; it could cause a foreign exchange crisis similar to that of 1978-79, forcing Bernanke's removal as that crisis forced the removal of G William Miller and his replacement with the estimable Paul Volcker.
In summary, even the prospect of another four years of Bernankeism is not grounds for excessive pessimism. While his policies, if allowed to combine with massive budget and payments deficits, could turn the United States into a 21st century version of Adam Smith's Bengal, there are tools of budget austerity and currency depreciation that can be used to counteract them. That these tools are likely to result in a reversal of Bernankeism and its replacement with sound policies is another very good reason for adopting them. Passivity in this case would not be a virtue.
In modern history, since Bernanke's policies are unprecedented, we have no easy benchmark by which we can measure this outcome. As in many cases however, Adam Smith, writing before economic growth was taken to be universal and inevitable, has an admirable template for our future in a Bernanke-driven United States, in his analysis of the declining fortunes of 18th century Bengal.
In "Chapter VIII - The Wages of Labor" of his Wealth of Nations, having discussed the flourishing economies of Western Europe, the American colonies and the static but wealthy China, Smith turns his attention to the problem of decay: "But it would be otherwise in a country where the funds destined for the maintenance of labor were sensibly decaying," he begins.
That is of course precisely the situation in which the United States finds itself after nearly seven years of Bernankeist monetary policy, which followed 11 years of monetary over-expansion under Alan Greenspan. A decade or more of balance of payments deficits in excess of US$500 billion annually, accompanied by interest rates that have depressed the US savings rate far below the capital needs of the economy and four years of $1 trillion plus budget deficits, have hollowed out the US capital base.
Historically the US economy has been noted for its gigantic readily available stock of capital, giving every US worker the knowledge that he had the world's largest pool of capital behind him. This is no longer the case; a recent Congressional Research Services study shows that the US has the lowest manufacturing fixed capital formation of any major economy of the 34-member Organization for Economic Cooperation and Development.
This is having the same effect in today's United States as it had in Smith's Bengal. Median US real household income has declined by $4,000 in the last decade, and the decline is accelerating.
As Smith put it of Bengal, "Every year the demand for servants and laborers would, in all the different classes of employments, be less than it had been the year before. Many who had been in the superior classes, not being able to find employment in their own business, would be glad to seek it in the lowest. The lowest class being not only overstocked with its own workmen, but with the overflowings of all the other classes, the competition for employment would be so great in it, as to reduce the wages of labor to the most miserable and scanty subsistence of the laborer."
If that's not a description of many people's experience in the US economy of 2009-12, I don't know what is. So far, the social safety net, food stamps and so forth have prevented utter destitution, while minimum wage legislation has substituted unemployment (or more usually, withdrawal from the workforce) for plunging wage levels.
However, the qualitative description is sound, and four more years of severely negative real interest rates, hollowing out the US capital base still further, will make it ever more accurate. While nominal benefit levels may be maintained, at enormous cost to the declining number of solvent taxpayers, rising inflation will doubtless reduce real wage and benefit levels, producing an ever more realistic alignment with the Bengal of 250 years ago.
Reading Smith makes it quite clear that, however much the Obama administration may wish to shift the burden of economic difficulties to the rich, the adverse effects of the Obama/Bernanke policies will fall mainly on the working poor.
"The liberal reward of labor, therefore, as it is the necessary effect, so it is the natural symptom of increasing national wealth. The scanty maintenance of the laboring poor, on the other hand, is the natural symptom that things are at a stand, and their starving condition, that they are going fast backwards."
If we regard Bernanke's loose monetary policy as immovable before 2017 (or January 2018, when Bernanke's 2014 term will end) then the economic management problem becomes clear. Economic managers, whether in a possibly Republican congress or those appointed by Obama in his second term, will need to stem the loss of capital from the US economy. Ultra-low interest rates, by depressing US savings rates and encouraging excessive leverage and speculation, will make this very difficult, but there are nevertheless some steps that can be taken.
First, the $500 billion annual US balance of payments deficit must be lowered. The best way to do this is to lower the dollar against the currencies of US trading partners. "King Dollar" policies will only hasten the outflow of capital and inflow of imports. Protectionism, which would slow the latter, runs the risk in the current global recession that it would lead to retaliation from US trading partners.
It would also wreck the World Trade Organization, which has played a valuable if modest role in discouraging the world from lapsing into Smoot-Hawleyism in the global downturn. World trade in 2011 recovered to a level above that of 2007; given the depth of the recession that is a remarkable achievement, incomparably better than the 65% collapse of world trade in the 1930s.
Bernankeism, by printing far more dollars than can be absorbed by world demand, tends to weaken the dollar in any case; this tendency should be encouraged, and exports should be encouraged by any means possible.
Secondly, in a situation in which Bernankeism is tending to de-capitalize the US economy, reduction of the Federal deficit becomes a top priority. The Republicans in congress will be seen as more or less powerless; they should take advantage of this to cave to the Obama administration on taxation, allowing a large tax increase, as far as possible achieved by closing loopholes rather than raising rates. A value-added tax, while a dangerous instrument to leave in the hands of greedy legislators, would have the virtue of shifting taxation from income to consumption, thereby encouraging saving and reducing imports and the payments deficit.
Conversely, congressional Republicans should adopt the "root-canal" approach on spending, forcing massive reductions in discretionary spending, entitlements and even defense in return for their flexibility on taxes. A long-term solution of the medical financing problem along the lines of the Paul Ryan Plan, in return for a modest VAT, would be worth it on balance, provided overall spending was kept on a sufficiently tight leash.
Politically, congressional Republicans should be able to shift most of the blame for both tax increases and spending cuts onto the Obama administration, while any loss of the United States' international position as a result of the defense cuts could also be blamed on Obama's foreign policy.
The objective should be the smallest possible government, financed as far as possible from current revenues; this will reduce the cash outflow from the depleted US savings base. Any unpopularity from root-canalism will on balance redound to the GOP's benefit in 2016, but, more important, the long-term budget problem will be solved, and the drain of capital from the US economy will be minimized. US middle class living standards will continue to decline, but not as quickly as they would have without the "root-canal" policy, and the seed-corn of growth will be preserved for future generations.
There is of course the possibility that Bernankeism will collapse of its own accord before 2017. The most likely form such a collapse would take is a sudden upsurge in inflation. Given Bernanke's "quantitative easing" policy and the extreme nature of his interest rate policies it's likely that an inflation burst, if it occurred, would come suddenly, rather than gradually as in the 1970s. Alternatively, an uncontrollable surge in commodity and energy prices could cause an economic downturn, as was partly the case in 2008.
In either of these cases, policies of a weak dollar combined with extreme austerity in budget policy would make the danger of a Weimar or Great Depression scenario less severe. In the event of a collapse, policymakers should concentrate on using it to ensure the removal of Bernanke, reducing the damaging period during which his monetary policies are in effect. In this respect a weak dollar policy would be helpful; it could cause a foreign exchange crisis similar to that of 1978-79, forcing Bernanke's removal as that crisis forced the removal of G William Miller and his replacement with the estimable Paul Volcker.
In summary, even the prospect of another four years of Bernankeism is not grounds for excessive pessimism. While his policies, if allowed to combine with massive budget and payments deficits, could turn the United States into a 21st century version of Adam Smith's Bengal, there are tools of budget austerity and currency depreciation that can be used to counteract them. That these tools are likely to result in a reversal of Bernankeism and its replacement with sound policies is another very good reason for adopting them. Passivity in this case would not be a virtue.
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