The Patriots

Bad economics can bring about or grow out of bad politics. But the question is, what are bad economics and bad politics?

Bad economics can bring about or grow out of bad politics. But the question is, what are bad economics and bad politics? Unless this is clearly and correctly identified, a bad situation can be made worse, and a good situation can be turned into a bad one. So sorting this out is crucial to having a free and prosperous society.

British economist, Robert Skidelsky, is confident that he knows the answer. In a recent article on “Good Politics, Bad Economics,” he states that bad economics and bad politics are free markets and limited government along classical liberal lines. How does he know that such economics and politics are “bad” in their effects on the society? The financial crisis of 2008-2009, Skidelsky says, was due to unbridled financial markets combined with “hands-off” economic policies once the downturn set in, in 2009-2010.

Good politics and good economics, in his view, comprise an openness and sensitivity to the concerns of many in the society for social securities and job assurances in a changing and uncertain world. Oh, Adam Smith’s invisible hand of unhampered free markets is fine enough when taking the long view, but, Skidelsky says, they are “also highly disruptive and prone to periodic breakdown,” in the shorter run.

Skidelsky: Populist Demagogues as Good Economists

Adhering to such Smithian free market policies opens the door to “populist” demagogues, such as Victor Orban in Hungary who has instituted illiberal political policies attempting to restrict civil liberties and personal freedom. But, on the other hand, as far as Skidelsky is concerned Orban has a highly redeemable set of good fiscal policies, based on a “sound Keynesian footing.”

This echoes back to the infamous forward that John Maynard Keynes (1883-1946) wrote for the German translation of his, The General Theory of Employment, Interest, and Money (1936), that “The theory of output as a whole, which is what the following book purports to provide, is much more easily adapted to the conditions in a totalitarian state than . . . under conditions of free competition and a large measure of laissez-faire . . .”

It is worth recalling that in 1936, the only remaining academic economists to whom the content of Keynes’s book could be addressed in recommending it as a guide for government economic policy were Nazi economists, since all others already had been removed from university and related positions by Hitler’s National Socialist regime.

Following in the footsteps of his intellectual mentor (being the author of a highly regarded three-volume biography of Keynes), Skidelsky points out that illiberal nationalist regimes such as Orban’s find it far easier “to pursue policies of social protection.” Why? They can use the heavy hand of government control to impose such policies on society without the type of resistance or public criticism possible in a more politically open liberal system.

The Bigger the Government, the Better for Keynesians

The smaller the government’s fiscal presence in the economic activities within a country, the less is likely to be the impact from “activist” government spending policies, since government expenditures and taxation would be relatively small to start with. If there is, say, a $1 trillion economy, with government taxing and spending only representing one percent (or $10 billion), a 20 percent increase in government spending in the form of a budget deficit only comes to an additional $2 billion.

But if, on the other hand, out of a $1 trillion economy, government taxing and spending comes to, say, 20 percent that is equal to $200 billion. If, now, the government increases it’s spending by only 5 percent through deficit financing that comes to $10 billion, or five times as much as in the first case.

Keynes’s point, and Skidelsky’s, is that the greater the degree of government influence or control over the economic activities within a country to begin with, including the size of government spending as a percent of the economy as a whole, the larger the impact from any increase in spending by that government. The bigger the government, the more policy-relevant is the introduction or expansion of Keynesian-type fiscal policies.

In fairness, Keynes had no sympathy for the ideology or the politics of the Nazi regime in Germany, and Robert Skidelsky is equally unsympathetic with the political and cultural policies of Orban’s government in Hungary. But Skidelsky believes that the best way to prevent or make less likely the coming to power of a populist, “right-wing” government like Orban’s is for a more liberal and democratic government to introduce “good” Keynesian and other interventionist policies before economic circumstances become so bad in a country that the citizens turn to an Orban-type of leader, due to the affects of “bad” free market policies that limit the size and scope of a government to “fix” and set things right.

Bastiat and Hazlitt: Good Economists Look Beyond the Short Run

Slightly modernizing the insight of the French free market economist, Frederic Bastiat (1801-1850) in his famous essay, “What is Seen and What is Not Seen,” economic journalist Henry Hazlitt (1894-1993) explained the crucial difference between a “bad” and  “good” economist in his classic, Economics in One Lesson (1946):

“The bad economist sees only what immediately strikes the eye; the good economist also looks beyond. The bad economist sees only the direct consequences of a proposed course; the good economist looks also at the longer and indirect consequences. The bad economist sees only what the effect of a given policy has been or will be on one particular group, the good economist inquires also what the effect of the policy will be on all groups . . .

“The long-run consequences of some economic policies may become evident in a few months. Others may not become evident for several years. Still others may not become evident for decades. But in every case those long-run consequences are contained in the policy as surely as the hen was in the egg., the flower in the seed . . . The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences not merely for one group but for all groups.”

Now no personal or moral slight is intended by implying that Robert Skidelsky, by Bastiat’s and Hazlitt’s definition, is a “bad” economist. It simply means that it is “bad economics” if the analyst, for whatever reason, exclusively or primarily focuses on the immediate or nearer effects from a government policy while ignoring or downplaying the possible or likely impact of such policies when taking the longer-run perspective on what the consequences of a policy may be.

The reason being, as the old adage says, “the road to hell is paved with good intentions.” It is clear from Skidelsky’s argument that he is concerned that if a “good” or well-intentioned government pursues “bad” economic policies, it may create the political conditions in which an authoritarian or populist demagogue may be able to promise “good” interventionist economics, some of which he might even successfully deliver, but at the cost of reduced or lost political and civil liberties.

However, a “good” diagnosis requires a correct judgment concerning the cause and nature of the (social) ailment. Otherwise, the illness may be made worse, or at a minimum recovery may be delayed or prolonged more than otherwise might have been necessary.

Short-Run Policies Created the 2008-2009 Crisis

What Skidelsky interprets as the economic system prevailing in the United States and most other Western countries has little to do with how classical liberals define a “free market.” Financial markets have been and are heavily regulated by government regulatory agencies. The creation of money and credit and the rates of interest they charge to borrowers are not truly market-based. Central banks set the regulatory and loan-creating rules for the member banks within the banking systems.

Governments and their central banks created the financial crisis of 2008-2009. For years the Federal Reserve had been increasing the quantity of loanable funds in the banking system, and when adjusted for price inflation as measured by the consumer price index, some real interest rates were negative. (See my article, “Interest Rates Need to Tell the Truth”.)

In other words, loan money was being handed out for free in terms of real buying power that a borrower was paying back to lenders for the period of their loans. To get the central bank-created money in the banking system out the door, besides the equivalent of negative interest charges on some loans, the banks were induced to extend loans to uncredit-worthy home buyers with the promise that government agencies like Fanny Mae Freddie Mac would pick up the tab if and when the loans went bad – which many eventually did.

Bad Economics and Short-Run Politics Cause Society’s Ills

What had motivated these policies? In the case of the Federal Reserve, a fear in the early years of the 21st century that there might be a tendency for price deflation, which the Fed Board of Governors decided had to be prevented at all costs through counter-acting monetary expansion. The longer run consequence was an unsustainable financial and investment bubble that came crashing down in 2008-2009. (See my article, “Don’t Fear ‘Deflation,’ Unless Caused by Government”.)

In the case of the housing market, pressures by members of Congress were placed on the government’s home loan guaranteed agencies – Fannie Mae and Freddie Mac – that not enough people were attaining the American dream of having their own home, especially among members of minority communities in the United States. So credit standards were lowered or seemingly almost waved. Banks were told not to worry; just extend home loans to those not meeting the traditional credit-worthy standards of income and work history or not enough of a usual down payment, because if things went wrong those government agencies guaranteed to cover any that went “bad.”

Misplaced fears about possible price deflation and the pressures of politicians looking no further than needing votes from happy home-owning constituents; these were the short-run policy contexts that created the longer run disaster of one of the severest economic downturns of the post-World War II period.

Macroeconomic Mindset Prevents Understanding of Markets

Both factors reflected the bad economics of focusing on the short-run. The Keynesian mindset is to have the monetary central planners try to micro-manage every twist and turn in the financial and economic climate, and frequently turn the money-creation and interest rate dials in an attempt to keep the macro-economy on an even keel, as the defined by the Keynesian-oriented policy makers.

The same applies to using government taxing and spending to try to influence investment, employment and wages in the economy as a whole. But, again, what this mindset summarizes away in the macroeconomic aggregates used as indicators and targets are the complex and interconnected microeconomic relationships in the structure of relative prices and wages, relative profitabilities of directing productions to satisfy multitudes of different consumer demands, and the need for on-going and continuous adaptations and adjustments in prices and wages, and the allocation of resources (including labor) for successful economy-wide coordination of what everyone is doing in the social system of the division of labor. (See my article, “Macro Aggregates Hide the Real Market Processes at Work”.)

The Best Short and Long Run Policy: Limited Government

For a market economy to succeed in this endeavor the only long run set of policies for any government needs to undertake is to protect the individual and private property rights of the citizenry, enforce all contracts and agreements peacefully and voluntarily entered into that are not fraudulent or misrepresentations, and prevent foreign aggressors from invading and plundering the people within a country.

This represents the “good politics” of a (classical) liberal political order that helps secure people’s liberty and assures the economic setting most conducive to prosperity and price-guided market coordination. A stable and healthy market order such as this precludes the likelihood of the disruptions and distortions that are central to Skildelsky’s concerns.

If such disruptions do arise for some external reason, it remains nonetheless the best long run and short run policy for open and competitive markets to be left free to rebalance and recoordinate in the most appropriate and timesaving ways possible. Government planners, regulators and bureaucrats can never know or acquire the needed and necessary microeconomic knowledge of time and circumstance that only the actors within the various sectors of the economy can discover and attempt to utilize in the most effective manner.

Following this type of economic policy approach is most likely to preclude the emergence and attractiveness of the populist demagogues that Skidelsky fears as threats to political freedom and civil liberties. His proposed policies are far more likely to bring about the very “bad politics” about which he is rightly concerned.

[Originally Published at the American Institute for Economic Research]

Alexander Hamilton was America’s first Secretary of Treasury under President George Washington. When he first entered office in 1789, America was an agricultural nation of just 4 million still broke from its financially costly victory over the British Empire in the Revolutionary War.

The states had accumulated relatively massive debts to finance that war, which mostly remained unpaid. The United States did not even have a national currency, with Spanish coins still in wide circulation and use. Steve Forbes explains in his recently published definitive work, Money: How the Destruction of the Dollar Threatens the Global Economy and What We Can Do About It, “America’s finances were in a state of disarray after the wild inflation resulting from massive money printing during the American Revolution.” As a result, “Hamilton faced the challenge of restoring the economy of the young republic that had been devastated by the Revolutionary War….”

Hamilton boosted America’s economy first by advancing legislation for the federal government to assume and pay off the debts of the states, establishing the foundation for America’s historic creditworthiness. That was recognized by America’s AAA credit rating for over 200 years, until 2011 when the relentless spending of the Obama Democrats led to the first credit downgrade of the nation in history.

But even more importantly for the nation’s long term economic growth and prosperity, Hamilton promoted The Coinage Act of 1792, which established the first U.S. Mint, and fixed the value of the dollar at $19.39 per ounce. That was devalued slightly in 1834 to $20.67, which prevailed for 100 years, until President Roosevelt adopted the only major U.S. devaluation in history during the Depression, to $35 an ounce. That prevailed until President Nixon took America off the gold standard in 1971.

Forbes explained the results: “Overnight the economy sprang to life. Capital poured in from the Dutch and also America’s former enemies, the British. Barely a century after Hamilton’s reforms, the United States was the premier industrial power in the world, surpassing even Great Britain.” He added, “Hamilton’s system of banking and stable money quickly attracted and generated capital. It turned the American economy into the leading industrial power in the world.”

Forbes further explains that while America was under the gold standard, the economy boomed at an astounding 4% real rate of economic growth. At that rate, our economy, incomes and standard of living would double every 17 years. That was the foundation of the American dream and our historic, geometric explosion into the world’s leading “hyperpower.”

Forbes adds that in the U.S., “Between 1870 and 1914, real wages more than doubled even though the country had millions of immigrants [greatly expanding the supply of labor]. Agricultural output tripled. Industrial production… surged a jaw-dropping 682%.”

Campaign poster showing William McKinley holding U.S. flag and standing on gold coin “sound money”, held up by group of men, in front of ships “commerce” and factories “civilization”. (Photo credit: Wikipedia)

The question is why did Hamilton understand economics so much better than the Ivy League poobahs of today, like Paul Krugman, who are more interested in promoting the socially hip stagnation of socialist equality than the dynamic economic growth of capitalism.

If only Colonel Hamilton was alive today, he would be more worthy of the Nobel prize in economics than at least half of those prize winners living today.

Great Britain experienced quite similar results under the gold standard. In 1696, the Enlightenment philosopher John Locke was joined by the path-breaking scientist and physicist Isaac Newton in arguing against devaluation in the process of Britain replacing or “recoining” its debased currency with new, unshaved, fully restored coins.

By 1717, Newton was Master of the Royal Mint, and he fixed the British pound to the value in gold of 3.89 pounds an ounce. That exact same historic value remained the same for more than 200 years, until 1931.

Forbes notes, “When it tied the pound to gold, Britain was a second-tier nation. Soon all of that would change.” A century later, “By the end of the Napoleonic Wars in 1815, Great Britain emerged indisputably as the world’s major power and global center of innovation.”

Economic Benefits of the Gold Standard

Fixing a nation’s currency to gold assures that the currency maintains a stable long term value, without inflation, or deflation. That enables a nation’s money to serve as a measure of value, like a ruler measures inches, or a clock measures time. Such a stable measure of value, in turn, means money can best perform its most essential function in facilitating transactions.

When money serves as a stable measure of value, it most clearly expresses the value of everything in terms of everything else.

That best enables producers to determine whether their production is adding or wasting value as compared to the value of the inputs to that production. Or whether they should be producing something else instead that might create greater value. That information is essential for an economy to maximize output and economic growth over time.

When a farmer trades his crop for such stable money, he immediately knows what that crop is worth. And he knows that he can keep that value of his production in the currency because it will hold its value over time, until he is ready to buy something with it.

That stability of the reward for production undisturbed by monetary fluctuations adds further to the incentive for such production.

Similarly, with a stable value for money, investors know the money they will receive back from their investment will be worth the same as the money they put in it, undepreciated by inflation. That encourages greater savings, investment and capital formation from within the country. And it encourages investment and capital to flow into the country from abroad. This maximizes overall investment, production and economic growth.

Nixon Takes America Off the Gold Standard

On August 15, 1971, President Nixon took America, and the world, off the gold standard completely, leaving a world of unanchored fiat currencies, by terminating the postwar Bretton Woods monetary regime.

Nixon and his advisors mistakenly believed that this would help the economy by promoting American exports, which Forbes recognizes as 18th century mercantilist thinking. [It was Roosevelt who took America off the Gold Standard, See the end of Bretton Woods - ED]

But it was a decisive turn for the worse for the American economy, and the entire global economy. Since that time, real annual U.S. economic growth has averaged 3%, down 25% from the prior gold standard long term trend. Forbes explains,

“If America had grown for all of its history at the lower post-Bretton Woods rate, its economy [today] would be about one quarter of the size of China’s. The United States would have ended up much smaller, less affluent, and less powerful.”

Moreover, “Since 1971, the dollar’s purchasing power has declined by more than 80%,” with about a third of that (26%) since 2000. Real incomes have been stagnant, or even declined. “[A] man in his thirties or forties who earned $54,163 in 1972 today earns around $45,224 in inflation adjusted dollars — a 17% cut in pay.”

Unemployment has been significantly higher on average. Globally, “After the 1970s, world economic growth has been a full percentage point lower; inflation 1.5% higher.”

Forbes observes, “The correlation between unstable money and an unstable global economy would seem obvious.” Indeed, the termination of any link between the dollar and gold immediately inaugurated worsening boom and bust cycles of inflation and recession in the 1970s, with inflation soaring into double digits for several years. Inflation peaked at 25% over just two years in 1979 and 1980.

It took the worst recession since the Great Depression in 1981-1982 to tame that inflation, with double digit interest rates for years, and unemployment peaking at 10.8%. The Reagan/Volcker/Greenspan strong dollar monetary policies effectively restored a discretionary link to gold, with gold stabilizing around $300 to $350 for 20 years. That kept close control over inflation.

But this discretionary standard broke down as 2000 approached. The Fed loosened money and reduced interest rates over the Y2K scare, contributing to the tech stock bubble. Much worse, the Bush Administration supported a weak dollar monetary policy again on the mercantilist/Keynesian confusion that would help the economy by promoting exports.

That included more loose money and 2½ years of negative real interest rates which served to pump up the housing bubble and lead, along with Clinton’s wild over regulation (in the name of affordable housing), to the 2008 financial crisis and recession.

The best thing about Steve Forbes’ new book, Money, is that it discusses exactly the specific reforms that should be adopted today to establish a modern, 21st century link to gold for the dollar. That new system would not require the federal government to hold any gold stockpiles, and the money supply would not be limited to the availability of any quantity of gold.

Federal law would fix the dollar’s value in gold at a specified market price. That price would be set by some index to recent market prices for gold, perhaps the average gold price for the last five to 10 years, marked up by 10% as a hedge against causing deflation in the process. Federal law would mandate that the Fed conduct its monetary policy to ensure a stable value of the dollar at that market price.

The Fed would enforce that price through its open market operations buying and selling U.S. government bonds. If the price of gold began wandering in the market above the specified market price, that would signal the threat of inflation, and the Fed would begin tightening monetary policy by selling bonds to the market in return for cash withdrawn from the market.

That reduced money supply would hold down price increases in the market, including for gold. The Fed would continue this policy, until the market price for gold returned to its specified target value.

If the price of gold began wandering in the market below the specified market price, that would signal the threat of deflation. The Fed would then begin loosening monetary policy by printing cash to buy U.S. government bonds in the market. That would increase the money supply, which would tend to increase prices in the marketplace, including for gold.

The Fed would continue this policy until the market price for gold returned to its specified target value. The Fed would be required by the federal law to take such actions to prevent the price of gold from varying from the target price by more than 1%, which was the range permitted under the Bretton Woods system for currencies to fluctuate against the then gold backed dollar.

The federal law would provide that this new monetary policy would become effective at a specific date set in the future, perhaps 12 months away, to enable the private economy to plan for and adjust to the new policy. The law should grant the President or some other federal official the power to adjust the target price for gold to reflect more recent market prices as the implementation date approaches.

Those more recent market prices would better reflect what the target gold price should be when the dollar is based on this new link to gold.

A lesson learned from experience with President Obama, the law should also specify that any member of Congress would have standing to sue the President or other designated official if he or she did not carry out the law regarding this later market based adjustment as provided, and that federal courts would have the power to enforce relief. For example, not following more recent market prices in adjusting the target price would be a violation of the law.

This would effectively mean that the Fed would no longer have any power to pursue discretionary monetary policies to try to guide the economy in one direction or another. The new federal law would bar the Fed from attempting to manipulate interest rates, for example.

The Fed would no longer have the power to set the federal funds rate, which is the rate banks pay to one another to borrow reserves. The Fed would continue to have the power to act as a lender of last resort to deal with financial panics that might temporarily threaten an otherwise sound bank.

So the Fed could continue to set the “discount rate” that it would charge for such short term, lender of last resort borrowing. But even that would be required to be set above market rates, so that the Fed would not become a cheap source of funds for banks to borrow to lend out.

Along with a federal balanced budget amendment to the Constitution, this would effectively make Keynesian economics illegal. That would be highly desirable, because Keynesian economics is proven not to work, and Keynesian advocates are so oblivious to reasoned discussion on the point.

As a safeguard to help ensure that the Fed did follow its responsibilities under this new law, the law should specify that anyone could turn dollars into the Fed, and get gold at the legally specified target price. If the Fed was following the law, it could always buy gold in the market to pay for such a redemption in return for the target price for gold.

If the Fed was not following the law, then it would likely not be able to finance such mandatory redemptions. The new federal gold law should again specify that any member of Congress would have automatic standing to sue the Fed to enforce the law.

Another safeguard would involve removing all barriers to the rise of private, competing, alternative currencies, to challenge the Fed to enforce and follow the law. That would mean no taxes, including capital gains taxes, could be assessed on sales of gold and silver. If the Fed did not follow the law, then these competing currencies could displace the dollar.

Such a new gold link to the dollar would be the last, missing component to any comprehensive strategy to restore traditional, world leading, American prosperity. Such a strategy would include as well personal and corporate tax reform to lower tax rates, deregulation of unnecessary regulatory costs and barriers, reduced federal spending to balance the budget and reduce the national debt as a percent of GDP, and free trade.

Those policies could be expected to restore long-term U.S. economic growth to 4% of GDP, which would leapfrog the American economy another generation ahead of the rest of the world.

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