Legislating Prosperity

Martin Feldstein is currently the president emeritus of NBER (the National Bureau of Economic Research), the body charged with determining that recessions have begun long after everybody knows they have, is the 'George F. Baker' Professor of Economics at Harvard University, was once the chairman of the Council of Economic Advisers in the Reagan era (during which time he reportedly was unhappy with Reagan's huge budget deficits and acquired a reputation of being a 'deficit hawk' - not that it did much good), and has once been mentioned at being in the running for the nowadays prestigious, if thankless, job of Federal Reserve chairman.

In short, he's the quintessential establishment figure, a high ranking courtier economist if you will. A tiny blemish on his career was inflicted by him having been chief of the AIG financial products division, the one which wrote all those CDS at the height of the bubble that brought the firm to ruin and into government 'conservatorship'.
He's also, at present, an 'adviser to the McCain campaign' , so you would think his views on economics have a free market bent. However, you would be wrong.

A recent Washington Post article informs us, that the no doubt influential Feldstein wants to legislate us back to prosperity.

The problem is that regardless of who wins, this advice will probably be heeded.

"Further legislation to deal with the economic crisis should not wait until the new president takes office. Fortunately, the president-elect will be a senator and can propose legislation without waiting to be sworn in as president." avers Feldstein.

In other words, let's not think too much about it, we need to act now.

Then come the proposals that should make anyone who has actually studied the big busts of the past cringe with apprehension.

Proposal number one is to get in front of the market clearing process and fix prices. Feldstein wants the government to do whatever it can to keep house prices from falling.

Feldstein: "But it is important for Congress to go further and stop declining prices from pushing a large portion of the other 37 million homeowners with mortgages into negative equity, which could tempt them to default. The mortgage replacement loan plan that I suggested in June, essentially a congressionally enacted mortgage "firewall" to prevent prices from dropping too far, is one possible way to do that."

One of the problems the housing industry is facing is the enormous oversupply of houses on the market. Recently, existing home sales have actually been improving. According to Calculated Risk, "Sales were higher in September 2008 than in September 2007 - the first time the year-over-year sales have increased since November 2005."

Now why would that be? The answer should be obvious to economists and laymen alike: house prices have finally reached a level where buyers can be enticed to return to the market - there is finally, a small ray of hope for the housing sector of the economy. Feldstein thinks the best thing we can do is to arrest this process via legislation.

Feldstein then continues with the usual Keynes-inspired yammering about 'falling aggregate demand':

"Falling home prices have already reduced homeowner wealth by about $3 trillion; the stock market decline has cut wealth by an additional $8 trillion. This reduced household wealth is causing consumers to cut spending, leading to lower employment, lower incomes and, therefore, further cuts in consumer spending.
Other components of aggregate demand are also falling. The decline in consumer spending will lead to less business investment in plants and equipment. And the recession in Europe and Japan will further reduce our net exports.
With the Fed's benchmark interest rate down to 1 percent, there is no scope for an easier monetary policy to stop the downward spiral in aggregate demand.
Another round of one-time tax rebates won't do the job. The rebates that Congress enacted this spring failed to stimulate consumer spending: More than 80 percent of tax rebate dollars were saved or used to pay down existing debt."

So you see, saving and paying down of existing debt is, in Martin Feldstein's view of the world, a bad thing. A society that has managed to break all previous records in the total credit market debt-to-GDP ratio due to an ill-fatede experiment with 'elastic currency' and massive credit expansion out of thin air should not , according to Feldstein, begin to save and pay down debt, but finding itself in the current hole , should keep digging furiously. That will make things better.



the total credit market debt to GDP ratio (see if you can spot the bubble periods).

Feldstein believes apparently that now that the biggest credit and asset bubble of all time - a bubble that has probably depleted the pool of real funding of the entire planet - has burst, the inevitable bust can be averted by doing the same things that have been done before in similar situations by other governments, only, this time, the result will be different.

He doesn't trust those irresponsible consumers anymore to do the job though, with their recent saving and paying down debt propensity.

Therefore, he continues, rather lamely:

"The only way to prevent a deepening recession will be a temporary program of increased government spending. Previous attempts to use government spending to stimulate an economic recovery, particularly spending on infrastructure, have not been successful because of long legislative lags that delayed the spending until a recovery was well underway. But while past recessions lasted an average of only about 12 months, this downturn is likely to last much longer, providing the scope for successful countercyclical spending."

They didn't build the Hoover Dam fast enough? FDR did not have 'enough time to use government spending to stimulate economic recovery' because the depression was over so quickly?

Feldstein continues: "The president-elect should focus on developing a mechanism for identifying and funding spending initiatives that can occur quickly and that would otherwise not be done. While it would be good if some of the increased spending also contributed to long-term productivity, the key is to stimulate demand."

Spending that 'would otherwise not be done' is of course apt to be a complete waste of scarce resources. That is precisely why it would 'otherwise not be done'.
Let us also consider the constant worries about aggregate demand. Demand as such is never a problem in an economy, unless the unlikely case were to occur that all consumer wants are satisfied completely. In an economic bust, demand does of course decline, as everybody is trying to rebuild savings and the necessary process of the realignment of the capital structure means that jobs are perforce temporarily lost. The best way to revivie demand is to allow prices to fall and to allow this process of restructuring to proceed unhindered. The more government intervenes, whether by price and wage fixing, or taking the resource allocation process out of the market's hands, the bigger the delay in reviving demand will be.
In short, everything that Feldstein proposes is likely to have the opposite effect of that intended. This should not only be clear from the point of view of economic theory (he is an economist, after all), it should also be clear from the historical experience with government interventions during a bust. We do not necessarily have to go back to the 1930's to see that - we only have to look at Japan's post bubble experience.

Feldstein has more ideas: "The increased government spending should include not only money for infrastructure such as bridges and roads but also for a wide range of equipment. Rebuilding some of the military capacity that has been depleted by the wars in Iraq and Afghanistan could be done relatively quickly and should be part of the overall package."

'Increased government spending on infrastructure' was exactly what Japan did, in spades. To this day, Japan's 'bridges to nowhere' are infamous.
It's nice of Feldstein not to forget the military-industrial complex, but let us consider that the Pentagon - which as of 2001 could not account for $2.3 trillion that had been thrown into its voracious maw (it's a good bet this figure has increased in the meantime) , is already a recipient of tax payer largesse unequalled in the world.
As USA Today reports , the 'Pentagon budget hits record in proposed spending bill', and that is of course not counting the two wars it is 'running on the side' - those require extra spending, and lots of it. So Mr. Feeldstein need not have worried about military spending - more of it is definitely on the way.

Nota bene - the likely cost of the two wars: according to a 2007 Congressional Budget Office estimate, both wars could cost up to $2,4 trillion through the next decade.

benefit: so far, zero. the stated war aims (finding and destroying weapons of mass destruction in Iraq, catching/killing Osama bin Laden and his henchmen in Afghanistan) have not been crowned with success. As is usual in such situations, the war aims have been shifted several times, but the point remains that the original justifications for spending this much blood and treasure have long ago turned into dead letters.

The main problem with Feldstein's ideas remains that whatever interventions government undertakes, the resources that it must commandeer to do so are limited. Whenever government builds a bridge to nowhere, this may add to GDP, but it will diminish society's overall wealth.
The resources channeled toward building said bridge, or building new Humvees for the army can not be used anymore for anything else. In short, we are faced with an analogy to Bastiat's 'broken window fallacy' here.

Feldstein seems to firmly believe that unless bureaucrats decide how to best allocate scarce resources, we are doomed. The exact opposite is true - the more of the resource allocation process is taken away from the market by government, the worse the economic situation will become. There is a reason why the Soviet Union did not turn out to be the utopia of riches it was meant to become - central planning of the economy is doomed to failure a priori.

Feldstein concludes: "Although the economy is facing severe challenges, the president-elect can turn the situation around by introducing legislation to deal with the downward spiral in home prices and with the declining level of aggregate demand. It is important that such legislation be enacted as quickly as possible."

No, the president can not turn the situation around by introducing price-fixing legislation. We should all hope (as vain as that hope may be) that such legislation is not only not 'enacted as quickly as possible' but that it is not enacted at all.

Meanwhile, we should commiserate with the Harvard economics students on whom this man has been let loose.