Stimulus Blues

I recently had the opportunity to take an unoffical poll of my economist colleagues a the City College of San Francisco, where I teach. One of the areas of very strong agreement was that the US dollar is the most serious risk to the US economy (there was one dissenter out of six economists). The other area of agreement was that the US needs another stimulus, on the order of $500 billion. Here, I was the lone dissenter. (Several of my colleagues didn’t feel another stimulus was politically feasible; I don’t think another stimulus is desirable economically.)

My colleagues are in good company; Paul Krugman, the 2008 Nobel prize-winner in economics has called for a second stimulus, as has Robert Reich and many others. A majority of economists were in favor of the first stimulus, though there were also some prominent dissenters. I think the views of economists tend to mesh with the conventional wisdom that the government has to do something.

The problem is that doing something is rarely a good substitute for doing the right thing.

Economics has largely scrapped the distinction between necessary and surplus value; necessary value is the portion of value that reproduces the capital and labor that went into producing a good or service, while surplus value is the additional value of the product above the cost of production. Without this key distinction, it becomes impossible to distinguish between economic activities which are productive (directly produce surplus value) and unproductive (those that do not); we’re left with only GDP numbers, without a notion of where the value flows came from.

To try to increase GDP without considering whether we’re increasing productive or unproductive economic activity is dangerous in an economy like the US, where unproductive activity has been steadily rising over the last 60 years. This rise has been financed by growing debt and capital inflows to the US economy, but as these flows slow, unproductive activity becomes less and less viable. To put it simply, the future of the US economy is in agriculture and manufacturing, not in finance, retail, or advertising. While there will always be a place for finance and other unproductive activities in the economy, it must be recalled that government is also an unproductive activity. As government spending increases, it absorbs a greater portion of the economy’s total surplus, at the very moment when that surplus is most needed to restructure, innovate, and re-invest. That is a recipe for a lingering malaise, such as what Japan experienced in the 1990s.

This is the time for government to cut back, do less and spend less, to balance the budget, and to trim taxes. In short, the government should take the advice given to a man in a small pond, thrashing about in an effort to make the muddy water clear:

Be still; it will happen best on its own.

Ah, Krugman!

To sum up: A few months ago the U.S. economy was in danger of falling into depression. Aggressive monetary policy and deficit spending have, for the time being, averted that danger. And suddenly critics are demanding that we call the whole thing off, and revert to business as usual.

The above is a quote from the marvelous Paul Krugman. I love him; and yet, he's so wrong right now.

Let's be clear: aggressive monetary and fiscal policy have not averted any danger to the economy. The danger is not inflation, nor is it deflation. The danger is economic distortions. That is, massive investment in unproductive economic activity (retail, advertising, finance, etc.). This kind of economic activity does not produce anything, and hence it is the major threat to the economy.

Why are there economic distortions? Why should it be the case that the market, which often gets things right, ought to be disastrously wrong? What causes the distortions is the massive inflation of the money supply. That may lead to inflation or it may even lead to stable prices, even deflation for a time. It all depends on how the extra dollars are used. If they are saved, no inflation in consumer prices. If dollars are spent elsewhere in the world, no inflation (at least in the US). If those extra dollars are spent in the US, expect to see some inflation.

Rising or falling prices is not the danger. The danger is that there is a prolonged period of confusion: what are my assets worth? Is my business viable? Should I start this business? What is the market saying?

If the answers to these questions are unusually obscure for a long period of time, the result will be stagnation, low growth, and unemployment. This is the danger. And it's in full bloom now. More aggressive monetary and fiscal policy will worsen the situation, not make it better.

Reasons for Economic Optimism

I was inspired by Justin Fox's recent post in Time, 5 Reasons for Economic Optimism (he gives 4). Although I differ with him rather sharply on what exactly are the reasons to be optimistic, I agree with his premise: it's vital to look for the ways in which the current economic situation is or will be, for the greatest good. Before I give you my list of reasons, let's take a look at Mr. Fox's list.

1. The Stock Market Is No Longer Overpriced

My response: stocks are still heavily overvalued. The current bear market has taken stocks more than 50% below their peak, to a low of 6548. As of 4/21/09, the dividend yield for the Dow was 3.51%, while that of the S&P 500 was 2.61%. A bear market historically reaches its bottom when the dividend yield is 6 to 8%. The stock market is coming off a 27-year bull market, which took the Dow from 800 to over 14,000. (check out my earlier piece on this) A bull market of this magnitude is not corrected in a few months. As a matter of mass psychology, we'll be near a bottom when the overall consensus is that putting money into stocks is as wise a thing to do as setting fire to your money.

2. The Government Is On The Case

My response: Unfortunately, much of what the government is doing is interfering with the process of adjustment which is necessary to restructure the economy, clear out losses, bring an end to corporate strategies that were essentially unsound, and move the economy toward productive economic activity. Expect the government to engineer massive amounts of inflation, as Greg Mankiw and others believe would be helpful.

3. Consumers Are Adjusting to the New Economic Reality - And Fast

My response: Mr. Fox argues that the speed at which consumers are cutting spending is a good sign, for it will lead to a rebound in consumer spending that will help the economy. Interesting point, but I don't find it persuasive. What we need is more investment, not more consumption. To that end, saving is needed, for ultimately, there is a macroeconomic equality between savings and investment. Though we have been able to avoid that equality for some time because of financial out-flows (i.e. the financing of US current account deficits and budget deficits through foreign buying of financial assets), savings ultimately equals investment. So more saving is good in itself, not only as a sign that the carnage of lower consumption is almost over.

4. Reinvention and Change Are What the US Is All About

My response: It's hard to argue with this one. And Mr. Fox also correctly identifies that many economic activities of the boom years were unproductive: he singles out finance and real estate as two of the big culprits. Unfortunately, he believes this means that the US dollar will continue to be the world's reserve currency forever. Does he fail to see the many signs that the reign of the dollar is nearly over? The strength of the dollar since Fall 08 is only a temporary response to fears of financial armageddon.

* * * * *

OK, so here's my list.

1. Moving from an economy dominated by unproductive activity to one dominated by productive activity will be good for America. For too long, American innovation and entrepreneurship went into venues that were basically deceitful, put others at risk in order to generate profits, or were unsustainable. We've gotten to be masters of finance, real estate sales, and retail sales. It will good for our innovation to be re-channelled into activities based on sustainable growth.

2. As I mentioned above, consumer saving is a good sign. Living with a zero or negative savings rate is unstable and tends to lead to volatile investment. A high savings rate should ultimately lead to a high level of investment. The fact that consumers are spending less means they are facing reality. That's a good thing in itself.

3. The End of Bling focuses our attention less on conspicuous consumption and more on the things that really matter. That will differ for each one of us, but it seems likely that the recession will lead to a decreased level of materialism in society, and an increased understanding that consumption should be in the service of the purpose of our life, not the other way around. Once one's basic survival needs are met, the kinds of things that tend to make people happy in a lasting way are having deep relationships, being able to meet one's responsibilities, and making a meaningful contribution to the world. This crisis offers us the opportunity to re-evaluate our lives.

4. The environment will be a beneficiary of decreased consumption among the rich nations. America cannot continue to consume 25% of the world's resources.

5. The financial crisis will end the international hegemony of the US dollar, and encourage nations to consider sound, honest money, based on an item of real value. The natural choices are money based on gold, silver, copper, or other metals. There are other possibilities for backing money, including a basket of commodities. (These are less desirable to me, for reasons I'll describe in a future post) Moving away from a world monetary order based on fiat currencies will be good for the US and good for the world, because fiat currencies are essentially dishonest.

6. The crisis will end US military adventurism in the Middle East and elsewhere. The reason for this is that as the dollar loses its status as a reserve currency, we will not be able to afford to continue to occupy Iraq, Afghanistan, or any other country. We will have to dramatically cut all government spending, for deficit spending will no longer be an option. When we have to balance the budget, these foreign military adventures will simply become untenable. They were only possible based on the unrealistic idea that we wouldn't have to pay for them. Americans are not motivated enough to go to war in distant lands when they realize it will mean fewer schools, hospitals, roads, and smaller pensions.

So take heart America! This crisis will return us to our core values.

Robert Reich: "Double the Stimulus"

I like Robert Reich. He has a wonderful style of writing, at once assertive in his rhetoric and reasonable in his tone. In a recent blog post, (3/13/09) he calls for a new stimulus of roughly equal size to the last stimulus of $787 billion.

That is interesting. The President of the European Union, Czech PM Mirek Topolanek has just made headlines by calling the stimulus the way to hell. Topolanek argues that to ramp up spending during a recession is the wrong move. He's going against the grain, and since his center-right party just lost a vote of no confidence, he probably won't have much influence. It does seem like an unusually provocative statement.

Double the stimulus or road to hell?

In Marxian terms, this recession is all about what is called 'unproductive' economic activity, meaning labor which is not designed to produce value (i.e. activities which directly transform raw materials with labor in order to produce something which meets a human need). Unproductive activity is important, yet it does not directly produce an economic surplus (that amount which is produced which is greater than the needs of the direct producer). Over the last 60 years, the US economy has dramatically increased its unproductive activity, shown nicely in Measuring the Wealth of Nations, by Anwar Shaikh and E. Ahmet Tonak.

The activities of the Federal government, though important, are unproductive in the sense that they are not intended to produce a surplus. That means that government must be funded from a portion of the total surplus produced in the US. Since the crisis facing US capitalism is a crisis of unproductive activity, it cannot be solved by increasing the amount of unproductive activity.

In the years to come, we will see a return to productive economic activity: agriculture and manufacturing will once again dominate the US economy.