09 February 2009

Change we can’t possibly believe in -- 1

Well Marie Cocco is at it again.

Now for an economic strategy that really trickles down.

Down to laid-off workers who lost their health insurance with their jobs. Down to the working poor and the newly poor, who need food stamps for their families to survive. Down to the teachers who will remain in their classrooms because states won't have to severely reduce their aid to cities and counties. Down to construction workers, and perhaps even down to those just laid off at Caterpillar who might be called back from the unemployment line. They can get to work making the heavy equipment the construction crews will need to repair roads and bridges and sewer lines.
Look, Bush's supposedly discredited economic policies were Keynesian, or at least Keynesianesque. So are Obama's supposedly different economic policies.

I know: "James," you ask, "how can this be?"

Since Keynes's topic is relevant to the dilemma we now confront (i.e., how to coax a revival of prosperity at a time of declining business confidence and investment) let's recap Keynes's economics, specifically as he explained it in his 73 year-old, The General Theory of Employment, Interest and Money, (a real page-turner), written during The (First) Great Depression (the Second, apparently being the one in which we presently live). Here's a quick and dirty overview. Now, forget the Econ 101 gloss about how Keynes was little more than an advocate of deficit spending. That is propagated only by people who cannot possibly have read the General Theory, or have a vested interested in not giving an accurate report of its content. (On the other hand, to be fair, that gloss may be honestly given by the sort of people who, in the interest of simplification think "Deficit Spending" is as accurate a way of summing up Keynes as "Twinkle, twinkle, little star, how I wonder where you are" is of summing up the purposes of astronomy. But I digress.)

Keynes was preoccupied with a situation very much like our own. A long boom had ended (i.e., the "Roaring" twenties). The boom, as he explained it, had been "characterized by optimistic expectations as to the future yield of capital goods." Even Keynes probably couldn't have imagined a world where a company could trade at more than its earnings, but that amount of optimism is certainly what he had in mind. And then came the crash, at which time "disillusion falls upon an over-optimistic and over-bought market, [and] it...[falls] with sudden and even catastrophic force." The traditional cure for such an investment collapse was a decline in interest rates. Lower rates, at least in theory (I love that phrase), should encourage investment in productive assets, the returns upon which are likely to be higher than the cost of borrowing, and higher than the return on Treasury bonds. But what if the decline in business confidence is so drastic that the owners of capital are wary of investing in new plants and equipment, regardless how low the interest rate falls? That's what happened during the Depression: the money was there; but it wasn't being invested.

That's what Keynes explored in The General Theory. He called the reluctance of investors to purchase real assets, "liquidity preference".

"The collapse," he wrote, "may be so complete that no practicable reduction in the rate of interest will be enough." This is exactly the problem that Greenspan (and President Bush) faced in 2001, Greenspan cut interest rates seven times in 2001, for a total of three full percentage points (by August 2001), but investment spending still declined. The Dow moved from 10,551.18 on Monday, 1 August to 9,949.75 on Friday 31 August 2001. The following week the Dow rallied a bit closing at 10,033.27 on Wednesday, but finished the week at 9,605.85 on Friday, 7 September (down from 11,259.87 the previous year). This, you may recall, was all a result of the Bush campaign's “talking the economy down”.

And then, of course, there was 11 September 2001. The following week, the Dow closed at 8,235.81, 21 September, from which date the market began a rather steady increase, closing at 10,635.25 on 19 March 2002. But by Friday 20 September 2002, a year after the week beginning 10 September 2001, the market closed at 7,942.39. Tough times, to be sure. But by late 2007, things had improved – no thanks to the now-discredited “Bush” policies, I’m sure. On 9 October 2007 the Dow closed at 14,164.53. On 11 October it reached an intra-day actual of 14,198.10. At that point the ride was pretty well over. Housing prices, which had peaked in 2005, were declining by 2006. And, in October 2007, the Treasury Secretary was referring to the bursting housing bubble "the most significant risk to our economy” (here). The rest is history.

President Obama now faces circumstances similar to those his predecessor faced.

To be continued...

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James Frank Solís
Former soldier (USA). Graduate-level educated. Married 26 years. Texas ex-patriate. Ruling elder in the Presbyterian Church in America.
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