Topic: Monetary Policy
The Coming of Galbraith

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As I gazed today into the smokey ruins of our immediate future, I asked myself where America will likely turn its attention next when current policies fail. The answer I found turned my blood cold.

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by Walt Thiessen
(libertarian)
Sunday, June 21, 2009

The ghost of Milton Friedman rides through the halls of government and the Fed these days, exhorting his legions of supporters (Bernanke, Summers, Geithner, et al) toward a final thrust into solvency and economic turnaround. Today, President Obama is a Friedmanite, but what will he become once the Friedman vision fails, as it must?

In that short paragraph, I offend many "allies" of free markets, because for so long his supporters viewed the late Professor Friedman as the preeminent champion of free markets. In truth, he championed conservatism over free markets. Whenever he found a need to choose between the two, he chose conservatism in all its gory...er, glory. 

I do not mean to suggest that nothing that Friedman ever said spoke to the ideal of free markets. To the contrary, much of what he wrote sounded very free market, and from his microeconomic view it was exactly that. But within his macroeconomic view, freedom disappeared almost entirely.

Nowhere is this more true than in his monetary theory. Friedman, more than any other economist of the 20th century, resurrected monetarist economics. His arch-rival, Harvard's John Kenneth Galbraith of wage and price control fame in the 1940s, correctly pointed out repeatedly that the theories Friedman relied upon uniformly led to ultimate disaster, historically speaking. As part of my research for my upcoming novel about the financial crisis and its root causes, I re-read (after many years) Galbraith's book on money, simply entitled, Money: Whence It Came, Where It Went (Houghton Mifflin Company, Boston, 1975). The ascendance of monetarism over fiscalism in the 1980s and 1990s supposedly "defeated" the Galbraithian impulse, and few now pay any attention to the late Harvard man's dictums. They will soon rue the day they made that choice.

While he wrote the book in the mid-1970s, his analysis will speak to eager ears in 2010 and beyond. Galbraith is a statist, beyond dispute, who leaned toward liberalism but who thought of himself as neither liberal nor conservative. Instead, he and his supporters thought (and continue today to think) of him as a pragmatist.

Make no mistake...the policy currently pursued by the Fed and the Obama administration (initiated first by the Bush administration) to restore liquidity to the banking system derives directly from the ideas of Professor Friedman. Now comes Galbraith's son, one James K. Galbraith, holder of the Lloyd M. Bentsen Jr. Chair in Government/Business Relations at the LBJ School of Public Affairs, University of Texas at Austin, and senior scholar with the Levy Economics Institute. In the great tradition of his father, Galbraith wrote a largely ignored article which appeared in Washington Monthly in their March/April 2009 edition. Entitled "No Return to Normal," Galbraith wrote eloquently in some detail about the current approach, explaining quite clearly why all the bank liquidity in the world will not likely get the economy moving again, because it all really depends upon the consumers, and they're in savings mode, not spending mode. Read now from the Book of Galbraith:

The oddest thing about the Geithner program is its failure to act as though the financial crisis is a true crisis—an integrated, long-term economic threat—rather than merely a couple of related but temporary problems, one in banking and the other in jobs. In banking, the dominant metaphor is of plumbing: there is a blockage to be cleared. Take a plunger to the toxic assets, it is said, and credit conditions will return to normal. This, then, will make the recession essentially normal, validating the stimulus package. Solve these two problems, and the crisis will end. That’s the thinking.

But the plumbing metaphor is misleading. Credit is not a flow. It is not something that can be forced downstream by clearing a pipe. Credit is a contract. It requires a borrower as well as a lender, a customer as well as a bank. And the borrower must meet two conditions. One is creditworthiness, meaning a secure income and, usually, a house with equity in it. Asset prices therefore matter. With a chronic oversupply of houses, prices fall, collateral disappears, and even if borrowers are willing they can’t qualify for loans. The other requirement is a willingness to borrow, motivated by what Keynes called the "animal spirits" of entrepreneurial enthusiasm. In a slump, such optimism is scarce. Even if people have collateral, they want the security of cash. And it is precisely because they want cash that they will not deplete their reserves by plunking down a payment on a new car.

Say what you want about both Galbraiths (and I could say plenty) but give them their due. The son carries on the father's tradition. However misguided his economic prescriptions were, Galbraith the Elder's analysis cannot be ignored. He often skipped key pieces of history in his analysis (thus leading him routinely astray) but few doubt that Galbraith attempted to learn from history. His books and other writings routinely spanned and summarized that history and at times displayed significant insight.

Now comes Galbraith the Younger sounding exactly like his father. His analysis that the current Fed/Government approach must fail rings true. Few writers on this website doubt it. Unfortunately, we must also recognize the reality that Austrian economics has not yet gained traction among the powerful. When the failure of the current policy finally becomes evident to all inside and outside Washington, where will the cogniscoti likely turn their attention for guidance? To the Austrians? If only wishing made it so!

No, they'll likely turn to James K. Galbraith instead, because of his pedigree. Rothbard and Mises never gained the level of respect that Galbraith  the Elder did, not because of their scholarly analysis (which blows the doors off Galbraith, Friedman, Samuelson, and everyone else of the 20th century), but because no one listened to them then...and likely won't listen now. No, they'll turn instead to pedigree...to Galbraith the Younger (or perhaps I should call him Galbraith II).

So what can we expect from Galbraith II? Nothing short of: massive (even by today's standards) government spending and intervention, gigantic increases in Social Security and Medicare benefits, wage and price controls, and quite likely, war. Galbraith II waxes eloquently over the recovery of the American economy during World War II, and though he does not say so in his article (he focuses on energy and climate change for ecomomic stimulation instead), you can almost feel him hoping and praying for a similar world war in our near future. 

He wants massive re-regulation of banking and finance. He wants the government to spend money like there is no tomorrow, because in his view there is no tomorrow without it. And what of the massive amount of debt all this spending must generate? Read his own words:

The chorus of deficit hawks and entitlement reformers are certain to regard this program with horror. What about the deficit? What about the debt? These questions are unavoidable, so let’s answer them. First, the deficit and the public debt of the U.S. government can, should, must, and will increase in this crisis. They will increase whether the government acts or not. The choice is between an active program, running up debt while creating jobs and rebuilding America, or a passive program, running up debt because revenues collapse, because the population has to be maintained on the dole, and because the Treasury wishes, for no constructive reason, to rescue the big bankers and make them whole.

One thing Galbraith II forgot to mention is where the money will come from to pay the interest on all this new debt. Already, national debt interest equals roughly 50% of all income taxes collected each year. Under Galbraith's plan, we will soon be borrowing money to pay the interest, thereby guaranteeing the collapse of the financial system which Galbraith already acknowledges must happen. This apparently minor oversight leads to a gigantic oversight which he expresses as follows:

Second, so long as the economy is placed on a path to recovery, even a massive increase in public debt poses no risk that the U.S. government will find itself in the sort of situation known to Argentines and Indonesians. Why not? Because the rest of the world recognizes that the United States performs certain indispensable functions, including acting as the lynchpin of collective security and a principal source of new science and technology. So long as we meet those responsibilities, the rest of the world is likely to want to hold our debts.

Third, in the debt deflation, liquidity trap, and global crisis we are in, there is no risk of even a massive program generating inflation or higher long-term interest rates. That much is obvious from current financial conditions: interest rates on long-maturity Treasury bonds are amazingly low. Those rates also tell you that the markets are not worried about financing Social Security or Medicare. They are more worried, as I am, that the larger economic outlook will remain very bleak for a long time.

Hear that, everyone? The threat of inflation is over! All that money poured into the system, and all the petrodollars, eurodollars, and asian dollars sitting out there will not come back to haunt us! So spaketh Galbraith. So the political leaders will eventually believe, once their current approach fails.

God help us all.

©2009 Walt Thiessen, all rights reserved. You must have written permission from the author in order to republish this work.
Published: Sunday, June 21, 2009
Last modified: Sunday, June 21, 2009

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