With all this talk about fiscal austerity from the political Right, the public (and the markets) remain as confused as ever! Can we find some middle ground? by Bill Gee
(centrist)
Friday, January 28, 2011
In the second week of the Microeconomics class that I teach at Burlington County Community College, I ask my students to discuss the Circular Flow Model with this question:
"Describe which point on the Circular Flow Model that you believe to be the "weakest link". In other words, what part of the model do you think needs the most support from non-market intervention (i.e. the government)?"
An endless source of fascination for me is the sheer variety of answers that students have for this question, which is more of a reflection on the political tides and personal experience than any real understanding on how market economies actually work. To be fair to my students, after only two weeks of an introductory course on economics, I do not expect them to really understand circular flow, and I designed the question mostly as an exercise to expose political bias. Nonetheless, the responses are interesting.
Without going into the details, when I posed this question to students in September, the general trend of the discussion seemed to focus on which areas the government should intervene in the economy. For example, students would identify either Businesses or Households as the "weakest link" and then go into details of how the TARP and/or the Stimulus of 2009 helped to keep the economy from self-destructing. When I asked the question this past week, the focus of the discussion was on how government intervention in any part of circular flow will tend to slow it down to the point where the market economy does not work anymore. If you search what the Web to see how the world's leading economists are leaning, you will likely find a similar shift to their opinions. This represents the new culture of austerity that is lauded by the political Right.
The question comes down to this: Should the Government work to further stimulate the economy or should it back off and let the economy self-correct?
In this corner: Stimulate and regulate until the economy recovers.
Supporters of the Federal Reserve and the President like to point out that without the TARP, Stimulus, the Frank-Dodd Financial Regulatory Act, and Quantitative Easing (I & II), the economy would have already failed and we would be in the midst of the Second Great Depression. Unfortunately, we will never know if they were right because it is very difficult to "prove a negative". I other words, the economy did not collapse. Whether this is thanks to governmental policies or despite them, we will never really know. These are their arguments in a nutshell:
1) The TARP's support to Business provided them with the added liquidity they needed to prevent them from collapsing. If the Wall Street firms, banks and automakers who received the funds did not get the help, the resulting loss of jobs and productivity would have seriously hurt the circular flow from providing the Resource Market with a place to sell their services.
2) The Stimulus' support to Households in the form of "shovel-ready" jobs, tax breaks to the Middle Class, and investments in infrastructure gave workers the means to participate in commerce as well as providing a market to sell their labor resources while businesses reorganized from the financial crisis.
3) The Frank-Dodd Financial Regulatory Act of 2010 will protect everyday citizens from evil credit card companies and unethical Wall Street traders who helped to cause the financial meltdown in the first place.
4) Quantitative Easing (i.e. printing money) produces further liquidity in the economy, which allows it to support the government's programs as well as making more money available for private businesses to invest and create jobs.
In the other corner: Engage in Austerity and let the market recover on its own.
Supporters of "fiscal austerity" feel that the government is already too involved in the circular flow of the market. In fact, they believe that government involvement does more to slow the progress of the economy while in the meantime running up Trillions of dollars in debt. They believe that almost all government involvement in the economy should stop, and some have even gone as far as saying that we should abolish the Federal Reserve. These are their arguments in a nutshell:
1) The TARP created a dangerous precedent where financial companies will continue to engage in extremely dangerous practices because they know that the government will not allow them to fail should their gambles prove to be wrong. In the meantime, they take home even larger salaries and bonuses while they destroy the fortunes of everyday investors. They also point out that some banks used their TARP funds to invest overseas, buy-up competitors, or they simply hoarded the money while tightening credit terms for small businesses seeking loans.
2) The Stimulus' support to Households had two serious consequences. First, many taxpayers used their extra cash to simply pay down debt or put into the bank. This provided further profits for Wall Street banks while it did nothing to stimulate spending. Second, the continued renewal of unemployment benefits created an underclass of workers who were content to collect money from the government while not actively seeking to find new work or update their skills.
3) The Frank-Dodd Act adds a new layer of regulation onto an already-failed regulatory system in this country. The provisions in the law fail to address some of the worst abuses that brought about the financial crisis and unethical businesses have already found ways to circumvent the new law.
4) Quantitative Easing will only lead to hyperinflation, and/or create a trade war with the countries we do business. We have accused China of manipulating their currency to make their goods more affordable to its trading partners, and the Federal Reserve appears to have done the same thing by purchasing more US Treasuries with money created out of nothing.
Austerity has the upper hand.
For the moment, supporters of fiscal austerity have the upper hand in the argument. They point to the National Debt as a threat to America's future, and voters seem to have their support for the moment. However, this can change.
In a Bloomberg column by David Blanchflower, he points out to how austerity in Europe has already led to slowing economic growth, and in the case of Greece, Spain and United Kingdom, has led to a possible double-dip recession. He warns that if the world's largest economy, the United States, engages in a similar path, it could lead to a double-dip there as well. He further points out that following the first round of the Great Depression, the US Congress engaged in a program of austerity, which led to an even deeper recession that we now call the Great Depression.
Is anyone right?
While the final word on this argument is far from over, its resolution is far from clear.
On the one hand, if we continue down the road of financial stimulus, will we end up bankrupting our country, creating a culture of moral hazard that encourages reckless fiscal behavior, while creating a government that is so large that it stifles growth? On the other hand, if we tell our government to get out of the economy, will we create a culture of lawless corruption in the financial world, where the average consumer and small business has nowhere to redress their concerns, while our infrastructure crumbles beneath our feet?
Perhaps the answer is a mixture of stimulus and austerity, but the question remains as to whether we have the political will to meet each other in the middle so we can find the best solutions for everyone.
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Posted By: Walt
Date: January 28, 2011 04:39:15 PM
There's a third option that your article omitted to include. We can call it the "competitive currency" solution. Allow precious metals to be used as currencies (which is illegal right now). Eliminate the "legal tender" laws. Allow these currencies to circulate separately and independently of the dollar. In other words, no indexing gold or silver to paper at a government-fixed rate; allow their relative values to float in the market. Put these competing currencies into peoples' hands, currencies that actually retain its value over time, and watch how fast the economy recovers, regardless of what the Fed or the Congress does! I would cautiously predict that they would become the monetary options of choice for the entire world within 20 years, and the current economy would show rapid recovery with a year.
A wonderful byproduct of this policy is that it would allow all of the debt-based currencies of the world to crash-and-burn without destroying their respective populations.
Posted By: Bill Gee
Date: January 30, 2011 04:20:16 PM
Using precious metals as as currency? I thought this discussion was settled at the beginning of the 20th Century when it became clear that a nation cannot depend on what it can pull out of the ground for their economic growth. It's bad enough that the mining industry does such horrible things to the environment, if we went back to using metal as currency, it would spur such a rush to mineral cites that it would take centuries for the environment to recover.
Economics 101 - Money only has the power to purchase goods and services as long as producers and consumers have faith that it can be used as a medium of exchange. In the 1890s when the government started coining silver dollars, nobody wanted to use them, therefore they had no value. The same is true for the aluminum nickels that were coined during WWII.
The US Dollar might be doomed, but what will replace it will be another "reserve" currency. To go back to a metal-based currency would be a huge mistake not only for worldwide economic recovery, but for the environment as well.
Posted By: Walt
Date: January 31, 2011 09:15:28 AM
Using precious metals as as currency? I thought this discussion was settled at the beginning of the 20th Century when it became clear that a nation cannot depend on what it can pull out of the ground for their economic growth. It's bad enough that the mining industry does such horrible things to the environment, if we went back to using metal as currency, it would spur such a rush to mineral cites that it would take centuries for the environment to recover.
Economics 101 - Money only has the power to purchase goods and services as long as producers and consumers have faith that it can be used as a medium of exchange. In the 1890s when the government started coining silver dollars, nobody wanted to use them, therefore they had no value. The same is true for the aluminum nickels that were coined during WWII.
The US Dollar might be doomed, but what will replace it will be another "reserve" currency. To go back to a metal-based currency would be a huge mistake not only for worldwide economic recovery, but for the environment as well.
You do not offer a shred of evidence to back your wild, irrational, and totally inaccurate claims, except for some vague evidence that isn't even close to being true. What the 20th Century has settled is the following:
[LIST=1]
[*] The dollar's value plummeted at the fastest rate in 200 years since we were mostly removed (by government force) from precious metals in 1933, and then completely removed in 1971.
[*]Your environmental claims are bizarre and unfounded. Mining goes on all the time. There aren't vast, untapped precious metal resources just waiting to be dug up. That's why they're called "precious". Claiming that there's going to be all this new mining going on all over the place once we permit precious metals to be used as money again is absurd and a shameless, unfounded scare tactic.
[*]"Money only has the power to purchase goods and services as long as producers and consumers have faith that it can be used as a medium of exchange." That's true. It's also why, when the banks inflated the money supply (via bank deposits) in the 1920s and early 1930s, while the government forced gold to trade at $20.65 an ounce despite the artificially induced monetary inflation, the people chose to hang onto the metal while gladly getting rid of the paper by spending it. Clearly, the marketplace expressed extreme preference for the metal. But FDR and the government didn't want the banks to give up on the practice of monetary inflation (because it's so useful and profitable for the government), so FDR (falsely) blamed the gold owners for causing the Great Depression and ended the gold standard.
[*]"In the 1890s when the government started coining silver dollars, nobody wanted to use them, therefore they had no value." You really need to take another look at history. See http://www.goldline.com/us-silver-dollar-history for a good article on the subject. See in particular the two paragraphs from that article which say, "Hundreds of millions of Morgan silver dollars were struck between 1878 and 1904 (with one last mintage in 1921). In 1918, the Pittman Act authorized the melting of 270,000,000 silver dollars. With this single act, the Morgan silver dollar’s population was greatly reduced. Even more silver dollars were melted as the silver content of these coins exceed the dollar face value....The Morgan silver dollar was ultimately replaced by the “Peace” silver dollar which was minted to commemorate the armistice following WWI. However, the coin has enjoyed great popularity. In fact, in a 1993 survey by the magazine Coin World, the Morgan silver dollar was named the most popular of the older United States coins series."
[*]There are no other paper-based currencies in existence that can replace the dollar. God help us if the powers-that-be force another brand-new, debt-based currency on us to use as a world reserve currency. If you think the dollar depreciated quickly over the past 50 years, just wait until you see how quickly the new currency will depreciate. It will break records!
[/LIST]
Ultimately, the best argument to make against your preposterous claims is this. If no one wants to use silver, why not make it legal? By your own logic, no one will want it, so there's no harm done in legalizing it! Of course, you and I know that the opposite is true. Allow people to use gold and silver legally as money, and people will flock to it because they will consider it to be the best possible value as money...and rightly so.
Posted By: Bill Gee
Date: February 1, 2011 10:43:34 AM
Walt,
I really didn't want to get into a currency discussion - as you noted, I did not check all of my facts before responding to your posting. My posting was based on the "Circular Flow Model" and whether intervention or austerity is likely to bring about economic growth. Therefore, I think calling me "wild" and "irrational" was not appropriate as I was not entirely prepared to debate you on this largely unrelated topic. You can call me "inaccurate" on some of my facts, but I don't appreciate having my character attacked.
That said, I would like to respond to one of your points.
There is likely going to be another debt-based currency to replace the dollar. Russia and China have been pushing for it for the past three years and if the US dollar should collapse, which it probably will, the world will be looking for a new reserve currency to replace it. The Chinese & Russians would like the IMF to be the custodians of this new "I-Dollar". Whether we think it's a good idea or not, (just look at what's happening to the Euro) it think the liklihood of it happening is high.
No matter how many arguments we make to the contrary, it is highly unlikely that precious metal currency will ever come back unless it is preceded by a total global economic collapse. The "powers that be" would not want to see the value of their wealth destroyed, so they will hold on to their paper and electronic money as long as everyone else will accept it as a medium of exchange.
Posted By: Walt
Date: February 2, 2011 06:39:04 AM
Bill,
If you engage in false rhetoric and claim it as truth, why is it wrong to call your rhetoric "irrational" and "wild"? If you carefully and unemotionally take another look at what I wrote, I called your claims irrational and wild. I was talking about your claims, not you personally. The phrase I used was, "...to back your wild, irrational, and totally inaccurate claims...." So I suggest you stop taking arguments personally and stop blaming me for a character attack in which I did not engage. If we can't emphatically reject another person's claims, we can't debate.
As for my argument being "not appropriate as I was not entirely prepared to debate you on this largely unrelated topic", I strongly disagree with that logic. Your logic basically states that any position on an issue that is not currently advanced by leading politicians is inappropriate for consideration. On the contrary, the entire financial crisis of 2008 is all about the monetary and banking system! The slow recovery is also all about the monetary and banking system, even if the politicians refuse to admit or acknowledge it. To dismiss the monetary and banking system as "unrelated" is preposterous.
Also, the likelihood of precious metals making a comeback is irrelevant to the question of whether we should discuss the issue. After all, two years ago, it was almost impossible to believe that the concept of auditing the Federal Reserve would ever get serious consideration by Congress. The argument against it largely consisted of the notions that the public doesn't really know or care what the Fed does and that monetary policy is a non-starter as a political issue. Fast forward to today, and now Audit The Fed is one of the most electric and most controversial topics in Congress.
So frankly, claiming that precious metal currency is irrelevant is...itself...an irrelevant argument.
I'd like to see you actually address the topic of commodity-based currency versus debt-based currency, instead of running away from it.
Posted By: Bill Gee
Date: February 2, 2011 05:20:49 PM
Hi Walt,
Fair enough. I will address the currency issue in a forthcoming column. Frankly, until you made your arguments, I thought the debate was moot but apparently I was wrong.
