Get the kids, get the dog, and grab whatever weapons you happen to have within arms reach, zombies are coming! Now, I’m not talking about the raised dead, like we all saw on Thriller, but rather bond vigilantes, about to pull the plug on good old Uncle Sam because they perceive us as unable or unwilling to pay our debt. At the G20 summit this week, President Obama argued that more Keynesian stimulus was necessary until employment recovered. The rest of the G20 balked, opting instead of fiscal austerity, because they fear the bond vigilantes. Economist Paul Krugman, Nobel laureate, believes you can put that weapon down:
“Yes, America has long-run budget problems, but what we do on stimulus over the next couple of years has almost no bearing on our ability to deal with these long-run problems. As Douglas Elmendorf, the director of the Congressional Budget Office, recently put it, “There is no intrinsic contradiction between providing additional fiscal stimulus today, while the unemployment rate is high and many factories and offices are underused, and imposing fiscal restraint several years from now, when output and employment will probably be close to their potential.” Nonetheless, every few months we’re told that the bond vigilantes have arrived, and we must impose austerity now now now to appease them. Three months ago, a slight uptick in long-term interest rates was greeted with near hysteria: “Debt Fears Send Rates Up,” was the headline at The Wall Street Journal, although there was no actual evidence of such fears, and Alan Greenspan pronounced the rise a “canary in the mine.” Since then, long-term rates have plunged again. Far from fleeing U.S. government debt, investors evidently see it as their safest bet in a stumbling economy. Yet the advocates of austerity still assure us that bond vigilantes will attack any day now if we don’t slash spending immediately.”
However, advocates for austerity want to cut off unemployment benefits, when the housing market, and the larger economy, is still on life support. They want to fire teachers, firefighters, and policemen around the country by slashing state aid. In the halls of power, you can hear faint echoes of Herbert Hoover. These austerity advocates often talk about Japan’s lost decade, and the inability of government spending to lift that country out of its recession. However, no less than the Economist, Bible to the global business elite, brings up the much more pertinent examples of Canada and Sweden:
“The advocates of austerity… base their argument on cases in the 1990s, when countries such as Canada to Sweden cut their deficits and boomed. But in most of these instances interest rates fell sharply or the country’s currency weakened. Those remedies are not available now: interest rates are already low and rich-country currencies cannot all depreciate at once. Without those cushions, fiscal austerity is not likely to boost growth.”
What would be a sensible action to take right now? Well, how about finally tackling entitlement reform? Sure sure, Republicans would never undertake bipartisan work on entitlements in their Party of No posture, but stepping outside of political reality, now is the perfect time for politicians to compromise and craft a sensible reform of Social Security. If not now, when? It would send the right signals to those (imaginary) bond vigilantes that everyone worries about so much, but more to the point, it would deal with the long-term deficit, which we will have to deal with sooner or later. Politicians will always try to punt that football down the road, but who is to say that there will be a better opportunity in the future?
John Maynard Keyes wrote in 1945 that “the day is not far off when the economic problem will take the back seat where it belongs, and the arena of the heart and the head will be occupied or reoccupied, by our real problems – the problems of life and of human relations, of creation and behavior and religion.” In the United States, we have pursued a policy of unquestioned growth and expansion, following the recommendations of prominent economists with an ardor that borders on religiosity. However, the economic problem, as Keynes described it, has not taken a back seat, but rather has the developed world in the grip of a severe recession.
In the United States we have always looked to economists for the magic to make our economy go. Milton Friedman, winner of the Nobel Prize in Economics, believed that a free market economy could expand and prosper with minimal government interference. Alan Greenspan, an admirer of Friedman, was revered as an enabler of unending growth during his service as Chairman of the Federal Reserve; he received the Presidential Medal of Freedom, the inaugural Harry S. Truman Medal for Economic Policy, the inaugural Thomas Jefferson Foundation Medal in Civilian Leadership, and was named both a Knight Commander of the British Empire and a Commander of the French L’Egion D’honneur. Presidents from Ronald Reagan to George W. Bush all trusted Greenspan with the keys to the economy. During the same time period, Bill Clinton, a Democrat, trusted economist Larry Summers’ advice that deregulation of banking and finance would also lead to continued growth; that was the height of Milton Friedman’s influence. Barack Obama appointed Summers to be Chairman of his Economic Council despite the fact that his policies were partly at fault for the current economic crisis. Why do all of these Presidents, from Reagan on the right to Obama on the left, put so much faith in these economists? Keynes, in The General Theory of Employment History and Money (1935), addressed this question. He wrote that:
“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas.”
The economic policies of the United States have become more and more complex since Keynes’ time. Over the decades, as the United States left the Gold standard, and created a dynamic economy reliant on the growth of consumption and continuous expansion, we have relied and trusted economists to make it all work. Most Americans who do not work on Wall Street have trouble understanding even some of the basic terminology and concepts used in finance today. Many of us learned what a Collateralized Debt Obligation was last year, and discovered how debt was securitized in such complex ways that even some of the old hands in charge of major firms didn’t really understand. Americans trusted economists to drive our growth, and while many don’t understand the problems we face, they expect economists to create a deus ex machina to miraculously get us out of the recession and onward to unending growth.