The New American Economy?

I recently read Bruce Bartlett's new book The New American Economy, which is a fascinating read if you're schooled in economic theory, or at least have taken an Economics class in college. What first struck me about this book is that Bartlett, a conservative, takes on conservatives and says they have it all wrong. I am not sure if I agree with Bartlett's observations, but I greatly respect his opinions, particularly since he puts much thought and research into what he writes.

Bartlett, like many other economists, states that the current financial crisis is much like the Great Depression. The most striking similarity is that we have experienced a largely deflationary cycle, which Bartlett demonstrates is just as bad as an inflationary cycle. His belief is that Keysian economic theory offers better solutions to the crisis than supply side economics. Although modern conservatives abhor Keynes's theories, Bartlett goes to great lengths to show that Keynes was quite conservative. After reading his book, I tend to agree that Keynes offers better solutions in this environment than supply side economics.

Right now, we need to back up a bit and explain the theories a bit. Lord Keynes believed that stimulating demand was the best way to grow an economy. He stated that this was done in two ways: 1) monetary policy, which includes large injections of capital into the economy by the central bank; 2) fiscal stimulus to increase the velocity of money. GDP is the product of the money supply and the velocity of money. Supply side economics focuses on the supply side of the demand/supply curve, as the name suggests. Supply side is concerned with stimulating supply to get the economy moving. In a general sense, Keynesian economics works best in a deflationary environment, supply side works best in an inflationary environment. With unemployment at 10%, with housing prices down, with auto sales in the dumps, with retail sales in general sluggish, demand needs to be stimulated.

What Part of George W Bush Was Conservative?
Where did we go so wrong as an economy in the first place? In general, I place more blame on the Republicans, particularly during the George W Bush years. Let's face it, we know Democrats like to spend taxpayers' money lavishly on crap that winds up with disastrous results. What is really disappointing is that Republicans took on this same persona during the GWB years. I laugh when people describe GWB as a conservative. I ask "What part of George W Bush was conservative?" I believe that the principles of conservative government involve three aspects: 1) Limited government (this above all else!); 2) Fiscal responsibility; 3) Judicial restraint. Limited government? Bush created a new cabinet level post that is still largely undefined to this day. Fiscal responsibility? Record deficits (although Obama has since obliterated this). 3) Judicial restraint? I hand you the Terri Schaivo case. The saddest part of the Bush years is that most of the self-proclaimed conseratives went along with all of it. So, the conclusion is that we went wrong as an economy because the Republicans abandoned their principles in the name of political expediency.

In the 2004 campaign, Bush proudly proclaimed "the ownership society" and used record home ownership as the shining example. However, this was a house of cards, built by Federal Reserve chairman Alan Greenspan's easy money, the purchase of Democratic politicians (particularly Senator Christopher Dodd and Rep. Barney Frank) by Freddie Mac and Fannie Mae, and the Republicans, led by Bush, playing along. Fannie and Freddie became Ground Zero in the housing crisis, fostered by Greenspan's easy money (which was too easy for too long), and Bush's "ownership society." Of course, I cannot help but laugh at President Obama trying to scold "greedy Wall Street bankers" for not lending money. Who are they going to lend to? Are the banks supposed to make the same stupid loans that got us all in this mess in the first place? Also, for the record, those "greedy Wall Street bankers" were the second largest contributors to Obama's 2008 campaign, behind only trial lawyers.

Stimulus and Republican Irrelevancy
Back to Bartlett's book, he states that the $787 billion fiscal stimulus passed by Congress earlier this year was the right thing to do for the economy. Further, he states that the Republicans will only become more and more irrelevant if they stick to their cutting taxes and cutting spending themes. He may be right for today, but what we are seeing from the Democrats today leads me to believe that we will have a huge inflation problem in a few short years.

Where Bartlett's book really falls short is in describing what all this means for the future. He does a great job of researching Keynes, and lays it out in reasonably good laymen's terms. But what the application of these theories holds for future growth is sorely lacking in this book.

Sub-Optimizing Growth
Historically, government is a terrible allocator of resources. To suggest that we are going to optimize long-run economic growth simply by government stimulus is pure fiction. As the government becomes more pervavise in the economy, we can only assume that long-run growth will be sub-optimized. Since the end of World War II, the US economy has grown by about 3.2% annually. However, a larger government sector can only lesson this long-run average. Waste, corruption, the power to tax and the power to run large annual budget deficits as far as the eye can see will ensure that the economy will grow at a lower level of annual growth, which will translate into lower standards of living for Americans across the board.

So, stimulate the economy to get us out of this mess. Flood the system with money. Then get the hell out of the way. Keynes believed in fiscal stimulus, but he also believed that government should pull all the stimulus and get out of the way as the economy recovered. Otherwise, get ready for another round of double digit inflation, combined with high unemployment and bring on the supply side economics.

10 Surprises for 2010

Those who work in the investment business anticipate a piece about this time every year from Byron Wien, former strategist at Morgan Stanley entitled "10 Surprises". His 10 surprises reflect events that he believes will happen in the upcoming year that, at the time of writing them, are well outside the consensus thinking. His events usually focus on financical market, economic and political events (for instance, he called Barack Obama's victory in 2008 while the consensus held that Hilary Clinton would be the Democrat's nominee for President). In that spirit I'll launch my top 10 surprises. I make no promises that my top 10 surprises are outside the consensus thinking. If you have any you'd like to add, feel free. Enjoy!

1. The economy will show a brief recovery before falling back into a "double dip" recession. Unemployment will stay persistently high, only dropping to about 9 percent before heading back up to 10 percent.

2. Inflation and interest rates stay at historically low levels. With the economy in the tank, bank assets continue to decline, easing any inflation fears and keeping interest rates in check. The price of gold will drop dramatically, while stock prices will decline 3 to 5 percent in 2010.

3. With opposition to health care reform high, moderate Democrats in the Senate will keep Congress from passing any meaningful health care reform, and the issue is essentially done for the remainder of President Obama's term.

4. At least one major department store chain will go out of business in 2010, likely a mid-range department store chain.

5. The American car companies, particularly GM, will show surprising strength in 2010, with sales coming in better than expected. Sales of imported cars will slow dramatically.

6. The U.S. housing market remains in the doldrums. Housing starts will rise slightly in the first half of the year, but housing prices will remain low. Housing starts will taper off again in the second half of the year.

7. The dollar will remain weak, the deficit will run at another record, and in the fall 2010, politicians, bankers and investors will be discussing the government's ability to borrow further, and fears of a government default on its debt will create a mini-panic on Wall Street.

8. The U.S. will remain mired in a stalemate in Afghanistan, with no discernible progress. President Obama will be pressured by his own party to get out, while the Republicans of all people will be supportive of his policy to remain in the worn torn country.

9. Republicans will pick up significant seats in both houses of Congress, but will fail to win a majority in either house. Republicans will pick up at least 25 seats in the house, and maybe 4 in the Senate.

10. Finally, 99 percent of us will break our New Year's resolutions within the first two weeks of the new year. But not to worry, for tomorrow is another day.