Obama and the Future Economy

Perhaps the most telling signal that Obama has no fundamental change in economics came during his December 9 interview on MSNBC’s “Meet the Press.” After discussing his plans for billions of dollars in new bailouts and billions more for government infrastructure programs, he faces, of course, the question of how to pay for all of this. His advice: “we can’t worry short term about the deficit.”[1] In other words, in the short term, print, borrow, spend!

Now, the most striking thing about this thinking is that it directly contradicts the most fundamental fact of economics: that indulgence in the short term sets up a future of debt and poverty. This was the fundamental lesson emphasized in Henry Hazlitt’s popular book Economics in One Lesson (1946).[2] He summarizes the “lesson” of “the fallacy of overlooking secondary consequences”: “The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.”[3]

It sounds, at first, as if Obama applies this wisdom, for he does warn us not to worry about the deficit in the short term. But a closer look reveals that his idea is a perversion of Hazlitt’s sound advice. The conservative economist emphasized avoiding deficits in the short term in order not to cause greater problems in the long. Obama has this reversed, but cleverly employs the same language: he wants greater deficits in the short term in order to spend in the short term, in order to create a “blood infusion” into an ailing economy. This type of irresponsible spending is the very problem the great economist warned against.

Hazlitt puts it in common terms:

Doesn’t everybody know, in his personal life, that there are all sorts of indulgences delightful at the moment but disastrous in the end? Doesn’t every little boy know that if he eats enough candy he will get sick? Doesn’t the fellow who gets drunk know that he will wake up next morning with a ghastly stomach and a horrible head? Doesn’t the dipsomaniac know that he is ruining his liver and shortening his life? Doesn’t the Don Juan know that he is letting himself in for every sort of risk, from blackmail to disease? Finally, to bring it to the economic though still personal realm, do not the idler and the spendthrift know, even in the midst of their glorious fling, that they are heading for a future of debt and poverty?[4]

Seen like this, Obama’s short-term, deficit-blossoming, debt-financed “stimulus” plan is nothing short of the very national indulgence that 1) caused the current mess in the first place, and 2) will only serve to create a national hangover. Or worse. Obama’s economic “blood infusion” is tainted blood, and the patient—the economy—will die of government AIDS.

But this has been a classic mistake of economic policy. Hazlitt wrote with the massive debt-financed spending of FDR’s administration in his immediate hindsight. He knew the problems first hand. And he wrote against the most famous economist of the twentieth century—the one who systematized the theory of deficit spending—John Maynard Keynes. Keynes argued that a high deficit was ideal as long as it got people working immediately—in other words, he believed in government-created cash infusions and government projects in order to stimulate the economy. His most famous quip strikes against conservative, long-term thinking: “In the long run we are all dead.”

Hazlitt writes against this foolishness. He argues,

Yet when we enter the field of public economics, these elementary truths are ignored. There are men regarded today as brilliant economists, who deprecate saving and recommend squandering on a national scale as the way of economic salvation; and when anyone points to what the consequences of these policies will be in the long run, they reply flippantly, as might the prodigal son of a warning father: “In the long run we are all dead.” And such shallow wisecracks pass as devastating epigrams and the ripest wisdom.[5]

The “elementary truths” Hazlitt explains have, of course, been consistently ignored throughout American history, not just in his own time. We are all in the position he describes: “we are already suffering the long-run consequences of the policies of the remote or recent past. Today is already the tomorrow which the bad economist yesterday urged us to ignore.” Obama simply wants to extenuate the same policies of the same bad economist: ignore short term debt, finance short-term concerns with what will undoubtedly be long-term debt.

But then again, repeating errors is a common problem with politicians in charge of other peoples’ money. Obama speaks decisively in calling for a moratorium on foreclosures until “we can get banks and homeowners to renegotiate the terms of their mortgages so that they are sustainable.” Such rhetoric might sell unthinking supporters, but it ignores real concerns. A recent report relates that over half of home loans renegotiated in the first half of 2008, already face pending default or have already defaulted a second time.[6] That took barely six months for some of them. Why? Were the new rates not as manageable as they thought? Have credit-swamped lifestyles overwhelmed some people’s ability to pay? Or worse? Whatever the possibilities, nothing short of government actually paying people’s mortgage payments for them will stop some from failing. So why throw more debt money at it?

Of course, as with all government handouts, you face the problem of moral hazard—the problem that handouts subsidize bad behavior, and thus, create more of it. Obama is aware of this: “that’s one of the tricky things we’ve got to figure out . . . an incentive to act more irresponsibly.” But Obama, following the example of bad economists, refuse to see this as the inevitable consequence of government-funded debts. Rather, he wants to blame the free market, and create more control in addition to his debt programs. He wants, “as part of our economic recovery package . . . a strong set of new financial regulations in which banks, ratings agencies, mortgage brokers, a whole bunch of other folks start having to be much more accountable.” See, it’s never government’s fault (unless of course you mean the previous administration’s, which Obama also short-sightedly blames), it’s always the evil banks, the evil brokers, the evil markets. But somehow we never escape the business cycle where government-created money ends up creating too much easy credit, leads to a bubble in certain markets, which then pops, leading to rapid loss of value, leading to defaults on loans, leading to recessions that spread into every market that the originally bad credit extends to. For some reason, the original government “infusion” never gets the blame: instead politicians always clamor for more of the deficit-financing that started the whole situation.

One of the great proponents of Keynes’ government manipulation and spending theories was American economist John Kenneth Galbraith. An award winning, politician-hand-shaking writer, Galbraith blamed economic problems on brokers and speculators, and called for the economy to be micro-regulated by big-government. Through his work Keynesian ideas ruled America from the post-war era forward. They have not stopped. Even today, ignoring the waves of Federal Reserve monetary and regulatory policies that have fueled the crisis, Galbraith’s son greeted a recent interview with attacks on freedom in enterprise. He blamed those who have “contempt for the supervisory role of government” and called, in reaction, for stronger government interference in money and markets. He argued that economics students in universities should be forced to read more of Keynes and of his father Galbraith. Again: blame the market, and call for more government salvation. It is interesting that Galbraith received the Presidential Medal of Freedom from Bill Clinton in 2000. Beside the irony of giving a “Freedom” metal to a ceaseless fan of increasing-government, we now see the revivification of Clinton’s interest inObama’s rhetoric.

Despite this great display of—what? ignorance or arrogance?—on economics, Obama is right about one thing: “Things are going to get worse before they get better.”

You can say that again. While most economists and investment news talking-heads were blindsided by surprise by the recession, many mainstreamers are now predicting things to get much worse. This is, of course, an oddity. Pessimism about markets is a no-no among economic press. Bad news creates panic creates more falling markets; so we must avoid the R-word at all costs. But once the reality sets in, pundits immediately switch gears and understate their forecasts. This way, if earnings fall, “We knew this would happen.” Else, if they exceed their new lower estimates by a few cents, “Good News! WidgetCobeat expected earnings! Buy, buy, buy!” But today, news is growing worse than most could imagine. A recent article from Fortune asks eight mainstream investment experts and receives not just pessimism, but fear. It’s not just worse, but the worst.

John Train, author and chairman of New York investing group, Montrose Advisors, has over fifty years dissecting and writing about Wall Street, investment and economics. He provides the most glorious statement on the modern climate I have read yet: “Keynes observed that pragmatic businessmen often could not imagine that they were the slaves of defunct economists, but ironically, never is this more true than today of Keynes himself. So we run a huge deficit to postpone the worst. That means inflation, so bonds are unsatisfactory.”[7]

Not only is it refreshing to hear a mainstream money man call out Keynes, but note the directly opposite view from our president-elect: running a huge deficit will postpone the worst. Deficit economics is, of course, the core of Keynes’ queer economics.

The expert following Train gives a telling critique of current policy as well. Meredith Whitney, an analyst for Oppenheimer who early-on warned that problems loomed for the big banks, points out that the massive $700 billion bailout merely funds a holding action. She says, “What the federal government has done so far—with TARP, bailing out Citigroup, etc.—has stemmed the bleeding, but what it hasn’t done is fundamentally alter the landscape.”[8] She is pessimistic about the government actions, pointing out that “the strategy changes have not solved anything.” But will the government admit to a failed theory, a bad economic philosophy? Or will they keep digging the hole deeper? Whitney sees more deficit spending: “So far we’ve had TARP 1.0, TARP 2.0, and TARP 3.0, and I’m certain there will be a 4.0, a 5.0, and a 6.0. There has to be, because the companies cannot raise the capital they need, which means that the default provider of capital has to be the federal government.”

PIMCO founder Bill Gross speaks about the causes: they are more widespread than just one aspect of the housing market. Debts of all sorts added to the enormity of the problem. He explains, “To blame this on subprime mortgages alone would be to dismiss an era of leveraging that encompassed derivative structures of all types, embodying a belief that economic growth was always and everywhere a certainty and that asset prices never go down.”[9] Leveraging is a key word here. What does it mean? Leverage generally refers to investments bought with debt. In other words, money is borrowed at a rate of interest, and then invested in hopes of gaining a rate of return higher than the interest owed. Multitudes of problems can occur in this scenario: risky investments that lose value not only cannot outweigh the interest owed, but also lose the ability to pay back the principal. How do you pay back any debt when your key investments have gone sour? Borrow more? Then the debts and interest compound. Now, consider what happens when a company uses leverage to invest in a company that itself has leveraged investments, probably in a major investment bank that itself has leveraged its cash holdings including high-risk mortgages.

Curiously, after seeing that debt financing of all sorts lay at the root of the present crisis, Gross claims that government debt financing is the only way out: “Federal spending and guarantees in the trillions of dollars will be required to fill the gap created by the deleveraging of private balance sheets.” But in the very next sentence seems to me to speak out of the other side of his mouth. He calls for private assumption of risk for all parties: “In turn, lenders and investors alike must begin to assume risk as opposed to stuffing money in modern-day investment mattresses.” His proposed solution sounds hypocritical, but it is actually consistent. He essentially scoffs at thrift and saving. His solution essentially says, “Get more government debt, give it to the banks, and make them take “risk”—that is, start making loans.”

Are we hearing a pattern here? It seems that no one believes in stuffing the mattress anymore. No more saving money. Instead, we spend until we run out, then we borrow more. But the money has to come from somewhere. The refrain seems to be that government is that magic mattress. We keep going back to it for more money. Of course, if we continue the course of debt-financing at all levels, and keep leveraging our children’s inheritance instead of disciplining our lifestyles with thrift, then we may end up with no mattress at all—and sleeping in the streets.

The Bible has much to say about debt. Not much of it is good. The Ten Commandments and the law are filled with cases about handling money and debt. Debt is slavery, and the borrower is servant to the lender. This is as true for nations as individuals. National debt was a curse of disobedience (Deut. 28:43–44). There is no such thing as a “Medal of Freedom” in a nation that is based on a debt-based economy. The very thought is blasphemy. It is not a passing gloss of pietism for Paul to say, “Owe nothing to anyone except to love one another; for he who loves his neighbor has fulfilled the law” (Rom. 13:8). Christians should take these teaching seriously. Make a plan to sacrifice non-necessities from your lifestyle. Cut back. Learn to discipline yourself into a lifestyle of thrift. And with what you save, it may not be a bad time to stock up on dry and canned goods. If the near future is a bad as the experts are beginning to say, it will be wise to be prepared.

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