Some Economic Rambling…

I read an email on my AP Economics discussion list in which the writer basically expressed a negative view of Keynes and had praise for Reagan. He justified the Reagan defense deficits as having won the Cold War for the USA and the tax cuts as having spawned the booms of the last 30 years. Basically, it was the argument that less government is better: laissez-faire.

I disagree.

The boom of the 80s-00s was an extended version of the boom of the 20s and the 1900s: loose banking rules, easy credit, and profits taken from speculation on markets instead of actual production. Reading an economic history of the 20s is eerie, with all the references it makes to how Goldman Sachs and JP Morgan gamed the markets. When real estate prices peaked in 1927, the erosion in that market led to contractions in the banking system, culminating in a refusal of banks to roll over loans extended to stock market speculators. With stricter bank rules in place, we had a business-unfriendly environment, but we also had a panic-free environment. Looking at American economic history from 1800 to 1900, one sees nearly every decade punctuated with either a major war or a financial panic. That was an era of low to no government taxation or economic involvement, Civil War aside, and little or no government regulation of the banking sector. The Panic of 1907 and the Panic of 1929 were the last of the 19th-century style financial collapses. We haven’t seen the likes of them since, until banking rules were relaxed, easy credit returned, and speculation took hold of formerly stable markets.

The difference with the S&L crisis and previous ones was the willingness and ability of concerned parties to create further bubbles: tech in the 90s and property in the 00s. Krugman himself outlined the need to create a housing bubble in an article he wrote in the wake of the tech crash of 2000-2001.

The current financial situation is far from rosy. With high unemployment, income tax returns are significantly lower. I would speculate that states without income taxes may be seeing less of a financial hit because they still collect property and sales taxes – although sales tax returns remain lower than they were in the go-go days. Consumer credit spending is way down, which presents much slower growth prospects than were available in the decades since the opening up of credit markets.

Regarding Reagan… A deficit is a deficit is a deficit. For all the anti-Keynesianism in the Reagan party, his policies underlined Keynes’ main points: deficit spending will boost demand. Now for the growth of the debt: Reagan excoriated Carter for presiding over the national debt increasing to $1 Trillion. Carter’s policies increased the debt by $0.28 Trillion: By 1984, Reagan’s policies had increased the debt by $0.66 Trillion and by 1988, another $1.04. Bush I’s deficit total was $1.4 Trillion. Collectively, Reagan and Bush I increased the debt as a percentage of GDP from 32.5% to 66.1%. Clinton oversaw a large debt increase in his 8 years, which many regard as an extension of the Reagan/Bush I economic policies, totaling $1.63 Trillion, but because of overall economic growth the debt went from 66.1% of GDP to 56.4% of GDP. Bush II presided over continued growth during his two terms, but also increased the debt by $4.36 Trillion. Debt as a percentage of GDP grew to 83.4% under Bush II.

During all the economic good times, Keynes would have advocated reducing deficit spending and then paying off the debt to cool off the economy if it overheated. In that sense, all the presidents since Carter have repudiated Keynes by maintaining deficits in good times. In that sense, our policies from Reagan forward are reminiscent more of the French nobility pre-1789: massive spending on wars coupled with a continued extravagance at home.

As for the benefits of the Reagan defense spending, the Soviet economy was already well on its way to collapsing on its own. The Chinese Communists point to the political liberalizations of Gorbachev as being the final nail in the coffin of Soviet hegemony, which explains their determination to dig in their heels politically. I wrote an article and prepared a simulation in early 1991 that demonstrated the Soviet Union was facing an imminent collapse due to internal causes at a time when the US intelligence services were predicting a continuation of the Cold War and a need for massive defense spending for years to come. My article and simulation were due for publication in December 1991 – the collapse of the Soviet Union due to internal causes in August put the kabosh on that. As Americans, we never saw a nickel of the peace dividend, but *that* discussion moves more into the concept of the military-industrial complex, so I’ll pass over it for now.

I’ll sum up with saying that Laffer and Keynes are both in agreement on the stimulating effects of tax reductions, but that Minsky is even more right on the subject of the collapse of markets. Sufficient regulation of banks and other “business unfriendly” measures, while they slow growth, also prevent major market corrections, which increases long-run stability. I recall Keynes’ policies being designed to smooth out the business cycle – reducing the swing of both the boom and the bust. In recent years, our desire for bigger booms has left us vulnerable to equally big collapses.

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