The Politics of Recession

0:00Thank you, Mark, and good afternoon, one and all. I am very pleased and indeed honored to address you, the friends and supporters of the Ludwig von Mises Institute today. Yes, it's true, as some of you are aware, I did work in a Bush administration. For some 16 months, I was chief economist in the United States Department of Labor. I took a walk on the dark side, you might say, tried to sip from the cup of power. Well, how could I do that? Well, we know human motivation is complex, so to put the best spin on it, I'd attribute it to frustration over governmental policy and maybe a certain naiveté.

0:55Although true, it may have been more sinister as Samuel Johnson observed in 1773 about human weakness, quote, wickedness is always easier than virtue, for it takes the shortcut to everything, unquote. So, condemn me if you must, yet I saw economic policy and propaganda being made in close relief. And my conclusion, I'm a straight, get to the bottom line guy, the low opinion I held of government before I went to Washington D.C. was not elevated by participation in same.

1:45Another way to put this bottom line is that I saw a complete disconnect between reality, that is the economics of the business slump, politics and proper policy. I repeat, there was a complete and total disconnect between economics and politics. Now, the more cynical of you, and there are some gathered here today, will be nonplussed by my observation. After all, FDR ridiculed the sign on his Treasury Secretary, Henry Morgenthau's desk.

2:32Does it contribute to recovery with the rejoinder, this is politics? The devious Mr. Roosevelt meant that the New Deal was, quote, not about economic recovery, but about displacing business as the nation's predominant elite, unquote. That's according to the Wall Street Journal columnist Robert L. Bartley a few days ago. On the other hand, there are some more earnest types present, I'm guessing. And you might recognize that this continuing disconnect between intervention and our scientific knowledge of recessions is a disaster.

3:22Why? One way to put it is, as Mises observed, the main issues of present-day politics are essentially economic. I want to put this latest recession in context, and if we need definitions of politics or recession, I'd be happy to supply them as I do in this paper, but I don't think we need them. When the Bush administration took office in January of 2001, a downturn was already underway. The president and his coterie said so and blamed Clinton. Who else? But hushed up when they were accused of talking the economy down.

4:08Some of you may recall that. OK, the hush-up was a mistake. A dose of truth about the economy, along the lines of the early 1980s Reagan model, would have worked better. Would have worked better. But they learned or mislearned an early lesson about Psychology and Confidence in Washington, D.C. You don't have to work there very long to find out that politics is all about the confidence game. And I mean that in the very pejorative sense as well. And prestige, these intangibles of prestige. And I was immediately struck and I got there a week before September 11.

4:56I started on the job the day after Labor Day in 2001 about how the economic news was always spun by administration spokespersons with pom poms, a flutter, cheerlead, cheerlead, cheerlead. Although, I think as Bill Fleckenstein, the financial columnist says, all of this is an insult to the cheerleading field. But as Walter Bastiat, we heard his name, I believe it was from Sean earlier, said in the 19th century, he says, quote, the people are most credulous when they are most happy, unquote. So make the people happy, foundation or no.

5:43Now, politicos and mainstream economists believe that our fragile, and I've got to use quotation marks, sorry, capitalist economy depends critically on sustaining confidence. This month, Martin Feldstein, I always want to say Marty, but I don't know the man, Marty Feldstein, go ahead Morgan. Once President Reagan's Chief Economic Advisor, he wrote in the Wall Street Journal earlier this month, that's all I read, of course, is the Wall Street Journal, but hey, for the mainstream, where better to go? Okay, New York Times, right, left, mainstream. Feldstein wrote quote, because confidence is so important for spending decisions the declining number of jobs until the September report created the risk of a self-fulfilling prophecy of low demand and weaker employment and that's why the recent upturn in employment plus 57,000 jobs you know that's rounding error that's sampling error it's just just nonsense but it was the first positive report Report in 2003, so hooray, hooray, hooray.

7:00OK, end of quote. Now, I ended it a little earlier. Probably got that. Wall Street or Washington DC, these economists are all Keynesians now. That was indicated by, I think, Roger and Sean in earlier remarks. It's just amazing. It's just flabbergasting. Well, to me, naive child that I am. And they believe spending and keeping it pumped up are about all that matters as keys to prosperity. They know a lot that just ain't so, but I always look for the soft underbelly. They know enough. They suspect enough is amiss, however, in our fundamentally sound economy.

7:50Read my lips, it's fundamentally sound. They just hired a quote, strong crisis manager, unquote, at the New York Federal Reserve Bank, a guy named Timothy Geithner, who worked in the Clinton Treasury Department and was president of the IMF, the International Monetary Fund. Gee, I wonder why they're interested in somebody who's got strong crisis management skills. Could it be that ever since at least certainly the Mexican crisis, that crisis management is the key? I didn't ever know this about central banking. I thought they were just stingy guys that kept the tight rein on the money supply. Remember that old era or mythology?

8:37Now, also as a contextual remark about our latest recession, Note that since September 11th, a new war, or is it a portfolio of wars, has been initiated, and that replaced the late lamented end of the Cold War, fortunately, and that's pushed this whole, the economy, into a distant second place, but in the public mind, or in public opinion. So the public has cut the administration, and of course the public doesn't know a whole lot about the Federal Reserve, but cut them plenty of slack, though it may prove exhausted come November 2004.

9:23And people in the administration are definitely getting nervous. They're not entirely sure of re-election. Now, I want to go back, following those remarks about the recent situation, to look at predecessors and policy. Now, FDR, as many of you know, but some don't, perhaps, FDR didn't invent counter-cyclical policy to fix a business slump. No, we can always look to the Republicans for such innovation. And it was a Republican president of course who set the table for counter cyclical fiscal policy, if not monetary policy, Herbert Hoover. And I want to go back and review a little bit of that. Remember that the last so-called free market recession was sharp but brief in 1920-21, by some standards it lasted sort of a typical recession period, I think it was eight months of downturn.

10:38Now the Harding administration, yeah we know Warren Harding fortunately was busy doing other things, but there was a lot of precedent in federal tradition. The administration stood by and did nothing because, quote, everything was too high, unquote. In other words, people were used to having prices generally, money prices come down as money wages come down after a war, after the World War. And the depression was something that, quote, ran its course like measles, unquote. So, you know, public opinion was way different back when. There was, yes, political pressure to intervene in 1920-21.

11:26But the favored theory of earlier business crises carried the day last time. Quote, businessmen got themselves into this mess, so let them get themselves out of it, unquote. One of the activists arguing in favor of intervention in 1921 was the progressive Secretary of Commerce, Herbert Hoover. And the Republican Party member was a party of progress. It was filled with leftists of the respectable sort as Herbert Hoover. When the roaring 20s came to a roaring stop, we can mark it with the stock market crash in late October 1929, the great engineer Herbert Hoover was in place to administer his remedies.

12:22And Mr. Forward-Looking would take on the business cycle and as Paul Johnson, the British historian or English historian said, Stomp it flat with all the resources of government, unquote. And Hoover was also called the Wonder Boy and in his memoirs he recalls, quote, No president before had ever believed there was a governmental responsibility in such cases. Therefore, we had to pioneer a new field." And now the parallels between Hoover's policies and rhetoric and the current Bush-Greenspan policies are remarkable.

13:09And I'll tick off some of these. Hoover inflated credit and bullied banks into lending, keep the party going. He signed the Agricultural Marketing Act to subsidize farming. He pursued a high-wage policy by a variety of measures including extracting corporate pledges to not cut wage rates. He also signed the Norris LaGuardia Act, anti-injection act, to help empower labor unions. A fourth area was that he cut taxes heavily. He did that initially, and then later on they were raised when he lost control of Congress because he'd lost the battle for public opinion.

13:57He pushed federal expenditures up by 42% in one year, shows you things are good. That's not that bad at least. And he drove the burden of total government up by about five percentage points of the gross private product in one year. According to Murray Rothbard, he deliberately ran a huge deficit, was proud of it, thank you very much, and this is the conventional wisdom, of course, today. He started more major public works, I can name one of them out in Nevada, and then the federal government had embarked on in the previous 40 years, No, I'm sorry, correction. The previous 30 years. 30 years. That was an error. I was correcting myself. I'm good at that, yeah.

14:46I make errors but I correct them in a hurry. He attacked the stock exchanges and he urged the public to, quote, quote, invest on the basis of the future of the United States, unquote. Not judging value of companies based on earnings or stuff like that. Sound familiar? He signed, of course, the well-known Smoot-Hawley Tariff Act. He lost the confidence of foreigners, which were on the cusp of doing, it seems, in the dollar who began to pull out their gold. Then we were on an attenuated form of the gold standard.

15:32Well, okay, after four years of frenzied interventionism, what was the result? Everybody saw what the result was, right? The Hoovervilles and, I remember one hitchhiker, it's told, he had a sign. It said, pick me up or I'll vote for Hoover. You know, his political handler says, get off the front page, you know, after three years of this. And as Rothbard put it, it was a ruin, quote, unprecedented in length and intensity, unquote. Well, at least he didn't resort to a shooting war. I've got to give him, you know, let's look at both sides of the ledger here.

16:17And what did our leaders in Washington D.C. learn from this episode? Well, Hoover bragged, quote, I mean, did he learn anything? No, let's consult his memoirs. Quote, we might have done nothing. That would have been utter ruin. I love that word, ruin. Instead, we met the situation with proposals to private business and to Congress of the most gigantic program of economic defense and Counter-Attack Ever Involved in the History of the Republic." Gigantism. That's my platform. Rexford Tugwell, one of FDR's impudent nobodies, as H.L. Mencken would put it. Well, he's part of the brain trust, to put it the way historians do.

17:07He finally conceded in an interview 40 years after the event, quote, We didn't admit it at the time, but practically the whole New Deal was extrapolated from programs that Hoover had started. Well, we know how counterproductive these interventions are. To quote Murray Rothbard, Whenever government intervenes in the market, it aggravates rather than settles the problems it has set out to solve. This is a general economic law of government intervention, unquote. Rothbard concludes his book on America's Great Depression, quote, bravely Hoover used every modern tool, every device of progressive and enlightened economics, every facet of government planning to combat the depression.

18:02For the first time laissez-faire was boldly thrown overboard and Every Government Weapon Thrown into the Breach and what a work of art we have. At least Hoover had to refute a then respectable rival, laissez-faire theory known as promoted by the reactionary liquidationists. Liquidate Andrew Mellon, the Secretary of the Treasury, So we need to liquidate labor, this term liquidation has a real harsh tone to it in an era of genocide but to allow bankruptcy, you know, it's just a terrible, terrible thing apparently.

18:49Now today reputable economists on Wall Street and inside the Beltway do not advocate laissez-faire as the corrective or non-intervention. But what really drives me nuts is that their economics is on a par with that once known as proposed by the monetary cranks. They're just monetary cranks, and yet they have all the prestige of the profession. What they do know in Washington is, quote, smart politics, unquote, right? Carl Rove will tell you what's the right thing to do on a steel tariff issue, right? That's where the Bush administration really lost it, in terms of a sequence of bad policies.

19:41The policies consist of happy talk, reassurance, it all is well. It's all under government control. That doesn't reassure me if it were true, but... and extravagant use of the Hoover FDR tools, you're just, you know, bigger and better. Mises wrote, quote, all governments are firmly committed to the policy of low interest rates, credit expansion and inflation. When the unavoidable aftermath of these short-term policies appears, especially if it's on my watch, They know of only one remedy, to go on in inflationary ventures, unquote. Now when they, Roger says, well how many arrows do they have in the quiver, when they're down to a one percentage point fed funds rate?

20:32In our office we would say he's got four arrows left. 25 basis points apiece, right? And then Ben Bernanke comes out and he says, oh no, we can monetize long bonds, long bonds, et cetera, et cetera, we have the printing press, blah, blah, blah. And then what happened in the bond markets was interesting because when in June the committee came out and only reduced the Fed funds rates by 25 basis points, that's when we had an implosion in the bond market, right? Yields went up by a percentage point or more, at least on the bellwether 10 year. And that's when they went back to their editors and said, you know, we need to change our communication policy.

21:22They're going to doctor up the way they justify their stupid decisions. Okay, so that's smart politics, I guess. Okay, this tragic situation goes beyond the direct policymakers, of course. We should cite two additional groups beyond the direct policy makers, economists and the public. That sounds like a good book title, that was a book title by Bill Hutt, one of my heroes. Now first let's look at economists. What's wrong here is that they have treated monetary problems in a superficial way.

22:08failed to integrate money into their theory of markets. They naively embraced the neutral theory of money, you know, well let's just make bananas money, right? They build these general equilibrium models, I'll just name a commodity, one of them will have the monetary function. This is the kind of flippant, ahistorical and non-logical things they do, so that money is going to be neutral, won't don't have any distortive effects, any changes in the volume of money and credit, etc. And they failed to appreciate, the mainstream profession has failed to appreciate how monetary manipulation necessarily distorts markets and causes booms followed by corrective busts.

22:55Hence, Benjamin Strong, governor of the New York Federal Reserve Bank in the 1920s could say, ignorantly and without guilt, it's a low-fat statement, quote, I'll give a little shot of whiskey to the stock market, unquote.

23:22Okay, so you won't catch the revered Dr. Alan Greenspan in that same statement, Also known as, since his knighthood, was it knighthood? I don't know, the queen did something on a shoulder with a sword. But we would call him, not Sir Prince-a-Lot, he sure prints a lot. Or, you know, you want somebody in the private sector? Larry Kudlow, right? Larry Kudlow. Or, the Cato Institute, some of you might have seen the latest Cato policy report, Bill Niskanen, chairman of the Cato Institute, normally a sensible free market inclined economist, headline, monetary policy is still too tight. So, I was one lonely guy inside the beltway for 16 No misunderstanding in economics as a science has done more harm than the role of money and credit in business boom and bust.

24:44Second, I've got to cane the public a little, not near as hard as the economists, But they need to bend over a little bit too because the public is myopic. They'll behave with great sense in the marketplace and do stupid things in the political arena. And so they've got a myopic disposition. They favor lower interest rates. That's the political balance of power and the culture. And if it's done by costless credit expansion and the authorities assures it's true, I'll believe in magic, right? It's just an irresistible temptation for politicians. It's the easy way.

25:30And bureaucrats and economists want to comply. You want to be popular. I don't want to go too much further. The public is pretty ignorant, but educable, and they do want to hear the truth, I insist, ultimately. But I can't resist concluding with respect to the issue of the public on money and fiscal policy and the politics, therefore, with H.L. Mencken's theory of democracy, because it surely applies all too well here. The public, this is the democracy, it's that system where the public gets what it wants, good and hard.

26:18Thank you so much for your kind attention.