Christopher Whalen

“[F]or many philosophers, conflict is inevitable in politics because a government should seek both to make its people equal in wealth and opportunity and also to safeguard their liberty, but it cannot do both because people can be made equal only through serious constraints on their freedom. This is not simply a statement of the obvious fact that different people and different communities hold different values. The argument claims that even a single sensitive person cannot express, either in how he lives or how he votes, all the ideals he knows he should recognize.”

Justice for Hedgehogs
Ronald Dworkin

In an article in the April 28, 2011, New York Review of Books, “For a National Investment Bank”, Robert Skidelsky and Felix Martin argue that the Obama Administration ought to create yet another state sponsored financial institution in the US to explicitly stimulate the economy by issuing debt. This is a truly bad idea whose time has come and gone.

The authors rightly describe the lack of aggregate demand in the US, something we have also discussed at some length in this space. “Few dispute that the US is not enjoying a normal recovery by recent standards,” they write. So true. But their suggestion of creating a new government sponsored enterprise (GSE) to address slack growth and employment lacks imagination and practicality. Skidelsky and Martin specifically want to use the NIB to finance public infrastructure projects, but without the new debt required showing up on the federal budget. How clever.

Nowhere do Skidelsky and Martin, nor most neo-Keynesian economists, admit that much of the nominal economic growth of the past several decades in the US was increasingly supported by debt and inflation. The national investment bank they propose would take its place alongside dozens of existing New Deal and Great Society agencies such as Fannie Mae and the Federal Housing Administration, as well as the Bretton Woods GSEs including the IMF and World Bank. Martin, an economist at Thames River Capital LLP, worked at the World Bank for two stretches between 1998 and 2008 and must be familiar with this history. The NIB is more of the same stuff in policy terms.

The NIB proposal shows just how bankrupt the American political discourse has become when it comes to economics, but especially on the left.  It also reveals the indifference of liberal economists to the political consequences of economic policy choices. This is not to suggest that Republicans are exactly fonts of economic innovation at present. Most Republicans are indistinguishable from big government Democrats in terms of their willingness to prune back the corporate state. Fiscal conservatives have been fighting this battle for decades now.

The first observation about the NIB proposal is that we are talking, once again, about using debt to create the illusion of economic prosperity. Skidelsky, Emeritus Professor of Political Economy at the University of Warwick and the author of Keynes: The Return of the Master (2009), is an unabashed advocate of the aggressive state in action. Yet what he and Martin propose promises few benefits in economic terms. Indeed, you cannot make an argument for more GSEs on utilitarian grounds.

The most offensive thing about the NIB proposal is that it pretends to rely upon Keynes. Skidelsky and Martin say that they intend some sort of pump-priming, jump starting catalyst for private sector growth. Keynes was no apologist for using debt to simulate real economic growth but he also believed in individual economic liberty, which he greatly benefited from. Living through the privation in the UK during and after WWII, Keynes understood the desperate situation facing Britain. Modern economists spend too little time considering politics when assessing the motivations of the day.

My friend Sol Sanders and William Alpert talked about Keynes in The Institutional Analyst last month (Keynes, Keynesianism — and Keynesianitis): “‘The day is not far off’, he wrote, ‘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 2010 we are still waiting.”

The same lack of demand and unemployment that faced Keynes and the leaders of the Western economies after WWI and WWII, and to which Skidelsky and Martin rightly raise in alarm, has driven liberals today to embrace ever more inflation and debt. An aggressive combination of reflation by the Fed and restructuring of the housing and banking sectors is the way to restore US economic growth, but you won’t hear about restructuring large banks from adherents of the neo-Keynsian faith.

Skidelsky and Martin assess the political situation facing the Obama administration, saying “that it has become politically impossible to increase the deficit.” Quite right. But the solution offered by these two honorable gentlemen is to create yet another GSE to issue more debt off the books? Such expedients are entirely transparent to the marketplace, but Skidelsky and Martin do not seem to appreciate that more incremental debt buys less and less bang for the buck in terms of nominal economic growth.

Skidelsky and Martin, and their American contemporaries led by the likes of Paul Krugman, call for “fiscal stimulus,” but what they are really arguing for is permanent inflation. The Fed has been pursuing the reflation path via quantitative easing, but with less than astounding results, owing to the lack of benefit for US households.

The only way to fix the twin problems of deflation and unemployment is to keep money easy and restructure the insolvent parts of the banking system and economy. In both the US and EU, the policy has been implemented but the lack of financial restructuring of the insolvent banks of the US and EU is the chief obstacle to economic renewal. To restructure and renew is the alternative to the proposal from Skidelsky and Martin.

Instead, Skidelsky and Martin want to layer more state-guaranteed debt on top of an already wobbly foundation. This is not only bad economic policy, but it has truly hideous political implications. John Stuart Mill acknowledged that utilitarianism had to admit the moral superiority of classical liberalism and that, to save it, certain preferences (those the classical liberals generally would favor) simply had to be acknowledged as preferable.

Why is it that so few economists ever assess the social and political implications of their policies? Skidelsky and Martin are following the road to hell trodden by Franklin Roosevelt in the 1930s. Not only do we have the New Deal zombies like Fannie Mae and the Federal Housing Administration as examples of failure, but dozens of parastatal banks and development entities in the EU that are effectively insolvent today. The embrace of the fascist economic model proposed by Skidelsky and Martin has not saved the EU from economic malaise.

As Ronald Dworkin notes in his new book, Justice for Hedgehogs, the differences between different ethical and political systems do matter very much. Keynes believed in using temporary government action to help restore private economic activity, but I doubt he would have supported the type of debt accumulation much less the creation of permanent GSEs that Skidelsky and Martin propose.

Instead of embracing a permanent state of inflation, as has been the case in the US since the 1970s, we need to deflate the bubble and start again. It is not too late for President Obama and Congress to restructure the US financial system, fix the housing market and create the conditions for true economic growth. All we need to succeed is leadership and the knowledge that the bastard children of Lord Keynes cannot help us in the difficult task ahead.

Back in October, after the meeting of the Federal Open Market Committee, the Associated Press reported that “The Federal Reserve is likely to take additional action to rejuvenate the economy and lower unemployment, an influential member of the central bank’s policymaking group said.”

Of course the Fed neither rejuvenates economies nor creates jobs.  For some reason members of the media attribute magical powers to the US central bank and its employees.

Part of the reason for this divine veneration is that there is little in the way of ideas or resources elsewhere in the federal government, thus the holy printing press is now well and truly the only game in town.

Since October the Fed has purchased hundreds of billions of dollars in US Treasury debt in an effort to force liquidity into private assets.  But while the U.S. central bank is able to float the Treasury’s red ink on a sea of new fiat paper dollars, overseas the great deflation has left global central banks largely emasculated.  Unable to create their own money with the ease of the Fed, even the largest central banks in Europe have gone begging for alms in the form of dollar swap lines from Chairman Bernanke.

Other global central banks are chronically short dollars and the Fed is the proverbial tail wagging the global doggie.  Treasury Secretary Timothy Geithner brags about collecting hundreds of billions in nominal greenbacks recovered from the TARP, Ally Financial and AIG bailouts, among others, but it is Fed Chairman Ben Bernanke and his colleagues on the Federal Open Market Committee who are playing the big game with trillions of new fiat paper dollars.

The Daily Bail asks: “Will Bernanke Scoop Up $50 Billion Of Ireland’s Toxic Assets? Fine Gael Seeks MASSIVE Loan From U.S. Fed” This is a very good question since the Irish government likely to be elected in a week or so is going to face an assortment of very unpleasant choices.  If Ireland’s new political coalition goes hat in hand to the American central bank, the new regime is not likely to last very long, especially with the IRA now talking of great conspiracies among private business.

Neither are Chairman Bernanke and the Fed likely to endure if they continue to play the role of de facto global central planning agency without explicit legal authority from Congress.  The trouble here is both one of legal authority and the deleterious effects of current Fed policies.  The more the Fed tries to help the domestic economy with low rates and explicit bailouts, the worse our collective predicament.  Recall the advice of Martin Mayer, who always taught that the Fed (and government generally) should emulate the physician and “first do no harm.”

The Fed keeps interest rates artificially low to “help” the current situation, but in doing so only stokes inflation and bubbles in sectors such as food, energy and strategic commodities — and also market sectors such as equities.  In the past, the central bank has attempted to fine tune the national economy, most recently in the period a decade ago when then-Chairman Alan Greenspan stepped on the monetary gas.  Not only did the resulting surge in cheap credit stoke a domestic housing boom in the US, but it created booms in global financial assets and also internationally traded goods that impacted investment and asset allocation decisions around the world.

With the 30-plus percentage decline in US housing prices so far and another 10-20% in prospect this year and in 2012 before we hit the bottom, the Fed faces continued asset price deflation at home even as the impact of its accommodative policies are already boosting global inflation.  The combination of volatile weather and poor logistical planning in terms of stockpiles could make the global food supply situation acute in 2011-2012.  The Fed, not hedge funds, is making the situation worse in markets for energy, commodities and food.

The Fed’s extreme monetary policies used to bail out the largest banks are creating bubbles with cheap credit.  Look at the bull market in commercial real estate assets, for example, an entirely speculative financial phenomenon.   Prices for well-located assets are driven up by speculative interest among investors who prefer CRE risk to zero yields on Treasury paper.  But is there sufficient cash flow under these assets to support these valuations?

With yields on longer maturities climbing, it seems that the greatest risk facing the Fed is the transition from life support to something that resembles a sustainable run rate.  Trouble is, Bernanke and a majority on the FOMC still seem to be making policy decisions based upon domestic criteria, this even as the extreme easy money policies of the Greenspan/Bernanke era have already achieved the implicit policy goal of asset price reflation.  It’s all relative, you understand.  When an election-focused White House calls for economic recovery, Bernanke, like Greenspan before him, dutifully steps on the gas, seemingly heedless of the risks.

Of course, classical reflationists argue that the Fed is doing precisely the right thing by using low interest rates to force liquidity into private assets.  One reader of my work rebukes those who argue for monetary restraint and invokes Irving Fisher in his famous 1931 “Econometrica” article.  By lowering rates on Treasury bonds below where they might otherwise be, he argues, Bernanke “is likely to push investors into corporate bonds and lower spreads–which, in the end, are the ONLY real engines of growth in the financial markets.”

The trouble with this argument, like the neo-Keynesian corollary about the use of debt to fund fiscal stimulus, is that expedients such as low interest rates and deficit spending are meant to stimulate economic growth on the margins, not to replace private sector demand and economic activity that does not exist.  Bernanke and his fellow travelers on the FOMC, it seems, have entirely embraced the world view of Paul Krugman and Robert Reich, and echoed among the inflationati in the EU led by Martin Wolf, that new monetary emissions are an apt replacement for fiscal spending.

The problem with living in a world where relativity is the operative standard is that there is no truth in an objective sense.  Political survival, not civil society, is the first priority, so members of the FOMC will say and do anything to get through the day, no matter how internally inconsistent or reckless.  Until Bernanke and the FOMC start to recognize that their well-intentioned efforts to help the domestic US economy are creating the precursor for future global economic collapse, we cannot truly bring the Fed under effective public control and begin the process of national restructuring in America.