Thursday, September 25, 2008

John McCain Follows Jimmy Carter

In an e-mailed press release, Andy Martin asks whether George Bush's invitation to Barack Obama to "help solve the financial crisis that is supposedly threatening America" may have been "the biggest blunder in presidential politics since President Jerry Ford in 1976 said Poland was not in the Soviet sphere of influence."

I have been complaining about the Federal Reserve Bank's influence on the economy and the triumph of Keynesian economics among Republicans for the past two or three years, and my old friend Howard S. Katz has been complaining about them for nearly 40 years. The underlying problem with the current financial system is its excessive expansion of credit, which in turn stimulated overly aggressive lending and excessive real estate prices.

The response of conservatives to the crisis reflects what psychologists call perceptual distortion. Distortion occurs when someone feels threatened by information. The person does not hear it or hears it differently.

Conservatives have been reacting to the current decline in real estate prices by saying it is due to Progressive lending programs, which is only partly true. The excessive lending, like the tech bubble, would not have occurred without Republican Federal Reserve monetary policies. When Nixon said that "we are all Keynesians now" he ensured that distortions of this kind would occur over time. It took 37 years, and Howard is to be commended for fighting this fight during the upswing of the Republican Keynesian bubble.

Politicians always try to repeal the laws of economics, and we see the same kind of distortion occurring among Republicans now. One example is the belief that even more inflation, increasing the money supply by one half or $750 billion, would solve the problem. This, of course, begs the question of why the past 75 years of monetary inflation did not solve the "problem". Also, the idea that house prices must always rise was nonsensical when people were saying it in the '80s, '90s and '00s. Now that it is turning out to have been false all along, politicians and conservatives argue that there is a CRISIS.

The correction of real estate prices will causes losses among those who paid too much, just as the tech bubble of 1999 caused losses. Rather than confront the excesses and incompetence of the Federal Reserve Bank as an institution, conservatives, along with the Progressive media, frame this as a CRISIS. A CRISIS.

Martin points out that Obama has been making political hay out of Bush and McCain's naive invitation:

"Obama will have attained the last stop on his self-referential crusade by being accepted at the White House as a statesman and dealmaker. Good grief."

The invitation is symptomatic of incompetence at the apex of the Republican hierarchy that is philosophical as well as political. Lacking a truthful model of what Federal Reserve Bank monetary expansion over the past 40 years has done to the economy, the Republicans fall into the same pattern that Jimmy Carter did in the late 1970s when he listened to the Progressive economists of the Brookings Institution who claimed that inflation helps the poor and working classes because they hold more debt than the wealthy. This claim overlooked historical and dynamic realities. In particular, monetary expansion boosts the stock market, helping the wealthy. Inflation comes several years later and will not show up in cross sectional or even three-year-lagged correlations between monetary expansion and wealth. The gains that the middle class enjoys due to inflation are entirely attributable to increasing house prices and so are difficult to extract except through debt (or becoming homeless), which requires a riskier profile than many people prefer. Neverthelss, debt and inflation have become national habits, creating a stress-and-risk profile that frustrates many Americans, even as they consume on credit. Moreover, much of the gain from house prices is eroded through increasing repair, insurance and property tax costs.

Older Americans are forced to give up their homes because of such costs, and many are forced into poverty in order to continue to live in their homes. Economists treat increasing house prices as wealth gains, but such gains come at the costs of increased risk.

Equally, such gains come at the expense of other Americans. In order to gain due to house prices, Americans must ultimately sell their homes to new buyers, and those buyers must pay much higher prices. Thus, higher house prices mean that new buyers cannot afford homes equal to what they once could. My students will not share in the American dream if the current Republican administration has its way. On paper Americans seem to become wealthier, but what has occurred is a transfer of wealth from buyers to sellers, and the sellers often do not want to sell but have to because they would forced into eating cat food otherwise. Moreover, they cannot enjoy their "wealth" because doing so involves increasing stress due to borrowing or selling. Thus, inflation destroys community. It pits one generation against the other, it forces people to leave their homes and it prevents children from remaining in the communities in which they grew up.

The lag between monetary expansion and price inflation prevents economists from detecting monetary expansion's relationship to income inequality. Hedge funds have obtained capital and made profit through monetary expansion. That wealth is attributable to future inflation. Demand for resources increases prices in later periods, when average Americans foot the bill for the hedge fund managers' profits. In order to see this you need a multi-decade view. The methodologies that economists use look at single years at a time and relate same-period phenomena (inflation in this period versus house price in this period), but the process takes decades to unfold. However, left wing writers such as William Greider in his book "Secrets of the Temple" about the Fed, were happy to make the nonsense claim that inflation helps the poor. Greider can be excused because he was basing this argument on academic studies. But how wrong can academics be before we conclude that they are simply quacks and then move on?

Unfortunately, today's conservatives have bought into the Keynesian model, which is now going to turn out to be suicidal for them. They are following the path of Jimmy Carter.

I would urge a return to monetary conservatism, the gold standard, and a Great Awakening from Republicans' Keynesian slumber.

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