Professor Elam

Job One: Wean The Economy Off Of Politics

By CHARLES KRAUTHAMMER | Posted Friday, November 28, 2008 4:30 PM PT

In the old days — from the Venetian Republic to, oh, the Bear Stearns rescue — if you wanted to get rich, you did it the Warren Buffett way: You learned to read balance sheets. Today you learn to read political tea leaves.

You don't anticipate Intel's third-quarter earnings; instead, you guess what side of the bed Henry Paulson will wake up on tomorrow.

Today's extreme stock market volatility is not just a symptom of fear — fear cannot account for days of wild market swings upward — but a reaction to meta-economic events: political decisions that have vast economic effects.

As economist Irwin Stelzer argues, we have gone from a market economy to a political economy. Consider seven days in November.

On Tuesday, Nov. 18, Paulson broadly implies that he's only using half the $700 billion bailout money. Having already spent most of his $350 billion, he's going to leave the rest to his successor. The message received on Wall Street — I'm done, I'm gone.

Facing the prospect of two months of political limbo, the market craters. Led by the banks (whose balance sheets did not change between Tuesday and Wednesday), the market sees the largest two-day drop in the S&P since 1933, not a very good year.

The next day (Friday) at 3 p.m., word leaks of Timothy Geithner's impending nomination as Treasury secretary. The mere suggestion of continuity — and continued authoritative intervention during the interregnum by the guy who'd been working hand in glove with Paulson all along — sends the Dow up 500 points in one hour.

Monday sees another 400-point increase, the biggest two-day (percentage) rise since 1987. Why?

Three political events: Paulson's weekend Citigroup bailout; the official rollout of Obama's economic team, Geithner and Larry Summers; and Paulson quietly walking back from his earlier de facto resignation by indicating that he would be ready to use the remaining $350 billion (with Team Obama input) over the next two months.

Lobby For Life

That undid the market swoon — and dramatically demonstrated how politically driven the economy has become.

We may one day go back to a market economy. Meanwhile, we need to face the two most important implications of our newly politicized economy: the vastly increased importance of lobbying and the massive market inefficiencies that political directives will introduce.

Lobbying used to be about advantages at the margin — a regulatory break here, a subsidy there. Now lobbying is about life and death. Your lending institution or industry gets a bailout — or it dies.

You used to go to New York for capital. Now Wall Street, broke, is coming to Washington. With unimaginably large sums of money being given out by Washington, the Obama administration, through no fault of its own, will be subject to the most intense, most frenzied lobbying in American history.

That will introduce one kind of economic distortion. The other kind will come from the political directives issued by newly empowered politicians.

First, bank presidents are gravely warned by one senator after another about "hoarding" their bailout money. But hoarding is another word for recapitalizing to shore up your balance sheet to ensure solvency.

Schumer-Mobiles

Is that not the fiduciary responsibility of bank directors? And isn't pushing money out the window with too little capital precisely the lending laxity that produced this crisis in the first place? Never mind. The banks will knuckle under to the commissars of Capitol Hill. They control the purse. Prudence will yield to politics.

Even more egregious will be the directives to a nationalized Detroit. Sen. Charles Schumer, the noted automotive engineer, declared "unacceptable" last week "a business model based on gas." Instead, "We need a business model based on cars of the future, and we already know what that future is: the plug-in hybrid electric car."

The Chevy Volt, for example? It has huge remaining technological hurdles, gets 40 miles on a charge and will sell for about $40,000, necessitating a $7,500 outright government subsidy. Who but the rich and politically correct will choose that over a $12,000 gas-powered Hyundai?

The new Detroit churning out Schumer-mobiles will make the steel mills of the Soviet Union look the model of efficiency.

The ruling Democrats have a choice: Rescue this economy to return it to market control. Or use this crisis to seize the commanding heights of the economy for the greater social good. Note: The latter has already been tried. The results are filed under "History, ash heap of."

© 2008 Washington Post Writers Group

 

New New-Deal 'Jolt' Overestimates Real Impact Of The Old New Deal

By GEORGE F. WILL | Posted Friday, November 28, 2008 4:30 PM PT

Early in what became the Great Depression, John Maynard Keynes was asked if anything similar had ever happened. "Yes," he replied, "it was called the Dark Ages and it lasted 400 years."

It did take 25 years, until November 1954, for the Dow to return to the peak it reached in September 1929. So caution is sensible concerning calls for a new New Deal. The assumption is that the New Deal vanquished the Depression.

Intelligent, informed people differ about why the Depression lasted so long. But people whose recipe for recovery today is another New Deal should remember that America's biggest industrial collapse occurred in 1937, eight years after the 1929 stock market crash and nearly five years into the New Deal.

In 1939, after a decade of frantic federal spending — President Herbert Hoover increased it more than 50% between 1929 and the inauguration of Franklin Roosevelt — unemployment was 17.2%.

"I say after eight years of this administration we have just as much unemployment as when we started," lamented Henry Morgenthau, FDR's Treasury secretary. Unemployment declined when America began selling materials to nations engaged in a war America would soon join.

In "The Forgotten Man: A New History of the Great Depression," Amity Shlaes of the Council on Foreign Relations and Bloomberg News argues that government policies, beyond the Federal Reserve's tight money, deepened and prolonged the Depression. The policies included encouraging strong unions and wages higher than lagging productivity justified, on the theory that workers' spending would be stimulative.

Instead, corporate profits — prerequisites for job-creating investments — were excessively drained into labor expenses that left many workers priced out of the market.

In a 2004 paper, Harold L. Cole and Lee E. Ohanian, both of UCLA, and the Federal Reserve Bank of Minneapolis argued that the Depression would have ended in 1936, rather than in 1943, were it not for policies that magnified the power of labor and encouraged the cartelization of industries.

These policies expressed the New Deal premise that the Depression was caused by excessive competition that first reduced prices and wages, and then employment and consumer demand.

In a forthcoming paper, Ohanian argues that "much of the depth of the Depression" is explained by Hoover's policy — a precursor of the New Deal mentality — of pressuring businesses to keep nominal wages fixed.

Furthermore, Hoover's 1932 increase in the top income tax rate, from 25% to 63%, was unhelpful. And FDR's hyperkinetic New Deal created uncertainties that paralyzed private-sector decision-making. Which sounds familiar.

Bear Stearns? Broker a merger. Lehman Brothers? Death sentence. The $700 billion is for cleaning up toxic assets? Maybe not. Writes Russell Roberts of George Mason University:

"By acting without rhyme or reason, politicians have destroyed the rules of the game. There is no reason to invest, no reason to take risk, no reason to be prudent, no reason to look for buyers if your firm is failing.

"Everything is up in the air and as a result, the only prudent policy is to wait and see what the government will do next. The frenetic efforts of FDR had the same impact: Net investment was negative through much of the 1930s."

Barack Obama says the next stimulus should deliver a "jolt." His adviser Austan Goolsbee says it must be big enough to "startle the thing into submission." Their theory is that the crisis is largely psychological, requiring shock treatment. But shocks from government have been plentiful.

Unfortunately, one thing government can do quickly and efficiently — distribute checks — could fail to stimulate because Americans might do with the money what they have been rightly criticized for not doing nearly enough: save it.

Because individual consumption is 70% of economic activity, St. Augustine's prayer ("Give me chastity and continence, but not yet") is echoed today: Make Americans thrifty, but not now.

Obama's "rescue plan for the middle class" includes a tax credit for businesses "for each new employee they hire" in America over the next two years. The assumption is that businesses will create jobs that would not have been created without the subsidy. If so, the subsidy will suffuse the economy with inefficiencies — labor costs not justified by value added.

Here we go again? A new New Deal would vindicate pessimists who say that history is not one damn thing after another, it is the same damn thing over and over.

© 2008 Washington Post Writers Group