On Helmsmanship

The first ship I ever steered was USS Iowa (BB-61) a 45,000 ton behemoth as long as three football fields, propelled by more than 200,000 horsepower.

The boatswain's mate who taught me to steer emphasized that I shouldn't use too much rudder. If I did, I would be constantly chasing the course back and forth across the compass binnacle and never get it right. Even worse, the constant corrections would slow the ship down and waste fuel. If I just used a light touch, natural wave action would usually bring the ship back on course.

As it turns out, the same principal applies to the economy and inflation.

There are two kinds of inflation. There is "headline" inflation, which includes highly volatile prices like food and gasoline. This kind of inflation is notoriously seasonal and subject to temporary influences (bad weather, for example).

The other kind of inflation is referred to by economists as "core" inflation. That is the underlying inflation rather than day to day price fluctuations.

When the Fed manages monetary policy, they have found through experience that they should limit their measures to those affecting core inflation.

Core inflation right now is less than two percent. Furthermore, it is not increasing and there is no sign it will increase anytime soon.

The problem for most of us is that we spend money at the grocery store and gas station in response to "headline" inflation.

Nonetheless, it would be bad for all of us if the Fed started responding to headline inflation with a heavy hand on the helm. That would be another way to kill economic recovery. Goodness knows, the House of Representatives is doing enough on its own to accomplish that. They don't need the Fed's help.

It's the Economy, Stupid!

Eighteen years ago, the Clinton administration focused its efforts intently on improving economic conditions for ordinary Americans. As a result, during President Clinton's two terms from 1993 to 2001, employment in this country increased by 23 million jobs, far surpassing the rate of growth of the population.

During President George W. Bush's first term, there was zero job growth, while the population grew, resulting in a lower percentage of Americans employed than in 2001. By the end of President Bush's second term, the total of job increases during his eight years was 4.8 million. The Bush job increases fell significantly below the increase in population.

As soon as he became president, George W. Bush insisted that tax cuts would lead to more prosperity for Americans.

It didn't work then and it won't work now.

Why do we keep repeating failed experiments?

British Austerity

The Cameron government in the UK is busy testing the hypothesis that the way to economic recovery from a severe recession is to drastically reduce government spending.

How is that working out? Not so well, according to the latest information from the Financial Times. While the government is touting GDP growth in the first quarter of this year, it is only 0.5%. That offsets the previous quarter's decline of 0.5% and shows the British economy essentially treading water.

Britain's opposition finds the performance unimpressive. Mr. Balls, the chancellor of the shadow (opposition) government in waiting, observed that Chancellor Osborne “doesn’t seem to understand that without jobs and growth you can’t get the deficit down. The slower growth, higher unemployment and higher inflation we now see under George Osborne means he is now set to borrow £46bn more than he was planning to. That’s a vicious circle and makes no economic sense at all.”

Regrettably, our own deficit hawks seem bent on leading us down the same path.

By the way, the "austerity will get us out of recession" hypothesis has been tested before. We tested it in 1929. Japan tested it in the 1990's. It doesn't work.

No Shutdown, But We Still Have a Problem

The good news is that we apparently won't have a government shutdown (at least as of 10:39 p.m. April 8, 2011).

The bad news is that the result is a reduction in government spending.

The worse news is that the deal is based on a lie - that the Great Recession and resulting unemployment resulted from budget deficits and national debt. The assurances that reducing spending will bring back prosperity is worse than a lie. It is a destructive lie.

Reduced spending has the potential to bring our very weak recovery to a screeching halt and initiate a new round of economic decline.

I don't like to sound pessimistic. Under normal circumstances, the budget wrangling would be very important, but not dangerous.

After all, the key issue of any political dispute is "who benefits" and "who pays?"

That is the heart of politics. And it affects everyone's welfare.

Where were the deficit hawks when Reagan and Bush I quadrupled the national debt? Where were they when Bill Clinton left behind a budget surplus and a plan to pay off that debt within a decade?

Were they not listening when Dick Cheney asserted that "Reagan proved that deficits don't matter."

Actually, no Democrat believes that deficits don't matter. It is just that there is a time to cut expenditures and a time to spend more.

If we want jobs, now is the time to spend more.

When the economy recovers, we need to reduce both public and private debt.

Euro vs. the Dollar

My graduate professor of international economics, George N. Halm, used to illustrate the phenomenon of runaway inflation (hyperinflation) by telling what life was like when he was a teenager in Germany after World War I.

Professor Halm's mother, a widow, lived on a government pension. Each category of pension was paid on a different day of the week, with widows coming on Friday. By Friday, the value of the pension, which was set on Monday, had dropped out of sight. Even so, he hopped on his bicycle, collected his mother's pension at the pension office and raced around town buying as many household necessities as he could before the value of the money dropped too much farther. The operative principal was to spend the money before it disappeared.

How could shopkeepers know how much to charge? They created an informal price index system. For example, the price of a haircut was indexed to the price of breakfast rolls each morning.

Clearly it was impossible to live that way, and understandably Germans remain paranoid about inflation.

Still, they overdo it. A modest amount of inflation allows price adjustments without triggering deflation. Because of the way the Euro zone was established, the interest rate for the zone is set by the European Central Bank, which is essentially the German Central Bank. They are about to raise the interest rate in the Euro Zone to make sure there is zero inflation in Germany, despite the high probability that this will destroy economic activity in several smaller countries.

It will also place added pressure on the US economy by, among other things, driving up the international price of oil.

Shutdown?

As of today (April 7, 2011), it looks like we are bound to have a government shutdown.

According to the polls, most Americans recognize that it is the Republicans in the House of Representatives, many of whom have never served in public office before at any level of government, who are driving toward this train wreck.

My concern is not just the adverse effect of a shutdown on my personal situation (my US Navy retirement check is likely to be delayed, and possibly my Social Security check), but more importantly the damage it will do to the economy.

In fact, I am disappointed that no one is explaining that any reduction in government spending is likely to bring our weak recovery to a halt and might even start another downward spiral.

The reason is that we are in a liquidity trap. I have explained this phenomenon before.

If I were of a mind to believe in conspiracies rather than mere incompetence, I would suspect the Republicans in Congress intend to wreck the economy and blame the president.

Cheney: "Reagan Proved Deficits Don't Matter"

How soon we forget.

Seven years ago, conservative think tanks and Vice President Cheney were arguing that deficits have no adverse effects on the economy.

Their arguments are summarized here in a 2004 Washington Post article.

What has changed?

For one thing, the real estate bubble collapsed in 2007, nearly bringing the economy to its knees.

For another, we now have a Democrat in the White House for Republicans to blame.

A One-Armed Economist

President Truman once complained about his economic advisers.

"They come in," he said, "and tell me 'on the one hand, this,' and 'on the other hand, that.'"

"What I need," he lamented, "are some one-armed economists."

If You Lived Here, You'd be Home by now

Years ago, when we lived in the big city, downtown developers tried to lure home buyers with signs for commuters that said, "If You Lived Here, You'd Already Be Home."

I think of that every time some pundit talks about how urgent it is to reduce the deficit. The last President to successfully reduce the deficit was Bill Clinton.

In fact, according to CBO projections, if G.W. Bush had continued the Clinton policies, we would have not only reduced the deficit, we would have paid off our national debt by now.

The last previous presidents who reduced the deficit were Jimmy Carter and Lyndon Johnson.

Ronald Reagan tripled the national debt during his tenure. By the end of George Herbert Walker Bush's administration, the debt was four times as great as at the beginning of Reagan's term. At the end of Bush I's term, the debt equaled 66% of the Gross Domestic Product. By the end of Clinton's term, it was down to 56% of GDP.

How would you like for the country to have zero debt right now? We'd have much better fiscal options, wouldn't we?

Instead, by the end of George W. Bush's term, our debt had risen to 83% of GDP, and we were in the midst of the greatest recession since the Great Depression. In fact, had it not been for the safety nets put in place after the Great Depression, we could easily have had an even greater depression.

But let's get one thing straight - the national debt didn't cause unemployment. Nor did it cause the great recession - mishandling of private debt and financial misfeasance did that. And so far, the national debt hasn't caused any inflation.

Now is absolutely the wrong time to balance the federal budget, thus reducing aggregate demand and stifling what little recovery we have going.

Once we get back to near full employment, though, we need to pay down the public debt and drastically reduce private debt. We won't be able to do that without getting back to making things instead of just making deals.

To get there, we need to reward the thing makers and take away special rewards for financial manipulators.

Principles of Finance

"High finance isn't burglary or obtaining money by false pretenses, but rather a judicious selection from the best features of those fine arts."

Mr. Dooley (Finley Peter Dunne)