The Economic Policies of Failure

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by: Nicholas Jones

Dec. 8 (Bloomberg) -- President-elect Barack Obama is focusing his economic recovery strategy on making the biggest investment in the nation’s infrastructure since President Dwight D. Eisenhower created the interstate highway system a half- century ago.

Markets cheered, analysts applauded, and I...cleaned up the bits of vomit that didn't quite make it into the toilet, but this IS the "New" America...or is it?

There is plenty more of this to be expected going forward. Unless you've been sitting in your mom's basement exclusively playing World of Warcraft for the past 12 months, you saw this as an inevitability. If that's not the case for you, and you were still too incompetent to foresee this, YOU ARE THE PROBLEM.

Regardless, this is not some drastic change in U.S. policy. Liberal economics has driven this country for several decades now. As a result, it has recently climaxed into this Incredible Hulk like beast that we have all come to know.

Before we go on, I want say that I don't want this piece to be construed as a political article. I am a TRUE economic conservative in the sense that they don't exist anymore. This does not mean I associate myself with the Republican party when in fact they are just as Liberal economically as any Democrats in office. They just try to hide it.

Economic Fate Sealed

Let's take a walk down memory lane and discuss how the Bush/Clinton Monarchy pissed off the Incredible Hulk economy.

I need to start this analysis by mentioning that we've been in a Keynesian run economy since the Great Depression. Although recent administrations have taken that to an extreme, their policies are a direct result of Keynesian theory limitations and eventual failure (refer to my three part series on Keynesian failures for more background).

The greatest limitation set in place is the inability of the economy to deflate and the necessity of liquidity to continually grow in order to prevent the house of cards from collapsing. As a result of this, we saw some dramatic changes under the Clinton administration that really started this train rolling.

You've got to give it to the man, ol' Billy Clinton was good at more than smooth talking his interns. The man and his cabinet were very innovative in taking Keynesian economics to a new extreme.

In a sense, Clinton laid the framework for this crisis. First off, Clinton and Robert Rubin rewrote the rules governing the Community Reinvestment Act. In doing so, they applied all sorts of political pressure on institutions to lend to people who weren't credit worthy. Again, this is the Liberal economic way. It's the something for nothing scam and it doesn't work.

The problem was that these potential borrowers couldn't be given your typical 30-year fixed rate mortgages. Hence the creation of the now infamous exotic mortgage instruments you hear about today.

Now we have a massive influx of mortgage debt flooded into the system. The problem is that this created an imbalance in the fractional banking hoax. Have no fear, because Clinton had another ace up his sleeve.

He simply changed leverage rules. Historically, banks were only allowed to take 18x leverage on their balance sheets. Bill replaced the 18x leverage ratio with a 40x leverage ratio. As you can see, Clinton and his cabinet are well on their way to creating a massive credit bubble.

(Note: If you are happy in your naive Obama, nobody is holier than thou views, please don't read the rest of this note. Obama has essentially reinstated the ENTIRE cabinet that served under Clinton. The only one who is missing is Madeline Albright. That's where Hillary Clinton comes in.)

So to briefly recap, Clinton pushed sub-prime lending, and changed leverage rules in order for banks to finance the growth. What I haven't mentioned that the banks also needed to get creative in order to take on this new found debt. Hence we have the creation of illiquid credit derivatives and credit default swaps.

As previously mentioned, the Clinton era took Keynesian/Liberal economics to a level not seen before. As preached by Keynesian theory, a large growth in the credit and/or monetary base will result in a period of economic expansion. That's exactly what happened, and Clinton is perceived as one of the better presidents in recent times because of it. In reality, we are sort of paying for the economic expansion under the Clinton era.

The problem with Keynesian theory is that each economic expansion results in proportional economic downturn. Considering the growth resulting from the creation of sub-prime lending, 40x leverage, and credit derivatives, the ensuing decline can be expected to be quite severe.

Bush Whacked into Depression

The Bush era is one that will be remembered for some time to come, but not for the reasons Bush would like. In his defense, for the above mentioned reasons, he never stood a chance. This is not to say the man is a completely incompetent idiot who rode daddy's coat tails into a presidency that he doesn't remotely deserve. I digress.

Let me mention one more time, AN ECONOMY BASED ON KEYNESIAN THEORY CANNOT WITHSTAND A CONTRACTION IN LIQUIDITY. Bush happened to not only inherit an economy that was preparing for contraction, he was inheriting an economy that was coming off of a Keynesian mutation unique to history.

So what did Bush do? Remembering that the man is completely incapable of unique thought, he did exactly what his advisers (schooled in Keynesian theory) told him to do; throw everything, including the kitchen sink, at it.

What ensued was a dangerous cocktail of monetary and fiscal stimulus. Bush cut taxes, increased government spending, and inflated the money/credit supply. All stimuli on their own rights, but put together, creates a sort of economic crack cocaine.

Similar to the Clinton Keynesian stimulus, it worked...for a period of time. Bush and company were able to stave off economic contraction and actually produce some decent growth. But it was this sort of policy that finally pushed us past the tipping point.

(Note: Again, if you have recently signed up as a platinum member of the Barrack Obama fan club, I suggest you stop reading here. As mentioned in the Bloomberg article, Obama supports this sort of Keynesian adrenaline shot at or above a level seen in the Bush administration. All those who voted for "change" and against for more years of Bush got completely duped in the largest public puppet show ever seen.)

We all know what happened next. So what's the moral of the story? If there was one, I guess it would be that our political process is completely meaningless. It doesn't matter what party or which official is elected. Besides some of the minor details, they all follow the same economics policies. The difference between the good ones and the bad ones is simply the result of where they fall on the Keynesian cycle. Obama is no different, and if anything is a more extreme example of the same problems that got us here.

Disclosure: No positions.