The Economics of the Past Won't Solve the Problems of the Present and Future

Imagine if you will someone who just bought his or her first car. As they leave the dealership they are reminded by the dealer to keep pressure in the tires above some minimum level. The new owner dutifully follows the advice. As soon as the pressure in the tires drops bellow the desired point the owner pumps air and all is well. As the tires get worn out the owner’s frequency of pumping air increases. Then one day the car gets a flat tire. The driver makes it to the service station and starts pumping air into the flat. Unfortunately, no matter how much air he pumps, the tire still goes flat after just a few minutes. Fairly soon the car’s owner will realize that a hole has permanently altered the tire and the previous solution of pumping air will not work. He will have to fix the tire another way.

As you might have already realized, the tire in this story is our economy and the driver can represent any number of government agencies and politicians who advise policy makers on economic decisions. As it appears now, apart from a number of ultra conservative and libertarian politicians, the government’s weapon in fighting the recession has been pumping money into the economy in the form of stimulus and bailouts. So far that has not worked. At some point, and this point might very likely be now, it should be worth asking: "Has the American economy fundamentally changed? Are we pumping air into a flat tire?"

Modern economics since the days of John Maynard Keynes has relied on statistics from past data to adjust the valves of monetary and fiscal policies. This works well as long as recessions and other undesirable activities stay within previously observed boundaries. However, when those boundaries are broken, continuing the same policies as in the past can prove to be as futile as pumping air into a flat tire, and with money not being as abundant as air, the old methods might actually prove to be dangerous. A disastrous result of current policies will at some point in the future make interest payments on the federal debt the largest portion of the federal budget. The appropriate thing to do now is to recognize the limits of economics and tackle the current problems with a wider focus and tools such as political philosophy and a broader view of history.

If we rely exclusively on the recent past for guidance, we will confront the future unprepared, for there is no data to study about the future. None at all. We can think of one last metaphor, a whale approaching the shallow waters of the beach shore for the first time. With only the deep ocean waters in its memory the whale will ignore the danger posed to it by the coast line. It is in this moment that a rogue wave or a bad choice can push the whale onto the shore with no means of getting back. My advice to American policy makers is this: Look to the past, but anticipate the unexpected future. If we don’t, our country can find itself similar to that beached whale, unable to make it back out to sea.

Comments

[J. D. Swampfox:]

The writer says, "If we rely exclusively on the recent past for guidance, we will confront the future unprepared, for there is no data to study about the future." True, as far as it goes - The Black Swan event theory is based on the idea that the inconceivable, from the perspective of the recent past, should be expected. The demise of Long Term Capital was the first reminder, but investment houses didn't heed it. Oliver Hardy to Stanley Laurel: "Now look at the fine mess you've got us into."

Mar 13 09:17 AM

[Dave Wrixon:]

The problem confronting our whale is the the time is about to turn on the dollar and the foreign investors will soon pull the plug. Premier Wen may frett about the devaluation of his dollar assets but he stands to gain far more in buyer power from an appreciation of the Yuan,so it is just conceivable that he will a some point full the plug on US Treasuries. That will leave our whale stranded regardless of whether it proceed further or not.

What is not generally appreciated by Americans, who are still struggling with their own personal credit drying up is that the same thing can easily happen to their government. Of course, they have the option of simply printing a lot more dollars, but that will only serve to increase the rush for the exits and at the same time reduce the real value of all salaries in the US. Prices, however, will start to surge ahead to due the increase in costs of imports. At that point the resolve of Government will face its ultimate test. Will it attempt to cap wage settlements or will it let a wage/price spiral rip. This will eliminate a substantial amount of the outstanding personal debt, but at the same time it will erode the value of savings. However, this would help greatly to decelerate the crash in asset values.

It may well be that the stock market rallies are not anticipating recovery as much as price inflation.

Mar 13 10:55 AM

[Aristophanes:]

The author wrote:

"Modern economics since the days of John Maynard Keynes has relied on statistics from past data to adjust the valves of monetary and fiscal policies."

Ah, but modern investing strategies by the "quants" on the bank payroll came up with future prediction models. And these have failed so badly everything is in distress.

Historical data cannot predict, but it can frame scenarios and form the basis for tempered reaction and policy—as long as one understands it, especially the politicians.

That's why Bernanke gets scorn for being spineless. As a Depression era economic historian he should have seen a bubble. They are historically predictable and the math looks pretty much the same. Yet Bernanke did not see and did not act.

Mar 13 01:27 PM

[austrian63:]

What's even harder to accept is the fact that Bernanke's old boss Alan Greenspan and Benanke himself caused the bubble by growing the money supply.

When's the last time you made a mess but did not know you made the mess?


On Mar 13 01:27 PM Aristophanes wrote:

> The author wrote:
>
> "Modern economics since the days of John Maynard Keynes has relied
> on statistics from past data to adjust the valves of monetary and
> fiscal policies."
>
> Ah, but modern investing strategies by the "quants" on the bank payroll
> came up with future prediction models. And these have failed so badly
> everything is in distress.
>
> Historical data cannot predict, but it can frame scenarios and form
> the basis for tempered reaction and policy—as long as one understands
> it, especially the politicians.
>
> That's why Bernanke gets scorn for being spineless. As a Depression
> era economic historian he should have seen a bubble. They are historically
> predictable and the math looks pretty much the same. Yet Bernanke
> did not see and did not act.

Mar 13 08:52 PM

[Aristophanes:]

On Mar 13 08:52 PM austrian63 wrote:

> What's even harder to accept is the fact that Bernanke's old boss
> Alan Greenspan and Benanke himself caused the bubble by growing the
> money supply.

I don't blame the Fed for causing the debt problem. I see that the US economy was expanding and productivity was rising. Unfortunately, the GDP gains from the productivity increase was not funnelled back to the labour pool. Household income stagnated, so the political solution was to allow for expanded debt via the money supply. For the last decade wages have gone backwards. Families are poorer even accounting for inflation.

Easy credit, weirdo mortgage products, securitization, and uber-cheap imports were substitutes for passing on the gains of productivity through wage increases. We were told it was more efficient for the new "ownership society" to bet debt against our houses as a means of growing net household wealth.

Then we used the Fed even more to paper over (literally) this wage/productivity gap. If you strangle your middle class, there will be economic catastrophe. This will happen again unless the proceeds of economic activity are better distributed.

> When's the last time you made a mess but did not know you made the
> mess?

Spilled some milk from the fridge last night. My sock found it the next morning.

Mar 14 12:38 AM

[Ferdinand E...:]

Gennady, you know as well as I do that the whale is going to make it out to sea again. Just be glad that the gent in the driver's seat isn't John McCain, because he might have tried to speed up the process, with the result that Governor Palin might have ended up calling the shots. With all due respect, I can't think of anything worse than that.

Mar 14 08:45 AM

[change is t...:]

Your title is a testament to a the power of sound bites. Your writing is as much poetry as prose.

But what is your point? America has changed? We are pumping air into a flat tire?

O.K. Now what?

Political philosophy? Broader view of history? What does that mean?

Mar 14 11:55 AM

[henarl:]

The tire analogy is entertaining but not to the point. The car owner has an obvious easy solution - buy a new tire.

The whale anology is more to the point but not taken far enough. Whales DO end up stranded on the beach because they are genetically predisposed to only expect deep water. Thus, those that stray too close to shore are doomed.
I leave it to you to extrapolate that to the present economic condition.

Mar 14 12:42 PM

[Danny Newton:]

I am a little uneasy at the theory that the government can stimulate the economy by doing special programs or targeting money to certain kinds of spending. In a perfect world, all government spending would be stimulative in that law and order, fire protection, basic education, transportation and health related activities like sewer and water projects all promote higher productivity. I think we already bought a new tire with a hole in it and are filling it with false hope. This tire is thought to be working in a strange new universe where the old rules do not work.

The idea that the classic determinations of efficiency such as the ratio of output to input are somehow inappropriate, inconvenient or too restrictive because they prevent Utopia formation can have the effect of preventing movement toward Utopia.

Somehow there seems to be a new Economics being created that requires that the old laws of supply and demand, elasticity, the law of diminishing returns, be ignored in much the same way that String Theory seeks to replace Einstein's Theory of Relativity. The Broken Window Fallacy seems to apply to the creation of the next bubble, green jobs, but after droning on about how these jobs are going to be high paying jobs, objections sink beneath the froth of jubilation. Who repealed basic economic concepts? Did they get a Nobel Prize for it?

There seems to be no fear that the spending spree of stimulative money and jobs represents in any way a large collection of lost opportunities. The new Keynesian seems to be, in the popular mind, free of any idea of the concept that one project might be better than another and that in a world of limited resources, the better projects should somehow float to the top of the list.

Mar 14 02:43 PM

[CLH:]

There is nothing the govt. can do to change human nature. There will always be bubbles ---and also wars. Those who are idealistic are fools (Carter, Clinton and Obama). Capitalism always works out its mistakes--the govt. is incapable of anything rational.

Mar 14 06:01 PM

[investor88:]

Genady has a point there. The remedy may not be apparent, we may have to re-set.

Mar 15 06:04 AM

[mediapro:]

DARPA
The Internet
Stem cell research
NASA

Without these evil, government-funded projects we probably would not have cell phones, orbiting communications satellites, Tang orange drink (OK, a bad example), proliferation of computer technology, etc.

In every foreign intervention that the Coporatocracy has engaged in since WW II (Iran, Nicaraugua, Argentina, Malaysia, Bolivia, Venezuela, etc.), the scheme of bribing the corrupt oligarchs to build infrastructures that benefitted the corporate interests of this country yet could not be supported by the wage levels of these countries, imposing usurous terms for IMF and World Bank loans when the country's inevitably went into default, and propping up these hand-picked right wing strong men, all led to unforeseen consequences. If you cry about the circumstances in these countries relative to our relations with their current leaders, you have no one to blame but yourself and Mr. Reagan and Bush for being so blind about the results of unfettered belief in capitalism.


On Mar 14 06:01 PM CLH wrote:

> There is nothing the govt. can do to change human nature. There will
> always be bubbles ---and also wars. Those who are idealistic are
> fools (Carter, Clinton and Obama). Capitalism always works out its
> mistakes--the govt. is incapable of anything rational.

Mar 15 06:04 PM