Obama's Economic Failure

Obama's failure to tackle the recession is becoming more and more apparent with each passing day. His childish mantra of blaming Bush for every lousy economic statistic that emerges no longer washes with the great majority of Americans. Perhaps the time is not far off when it will be seen that the Democrats' relentless commitment to building a statist juggernaut is the real obstacle to a sustained recovery that will bring prosperity in its wake.

Meanwhile the economy's deepening recession has not caused Fed officials to reflect on their economic prescriptions. Janet Yellen, President of the San Francisco Fed, appears completely baffled as why anyone should be silly enough to think America could be facing a severe inflation. Let me give her a clue. Bernanke doubled the monetary base virtually overnight, the fastest increase in US monetary history.

Right now the gap between the actual money supply* and the monetary base is practically nonexistent, indicating that if the excess reserves that Bernanke created reach the public the money supply will explode followed by surging inflation. What baffles many observers is why the likes of Yellen cannot make the connection between the Fed's monetary policy and prospective inflation.

Not content with telling us to ignore Bernanke's monetary mismanagement Yellen warns that the mistake of the 1937 should not be repeated when the Fed stopped the recovery in its tracks by tightening the money supply which sent the economy spiraling into another depression. Balderdash.

Nothing of the kind happened. Huge gold imports from Europe greatly inflated the banks' reserves. (I'm referring to the member banks). Rather than raise the discount rate or sell securities the Fed thought it better to avoid a massive credit expansion by doubling the banks' reserve requirements.

It must be understood that these excess reserves were just that — excess. They were in effect idle balances. In fact, after the banks' reserve requirements were doubled they were still left with $1 billion in excess reserves.

Moreover, these reserves continued to grow as more gold entered the country from Europe. If the Yellen view were correct then the Fed's actions would have resulted in a sudden rise in interest rates. It didn't. It can be seen from the following table that commercial paper stayed below 1 percent.

This was ridiculously low. From 1900 to beginning of the depression the lowest rate for paper was 3.12 percent, and that was in 1916 and 1924 respectively. (Commercial rates reflect the short-term rates at which business borrows).

At a glance, I would say the average rate for that period exceeded 4 percent. The figures for the 1930s reflect the depressed state of the economy and are so low that a small movement in any direction would have had no effect on the demand for funds. It can be easily seen that that there is no correlation between these rates and changes in the rate of unemployment.

However, there is a correlation between movements in productivity adjusted real wages and unemployment.

What caused the 1937 economic collapse was a huge union wage push — fully supported by FDR — that drove real wages even further above their productivity levels. The result was horrific. The Federal Reserve Index showed industrial production dropping from 115 in August 1937 to 76 in May 1938. Car production dived from 3.9 million in 1937 to 2 million in 1938. The situation was saved by the outbreak of war in Europe in 1939.

Australia's experience is very instructive. Her economy started to slow in 1927. By 1930 unemployment had risen to more than 12 percent and then rapidly accelerated, hitting 23 percent in 1932 (some people think the real rate was much higher), after which it began to fall dropping to about 9 percent in 1938. Throughout the 1930s real wages remained constant though, as the chart below shows, productivity fell. (C. B. Schedvin, Australia and the Great Depression, Sydney University Press, 1988, p. 350)

Obviously, if productivity falls while real wages are maintained then the productivity adjusted wage rate must rise, meaning that unemployment will increase, which is exactly what happened. It also follows that if productivity rises again while real wages remain unchanged then this should increase the demand for labor and drive down the rate of unemployment. This also happened. The conclusion is inescapable: unemployment closely tracked changes in the productivity adjusted wage rate.

Note: The table clearly shows that the unemployment rate tended to fall in tandem with a decline in Consumption as a percentage of GDP. According to the commonly held view the reverse should hold. In addition, government purchases held up during this period, falling by a 0.3 percentage point from 1936 to 1937 before rising again. Yet it is still being suggested that this meager reduction in government spending caused another depression.

Compare this to the immediate post-war situation where between 1945 and 1947 the Truman government slashed Federal annual spending from $95 billion to $36 billion — a $59 billion cut in two years, a 62 percent reduction that amounted to 26 percent of GDP as it stood in 1945. Instead of the mass unemployment that Paul Samuelson confidently predicted would emerge when the war ended and government spending was slashed America entered an unprecedented period of prosperity.

Yellen said that policymakers need "wisdom and patience". I strongly suggest that she take her own advice

---

*I use the Austrian concept of the money supply: Cash plus demand deposits with commercial banks and thrift institutions plus government deposits with banks and the central bank plus demand deposit at foreign commercial banks and foreign official institutions plus sweeps.

Comments

[John Galt:]

Think of the economy as a giant auction filled with buyers ( consumers) and sellers ( producers/businesses).

Inflation is the act of the buyers bidding up the prices from the sellers overall. It's not 1 or 2 items going up in price, it's a gradual increase in everything.

I don't believe printing money causes inflation. More money LEADS to inflation because people have more money to bid and chase prices higher but printing more money in itself is not inflation.

If you had 100 dollars in your wallet and tomorrow you had 200 bucks in your wallet ( but you didn't spend it), then how is that bidding up prices? If the government doubled the money supply but the money wasn't spent..prices wouldn't double... but if people continued their normal behavior it would. People aren't resuming their normal behavior... the consumer went into hibernation and the savings rate is shooting up.

We are in a current deflationary enviornment but yes, the government is doing everything it can to combat that with inflationary policies.

Team inflation sees what the government is doing ( inflationary) and believes we will have inflation.... We should at some point in the future, agreed.

Team deflation sees the deflationary forces and sees deflation. I agree. These people also see economic green shoots and that's where I disagree with them. Most all of us can agree that this won't be easy...

Jul 09 11:05 AM

[CautiousInv...:]

With each passing day Obama is further vested in this economy and it will soon be his.

While not an enthusiastic supporter of Fed policy, I think the Fed has done a better job of handling monetary policy than has the administration and congress in its handling fiscal policy.

Unlike the Fed, the administration and congress underestimated the severity of the current recession; the nature of the recovery that would ultimately follow; and the correct fiscal policy response to address the loss of jobs and the serious output gap.

CBO forecasted that unemployment would peak at 9.0%; it is presently 9.5% and is likely to edge up to 10% to 11% in 2010 where it could linger for some time. And not understanding the virulent nature of recessions induced by finanacial crises, the administration and congress forecasted a rapid return to growth by anticipating the econonic growth of 3.6% in 2010 and 4.6% in 2011.

Not only will there not be a V shaped reovery but the ensuing growth will be much more subdued and likley to be in the 2% range.....what some are calling the new normal. In addition to reduced trade and large budget deficits, many structural imbalances must be corrected which will depress spending and investment for years to come. The most obvious is the need for the consumer to repair the battered household balance sheet.

Failing to understand the depth and nature of the recession, congress and the administration went about designing a stimulus plan by compiling a hodge podge of 8,500 earmarks, various pet projects and blatant pork and folding the mess into a $499 billion spending package. Tax relief in the amount of $288 accompanied the stimulus measure.

On the campaign trail Obama promised spending on roads, bridges, electrical grids, new energy platforms and a variety of other infrastructure which would both improve our economy and create jobs. In place of this, and with no over arching strategy, policy or design, we got about $90 billion of infrastructure spending and $419 billion of social engineering, safety netting and income transfer spending. While there was much rhetoric, there was little or no debate about what types of spending would yield the most jobs. It was a congressional free for all along party lines.

By my calculation about 13% of the total package has been either spent or released into the economy and already there is discussion of the possible need for a second stimulus measure. Based upon this, I believe there is a growing awareness that the first measure is an abject failure and is not an economic stimulus package; it is a massive spending jubilee that will not produce anything close to the promised 3 million jobs.

Jul 09 12:04 PM

[datadave:]

Just keep saying dumb words like 'statist' and those of us who aren't the AynRandistas that got us in this mess and can think against the current 'free market' grain will take you seriously. Revisionist historonics don't work.

Study Peter Bernstein's works such as "Wedding of the Waters" and see how 'state' and 'private enterprise' work much better than against each other. Giving wage deflationists such as the small minded Chamber of Commerce types policy control would sink us to Haitian style's of economies where the oligarches rule and the majority suffer.

However, agreed with title so far. Obama's failure is that he's too conservative and a Reaganite. Read his book and understand how middle of the road and conservative he is. Blame his lead economic advisor Larry Summers for conspiring with Phil Gramm in inflating and ruining the banking system with unregulated farces such as a 600 Trillion (face value) derivative market.

Jul 09 12:08 PM

[John Galt:]

Datadave:

Just keep talking about ideas you've never explored and books you've never read.

Who is John Galt?

Jul 09 03:20 PM

[WS1835:]

Excellent article Gerard!

After searching through numerous analyses of the Great Depression and the government response under Hoover and Roosevelt, I have formed three general conclusions:

1) The primary element that turned a short crash/recession into a decade long depression was wage controls. Artificially high wages create high unemployment, reduce export competitiveness, and discourage expansion of the workforce at the beginning of a recovery. With Hoover and Roosefelt both advocating and/or mandating the maintenance of prevailing wage levels rather than allowing them to react to the economic conditions, recovery was made almost impossible.

2) Increases in government spending (even large ones) do not significant affect long term unemployment and do not produce viable economic growth. The effects of public stimulus is generally restricted to make-work employment (WPA, etc) and temporary projects, while it simultaneously displaces private investment and skews labor markets.

3) Decreases in government spending (the larger the better) have significant affects on long term economic growth and tend to greatly shorten the length of economic downturns. Your example of Truman in the late 40's is a good one. Also reference Harding's policy during the aftermath of WWI and Wilson's progressive policies. The post-WWI recession was sharp and sudden, but quickly evaporated in the face of Harding slashing spending/taxes, and adopting a business friendly stance. His policies set the stage for the roaring 20's just as Truman set the stage for the growth of the 50's.

Jul 09 03:55 PM

[Jason Rines...:]

Loved this article and analysis, all except the last bit of 1945-1947. Mass unemployment did not emerge as new invention created during WWII such as the computer, rocketry, nuclear power, jet power etc. provided sustained employment at good wages. Government was forced to conduct the R&D to win the war. It was private capital and the citizenship that was the beneficiary of the R&D but other then that, all the programs of the 1930's were stupid, besides building the Hoover Dam and Superhighways.

Superhighways that had been started in the 1930's gave access to America like never before and many of these war factories switched production back or to automobiles and the technologies mentioned. Post-war construction and the US being the lone capitalist superpower provided opportunity for accelerated job growth for American white collar workers of all sorts on a global basis.

Still, the general numbers were still recessionary right into the 1950's. I really attribute the inventions of WWII for the ability of the US government to pay down it's massive public debts and a demolished Europe left the US receiving the prize of international currency reserve. Ike in the 1950's curtailed illegal immigration that certainly had to contribute to unemployment for unskilled labor.

Jul 09 04:33 PM

[Mark Bern:]

WS183,

I agree with much of your comment, but regarding your assessment of why the Depression lingered so long I must point out that you are missing an important point. While wage controls did its damage, the growth of isolationism around the globe was also a major cause of the depth and severity. If I'm wrong on this, please let all the publishers of school texts covering the Depression know, because they all have it wrong as well.

Otherwise, thanks for a very thoughtful comment and excellent points on the value (or lack thereof) of government spending.

Jul 09 04:57 PM

[awake09:]

Datadave: "However, agreed with title so far. Obama's failure is that he's too conservative and a Reaganite.'

Give me a fat, liberal break.

Jul 09 05:55 PM

[awake09:]

Do people like Datadave live in such an ideological bubble zone that NOTHING outside of the left wing media paradigm even registers with them? Some people on here are really comical. Unfortunately, they also vote, and that's why I can't sleep at night.

Jul 09 05:57 PM

[Mill Rat:]

It is too soon to call this "Obama's economic failure". This economic failure was in place long before Obama took office.

Obama's role, so far, has been analagous to that of a emergency room surgeon who is trying to repair the injuries following the aftermath of several reckless-driving teenagers crashing into "whatever". He did not create this mess. Rather, his team is trying address the aftermath. Unfortunately, his "nursing staff" is Congress. (I do, indeed, agree with the comments of "Cautious Investor" above.)

The names of the reckless teenagers are many. They include members of BOTH parties (Christopher Cox, Alan Greenspan, Phil Gramm, Robert Rubin, Bill Clinton, Henry Paulson, the plutocractic Cheney / Bush Presidency, and the corrupt bond-rating agencies). The root cause of their crash was getting drunk on a blend of deregulation and the easy money sourced from inadequately-regulated Collateralized Debt Obligations and Alan Greenspan.

Ultimately, too many economic resources were caused to flow into the residential real estate bubble (over the past several years). Now those excess resources have to reallocate themselves to other areas where society has a greater need. Ideally, this is best done via the free market. Unfortunately, for many, the necessary transition period for this to happen can mean homelessness, hunger, and untreated disease when no safety net exists.

A key variable that has not been explicitly mentioned in this discussion is "monetary velocity". It is the catalyst by which money supply can be converted to inflation. Right now it is very low. Perhaps that could be good topic for a future article?

The return of soldiers from World War II (and World War I) likely caused a significant increase in "monetary velocity". This probably compensated for the reductions in government expenditures that were made at those times.

What alternative economic fix are you proposing, instead? Say's Law (supply-side economics), perhaps? or simply Darwinian Laissez-Faire?

Bryan

Jul 09 09:40 PM

[danf:]

Mr. Obama is clueless. He is our next Jimmy Carter. Worse, he is in the pocket of wall street, lawyers and the NEA. All vampires sucking on the neck of our country and draining the vitality from our civilization.

Could America today build the Hoover dam or get to the moon in 10 years ? I dont think so. The nation is in the hands of takers and talkers. The doers have all been marginalized. Pretty face, pretty tele-prompter speaker whose image is protected by the media. But does our nation deserve anything better ? Probably not.

Jul 09 10:55 PM

[roywil:]

"You get the government you deserve."


On Jul 09 10:55 PM danf wrote:

But does our nation deserve anything better ? Probably not.

Jul 09 11:07 PM

[roywil:]

Did you miss you evening meds, datadave?

On Jul 09 12:08 PM datadave wrote:Obama's failure is that he's too
> conservative and a Reaganite.
> Larry Summers for conspiring with Phil Gramm in inflating and ruining
> the banking system with unregulated farces such as a 600 Trillion
> (face value) derivative market.

Jul 09 11:09 PM

[Al Fin:]

Normally when a person goes from a flaming Columbia radical to President of the United States, a certain maturing process of accepting responsibility will set in. In Obama's case, we may have to wait the entire 8 years for the POTUS to stop apologising for past presidents, stop paying off political cronies, and start governing intelligently.

He is a green avocado that may never ripen. If not, the country will be out a few dozen trillion more before it is all over.

Jul 10 12:11 AM

[pater_teneb...:]

For people interested in the first part of the depression under Hoover, i have written a blog a while ago detailing the events (and comparing them to the policy-maker reaction to the financial crisis of 2008).
My major source for historical information has been Rothbard's 'America's Great Depression' (a book i highly recommend).

www.acting-man.com/200...


On Jul 09 03:55 PM WS1835 wrote:

>
> Excellent article Gerard!
>
> After searching through numerous analyses of the Great Depression
> and the government response under Hoover and Roosevelt, I have formed
> three general conclusions:
>
> 1) The primary element that turned a short crash/recession into
> a decade long depression was wage controls. Artificially high wages
> create high unemployment, reduce export competitiveness, and discourage
> expansion of the workforce at the beginning of a recovery. With
> Hoover and Roosefelt both advocating and/or mandating the maintenance
> of prevailing wage levels rather than allowing them to react to the
> economic conditions, recovery was made almost impossible.
>
> 2) Increases in government spending (even large ones) do not significant
> affect long term unemployment and do not produce viable economic
> growth. The effects of public stimulus is generally restricted to
> make-work employment (WPA, etc) and temporary projects, while it
> simultaneously displaces private investment and skews labor markets.
>
>
> 3) Decreases in government spending (the larger the better) have
> significant affects on long term economic growth and tend to greatly
> shorten the length of economic downturns. Your example of Truman
> in the late 40's is a good one. Also reference Harding's policy
> during the aftermath of WWI and Wilson's progressive policies. The
> post-WWI recession was sharp and sudden, but quickly evaporated in
> the face of Harding slashing spending/taxes, and adopting a business
> friendly stance. His policies set the stage for the roaring 20's
> just as Truman set the stage for the growth of the 50's.

Jul 10 01:51 PM

[MudEngineer:]

If this drunken sailor Obama with no compass and basically lost at sea who is now spending our money at three times the rate of the previous overspending administration is a conservative like Ronald Reagan, I will drink the crude oil that I work so hard to find in the Gulf of Mexico.

Your Kool-Aid must have been spiked with hallucinatory drugs. While your getting your dose of truth, why don't you ask Obama to provide a real birth certificate which he has spent hundreds of thousands of dollars in legal fees not to have to come up with it to this date.


On Jul 09 12:08 PM datadave wrote:

> Just keep saying dumb words like 'statist' and those of us who aren't
> the AynRandistas that got us in this mess and can think against the
> current 'free market' grain will take you seriously. Revisionist
> historonics don't work.
>
> Study Peter Bernstein's works such as "Wedding of the Waters" and
> see how 'state' and 'private enterprise' work much better than against
> each other. Giving wage deflationists such as the small minded Chamber
> of Commerce types policy control would sink us to Haitian style's
> of economies where the oligarches rule and the majority suffer.
>
>
> However, agreed with title so far. Obama's failure is that he's too
> conservative and a Reaganite. Read his book and understand how middle
> of the road and conservative he is. Blame his lead economic advisor
> Larry Summers for conspiring with Phil Gramm in inflating and ruining
> the banking system with unregulated farces such as a 600 Trillion
> (face value) derivative market.

Jul 10 10:23 PM

[Kunst:]

The current fiscal year started in October 2008. This is still Bush's mess.

Jul 11 02:20 AM

[Mill Rat:]

The following article by Bruce Krasting appeared in Seeking Alpha on April 24th of this year. I find it to be rather persuasive....

seekingalpha.com/artic...

Jul 13 05:54 PM