Republican Keynesians Need To Come Out Of The Closet

by: HiddenValueInvestor

President Richard Nixon famously said "we are all Keynesians now." Well, that was then and this is now. Nobody in the Republican party will publicly call for anything remotely looking like a Keynesian style stimulus plan. Yet there are many closet Keynesians in the Republican Party. Few in Congress would actually vote for a plan that balances the budget in the next two or three years. That would require big cuts in Defense spending and the Republican position is to hold the line on cutting Defense. The reason is they know the economy is too weak to stand such a shock and that massive deficit spending of $1 trillion per year is needed just to keep unemployment in the 8-10% range. On the Democrat side of the aisle no one in a leadership position is calling for another Keynesian-style stimulus plan. In fact, President Obama is noticeably silent on the issue. Additionally, the vast majority of talking heads in the media with the seemingly singular exception of Paul Krugman call for some form of a Grand Bargain to reign in deficit spending. For most of the post-World War II era both Republican and Democratic Presidential Administrations practiced Keynesian economics. Yet when the country has finally fallen into a depression open advocacy for Keynesian economics has been tossed aside. The current depression will not end for years until those closet Keynesians come out into the open and admit the obvious. It had been accepted as common wisdom for years in the U.S. that World War II spending ended the Great Depression, so why is everyone in denial of the obvious?

Because of this wink wink denial the U.S. is getting very inefficient deficit spending. It would be better to confront the issues holding back economic recovery and spend the money necessary to end the depression. For example, troubled mortgages are still causing a significant drag on economic growth. Even though we have record low mortgage rates under 4% over half of the people with mortgages cannot qualify to refinance due to job losses, poor credit, or homes that cannot appraise for a price high enough to qualify for a refi. Congress could require the banks to lower the interest rates for those that cannot qualify due to income or credit problems in exchange for the cash necessary to write down mortgages that are underwater. Lowering the interest rates on these mortgages would create a big boost in disposable income for consumers. It would also have the benefit of improving the quality of bank balance sheets, ending the lending drought. Finally, it would end the foreclosure crisis allowing the housing market to begin a recovery leading to a surge in home starts.

But this requires an open acknowledgement that Keynesian economics is the way out because it would require additional upfront deficit spending. Instead we get inefficient deficit spending that fails to solve any of the problems. Ironically most of the troubled mortgages are already guaranteed in one way or another by the federal government. We fund the losses of Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) on an ongoing basis rather than take the write-off upfront. We have 25 million extra people on food stamps, Medicaid, and other forms of assistance that used to be working, creating a perpetual underclass that does not pay income taxes. Despite the hand wringing in the end the Congress is not going to vote to throw those people off the dole or make large cuts to Defense spending. In the long run we are spending a lot more money treating the symptoms than it would take to actually pay for a cure. The only sensible way to actually lower the deficit and eventually balance the budget is to acknowledge the root problems, address them upfront, and get those 25 million people back to work. By denying the obvious we will be perpetually stuck with the worst of both worlds; unemployment and large deficits.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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