As Shakespeare might have queried..."alas, perchance I hear an echo..?":
"The economic conditions that we will analyze can be summarized as
(1) Signs indicate that a depression is finally over.
(2) Interest rates have been close to zero for years, but are now finally expected to rise.
(3) ...there are concerns from both policy makers and market participants over indications of excessive inflation.
(4) This is of particular concern to some who point to a large expansion in the monetary base in the past several years, as well as the current bank holdings of large excess reserves."
Does this sound familiar? Is there any economist who hasn't blamed the Fed, the White House, Congress, and the budget process for the current anemic recovery, as well as the fiscal and banking crises? In addition to bank reserves, US corporations are sitting on nearly $1.5 trillion cash on their books.
Well, I can tell you it is from an NY Fed Study. The authors, Eggertson and Pugsley (not the Pugsley from the Addams Family, though conditions have been pretty frightening lately), were writing about....drum roll please... 1937.
We all hear about the great crash of 1929. For decades this has been the sock puppet used by progressives to suggest that markets are dysfunctional and need to be coddled by enlightened federal regulators; that the economy is basically unstable and needs enlightened Congressmen and Senators to spend it into utopia; and that investing is a crap shoot. When all they say is said and done, we are better off counting on a social security Ponzi scheme to take care of us in retirement.
Until the advent of Keynesian economic theory after WWI, the concept of fiscal policy was unheard of. For the purpose of this article I will define Fiscal Policy as the use of taxing and spending powers by the federal government to obtain a specific economic goal. That goal is usually full employment. After Franklin Delano Roosevelt won in a landslide in 1932, a veritable alphabet soup of government agencies and bureaus - some alive to this very day - sprung out of legislation and executive fiat to combat soaring unemployment, business and bank failures. Their purpose was to generate jobs - shovel ready, as we might say in our day - for the legions of unemployed.
Rarely is the effectiveness of these programs ever questioned. It is accepted as fact that the stock market surge which began in 1932, and the decline in unemployment that took place over the next few years, were proof of the effectiveness of Roosevelt's policies. Never mind that unemployment remained in the mid-teens, well above historical levels; or that stock prices were only two-thirds of their previous peak. The concept that enlightened federal spending could moderate economic crises was firmly planted in the public's, and especially academia's mind. Much the same claims are made now: the economic recovery since March of 2009 is because of Federal Government stimulus. Ask any bureaucrat: they'll tell ya! At your expense.
But have they worked? Have they ever worked? This is what makes 1937 a crucial lesson for our time; and why fiscal policy advocates have so little to say about it. The 1937 crash and recession shows that fiscal policy did not work! Right smack in the middle of the depression, barely into Roosevelt's second term, came solid proof that fiscal policy was a failure.
Let me give an analogy first. How did you teach your youngster to ride a two-wheeled bicycle? Simple...while he or she was riding along, wobbling the steering wheel from side to side, you stood behind them with your hand on the seat and guided the bike so that it would not fall.
You let go. The kid goes off on his own. Eureka! Your lessons and help have taught the kid balance; the child now knows how to ride a bike.
Suppose the fella falls flat on his face. Obviously your lessons have not worked. Sure.. Maybe you need to hold that seat a little longer. But success is measured in not how long you hold the seat, but in what happens when you let go. Are you going to hold onto the seat until the kid is in college? Of course not. Twenty-six y/o kids living in their parents cellar after graduation does not signify economic success.
By 1936, the government had spent billions (which was a lot of money back then, as Everett Dirksen might have said) on make work programs such as the WPA; forced manufacturers and farmers to adjust output under the NIRA; and... oops, I forgot... kept interest rates near zero to help homeowners and borrowers get back on their feet.
The time had come to see if the programs were successful. What we later called pump-priming, providing government jobs at first so that they lead to private sector jobs and economic growth second, was finally scaled back. It was time to see if the new "jobs" created would cascade through the economy on their own. Spending was cut and some taxes were raised.
It was time for Washington to let go of the seat.
The child fell flat on his face. Within months, the stock market had dropped further and faster than any time in the earlier crash. Unemployment climbed faster than it did any time from 1929 to 1932. Corporate profits collapsed. The panic on Main Street and Wall Street was superseded only by the panic in Washington.
We let go. The economy collapsed. Fiscal policy (and yes, monetary policy of forced low interest rates) was a failure. Less than five years after it was first tried.
Much like today! Unemployment remains stubbornly high. Trillions have been spent on stimulus programs, and monetary policy remains loose.
What are the investment consequences? Zero interest rates punish savers and retirees, while pushing up the price of treasury bonds. Ask anyone lucky enough to hold the iShares Barclays 20+ Year Treasury Bond ETF (TLT). Money flows into commodities, such as gold. Ask any investor in the SPDR Gold Trust ETF (GLD). The slightest hint of a bear market panics the Fed into more QE sequels than reality TV shows. Long-term investments in blue chip portfolios such as the SPDR S&P 500 Trust ETF (SPY) or the SPDR Dow Jones Industrial Average ETF (DIA) show miserable returns.
It's important to understand the reason why fiscal policy fails, as well as the fact that it does not. There are four ways for you to spend money, although most people are familiar with only two:
- You spend your money on yourself. You have the incentive to economize (look for bargains) and satisfy (buy something you like).
- You spend your money on someone else. You still have the incentive to economize, but satisfaction is harder. Your niece wanted an Ipod, not an Izod, you fool!
- You spend someone else's money on yourself. You have no real incentive to economize - who cares, its not your money. Go get those Ugg boots and matching Coach purse!
- Finally, you scan spend someone else's money on still another person. You have neither an incentive to economize, nor satisfy. Spend a few million on a bridge to nowhere.
Guess which one of the categories fits under fiscal policy? Correct: choice four. And yet journalists, politicians, bureaucrats, and unfortunately many investors stand agape when "stimulus programs" waste money and provide little true value to taxpayers.
Two minor asides. When I taught this 4x4 matrix in my economics class, a very haughty and overpaid public schoolteacher sitting in the back got in a terrible huff, raised her hand, and said "just how many people fit into category 4!" I promptly replied, "every government employee, including you and me," since I was a Professor at a State University at the time. It shows you how ingrained this mentality is among government employees.
And when I discussed this in a graduate seminar, the professor, a former Ambassador to Spain, pleasantly quipped, "but then, is there no government spending which adds value to an economy?" A very reasonable question. There are many good examples of such spending, and I hope to discuss them in the comments section and in future articles.
But that is broader than the simple issue being discussed here. We need to focus on the limitations of fiscal and monetary policy, rather than suggest "more of the former and longer on the latter!" is the way out of this mess or any other period of difficulty. Until we do, we are destined to continue with sub-par economic growth as resources are diverted from Category One to Category Four spending.
"A sick chicken in every pot, and two Tesla's in every garage."
Disclosure: I am long SPY.
Additional disclosure: Understanding the role, function, strengths and weaknesses of fiscal and monetary policy is THE economic and political challenge of our time.