Gerard Jackson's  Instablog

America — like every other country — has had its inept economic managers. No political party has a monopoly of economic incompetence. But without a doubt Obama and his crew are rapidly shaping up to be the biggest bunch of incompetent economic managers since the 1930s, irrespective of what yelping leftwing historians assert. And I do include Bernanke, Geithner and the rest of those economic geniuses. (The idea that Bernanke is some kind of expert on the Great Depression is an absolute joke.)

Obama's leftwing obsession with permanently expanding the size of government, now matter how much it damages living standards, is deepening and prolonging this recession. In fact, given the official unemployment rate of 10.2 per cent (it translates into 17 to 20 per cent if we include short-time working, discouraged workers and part-time workers who want a full time job), which looks to rise even further, I think it's safe to say that the US has now moved from being in recession to being in a depression.

What is the Obama's solution? More regulations and more taxation. What a genius. The capital gains tax is set to leap by 69 per cent, all the Bush tax cuts — and I do mean all — are going to be repealed, massive spending programs are in the pipeline, the deficit is exploding along with debt, and the most irresponsible and financially reckless Congress in American history is trying to dream up new ways to extract even more money from the hapless public. Believe you me, Americans have seen nothing yet. (Bernie Madoff must be wondering why his fellow Democrats are not sharing his cell block with him.) The costs of this economic lunacy — if left unchecked — will be a permanently sluggish economy, if not outright stagnation, plus a higher rate of lasting unemployment

Americans will not be the only ones to suffer. The intellectually scintillating Bernanke, Geithner and their galere of economic hanger-ons have hit on the brilliant scheme of trying to export America's unemployment by depreciating the dollar. (In the 1920s and '30s this was called "exchange dumping".) If you print enough dollars you will eventually force down the exchange rate.

Foreigners only have to look at Obama's spending to realize that there is no way taxation can pay for it. Moreover, the sheer scale of the Democrats' profligacy rules out sufficient borrowing. This leaves only the printing press. However, this raises a problems for those pesky foreigners. If they allow the dollar to slide then it will hit their export industries. Fewer exports means more unemployment. This they would not like. They might decide that depreciating the US dollar was a sneaky way of raising tariffs — and they would be right. (Americans shouldn't get the daft idea that a cheaper dollar won't affect their standard of living.) This would explain why Asian countries have been buying dollars. It's an attempt to protect their exports. But they know Ol' Bernanke can churn out them dollars faster than they can buy 'em. Hello, suckers.

Another problem is that some Asian countries have unofficially pegged their currencies to the dollar. What this means is that for every dollar that enters the country the central bank must print the equivalent in the local currency. Bernanke's monetary policy has led foreigners to borrow US dollars at a ludicrously low interest rate. They then use these dollars to speculate at home. Liquidity (a fancy name for the money supply) expands, fueling speculation in shares and real estate. Brilliant. Unable to spark a boom at home Bernanke and his fellow economic mountebanks help trigger one in Asia.

Nevertheless, these foreigners have nothing to worry about. Honest Tim Geithner — the man who cheated on his taxes and was then given a clean slate — assured them that he really, really, really does believe in a "strong dollar" and even "market oriented exchange rates"*. So their concerns about the incredible shrinking dollar are totally misplaced because anybody who is anybody just knows Honest Tim would never tell a fib.

"Market oriented exchange rates" is a weasel phrase when uttered by someone like Geithner. It says nothing about whether Bernanke will continue to debase the dollar, only that it will be sold at the going rate, which will get lower and lower as the printing presses work overtime. Bernanke and Geithner are using inflation to raise US exports and curb imports. The result will be to further distort the pattern of international trade and perhaps even spark a trade war. And for what? To try and save the Democrats' political skins and their destructive economic policies.

A country can no more devalue its way to prosperity then it can spend its way into solvency. The combined effect of Obama's economic policies will be lower real wages, which means a lower standard of living for Amreicans. But look on the bright side: Buffett will still be fabulously rich as will be all those super rich Hollywood Democrats. For them the American Dream will continue

*The question of exchange rates is not a straightforward one. See Will the exchange rate kill manufacturing

Gerard Jackson is Brookesnews' economics editor

The same media types who screamed blue murder with undisguised glee when unemployment hit 5 per cent under Bush are now telling us that the current 10.2 per cent rate is being driven by rising productivity and so there is little that can be done about it in the near future. I find this reasoning very suspicious. It looks to me as if Obama supporters have resigned themselves to a persistent high rate of unemployment and are looking for an excuse to rationalise it. Now let's take a look at their simplistic reasoning. As two of these brilliant economic analysts put it:

As long as companies can get their workers to produce more, they have little reason to hire — at least until consumer spending picks up. And the squeeze on incomes could depress consumer spending, putting the economic recovery at risk. (Productivity gains may be bad news for job seekers, Martin Crutsinger and Stephen Manning, AP, 5 November).

We actually have several fallacies here. The very idea that rising productivity can create widespread unemployment stands refuted by economic theory and the historical record. It evidently did not occur to this pair that they were regurgitating — in another form — the old fallacy of technological unemployment, the obverse of which is less technology means more jobs. One should note that the reason for the increase in productivity was not been mentioned, probably because the leftwing journalistic mindset is incapable of independent thought.

A genuinely enquiring mind would have quickly realised that in an effort to stay afloat during a recession, especially very severe ones, firms will eliminate marginal operations and, particularly in the case of manufacturers, shut down inefficient plants. To do otherwise is to risk bankruptcy followed by 100 per cent dismissals. (Regardless of leftwing folklore and Hollywood idiocy, capitalists are not moustache-twirling villains who delight in evicting widows and orphans.) The result is usually a rise in productivity not only because more efficient plant are operating but also because fewer hours are being worked. Normally this process is followed by an increase in the demand for labour because the effect of an increase in productivity is to reduce the cost of labour relative to the price of the product.

The charts below neatly illustrate this point by showing what happened to unemployment in Australia during the Great Depression. The first chart shows productivity beginning to rise in 1931-32 while the second chart shows that unemployment began to fall at the same time and continued to drop as productivity rose. During this period the real wage rate index varied between 98 and 100, making it virtually constant. By 1938 payrolls had expanded considerably and unemployment had fallen to 8.9 per cent while in the US it had risen to 19 per cent. Moreover, Australian governments actually cut spending, the very opposite of Roosevelt's policy of spend, spend and then spend some more.

Unlike Australia the US did not experience a sustained drop in productivity at any time during the Great Depression despite the massive contraction in output. From June-July 1929 to February-March 1933 manufacturing production plummeted by 51 per cent. By the following June-July output increased 20 per centage point. Therefore, from mid-1929 to mid-1933 production fell by 29 per cent while unemployment rocketed from 3.2 per cent to 24.9 per cent. However, output per man hour rose by 19 per cent despite the fact that by February 1933 output per worker was 85 per cent of the 1929 level. By the following June output per worker exceeded the 1929 level by 9 per cent. (Frederick C. Mills, Prices in Recession and Recovery, The National Bureau of Economic Research, Inc., New York, 1936, pp. 328-31.)

So how did Australia manage a sustained fall in unemployment in the absence of big government spending programs while the US suffered higher levels of unemployment accompanied by a severe fluctuation in 1937-38? The answer lies in the real wage rate. During this whole period Roosevelt and his union allies prevented the real wage rate from fully adjusted to changes in productivity. (Obama's union policy is poison for the US economy.) If real wages had remained largely unchanged — as happened in Australia to a considerable degree — then the level of American unemployment would have followed the Australian pattern.

Like the rest of the economic commentariat — left and right — Crutsinger and Manning take it for granted that consumer spending drives the economy. This is because about 70 per cent of GDP consists of consumer spending. But what is not understood by these people is that the practice of omitting spending on intermediate goods is a dangerous fallacy that skews the national accounts in the direction of consumption. What matter is total spending. Once we take account of that consumer spending falls to about one-third of total spending. (The Bureau of Economic Analysis has been taking this approach for some years.) Therefore it is business spending that drives the economy, a fact that was once well known. Moreover, the emphasis on consumer spending is tacitly assuming a two-stage economy: production and consumption. But as was pointed out more than 70 years ago:

The larger number of payments is not from consumers to producers, but is made between producers and producers, and tends to cancel out in any computation of net incomer of net product value. "In fact, income produced or net product is roughly only about one-third of gross income." [Italics added]. What is cost for one producer is in part income for some other producer, but part of that income the latter has to pay out in costs to other producers in another stage of the productive process (for intermediate products, raw materials, supplies, etc.), and so on. All that is necessary in order that equilibrium be maintained is that consumers' incomes equal the cost of producing consumers' goods; the total of producers' payments necessarily exceeds that of consumers' incomes. (C. A. Phillips, T. F. McManus and R. W. Nelson, Banking and the Business Cycle, Macmillan and Company 1937, p. 71).

Leaving aside the theoretical argument against consumer spending we find that the idea is not even supported by the facts. If consumer spending does fuel an economy then it follows that a significant fall in consumption must lower the demand for labour and raise the level of unemployment. Yet we find the very opposite happened in Nazi Germany. From the beginning of Hitler's chancellorship to 1939 unemployment fell to the extent that severe labour shortages emerged. Yet real consumer spending contracted. Without a doubt living standards were significantly lower than in 1929 and yet the demand for labour kept rising*. Why was this? Because massive amounts were being spent on plant and equipment for war materiel at the expense of consumer goods.

It is not changes in productivity that determine the level of unemployment but the ratio of the real wage rate to the value of the worker's marginal product. This makes nonsense of the assertion that Americans must now tolerate a high rate of unemployment because there is a Democrat in the White House.

Several things are going on here. I think the malinvestments created by the previous credit expansion are still creating unemployment as the necessary readjustments are made. Secondly, Obama's policies are creating an enormous amount of uncertainty. His proposed taxes and plan for 'health reform' are not good for business, particularly small business. I think it quite possible that these policies now form a substantial impediment to hiring labour and could help explain why corporate cash balances are piling up. His massive spending and borrowing program would cripple investment while his energy policy alone is enough to devastate the economy. In short, his economic policies are the real barrier to full employment and sustained economic growth.

*There is no contradiction between a fall in the "intensity of demand" for labour with a monetary rise in the demand for labour. A fall in the former simply means a drop in the real wage rate. If the real wage falls as the ratio of capital to labour increases then this means masses of capital are being wasted. In other words, they are not being directed to an increase in consumption.

Gerard Jackson is Brookesnews' economics editor

My last article on Obama's energy policy (Cap and trade would sink the US economy and permanently change the political landscape) certainly provoked an angry response from the green energy brigade. Now experience has taught me the futility of trying to reason with those who dogmatically cling to ill-informed opinions. Nevertheless, considering the extreme importance of this issue it is pretty clear that the nonsense that is being dished up in defense of Obama's energy policy needs to be refuted. I don't imagine for one moment that my critics are open to a closely reasoned argument. Hence this response is for those who prefer facts and reason to green dogma.

The first thing I noted is that all of the criticism was completely void of economic reasoning. It seems that for these people economics really doesn't matter, particularly if its conclusions run counter to green dogma. Secondly, I was left wondering in some cases whether the critic had actually read the article. My third observation was the tendency of some critics to rely entirely on logical fallacies.

One line of attack is that mine is an old and tired argument that was discredited by the clean air acts. Therefore, as these acts did not hurt American industry then neither will Obama's energy policy. This is a non sequitur. It does not follow that because these acts allegedly had no detrimental effect on industry and therefore living standards Obama's energy policy will not damage the US economy. Moreover, it simply is not true that stringent environmental controls did not have damaging consequences. Like it or not, environmental regulations are not costless.

In 1979 the economist Murray Weidenbaum calculated that pollution controls were costing industry $100 billion per annum. (About $262 billion in today's money). This expenditure was at the expense of investment that would have raised the productivity of labour and hence real wages. Work by Harvard economist Robert Leone revealed that water pollution controls slashed the number of metal finishing factories from 70,000 to 5,000. Further investigations also showed that these regulations had the same effect on tissue-paper manufacturers. The results were predictable: large firms survived while their smaller competitors were bankrupted. Needless to say, these large concerns favoured the regulations¹.

I find it very hard to believe that the pollution from metal finishing factories was so great that 93 per cent of them needed to be bankrupted. Proponents of these regulations could argue that the bankruptcies were simply the result of the "Pigouvian" policy of taxing negative externalities so as to bring private costs into line with social costs. Unfortunately Pigou's tax solution is deeply flawed. His erroneous view of the problem led the British economist Ronald. H. Coase to develop what became known as the Coase theorem, which basically argues that optimum outcomes are achieved if property owners are allowed to negotiate between themselves. (This is a highly stripped down description of the theorem). In other words, the problem here is not market failure but institutional failure.²

It is generally recognised among economists that the Coase approach is superior to the Pigouvian remedy, though I believe it does contain a serious flaw with respect to its particular use of prices. Now if the Coase approach had been applied to the water-pollution problem would 65,000 metal-finishing factories — not to mention a large number of paper-tissue manufacturers — have been forced to wall? I doubt it.

A Pigouvian policy results in a bureaucratic strait-jacket, a one-size fits all irrespective of individual circumstances. Moreover, it is open to corruption and political abuse. For instance, what is to stop green fanatics in the Environmental Protection Agency from using it to try and destroy an industry — coal mining, perhaps — that they don't like?

Pollution controls are not costless. This is not to imply that they are not necessary, only that we need to be made aware of the fact that there are always trade offs. I was raised in the Midlands, sometimes called the industrial heart of Britain, and I still vividly remember the unbelievable density of the smog — which was also a killer — and its frequent recurrences. Thanks to the clean air acts (there was no pollution tax) smog quickly disappeared from the British environment. But This only happened because economic growth had created the wealth and the means to eliminate smog with very little cost to the economy.

One critic declared that "connecting a cap and trade tax to capital was dishonest". This amounts to saying that a land tax would not affect the price of land, or that changes in demand cannot affect the prices of capital goods. In other words, only a complete economic illiterate could make such a ridiculous assertion. Fortunately there exists a recent example that neatly exemplifies my point. Australia's National Generators Forum estimated that the Rudd Government's carbon tax would impose $10 billion in capital losses on coal-fired power plants. (ETS 'may bankrupt power stations', Lenore Taylor, The Australian, 1 May 2009). So much for the air-headed notion that carbon taxes cannot affect the prices of capital goods and therefore the capital structure.

In order to deal with the remaining criticism I must once again return to capital theory. For the sake of simplicity I shall use the orthodox approach and assume capital is homogeneous, with the proviso that capital goods are also discrete. This means that we can now measure the actual amount of capital. Let us number the capital stock at 100. Of this amount 10 units are used to provide electricity for the whole economy. We also assume that all the firms have factor combinations that minimise their average costs of production.

Everything is going swimmingly until a group persuade the government that unless the current method of using centralised generating plants to produce electricity is abandoned in favour of wind and solar power there will be a colossal environmental disaster. The government now mandates that the plants must be phased out and alternative energy used instead.

But because energy density for solar and wind is pathetically weak and hellishly unreliable these alternatives will require vastly more capital and labour to produce the same amount of electricity as a centralised generating plant³. Now let us say it has been estimated that alternative energy production is three times more expensive then the usual method. Does this mean that the economy would now need 30 units of capital to produce its electricity? Bad as this would be, the actual situation would be far worse.

As centralised power plants are closed down more and more labour, land and capital has to be directed to the production of the same unit of electricity. In plain English, productivity will dive and prices will "skyrocket", a fact that Obama admitted and which his supporters ignore. The price of electricity rises, not because it costs more (prices determine costs, that's why imputation exists) but because there is less of it. Because electricity prices are rising firms now find that their factor combinations no longer minimise their average costs of production. These combinations will start to disintegrate as firms move to more labour intensive techniques that employ less energy and capital goods will be abandoned⁴. Productivity falls, forcing down real wage rates and hence living standards. If this process continued uninterrupted the economy would come to rest at a point where living standards and the consumption of electricity have reached an abject level.

Critics could once again scream that this approach is too simplistic to apply to the US economy. On the contrary. In the real world capital goods are heterogeneous: this is a fancy way of saying that they are not perfect substitutes for each other. In such a world there is a great deal of specificity, meaning that changes in costs and demand can completely destroy the value of specific capital goods. This is one of the reason's Obama's energy policy would be particularly devastating.

Two further points: I thought it was clear from my last article that the idea that revenue from a carbon tax could offset its destructive effects was ludicrous⁵. Judging from some of the emails I got I was wrong. However, it should now be abundantly clear why it is impossible for tax cuts to offset the income effects of a carbon tax let alone stabilise energy prices and stimulate the economy.

This now brings us Co2 and the Orwellian dishonesty of the greens and their media allies. Co2 is not a pollutant: it is a nutrient and the building block of life. Secondly, it is not true that human activity correlates with the amount of Co2. The green argument that human activity correlates with global temperatures is another lie. (The Carbon Sense Coalition).

A final note: Not a single critic commented on the quotes from leading greens in which they admitted that alternative energy sources are to be promoted because they are expensive. Now why was that, I wonder?

1. The role that the big meat packers played in regulating their industry during the Teddy Roosevelt administration was detailed by Gabriel Kolko. (The Triumph of Conservatism, Free Press, 1977. pp. 98-108).

2. With respect to market failure, one obviously exasperated critic wrote, "OK smarty pants, whats your brilliant theory to explain the financial and banking crisis?" What is it with these people? I have written numerous articles on the causes of the trade cycle and the financial crisis and this bloke wants to know what my theory is. It is not my theory, it is the Austrian school theory, the roots of which can be traced back to some of the early classical economists. Seeing as this character is too lazy to do a Google search I'll give him a hand. Try Prime Minister Rudd's misbegotten assault on the market goes unchallenged.

3. In my last article I emphasised the fact that even if these alternatives were 100 per cent efficient technically they would still be horribly inefficient economically and that there is absolutely nothing that can be done about this situation. This why I said you cannot get a gallon out of a pint pot. Nevertheless, critics still mindlessly asserted that all we need is "greater efficiency". Now imagine that two techniques, A and B, produce p. A requires one unit of labour and nine units of capital while B requires one unit of labour but only 3 units of capital. It is obvious that B is the more efficient technique. However, in the greens' world we would be forced to adopt A. And this is eactly what is happening with respect to energy.

4. Some could argue that because these capital goods are perfect substitutes they would simply be recombined with labour and land but with a lower level of productivity. My argument is that capital goods are by definition complementary. This means that because of the supply of electricity had been drastically curtailed there would not be enough energy to now employ the entire capital stock.

5. The Sydney-based Centre for Independent Studies has also been promoting this rubbish.

Gerard Jackson is Brookesnews' economics editor