Financial FAQs

It is smart government that creates better economic growth, not smaller government, per se.  Smart government means effective government that finances and regulates what the private sector can’t or won’t.  So that doesn’t mean downsizing government for its own sake, since the private sector can’t regulate itself, and won’t finance what it doesn’t believe will be profitable.

A recent New York Times’ Op-ed by Paul Krugman talks about what it doesn’t take to run a government—specifically whether owning a private equity firm or being a corporate CEO qualifies one to be President of US. Well, Herbert Hoover and perhaps GW Bush were the last 2 Presidents who were business executives, and the policies of both caused the largest economic downturns in our history.

Why? Because they subscribed to ideologies rather than the reality they were facing. Hoover reacted to the 1929 Black Friday market crash by tightening credit to protect the creditors, thus causing record deflation, when he should have loosened credit to counteract the plunging prices. JM Keynes hadn’t published his theories until 1936 that said a Great Depression was like wartime—emergency spending measures were the only way to lift production during such tough times.

Whereas GW Bush believed in Trickle-down economics. He reacted to 4 years of budget surpluses under President Clinton by believing (as did Fed Chairman Greenspan) all those tax monies should be returned to the private sector—mostly by giving tax breaks to the richest—since “Deficits don’t matter”. Instead everyone’s income fell except that of the top 10 percent, causing the huge borrowing binge that burst the housing bubble.

Both business Presidents came from the private sector, which meant they had little idea of how to make government work. The fallacy was in believing it was up to the private sector alone to bring back growth. But growth doesn’t happen by itself. Not when the private sector becomes overextended and over indebted, which is the cause of all recessions and depressions, really.

Economists know it is oversupply that drives down prices and so profits, causing debt defaults on the most highly leveraged. This is why we have business cycles and is no fault of government, which doesn’t produce anything. In fact, economic downturns occur fairly regularly, as anyone can check on the National Bureau of Economic Research website, www.nber.org. It is how to climb out of those holes that is hardest for business types to know.

Modern history since the Great Depression tells us in fact government is not the problem. It doesn’t rob from anyone, but instead finances the most important segments of our economy. Besides defense it finances education, future research and development, public services, and environmental and financial regulation—that private sector business won’t. It’s too risky for private businesses, and doesn’t give them immediate returns. How does one calculate the profit from use of our public highways and bridges, for instance? Yet without those services the private sector cannot function.

So what about the huge government debt amassed since 2000? In fact, it isn’t the dollar amount that matters, but what it is as a percentage of GDP. We had no problem with running the deficit up to 121.7 percent of GDP in World War II, even though most of the ‘goods’ went up in smoke, rather than back into the economy. Firstly, it generated jobs for everyone, including women. And secondly, it modernized our industrial base that enabled U.S. to grow out of such debt until it fell to 40 percent of GDP in 1980, while giving the post-WWII U.S. economic superiority over those economies devastated by war.

The deficit only began to grow again under President Reagan, who coined the term, “Government is the problem”. Why? Because as his Budget Secretary David Stockman explained, cutting taxes didn’t reduce deficits, because it reduced the revenue needed to pay for the tax cuts. It was only when President Clinton restored the pre-Reagan tax rates and reduced government spending that we had 4 consecutive years of budget surpluses. In fact, what was left of the WWII debt—some $1.2trillion—would have been paid off if GW Bush had elected to continue his policies rather than borrow more money.

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Graph: Wikipedia

Christina Romer, former White House Chief Economist, explained the effects of government stimulus spending in a recent New York Times Sunday Op-ed . A historian of the Great Depression, her thesis is that without the various stimulus programs, such as Obama’s 2009 ARRA $800 billion stimulus spending, we would still be in a deflationary recession.

Furthermore, “In place of the tepid budget agreement now in place,” said Dr. Romer, “we could pass a bold plan with more short-run spending increases and tax cuts, coupled with much more serious, phased-in deficit reduction. By necessity, the plan would tackle entitlement reform and gradually raise tax revenue. This would be the World War II approach to our problems.”

Then what is smart government? It’s been proven time and again that just returning $$ to the private sector during deep recessions doesn’t spur growth, because they don’t spend it. Two examples are the current cash hoarding by corporations of more than $2 trillion, while paying outsize incomes to their executives, and banks keeping almost all of their reserves with the Fed rather than lending their excess cash out to spur growth.

Why do they continue to hoard? The private sector really doesn’t like much risk, contrary to assertions by free marketers who trumpet that entrepreneurs must lead the way for any recovery, if only there was less regulation! In fact, there are very few successful entrepreneurs, because the failure rate of entrepreneurs is very high. The track record of venture capital tells us so. Even the track record of Presidential candidate Mitt Romney’s Bain Capital is mixed at best. Private Equity Firm Bain Capital may have actually eliminated more jobs than it created, when the record is looked at closely.

Harlan Green © 2012