Growls

A lot has happened since we last growled about the financial crisis on October 6. It seems every passing day brings a story of another company or industry being bailed out  or some stimulus package being concocted.

Today, the Wall Street Journal reported on the announcement this afternoon by President-elect Barack Obama of his economic team. He also called for a "stimulus package to deal with the immediate crisis," adding the "economy (is) in distress." That raises the question of whether a stimulus package is the proper economic medicine and just how effective past stimulus packages have been.

Russell Roberts, economics professor at George Mason University, wrote in an op-ed titled, “Don’t Just Do Something, Stand There,” in the Wall Street Journal on October 31:

“By acting without rhyme or reason, politicians have destroyed the rules of the game. There is no reason to invest, no reason to take risk, no reason to be prudent, no reason to look for buyers if your firm is failing. Everything is up in the air and as a result, the only prudent policy is to wait and see what the government will do next. The frenetic efforts of FDR had the same impact: Net investment was negative through much of the 1930s.

“The next administration is unlikely to do any better. Mr. Bernanke is perhaps the greatest living authority on the Great Depression, yet he has failed to stem the damage. Messrs. Paulson and Bernanke are confronted with a sick patient. They have antibiotics. They have a scalpel. But is there any evidence from the last seven months that they understand the underlying cause of the illness, or how to cure it?

“Worst of all are the political incentives that are unleashed when Washington promises to spend a trillion dollars (and counting). No one can spend such money wisely even if they want to. The information about who needs to be bailed out and who needs to fail is too complicated. Inevitably, such decisions will begin to be more about politics than economics.”

Could the politicians even solve the current economic problems if they had the necessary information? Not likely according to Brian Riedl, a fellow at the Heritage Foundation. In a Wall Street Journal op-ed on November 14, he explains:

“Government stimulus bills are based on the idea that feeding new money into the economy will increase demand, and thus production. But where does government get this money? Congress doesn't have its own stash. Every dollar it injects into the economy must first be taxed or borrowed out of the economy. No new spending power is created. It's merely redistributed from one group of people to another.”

In an op-ed posted the previous day at CNN.com about a bailout for the Big Three automakers, Dan Mitchell of the Cato Institute wrote:

“A taxpayer bailout would be a terrible mistake. It would subsidize the shoddy management practices of the corporate bureaucrats at General Motors, Ford and Chrysler, and it would reward the intransigent union bosses who have made the UAW synonymous with inflexible and anti-competitive work rules.

“Perhaps most important, though, is that a bailout would be bad for the long-term health of the American auto industry. It would discriminate against the 113,000 Americans who have highly-coveted jobs building cars for Nissan, BMW and other auto companies that happen to be headquartered in other nations.

“These companies demonstrate that it is possible to build cars in America and make money. Putting them at a competitive disadvantage with handouts for the U.S.-headquartered companies would be highly unjust.

“A bailout also would be bad for General Motors, Ford and Chrysler. The so-called Big Three desperately need to fundamentally restructure their practices. More specifically, the car companies need to endure some short-term pain in order to restore long-term viability. But that won't happen if politicians raid the treasury."

Michael Spence, a 2001 Nobel laureate for economics, tried to answer the question of whether a bailout will work in an October 6 essay in Forbes. He concludes:

“If the due diligence was done well, market prices (including housing prices) will, over time, return to something like the intrinsic values, at which point the government will be inclined to sell the assets/mortgages at a measured pace. Will this work? It could. No one knows for sure. But $700 billion is not enough additional capital. The bailout will, therefore, stand or fall on whether it succeeds in causing private capital to return to the sector.”

In a Pajama Media essay on November 21, Dan Mitchell takes on the Keynesians and argues it is a myth that government spending ‘stimulates’ the economy. He explains:

“The people who lend the money to government generally are not the same people who get money in their pockets because of the new spending or tax rebates, but that’s not important. The Keynesian theory is based on the notion that there will be an increase in overall spending power, yet that clearly is not the case. Some advocates of this theory get a bit more creative and say that Keynesianism works because it increases consumer spending rather than the money sitting idle. But money that is unspent by consumers does not sit idle. It winds up in the banking system someplace and is used to finance investment spending. So-called stimulus programs, at best, shift how national income is used so that more gets consumed rather than invested, but at noted earlier, there is no increase in overall economic output.”

Mitchell also writes, “The real-world evidence also confirms that Keynesianism is a failure. Indeed, it was a failure even before Keynes published The General Theory in the mid-1930s.”

Arnold Kling, an adjunct scholar at Cato and a former economist at the Federal Reserve Board writes in the American Enterprise Institute’s “The American:

“Main Street remains suspicious of government plans to buy distressed mortgage assets. Leading politicians and newspaper editorials are struggling to explain how the financial bailout will help Main Street. They see that the challenge is to get the American people to come around.

“In fact, it is the elites who are badly misguided. The reality is that the Paulson plan is nothing more than a government assistance package for a declining industry. It has been embraced eagerly by Democratic politicians who welcome the enhanced power they will enjoy as a result of merging Big Finance with Big Government.

“The American people are being given two reasons to support the bailout, namely, that it is needed to prevent another Great Depression and that it will actually earn a profit for taxpayers. Both rationales are suspect.”

It seems appropriate to close with the following comment by Anna Schwartz during an interview in the Wall Street Journal. Ms. Schwartz is the co-author with Milton Friedman of “A Monetary History of the United States" (1963). It is considered by many to be "the definitive account of how misguided monetary policy turned the stock-market crash of 1929 into the Great Depression."

"(F)irms that made wrong decisions should fail . . . You shouldn't rescue them. And once that's established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich. (The trouble is) that's not the way the world has been going in recent years."

UPDATE (12/9/08) Title renumbered to "VI" since "V" was posted October 9, 2008.