Just the opposite. The Great Depression originated in the excesses of state action—the massive indebtedness and inflation of the Great War and the easy-money credit bubbles of the Roaring Twenties—not to its supposed deficiencies.
Likewise, the post-war business cycles prior to Greenspan’s accession were short-lived, well-contained and self-correcting. They too were owing to the errors of state action, not the inherent flaws of capitalism or an alleged business-cycle instability that threatened an unstoppable downward spiral.
Specifically, two of these recessions were temporary consequences of what had been red-hot war economies in 1953–54 (Korea) and 1969–70 (Vietnam). The first was self-cured by the inherent resilience of market capitalism and involved virtually no fiscal or monetary “stimulus” under the orthodox strictures of President Eisenhower and William McChesney Martin at the Fed.
Likewise, the post-Vietnam so-called recession hardly registered in the economic statistics—–save for a 70-day auto strike. The latter wasn’t even a business cycle, but a random shock from the complete shutdown of GM and its massive supplier base in the fall of 1970 at a time when GM was at its peak and occupied 45% of the entire US auto market.
Needless to say, that strike was eventually resolved by the parties involved, triggering a sold rebound immediately thereafter. There was no business cycle failure or threatened tumble into an economic black hole—nor did the fiscal and monetary authorities of the day do much to “stimulate” the natural forces of recovery.
By contrast, the two deepest recessions of the pre-Greenspan period—the 1974–75 downturn and the deep 1981–82 recession—were caused by a very evident villain. In those cases, you can pin the tail squarely on the donkey at the Federal Reserve itself.
As we also demonstrated in The Great Deformation, the mid-1970s boom-and-bust cycle was not caused by the 1973 post-embargo “oil price shock.” To the contrary, it was the result of Fed Chairman’s Arthur Burns’ abject submission to Nixon’s demand for a 1972 pre-election surge of the U.S. economy.
The obsequious and weak-spined Professor Burns, in fact, pumped reserves and new credit through the banking system at nearly a 40% annualized rate near its peak. It is that action which set the stage for the inflationary blow off in 1972–74 and which necessitated a sharp monetary braking action thereafter.
As to the deep plunge of the early Reagan era, the Mighty Volcker was at the helm, of course, only because Arthur Burns and his successor, the hapless golf cart manufacturer William Miller, had fueled a massive domestic credit expansion during the second half of the 1970s.
Accordingly, the double-digit inflation that Volcker brought to heal was manufactured by the central bank, not by the OPEC cartel, silver and copper speculators or greedy consumers, as Jimmy Carter had it at the time.
THE DEMISE AND REVIVAL OF FULL-EMPLOYMENT KEYNESIANISM
Moreover, as of Volcker’s turn at bat, there was at least a possibility that Washington policy might escape from the thrall of Keynesian economics. That’s because in its original fiscally oriented guise it had flopped miserably during the previous two decades.
It had been first installed on the fiscal side during the Kennedy-Johnson era, and was then embraced by Nixon himself when his itinerant policy groupie, George Schulz, professor of labor economics, persuaded him to adopt the full-employment budget concept.
The latter was pure Keynesian claptrap. In fact, it was the original incarnation of the hoary idea referenced above that the United States was a closed domestic economy resembling a giant economic bathtub, which needed to be filled to the brim with GDP for maximum societal welfare.
According to Schulz and his original band of business Keynesians, the job of the state was to mobilize aggregate spending via fiscal deficits and easy monetary credit. These spigots of state-fueled “aggregate demand” would then be held open until the economic-policy experts certified that potential GDP and full employment had been achieved and that the bathtub was full to the brim.
Mercifully, the primitive experiments with so-called full-employment stimulus during Johnson’s “guns and butter” policies after 1965, and the Nixon-Burns money-printing spree of 1972–74 resulted in the 1970s catastrophe of stagflation. Accordingly, bathtub-based Keynesianism was on deaths door when Ronald Reagan arrived at the White House in 1981.
And the giant Reagan deficits notwithstanding, it was further buried by the roaring success of Volcker’s hard-money policy and the Reagan’s administration resolute refusal to consider anything that smacked of proactive fiscal or monetary “stimulus” during the dark days of 1982.
In this context, it needs be recalled that the giant Reagan deficits were structural, not cyclical forms of discretionary Keynesian stimulus. As it happened, they were owing to a planned tripling of defense spending and a tax-cut bidding war that got totally out of hand in the summer of 1981. The latter ended up reducing the permanent out-year revenue base by 6% of GDP compared to an original White House goal of 3.5%.
These were both policy errors in their own right, of course. But they involved no notion at all that capitalism needed the helping hand of the state in order to get back on its feet after a state-sponsored credit inflation had set it on its heels.
Then came the 1984 election campaign about morning in America, which was mainly harmless political bloviating. But the White House politicians could not leave well enough alone.
Soon there followed the disaster of the Plaza Accord of 1985, designed to trash the dollar and artificially stimulate domestic economic activity. And then on the heels of the Plaza Accord there transpired the real calamity: Ronald Reagan was tricked by Jim Baker and the Republican elders on Capitol Hill into forcing Volcker out of his job as chairman of the Fed. In Chapter 5 we will show that the double-talking, power-seeking, lapsed gold bug named to replace him, Alan Greenspan, brought Keynesian bathtub economics right back into the center of policy, and then doubled down during the 1990s.
Yet in the world after Mr. Deng’s pronouncement that it is glorious to be rich and even more virtuous to export, the idea of a full-bathtub policy in a single country is absurd. Industrial capacity and labor are global and incessantly dynamic, meaning that the primitive measures of domestic-labor and business-capacity utilization published by Washington’s rickety statistical mills measure nothing that is accurate or economically meaningful.
Thus, the utilization rate of the auto industry, as was discussed previously, might have been remotely relevant before 1980. Today it reflects a domestic-sales and production cycle that leaks like a sieve owing to the integration of the North American auto production base under NAFTA and the massive ebb and flow of export vehicles from Europe and East Asia.
So instead of a full bathtub of domestic employment and GDP, the Fed has generated a $45 trillion financial bubble since Alan Greenspan took the helm in August 1987. After 29 years, honest price discovery has been destroyed, thereby reducing the nerve centers of capitalism—the money and capital markets—to little more than gambling casinos.
This central bank-caused disabling of capitalist financial markets has been exceedingly counterproductive. Speculative rent seeking in the financial arena has replaced entrepreneurial innovation and supply-side investment and productivity as the modus operandi of the US economy.
In short, the pursuit of Keynesian business-cycle management and stimulus through central bank interest-rate pegging and massive monetization of existing public debt results in systematic falsification of asset prices, not “stimulus” of the Main Street economy. It amounts to monetary central planning for the perverse purpose of redistributing wealth to the top of the economic ladder.
THE FOLLY OF THE BATHTUB-ECONOMICS MODEL AND KEYNES’ ODE TO HOMESPUN GOODS
As indicated above, the Keynesian bathtub model of a closed, volumetrically driven economy is a throwback to specious theories about the inherent business cycle instabilities of market capitalism that originated during the Great Depression. These theories
were wrong then, but utterly irrelevant in today’s globally open and technologically dynamic post-industrial economy.
The very idea that 12 people sitting on the FOMC can adroitly manipulate an economic ether called “aggregate demand” by means of falsifying market interest rates is an especially bad joke when it comes to those parts of “potential GDP” comprised of goods-production capacity and the measurement and mobilization of the potential labor force.
In the case of goods production, today’s world of open trade and massive excess industrial capacity means that the Fed can do exactly nothing about domestic slack in the goods production sectors. As we have seen, whether the domestic steel industry’s capacity utilization rate is 90% or 60%, for example, is a function of how much steel the Chinese are dumping on the U.S. market and how aggressive the Commerce Department is in imposing anti-dumping penalties—not 25 bps on the money market rate.
In the vastly oversized global steel market case and that of virtually all traded goods, it all depends upon the marginal cost of labor, capital and materials and the extent of state intervention and subsidization.
Indeed, the only thing that the denizens of the FOMC can do about capacity utilization in any domestic industry is to reread Keynes’ 1930 essay in favor of homespun goods and recognize that it is they—not Donald Trump—who are the real advocates of protectionism!
As I detailed in The Great Deformation, the Great Thinker actually came out for stringent protectionism and economic autarky six years before he published the General Theory and for good and logical reasons that his contemporary followers choose to completely ignore.
Namely, protectionism and autarky are an absolutely necessary correlate to state management of the business cycle. Indeed, Keynes took special care to make sure that his works were always translated into German, and averred that the state-controlled economy of Nazi Germany was the ideal test bed for his economic remedies.
Eighty years on from Keynes’ incomprehensible ode to statist economics and thoroughgoing protectionism, the idea of state management of the business cycle in one country is even more preposterous.
Thus, in the case of potential labor supply, the unutilized amount of labor (i.e. unemployment) is a function of the global labor cost curve. Furthermore, labor is now employed in atomized form as hours, gigs, and temp agency contractual bits, not headcounts as toted-up by the Census Bureau’s employment survey takers (or fakers).
In fact, the Census Bureau survey takers and the BLS numbers crunchers don’t have the foggiest idea about how to compute the nation’s potential labor supply. Nor do they know much of it is employed on any given day, month or quarter.
Accordingly, the Fed’s apparent target of 5.0% on the U-3 unemployment rate is especially ludicrous. The denominator of that figure is a crock because it excludes 92 million adults not even counted as being in the labor force—of which only half are retired and receiving Social Security benefits (OASI).
At the same time, the numerator is way understated because it excludes not only all of the uncounted millions deemed not in the labor force, but also excludes millions more who are functionally unemployed, but are counted as jobholders if they work only a few hour per week. The computed result, therefore, is as good as pure noise as you are likely to find anywhere.
As I indicated earlier, in today’s economy they only way to measure labor is on an hours basis because increasingly that how it is scheduled by employers. At the present time, there are 210 million adult Americans between the ages of 16 and 68—to take a plausible measure of the potential work force.
Accordingly, if we accept the convention that all adults are at least theoretically capable of holding a full-time job (2,000 hours per year) and pulling their share of society’s need for production and work effort, that amounts to 420 billion potential labor hours in the US economy.
By contrast, only 240 billion hours are actually being supplied to the U.S. economy according to recent BLS estimates. Technically, therefore, there are 180 billion unemployed labor hours, meaning that the real unemployment rate is 43%, not 5%!
Yes, we have to allow for stay-at-home wives, students, the disabled, early retirees and coupon clippers. We also have drifters, grifters, welfare cheats, bums and people between jobs, enrollees in training programs, professionals on sabbaticals and much else.
But here’s the thing. There are dozens of reasons for 180 billion unemployed labor hours, but whether the Fed is monetizing massive amounts of the public debt and pegging money-market interest rates at 38 bps or 63 bps doesn’t even make the top 25 reasons for why these potential hours are unutilized.
What actually drives our current 43% pro forma unemployment rate is global economic forces of cheap labor and new productive capacity throughout the EM, and also dozens of domestic-policy and cultural factors that influence the decision to work or not.
In that context, schoolmarm Yellen’s focus on the minutia of the BLS labor statistics in the pursuit of her campaign to fill up the bathtub of potential GDP is borderline loony.
For instance, the amount of unmonetized labor utilized in households and elsewhere is constantly changing depending on demographics, household composition, cultural values, economic pressures on family budgets, child-care costs and availability and much more. The Fed can’t possibly keep up with this or take account of it in calibrating full employment.
That point was brought home way back in the 1970s during one of those periodic Washington debates about full employment. Legendary humorist Art Buchwald weighed in with a sure fire way to double the GDP and do it instantly.
That was at a time when most women had not yet entered the labor force and politically incorrect discussion was still permitted on the august pages of the Washington Post.
Said Buchwald: “Pass a law requiring all men to hire their neighbor’s wife!”
That is, monetize all of the cleaning, cooking, washing, ironing, scrubbing and errands and shopping done every day in American households by unpaid spouses and get the monetary value computed in the GDP. And in the process, get homemakers factored into the labor force and their contribution to the economy’s real output reflected in the labor utilization rate.
As a statistical matter—even though four decades of women entering the labor force have passed since Buchwald’s tongue-in-cheek proposal—there are still approximately 75 billion unmonetized household labor hours in the US economy. Were they to be counted in both sides of the equation, our 43% unemployment rate would drop to 25% for that reason alone.
Needless to say, whether household labor is monetized or not has no impact whatsoever on the real wealth and living standards of America, even if it does involve important social-policy implications. But unmonetized household workers are absolutely is part of the potential labor supply, and changes in their participation rate in the monetized economy is highly variable depending on almost anything you can think of except 25 bps on the Wall Street borrowing rate.
And the same thing is true for almost every other factor that drives the true hours-based unemployment rate. Front and center is the massive explosion of student debt—now clocking in at $1.3 trillion compared to less than $300 billion only a decade ago and virtually zero when Greenspan launched Bubble Finance.
The point is not simply that this debt bomb is going to explode in the years ahead; the larger point is that for better or worse, Washington has made a policy choice to keep upwards of 20 million workers out of the labor force and to subsidize them as students.
Whether millions of these debt serfs will get any real earnings-enhancing benefit out of this “education” is an open question—even as the answer leans heavily toward not likely in either this lifetime or the next.
But these 40 billion potential labor hours are now far greater in relative terms than under the stingy student subsidy programs, which existed in 1970 when Janet Yellen was learning bathtub economics from James Tobin at Yale. Stated differently, there is enormous “slack” in the labor for
ce because the higher-education lobbies rule the roost on Capitol Hill, not because Janet Yellen and her posse rule the money-market rate.
Likewise, there are currently about 17 billion annual potential labor hours accounted for by Social Security disability recipients. Again, that is a much larger relative number than a few decades back, and it is owing to the deliberate liberalization of social policy by Congressional legislators and administrative law judges. The FOMC has nothing to do with this form of unemployment, either.
Then there are the billions of potential labor hours in the unmonetized “underground” economy. While the social value of work by drug runners and street-level dealers is debatable, it is self-evident that state policy—in the form of the so-called “war on drugs” and the DEA and law-enforcement dragnet—account for this portion of unutilized labor, not the central bank.
The same is true of all the other state interventions that keep potential labor hours out of the monetized economy and the BLS surveys. That starts with the Obamacare 30 hours per week threshold and goes from there to the minimum-wage laws and petty licensing of trades like beauticians, barbers, electricians and taxi drivers, among countless others.
Finally, there is the giant question of the price of labor as opposed to the quantity. And here it needs to be noted that “off-shoring” is not just about shoe factories and sheet and towel mills that went to China because American labor was too expensive.
Owing to the rapid progress of communications technology, an increasing share of what used to be considered service work, such as call centers and financial back-office activities, have also been off-shored on account of labor price.
Moreover, the process of direct wage suppression due to off-shoring of goods and services production has ricocheted into adjacent activities. That’s because former holders of offshored jobs have been willing to accept lower wages in purely domestic sectors when push comes to shove.
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