December 19, 2011
Okay, Samuelson actually wants to say goodbye to Keynes, but he would have had a better case if he was talking about Darwin and the theory of evolution. After all, when we have seen nothing but confirming evidence for years, why should we still accept the theory?
Samuelson tells readers:
“The eclipse of Keynesian economics proceeds. When Keynes wrote “The General Theory of Employment, Interest and Money” in the mid-1930s, governments in most wealthy nations were relatively small and their debts modest. Deficit spending and pump priming were plausible responses to economic slumps. Now, huge governments are often saddled with massive debts. Standard Keynesian remedies for downturns — spend more and tax less — presume the willingness of bond markets to finance the resulting deficits at reasonable interest rates. If markets refuse, Keynesian policies won’t work.”
It seems the problem here is that Robert Samuelson has not heard about the euro. The countries he has identified as reaching a situation where they “lose control over their economy” are all on the euro. These are countries that do not issue their own currency. In this sense they are like Ohio and Texas. These states cannot freely run deficits because the Federal Reserve Board has no explicit or implicit commitment to back up their debt. Greece, Italy and Spain are in the same situation, as the European Central Bank (ECB) has repeatedly insisted that it will not back up the government debt they issue.
Samuelson says it is “unclear” why, given our own debt and deficit, interest rates are still just 2 percent and investors are willing to lend us trillions of dollars. Actually it is very clear. The Federal Reserve Board stands behind the debt of the United States government and there are few good investment opportunities in the current economy.
Comparing the interest rate on government debt of countries with similar debt/deficit situations, it is very clear that being able to issue currency makes an enormous difference. For example, the interest rate on Spain’s and Austria’s debt is much higher than the interest rate on UK debt, even though both countries have much lower debt to GDP ratios. In short, Samuelson finds mystery and confusion where in fact there is none.
He does the same in warning us off stimulus. First he cites Christine Romer, President Obama’s former chief economic adviser, as saying that determining the exact number of jobs created by the last stimulus is “incredibly hard.” As Barbie would say, so is math.
We can’t know the exact number of jobs generated by the stimulus because a hell of a lot things were going on in the economy at the time and it is very difficult to construct a proper counterfactual. This does not amount to an argument against stimulus.
It is incredibly hard to determine the counterfactual if the United States did not enter World War II. In Samuelson’s world that would be a compelling argument against having fought Hitler. The research that has attempted to measure the number of jobs created found that the impact was pretty much along the lines predicted by the Obama administration, but yes, there is a large degree of uncertainty around these numbers.
Finally, he comes up with a harsh warning against trying the more stimulus route. Quoting Berkely economist Barry Eichengreen, he tells readers:
“At some point, however, investors will recognize this behavior for the Ponzi scheme it is. … If history is any guide, this scenario will develop not gradually but abruptly. Previously gullible investors will wake up one morning and conclude that the situation is beyond salvation. They will scramble to get out. Interest rates in the United States will shoot up. The dollar will fall. The United States will suffer the kind of crisis that Europe experienced in 2010, but magnified.”
So Eichengreen, through Samuelson, is telling us that if we go the route of more stimulus we will get a really bad situation. There are two issues here. First is Eichengreen’s story credible? And second, what is the alternative?
Eichengreen presumably has not made the same mistake as Samuelson, but again we issue our own currency, so the United States can never literally be in the same situation as Europe in 2010. We can always pay our debt, it is denominated in dollars and we issue dollars.
But Eichengreen tells us the “dollar will fall.” Actually, the official policy of both the Bush and Obama administrations were that we want the dollar to fall (mostly against the yuan). This is the only plausible way to address our trade deficit. A lower valued dollar will make imports more expensive, leading us to buy less of them, and make our exports cheaper, causing foreigners to buy more.
If we could get the dollar to fall enough to balance our trade it would create over 5 million jobs in manufacturing. This is more than 250 times the number of jobs that the oil industry claims will be created by the Keystone pipeline. Why would we be concerned about this prospect?
If Eichengreen means that the dollar would go into a free fall — reaching 3 or 4 dollars to a euro, 2 cents to a yen, 40 cents to a yuan — this is more than a bit hard to imagine. Under such circumstances U.S. exports would be hyper-competitive and our import market for other countries would vanish. Maybe Eichengreen wants to bet that this is a plausible future, but I doubt that many others would.
If for some reason investors really did send the dollar into a free fall, our trading partners would have no choice but to intervene in order to avoid the enormous damage that such a collapse would imply for their own economies. (Of course it is worth remembering that the long-term deficit horror stories are entirely driven by health care costs, a fact that Samuelson used to know.)
In short, the horror story is nice for little kids, but not terribly plausible in the real world. (Japan’s debt to GDP ratio is over 200 percent, we have a very long way to go before we get there. It can borrow long-term in financial markets at interest rates a bit over 1.0 percent.)
Finally, what is the alternative? Tens of millions of people are supposed to go unemployed or underemployed. These are people unable to care for their children properly, unable to prepare for their own retirement, and in many cases, unable to keep their homes. Absent major stimulus, things are not going to get better for these people anytime soon. And given the consistently overly optimistic track record of forecasters, it may be close to a decade until we have fully recovered from the downturn.
It is important to remember that the unemployed/underemployed are not in financial trouble because they messed up. They are in financial trouble because people like Alan Greenspan, Ben Bernanke, and Robert Rubin messed up. They are in financial trouble because news outlets like the Washington Post only had room in their news and opinion pages for people whining about budget deficits. (This is back in 2004-2007, when deficits were small.) They had no room for the people warning that the housing bubble would inevitably burst and sink the economy.
But Samuelson says that we have no choice but to make these people suffer because if we don’t then something really bad will happen. It is difficult not to ask whether Samuelson’s assessment of this risk of the bad unknown may be somewhat different if it was his family that was facing unemployment and eviction.
Addendum:
Samuelson ended his column by saying:
“Were Keynes alive now, he would almost certainly acknowledge the limits of Keynesian policies. High debt complicates the analysis and subverts the solutions. What might have worked in the 1930s offers no panacea today.”
As Gary Burltess reminds me, the debt to GDP ratio in the UK in the mid-30s when Keynes was writing The General Theory was close to 200 percent.
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