President Obama is Learning the Hard Way

William Krehm

The New York Times (09/06, "Stimulus Talk Yields to Calls to Cut Deficits" by David E. Sanger and Sewell Chan) reports: "Washington – At a moment when many economists warn that the American recovery is likely to be imperiled by prolonged unemployment and slow growth, President Obama is discovering that the tools available to him last year – a big economic stimulus and action by the Federal Reserve – are both now politically untenable.

"The mood in both parties of Congress has turned decidedly anti-deficit, meaning that job-creation programs favored by the White House and Democratic leaders in Congress have been cut back, then cut again. It is a measure of the mood that Mr. Omaha on Tuesday hailed an initiative by his administration to cut the budget of most major government agencies by 5%, at a time when conventional theory would call for more government spending to lift the economy.

"Even the Federal Reserve is pulling in its horns. No one could expect it to cut interest rates further – they are at rock bottom."

That is exactly what we warned President Obama of in our one-sided correspondence: that not all price increases are "inflationary." Prices in a high tech, highly urbanized world, in which the average citizen is living to a far riper age than his ancestors did, and has need certainly of a high-school, and more frequently of a university training, even a doctorate, prices can go up for reasons entirely different from an excess of demand over supply. That may be summed up under the heading of "investment in human capital," which would include health care and surroundings that would allow making full use of that costly equipment. That conclusion I first published in the outstanding French economic journal of that day, La Revue économique (May 1970).

In it I warned that unless the new non-market factors that have entered into price-determination were recognized, the world economy would come up against a brick wall.

That in fact is what happened, when The Times now writes that the Fed is at rock bottom in fighting "inflation." However, that is merely proof that the ongoing price increases are not the result of continued "inflation," but of an atrocious contortion of the government's accountancy that confuses government investment in physical and human capital with debt, rather than recognizing them as capital. I have given more details of the consequences of this confusion elsewhere in this issue of ER.

If you wipe out all history pertinent to a problem, and reduce the ever more complex, entangled economies of our day to two simplistic factors – supply and demand – and when your elected representatives and the teaching staffs at most of our universities have been savagely restricted to the official policy by the threat of losing their positions, you have a society in a depth of moral trouble deeper even that the world's current economic despair. That explains the Times' remark that Mr. Obama is finding that the tools "available to him last year" are no longer available.

Certainly not if he persists in seeing in our price rise "inflation" rather than a reflection of the investment in physical and human capital investment at all levels of government.

On top of that Mr. Obama made the further blunder of retaining as economic advisers top bureaucratic brass that had helped lead the world into its current quandary. Had the suppression of our economic history not been a key component of this ultimate power-grab of irresponsibly speculative banking, he could have consulted many great economists and economic historians on this crucial matter.

But back to the Times: "'My best guess is that we'll have a continued recovery, but it won't be terrific,' Ben S. Bernanke, the Fed chairman, said at a dinner at the Woodrow Wilson International Center for Scholars on Monday night. 'And the reason it won't feel terrific is that it's not going to be fast enough to put back to work eight million people who lost their jobs within a few years.'

"One could almost envisage the winces in the White House as Mr. Bernanke observed that even if the economy grew at 3%, which would be considered a healthy pace,. it would do little more than keep pace with the normal rate of growth of the work force.

Virtually daily White House officials have struggled to explain how their strategies to provide economic stimulus to bring down the unemployment rate square with Mr. Obama's oft-expressed commitment to tackle a record budget deficit.

"They talk about spending this year in modest amounts – while waiting for the prescriptions of the president's commission on debt reduction, which reports, conveniently, a few weeks after the midterm elections.

"In the next breath, they say that the only long-term strategy that will get Americans back to work and bring the deficit under control is promoting rapid economic growth. That is the elixir that allowed the Clinton administration, where many members of Mr. Obama's team cut their teeth, to briefly wipe out budget deficits. But it is unclear where that growth will come from – and how soon.

"So rather than promoting another broad stimulus package, the White House is pointing to a series of familiar-sounding, low-cost measures to create jobs: stimulating export-oriented manufacturing, subsidizing energy-efficiency improvements by homeowners, preventing layoffs of teachers and police officers and pressing for a new (and unpaid for) highway bill that could, like the census, create a short-term burst in hiring.

"Lawrence H. Summers, the director of the National Economic Council and the adviser at Mr. Obama's elbow, argued that the effect of last year's $787 billion spending program had not fully kicked in. 'Given fiscal lag, the Recovery Act is still gaining force and having increasing impact,' he said, adding that the administration's job approach 'goes beyond spending programs' to include mortgage relief for homeowners and expanding lending to small businesses. 'We will not let up on jobs as a priority until unemployment returns to normal levels.'

"Congress has enacted or is likely to an estimated $200 billion worth of additional spending to last year's package, the appetite for a big new fiscal boost has slackened.

"The anti-deficit mood is not limited to Washington. Over the last two days, Britain and Germany have announced austerity plans, in contrast to what many in Europe were arguing for a year ago. Spain and France have announced similar moves. The politics of those moves vary from country to country. In Britain, it is explained by the election of a Conservative government; in Germany by the usual postwar German aversion to deficits.

"But the crisis in Greece has focused minds across Europe, especially in Spain, Portugal and Ireland. So two weeks ahead of a meeting of the Group of 20 economic powers in Toronto, there is a widespread consensus that grand stimulus programs are a thing of the past.

"The box that Europe, the Obama administration and Congress find themselves in today – desperate to stimulate the economy and fearful of the political reaction – gives new meaning to Milton Friedman's famous line of the mid-1960s. 'In one sense, we are all Keynesians now,' he wrote to Time magazine… [Keynes] called for government spending to counter downward cycles in the economy. In a less-remembered continuation of that sentence, Friedman added, in another [sense] nobody is any longer a Keynesian.'

However, to deal with the issue simply as how much debt politicians are prepared to take on is to trivialize it beyond qualification. If someone unloads his check for, say $500, on a bank where he has no account and is nabbed, he will get a prison sentence. Compared to that, the scale of the current falsification of what are our governments' capital assets, the crime of the $500 crook is salted peanuts. And yet it so intimidates the media and most of our universities about the nature of government investment – both in material and human capital – as to inflict mass unemployment, that can only lead to further war and social collapse.

Yet there is no way of determining what is government debt and what is investment, without serious accountancy. Had double-entry accountancy (also known as accrual accountancy) not been brought to Europe by the Knights Templar from the Holy Land, there would have been none of the lengthy voyages that led to the discovery of the Americas and the Eastern sea-route to China. Nor would there have been the unification of the tiny feudal principalities of Europe into united nations.
The distinction between debt and investment must be clear of ambiguity. However, the mega-banks have elbowed out their governments in determining the real category of government spending.

That was one of the great lessons learned the hard way during the Depression of the 1930s. It was embodied in President F.D. Roosevelt's Glass-Steagall law prohibiting commercial banks from acquiring interests in "other financial pillars" – specifically in those remote days, brokerages, insurance, and mortgage companies. Commercial banks had to finance other firms' transactions, not trade on their own account as investment banks. For that would give them access to the cash reserves required for the businesses they took over. And it empowered them to gamble on their own account with the capital reserves of other businesses.

On Fictitious Bank Capitalization

That is the origin of current confusion between what is government debt and assets that has floored the world economy today. And since government credit has long ago replaced the gold standard, government credit by the central banks – certainly in Canada where the central bank was nationalized in 1938 – relatively little use is made of that facility available directly or indirectly to all three levels of our government.

About economic theory, F.D. Roosevelt knew little. But he brought to the Depression of the 1930s an open mind, and a determination to get the country out of the ditch. By the time he was inaugurated in 1933, 38% of the nation's banks had shut their doors. Instead of bailing them out with government loans, he declared a bank moratorium that lasted a month during which he consulted with economists of every stripe. As a result when the banks opened their doors again they were restricted to commercial banking. And by 1935 the Glass-Steagall law passed Congress forbidding them to acquire interest in other "financial pillars" such as brokerages, insurance and mortgages companies. They were confined to financing trade. And in addition, a lively, highly necessary discussion was encouraged for local initiatives to issue script that could be used only to finance local trade and massive hydro-electric projects were undertaken by the government.

In Canada, the Bank of Canada, founded three years earlier as a privately-owned institution in imitation of the Bank of England, was bought out by the Canadian government in 1938, and thus was available to handle its capital investments at a token rate of interest. That permitted Canada to finance its Second World War on more favourable terms than either US or Britain.

That made it possible for Canada not only to repair the neglect of a decade of depression and five years of war, but to assimilate millions of mostly penniless immigrants and convert our essentially agrarian economy to a modern industrial one. Only in the 1970s under the conservative government of Brian Mulroney, particularly sensitive to Washington's preferences, was this discontinued. By the 1970s it had fallen into disuse and since then Ottawa has done the bulk its financing through private banks. Yet the original powers of the nationalized Bank of Canada are still on the law books, though not made much use of. Thereby hangs an instructive tale. Eager to toe the Washington line, PM Mulroney proposed a revision of our Bank of Canada legislation that would declare "zero inflation" and the autonomy of the Bank of Canada from the Government as the law of the land. But his own caucus in the House of Commons turned him down. Since then no government has dared tamper with the fundamentals of the Bank of Canada Act as it appears in print. But what actually happens in practice is another matter.

Accrual accountancy was smuggled into the US Federal bookkeeping to stave off a seemingly inevitable international financial crisis brought on by the North American Free Trade Agreement that led to the collapse of the Mexican economy, that lost little time in spreading internationally. In desperation US President Clinton brought in accrual accountancy, though to avoid the economic pieties that had taken over, he called it "savings." Savings, however, usually refer to very liquid or short-term securities that can help emergency calls, and what was involved here were highways, bridges and even raw land. That however, produced a surplus on government balance sheets helped bring on an economic upswing that got Clinton his second term and the world a boom until the collapse of the very late 1990s.

That, however, still leaves out of sight and mind human capital, the unique value of which was undoubtedly the most important lesson to come out of World War II. Immediately after the war ended, Washington dispatched to Japan and Germany hundreds upon hundreds of economists to study the war damage and predict how long it would be before these two countries could again become formidable traders. Some sixteen years later one of these, Theodore Schultz, published a book explaining why their conclusion had been so wide of the mark. This he attributed to their having concentrated on material destruction while giving scant importance to their skilled workers coming through the conflict almost intact.

From this Schultz concluded that investment in human capital was the most profitable a government could make. For this, he was for a few years celebrated, decorated, and then completely forgotten. For that is a message that speculative banking staging its style "recovery" cannot possibly tolerate. Even the record of the thirties and how society managed to curb speculative banking had to be buried.

COMER would be happy to enlarge on our program during the coming Toronto conference.

William Krehm
Chairman, Committee on Monetary and Economic Reform

– from COMER, June 2010