Today is inauguration day. George W. Bush will officially depart as soon as Barack H. Obama is sworn in.
The Audacity of Hope is the title of Obama’s campaign book. As with Bill Clinton’s A Man from Hope video, the accent is on the positive.
To campaign on hope is a tried-and-true tradition. Like second marriages, this is hope triumphing over experience. Also like second marriages, the honeymoons are shorter.
The general public is always optimistic when a President is inaugurated. Most voters want to believe that things will get better. If things have been going well, they expect this to continue.
The greatest optimism usually occurs at a first-term President’s inauguration. People were optimistic about Clinton in 1993, Reagan in 1981, Kennedy in 1961, and Eisenhower in 1953. The one exception was Nixon in 1969. The election had been very close, the Vietnam war was a quagmire, and Nixon was widely distrusted as “tricky Dick.” The pessimists had every reason to be pessimistic in 1969, as things turned out. But you would not have guessed this in 1972. He won in a landslide, despite the recession and the huge back-to-back Federal deficits in 1970 and 1971, his unilateral annulment of the international gold standard, his unilateral imposition of price and wage controls, the shortages that resulted, the continuing quagmire in Vietnam, and the rumors about the Watergate break-in. The quadrupling of the price of oil in 1971 was also bad news.
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There was brief optimism over Gerald Ford, despite escalating inflation and despite Nelson Rockefeller as the appointed Vice President. But optimism gave way to pessimism in what became the worst post-war recession. He was sent packing in 1976.
Reality usually intrudes. Eisenhower experienced two recessions, 1953 and 1957, years of his inauguration. Kennedy got trapped in Vietnam. Then he was assassinated, undermining faith on the “can-do liberalism” of the pre-Kennedy era. Johnson’s disaster in Vietnam undermined liberalism even more. Nixon gave us serious inflation, a scandal and a resignation, and no resolution of the Vietnam War. Ford was a fluke. He never recovered from his pardon of Nixon. Carter experienced the worst peacetime inflation in American history and then a recession. To that was added the Iran crisis: the hostages and the failed rescue attempt. Reagan escaped, just as Eisenhower had escaped. He was the Teflon President. Clinton also escaped. He was the charm President. He could talk his way out of anything, just as Reagan could. Reagan’s 1984 campaign promised “morning in America.” It looked plausible until September 11, 2001.
DEFICITS AND FIAT MONEY
Half a century ago, the master humorist and serious political scientist C. Northcote Parkinson coined Parkinson’s law: “Work expands so as to fill the time allotted for its completion.” He suggested other laws, but that one became his most famous law.
He made a very important point when he discussed government committees in charge of spending. He said that a committee will wrangle over a few thousand dollars but hardly discuss a bill to spend several million. (The numbers were lower in the 1950′s.) Why is this? Parkinson offered an answer. Members of a committee have experience with several thousand dollars. They know how much can be wasted. They also know how little it will accomplish. But they have no personal experience with millions. They don’t argue over a huge number because it is merely a number. They don’t connect emotionally with it.
Half a century later, the committees spend a hundred billion dollars without worrying about it. There was that one fine moment in September 2008, when the House of Representatives voted down the Administration’s $700 billion bailout of the banks. Three days later, the House passed it.
From then until now, neither political party has blinked about bailouts. The Federal Reserve System has added $1.6 trillion to the monetary base since April 1, 2008. The Federal government has agreed to absorb bad debts in the range of $8.5 trillion, after last week’s deal with Bank of America, the nation’s largest bank (this week).
Serious resistance to Federal spending is over. There will be debates over which groups get their hands into the bag of loot, but the bag will surely grow.
The House Ways and Means Committee and the Senate Finance Committee do not officially ask, let alone answer, the following questions:
Who will invest in this debt at today’s interest rates?
Will these investors be private Americans?
Will Asian central banks buy this debt? (Have they already begun to sell it?)
Will the Federal Reserve System buy this debt with newly created money?
How high will interest rates go? How soon?
How will this debt be repaid? (Joke!)
How will the government be able to roll over this debt from now until Doomsday? (When is Doomsday?)
What effect will investment in Federal debt have on the cost of capital in the private sector?
If the private sector cannot attract capital at low rates, what effect will this have on future production?
When will these trillion-dollar annual deficits end?
Because such questions are considered fiscally naïve, the committees do not hold hearings on any of them.
Why are these questions considered fiscally naïve? Because they involve two things that Congress rarely considers: (1) economic cause and effect; (2) the long run.
PANDORA’S BOX CONTAINED HOPE
We usually forget this. The Greeks understood that hope springs eternal. But the evils in the box are permanent.
We still like to celebrate Pandora’s optimism on January 20, every four years. It is part of the American political tradition. But then the other escaped evils reassert themselves.
Optimism regarding Obama’s Administration, as with every new administration, rests on a presupposition: politics trumps economics. This is another way of saying that legalized coercion trumps voluntarism.
Faith in the means of this triumph is lodged in three institutions: the national government, the Federal Reserve System, and foreign central banks. No matter how bad things get economically, voters believe in these three institutions, if they actually have heard of central banking, which few have and fewer remember.
Today, the national government is running at least a $1.2 trillion annual deficit. To this will be added whatever the proposed stimulus law will cost. Estimates run in the range of $400 billion a year for two years. Obama has said that annual deficits in the trillion-dollar range will go on for years. He has not been specific, rather like his date for a pullout from Afghanistan.
The public does not care. Optimism is still widespread. Like a spouse in a second or third marriage, who does not yet know of her partner’s snoring, the voters expect smooth sailing through treacherous financial waters.
The Bush Administration established the precedents: a $700 billion bailout (plus $150 billion in Congressional pork), the various bank bailouts, and the nationalization of the mortgage market. Whatever President Obama proposes will be an extension of existing policies. There will be no successful opposition. There will be no turning back.
THE POINT OF NO RETURN
Critics like to say that we have gone beyond the point of no return. There is no agreement on when this point was reached or what it was.
My view is that it was the ratification of the Constitution in 1789. I have written a book on this, Conspiracy in Philadelphia. Even for me, this book is considered controversial. You can download it for free.
The case can be made that the war of 1861–65 was the point of no return. But I think it was the election of 1904, the most forgotten Presidential election of the twentieth century. Only a handful of historians and political junkies can tell you who lost. A slightly greater number can tell you who won: Teddy Roosevelt. Can you name his opponent?
I thought not.
It was a New York politician, Alton B. Parker. He was a pro-gold standard politician. I have written about this election before. When he lost, William Jennings Bryan was overjoyed. He said that the Cleveland wing of the party was finished. He was right. Bryan got one more shot at the Presidency in 1908. He lost for the third time. Four years later, Woodrow Wilson won. In that election, three Progressives – statists – ran against each other: Roosevelt, Wilson, and President Taft. That year also saw a Constitutional Amendment establishing the direct election of Senators. Another amendment was said to be passed – technically, it wasn’t: the income tax. In 1913, late in December, the Senate passed the Federal Reserve Act.
No turning back. No turning back.
The Medicare Act of 1965 made it impossible to avoid a national default. The numbers are horrendous. Occasionally, a subcommittee of Congress invites an economist to come and testify on this. The testimony gets no publicity. The committee chairman thanks the economist, who then returns to obscurity.
This fiscal year, the combined unfunded liability of Social Security and Medicare will be in the range of $75 trillion. No one in government notices, other than Ron Paul and a few similarly minded House members. No one cares. Such numbers are considered naïve. They are only numbers. Numbers above $1 billion do not register mentally. Parkinson told us this during Eisenhower’s Administration. Nothing has changed.
I do not know how long the political honeymoon will last. I do know this: the magnitude of the Federal deficits and the magnitude of Federal Reserve monetary base inflation will not bring anything like smooth sailing through the financial storm.
We have already seen the monetary base translated into expansion of M1. Offsetting this has been an increase in excess reserves deposited by banks at the Federal Reserve. Last fall, the FED began paying interest on reserves. That change in policy had been scheduled for 2011. It was moved up because of the crisis. Now the FED pays nothing. Excess reserves now receive nothing. Banks must pay interest on all deposits. Where will they get an even greater rate of return? They are losing money on every dollar held at the FED. The shrinking money multiplier will reverse when banks pull money out of the FED and start buying T-bonds or whatever else will safely pay a positive rate of interest.
The political game will go on. The economic causes will continue: national debt and monetary inflation. Historically, this has led to price inflation. Deflationists tell us, “This time it’s different.” We shall see. We shall see before the next Congressional elections.