Age of Aquarius is over – Put some clothes on

Comments I received after my last blog confirm what I have been sensing since the last US presidential election – people are losing interest in analysis. It is not possible to summarize all the facets of this loss but a common thread is that we are in an age or a cycle that appears to be strengthening – and that stage or cycle is one that seems to be on auto-pilot. 

Thus attempts to argue or reason against it are virtually useless. That some Democrats stress that winning the election gives them the right to move on with their agenda of change just reinforces these feelings of inevitability. 

This posting is meant to address this seeming loss of hope amongst those who do not agree with the policies of the Democrats. I am a little more optimistic than some of these worried folks and I believe my optimism is supported by history. But I have to admit, it is not easy as a macroeconomist to watch the current experiment. It reminds me of looking back at the early 1970s and the Nixon Wage and Price Controls. 

Everyone knew they would fail – the only question was when they would end and how much damage they would cause. Instituted in August 1971 they were finally abandoned in 1974 as prices continued their escalation through 1980. Nixon, a conservative economist was mystified by the newly coined macroeconomic disease – Stagflation – and he lost faith in traditional macro and opted to try something new and different. (By the way I coined the term Infession at the time but apparently my status as a graduate student did not allow my terminology to rival the more popular term stagflation.)

Today our government is tormented again by a new disease – this time it is a housing and financial crisis that led to a deep recession of six quarters followed by a very slow and weak recovery period. Our policy makers responded with a strong dose of traditional Keynesian stimulus – a coordinated fiscal and monetary expansion that injected trillions of dollars into the economy. At the onset of the recession in 2008 it seemed reasonable to support a housing/financial intermediation with a strong Keynesian spending impulse.  But we are now many years beyond the beginning and the end of the last recession and the Keynesians are not ready to throw in the towel. The reluctance to ditch continued stimulus seems shared in many important places including Japan, Switzerland, Great Britain and others.  The European Central Bank joins our Federal Reserve in a pledge to do what is necessary to keep spending growing.  Both have acknowledged risking higher debt and inflation for the sake of short-term economic stimulus.

It may be surprising to many of you that some monetarists support the use of a Keynesian stimulus in the short-run.  Some monetarists accept much of the Keynesian model as it relates to the short-run. But monetarists and other non-Keynesians distinguish themselves when they disagree with Keynes’ statement that we are all “dead in the long-run.” This was Keynes’ way of saying that all that matters is the here and now. Non-Keynesians, however, think we need to worry more about the future. Many non-Keynesians might agree to the stimulus in 2008 and 2009 yet object strongly to continuing such a policy beyond the worst of the recession.

And that is where we find ourselves in 2013. Keynesians believe that austerity or a policy to even gradually remove stimulus today would be tantamount to pulling the proverbial rug out from under the economy.  They don’t even want to talk about it. It is like global warming. If a person challenges conclusions from weather data they are branded immediately as either ignorant or falsely motivated. And those are the nice names. Someone who worries today about future debt or inflation is not considered to be serious. In this environment it is no wonder that people don’t want to analyze or argue.

So let me turn away from the specifics of the debate and explain why history makes me somewhat optimistic. I think we are rapidly nearing the end of an age of government growth. You will scoff at this prediction because you see no end to government growth but it is often just when things look like they will never change that they do. I am not predicting that the government will vanish but I do see signs that the share of government in the economy will stabilize and decrease.

Who could imagine the Soviet Union falling when it did? At one time it seemed impossible that the German advances before World War II could be stopped. Before coal was discovered European wood was rapidly being depleted with the usual consequences on energy and transportation costs. At one time all the South American countries were run by dictators who promised a future with a closed, self-reliant economy. Much of Africa was once run by European colonials and much of the population was in slavery. The Age of Aquarius as depicted in the musical Hair promised a change in values that had its day but petered out...or else we'd all be wearing tie-died clothing.  History suggests that times do change. Sometimes when they seem the blackest is when they are closest to change.

And that makes sense. Because when times seem the worst is when it becomes more and more difficult to tell the same old untruths. The story of the emperor who wore no clothes was written for an important reason. People will go along with things so as to not disturb the leaders. In that story it was child who said the obvious – noting that the emperor was as naked as a blue jay. And then EVERYONE agreed to that reality. Clearly the emperor needed some new duds.

In the case of government growth and current macro policy it won’t take that much longer to see the failures. We have had about 75 years of this age and while I have no desire to go back to the 1930s it is clear that the government process needs a lot of oversight and improvement. The gem of the government process – Social Security – is nothing like what was promised.  Young adults worry that this protection will not exist for them when they retire. The cost of Medicare and Medicaid grew by multiples of original cost estimates. The War on Poverty has done almost nothing to eliminate poverty and some might say that it has institutionalized it. Obamacare is just getting started and one can predict that it will not fulfill some of its most important promises as the economy tries to digest its thousands of pages of new regulations. An article I read this week projects private healthcare policies doubling in price as early as 2014. They will likely be called traitors by our current government. 

Already there is visible proof that neither the government nor the central bank knows how to reverse what were supposed to be temporary stimulus programs. The end of the temporary decrease in payroll taxes in 2013 is causing the US economy to slow even further this year. The politicians promise to reverse engines at just the right moment but we all know that the date is coming closer and closer when we will have violent reactions to rising inflation, interest rates, and national debt.

I probably left out a lot of the writing on the wall – but the more important part of this story is that the average voter is going to soon feel the negative impacts of the end of the Age of Government Growth. We know the rich cannot and will not support the present and future growth. No amount of make-up applied to smiling political faces will be able to mask the impacts on the middle class. Their incomes will be taxed away and inflation will eat at their earnings. The next government financial crisis will make it impossible for young people to save anything for the future as their 401Ks shrink in value. Young workers will feel hemmed in without future prospects. Government programs will be less affordable and the world will no longer lend money to the US government. Government programs will have to be seriously scrutinized. People will be heard saying – why didn’t we see this coming? Why did we let this go so far? We have had major government deficits ever since the 1960s! 

The average person will come to understand through personal experience that while it sounds good for government to help them – it often is not their best alternative. Somehow the government kept this deception going for nearly a century.

So let’s keep arguing. Let’s keep making the case for unintended consequences. Let’s be specific about why stimulus is not always the answer. Let’s keep reminding people why piling up national debt is self-defeating.  Let's keep explaining how and why more conservative policies, though not perfect, are often better than knee-jerk government solutions. The Age of Aquarius is over. So is the age of rapid government growth! Somebody please put some clothes on Nancy Pelosi!