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The Futility of Demand Side Measures
The Fed has just embarked on QE3. Among other things and in addition to Operation Twist which remains in place, the Fed will be purchasing an additional $40 billion per month in Mortgage Backed Securities (MBS). Short term interest rates will remain where they are until at least mid-2015.
Another bout of demand management via high powered money printing. One may ask what the Fed really expects to accomplish with this. The massive deleveraging that began in 2008 isn’t over. Despite the recent housing pickup in some areas, there is still a huge overhang of houses with mortgages that are underwater. Unemployment remains high. How will driving mortgage rates to zero cause overleveraged, unemployed borrowers to run out and start buying houses? And would this be desirable? (The Fed’s action may cause the underleveraged buyers of Hong Kong, whose currency is pegged to the US dollar, to run out and buy houses. But that’s another story.) Of course, if you own stocks you’re happy. Risk-on is the only trade that makes sense in a zero short term interest environment.
As I see it, QE3 constitutes a massive misallocation of resources and is potentially wildly inflationary. To be sure, the world is in disinflation right now. Most tradable goods are in oversupply thanks to globalization and productivity gains. So the inflation worriers will be crying wolf for a while. But not forever.
It’s the same with fiscal policy. The wilder eyed Keynesians are still calling for more stimuli. Using IMF data, the IMF calculated US net general government net debt/ GDP is now 80.2% and continues to move upward. And that ratio ignores the present value of the massive unfunded entitlement liabilities facing the US over the next forty years. Reinhart and Rogoff, their now classic This Time Is Different as well as other papers, have concluded that economic growth is adversely affected when the government’s debt/GDP ratio hits 90%. Government spending tends to be wasteful, politically driven and a misallocation of capital. How can an economy possibly benefit from this?
The history of fiat paper money is a scary one. Fiat paper money—unbacked by a commodity like gold or silver – has always depreciated in value and frequently to zero. The Chinese, like they did with so many other things, invented fiat paper money back in the eleventh century. Those interested in the early Chinese experience should read Ralph T. Foster’s delightful book, Fiat Paper Money, The History and Evolution of Our Currency. The book has a number of wonderful charts that show various issues of Chinese currency eventually becoming worthless. In every case the commodity backing was eventually withdrawn as massive amounts of new paper was issued.
One “delightful” story from Foster. In the late 1200s, as they had done in China as the Yuan Dynasty, the Mongolians conquered Persia. A man named Ezuddeen Musuffer convinced the Mongolian ruler of Persia to introduce a system of fiat paper money as had been done in China. The Persians had been using precious metals as money for centuries and reacted violently against this introduction of paper money. Muzuffer reportedly was torn apart by a mob and thrown to the dogs.
I am not proposing that our monetary authorities be subject to that type of discipline. But what I am suggesting is that further manipulation of monetary and/or fiscal policy is counterproductive. Most economists are either Keynesians or monetarists or some combination thereof. They have been trained to spend all their time looking at things that in the current environment are demand manipulation oriented and are therefore currently irrelevant or harmful. Demand side government manipulation in the face of global deleveraging is futile. It is to the supply or structural side that policy makers must look as they deal with the coming fiscal cliff. It’s on the supply/structural side where jobs can be created and productivity enhanced.
Some Supply Side/Structural Reforms
Here are some ideas:
- Energy – Set American energy free! Thanks to technology breakthroughs which are not limited to the now vaunted horizontal drilling and fracking, the United States has the potential to become the new Saudi Arabia of energy. Coal, natural gas, oil – you name it and the United States has got lots of it. Throw Canada (the new Kuwait?) into the picture and North America becomes the new Persian Gulf. But what is current American policy? The answer is discourage and/or prohibit the development of domestic American and Canadian conventional sources of energy. Instead subsidize the development of unproven, unreliable and inefficient alternative green solar and wind energy projects, which when looked at closely, have their own serious environmental issues. Blocking the Keystone pipeline, refusing to grant permits to drill for new oil and gas on government lands, holding up of deep water drilling of the Gulf Coast, holding up of approvals for new LNG export facilities, prohibiting of further oil exploration and drilling in Alaska – the list of anti-supply side energy measures promulgated by the American Administration is endless. Thousands of jobs are not being created, economic efficiency is going down the drain, and all the while, the Middle East is in flames! When will the American people connect the dots? The United States and Canada could become the major source of reliable energy for the world. (By the way the United States is not the only advanced country pursuing anti-supply side green energy policies. Germany is planning to replace its highly efficient and completely safe nuclear system with yet to be proven alternative sources. But again, that’s another story.)
- Taxes – Much has been written about taxes and I haven’t too much to offer here. I believe the famous Laffer curve exists and cannot be ignored. But at this point the most important thing that can be done is to simplify the American tax structure. Simplification – and that means at least a semi-flat tax-- would be an enormous productivity enhancer. Taxation for the purpose of income redistribution and which does not increase revenues is an abomination and a productivity and economic growth killer.
- Health Care -The implementation of Obamacare, with its miles and miles of new regulations, hidden and not so hidden taxes, and implicit price controls, hangs like a dark cloud over the American economy. The American health care system is broken and Americans want a new system. I won’t argue that. But the US needs to go back to the drawing board and come up with a new market friendly plan.
- The Financial System - In 2008 the global financial system imploded. Reforms were needed and inevitable. But what America got was the Dodd – Frank bill. Named after the bill’s sponsors Senator Chris Dodd and Representative Barney Frank – the two rogue legislators most responsible for the Fannie/Freddie fiasco – the bill introduces an enormity of government rules and regulations which are bound to destroy productivity and hinder the growth of the financial system. American needs to go back to the drawing board on financial reform as it does with health care.
It is generally agreed that the new and exciting globalized world of computer, internet, and biotechnology, that a well-educated citizenry is crucial. Long term economic growth depends on it. Every country has its own set of problems in this area. I will confine myself to the educational problems of the United States which in some ways are unique.
Talking about education in the United States can be a very sensitive issue. But it is America’s—and the world’s—most pressing long term supply side/structural problem. How can a problem be solved if nobody can talk about it or only recite politically correct slogans?
As I see it the US has one huge educational problem which can dramatically affect economic growth longer term. The problem is that the majority of African American and Hispanic children, who in the future will constitute an ever larger percentage of students in the US, are underperforming relative to US whites and Asians and to students globally. Moreover, overall they have not exhibited significant positive improvement trends. This situation cannot be allowed to persist.
A great deal has been written on this subject, usually by people with a special agenda. My agenda is how to remove structural/supply side barriers to economic growth and along the way discover investment opportunities. I have relied on the Heritage Foundation’s Jason Richwine who can be controversial but who starts with the data and not with wishful thinking. I would also cite the Bank Credit Analyst’s March 2011 monthly forecast which discusses this issue in depth. Finally there are at least three frequently referenced sources for measuring student performance including the National Assessment of Educational Progress (NAEP) test undertaken by the US Department of Education, the OECD Programme for International Student Assessment (PISA) test and the Trends in International Mathematics and Science Study (TIMSS) sponsored by the International Association for the Evaluation of Educational Achievement (IEA), an international organization of national research institutions and governmental research agencies.
Consider:
1. The relative underperformance of African American and Hispanic groups relative to whites and Asians has persisted over time. The performance of the former groups can be considered unsatisfactory in the context of the global knowledge economy. Moreover, at least in Richwine’s opinion, Hispanics, after showing academic (and income) improvement from the first to second generation, level off by the third. They thus differ from the Jews, the Irish, the Italians and the Poles that went before them.
2. Money isn’t really the problem. According to OECD data, the US spends more on primary education per pupil than any other major economy. Moreover, although his conclusions have been challenged and there may be some important exceptions, Richwine’s analysis of the data has led him to conclude, even after allowing for regional cost differences, that overall those US public schools with predominantly African American and Hispanic student bodies are not significantly underfunded as compared with schools with predominantly Asian and white student bodies.
3. Asian students seem to do well whether in Asia or (in spite of?) in the much maligned public American schools. White students have similar records when compared to Europe.
4. The Chicago school strike is an eye opener. The union, which apparently has a significant African American membership, argued against performance/test score based salary systems since, according to media reports, they viewed their predominantly minority students as difficult to teach thanks to problems of poverty, drug abuse at home, single parent families etc. If a teachers union with a substantial minority membership views African American and Hispanic children as difficult to teach and does not want its teacher members to be judged on the students’ performance, that is very discouraging.
Some Suggestions—my first suggestion is greater reliance on Charter and private schools. While the record for Charter School improvement of scores is not unambiguous and selection biases muddy up firm conclusions, overall the private sector is always more efficient than the public. Why should it be different in education? There seems to be a great deal of parental support for Charter Schools.
A second suggestion is greater reliance on for-profit education. As the public sector faces budget problems and cutbacks are being visited on institutions like community colleges which have served minority students, for-profit colleges have stepped into the breach. This is despite charges, perhaps justified in some cases, that for-profit colleges have gamed and abused the (easily gamable and abusable) Federal student loan system. The current American Administration seems to have an ideological bias against the private sector in general and education is no exception. Most students don’t share this bias. The Apollo Group, which operates the University of Phoenix, currently with all the bad publicity, can boast some 400,000 students. Have they all been hoodwinked?
While the performance of American public education and its growing minority population stagnates, the internet is bringing a revolution to global education. One example is massive open online courses (MOOC). A technology driven revolution driven by the private sector is underway in education. Capitalism can be viewed as a problem solving mechanism. If you solve somebody’s problem, you get rich. If allowed to operate without government interference and ideological binders, the private sector as it always does will see the underperformance of American minority students not as an unsolvable problem but as an opportunity.