How Could We Now Avoid a new Great Depression?

How Could We Now Avoid a new Great Depression?

In a previous blog post, I explained the crucial role of interest rates in driving the world economy, and cited some of my earlier work in economics on those kinds of issues. When Trump announced his plans for the economy, I was amazed that the two key elements were exactly what caused the Great Depression of the 1930’s: (1) a commitment to crack down on the Federal Reserve (much as some Republicans have cracked down on the Supreme Court and even NSF, quietly but effectively), and substantially cut back the world money supply; and (2) intense cutback on trade and new restrictions on trade, like the famous Smoot-Hawley action of the 1930’s. Many economists signed an open letter warning about the implications. Trump’s plan was discussed on CNN by one of the friends he brought together for the meeting which led to the plan, and nothing he said was reassuring at all.

So where are we now?

I will resist the many temptations to talk about related issues, like how the markets have gone up and down and how they might respond in the future, or like the essential lack of serious professional content in economics in any of the election debates. As of today, the key new event is:

A serious talk by Carl Icahn, who helped launch Trump in the first place, who reaffirmed and clarified the Trump economic policy.  He basically just said:

====================

“It is not sustainable to maintain aggregate demand by money supply and zero real interest rates. Zero real interest rates are unsustainable because they cause instability, like the possibility of real estate bubbles and things like that. Our policy will be to maintain demand by using fiscal stimulus, which is the better way.” And I was privately informed that a new head of Federal Reserve will be a bona fide serious economist, equipped to follow through.

======================

OF COURSE we should want (and work for) success here, exactly as Obama and Clinton have urged us all to do.

But: will it work, and what are the hazards?

First, it is reassuring that they really do want to maintain aggregate demand.

But to increase aggregate demand by fiscal means they must either increase spending or reduce taxes or both. Short of voodoo nonsense, that would require a big increase in the deficit – exactly what sequestration was constructed to prevent. I for one will never forget Kasich’s successful heroic effort to create a bipartisan patch to prevent the deficit bleeding which was occurring before that. If we start borrowing a whole lot more money again (with or without faith that god will magically make the numbers work for us), AND raising interest rates... we again enter territory unexplored as yet in the US, but well known in South Americn. (There is a Chilean economist, Ffrench-Davis, whose work should be required reading for any economist in the US if we really follow Icahn’s proposed path.)

So: is it hopeless?

Not entirely, but it’s a kind of “mission impossible” that would require a whole lot of flexibility and strength of mind beyond what one would normally expect possible in Washington. No, not a whole lot of narcissism; a whole lot of objective, analytic, mathematical insight.

Trump actually gave some hints of what COULD be done to make his policy viable, which I mentioned before. There are really only two big, direct options. One is a massive reversal in the growth of medical costs, even beyond the reduction in the rate of growth which Obamacare has already delivered. (Back in the real world, we all know that medical costs are still rising faster than they should, but less than they would have, due to Obama’s inability to get more than a kind of 50-50 compromise in Congress. Some lobbyists have proposed “solutions” like what certain friends-of-the-governor have done to taxpaying in Virginia: big promises of reduced costs through the magic of paying selected people in the private sector, followed by a big increase in costs due to constant efficiency plus added markups and new paperwork.) One is reduction in nonproductive tax loopholes and tax breaks – but the tax plans we have heard so far would increase them, not decrease them, and in DC “productive” often seems to be measured by how much money they give to PACs, negatively correlated with aggregate demand generated per dollar of deficit. Without a massive midcourse correction in those two areas, the Icahn policy is a prescription not for 1930’s US but 1930’s South America, maybe even worse.  

Still, I do hope it works, and that sequestration is relaxed so much that we can even reverse the horrible cutbacks in education which the US is already suffering from (in great part because of pressures on states).  Technical economics offers ways to actually measures aggregate demand per dollar of deficit source, to fine tune all this, and even a few other useful options, beyond the scope of this blog post. (Those also require automatic stabilizers, looking ahead.)

In the debates, discussing how to avoid cutting social security, Trump proposed more competition in things like defense procurement. But Trump has also proposed an INCREASE in defense spending; thus more effective competition is extremely important to the PRODUCTIVITY of that defense (and related) spending, but not to the Icahn plan as such. There is an extreme need for much more competition in that sector, and I very much hope that folks like McCain and Steidel have a voice in this. (Even I have some specifics of some importance.) It has the potential to increase economic productivity through better general technology, above and beyond the issue of maintaining aggregate demand while limiting deficit.

===================================

Icahn’s comments about interest rates remind me of important technical issues which I can only touch on briefly today.

Real interest rates serve as instructions to the world economy about whether to care for the future (zero means the future is as important to us as the present) or not (under high interest rates, the economy is instructed to get rich now even if everyone dies a few years later). Human behavior is more stable and predictable if we simply never pay attention to anything which might happen in five or ten years – until that thing eats us alive. Creatures who do not think are more predictable than creatures who do, but there is a very heavy price to be paid. Yes, with zero real interest rates we need to be more careful about the details of economic relations, to reduce the resulting craziness (like overvaluation of Trump’s property), but failure to properly value investments in the future is fundamentally harmful to growth and sustainability.

All for now.

Well.. let me note that EU and China will also be crucial re whether the world avoids a new Great Depression, but those complexities are well beyond the scope of this blog post. There is some link between the EU issues and what we posted earlier at nss.org/EU and www.werbos.com/Atacama.pdf.  For China... I only have a few reviews at Amazon now.