Are we heading towards a 1970’s economy?

Written by epublius
Sunday, 07 June 2009 19:45

After listening to all of the pundits on both sides of the economy issue, the future does not look good. President Obama seems confident that his plan will improve and stabilize our economy. Of course, what else would you expect? The truth is, no matter who is leading this country those within any sitting administration will spin their view in the most favorable light.

Often the reality presents a much different picture.

What many people do not realize is that the economy is driven by emotion and perception then becomes reality. If the public views the economy as bad they change their behavior. These changes translate to real changes within the economy. If people reduce spending then the economy suffers. It becomes a self-fulfilling prophecy.

For many decades, our economic system has been based on the Keynesian theory of economics [1]. This theory advocates the idea that government can level the economy through monetary and fiscal policy. The government uses three tools to manipulate the economy: taxation, spending and interest rates. The idea is to control the natural cycle of growth and decline. The belief is that if you can limit the swing of growth and decline you can maintain growth and reach maximum employment.

All economists believe they understand the economy and speak from a position of authority. In the 1970’s Paul Volcker was appointed chairman of the Federal Reserve and he too believed he had a handle the on economy. At that time, the economy was in bad shape. Faced with high unemployment and high inflation, Volcker believed raising interest rates would correct the problem. He was wrong. The economy got worse, prices skyrocketed, and the public learned a new term stagflation. “John Maynard Keynes wrote in The Economic Consequences of the Peace (1919) that governments printing money and using price controls were causing a combination of inflation and economic stagnation in Europe after World War I.” [2] In the 1970’s we had both of these factors in play.

Under the Keynesian model taxing, spending and interest rates are used to control the market. The problem is when the government has a high deficit - taxing and spending becomes ineffective. In the 1980’s these two tools became useless leaving interest rates as the only tool left in their arsenal. Unfortunately, prior to that period they continued to raise interest rates, which had the opposite affect they intended. When Ronald Reagan took office, he recognized this and worked to cut taxes and lower interest rates. This created the longest growth period in American history. In recent years, our government continued to overspend creating a large deficit, which hurt our economy. Then with the recent collapse of the banking industry due to poor regulation, the economy went south.

Under the Keynesian theory, government spending on public works will create a stable economy. The truth is it cannot. In the 1930’s, President Franklin Roosevelt established the Works Project Administration (WPA) as part of the “New Deal” to create jobs and improve infrastructure. This infrastructure was needed, but it did not create enough jobs to bring us out of the depression.

Government cannot create as many jobs as the private sector because of one fundamental difference. Government does not create profit. Taxation is the number one means for the government to raise funds. Companies built products and offer services to create profit. This profit is used to pay their employees, the investors and more importantly expand their businesses, which creates more jobs. The government on the other hand has to raise taxes, use deficit spending or print money to create more jobs. When they raise taxes, this takes more money out the pockets of the consumers and business, which limits the ability of companies to expand.

Our government continues to spend and our deficit has grown to 4 trillion dollars. The government is going to have to borrow 2 trillion dollars and print the remaining balance. Printing money has a negative effect on the market because it devalues the dollar and it drives up the cost of products and creates inflation. Simply, it takes more dollars to buy the same amount of goods. Our economy has been going through a devaluation period and prices have been falling in some areas. Inflation is being kept in check by falling prices. Therefore, the appearance is that prices are stable.

At some point, the Federal Reserve will have to raise interest rates to help cover the rising costs of the deficit. Borrowing and printing money will only take them so far and raising taxes during this economy will have even dire consequences. If the government continues to drive deficits higher, the tools that the government has at its disposal will be ineffective. Everything the Government is doing has been tried before and it did not work then and it will not work today.

History has already shown us all of the pitfalls of trying to manipulate an economy. We only have to look at the policies attempted in the 1930’s, 1970’s and 1980’s to see what works and what does not. Today, we are in uncharted waters. Never in our history have we had a deficit this enormous. No one knows how this will play out.

We can look at some truths about government policy and the economy.

  • We have never spent our way out of a recession or a depression.
  • Printing money devalues the dollar and creates inflation.
  • Raising interest rates tightens money supply and creates inflation.
  • Raising taxes reduces consumer spending and stalls job creation.
  • Government deficits affect all aspects of the economy.
  • The private sector will always create more jobs than the Government.

Analysis of history and the direction our government is taking us does not paint a pretty picture. Expansion of the role and scope of government will only make things worse. My fear is that President Obama knows this, but truly seeks to move the United States towards a more Socialist government just like Roosevelt did during the Great Depression.” In the final analysis the policies that President Obama is pursuing will return us to a 1970’s economy with high employment and inflation.

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