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What goes around comes around

Posted: March 15, 2009 1:16 a.m.
Updated: March 15, 2009 4:55 a.m.

"I am now a Keynsian in economics," the president said when he broke ranks with previous administrations and proposed a huge federal spending package he hoped would stimulate the economy.

No, the president wasn't Barack Obama, but rather Richard Nixon. The year was 1971 and Nixon was embracing the theories of the British economist John Maynard Keynes, who believed that fueling the demand for goods and services - by cutting interest rates and spending government money on infrastructure - was the key to growing the economy.

It flew in the face of the Kennedy administration's supply-side (later called "trickle-down") approach of cutting corporate and capital gains taxes to increase the nation's output and create jobs.

Conservatives tagged Nixon a "liberal," and it was a peculiar time for him to switch macroeconomic horses, considering that inflation was running out of control at 4 percent to 6 percent. (In 1970, with the nation still on the gold standard, 4 percent was considered out of control.)

Nixon's spending plan would increase demand and bring prices along with it - so he tried to stave off mounting inflation by artificially freezing wages and prices.

It didn't work. The Arab oil embargo of 1973 drove oil prices through the roof, increasing the cost of doing business across the board. Unemployment rolls swelled when companies couldn't afford to take on more workers.

The old axiom that inflation and unemployment were inversely proportional was proven false as we entered a period of stagflation - rising prices and high unemployment.

By 1974, when the nation was off the gold standard, inflation was running in double digits and continued to climb through the Ford and Carter years.

Coupled with an American hostage crisis in Iran, the high inflation rate cost Carter a second term in 1980.

Enter Ronald Reagan with his Kennedyesque cuts to capital-gains and other taxes, which encouraged investment and sustained economic growth, brought inflation back down and created new jobs.

Never much of a monetarist, George H. W. Bush broke his "no new taxes" pledge and the economy faltered from 1990 to 1992.

Then Bill Clinton came along with promises of a new beginning.

Actually a throwback to Eisenhower, Clinton rolled back some of the Reagan tax cuts but also cut federal spending - balancing the budget and fueling more economic growth in the process.

What goes up must come down; by the time he took office in 2001, George W. Bush inherited a mild recession that went into a panic and uncertainty nine months later.

In late 2002 - after 9/11 and before the U.S. invasion of Iraq - Bush donned his supply-side hat and unveiled a 10-year plan to cut taxes and spur investment again.

Or in his vernacular, a "stimulus" plan.

What few foresaw were the following six years of deficit spending on a protracted war and huge borrowing from overseas investors to pay for it.

What the economists did foresee was the opportunity to expand the supply side of the equation. Increasing the supply of goods and services would drive down prices and keep inflation in check.

For much of this decade it worked. Inflation was near zero, and prices were so low that we had a Starbuck's on every corner, multiple Wal-Marts with their always-low-prices in every community, and a few Mervyn's and Circuit City's, to boot - at the expense of the mom and pop who thrived in the 1990s under Clinton's small-business tax cuts but could no longer compete in an economic climate that favored big boxes and discount prices.

To stay competitive, the nation's banks lowered the price of money, offering residential mortgage loans at rates better (lower) than prime. Demand for new homes increased, and home values went along for the ride. Homeowners borrowed more money against their newly appreciated property values, and banks were more than happy to lend.

Eventually the bubble burst, as all bubbles do.

Goodbye banks, goodbye home values, goodbye Mervyn's and Circuit City and the other vestiges of an economy that took too long a drink from the supply-side spigot.

Some banks fared better than others, including our home-grown Bank of Santa Clarita, which wisely stayed out of the mortgage loan and big construction business.

But you can't win for losing - or for stellar fiscal management. Last month the local bank learned it will take a $400,000 punch to the jaw, not because of anything it did wrong but because the FDIC is hitting it and other banks with an unexpected charge to cover $65 billion in other guys' misdeeds.

Old axioms never die completely; today the deflation we're seeing as mismanaged banks fail and businesses close is resulting in the expected high unemployment rates as companies lay off workers.

Enter a new president and a different kind of "stimulus," one rooted in the Keynsian idea that tax cuts for consumers will expand the economy because they will keep more of their money and demand more goods and services; and spending government money on infrastructure will put more people to work.

In theory, it should drive prices higher and spur inflation. Whether enough businesses are willing to gamble on hiring more workers remains to be seen. Another sudden jolt to the economy right now like last year's run-up in gas prices would mean stagflation.

It's a precarious time. We've been down this road before, only the numbers are bigger and the losses are wider this time.
We voted for change. Don't forget that "audacity of hope" was part of it.


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