Not default, growth: Wall Street, Main Street and even Washington gets it now

A view from America, originally published at Forbes Blogs.

The signals were crystal clear that even without a deal Washington absolutely was not going to default. Being Washington it had to strut and dramatize. Assuming that the free market is even half as smart as we think, the bond markets would have come undone assuming even a hint of the U.S. falling into arrears with creditors.  Instead, Bloomberg.com’s headline on Saturday spoke volumes:  “Treasury Yields Tumble to 2011 Lows.”

Wall Street was just watching Washington’s Big Sitcom and passing the popcorn.  Bloomberg, again, already had reported that reassurances had gone forth from the Treasury to the Big Banks that the federal government is not so stupid as to stiff its creditors. Treasury would apply the necessary cash receipts to paying its interest when due. According to Bloomberg’s Peter Cook and Cheyenne Hopkins:

The U.S. Treasury will give priority to making interest payments to holders of government bonds if lawmakers fail to reach an agreement to raise the debt ceiling, according to an administration official.

It is inconceivable that any administration, especially one as fecklessly beholden as this one, would entertain, even momentarily, the idea of alienating its lenders. Wall Street got this early.

Main Street got this too. Even Washington got this. Still… our leaders have a primal need to posture and shake their fists at one another. Nobody exemplified this better than House Minority Leader Nancy Pelosi in her “other-worldly,” in the words of journalist Mark Tapscott, declamation that “We’re trying to save life on this planet as we know it today.” Pure soap opera.

The reality? Politicians will spend every penny they can get their hands on. They always have. They always will. We the voters reward them (re-election!) for spending. We punish them (defeat!) for frugality. Our leaders may be crazy. They are not stupid. Consider this peek by financial guru John Mauldin about his recent meeting with 10 U.S. Senators to discuss his book Endgame.  “They all noted that their mail was running 100 to 1 against cutting Medicare. Every one of them.”

Mauldin, despairingly, envisions a Value Added Tax as the desperate alternative to Depression 2.0 which he predicts is the consequence of not getting the deficit under control (something which, of course, The Deal does not really do).  But there is an alternative to the VAT: serious spending restraint plus growth.  One of the smarter GOP economists out there, Ike Brannon, has written trenchantly:

The primacy of economic growth in generating tax revenue cannot be overstated: the fastest post-war increases in tax revenue growth occurred in 1997-2000 and 2004-2007, when revenues went up by nearly 50% in each instance. Tax rates did not go up at all during that time — the rapid increase in revenue occurred because we were in a sustained period of strong economic growth.

It is necessary to restrain and valuable to cut excessive federal spending. This columnist is for rolling spending back to 2006 levels: Take That! But the only proven way to eliminate the deficit is through spending restraint plus growth. The fight, the one that really matters, is about how to get growth. Almost unnoticed, conservatives are close to winning this argument.

The right believes in free markets:  low tax rates, a stable (ideally gold convertible) dollar, free trade, mild regulation. Worked for Reagan. Worked for Clinton. Both created many millions of jobs by unleashing free market forces: firming up the dollar, cutting or maintaining low marginal tax rates, deregulating business, freeing trade, reforming welfare.

The left believes that the way to create economic growth and jobs is by (now seriously unpopular) government spending. This is called Keynesianism. Hayek on Keynes: “He was a very great man, but I don’t think he was a great economist.”

Keynes did not end the Depression. As it happens, George Warren did. Who? Cornell University Professor George Warren persuaded FDR, against the advice of all of his experts, to rectify the pent-up deflationary pressures caused by the gold-exchange standard.  How?  Devalue the dollar from $20.67 to $35 an ounce.  This process was heretical to the Establishment (the patrician Dean Acheson, FDR’s Treasury Undersecretary, resigned over it), and conducted somewhat out of the public eye in rather inscrutable ways:

One morning, as Roosevelt ate eggs in bed, he and Secretary of the Treasury Henry Morgenthau decided to change the ratio between gold and paper dollars. After weighing his options, Roosevelt settled on a 21 cent price hike because ‘it’s a lucky number.’ In his diary, Morgenthau wrote, “If anybody ever knew how we really set the gold price through a combination of lucky numbers, I think they would be frightened.”

It worked. The Depression lifted. Employment began to grow.

Meanwhile Keynes was in the public eye. The arch-proponent of deficit spending had been proved prophetic in predicting the damage inflicted on the world economy by the Versailles reparations.  Also Keynes was master of Narrative. He could turn a memorable phrase. (“I work,” he wrote in a letter to his then-lover Duncan Grant, “for a Government I despise for ends I think criminal.”)

The left, charmed and mesmerized by Keynes, attributed the lifting of the depression to Keynes’s deficit spending formula rather than to its true source, monetary reform.  Much of the left still labors under the misimpression that the Great Depression was caused by a breakdown of the gold standard.  It was not.  As Ben Bernanke publicly noted, it was caused by the breakdown of (what Jacques Rueff called) its “grotesque caricature,” the gold exchange standard.  The left labors under the misimpression that what ended the Great Depression was deficit spending, doctrinally embracing “cargo cult economics.”  Keynes, a true humanitarian who hated dogmatism, almost certainly would have been appalled by his ardent modern acolytes.

There are grounds to believe that President Obama, more (not unlike FDR) of a pragmatist than an ideologue, is bailing on the left. He was assured by his advisors that gargantuan deficits would create jobs and growth. He engaged in an orgy of spending with gusto and a confident expectation of a rip-roaring economy to carry him triumphantly to a second term.

Instead Obama got 1.3% economic growth rates, the economy teetering on the edge of a double dip, an unemployment rate over 9%, and shrill claims from the hard left that mere near trillion dollar deficits simply are not enough.  These claims have the same inherent level of credibility as those of 9/11 “truthers” and UFO-abductees.  As the New York Times’ Jackie Calmes reported on July 30:

However the debt limit showdown ends, one thing is clear: under pressure from Congressional Republicans, President Obama has moved rightward on budget policy, deepening a rift within his party heading into the next election.

Entering a campaign that is shaping up as an epic clash over the parties’ divergent views on the size and role of the federal government, Republicans have changed the terms of the national debate. Mr. Obama, seeking to appeal to the broad swath of independent voters, has adopted the Republicans’ language and in some cases their policies, while signaling a willingness to break with liberals on some issues.

It is highly likely that, the curtain having fallen on the “Debt Ceiling” melodrama, a new consensus for growth along free-market, rather than deficit spending, lines readily is visible.  “Keynesianism” (a one-word contradiction in terms) was given a fair trial, failed, and lies utterly discredited as a job generation strategy.  Meanwhile the GOP has begun, through figures such as House Majority Leader Rep. Eric Cantor, to explore some credible free market growth proposals.  Just add some gold convertibility and voila!

To paraphrase Dr. Martin Luther King, the arc of the federal spending universe is long, but it bends toward restraint. Serious spending restraint, and preferably real cuts in the warfare/welfare State, plus strong growth through free market policies is the new consensus.  It is a consensus that even President Obama shows signs of finding irresistible.

1 Comment

  • mrg says:

    There is a very strong moral case for default, as Rothbard sets out convincingly in Repudiate the National Debt.

    Government debt is the only kind that passes from father to son. It is fundamentally unlike private debt contracts:

    Instead of a low-time preference creditor exchanging money for an IOU from a high-time preference debtor, the government now receives money from creditors, both parties realizing that the money will be paid back not out of the pockets or the hides of the politicians and bureaucrats, but out of the looted wallets and purses of the hapless taxpayers, the subjects of the state.

    Though I agree that it was never likely, it is a shame that the US didn’t default.

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