MarketWatch’s Howard Gold had a very interesting and informative article about how the two giants of 20th century economic thought have failed us in the 21st century. His article, “Great Recession cooks Friedman and Keynes”, does an excellent job of explaining how the implementors of Friedman (Fed Chairman Ben Bernanke) and Keynes (Presidents George W. Bush and Barack Obama) failed to deliver, even though they followed their predecessors suggested solutions explicitly.
However, the one area where even he admits that his article falls short is in explaining the underlying reasons why these didn’t work and how an improved solution can be uncovered. He even says, “If he or she succeeds [in solving this conundrum], there’ll be a Nobel Prize with his or her name on it.”
Well, I cannot offer a comprehensive solution, complete with economic calculus formulae and pretty graphs, but I would like to take a crack at explaining why the old theories don’t work anymore.
The reason the old theories of Friedman and Keynes don’t work now is for the same reason that the banks caused the financial collapse: bad starting premises.
The banks assumed that house prices will always rise. When this starting premise ended up being untrue, the rest of the theories of marketing loans and derivatives as investment vehicles collapsed, taking down Lehman, AIG, and most of the market capitalization of CitiGroup and Bank of America – as well as our national debt.
The theories of Keynes and Friedman also had some implicit assumptions that nobody truly considered: the inevitability of some long-term inflation and GDP growth. These premises, like home prices, are based on the same thing: a growing labor pool and a closed-system (i.e., economic policies are national, not international, in scope).
As the number of workers (and the general population) continues to increase, the demand for housing, cars, food, and other goods increases. This results in a small but positive general inflation rate. Housing prices increase because God ain’t making more land, but more people want a place for their stuff. Additionally, a growing labor pool would have growing demand for goods, even if that labor pool is not fully employed.
BUT – our labor pool is not growing significantly anymore. The 45-year economic boom from JFK to W was the result of the baby boom. It’s no mere coincidence that the year the first baby boomer started collecting Social Security is also the same year of the economic collapse. Coupling this with the fact that these boomers decided the right to privacy included the right to prevent the conception of children (as well as kill any unintended offspring before birth) means that the labor pool is contracting even more than a mere labor pool bubble would have produced.
The labor pool super-bubble – expanded by victorious, affluent (due to being the only nation with intact factories after WWII), and GI Bill-educated soldiers making babies – is bursting now, due to the children of the WWII-era generation artificially limiting their own family sizes via birth control pills, condoms, and abortion. The non-replacement of the previous generation is fulfilling the prophecies of Pope Paul VI’s Humanae Vitae. Or, as Pope John Paul II warned Poland, “a nation that kills its children is a nation without a future.”
This is why tax cuts don’t work anymore – the taxable income pool is shrinking. This is why government stimulus won’t work in the long-term – not enough laborers to tax into paying back the debt, as well as meet the demands of entitlement programs.
Finally, the isolationist culture that Friedman and Keynes were addressing 90 years ago had an implicit assumption of a country solving (and creating) its own problems. In the global economy of the 21st century, this is no longer true nor possible. Therefore, the old, closed-system theoretical models don’t work the same way.
The way to increase demand for American products is to stimulate the European economies. The way to alleviate the debt spirals of some European nations is to parasite off of the other European nations. The way to fund America’s and Europe’s debt is with Chinese money. The way to build China’s infrastructure is with Chile’s copper.
None of these are accounted for by Friedman or Keynes. It’s not enough to lower taxes – you’ve got to lower them below that of other nations to retain laborers. It’s not enough to merely build infrastructure – you’ve got to build it to be more efficient than that of other countries. We can’t just spend and worry about paying later, because we are no longer our own debtors.
Our government doesn’t sell war bonds or T-bills to us to fund their activities; they buy present dollars from other countries for more future dollars. In other words, they are borrowing from the future to pay the present – but that future doesn’t look as certain as it did in decades past. Therefore, we are borrowing from the futures of other nations, hoping they don’t catch on. However, once a country lending us money thinks we might default – or even threaten to make those future dollars less valuable – they will dump that investment. This makes them, not us, the ultimate determinant factor of our economic well-being. In other words, we are selling ourselves as their slaves.
Sin results in spiritual and physical slavery – spiritually, it is ownership by the devil and his addictions; physically, that slavery is most often incurred as financial debt. Plain and simple, morality breeds affluence. We should not seek morality merely for the sake of receiving financial blessings from God – but it’s better than the alternative.