By David Stockman
Some people are either born or nurtured into a time warp and never seem to escape. That’s Janet Yellen’s apparent problem with the “bathtub economics” of the 1960s neo-Keynesians.
As has now been apparent for decades, the Great Inflation of the 1970s was a live fire drill that proved Keynesian activism doesn’t work. That particular historic trauma showed that “full employment” and “potential GDP” were imaginary figments from scribblers in Ivy League economics departments—not something that is targetable by the fiscal and monetary authorities or even measureable in a free market economy.
Even more crucially, the double digit inflation, faltering growth and repetitive boom and bust macro-cycles of the 1970s and early 1980s proved in spades that interventionist manipulations designed to achieve so-called “full-employment” actually did the opposite—that is, they only amplified economic instability and underperformance as the decade wore on.
The irony is that the paternity of this real world proof came from the Yale economics department, which was inspired in the 1960s and 1970s by one of the most arrogant, wrong-headed Keynesians of modern times—–Dr. James Tobin. It was Tobin’s neo-Keynesian theories and activist role in the Kennedy-Johnson White House which gave rise to the Great Inflation and its destructive aftermath.
Still, Professor Tobin could perhaps be forgiven for the original science experiment in full employment economics he helped author from his perch at 1600 Pennsylvania Avenue. After all, economics was just then enamored by newly invented large-scale math models of the US economy and their equations always generated beneficent results.
But there is no debate about what happened next. The Heller-Tobin CEA proclaimed that the America of the early 1960s—an economy that Eisenhower had left in fine, growing, non-inflationary fettle—was suffering from too much “slack”. This included unnecessarily high levels of unemployment (@ 5.5% in 1962!) and a general failure to utilize capital and labor resources at their full-employment level and thereby achieve “potential GDP”.
The latter was held to be mathematically calculable and was reckoned by the JFK’s Keynesian doctors to be tens of billions greater than reported GDP. Accordingly, until the nation’s economic bathtub was filled full-up to the brim there was an urgent need for more fiscal and monetary stimulus.
When conservatives protested that deficits should be reserved for national emergencies and were potentially inflationary, Tobin and his acolytes impatiently huffed that traditionalists didn’t understand economic “slack” and its policy cures. As they had it, “slack” was an economic free lunch that could be harvested by means of “accommodative” policy until the last steelworker was called back to work and every auto plant mustered a third shift.
Soon the experiment was off to the races with large deficit financed tax cuts for individuals, a generous tax credit for business investment, giant increases in Federal spending for the war on poverty and soon thereafter the war on Vietnam. And all this was accompanied by a steady drum-beat from Tobin for “easier” monetary policy. This encompassed feckless monetary experiments like the original treasury market “twist” and endless pontification about how the growing surfeit of unwanted US dollars abroad was actually a gift to the rest of the world.
If the Europeans wanted to redeem their excess dollars, as they had the right to do under Bretton Woods, Tobin had a plan: Instead of gold, give them 10-year US debt that would never be paid back.
Needless to say, the whole thing ended in calamity. Johnson’s guns and butter economy got red hot; inflation soared; widespread shortages suddenly materialized; large industrial strikes proliferated; the US balance of payments plunged deep into the red; and then a full-blown dollar and gold crisis flared up in the winter of 1967-1968. All the while, insuperable pressure was put on the Fed to “accommodate” fiscal policy until the politicians could screw up enough courage to take away the fiscal punch bowl.
History makes clear that then and there the Fed was housebroken. When Johnson closed the gold pool on his way out the White House door and Nixon performed the coup de grace by defaulting on America’s obligation to redeem dollars for gold at Camp David in August 1971, the US dollar left the traditional world of monetary standards. Thereupon it embarked upon the brave new world of the PhD standard that reigns among all central banks today.
But here’s the historic crime of the piece. The serviceable and experience-proven regime of a gold-based monetary standard was destroyed by the PhD’s the very first time they got their hands fully on the levers of national economic policy. In the argot of Breaking Bad, the blame for the immense economic disorder of 1966-1983 was on them.
Accordingly, here is where professor Tobin gets his nomination to the Eternal Woodshed. Rather than going back to Yale chastened by the disaster he had wrought, he spent the next decades teaching a whole generation of students about the virtues of bathtub economics and that levitating “aggregate demand” was the essential key to keeping the US economy humming tightly along the arc of its full-employment potential.
Stated differently, not withstanding his own abject failure as a policy-maker,Tobin remained an evangelist for the proposition that a tiny clique of economists can deliver macro-economic results that are far superior to outcomes on the free market resulting from the interactions of millions of producers, consumers, savers, investors, entrepreneurs and speculators.
As is well-known, one of Tobin’s first students to be conferred a PhD after he repaired from his Washington follies to Yale was Janet Yellen. That was 1971. If Keynesian economics in a national bathtub that was not at all a closed system was nonsense even then, it surely is nothing less than a laughingstock in the blooming, buzzing, churning global economy of today—-a place where the source of the marginal supply of labor and capital cannot even be pronounced in Washington, let alone be measured, calibrated and factored into a policy equation.
Yet here is Janet Yellen at a Congressional hearing yesterday faithfully lip-synching professor Tobin. She has not even learned any new jargon in 43 years!
“In light of the considerable degree of slack that remains in labor markets and the continuation of inflation below the (Fed’s) 2 percent objective, a high degree of monetary accommodation remains warranted,” Ms. Yellen said.
This was all by way of justifying the lunatic proposition on which the Fed is now operating: Namely, that for the 68th consecutive month it kept the money market rate at zero—a condition that has never previously occurred in all of human history. Well, outside of post-bubble Japan anyway, and its evident how well that’s working.
But under the Keynesian macro-models— zero interest rates are really nothing more than a magical “slack” fighter. The assumption is that the US economy—even as it prepares to enter it sixth year of “recovery”—remains deficient in that mysterious ether called “aggregate demand”. Therefore more of same needs to be conjured by the ultimate in low interest rates—which is to say, 5 bps on the federal funds.
Well, let’s see. Non-financial business has taken its debt from $11.0 trillion on the eve of the financial crisis 76 months ago to $13.6 trillion today, but this immense borrowing binge all went into financial engineering in the form of stock buybacks, LBOs and M&A deals. Actual “aggregate demand” for real plant and equipment outlays is still $70 billion or 5% below it 2007 peak. So how can another month of ZIRP accomplish what the first 67 months evidently haven’t?
And then there is the consumer, who shopped during the entire 40 years of Dr. Yellen sleepwalk, but has now finally and unequivocally dropped. Household leverage soared after the Tobin/Nixon/Milton Friedman depredations of the 1960s-70s, but its now rolled-over. Stated differently, for 40 years the Fed tilted at the specter of “slack” through periodically slashing interest rates, but that only caused households to ratchet-up their leverage ratios—spending more today by hocking their future.
Accordingly, the Fed was not creating an ether called “aggregate demand” at all. It was simply causing consumer spending to be inflated by the layering of credit growth on top of available income. But with the leverage ratio now having just begun its long descent back toward solid ground, the Fed can conjure no ether of demand, but keeps banging the interest rate lever just the same...
Read the rest here:
http://www.lewrockwell.com/2014/05/david-stockman/yellens-bathtub-economics/
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