2014 Looks Like the Next Good Year by Martin Hutchinson September 12, 2011 As the Great Recession drags on, politicians assure us "Prosperity is just around the corner," in Herbert Hoover's unfortunate words, if we only follow their favored nostrums, usually involving spending more public money. However experience of the 1930s combines with the wisdom of Carmen Reinhart and Kenneth Rogoff's "This time it's different" to suggest that recovery may not be as imminent as all that. Nevertheless, free market economies have an ability to recover that is surprising, provided they are not held down by misguided government policy. Thus those bored with the current endless recession (or worse still, adversely affected by its prolonged unemployment and business malaise) can reasonably ask: given the normal forces of recovery, the particular features of this recession and the political cycle of disillusionment and electoral retribution, just when do we think the corner will finally be turned and a real economic recovery begin?
In the 1930s, those hoping for economic recovery got lucky in the British political cycle and unlucky in the American one (and even more unlucky in the German cycle). In Britain, the economically capable National Government took office in August 1931. Chancellor of the Exchequer Neville Chamberlain promptly banished Maynard Keynes from the Treasury (condemning him to six years of inferior investment returns, since he had been cut off from his sources of information) and instituted an anti-Keynesian economic policy of public spending cuts and a modest Imperial Preference tariff that proved remarkably successful. By 1933, the British economy was recovering fast, and 1932-37 provided the fastest peacetime five-year growth period since Lord Liverpool's era over a century before.
A few weeks ago I carried out a Gross Private Product analysis for the United States, subtracting government spending from GDP and looking at trends in private sector output, from which all wealth and jobs ultimately derive. The same calculations can be done for Britain, using the helpful website ukpublicspending.co.uk, and taking figures from before 1950 with a pinch of salt.
As in the United States, the greatest falls in Britain's GPP came during the two World Wars, as output was converted to military usage – GPP fell by 45% between 1914 and 1917 and by an astonishing 57% between 1940 and 1945. In both wars, private sector output fell to levels not seen since the nineteenth century, in the second war to the level of 1870.
However the British Great Depression was not all that Great -- GPP fell by 11.7% between 1929 and 1932. This fall has since been exceeded twice in peacetime, by the Heath/Wilson downturn of 1973-75 (14.1%) and the Gordon Brown one of 2007-09 (13.2%.) The Thatcher downturn of 1979-81 and the Thatcher/Major downturn of 1989-93, both of which caused endless angst among the chattering classes and the left, were barely half as severe. Thus while the Chamberlain policy of cutting public expenditure, even slightly (by a mere 2.1% in real terms, peak to trough) opened opportunities for the private sector and turned the Great Depression into rapid recovery, the Keynesian stimulus policies pursued in the much milder global downturns of 1973-75 and 2007-09 produced significantly deeper economic troughs.
In the United States, the political cycle in the Great Depression was as unlucky as that in Britain was lucky. The Republican elected just before the downturn began followed government-enlargement, protectionist and tax-increasing policies, thus making matters much worse. Then the Democrat elected at the bottom of the slump intensified the enlargement of government and added a heavy layer of regulation, ensuring that while output recovered from the appalling depths to which it had fallen, the recovery was only partial. Only when centrist policies were restored in 1939-40 did vigorous growth resume. In summary therefore, while the first year of vigorous growth in Britain was only four years after the beginning of the Great Depression downturn, in the United States there was a full ten years delay before recovery occurred.
From previous discussion in these columns, three things need to occur before we get a vigorous recovery. First, short-term and long-term interest rates need to be raised above the level of inflation. This will allow the U.S. capital base to recover through higher saving. Moreover, a higher cost of capital relative to the cost of labor will lead the corporate sector to refocus from outsourcing jobs by investing in emerging markets to creating jobs in existing U.S. facilities.
Second, the budget deficit, both short-term and long-term needs to be brought down to at most 3-4% of GDP ($500-600 billion) initially and balance thereafter, so that the private sector ceases to be crowded out. Ideally this will be achieved as it was by Chamberlain, simply by cutting out waste in government, but closing tax loopholes can help in this process if it appears necessary – removing the tax deductions for mortgage interest and state income taxes will have little adverse economic effect, while removing that for charitable contributions will have an economically positive effect.
Finally, the blizzard of regulations that has proved a substantial additional obstacle to economic growth in 2011 needs to be cut back. Ideally some of the most egregious new regulations must be repealed, and at least the flow of new regulatory activity must be halted.
Only when all three of these policy changes have been effected will rapid growth resume.
Setting out the problem in this way provides a valuable pointer to the timing of recovery. Little improvement will be seen in 2012. It's already clear that the Keynesians in the Obama administration and sections of the Republican party remain largely in control (don't forget that the first two attempts at "stimulus" were carried out under George W. Bush). Moreover 2012 is an election year, so the federal deficit is likely to rise rather than fall. Even to the extent that spending controls are instituted, they will be carefully designed to have little effect before the election.
Similarly Ben Bernanke has stated firmly that he intends to keep his zero interest rate policy in place until mid-2013. While it's very possible that events will cause him to modify this crazed ambition, in the short term only further monetary stimulus can be expected. Finally, the Obama administration's regulatory enthusiasts are unlikely to change direction until they are given very good reason to do so and such an awakening appears unlikely before the election.
What about 2013? After all, an election will have occurred and it's possible that a Tea Party administration will have taken office, with at least nominal control of both Houses of Congress. Even Mitt Romney has now committed himself to replacing Ben Bernanke, which offers a ray of hope at least on the monetary side (unless there is a surge for Jon Huntsman).
The problem here is one of timing. Bernanke's term of office expires only in January 2014, and it's likely that any but the most committed Tea Party President and Congress will not want to expend political capital on getting rid of him earlier (practically impossible in any case if he digs his heels in). While a lame-duck Bernanke would presumably see the wisdom of compromising at least somewhat with proponents of higher interest rates, he would tighten only grudgingly, and such grudging tightening might well be sufficient to buy him time to serve out the remainder of his term. Thus although interest rates in 2013 might rise, they would do so only at the snail's pace followed by Alan Greenspan in 2004-06, so short-term rates would still be no higher than 2% or so at the end of 2013 – well below the rate of inflation, which would doubtless have accelerated further.
An incoming Republican administration and Congress would similarly be able to make substantial deficit reductions only for the fiscal year beginning in October 2013, at the earliest. Likewise, while the blizzard of new regulations would dry up with a new administration, many regulations that were already in progress or were delayed in their impact would slip through in 2013. Thus, just as 1932 was a further year of modest net downturn in Britain after Chamberlain took office in August 1931, so even in the best case, 2013 would be unlikely to see any great economic vigor. The upturn would have to wait for 2014.
If Obama were re-elected, the outcome might not be much different. Assuming 2012 is another grim year, he would be re-elected only by a small majority, probably because of mistakes by the Republican presidential candidate, while the House and Senate would be very evenly divided, with maverick centrists in essential control. In that case, fiscal responsibility might be agreed upon by both sides, and 2013 would see genuine budget cuts (doubtless accompanied by modestly damaging tax increases), which would take effect in 2014. On the monetary side, if as I expect inflation was by then running at a rapid clip, Obama might feel that reappointing Bernanke was not worth the political capital it would cost. In the best case, like Jimmy Carter in 1979, he would see the virtue of appointing a Paul Volcker Mark II, committed to monetary stringency.
In that event, only the Administration's regulatory policy would prevent at least a modest acceleration in economic vigor in 2014. One could hope perhaps for a modification even in that, as Obama found major regulatory schemes stirred up opposition and were blocked by the centrists in Congress. So while 2014 might not be a year of really robust recovery, it could at least be a considerable improvement on its predecessors.
As Hoover said, prosperity is just around the corner. But the corner looks likely to last another 28 months or so.http://www.prudentbear.com/index.php/thebearslairview?art_id=10574 |
