Keynes

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Greenspan, Debt, and What To Do

Alan Greenspan who spent his life advocating free market solutions to every imaginable problem recently appeared on television, and with all the humility of a totally discredited thinker, went straight on advocating his old ideas. This only accomplishes two things: it perpetuates out of date thinking, and it confuses discussion. Perhaps worse: it validates wrong headed policy. We have plenty of that presently, so Greenspan’s comments only make thing more difficult.

Let me explain:

Basically Greenspan argues that economists are lousy at forecasting the economy – duh – and thus they should always choose the more conservative option when confronted with policy choices. This is an analogy to the old medical ethical statement of “first do no harm”.

The big problem is, of course, deciding which is the more conservative option.

During his television appearance Greenspan showed his old colors and declared without any empirical backing, that greater indebtedness was a bigger threat to the American economy than the current slow growth malaise. He consequently argued that we should, therefore, allow the Bush tax increases go into effect. As opposed to making any more effort to stimulate growth.

This is the option being pressed on us by a multitude of austerity advocates. They are completely indifferent to the consequences of such a policy, and seem inured to future of high unemployment, slow growth, and misery for millions of Americans.

The issue I have is that they are wrong both morally and in terms of theory. My position is that we should doing everything humanly possible to stimulate the economy, and if that implies adding more and more debt so be it.

Debt is the least we have to worry about.

The austerity argument starts with a false premiss and then proceeds to build on that wrongheaded foundation by piling up erroneous policy suggestions. The route that they head us down is called the road to depression.

Our economy suffers from a drastic drop in demand. People are simply not spending at the rate they used to. This means that savings are piling up, and that businesses are sitting on large amounts of idle capacity. The economy is awash with cash. No one is using it productively. Liquidity is not an issue. Opportunity is.

The austerity supporters diagnose things differently: they see issues on the supply side of the economy. They argue that we have a structural employment problem where labor costs are high because of government interference in the market – payroll taxes and pro-labor laws are oft cited examples; where labor skills are ill fitted to the current demand for labor; or where wages are simply too high. Each of these ‘structural impediments’ reduces the willingness of businesses to hire workers. Were they removed – were workers to take much lower wages for example – then our unemployment issue would go away.

The austerity crowd then augment this by suggesting that we cannot keep borrowing at our current pace. Sooner or later, they argue, we will hit a wall and our creditors will punish our profligacy. That punishment will come in the form of higher interest rates and even an unwillingness to borrow. The more aggressive amongst these folks ague we are fast approaching such a moment. To make matters worse, they also talk of a ‘crowding out’ of private investment by public borrowing. Crowding out is when private businesses of households find it hard to raise debt because the government has syphoned off the available cash for its own use through its own borrowing.

This argument is a non-starter.

Let’s attack the crowding out argument:

First, there is no evidence in the markets of the telltale rise in interest rates that would indicate the onset of creditor concern. On the contrary US rates are falling and are historically low levels. The evidence directly contradicts the austerity argument.

Second, as I mentioned earlier there is no crowding out going on. Businesses are knee deep in cash. They have accumulated historically high war chests of the stuff. There is no pressure in the credit markets from a conflict between the private and public sectors.

Third, in any case all the evidence – and I mean all the evidence – shows that the private sector is reducing debt. There is no demand for debt coming from that side of the economy. Deleveraging is still the order of the day.

So, lastly, with demand for debt non-existent, the private sector awash with cash, and debt reduction the order of the day, we have a massive potential problem: where does all that implied saving go? Into government debt. In simple terms the government’s huge increase in debt has simply offset the private sector’s equally huge reduction in debt and increase in savings. The money flooding the economy is being deployed usefully: it is helping forestall a depression.

And there is a massively important point to make here: we are getting a very high return on this debt.

Huh?

The reason is that for every day we linger in the doldrums we are foregoing the creation of wealth. An economy that operates well below capacity, as ours is, is missing the opportunity to turn that capacity into wealth. A further slide would make the loss of wealth worse. We should remember that this wealth is lost permanently. It cannot be earned back.

Now for the structural employment argument. There is no evidence to support it. When an economy develops structural issues it suffers from imbalances. High unemployment in one sector is accompanied by shortages in another with the result being a mix of high unemployment and high wage inflation. This kind of stagflation is a sure signal of supply side imbalances of one sort or another.

But we don’t have any such stagflation. We have high unemployment associated with low and declining inflation. Some would argue we are headed for a bout of deflation. These are symptoms not of structural supply side issues, but of a shortfall in aggregate demand.

Withdrawing government stimulus by allowing the Bush tax increase to come into effect can only make matters worse. Much, much worse.

One more thing: the austerity crowd overlooks history. Governments that cut spending in order to balance budgets have often so depleted demand that their economies shrink. Thus they collect less revenue – the tax base is smaller – their deficits grow rather than diminish, and they are forced to cut even more. In order to avoid this fate a government can cut less, but then it fails to achieve its goal also.

All of this leads us to the following set of conclusions:

  1. An economy in distress is forgoing wealth
  2. That wealth has more value than the cost of the debt required to forestall it
  3. Therefore more debt is the conservative option
  4. Rather than austerity which assuredly increases the loss of wealth
  5. Especially when there is no evidence of an impending credit crisis

So people like Greenspan are arguing something else. His argument boils down to the claim that economist’s really don’t know how to deal with this crisis, so we should throw in the towel and “allow nature to take its course”. What he really means is that the theories he has always advocates have failed, so we should just give in. Just because he has no idea, doesn’t mean that the rest of us don’t. The same goes for all the austerity advocates.

What makes me angry is that the policies do exist. And that this argument has been had many times before, with the same outcome. That the old guard persist and get attention detracts from our getting on with the job.

I think we have a moral obligation to mitigate the human misery caused by the failure of our market based system. That system went through a classic “Minsky moment” when ponzi financial practice imploded and produced a massive shift towards savings as businesses and households rebuilt their balance sheets. The outcome was a near depression as demand collapsed. A variety of government efforts simply put a bottom to the decline, but were not sufficient to impel a self sustaining recovery. So we are stuck in limbo with government debt accumulating and the private sector meandering along neither in sharp growth nor in sharp decline. Those government efforts were small with respect to the size of the problem: we built 10 foot levees to keep out a 20 foot wave. Yes, the damage was limited, but we are still under water. Those efforts were even more reduced in effect by their construction. Political pressures prevented them from being direct job creating activities such as government infrastructure programs. Instead the money went into tax reductions which were saved not spent, thus adding to savings and not demand, or into indirect spending that had a lesser impact, and which eventually found its way into company bank accounts rather than continuing to ripple on throughout the economy.

And while I am on the subject: we should ignore any debt to GDP ratio that uses current GDP. Why? Because it is depressed. The ratio of debt to GDP is often tossed about as if it represents an accepted rule for credit markets. It doesn’t. Were we to accelerate the economy GDP would rise quickly and the debt/GDP ratio would fall even if we kept exactly the same amount of debt. Debt ratios are helpful indicators not policy targets. We have to be mindful that we are solving the right problem.So when we assess the amount of debt appropriate for an economy, we have to take into account its wealth generating potential. A relatively fast growing economy can absorb a higher debt level than a moribund economy. That’s why it is vital we get our economy moving faster than its current 1.5% to 2.5% range.

This will be impossible if we give in to the austerity argument and reduce demand by cutting the deficit. At the moment we have enormous spare wealth generating potential waiting to be deployed. Plus we are facing low interest rates and a worldwide surplus of cash waiting for us to borrow. It makes sense, indeed it is the safest option, to take advantage of these circumstances and borrow that money, pile it into our economy, and get back to work.

No. Alan Greenspan has it backwards: the conservative policy is the one that energizes wealth creation. Not the one that limits growth.

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Econ 101: The Problem of Time

Time represents a special problem for economic theory. It gets in the way. It makes things messy. It introduces … gasp … the possibility of uncertainty. This latter being the really big problem.

As those of you who follow my ongoing opposition to textbook economics realize I have a major beef with the notion of markets as specified in the standard texts. That beef being based on the ridiculously unreal assumptions – contortions would a more apt description – that standard theory has to go through in order to “prove” that free markets always clear, and that they represent a preferable mechanism for resource allocation than the major alternative known as central planning.

Those of you familiar with the textbook explanation will notice that in order to arrive at the “correct” solution economists have to rig their theory. They make astounding leaps of faith. They assume, for instance, that all the actors on the economic stage have equal and costless access to all the necessary information needed to make rational decisions. They assume we are all omniscient. Not only that, but they assume we can process all that information instantaneously. We are prodigious calculators in their eyes. They go on and assume that their definition of rational is the only one we would use. This is convenient because it implies that once we have acquired all that information, and once we have calculated what to do, we will act in exactly the same way that an economist would. They don’t expect us to behave this way in actuality, but they expect that our behavior mimics what an economist would have done.

Thus standard theory assumes a world full of super rational automatons acting as if they were all economics PhD’s.

Very realistic.

It gets worse.

That’s where time enters the fray.

The problem is that to “prove” that markets always produce a socially beneficial result standard theory can admit of no uncertainty. It would muddy the waters and complicate things. It would mean that there is no single configuration of the economy that provides the maximum welfare. And the search for the single point is what drives standard theorists. An economy riven through with uncertainties could have more than one acceptable solution. Were that the case it could nor be assured that the market was any better than central planning.

Sometimes standard theory goes to even more absurd lengths to protect the sanctity of the markletplace.

Economists are obsessed with equilibrium – that singular point at which everything settles and welfare is maximized. But to get to equilibrium a market has to go through the motions of getting stuff produced, moved and bought. These are things that take time. But as I said time introduces uncertainty. So it is eliminated. The production, movement, and purchase a of goods and services is assumed to be instantaneous. That way markets can discover the prices at which they can clear. In something called general equilibrium theory, which is still the cornerstone of modern economics even though it has been attacked for decades, the bidding process during which market clearing prices are fixed is carried out by a disembodied “auctioneer” who sits outside the system, but collects and distributes information to producers and consumers. The haggling of a rowdy market is thus reduced to an auction during which everyone knows everything all at the same time. Neat. For those of you who are asking about time: the modernized version of the theory assumes that there are futures markets that embody sufficient information that future delivery of goods can be compressed into a current decision making process. The future is discounted into the present. And the ugly prospect of uncertainty magically melts away.

Even neater.

This is, of course absolutely ridiculous. But it is necessary to jump through these hoops if you want to preserve the sanctity of market magic. What economists have done is to create a system so convoluted and silly that they hope you don’t notice. The mathematics are extraordinarily elegant. The creators of the model won the Nobel Prize. Their creation dominates theorizing to this day.

They saved market magic, and that’s all that counts.

As Milton Friedman argued: it doesn’t matter how crazy the assumptions are as long as the result is correct. That begs the question as to how we know if the answer is correct. His view was that if markets arrive at an optimal solution in the model, we know the assumptions are OK.

I have a heretical view of all this.

I think Keynes was right in arguing that uncertainty is endemic. Markets may or may not be good allocators of resources. We don’t know. They may or may not arrive at equilibrium. We don’t know that either.

But I go further than this: I don’t think time exists.

There is no such thing as time. It is not a property of the universe. It is simply a convention, a scorecard, with which we keep track of change.

My view is that we exist in states of the universe. Each state is unique. Each is a full configuration of the entire system. Think of each such state as a single point in an infinite space of similar points. When we move from point A to point B we experience change: the configuration is slightly different. Since the two points are sequential we denote the movement as the passage of time. But in fact we have simply changed configurations. A history is a long string of points connected by a common thread. That thread being the observer through whose eyes the universe is being observed. As the observer jumps from state to state he or she experiences change. The trajectory thus created follows a path through the state space of the universe. It is not time passing, it is the universe changing.

Now what makes things change?

Entropy and the laws of physics that dictate creativity.

Creativity is the elimination of information. That sounds counter intuitive. But it is simple. When we create something we specify it. By being specific we eliminate all the alternative things we could have done. We reduce the choices to one. Thus when we build something from a lump of iron we start with a huge variety of things we could do. But we end up with just one of those things. We have eliminated the rest. We have reduced the amount of information.

Conversely, when we use things we add back that information. We do this in two ways. The iron thing we just made wears out. The iron returns to its original state albeit via the process of rusting. The iron remains, but the thing we specified is “used up”. The amount of iron available in the universe remains. The thing created does not. This is an approximation. But it explains the principle. This loss of information through the use and consumption of things is the process of entropy at work.

Entropy is often called the “arrow of time” because it has profound implications. It says that any closed system – the universe, of your cup of coffee – will always move from an more organized state towards a less organized state. In other words we lose track of the order. We lose specificity.

Economies can be thought of as such systems.

They are constantly moving from one state to another. Each state is a full configuration of the system. Each is unique. Each has different information content. As entropy tears away at the specifics of our products, we produce more. In a system dependent upon human intentionality like an economy the role of the laws of physics is played by our innovative and productive capacity. We marshall knowledge in order to fend off entropy. We locate, gather, and deploy resources in order to meet our economic goals. Those actions are creative. They allow us to configure the economy in order to meet our requirements. We combine natural resources with energy and our know how to make stuff. that stuff is a specification. It implies the reduction of entropy in the universe. But as we consume that stuff entropy re-asserts itself, and the laws of physics are preserved.

This view of what an economy is doing does not require us to speculate about equilibrium. It requires us to speculate about the search for resources; about the impact of their location; about the way in which we learn to use them; about the way in which technologies are developed; about the level of knowledge in society and the institutional or cultural constraints on its use; and about the structure of the networks or processes through which resources are transformed into products and moved to consumers.

None of this requires us to muddy things with time. Instead we simply observe how the economy moves through its state space as the process of search drives it onward.

But enough.

Time represents a problem to standard theory. Just not in my world.

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Its Official! The Recession’s Over … Yawn.

Hang out the flags. Set off the fireworks. The recession is officially over. Whoopee. The National Bureau of Economic Research says so. In fact, by their count, the recession ended in June 2009.

There, don’t you all feel better?

Not really.

The “Great Recession” was officially 18 months long, making it a full 2 months longer than the slumps of 1973/1975 and 1981/1982. Those two recessions were doozies and unemployment surged in both. Banks shuddered. Businesses lost money. Shops were closed. But neither felt like this last one. The reason being that both were followed by decent recoveries. Obviously I have a personal gripe about the 1973/1975 slide since its aftermath was sufficiently meandering to set the stage for the Reagan takeover and all the deterioration in our economy that his slippery illusion has implied.

Still, here we are, on the other side of what history will record as the worst slump since World War II. We are edging slowly away from the abyss. So slowly that many of us cannot tell the difference between being in recession and being in recovery. But let’s not be churlish: we should acknowledge that we are afloat and not sinking. At least those of us still gainfully employed. As for those other folks …

If you are someone who believes in market magic, let’s say you were schooled in textbook economics, then the slump has failed to clear out the dead wood sufficiently for the recovery to be robust. In particular you are really annoyed that wages have not dropped low enough to make it attractive for businesses to hire workers in droves. For you magic lovers the lunacy of government intervention has prevented the market from solving our ills. This slow growth is a direct result of that persistent and foolhardy intervention. If only, you mutter to yourselves, unemployment had reached 20%. Whatever it takes. Maybe 25%, like back in the good old days of depression era economics. Back when workers took their medicine like the undeserving ingrates that they are. Silly things like the minimum wage have stopped the market from “clearing”. Demand for workers is too low only because – you suggest – wages have failed to drop to a market clearing level. Then there’s all those payroll taxes imposed by the silly politicians who seem to think we should set aside cash for workers retirement. Phooey! If workers cannot save for their own retirement they should starve. That’s what the market says. And you believe the market magic myth.

It helps if you are a tenured professor when you articulate this myth. That way the slump never actually gets too close to the comfortable surroundings within which you pursue academic freedom.

But that’s another story.

No one ever said that hypocrisy and academia were not entwined.

Meanwhile those of us who base our economics on reality, and not magic, see it very differently.

We see the entire problem as one of insufficient demand. There are no jobs because businesses are being very sensible. They aren’t hiring until they can expect to make a profit from the labor of those new workers. Until business expectations turn more optimistic unemployment will persist. So the central aim of government is to stoke the economy in order to boost expectations. Once we get the engine rolling it will take off on its own and we can withdraw our support. Since the taxpayers are the ones who benefit from the growth in the economy, they get new jobs, pay raises, and all sorts of other neat stuff, it is not unreasonable for them to chip in up front and pay for the necessary boost to get the engine going. They chip in by taking on the responsibility to pay back the debt the government issues as it primes the pump.

Its a perfect example of “we the people” taking responsibility for our own welfare. Its also reality. It also is an affirmative rejection of the notion that “we the people” have to get hammered before we react to the mess that the bankers made.

We are grown ups. We will fix our own mess thank you. We do not have to wait for the market fairy to awake and wave her magic wand.

I am always astonished at how many good people grow up to reject the idea of Santa Claus or the Tooth Fairy, yet still cling to the Market Magic Myth.

It was always a made up story designed to keep the workers supine. The suffering inflicted by the depressions of the 1800’s and that of the 1930’s was turned into a punishment for the ills of the laboring class. It was converted into a parable about the “natural workings” of an economy. The story telling reached its apogee in the arcane and obscure pages of academic economics. Generations of workers were told that the decentralized mechanisms of the free market produced wealth for all. They would get a share of that wealth if only they obeyed the workings of the mechanism. Sometimes that meant hunkering down and starving as the market sought to work its magic and locate a new wage level. That new level seemed always to be lower than the old. But hey, there were new jobs in new places if only you all were willing to take that new wage.

This was the essence of the myth that became modern economic theory. In the hands of people like Schumpeter – he of the “gales of creative destruction” – and then the postwar wave of right wing theorists like Friedman and Lucas, economics became an apologia for naked capitalism. It gave up the pretense of being a science. Instead it contented itself with a justification of a particular form of economic activity.

Nowhere, and I mean nowhere, is there a scientific argument that free markets work to the benefit of society. Nowhere is there a body of scientific proof that central planning is worse than decentralized planning. On the contrary. You may be shocked to hear that during the 1930’s a great debate raged within economics between those who argued central planning was at least as efficient as capitalistic decentralized planning. The argument became known as the “Socialist Debates”, and engaged some of the most famous thinkers of that time. Oscar Lange defended socialism, while Hayek and von Mises defended capitalism. You might be even more surprised to hear that it was generally agreed that the socialists won the debate. There is no proof to support the contention that markets are better at anything. There never was. There was simply assertion and assumption. The victory was hollow. Poor Lange lost on points because of the horror of authoritarianism in Nazi Germany and then in the Soviet Union. That horror so tainted the discussion that postwar economics in the West became single mindedly pro-market, even in the absence of proof.

Back in the 1930’s it was Keynes who acted as the bulwark. He provided the realist view that saved capitalism from its own doings. He saw that the magic was a myth, and argued for a realist intervention in order to prevent the carnage that an imploding market can inflict on the workforce. By mitigating those effects he realized that he could stabilize democracy and allow the middle class to flourish.

This is, of course, nothing new to you. I bring it up because the Great Depression acted as an inflection point. The great debates back then were left incomplete and the proofs were never provided. Keynesian economics prevailed for three decades. It was only when the 1973/1975 recession seemed to disprove Keynes that market magic theorists like Friedman were able to get back into the discussion. With voters disillusioned by the oil shock and the falling away from the heady postwar growth rates of the 1950’s and 1960’s, it was easy to turn their heads back to the capitalist side of the 1930’s debate. Only this time, the Cold War ensured that there was no socialist or centralized side in the discussion. The debate was entirely one sided.

I think, perhaps, that our Great Recession is another inflection point. It is time to redress the one sided nature of the debate and ask simple questions of the magic believers. Questions like: where’s your proof?

I think of the last thirty years as a great experiment. The economy has been managed, by Republicans and Democrats alike, along free market lines. Regulations have been limited and reduced. Taxes have been cut. Welfare has been gutted. The minimum wage has been held down. Laws protecting trade unions have been eliminated or neutered. The list goes on. It may shock you to learn that it took a personal call from Milton Friedman to the SEC in order to persuade that body to allow the establishment of options trading. Up until his call the SEC saw options trading as a form of gambling. Friedman’s reputation was sufficient for them to open up trading. The derivatives melt down of 2007/2008 was thus a direct heir to his theorizing. It was his set of ideas that underpinned the financial collapse. To Friedman and magic believers derivatives are a way markets mitigate risks. Realists see them as gambling.

The experiment failed.

We now have the proof.

Then again, we always did. Ask any CEO whether they believe in free markets and they will respond with a resounding “yes”. Just as long as we retain patent laws; copyrights; restrictions on unions; import quotas where “necessary”; subsidies for agriculture; price supports etc. And just so long as they can establish centralized strategic plans to guide their businesses.

In other words not one CEO truly believes in market magic. Not one. They all run their businesses along centralized planning lines. General Motors is not a free market. Nor is General Electric. Apple. Microsoft. None. They are centrally planned mini economies.

In fact more economic activity in America goes on within the safe harbor of corporately constructed centrally planned economies than takes place in supposedly free markets. Even the OECD, hardly a socialist haven, supports that observation.

Now I am not going to support socialist economics. I find it fails too. But we must be more realistic about the economy in which we operate. We need to recognize that the free market experiment failed. It was always going to fail. It was based on ideas that were incomplete or highly tailored to the 1930’s. In the hands of ideologues masquerading as economists it became twisted. Economics was conflated with politics. It became the American state religion to argue that unfettered capitalism was the only economic system to believed. And like all state religions it turned from being believed, to being revered, to being enforced without thought.

We forgot why the debates of the 1930’s took place. And we forgot that neither of the two sides was correct. Keynes was. And he was in the middle.

I hope we can forget the extremism of the free market magic myth, and return to practical realistic economics. There are jobs depending upon it. Indeed, our respective futures do.

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Class Conflict?

It is taboo in America to talk of “class” as if it doesn’t exist. Of course it does, we just don’t like to admit it. I say this because so much of the current crisis seems to have class-like connotations, and more commentators are arguing in ways that indicate they agree.

A case in point is the recent article in The Nation by Joshua Clover – thanks to Phil Cunningham for pointing it out to me. James Kwak at The Baseline Scenario posts a parallel article. Finally Tony Judt, the historian, devoted almost his entire book “Ill Fares The Land” to the increased separation within American society.

The common theme that all three of these writers is their focus on the enormous shift in wealth that the last three decades have wrought. This shift was no accident. It was deliberate, and orchestrated by those who benefitted most. That they were enabled and assisted with enthusiasm by middle class Americans who have been left much worse off remains a mystery in need of thorough explanation.

The facts are clear and well known: wealth has been systematically concentrated by the very upper tier of wage earners, and by corporations whose policies and activities are, in general, dictated by that tier. The professional elite took full advantage of the tax regime put in place by Reagan and then modified by Clinton and the two Bush’s to secure their income stream. They also were the best positioned to exploit the deregulatory environment that has been the predominant governance structure since Reagan also. Pay scales were twisted towards the upper echelons, and those infamous bonuses in banking poured riches into the hands of a very few. A new privileged generation was created, and they are defending their privilege fiercely and astutely. Any talk of class warfare is squelched immediately as “un-American”. The only folks who benefit from dismissal of such talk are those who have the wealth. The rest are left to their anger and increasing sense of disconnection from the old “American Dream”.

I have hammered this issue recently, so I won’t repeat myself except to say that I think that the imbalance in wealth that now is so pronounced within American society is a major, if not the major, contributory factor in our crisis.

That no one on the left in politics has roared against the injustice being done is testimony to how thorough the ideas of the right have taken hold: even our media and academic elites are entrapped by the illusion. Further, politicians of all stripes have succumbed to the money that the power brokers can throw into elections. We have so many elections that the ability of a politician to resist the cash is reduced to zero. Members of Congress are now devoted to fundraising rather than governing. Senatorial races are so expensive that even the six year cycle is not long enough to allow for sufficient fundraising. Our Senate is fast becoming – if it is not already – a rich person’s club. It is no wonder that the banks and big corporations have disproportionate influence. They are the ones with the deepest pockets.

This theme will only loom larger as the wealthy attempt to stave off a return to the better balance of the 1950’s and 1960’s. They stand to lose a great deal, they will not go down without a fight.

But that’s no news.

My point today is to illustrate the gulf that now has opened up in our society.

I was fortunate enough to spend much of the summer this year in Dorset Vermont, a town characterized both by its physical beauty and its comparative wealth. Home prices in Dorset are established by the flood of money from New York City and Boston. True Vermonters cannot afford to live there. The locals are reduced to living on the periphery and providing the services needed by the largely absentee property owners: they mow lawns, clean homes, and shovel snow. They run gift shops and take care of the golf courses. In other words they ensure that the property owners can enjoy their privileges with ease.

This arrangement is two edged. The locals certainly benefit from the jobs generated by the influx of cash. But they are priced out of the community. The town is beyond them. Discontent lurks very close to the surface, and can easily be detected in conversation. While New Englanders are not exactly known for their warm embrace of outsiders, the situation has become more acute as more and more of the town is devoted to large and expensive homes that are occupied only occasionally. My own observation is that most of the homes on one prestigious street are used by their owners once or twice a summer. One at least seems to be simply a Labor Day retreat. The luxury implied by the ability of an owner to use a very expensive home a few days a year is the point to be driven home.

Inequality has always existed. And it always will. But not for decades has the distortion been so great that we have enough families to own enough towns like Dorset that they can reduce so many others to a support function. In the old days the folks providing the services were tied to a family. They were servants. That they are somewhat less closely tied nowadays simply means we can avoid calling them servants. They are now the service economy. But they are just as dependent. They are just as incapable of experiencing the life of luxury as the servants of yore. It is no accident that the majority of jobs generated in the recent past have been in these low wage service functions. The middle income layer has been stripped away either through global shifts to low wage nations, or through the destabilization of “flattened corporate hierarchies”. We have no middle management anymore, so we should not be surprised to have fewer middle income wage earners. In each case – globalization and lean management – the benefits flowed to profits and those with professional skills. Those left at the top of the now narrower pyramid received a disproportionate share of the increase on social wealth created. They used their advanced educations to “rent seek”. Which they did with a vengeance.

That this is now America and is not worthy of commentary is my issue. The division exists and is opening up. Eventually, as it always has in the past, it will breed a backlash. I believe the Tea Party challenge to the Republicans is part of that backlash. Anger is rising. It needs to be well understood and not dismissed.

One last thing: both Joshua Clover and Tony Judt point the finger at Hayek. I would add von Mises, Berlin, and Popper as well. As Judt articulates there were a number of Austrian born theorists back in the 1930’s who devoted their analysis towards a justification, and spirited defense, of a liberal worldview. That they overcompensated in their zeal is easily understood: they were embroiled in a passionate defense of capitalism and democracy in the face of the apparent success of communism – in the Soviet Union – and fascism – in Germany and Italy. During the 1930’s the depression and the manifest failure of capitalism represented a true existential threat to the liberal conception of society. Hence the works of Hayek and von Mises in economics and Popper and Berlin in philosophy. Most postwar neo-liberal economics can be traced back to Hayek or von Mises as reinterpreted by Milton Friedman and Robert Lucas and their cohorts at the University of Chicago.

I can excuse Hayek and von Mises for their mistakes. They were made in a good cause as they fought to save the liberal worldview from the extremism threatening the West back then. I cannot excuse Friedman et al since they were under no similar existential threat, and had the opportunity to see the benefits that the greater income equality of the immediate postwar years had brought to America.

That greater equality was a result of one major idea: that the government can, and should, play a positive role in society by ensuring all its layers of income earners prosper and derive benefit from the productivity increases brought about by technological advance. This idea was best articulated by Keynes whose work both Hayek and von Mises attacked with vigor. They failed to appreciate that capitalism requires limits if it is to not to be antithetical to democracy. Untrammeled capitalism runs headlong into the democratic ideal. Why? Because capitalism is essentially elitist. It inevitably concentrates wealth. Not just in the hands of the successful, but in their offspring. It creates class structure through time. Democracy, in direct contrast, is egalitarian. It presumes a degree of equality. It degrades class, and presumes opportunity is available to all. By involving everyone it inevitably ends up redistributing wealth through social programs and entitlements.

So democracy and capitalism collide in their extreme forms.

It is only when both are modified that they provide mutual support. Capitalism only survives when the middle class benefit from it. Democracy only survives as long as inequality remains within bounds and there is some engine for the provision of greater wealth.

It was Keynes who saved capitalism from its failures in the 1930’s. He insisted on it being limited. Hayek, von Mises, and their later followers reviled and ignored Keynes by insisting on its purity. Their’s was an idealism born of zealotry. It was decoupled from history and reality. It was easily co-opted by the elites for their own ends. It provided an easy story to tell. And it fitted nicely with the pre-existing American mythology of the rugged individual. The Keynesian message was too pragmatic and failed to resonate with voters during the sharply defined Cold War era. Americans sought, and then fell for, an ideal that could not produce its promise in the uncertain and flawed environment of the real world.

Just as the rugged individual was never real, nor was the free market and its supposed cure all qualities.

But by choosing the myth Americans have undone the great leveling that created the wellbeing that characterized the postwar years. The middle class was complicit in its own downfall.

So now we have rampant capitalism and weakened democracy just as Keynes would have predicted. That the two great liberal ideas are now in conflict does not augur well. They need reconciliation. We need to throw out the rotten purities advocated by Hayek, von Mises, Friedman and Lucas. They were an illusion that generated a class conflict.

Which is something we can do without.

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Obama’s Failure: Part 2

A few of you have called me harsh in my criticism of Obama. Perhaps I am. Allow me to expand a little on why I have the opinion I do. My narrative goes this way:

My worldview is largely informed by my own experience and education. No news in that. But it is heavily influenced by my interpretation of my family’s recent history. I use that history as a measuring stick. My grandmother plays a pivotal role since she is the farthest back that I can reach. She thus becomes the starting point in my analysis.

She started adult life as a servant in a small time aristocratic English family home. Think “Upstairs Downstairs”. She married the aristocrat’s personal jockey, who died before I was born so I have no memory of him. At some point she escaped the life of a servant and established herself as a single mother, self reliant and, as I recall, very independent. She successfully raised my mother and her 5 siblings on what was a meager living, and at a time when single mothers were not well received by society. She became the first woman in her town to vote. And she was the first woman in her town to own her own home. She had to suffer through the humiliation of “being allowed” to own a home as a single woman. Such was the backward attitude of society back then.

By “back then” I mean the 1920’s/1930’s. Not that long ago.

Since then my family has progressed steadily. First my parents emerged into solid middle class status, and then I was able to go even better. At least in terms of affluence. So I look back at this trajectory and see a family throwing off the shackles of working class limitation, and achieving, in less than 75 years, a typically well-off middle class life style. The question becomes what next?

And that’s where my anger at Obama surges to the surface.

As I survey the economy and America in general I see many families like mine. And I see far too many in retreat. The progress that my family has made in three generations is in jeopardy. We are at risk of falling backwards for the first time in a century. In the face of this retreat I can hear my grandmother’s words ring clearly in my ear:

“Peter” she told me once “Be careful, they can always take this way from us. We have to fight for everything.” And she meant “fight”. She didn’t mean discuss.

Why I needed to know this, I was around ten years old, I have no idea. But her words echo strongly nowadays. Because they are taking it away from us.

For thirty plus years the American middle class has plunged into a slow motion suicide. It has fallen prey to the illusion that it doesn’t need the help and protection of government in order to maintain its progress. This is despite all the evidence from the 1950’s and 1960’s when the growing affluence of the new middle class was underwritten entirely by constant intervention by the government in economic affairs. The returning World War II veterans were educated by the government; trade, and other policies were established to help recovery; huge stimulus was pumped into the economy to prevent the return of depression – one of the greatest fears coming out of WWII was that a slump was almost certain; and a stand-off between unions and management made sure that a good share of the surge in postwar productivity flowed to workers. Times were good and well balanced.

Keynesian economics was built in an attempt to protect capitalism form its self destructive tendency. A tendency amply demonstrated by the depressions of the 1800’s and then in the 1930’s. Keynes’ great project was to fend off the tendency towards extremism engendered by the fear felt by the middle class when its wealth is threatened. He realized that the poor have different fears – they have little to lose. And he realized the wealthy don’t care – they have the resources to protect themselves. It is the middle that is most vulnerable because its grip on wealth is the most tenuous. It is this middle that can swing rapidly towards extreme politics in an attempt to protect itself from the decline back to poverty. His big lesson was that stable democracies need to protect the middle class from predation by the elite. To do that he argued the government needs to play a role in maintaining economic stability.

Else “they can take it away from us.”

The problem is that during the boom of the post war era the memory of the fight for affluence faded. Affluence was taken for granted as if it were the natural state of an modern economy. The machinery that enabled the creation of the middle class was derided as inefficient and corrupt. The culminating event that allowed “them” to retake power was the oil shock of the mid 1970’s, after which normal economic policy appeared to fail. The postwar boom faded and the middle class was threatened. It sought reassurance that it would not fall back. This opened a chink for the right wing resurgence. Keynesian economics was attacked by the ideologically-driven alternative spelled out by Milton Friedman and his disciples – most of all Robert Lucas – at the University for Chicago. They argued for a return to classical economic theory that had no place for the government. Between them they articulated a theory of economics that enabled and legitimized the Reagan illusion. The purpose was to cut away the Keynesian style props, and allow the economy to fly free. The elixir sold to justify this was the great tax cut scam.

Reagan cut taxes and was the first President in American history to plunge the country into a peacetime debt. We prefer not to remember that now, especially given Reagan’s saintly status with his followers. But he sold the middle class a bill of goods. The facts are simple: since Reagan started America on its debt binge the only reason the middle class has not relapsed to prewar poverty is the steady accumulation of debt. Both private and public. Keynes would have been horrified since he argued the government should pay down debt when the economy was going well in order to be able to go into debt to stave off depressions. And his key disciples – notably Hyman Minsky – also argued that a reliance of finance, which a debt based economy becomes, is highly unstable due to the very nature of the way in which banking takes place.

We chose to ignore the wisdom drawn by the likes of Keynes from his direct experience of the Depression. We chose to ignore the warnings of people like my grandmother who had lived through the fight for equality and a chance to be free of poverty. We bought the illusion.

But all illusions end. Mostly in unhappy circumstances.

That’s where we are today.

The bubble burst. The middle class has learned that its reliance on debt to maintain its lifestyle is a sure road to ruin. Yet it reflects on its hard work and wonders where the rewards are. Why is it that education and health costs have spiraled out of control? Why is it that wages have not kept up with inflation for three decades? Why is it that home prices surged, then crashed? Why is it the we hear about endless deficits even while we are supposed to be rich and powerful? Why is it that America has reputedly poor education despite the money we spend? Why is it that our infrastructure is decaying? Why is it that we don’t live as long as our European cousins? Why are jobs so insecure? Why are profits booming even as we see unemployment rising? Why, in short, are we so insecure?

Because of the illusion.

We fell for the bait and switch.

We forgot that it is only the government – we the people – who have the collective strength to ensue that we are not taken advantage of.

We forget that untrammeled capitalism – true “laissez faire” – has been tried and rejected everywhere precisely because it undermines the middle. Nowhere in a true laissez faire economy is there room for a middle. All you end up with is a very small privileged top and a vast bottom. To give some dimension to that statement: the current estimated wealth of the family of the founder of Wal-Mart is equivalent to that of the poorest 120 million Americans added together. One family. Our very own aristocracy.

My grandmother would shudder.

We have worked so hard to escape massive and debilitating inequality, why would we willingly go back?

But go back we did.

America is now the most unequal society in the West. It suffers as a consequence. Poor people tend to be sicker, more stressed, and live shorter than rich people. Sure we can hide from the steady decay of standards for a while, but sooner or later, when enough middle class folks have fallen backwards things catch up. That’s where we are. At a tipping point. The degradation of the middle class life has reached a critical level. The loss of government help has steadily removed our lines of defense and now we are truly exposed.

The last two recessions have both been followed by jobless recoveries. Our economy now creates a bulk of low paying jobs balanced by a few very well paying ones. Our educated elite cluster into those well paying jobs and is thus able to pretend that nothing is amiss. Indeed our elite is now able to skim of the rewards of growth for itself: the distribution of incomes and wealth has returned to there prewar levels. American society is bifurcating at an alarming rate. The quickening of productivity over the last two decades has gone into profits not wages, which is the exact opposite of the experience of the early postwar years. There are no unions to force a better distribution. And government has been sidelined. Banks who were destitute two years ago, and entirely reliant on taxpayer aid have just – in 2009 – had their best year of profits ever. Ever. Yet we are mired in a crisis of their doing.

No wonder America is angry. No wonder the Tea Party attracts the white middle class. The fear is palpable. And Weimar Germany warns us that the political fall out of a betrayed middle class can be extreme.

Using my family history as yardstick: we have let my grandmother down. We have let “them” take it away. The postwar trajectory has been interrupted. The illusion is exposed as a fraud.

Or it should be.

And this is where Obama enters the story.

There is nothing novel in my narrative. Countless books, essays, and papers have been written about the demise of middle class America. The story is over-dramatized for effect, but contains the seeds of truth. A decade ago we could be accused of naysaying for attention. Nowadays it is hard not to say I told you so. The degeneration was foreseeable. The facts were accumulating. It was too easy to sell voters on the free market myth: after all why should we begrudge the wealthy their just due from their efforts? Isn’t that the American way?

Well no.

It never was.

There was always a healthy push back against inequality. Especially when it reached excess. American populism rears its head whenever the economy fails to benefit a big enough section of the voting public. Like now.

Obama could have seized this moment of populist upswell and channeled it into a constructive reconstruction of the role of government. He could have led us back towards a better division of the spoils or our collective hard work. He could have punished the banks for bringing down the economy, and thus he could have drawn the sting from the anger the industry justly created. He could have redirected our attention back to the days when America was not a military based economy – he could have heeded Eisenhower’s warning. He could have poured his political capital into fighting the free market myth from the outset, instead of restricting himself to policies that admitted defeat before they were announced. His was an opportunity to rebuild the middle class and stop its suicidal tendency.

He failed.

He didn’t put up much of a fight.

He tacked and trimmed.

He let the decline continue.

He let my grandmother down. Her legacy, and those of millions like her, is in doubt. He failed the very constituency who so dearly wanted him to succeed. The betrayal is enormous and probably irreparable.

Why?

Because his was the moment we could arrest the spread of extremism. His was the chance to make positive what was tending towards the negative. The continual shift to the right of the Republican party is a danger for us all. We need an intelligent right of center party. The health of democracy requires dialog and debate, not vitriol and hate. It requires sober argument and understanding, not pure obstructionism and volatile thoughtless riposte. He could have drawn a line and told the country that anything beyond that line was beyond the pale of decency. He could have offered a rehabilitated left of center narrative – the kind that Eisenhower as well as Truman would have recognized. He could have engaged on our behalf, and given expression to the accumulated frustration of those in the middle class who are not persuaded by the Tea Party.

He didn’t.

So the voices of unreason continue to build and we treat the affront of the recent gathering on the anniversary of Martin Luther King’s great speech as something we cannot fight.

We are leaderless at a time when leadership is both needed and crucial to the very fabric of the country.

I look around the Upper East side and see the vast array of wealth flaunted there. I see the new rich with their nannies and other help. I see a service economy manifest in the return to the days when my grandmother was a servant. Only we dare not call these nannies servants, even though that is exactly what they are. We fought so hard to create an economy where people like my grandmother could avoid being in service to others. Where jobs were available to provide a dignified and reasonably prosperous life for the mass we call the middle class. That was the achievement of the two generations before mine. And what have we done? Regressed to the days of inequality. We gave up. We sold my grandmother down the river.

The elite sold out. They are the ones with the servants now. Why should they protect us? The intelligentsia never had it so good, why should they attack inequality? But as the gap yawns wider the reaction is setting in. The Tea Party may be a minor phenomenon, but I wonder just how minor it will be if the drift towards greater inequality continues.

In the face of the threat of extremist politics we have a choice: fight back or capitulate. Obama capitulated.

That’s his failure: no fight.

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