Government directed business cycle, market disciplinary mechanisms, sovereign debt

Political economy:

We clearly do not have a "free" market economic system. Properly defined, our economic system is a "government directed" market system with a business cycle predominantly determined by government policies and actions.
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The government has been the predominant factor in the business cycle since WW-I.

When the government shifts from facilitating markets to influencing markets, that's when things go awry.

Through the intended and, especially, the unintended consequences of government policies and activities, the government has been the predominant factor in the business cycle since WW-I.
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As FUTURECASTS has frequently stated, there are indeed some very capable people in government, and indeed our market system is created by and dependent on an impressive array of good governance practices developed over several centuries. Indeed, the U.S. government is head and shoulders superior to that of any of the other major nations. Indeed, it is indubitably the lack of good governance practices and appropriate government institutions that explains the continued impoverishment within third world undeveloped nations.
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The superiority of the U.S. system of government is the good news. That's also the bad news. It just can't get much better than this. Because of the nature of the institution, because of powerful political and bureaucratic imperatives and the nature of government decision-making processes, government management is INHERENTLY inept.

For the good, the bad and the ugly of our government directed market system and the need to broaden economic analysis to cover the pertinent government policies and practices - to broaden the study of "economics" to cover the vast complexity of "political economy" - see Scott, "The Concept of Capitalism," See, also, Government Futurecast.

China provides the primary example of a state capitalist market system where the government owns or controls most "commanding heights" economic entities, and France provides an example of an industrial policy market system where the government picks winners and loser in important sectors. Although the U.S. government does some of these things, it predominantly confines itself to efforts to influence markets, not their participants. When the government shifts from facilitating markets to influencing markets, that's when things go awry.
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The government:

influences interest rates through the monetary policy of the Federal Reserve;
restricts imports and subsidizes exports;
sets banking policy, sometimes in accordance with narrow political interests;
allocates financial resources into favored market sectors like agriculture and housing, inevitably creating overcapacity and other problems;
shapes business capital structure by insanely favoring debt and punishing equity;
persistently elaborates its tax statute into a morass of noxious incentives;
increases its sovereign debt to levels that undermine national financial strength and stability;
dictates chronic loss of the purchasing power of its fiat currency;
establishes vast entitlements without regard to adequate cost controls;
disables essential market disciplinary mechanisms with moral hazard policies that turn credit market vigilantes into credit market enablers, resource allocations that alter basic supply and demand relationships, chronic inflation that alters economic incentives, and the elimination of the right to fail.

Undoubtedly, there is much more that can be added to this list.
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When governments provide good governance that facilitates profit driven market directed commerce, and when governments submit to the "golden straightjacket" of market mechanisms, sound currency and limits on sovereign debts, nations prosper.

Government constraints on market mechanisms and government policies that disable market disciplinary mechanisms have played the predominant role in every major business cycle contraction in the U.S. since WW-I. It was the removal of market constraints and the facilitation of market mechanisms that played the predominant role in achieving prosperity after WW-II and in the economic and financial recovery from the Keynesian inflationary morass of the 1970s. It was the removal of market constraints and the facilitation of market mechanisms that played the predominant role in the two decades of prosperous growth and stability during the 1980s and 1990s.
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When governments provide good governance that facilitates profit driven market directed commerce, and when governments submit to the "golden straightjacket" of market mechanisms, sound currency and limits on sovereign debts, nations prosper.
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Political expediency and ideological predilections, of course, chronically afflict Congress. To a greater or lesser extent, narrow political and ideological interests persistently trump the national interest and heedlessly subject the nation to a plethora of unintended consequences.
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The trade war was heedlessly instigated and maintained with the 1922 Fordney-McCumber Tariff Act and the 1930 Smoot-Hawley Tariff Act. The trade war destroyed the international markets that were vital to the vast agricultural sector of the economy during the 1930s, took a 10% chunk out of the automotive market as early as the spring of 1929 and broadly undermined the value of industrial commodities. By February, 1930, 15% of the wheat market had disappeared and another 10% was gone by 1932.
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In the nature of economic markets, the impacts extended far beyond just the losses from the closing of international markets. For the major cash crops - wheat, cotton, corn - the loss of market value for the domestic crop was more than three times the loss from the decline in export sales. The loss of export demand resulted in a 50% loss of value for the entire North American wheat crop between the summer of 1929 and the end of 1930, with further losses continuing thereafter. Similar results were experienced in the cotton market and, by 1931, in the corn market as well, and also in industrial commodity markets, destroying the economy of the entire midsection of the nation.
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Keynesian and monetarist economists determinedly ignore these basic market impacts when denigrating the importance of the trade war. They stupidly pretend that the impact was limited just to the loss of exports without considering the vast impact on the value of all the nation's cash crops and industrial commodities. The price curve for these commodities is very steep.
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European governments had already undermined international commerce with WW-I. The Versailles Treaty that wound up that atrocious conflict Balkanized the Balkans and totally ignored impacts on international commerce, but the U.S. government played an increasing role thereafter in the vast international tragedy that became the Great Depression.

Free markets didn't fail during the Great Depression, left wing claims to the contrary notwithstanding. The Great Depression was clearly the result of government activities and policies that imposed massive burdens and impenetrable constraints on market mechanisms.

Two Keynesian epochs:

The draining of the vast financial strength of the U.S. after WW-II, the Great Inflation of the 1970s, and the recent Credit Crunch recession clearly reveal the economic policy madness that periodically afflicts the government directed U.S. market system.
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The Keynesians brought in by the Kennedy administration were full of conceit and hubris, and some even claimed almost scientific certitude. They promised to accelerate economic growth and "obsolete" the business cycle.

Republican governance repeatedly favors the narrow political interests of unprincipled political hacks. Democratic governance repeatedly demonstrates not only their own vulnerability to political expediency but also a powerful susceptibility towards ideological and Keynesian madness.
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A plague of Keynesian economists transmitting the Keynesian madness periodically descends on Washington. The Keynesians brought in by the Kennedy administration were full of conceit and hubris, and some even claimed almost scientific certitude. They promised to accelerate economic growth and "obsolete" the business cycle. With such attitudes, they were capable of enormous mistakes.
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The publisher of FUTURECASTS online magazine responded to the first plague by publishing "Dollar Devaluation" (1967) accurately forecasting the devaluation of the dollar in the 1972-1974 period and the inflationary morass that would destroy 60% of the dollar's purchasing power in the decade thereafter. A financial column was provided for some business newspapers accurately explaining and forecasting the volatile twists and turns of the 1970s. At a time when establishment economists were achieving an astounding record of almost 100% failure in forecasting economic developments, the publisher's published forecasting record was almost perfect. See, Futurecasting Record 1, Futurecasting Record 2, and Futurecasting Record 3. His readers were thus forewarned in time to protect themselves - and even to profit from - that Keynesian debacle.
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The demonstrated forecasting ineptness of establishment economists is readily explained. They simply cannot forecast the failure of the policies that they are busy justifying for their politician masters and political causes. To the extent that their brains are addled by the Keynesian madness, their economic concepts are risible and the policies they support are certain to fail. Forecasting skill thus requires only a recognition of the inevitable failure of Keynesian policies and the modest talent to draw a reasonable time line to the period of failure.
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Now, a second plague of Keynesian economists has been loosed from the nation's foremost academic institution where the virus has been incubated since being eliminated from Washington in the 1980s. Why the faculties of arts and sciences in these institutions hate their country that much is a question that remains to be answered.
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FUTURECASTS in its earliest issues had foreseen and explained this re-infection. See, Economic Futurecast, at segment on "The conundrum of American monetary policy" republished from the 11/1/99 prototype issue. Indeed, FUTURECASTS online magazine was established to be ready to explain and forecast the inevitable failures of Keynesian policies for a new generation of readers so they too would be able to protect themselves - and even to profit from - this second Keynesian debacle. FUTURECASTS has for many years now averaged well over 30,000 hits per month.
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However, as one commentator aptly put it, history doesn't repeat, it rhymes. There have in fact been differences in this 21st century outbreak. Floating dollar exchange rates eliminate sudden devaluation crises, but sudden or smooth, dollar devaluation proceeds just the same. Monetarist concepts and expectations theory are among the improvements accepted for Keynesian theory, but these just improve matters at the margins and have some problems of their own. Keynesian theory remains rotten to the core and the disease produces the same economic maladies. The burdens of entitlements that lack cost constraints are reaching massive proportions.
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The Bush (II) Republicans surrendered to political expedience and abandoned the successful policies of the 1980s and 1990s. They couldn't resist the temptation to loot the public treasury and undermine market disciplinary constraints as favors for their supporters.

The Bush (II) administration and its three Republican Congresses inherited an economy that had regained its position of world leadership and financial strength - much to Keynesian astonishment. There was no secret about the economic policies that had enabled the U.S. to recover from the Keynesian inflationary morass of the 1970s. There was no secret about the economic policies that maintained two decades of increasing prosperity interrupted by only two short and shallow recessions. These policies were referred to as the "golden straightjacket," since they produced prosperity broadly over time but imposed discipline on politicians that the politicians hate.
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However, the Bush (II) Republicans surrendered to political expedience and abandoned these successful policies. They couldn't resist the temptation to loot the public treasury and undermine market disciplinary constraints as favors for their supporters. They began digging the nation into an economic hole the ultimate results of which were easy to see. This deplorable turn of events was repeatedly covered by FUTURECASTS. See, Heedless Government, Government by Crisis and Congress: The Engine of Inflation. The Republicans did not have the excuse of Keynesian influence. This was the same old fashioned heedless irresponsibility of unprincipled political hacks that created the disastrous trade war of the 1920s.
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The electorate responded in the only way it could - by kicking the bastards out. Unfortunately, the new bastards were even worse. The Democrats have continued and intensified Republican policies and have in addition exposed Washington to a second plague of Keynesian economists. They have thus proceeded to accelerate the disease process in much the same way as during the 1930s New Deal period.
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FUTURECASTS had provided its readers with accurate forewarning of the inevitable results of this conduct. The onset of a serious recession, now called the "Credit Crunch," probably before the 2008 election, was clearly forecast. Such factors as the Fannie Mae and Freddie Mac bubbles, the bank lending bubbles, debt leverage bubbles, the housing bubbles and the constraints in the energy markets and much more had been clearly explained as early as February, 2003. Further explanations and warnings followed. See, Eleventh Annual Review of FUTURECASTS Issues.
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By February, 2009, while the blood was flowing on Wall Street and establishment economists and talking heads were demonstrating their incompetence by speculating about a return of the Great Depression, FUTURECASTS told its readers to "buy now." FUTURECASTS correctly assured its readers that despite continuing volatility, the market would be substantially higher by the end of 2010.

"In any event, now while the blood is still running on Wall Street and idiot talking heads on television are comparing this significant recession to the Great Depression, this would definitely be the time to buy."

However, recovery will be troubled, disappointing and short. By trying to protect us from the impacts of bursting bubbles, the government in its usual ham handed way has prevented the markets from liquidating the mess. Banks still struggle with toxic assets and unperforming mortgages and other debts. The surplus housing inventory has still not cleared. Fannie Mae and Freddie Mac, now under explicit government direction, cost the taxpayer tens of billions of dollars each quarter. They insanely load up on low interest mortgages that will decline in value by hundreds of billions of dollars when mortgage rates return closer to market levels. The Federal Reserve also now has in excess of a trillion dollars in low value mortgages.
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However, corporations and other businesses have improved their competitiveness and their balance sheets, and a decade of high prices has restored the supply side of the energy market and removed the constraints on oil supplies. Oil will now fluctuate in line with commodity inflation, albeit with an extraordinary risk of supply disruptions that is made considerably worse by artificially low interest rates. Low interest rates and rising oil price inflation mean that oil in the ground is worth more than oil produced.
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FUTURECAST has thus fulfilled its primary obligation to its readers. It is now up to the electorate to keep kicking the bastards out - churning their elected officials - until the Keynesians are again sent packing so some sanity can be restored in Washington and those willing to make the hard decisions that will be needed to restore economic and financial health, stability and strength are able to guide government economic policy.
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Government policy must restore and facilitate market mechanisms, instead of constraining markets and disabling their disciplinary mechanisms. In addition, substantial cost constraints MUST be imposed on the nation's vast entitlements.

The economic policies of the 1980s and 1990s must be restored, no matter what the short term cost. Entitlement madness must be confronted and robust cost constraints must be imposed.

Confusing the credulous:

Keynesians excel at the production of excuses for policy failures.
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Reality always perversely refuses to conform to Keynesian expectations.

Keynesian are heroically unconcerned about the additional trillions of dollars of sovereign debts that they now assert is necessary to make their stimulatory efforts succeed.

Keynesian policies always send the nation into financial decline. Its adversaries and potential adversaries always prosper and expand their influence during periods of Keynesian madness. The nation's problems always ultimately reach "ungovernable" levels. Gold always rises.

Suddenly there are discussions about a minimum unemployment level consistent with non-inflationary growth that has inexplicably risen above 6%. This comes straight out of the Keynesians 1970s playbook. Why does this always seem to happen when Keynesian policies are pursued?

Budgetary deficits are simply never enough to do the job of stimulating the economy, and monetary inflation ultimately always fails to fulfill Keynesian expectations of reduced unemployment and restored prosperity. The current economic contraction is always different in unexpected ways that prevents realization of the benefits expected from Keynesian policies. Government policy makers are never skilled enough to properly execute Keynesian policies. It's all the fault of evil speculators! It's all the fault of the markets! The markets inexplicably fail to respond properly to Keynesian policies. Reality always perversely refuses to conform to Keynesian expectations.
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In the 1970s, scapegoats were sought for Keynesian failures as the economy descended into the morass of chronic inflation and business cycle volatility. Business was blamed for abusing market power and generating "cost-push" inflation, and unions were blamed for "wage push" inflation. OPEC and the oil companies are still stupidly blamed for much of the price inflation of the 1970s.
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Somehow, in the absence of monetary inflation and artificially low interest rates, there was no OPEC oil embargo or oil price shock during the Israeli invasion of Lebanon in the early 1980s. That chronic inflation is impossible in the absence of monetary inflation, and indeed is inevitable in the presence of substantial rates of monetary inflation, was amazingly rejected until the Keynesians themselves were rejected by the electorate and kicked out of Washington.
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Today, the Keynesians blame insurance companies for the health care price inflation caused by government policies. They blame "speculators" for recognizing and acting upon the inevitable failure of Keynesian policies. They blame consumers for refusing to respond with confidence to the Keynesian stimulatory efforts that have failed to stimulate the economy. Their policies have established a volatile and vicious business cycle, but they blame banks for not lending and businesses for not hiring in that environment. They are heroically unconcerned about the additional trillions of dollars of sovereign debt that they now assert is necessary to make their stimulatory efforts succeed.
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Meanwhile, the domestic economy has leaked a trillion dollars out through its balance of payments deficit in just two years. Substantial adverse impacts on the international trade and payments balances are always an unintended consequence of Keynesian policies. See, Blatt, "Dollar Devaluation" (1967).

Keynesian policies always send the nation into financial decline. Its adversaries and potential adversaries always prosper and expand their influence during periods of Keynesian madness. The nation's problems always ultimately reach "ungovernable" levels. Gold always rises.

If $2 trillion in budgetary deficits is insufficient, there should be $4 trillion. And trillions more during the next recession and the one after that. Nobody but a Keynesian can be stupid enough to expect that political leaders will ever pay down any substantial amount of this debt in between recessions. However, Keynesian stabilization efforts inevitably increase economic instability as debt loads and monetary inflation increase.
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Keynesians refuse to even contemplate the subsequent recessions that will inevitably follow one after the other in quick succession as a result of Keynesian efforts to prevent their occurrence. They view with astonishment the troubled and unsatisfactory nature of the intervening recoveries.
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Keynesians are suddenly quiet about their 1960s claims that they can accelerate growth and "obsolete" the business cycle. Instead, they begin generating excuses for failure. Suddenly there are discussions about a minimum unemployment level consistent with non-inflationary growth that has inexplicably risen above 6%. This comes straight out of the Keynesian's 1970s playbook. Why does this always seem to happen when Keynesian policies are pursued?
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The Keynesians now set the bar for success at an extraordinarily low level.

The Keynesians brag that there has not been another Great Depression. They thus set the bar for success at an extraordinarily low level.
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Like fundamentalist clerics warning of brimstone and damnation, Keynesians use threats of a return of the Great Depression to frighten people into acceptance of their concepts and policies regardless of disappointing results. That a return of the Great Depression is impossible without the government policies that caused the Great Depression is something they don't even want to think about. See, Blatt, "Understanding the Great Depression and the Modern Business Cycle," (2009) See, also, Summaries of Great Depression Controversies and Facts and seven Great Depression Chronology articles beginning with "The Crash of '29."
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To get another Great Depression, you need another WW-I that uses up the world's wealth and disrupts established courses of commerce. The war has to be followed by a Treaty of Versailles that imposes heavy reparations obligations on the losers and Balkanizes them into constituent ethnic or sectarian parts that are not economically viable. Then the major creditor nation must initiate a trade war that blocks entry to its markets and prevents debtors from earning the wherewithal to service their debts and prevents the new little Balkanized states from accessing international markets. It must adopt a mercantilist monetary policy that it rigidly maintains as the world falls apart around it.
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NOTE: All these factors are aspects of WW-I and post WW-I government policy. None are natural features of market mechanisms. Indeed, they all are constraints on markets. They are each immensely burdensome and stupid, but no single one of them would suffice to cause a Great Depression. The Great Depression was the result of a whole series of immensely burdensome government activities and constraints on the markets.

Keynesians are rightly embarrassed by the undeniable failures of their policies during the 1970s and so strive to direct attention elsewhere.

Today, some pieces of the Great Depression puzzle are actually in place, but thankfully not the primary pieces. Sovereign debt loads have increased massively, and China pursues mercantilist policies that weaken the finances of its debtor nations. However, there has been no great war since the 1940s, and the "naïve" U.S. somehow managed to preside over a far more enlightened peace process after WW-II than the more "sophisticated" European great powers at Versailles. Most important, globalization gives debtor nations the opportunity to earn the wherewithal to service their debts and small nations the opportunity to flourish within the broad global market.
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Although the analogy is far from perfect, the dangers of the modern business cycle are more in line with the Great Inflation of the 1970s than the Great Depression of the 1930s. However, Keynesians are rightly embarrassed by the undeniable failures of their policies during the 1970s and so strive to direct attention elsewhere.
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Ignored is the failure of Keynesian-type policies during the New Deal. There was, after all, still almost 19% unemployment in 1938, after six years of New Deal budget deficits, monetary inflation and industrial policy experiments. The New Deal not only retained all the worst of the economic policies of the previous Republican administrations, but they added new constraints on the economy, even attempting to subject the whole economy to a system of cartels against the public interest. They insanely adopted inflation as a "cure" for economic problems, and in several ways massively reduced the efficiency of the economy. Ominously, inflation as a remedy is again part of the economic madness in Washington.
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The Keynesian response, as usual, is that the budgetary deficits and monetary inflation were simply not big enough to get the job done, They never are!
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This is not rocket science. The bottom line is obvious.

Not until some principled adult supervision is provided for the Republican party and the Keynesians are kicked out of Washington will the United States restore financial and economic stability and strength.