Wednesday, July 7, 2010

Double Dip and Hayek vs. Keynes

It all comes down to "swimming baths" versus productive investment. That's my take from the latest round in the Hayek vs. Keynes wars. In dueling letters to The Times of London in 1932, teams of battling economists proposed solutions to the Great Depression. Wrote Keynes and his pals:

If the citizens of a town wish to build a swimming-bath, or a library, or a museum, they will not, by refraining from doing this, promote a wider national interest.

Hayek & Co. countered with this:

We are of the opinion that many of the troubles of the world at the present time are due to imprudent borrowing and spending on the part of the public authorities.

But the key to ending depressions, it seems to me, is to fix the balance sheets of underwater market participants. The reason you get panics is that, when asset prices decline, parties with highly leveraged balance sheets find themselves underwater. Counterparties sensibly lack confidence in these compromised actors and avoid transactions with them. That's why the infamous TARP was implemented: to fix the balance sheets of the banks so that they would have positive equity and other people would trust them. Once it was clear that TARP had succeeded the markets turned and confidence was restored.

Now, of course, we have a different problem. The huge fortune thrown at "stimulus" by the Obamis has brought into question the balance sheet of the United States itself. Has the enormous increase in the National Debt put the governments of the United States underwater?

And that returns us to the Hayek vs. Keynes argument. Does spending on municipal luxuries and "shovel-ready" projects really help? Capitalism teaches us that prosperity issues out of profitable enterprise, work that produces more value than it consumes. The record of municipal enterprise is that local politicians spend money on things the voters and the special interests want, not on things that makes the city more prosperous. Most government projects are money-losing white elephants.

The Hayek method, practiced by Ronald Reagan and George W. Bush, is that sound money and a good investment climate with low tax rates sets the stage for rapid recovery. But our liberal friends just don't want to believe that.

They may have to learn the hard way. As Poor Richard put it in 1743:

Experience keeps a dear school, yet Fools will learn in no other.

That's Benjamin Franklin for you.

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