Great Depression Online Archive Issue:

Better Lucky Than Good

Great Depression Online
Long Beach, CA
June 16, 2009

Inside This Issue You Will Discover…

*** The Legend of the Laffer Curve
*** Rising Prices and Higher Interest Rates
*** Better Lucky Than Good
*** And More

The Legend of the Laffer Curve

“Rahm Emanuel was only giving voice to widespread political wisdom when he said that a crisis should never be ‘wasted,’” began Art Laffer in an editorial published last week in The Wall Street Journal. 

If you don’t know who Rahm Emanuel is, he’s President Obama’s Chief of Staff.  If you don’t know who Art Laffer is, he’s the originator of the Laffer Curve. 

Legend has it, Laffer first sketched the Laffer Curve out on the back of a napkin in 1974 while dining with Donald Rumsfeld, then Chief of Staff to President Ford, and Dick Cheney, Rumsfeld’s deputy at the time.  Later the Laffer Curve would become the intellectual backbone of supply side economics.

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The premise of the Laffer Curve is that reducing marginal tax rates increases the flow of gross revenues to the government.  The idea seems simple enough…high taxes stifle productivity, low taxes encourage it.  In short, a small piece of a big pie is much more than a big piece of nothing. 

But like most economic theories, once put into practice things never quite added up like they did when penciled out on the back of a cocktail napkin.  The government taxed less and spent more…much more.

For example, since being put into practice around 1980, government debt has grown at twice the rate of economic output.

Since 1980 the national debt’s exploded from about $1 trillion to over $11 trillion.  Over that same time GDP’s gone from just over $2.7 trillion in 1980 to just over $14.2 trillion in 2008.  In other words, over that time, the national debt’s grown 1100 percent while the GDP’s grown just 526 percent.

As you can see, supply side economics didn’t supply all the revenue the government spent over the last 30-years.

Rising Prices and Higher Interest Rates

While Laffer may be a quack…all economists from Keynes on are too.  We won’t hold it against him.  Rather in search of instruction, let’s look at what he said in last week’s Wall Street Journal editorial.

“Here we stand more than a year into a grave economic crisis with a projected budget deficit of 13 percent of GDP.  That’s more than twice the size of the next largest deficit since World War II.  And this projected deficit is the culmination of a year when the federal government, at taxpayers’ expense, acquired enormous stakes in the banking, auto, mortgage, health-care and insurance industries.

“With the crisis, the ill-conceived government reactions, and the ensuing economic downturn, the unfunded liabilities of federal programs -- such as Social Security, civil-service and military pensions, the Pension Benefit Guarantee Corporation, Medicare and Medicaid -- are over the $100 trillion mark.  With U.S. GDP and federal tax receipts at about $14 trillion and $2.4 trillion respectively, such a debt all but guarantees higher interest rates, massive tax increases, and partial default on government promises.

“But as bad as the fiscal picture is, panic-driven monetary policies portend to have even more dire consequences.  We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s.”

Better Lucky Than Good

With Laffer’s gloomy prediction of what could happen, he also offers some advice to the Federal Reserve…

“Now the Fed can, and I believe should, do what it must to mitigate the inevitable consequences of its unwarranted increase in the monetary base. It should contract the monetary base back to where it otherwise would have been, plus a slight increase geared toward economic expansion.”

Laffer’s solution seems obvious to us…because it’s obvious to everyone.  And, no doubt, Bernanke will one day contract the money supply.  But just when he should do it…that’s the question no one really knows. 

Finagling with the money supply, you see, is more art than science…for no precise indicator will tell you when exactly to tighten things up or not.

“Oil’s above $70 per barrel,” one central banker may say.  “Better reign in the monetary base.”

“Manufacturing’s down and unemployment’s up,” another central banker could counter.  “Better keep the monetary flood gates wide open.”

The G-8 Nations met over the weekend and confirmed that no one really knows what they are doing…

“The world’s rich nations, heartened by signs the credit crisis is easing, have started to consider how to unwind rescue steps for their economies once recovery is certain, their finance ministers said on Saturday,” reported Reuters.

“Meeting in southern Italy, the ministers described their economies in the most positive terms since the collapse of Lehman Brothers nine months ago ushered in the world’s worst financial crisis since the Great Depression of the 1930s.

“But ministers clearly differed over how quickly the world should start rolling back huge state spending plans and hiking interest rates.  And there was continued disagreement over other aspects of the crisis, especially testing the health of banks.”

In the end, they all seemed to know less about what should be done than when the meeting began…so they punted…

“The meeting’s final joint statement said they had asked the International Monetary Fund to help them analyze possible ways of ending economic stimulus policies.”

Perhaps they’ll get it right and hit a monetary policy bull’s eye.  If they do it’ll be more luck than good acumen.  For they’ll be throwing darts at a moving target in a blizzard.

Better lucky than good.

Sincerely,

M.N. Gordon
Great Depression Online

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