The Fed’s Failed — And That’s a Good Thing

 

shutterstock_236267482Don’t expect any miracles from the economy. But don’t expect a collapse either.

In political terms, it’s kind of a Mexican standoff. Team Obama says they saved us from another Great Depression. And they point out that 3.1 million jobs have been created in the last 12 months. Republicans counter that this is the slowest post-WWII recovery on record and that real GDP is roughly $2 trillion below potential. They add that the labor-force participation rate is 62.7 percent, a 39-year low, and that there are at least 15 million people who work but can’t get jobs.

Yet both sides may actually come together for a major pro-growth initiative: an Asia-Pacific free-trade deal that will lower tariffs and other barriers. Lower tariffs are lower taxes.

Democratic labor unions don’t like this. Neither do isolationist Republicans. They both think American wages and jobs will be damaged. But as House Ways and Means chair Paul Ryan argues, free trade is a positive sum — both sides benefit — not a zero sum.

Export-related jobs typically create higher wages. And one-in-five American jobs depend on trade. Moreover, the spread of market capitalism and free trade in China, India, Vietnam, South America, and parts of Africa has lowered dollar-a-day abject poverty by 80 percent over the past three decades. (Pope Francis, take note.) And with hundreds of millions of people entering the global middle class, America’s low-cost producers are seeing their markets expand.

Of course, a strong corporate tax cut, on a territorial basis, with easy repatriation of overseas profits, would give U.S. businesses large and small even lower costs and greater competitiveness. But the corporate tax cut is not going to happen — at least until after the 2016 election.

So we’re left with a trade deal that may well happen. President Obama is working with Republicans to persuade Democrats to come on board with trade. Obama deserves credit.

Meanwhile, back to the economy, real-GDP (RGDP) growth was barely above water at 0.2 percent in the first quarter. Bad winter weather undoubtedly played a roll. But consider this: A year ago we had a decline in economic growth of 2 percent — again, largely due to the weather — but the next two quarters rebounded by nearly 5 percent.

So if you look at four-quarter trends for perspective, RGDP actually rose 3 percent over the past year. And business investment increased nearly 5 percent, despite a big cutback in energy-company capex.

In addition, exports over the past year increased 3 percent and imports 5.5 percent. People keep telling me the strong dollar is killing our exports. But they forget two things: King Dollar has led to across-the-board price drops, boosting consumer and business real incomes. And if exports keep slowing, blame the lack of production out of Europe, China, Japan, and elsewhere.

And you can’t overlook the very core of the American economy: private consumption plus private investment (C + I). It’s been rising at roughly 3.3 percent year over year for the past several quarters. Not bad. And profits and stock markets hover near record highs.

Then there’s the most underrated factor in today’s economy: zero inflation. This is totally pro-growth. It’s a tax cut.

The Fed’s monetary machinations haven’t worked. The M2 money supply has hovered around 6 percent for years, with nominal GDP (NGDP) around 4 percent. The monetarist experiment went nowhere. And that’s a good thing, as excess bank reserves never circulated through the economy and the velocity (turnover) of money continues to fall. But the strong greenback is holding prices down, including energy. Gold prices have been stable for years.

So NGDP at 4 percent with zero inflation leaves room for 4 percent real growth. It’s a good spot for the economy. But if the Fed had its way and raised inflation to 2 percent, RGDP might be crowed out to 2 percent or less. Why do we want that?

Paul Volcker used to argue that low inflation increases real growth. He was right. But Ben Bernanke and Janet Yellen argue that higher inflation increases real growth. They are wrong.

American economic growth has fallen way behind its long-term performance trend. Instead of 2 percent growth we need 4 or 5 percent.

This leads me to a final thought: It was Arthur Laffer and Robert Mundell who created the ultimate pro-growth mix of monetary and fiscal policy. Keep the dollar sound for price stability and reduce marginal tax rates to rejuvenate supply-side incentives. That mix worked in the JFK 1960s and in the Reagan-Clinton 1980s and 1990s. Add in a strong dose of free trade and deregulation, and the Laffer-Mundell hypothesis will return us to our long-term economic path and renew American leadership worldwide.

Question is, will the GOP take that growth model and run with it?

 

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  1. ParisParamus Inactive
    ParisParamus
    @ParisParamus

    OK, all I want to know is whether the trillions the Fed put somewhere, with the QEs, and the programs that preceded those are still in route to ending civilization, or not, or what.  I never understood all the post 2008-collapse Fed stuff.  Is disaster now baked in the cake.  Also, I’ve never understood where the hyperinflation never happened, or whether it will eventually show up..

    • #1
  2. Clavius Thatcher
    Clavius
    @Clavius

    Yes, I love the positive, factual outlook and I hope to God we get the leadership to take us there. I’ve always told my Clinton (Bill) hating father-in-law that Bill gave us free trade and welfare reform. The Republican Party has a great opportunity here.

    • #2
  3. user_48342 Member
    user_48342
    @JosephEagar

    Larry Kudlow:shutterstock_236267482

    This leads me to a final thought: It was Arthur Laffer and Robert Mundell who created the ultimate pro-growth mix of monetary and fiscal policy. Keep the dollar sound for price stability and reduce marginal tax rates to rejuvenate supply-side incentives.

    Question is, will the GOP take that growth model and run with it?

    This same model nearly destroyed the economy when the second Bush used it in the 2000s, though.  The problem with relying on the same policies for decades on end is that people adjust their behavior to it; the personal savings rate dipped into negative territory in 2005, effectively nullifying the positive economic effects of lower taxes.

    I think conservatives should stick to our current policy mix: rather than pairing tight money with massive fiscal deficits, as Bush did, we should continue to pair loose money with fiscal restraint.

    [edit: I just realized I may have misunderstood Larry’s point.  There are two supply-side tax camps today: a “pro-deficit” one and an “anti-deficit” one. I may have miscategorized Mr. Kudlow as belonging to the first camp, in which case I apologize.]

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  4. Pete EE Member
    Pete EE
    @PeteEE

    Are you in favor of an Asia-Pacific free-trade deal on in favor of giving Obama cart-blanche in negotiating  an Asia-Pacific free-trade deal?

    • #4
  5. user_645357 Coolidge
    user_645357
    @Acook

    The economists keep talking about zero inflation, but in the last six months, these things happened in my life:
    The dry cleaners raised the price for laundering a shirt from $1.75 to $2.00.
    The car wash I choose went from $13 to $15.
    My hair dresser raised her prices across the board by $10.
    Zero inflation? I don’t see it.

    • #5
  6. BastiatJunior Member
    BastiatJunior
    @BastiatJunior

    Joseph Eagar:

    This same model nearly destroyed the economy when the second Bush used it in the 2000s, though. The problem with relying on the same policies for decades on end is that people adjust their behavior to it; the personal savings rate dipped into negative territory in 2005, effectively nullifying the positive economic effects of lower taxes.

    What Larry described isn’t the Bush model.  Yes, Bush was OK on taxes, but he substantially weakened the dollar and increased government spending and regulation.

    What ruined the economy in the 2000’s wasn’t a continuation of the Reagan/Clinton policies, but a dramatic departure from them.

    Trouble is, none of our front runners seem to get it.

    • #6
  7. BastiatJunior Member
    BastiatJunior
    @BastiatJunior

    Pete EE:Are you in favor of an Asia-Pacific free-trade deal on in favor of giving Obama cart-blanche in negotiating an Asia-Pacific free-trade deal?

    Yes on the first part of the question.  On the second part, Obama doesn’t have complete cart-blanche.  The result of his negotiation will be subject to an up or down vote by a Republican congress.  That should limit any socialist poison pills he would put in it.

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  8. user_5186 Inactive
    user_5186
    @LarryKoler

    Clavius:Yes, I love the positive, factual outlook and I hope to God we get the leadership to take us there.I’ve always told my Clinton (Bill) hating father-in-law that Bill gave us free trade and welfare reform.The Republican Party has a great opportunity here.

    It gripes me that Clinton, as president, gets credit for things that Republicans did and forced onto the Dems. Here’s why it’s the Republicans who should get the credit: Clinton left to his own devices would not have done the pro-growth things that got us the extension of the Reagan boom. The essential ingredient was the Republicans. This is much like giving the credit for the end of the cold war to Gorbachev and the Russians — the essential ingredient was Reagan. Without Reagan it would not have happened and certainly not happened when it did and possibly not as peacefully.

    Both of these examples are liberal memes:

    1) Clinton was president, we had good growth — he gets the credit according to the liberals. Yet, what really happened is the build up during Reagan of good will and trust about the economy to the Republicans combined with the Republicans getting control of both houses of Congress for the first time in 40 years. Then, all of a sudden we have surpluses — does a Democrat get that credit? If so, it must be asked what he did when he had a Democratic congress.

    2) Gorbachev was General Secretary, we had the collapse of the Soviet Union because he was so nice that he didn’t send in tanks to Poland, Hungary and Berlin. Does someone who stops doing evil things get the credit for the good things that happen once the evil is stopped? As Bill Buckley said it’s like a man who stops beating his wife — is he a good man?

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  9. user_199279 Coolidge
    user_199279
    @ChrisCampion

    Citing stock prices as another reason for, well, whatever, ignores the Fed’s role in pumping it full of dollars in the first place.  It’s not a sign of economic growth or stability; it’s a sign that the Fed pressing a button every week for the past several years created capital that needed to go somewhere, and much of it found its way to the stock market.

    And it’s not zero inflation.  Just because the basket doesn’t include the goods we all buy doesn’t mean prices aren’t going up.  Oil’s pricing has had a huge effect on dampening price escalation but that’s hardly attributable to Fed policy.  What would the economy look like – as shaky as it is – if that core commodity’s pricing were the same today as it was a year ago?  WTI was twice per barrel what it is today.  If that price had remained stable GDP would be negative.

    I’m still unconvinced of the Fed’s utility in pursuing policies it seems to not understand very well, but plows straight ahead anyway.

    Gold pricing is stable?  That doesn’t look like a straight line to me.

    gold_30_year_g_usd

    • #9
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