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"The Same Failed Policies"   February 9th, 2009
Fiscal conservatism isn't the "same failed policies" that got us where we are       


More observations...

As President Obama ratchets up the partisan rhetoric in his effort to convince the American public of the necessity of his stimulus package, a curious message is being repeatedly utilized: We can't resort to the same failed ideas of the last eight years that got us into this mess.

I call this message "curious" because it implies two things: 1) That the current crisis was caused by the policies of President Bush. 2) That President Obama's solution is somehow different than the policies of the last eight years.

What's curious is that neither of those two implications is true.

The Cause of the Current Crisis

A quick review of the causes of the current situation is in order.

While there were arguably a number of contributing factors, the primary causes of the financial crisis were:
  1. Subprime Defaults. A significant increase in the number of foreclosures in the subprime mortgage market.
  2. Credit Default Swaps (derivatives). The increase in foreclosures caused a much larger change in the value of hard-to-value financial derivatives known as credit default swaps.
Both of these issues are more completely discussed in one of my previous articles.

In addition to the crisis in the financial sector caused by the above factors, we are simultaneously experiencing a more typical cyclical recession that has been exacerbated by the fact that the previous boom was, in large part, caused by an unsustainable level of borrowing.

While the excessive borrowing would have eventually collapsed under its own weight as consumers and businesses reached a debt level that would have made further borrowing nearly impossible, the boom came to a screeching halt sooner than it would have due to the crisis in the financial sector. The financial crisis caused a drastic reduction in the amount of money that consumers and businesses could borrow which immediately put the brakes on the unsustainable borrowing and spending.

In addition, all the news of economic gloom and doom has led to consumers scaling back their spending and, instead, hoarding their money as they have a general lack of confidence in the economy.

So, in summary, our current situation has been caused by:
  1. Subprime defaults.
  2. Credit default swaps.
  3. Excessive consumer borrowing.
  4. A lack of confidence in the market.
What "Failed Policies" Caused the Crisis?

When the president refers to "the same failed policies that got us into this mess in the first place" , it's clear that he's referring to the previous administration. This is further confirmed by Lawrence Summers, the head of his administration's National Economic Council, saying "Those who presided over the last eight years - the eight years that brought us to the point where we inherit trillions of dollars of deficit, an economy that's collapsing more rapidly than at any time in the last 50 years - don't seem to me in a strong position to lecture about the lessons of history" . And in Obama's first press conference on February 9th, 2009, he specifically referred to the failed policies of the "last eight years."

Recognizing that President Obama has taken to blaming Bush for the current situation, it would be very interesting to be able to ask him what "failed policies" he is referring to. What are the policies that President Bush instituted that lead to the current crisis?

The major policies of the Bush administration which had a potentially large fiscal impact are:
  1. 2001 Tax Cuts. The Bush tax cuts, largely promoted to help stimulate a struggling economy, supposedly "cost" $135 billion per year . However, by FY2007 federal receipts were still 39% higher than in FY2002 and, according to the cost estimate, the tax cuts have amounted to $1.1 trillion over the last eight years.
  2. Iraq War. According to current estimates, the War in Iraq has cost approximately $596 billion through February 2009.
  3. Prescription Drug Benefit. President Bush championed the prescription drug benefit addition to Medicare which was reported to cost between $72 billion and $120 billion per year . Considering it went into effect in January 2006 , it can be assumed that, on the outside, this program has cost the federal government no more than approximately $360 billion to-date.
If I'm forgetting any other programs instituted by Bush that significantly changed fiscal policy, I'd appreciate it if someone would let me know. However, those are the three that I recall. And while it could be argued that they have increased the national debt by $2.1 trillion, I don't believe that a persuasive argument can be made that any of those policies led to the subprime crisis, credit default swaps, excessive consumer borrowing, or a lack of confidence in the economy.

In fact, Lawrence Summers--in a keen example of contradicting messages--also said "We want to get the private sector to take responsibility for a situation that in many ways was created in the private sector" . It seems that the Obama administration isn't sure who they want to blame: Bush's administration or the private sector.

What Policies Does President Obama Propose?

In a nutshell, President Obama proposes borrowing and spending a lot of money. How much money and on what items is still up in the air as the Senate passes their version of the package and then negotiates with the House to reach some kind of agreement. However, it currently would seem that the total cost will be in the neighborhood of $850 billion (that's up from the $75 billion plan Obama advocated a year earlier during the campaign ).

Regardless of whether one chooses to believe that Keynesian deficit spending is beneficial or not, the fact of the matter is that it doesn't seem that Obama's stimulus package will change anything that President Bush instituted during his administration.

Obama's package will not repeal the Bush tax cuts (doing so would be economic suicide during a recession). It does not address the War in Iraq. It does not change the Prescription Drug program that Bush passed. And it turns the deficits, for which Bush was rightly criticized, from hundreds of billions of dollars to trillions of dollars per year.

If President Obama is so eager to distance himself from Bush's policies, why isn't he undoing Bush's spending policies? And if Bush did something wrong by doubling the national debt in eight years, why does Obama think we should spend money at a rate that--if sustained--would increase the national debt by the same amount of money in only about three years?

The fact of the matter is that if the president truly wanted to distance himself from Bush's policies, he would cut spending. Instead, Obama is trying to lay the blame on Bush's policies but then proposing to continue and expand those very same policies. President Obama is criticizing Bush's policies while pretty much doing the same thing.
    Update 2/11/09: While referring to Geithner's financial system plan, the following quote could equally be applied to Obama's stimulus plan: "The markets are looking for real clarity, and Geithner is very good at critiquing what went wrong in the last year, but just seems to be perpetuating it."

    Update 2/27/2009: Speaking of Obama's budget, Democratic Rep. Gene Taylor of said "change is not running up even bigger deficits that George Bush did." Even Democrats are recognizing that Obama's policies are more of the same.

What Does the Record Say?

In Obama's first press conference, the president declared that "tax cuts alone" cannot solve the problem. He claimed that that was proven by the Bush Administration.

In fact, the opposite is true. In response to the recession of 2001 that followed the dot-com bust, the only significant response on the part of the government was the Bush tax cuts. Everyone that paid federal taxes benefited from that cut slightly in 2001 (half a percentage point decrease) and then more significantly in 2002, 2003, and thereafter. The recession was quite short in length and mild in severity. The unemployment rate topped out at 6.3% in June 2003 and the recession itself only lasted eight months --just two months longer than the minimum definition of a recession.

Of course analysts can argue as to whether or not the severity and length of recession was reduced by the tax cuts or whether the economy would've turned around anyway. But what can categorically be rejected is the assertion that Bush's administration demonstrates that tax cuts don't work. Tax cuts were the only government response during the Bush administration and the recession was one of the mildest in recent history.

On the other hand, during the Great Depression, the federal government increased tax rates and engaged in stimulus spending. Not surprisingly, GDP did increase (since, by definition, increased spending will increase the GDP). But unemployment and the generally bad economic situation lasted a decade and didn't recover until the Second World War.

During the 1990's, the government of Japan engaged in a series of stimulus packages to try to jump start its economy which had been stung by a recession that was triggered by a situation very similar to ours: easy credit, risky loans, and unreasonable asset bubbles. The stimulus packages attempted to reduce the pain and stop the bleeding, but ended up just drawing it out.

In Obama's first press conference he suggested that the reason it failed in Japan was because the government waited too long before pushing stimulus packages through. However, that's a completely theoretical assertion that must be accepted on faith. We simply do not know whether Japan's economy would have recovered faster had the government acted sooner.

Liberals subscribe to Keynesian economics which advocates the government engaging in deficit spending to jolt an economy out of a recession. But the fact of the matter is there is no concrete evidence that it works. A decade of Keynesian spending didn't end the Great Depression--it took World War II. A decade of Keynesian spending didn't seem to help Japan, but liberals suggest that's because the spending didn't happen soon enough. The U.S. Government has been engaging in Keynesian/deficit spending for half a century--during which time we've had six recessions . And President Bush's astronomical deficit spending--a $1 trillion deficit last year--hasn't prevented our current recession. Yet we are to believe that doubling that deficit to $2 trillion will finally work?

While one can argue whether or not tax cuts have helped us get out of recessions, at least there are examples we can point to where it seems they did. The same can't be said for Keynesian deficit spending. Rather, it seems that excuses must be made to justify the lack of success of such deficit spending.

The Same Failed Policies: Deficit Spending

President Obama is right when he says that we can't go back to the same failed policies. But he's wrong when he suggests that those are Bush's policies. Obama's proposal is essentially Bush's deficit spending on steroids. In reality the "same failed policies" are the deficit spending policies that didn't help us in the Great Depression, didn't help Japan in the 90's, and didn't help Bush avert the current recession.

    Update 6/9/2009: Four months after writing the above, a CNN article made the same point using almost the same expression:

    All told, Bush raised spending from 18.5% to 21% of GDP, setting in motion a chronic budget gap by piling on new spending without paying for it. Under Obama the Bush trend keeps going, but this time on steroids.

While I can accept that a recession is a good time for the government to engage in infrastructure spending that is needed anyway, and which will provide long-term use and benefits, only about $50 billion of the current package appears to be on that kind of long-term infrastructure. The vast majority of the debt that we're generating is for government spending that will produce no tangible long-term infrastructure. And the Congressional Budget Office estimates the stimulus package will actually result in a long-term reduction in the output of the country.

So we're looking at a "stimulus" package that attempts to reduce short-term pain at the cost of long-term growth and produces relatively small amounts of long-term infrastructure that we can claim we're handing down to our children. To the contrary, we're saddling our children with $850 billion in debt and a less productive economy in exchange for perhaps $50 billion of tangible infrastructure.

If our children think that spending $850 billion for $50 billion worth of roads and bridges is a good deal then we have failed in our public schools.

The Party's Over

Interestingly, President Obama had a very interesting moment in his first press conference when he said:

"If all we're doing is spending and we're not making things, then over time other countries are going to get tired of lending us money and eventually the party's going to be over. Well, in fact, the party now is over. "

What was interesting is that after he uttered those words he had a rather awkward pause that is not reflected in the transcript. As I was watching I simply thought, "Yup, Mr. President, wait for it... the realization that you did indeed talk yourself into a corner."

The party is over. And it's borrowing precisely like this stimulus package which has typified the party. But even though the president realizes the party is over, his solution is apparently to slam down a few more beers before we drive home from the party without a designated driver.

Which is consistent with his town hall earlier in the day when he said "But I'm always good for a beer." Which isn't surprising. You really need to have a lot of beers to think this stimulus package is a good idea.

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