Ashby 2008

As I read of the intense dislike that modern fiscal conservatives have for John McCain, I cannot help thinking back to his vote against the Bush Tax Cuts. Republican electoral success over the past two decades has been based on a fantasy of Supply Side Economics, the idea that budget deficits are justified because tax cuts pay for themselves. In support of this idea, modern fiscal conservatives have worked very diligently to change the very definition of the term “fiscal conservative”. John McCain, early on, to his credit, recognized that Supply Side Economics was a fantasy, providing great applause lines during an election but not actually based on the operation of our economy. Again, to his credit, he didn’t think we should risk the future of our country on a self-delusion. When he voted against the Bush Tax Cuts, he did so for the old reasons – it was bad for the economy and morally wrong. McCain acted as an actual old-school fiscal conservative, rejecting the silliness that somehow became Republican Doctrine, and in doing so undercut the fantasy world of the Supply Siders.

Some commentators have suggested that the selection of McCain as the nominee would be the end of the Reagan Revolution. If that is what it takes to get the Republican Party back to fiscal reality, then let’s hope it happens. However, it won’t be John McCain that will have killed supply side economics, it will be George Bush, because he actually tried it. Supply Side, like that other famous economic fantasy, socialism, will have been proven wrong by reality. Modern Fiscal Conservatives are likely to eventually be as bitter and disillusioned as the ex-Socialist. Except of course a lot wealthier. As I read of the State of the Union Address, I couldn’t help but think that this will be the President’s real legacy - the death of supply side economics, and a re-validation of the model for government that developed out of the Depression.

Reading the attacks made me think back to something I wrote in late 2003 about the change in the definition of fiscal conservatism. It is posted below.
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December 2003

THE IMPORTANCE OF A BALANCED BUDGET

I used to know what “Fiscal Conservatism” was. Other labels shifted over time with changing values and historical situations. A “Liberal” of the 1800s has only a passing connection to the Liberalism of today. “Moderate” has always had a fluid meaning. However, the one label I thought was constant was “Fiscal Conservative”, because it was tied first and foremost to one fixed idea: other than in wartime, government should not spend more money than it takes in. A fiscal conservative was a person who believed in a balanced budget, who believed that we should pay for all the government we use, when we use it.

Fiscal conservatives, certainly, preferred a constrained federal government. A balanced budget was the best and perhaps only way to insure that we bought only the level of government that we needed. Economist Arthur Laffer is given credit for making it glamorous, but the law of diminishing returns is an economic truism that applies to any activity, including government. At some point, an extra dollar of government defense spending doesn’t make us any safer. An extra dollar spent on education doesn’t make children any smarter. At some point, we stop benefiting from additional money spent on government. Fiscal conservatives believed that if we have to pay for all of the government we use each year, we are much more likely to only buy the government we need – we will be conscious of the diminishing returns of an ever-expanding government, and choose to deploy our additional resources elsewhere.

Without being too disparaging of the profession, politicians sometimes have a tendency to try to secure votes by promising new services or benefits. If the voters actually get charged for the government they are using, it is much harder for politicians to make promises – they have to convince the voters that the programs they are proposing are something voters actually want to pay government to do. This forces voters to decide if the goal is worth the money and if government is the best tool for achieving the goal, or if they would rather spend the money privately to achieve the goal.

The most compelling argument for a balanced budget was moral – other than in times of war, fiscal conservatives believed that running a budget deficit was morally wrong. A budget deficit forces future generations to pay for government services being used today. Taking a person’s possessions without their consent is theft - a budget deficit is a theft by one generation of the property of another. Children used to go to debtors prison for the debts of their parents. We recognized that practice as barbaric. Why is forcing our children to pay for the government services we are using any different? Why should my grandchildren have to pay for the cost of maintaining the highways I drive on, or pay so that I can go to a national park for free? A budget deficit is the very worst kind of redistributive politics – it is taking money from people who do not have the right to vote, people who are not even born yet.

I used to know what “Keynesianism” was as well. The economist John Maynard Keynes was one of the more prolific commentators on the evolution and development of democratic capitalism. His understanding of how government actions increase or decrease economic demand and impacts the economy is now recognized as a basic description of our economy. Social Security, insuring that people past the working age still have a steady income, helps maintain the level of demand. Unemployment insurance helps protect against drastic swings in demand during economic slowdowns. Government tends to run budget deficits during the slow times, pumping money into the economy to spur growth, and surpluses during the boom times, taking money out of the economy and protecting against inflation. Keynes was one of the first to enunciate this basic macroeconomic ebb and flow of the interaction between the government and the economy.

However, Keynesianism was something more than just acknowledging the government’s impact on the economy. In its mild form, it meant believing that sometimes the government is justified in running budget deficits even during peacetime, if doing so is necessary to soften the swings of the economic cycle and help the economy grow out of a recession. In its extreme form, Keynesianism suggested that unemployment was as great a threat to our country as invasion, and that government had a moral obligation to manage the economy toward full employment, even if it meant permanent budget deficits. Extreme Keynesianism, somewhere deep down, did not believe that the “hidden hand” of the market actually worked, and that it was the government alone that could manage our economy for the greatest good for the greatest number.

Ronald Reagan was the person who started muddling both of these definitions, and in a way, our political discourse still hasn’t recovered. As all good Republicans used to do, Ronald Reagan campaigned in 1980 as a balanced budget fiscal conservative. He also ran on what he described as a new economic theory, Supply Side economics, based on the writing of economist Arthur Laffer.

An economic policy can certainly be derived from the law of diminishing returns. If government has grown too large, then by definition it is spending resources unwisely; we are realizing diminished value for our dollar of expenditures. If we shrink the size of government, resources previously consumed by government will be redeployed to the private sector. The private sector will use these resources more efficiently than government had, resulting in more economic value for the same dollar of spending. This enhanced economic growth would in turn increase tax revenues, which could support additional government services, if appropriate.

The Supply Siders weren’t actually arguing for redeploying capital. Supply Side economists theorized that the stagnation of the 1970s was the result of excessive government spending. Government had grown to the point of diminishing returns, and it was taking resources that the private sector needed for growth. If more money were put in private hands through a tax cut, even if it resulted in the government running a budget deficit, then the economy would start to grow again. Tax revenue would increase, and we would grow out of our deficit.

In eight years, Reagan never once proposed a balanced budget. The Supply Side economics of the 1980s didn’t free up resources, which were being poorly utilized by government – we never actually bought less government, or shrank the size of government. Instead, we just stopped paying cash for the government we were using. Not paying for what you are consuming always picks up the economy. This is the exact same functional tool that Keynesians proposed, massive deficit spending, and it behaved in exactly the way that Keynes predicted it would – it increased demand and helped jump-started the economy. We don’t categorize economic policies by the hopes and dreams of politicians – we look at the tools, the functional level. One of the things that I have always liked about being a Republican is that we try not to lie to ourselves – we try not to talk ourselves into positions, which have no connection to the real world. Supply Side economics is a form of Keynesianism – it is the government using deficit spending to increase demand. It walks like a duck, quacks like a duck – it is a duck. Any person that tells you that supply side economics is somehow different from Keynesianism shouldn’t be trusted with money – they are either lying to themselves or don’t understand economics.

I understand that for political reasons, Reagan couldn’t say that his planned tax cuts were Keynesianism economics – that was the philosophy of the Democratic Party, in the extreme the exact opposite of the fiscal conservatism that has always characterized the Republican Party, and that Reagan himself had campaigned on. Ultimately, this is exactly what Reagan did – he used a bout of massive deficit spending as one of the government’s tools to jump-start the economy. When the first President Bush raised taxes, I was relieved in every possible way. If Keynesianism is to be used as a tool of economic manipulation, this is the critical second part of it – once the economy is jump-started, we needed to actually start paying for the government we are currently using and end the budget deficits. Most importantly, Bush seemed to be reclaiming the core of fiscal conservatism – it is wrong to burden our children and grandchildren with deficits, even if balancing the budget causes immediate political pain for office holders. Raising taxes might have cost Bush his presidency, but it was the right thing to do.

It is worth noting that Reagan’s tax cuts were effective only because they were one of many tools the government deployed. Reagan’s efforts at deregulation and lessening bureaucracy also had a significant impact on U.S. businesses and at a philosophic and spiritual level Reagan made it okay to make money again – he de-stigmatized capitalism. Reagan’s tax cuts worked because they were part of a reasonably coherent economic philosophy and overall approach to re-energizing the economy.

Unfortunately, I have no idea what the current President Bush economic beliefs are. As hard as I try, I cannot make anything he has done fit into any kind of coherent philosophy or strategy. He doubled farm subsidies. Why? He imposed tariffs on foreign steel. As much as I hate to say this about the candidate I voted for, he seems to jump from one political convenience to the next. Now he is talking about going back to the large, long-term deficits of the 1980’s. He is proposing adding over a trillion dollars to our national debt – a trillion. Moreover, this is before the cost of the war, or its aftermath is added on – the war will be more debt on top of the trillion. President Bush doesn’t seem to actually care about the long-term impact of any of his economic policies, or the terrible impact of the deficits he is proposing. Without being too harsh, sometimes it seems he is intent on buying votes now with our children and grandchildren’s money.

It is frightening to think about, but the economic and political situation of his tax cuts don’t remind me of Reagan’s – they remind me of the economic policy of the last president from Texas, Lyndon Johnson, who also cut taxes while paying for a war. The large deficits he created led to the economic malaise and stagflation of the seventies. I pray that this will not be the case, but everything points in this direction. Depression aside, the seventies were one of the worst economic periods of the 20th century for the U.S.

As much as Bush seems a moral person, and talks in moral language, he seems to be missing what I think should be one of the most basic moral principles – we shouldn’t steal from our children and grandchildren. Let us hope that he again remembers the fiscal conservatism that has been the core of the Republican Party for a century. Let us all hope that someone that the President trusts can get through to him that deficits are morally wrong. Running a deficit is morally wrong.

Nothing illustrates the mass delusion that has overtaken the Republican Party more than the Club for Growth. For those who don’t know, the Club for Growth is an organization of very wealthy people who promote the economic benefits of lower taxes. For some reason, the members of the Club for Growth seem to have concluded that budget deficits resulting from the Bush Tax Cuts do not prime the growth of government, don’t distort the economy, and won’t have to be repaid by their children and grandchildren. At some point, all delusions come to an end. At some point, the members of the Club for Growth, (or the member’s children), will likely look back on its positions and conclude that the Club for Growth was instrumental in a larger government and larger tax burden. Yes, the Club for Growth should be re-named the Club for Growth in Government.

A balanced budget has always been the linchpin of Republicanism and fiscal conservatism. A balanced budget was a key tool to control the size of government, limited the degree to which the government could distort the economy, and was morally the right thing to do – it protected the interests of future generations that would be asked to repay any deficit.

Socialism by revolution certainly is the most dramatic, but Republicans have historically recognized that socialism by evolution, a gradual and inexorable expansion of government responsibility, was in some ways a greater danger. We don’t talk about socialism much anymore, but fear of creeping socialism was a primary reason that Republicans were so adamantly against government deficit spending. Republicans recognized that one of the best ways to control the growth of government was to force voters to pay for it as they used it. If voters actually had to foot the bill for the government services being provided, they would be much more likely to examine each proposed service to insure it was worth the money coming out of their pockets. Decoupling government spending from taxes almost guaranteed that the amount of money government spends would grow, and thus the government’s intrusion into our economy and lives would grow as well. People just tend to spend more if they can put it on a credit card.

As importantly, budget deficits undermined belief in the free market. Explicit in a budget deficit is the idea that the free market won’t grow and prosper on its own, that government intervention and control of supply and demand are necessary for the health of our economy. Republicans were concerned that if voters came to accept the idea that the government needed to manipulate and control the economy by pumping money into it to insure growth, then any shortcomings in the economy would lead to demand for government to do more. Once this cycle was started, each swing in the business cycle would result in ever-greater government spending, ever-larger deficits and even greater intrusion into the economy. Who knew where this might lead—would government eventually lose confidence in people’s ability to decide which agricultural products to buy, or to oversee their children’s education?

Strangely enough, the Bush Tax Cuts have proven everything the Republicans always worried about. The deficits have distorted the economy, leading to speculation and instability, and facilitated growth in the size and expense of government. President Bush will go down in history as the Republican President who most increased the size of government and the tax burden on U.S. citizens. Who knew that it would be a Republican President that confirmed the worst fears of the Republican Party?

Republicans also used to recognize that at some point, deficit spending would have to come to an end—our country would actually have to pay for all of the services being provided by our government. Modern fiscal conservatives seem to have this fantasy that in this situation the government would largely collapse, unable to pay for everything it is doing. Beyond the craziness of the idea (“We had to bankrupt the country to get it to spend less money”), Republicans who had lived through the Depression realized that in a democracy the answer is far more likely to be confiscatory tax policy—government would simply increase its tax rates on those who controlled the means of production to pay for the services government provided to those who didn’t. Republicans used to worry that bankruptcy wouldn’t be the end of Big Government—it would be the practical end of private ownership of the means of production. Yes, that’s right – in accepting massive budget deficits the Club for Growth is pushing us down a path that wealthy people used to believe would result in socialism.

This, ultimately, is what’s so baffling about the Club for Growth and the support of the Bush Administration tax policy in general by the wealthy. Certainly, the Bush Tax cuts put more money in this generation’s pockets. However, wealthy people used to understand the difference between a tax cut and a tax deferral. Wealthy people used to know that the only way to actually cut taxes was to cut government spending; in theory people with money understand a balance sheet, and that liabilities eventually have to be repaid. Have the members of the Club for Growth really deluded themselves into believing that the government debt won’t have to be repaid, and that it won’t be their children and grandchildren paying it? Is this what is now considered prudent stewardship? Have the members for the “Club for Growth” really convinced themselves that they are doing their heirs a favor?

I was reminded yet again of some of the lasting effects of the Bush presidency as I read the paper today. An article in the NY Times on OPEC had the following paragraph in it:

“OPEC said the reason prices rose to nearly $100 a barrel in recent weeks had little to do with supply and demand but was a result of trading by commodity investors and hedge funds, as well as geopolitical instability.”

Beyond the obvious impact this Administration has had on geopolitical instability, it is also worth noting that this President has unwittingly increased the amount of speculation on our economy. I talked about this in my paper on sub-prime mortgages, but the tax cuts the President likes to talk about didn’t actually go to business investment or to new business startups. The government tracks those figures, and they did not appreciably change after the tax cuts went into effect. So where did the money go? A very large part of it went to hedge funds, they used it to speculate on things such as mortgages, oil and gas futures.

The bulk of the tax cuts went to the wealthy, or the very wealthy, people who already had everything developed in investment strategies, with a spread of risk. When these people then received their tax cuts, they didn’t put the money into low-risk investments – they put it into high-risk investments, because it was essentially found money. The government doesn’t actually track hedge funds (the subject of a future post…), but hedge fund industry sources suggest that close to a trillion dollars have gone into hedge funds during the Bush presidency. Moreover, the hedge funds had to find a place to put the money, bets to make. Again, no firm numbers are available, but anecdotally it seems probable that hundreds of billions of that money was used to speculate on energy futures. Hedge funds bet that oil prices would go up, and because there was suddenly more money chasing oil futures, they did go up. This is how bubbles work – too much speculative money chases a given economic activity or output, causing the prices to spike upward.

As a side note, I have nothing against speculation – this is an important part of our economy. However, Republicans used to believe that the economy was for all practical purposes a natural organism, with its own internal balance. Deficit spending broke this balance, and led to negative consequences. In this case, the deficit spending greatly increased the amount of speculative capital, which has had a range of negative consequences on our economy. Does anybody else remember the days when the Republican Party actually understood the inflows and outflows of economic activity…?

So if energy prices are in a bubble, they should come back down, right? Unfortunately, not likely. A few years ago, OPEC used to be concerned that if prices went too high, it would cause a global economic downturn, which would significantly reduce demand, and further would cause countries to ration their use and look for alternatives, which would also reduce demand. For this reason, OPEC tried to keep the price within a certain range. I remember when that price range was about $30 a barrel. Now, however, OPEC and the oil producers have had an epiphany – people will pay $100 a barrel, and demand won’t drop.

The Bush tax cuts and geopolitical instability are by no means the only factors driving oil price increases – the industrialization of the third world is also a large factor. However, there was a time when Republicans took the responsibilities of government seriously. They realized that actions of government often had unintended consequences, and they were cautious to protect against government actions which harmed our country. This Administration, surely the worst Republican Administration in history, seems to have the opposite goal – they are intent on having the government do as many stupid things as possible, just to prove that government is incompetent. The next time you fill up, thank the President for the prices you are paying.

Thanks for visiting the Ashby 2008 blog, and reading the first posting. Of all the candidates in the Republican field, Ron Paul to my mind is the most honest and certainly not a “Crack Smoking Republican”. People have suggested that I am more of a Libertarian than traditional Republican. On social issues I am close to the Libertarian view, which I think used to be the mainstream Republican view as well. It’s not so much a matter of being socially Liberal as socially disinterested – I really don’t care what people do in their private lives, as long as they don’t spend my money to do it. However I do believe the government needs to have a defined and in some ways strong role in the economy, as a pre-requisite of a functioning capitalist system.

On economic issues, the Libertarians have chosen conceptual purity over how things work in the real world. Ron Paul’s stance on the Internal Revenue Service is a great example. He calls for abolishing the IRS, which is a great applause line. Traditional Republicans have always seen benefit in comparing the operations of government to the operations of private enterprise. Every company that I have ever been involved with has had a process and usually a department for accounts receivable. Every private enterprise has to worry about collecting the money it is due. Why would the United States of America be any different – why wouldn’t the government need a way of collecting money? Paul talks about moving to a different tax approach. But whether sales tax, value added, income tax – regardless of the tax structure, the federal government will still tax its citizens, and need to have a way to collect the money it is due.

At a broader level, I believe that a defined and in some ways strong role for government in the economy is critical to the health of our capitalist system. Adam Smith talked about the sheep markets as an example of the tenets of capitalism. A key part of the market was that each buyer could have approximately equal knowledge and could know what they were buying – each buyer could evaluate the sheep for themselves. In a modern exchange economy, buyers lack this knowledge. We buy a can of green beans, without actually being able to see the beans. We buy a small part of a company through the stock market, without being able to see any tangible proof of ownership. All of these transactions are possible because of the role played by government – the government insures the integrity of the transaction. Why is this important? Because without the integrity of the transaction being insured, buyers are much less likely to buy from people they don’t personally know, or products they can’t personally inspect. Without the government, a widespread exchange economy can’t happen.

It is worth noting that it is not just consumers that want government in this role – businesses have recognized the need as well. The food safety laws that were passed early in the last century, that allowed the development of national markets for food and the industrialization of agriculture, were supported by major meat packing companies like Armour and Swift. These companies recognized that if that selling processed and canned meat to consumers would require that the consumers trusted that the contents would match the product claims. And the easiest way to give consumers this level of confidence was to put the government in charge of assuring compliance. The meatpacking companies wanted government oversight, to insure consumers that the products were sound and safe. Banks wanted the federal government to insure deposits, to give people the confidence to deposit their money. Banking oversight and government limitations on acceptable risks and leverage were considered a small price to pay, because banks realized without the government’s role in guaranteeing the integrity of transactions the banks would have problems attracting deposits. And of course, no deposits, no loans, no profit.

Something has happened to the Republican Party. It used to be aware of the importance of government involvement in the economy – it used to actually remember what the economy was like before the government started guaranteeing the integrity of transactions. You know, regular depressions and all, runs on banks, periodic widespread fraud. Now, it seems, the party has slipped off into some kind of weird theoretical world, with no connection to what actually happens in our economy. The fantasy world makes for great slogans, but it’s no way to run a country. Unfortunately, none of the current Republican candidates seem interested in rejoining the real world, and realistically addressing the necessary role of government in the economy. I’ve said it before, and I’ll say it again – the most “Republican” candidate in the field is still boring ol’ Hillary Clinton.