Analysis: Prologue to the Book of Consequences

For several decades, neo-conservative and other radical economists stayed in the back hallways of academia and Rightist think tanks. In the first half of the 1980s, they had a moment in the political sun, and the practical application of their models was found to be worse than disastrous: the models turned out to be useful only to advance other agenda. In an interview with Bill Greider, Ronald Reagan's Budget Director, David Stockman, explained that no one in the Administration really believed in the Laffer curve effect; the Republican politicians' claim that federal tax revenues would increase if marginal tax rates were cut was just a ruse to starve the federal government of revenues to the end of forcing huge, program-killing cuts in domestic social programs the Right wing of the Republican Party so desperately, and for so long, had wanted.

Not only did the Reagan Administration not think neo-conservative economists' theories would work, they were counting on them not working. And the bet was right on the money: budget deficits during the Reagan years soared, and no perceptible Laffer curve effect was ever observed (although to this day one can find the occasional neo-conservative torturing some pile of innocent data just to get an article published in an obscure journal).

But, driven from the public eye for a time, the neo-cons have finally found a way back; and this time, they'll be much more difficult to chase away in a dignified manner.

The sad truth in economics is apparently that old, repudiated, disgraced theories don't die; instead, they lie dormant, seething in the minds of people waiting for another day when the political sunlight will fall upon their kind. This time, though, the radicals of Republicanism have built a new immune system that will guard them in the short and the intermediate terms against the intense vulnerability of their theories to realities of both the laws of economics and the rules of political gamesmanship.

The calculus of where the economy is headed is quite simple. Mainstream news media outlets bend over backwards to avoid appearing biased, so they avoid describing the future consequences of current political actions, even though the consequences are governed by rock-solid principles of economics and finance that are not open to disagreement among the learnéd. Unfortunately, the neo-conservatives have made a craft of disputing the indisputable, giving observers an impression of debate where none exists.

This is the same strategy used by fundamentalist Christians to present an illusion of controversy regarding evolution. There is, in fact, no controversy at all: evolution is a factual process that governs the descent of living organisms from previous, living organisms. Understanding of the mechanics of how evolution happens is the subject of intense and continuing scientific inquiry and debate; and a similarly intense, scientific inquiry is underway in theoretical and empirical economics to mathematically model and establish the exact parameters governing the micro- and macroeconomic behaviors of economic agents. This is good, solid work; and it has been going on for a long time. It is unglamorous, but it is the important grunt work that makes theory robust and (more importantly) highly useful.

Fundamentalists of the Christian faith do not see an essential need for scientific inquiry. The Holy Bible, in the book of Genesis, sets forth the way in which the world and its creatures came to be. Science in the pursuit of origins is unnecessary, and evidence is to them as a light post is to a drunk: there for support rather than illumination. And so it is with the neo-conservative economists. The data is only as reliable as it supports their unsavory theories. Evidence, overwhelming as it is, that the policy implications have economically dire, completely unavoidable, and socially destructive effects are, at best, a competing idea, and more likely, merely an opinion held by the old-fashioned (read that, "Keynesian") crowd.

Shout down the opposition when necessary; hide within the sanctuaries of your own kind as much as possible; and press your advantage through politicians craven for a constituency, a contribution, and an excuse.


Understanding the economics of what is happening and the grim ends to which it will lead isn't all that difficult.

Interest rates are the price of money. Some of that money—actually, a whole lot of that money—is available for lending. This is the supply of lendable funds market.

On the other side are lots and lots of different economic agents—households, businesses, non-profit organizations, school districts, towns, cities, states, nations, quasi-governmental agencies—that want some of that money. This is the demand for lendable funds market.

If the Federal Reserve stops printing as much money as it used to, the supply of lendable funds will shrink. Whenever just about anything is less plentiful, its price will go up, especially if it's something that everyone wants. So, when the supply of lendable funds contracts, the price of those lendable funds—interest rates—rises.

Now, on the other side of the market, if one of those many economic agents that want lendable funds becomes terribly greedy, then the demand for lendable funds will increase. Like most goods and services, if something like borrowed money gets really popular, its price should go up.

[Ah, but wait a minute! When computers got really popular, their price went down! Yes, but that was because the expected profitability of making computers drew competitors to enter the market, which caused supply to increase rapidly, pushing prices lower. Also, in the case of computers, the technology for building them got more and more efficient, so the cost savings were being passed along to consumers by the aggressively competitive entrants to the supply side. With money, there's only one manufacturer, the Federal Reserve (as the agent of the U.S. Treasury), so no competitive force exists to push supply outward when the Fed wants to push it the other way.]

So, the supply of lendable funds is contracting, which pushes interest rates up; and the demand for lendable funds is rising, which also pushes interest rates up. Put those two together, and the result is obvious: interest rates will go up.

Now, here's the bad part. People and businesses are not stupid: when something becomes more expensive, they'll demand a smaller quantity of it to the extent that they possibly can. But the federal government doesn't work that way: it will pay whatever it must to get the lendable funds it needs. So while the rest of the country backs off borrowing money, the federal government will just keep borrowing and borrowing as long as it has projects for which it wants money it doesn't have.

For the current year, the federal government will need to borrow about $440 billion dollars to pay the excess of its expenditures over the tax revenues it collects. Next year, it will need to borrow a similarly large amount of money for the same reason.

And above all of these federal deficits that the Bush Administration has been racking up, the government now says that it will need a whole lot of money besides this to pay for the partial privatization of Social Security. How much is a 'whole lot'?

Try maybe two trillion dollars. That's right: $2,000,000,000,000!

Now, put the economics together.

• The supply of lendable funds is being reigned in by the Federal Reserve. That drives interest rates up.
  
• The demand for lendable funds is pushing outward because the federal government simply must pay its bills, and it is hundreds of billions of dollars short every year. That drives interest rates up.
  
• The demand for lendable funds is about to go into the stratosphere because of a special need for another $2 trillion. That will drive interest rates up.

So, where are interest rates going? Here's a hint: UP!

Finally, what do people and businesses in the normal world do when the price of anything goes up? Why, they want less of it, of course.

People will want less borrowed money for cars, refrigerators, vacations, new homes, old homes, additions to their existing homes, new false teeth, elective surgeries, and all kinds of other things that borrowed money can buy in the here and now. And with interest rates being high, any extra income won't fill the gap of consumer purchases. No siree: high interest rates mean that money put in the bank is a better deal than money spent on new goods and services.

And businesses will want less borrowed money for working capital management, for research and development, for capital improvements, for new buildings, new restaurants, new shopping malls, new advertising campaigns, etc. And with interest rates being high, profits won't fill the gap of investment. No siree. High interest rates mean that money put in the bank is a better deal than money invested in new plant and equipment.

By the way, the last sentence in each of those last two paragraphs is the gist of an old adage about how saving money is an individual virtue but a collective catastrophe in a consumer society such as ours.

And all of this is not disputable. It is the way the world of rational economic agents works, and it will come about, now. The neo-conservatives can deny the principles of economics all they want—they can have their political thugs bully and intimidate reasoned voices into silence; they can make the mainstream media's untrained journalists think there are different possible outcomes, some of which are favorable—but that changes nothing about what will really happen. All it changes is how long it will take before voters finally put the antecedent of bad economic theory together with the inevitable consequence of bad economic times.

That, of course, means two things: first, the economy will get a lot worse; and second, the neo-conservative radicals this time will enjoy the limelight for a bit longer before they are rightfully blamed and ridden out of town on a rail.

Of course, given their track record over the past several decades, they should know their own way out of town by now.




The Dark Wraith has spoken.