Economic Policy: Where Do We Stand Now?

The economy won President Barak Obama his job and the economy is the focus of his agenda. Given the speed of events, it is not too early to assess the administration's economic policy and the key issues confronting us.

The administration's economic policy is a three legged stool. The first leg is the new bank rescue package; the second is its trade policy; and the third is the stimulus package. By the end of last week it already seemed a bit wobbly.

Treasury Secretary Timothy Geithner has the lead on the first two and he had a rough week.


Preventing a banking collapse is crucial. How do we prevent the debacle on Wall Street from destroying the banking system which must fund economic recovery? It was the collapse of the banking system that was the biggest reason an ordinary recession in 1929 turned into the Great Depression.

Geithner introduced the administration’s bank rescue plan on Tuesday and how did security markets react? They dropped like a rock. The stock market fell 4.6% in the first half hour after his speech was released. Bond prices fell. Markets around the world followed suit. Martin Wolf, the associate editor and chief economics commentator at the Financial Times (London), asked "Has Barack Obama’s presidency already failed?" Geithner’s plan lacked specifics and gave no indication that it would work.

Back to the drawing board.

The second leg is trade policy. Protectionism is a monster that must be caged. Trade is so crucial, but seems to be the most backburner of issues in the news. How do we avoid a return to the trade wars of the 1930s? The collapse of world trade was the second most important reason the 1929 recession turned into the Great Depression. The U.S. passed the Smoot-Hawley Tariff in 1930, Canada promptly retaliated before the law was even enacted. One nation after another tried to steal trade from the others by devaluing its currency and/or raising tariffs. As each tried to pull itself up by pulling down its mates, they all crashed to the floor. The nineteenth century's great age of globalization came to a final end. Will we learn from the past? For as Ben Franklin put it, "We must all hang together, gentlemen...else, we shall most assuredly hang separately."

America must lead the battle against protectionism. So far the new administration has been more a source of worry than leadership. As candidate Obama, the President advocated protecting American jobs on the campaign trail. That doesn't help. Congress tried loading the stimulus package with "Buy America" provisions. Even before being confirmed as the new Treasury Secretary, Geithner started out bashing China, but then had to backpedal when the finance ministers of the G-7 (i.e., the main economies) met in Rome. Peer pressure? After all, China's $581 billion stimulus package might do more to help slow the global downturn than Congress's many headed monster. Japan's decline at a double digit annual rate (see yesterday's posting) emphasizes how this is a global economic downturn with each country's decline feeding its falling domestic demand back to its trading partners.

And the third leg is the stimulus package: How do we get the economy jump started? Here the administration left the job of putting a stimulus package together to Congress, an institution whose approval ratings rank below those of former President Bush and used car dealers. The result is a package many people doubt will do the job but will blow up the deficit. It managed to unite the Republican opposition, no mean feat.

So even as the President basks in his Congressional victory on the stimulus package, his economic team is licking its wounds after a tough week. Managing economic policy is proving more difficult than campaigning against the status quo.

Monetary Policy: Meanwhile the Federal Reserve faces the daunting task of being ready to turn on a dime once (should I say "if") normality returns to financial markets. The explosion of the Fed's balance sheet poses major threats to its ability to conduct policy. When it turns the corner of the banking crisis and maybe sooner, the Fed faces the Sylla of a run on the dollar and the Charybdis of exploding inflation. That we should have a Ben Bernanke as Fed Chairman at this peculiar time and place seems providential. I do not envy him.

I must add Ben Bernanke to my ever lengthening list of causes to pray for.

"Booms, Technological Bubbles and Busts."

Milton Friedman died yesterday.

When I was in graduate school in the late 1960s, many of my peers were disciples of Mao and romanticized that thug Che Guevara. They carried around with them The Thoughts of Chairman Mao ("The Little Red Book") as if it were a badge of honor. I vividly remember the ugliness at the American Economic Association meetings when Friedman gave his Nobel Laureate lecture amid angry prrotests and demonstrations.

The "Little Green Book" (his Capitalism and Freedom) was the first book that made me think critically and creatively in economics. From today's vantage point, it appears to have won the long war with "The Little Red Book." His ideas have seized the commanding heights. It is a great irony that the best words to put on his tomestone would be those of John Maynard Keynes, the dominant intellectual force in economics from 1936 to the 1970s and the king whom Friedman deposed:

"The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood . . . Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back."

- J.M. Keynes, General Theory, ch. 24.

Today's Wall Street Journal is a must read. Not only is there a lead editorial on Uncle Milton (no surprise) and a front page article, but they published a new article by Friedman himself ("Why Money Matters") on the editorial page that is a gem. It could as easily have been titled "Booms, Technological Bubbles and Busts." Personally, I can't imaging still writing so lucidly and perceptively at 94. In fact, still breathing would be an accomplishment.

Fellow economist Michael Boskin leaves us with the image of Milton and Rose dancing at her birthday. The perfect signature on a full and fruitful life!

Pray for his soul and the wife who has lost a soulmate. May he be smiling down at us from the true commanding heights.