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July 20, 2009

Larry Summers and Obama are Taking the US Economy Down the Road of Economic Ruin
by Gerard Jackson

Lawrence Summers is Obama's chief economic advisor and by all accounts a very smart man. But if he is what passes for smart in the beltway then God help America. Let's take a look at some of the brilliant Mr Summers' economic proposals. He states that the future of the US economy depends on "more export-oriented and less consumption-oriented" policies. Just in case you didn't get it, Summers is proposing that the state direct the pattern of production and consumption.

This is called central planning. It is also pure hubris and betrays a total ignorance of why state economic planning must always fail. The seminal works of Mises, Hayek and Coase exploded the idea that economic direction by any central authority could ever prove superior to the market process. As Coase pointed out, state planning

is imposed on industry, while firms arise voluntarily because they represent a more efficient method of organising production. In a competitive system there is an 'optimum' amount of planning! (The Firm, the Market and the Law, University of Chicago Press, 1990, p. 37).

Summers' idea that directing domestic consumption into exports will expand the US economy should in itself have been enough to have him fired, that is if the Obama team knew any real economics. Another term for economic growth is capital accumulation, which in turn can only come out of savings. Put another way, savings is the process by which the demand for consumer goods (present goods) are directed into the production of capital goods (future goods) in order to produce a greater quantity of consumer goods in the future. That exports have nothing to do with this process should be obvious.

To direct greater production into exports means that capital goods that were used to produce for domestic consumption are now to be used to satisfy foreign consumption. For this to succeed domestic consumption must fall. In other words, Summers is proposing a cut in American living standards.

There are basically two way in which this can be achieved. The first one involves a devaluation of the dollar. A falling dollar raises import prices while lowering the value of American goods in terms of foreign currencies. This should increase the demand for American exports. Summers would expect this increase in foreign demand to be met by exporters commanding more capital goods. Even the most incompetent economist understands that this process involves a cut in living standards.

Summers has left no doubt in my mind that he is aiming for a devaluation. Allow the dollar to sink and export prices to fall without his pals in the White House having to issue any economic edicts. To drive down the dollar he needs more inflation at home. In this respect Bernanke, another Democrat, was being most accommodating when he virtually doubled the monetary base overnight.

Despite the fact that Keynes was something of a hawk on inflation his disciples have proved otherwise -- and Summers and Bernanke are no exceptions. This is why Summers recently downplayed an expected surge in inflation despite the massive increase in the monetary base. But once inflation begins to accelerate further downward pressure on the dollar will become irresistible as prices rise and the demand for imports rises. When this sort of thing happens the central bank usually applies the monetary brakes. However, the possibility that Obama -- with encouragement from Summers and other advisors -- might try to impose prices controls instead of tightening the money supply should not be discounted. Whichever policy is adopted the future looks grim.

Regardless of what Summers recently asserted the US was not on "the brink of catastrophe" a few months ago. There was no awful "abyss" into which the US economy was in danger of falling. The economy was suffering a huge financial hangover, courtesy of the very monetary policy that Summers and Bernanke are now defending. What needed to be done was for the enormous imbalances that a criminally loose monetary policy had created to be liquidated. Bernanke and Summers have stridently opposed this process. The result is that the economy remains moribund while unemployment is still rising. Any inflationary fuelled revival would be short-lived and the subsequent recession particularly painful.

There is no doubt that Summers believes the claptrap he is mouthing. When he claims that the billions provided by Obama and spent by "state and local governments" helped save the economy he means it, even though similar spending programs have never worked before. And they certainly never worked for Roosevelt¹.

We have to look at where Summers is coming from. He's a Keynesian and as such he still believes in the myth of demand deficiency and the discredited Keynesian multiplier. On top of that he subscribes to Clark-Knight view that sees capital as homogeneous and timeless. Hence capital becomes a permanent fund that reproduces itself without the need for savings, which in turn makes capital consumption impossible. Moreover, being timeless and homogeneous also means that capital is amorphous which would make the economy a two-stage process, production and consumption, instead of a highly complex structure consisting of stages of production made up of heterogeneous capital goods.

This dangerous error is reinforced by the GDP approach which categorises consumer spending as the most important economic activity. From there it is but a short step to treating changes in consumption as being responsible for recessions. But GDP is not gross at all: it is, in fact, it is a net product. To argue, as orthodox economists do, that to include spending on a firm's inputs in the national accounts would be double counting is nonsense. This is like telling an accountant that he must not include the cost of inputs in the company books because these are included in the prices of the firm's products².

While the likes of Summers are giving economic advice the future will continue to be grim. Nevertheless, the economic fallacies that he clings to do not in themselves justify Obama's ideological commitment to a massive increase in the size of government, no matter how much damage it does to the country. Therefore I must assume that Summers shares to a considerable degree Obama's leftwing views about the US economy. Perhaps he is fantasising about a "permanent Democratic majority" that will make him the country's economics czar.

1. America's recession: learning the wrong lesson from the Great Depression
2. Defending the Austrian explanation of why consumer demand does not drive the economy

Gerard Jackson
BrookesNews.Com

Gerard Jackson is Brookes economics editor.

Copyright © 2005-2010 Gerard Jackson

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