War or wu-wei

Last week, I explained the purpose of Obama’s $787 billion stimulus bill and why it is doomed to fail. Intriguingly, Wall Street’s massive vote of no confidence in the bill, which saw the Dow Jones Industrial Average drop 6.2 percent last week and smash through significant technical support at 7,550, seems to have shaken the confidence of some of the economists who had most strongly supported the stimulus notion.

I was genuinely surprised to see New York Times columnist Thomas Friedman declare this weekend that he was beginning to feel that spending billions more on GM and Chrysler was “subsidizing the losers” and that the pair of “giant wealth-destruction” machines should be permitted to go into bankruptcy. While it’s true that in vintage left-liberal fashion, Friedman calls for the federal government to hand over the $20 billion that the floundering automakers want to venture capital firms investing in technology instead, the mere fact that a left-leaning opinion leader has begun to grasp the concept that not all government spending intrinsically generates economic growth represents a giant leap forward for the economically illiterate crowd.

But if Friedman’s comments were surprising, those of his fellow New York Times colleague, Paul Krugman, were downright shocking. I have been extremely critical of the Nobel Prize-winning economist, particularly for his complete failure to even begin comprehending the basics of Austrian economics, but it was remarkable to read his Feb. 19 column, in which he departed from the conventional Keynesian myth that has claimed for decades that FDR’s New Deal ended the Great Depression.

Your grandfather’s recession, on the other hand, was something like the Great Depression, which happened in spite of the Fed’s efforts, not because of them. When a stock market bubble and a credit boom collapsed, bringing down much of the banking system with them, the Fed tried to revive the economy with low interest rates – but even rates barely above zero weren’t low enough to end a prolonged era of high unemployment. … [T]he Great Depression did eventually come to an end, but that was thanks to an enormous war, something we’d rather not emulate.

Unfortunately, one can see that Krugman is still clinging to the Monetarist notion that the depression occurred in spite of the Fed’s efforts, which only goes to show that he still has not made the connection between credit-inflated malinvestment of the sort that funneled investment resources into unproductive, wealth-destroying sectors such as the automakers and housing, and the inevitable busts that follow these inflation-induced investment booms. And yet, there are some signs that even the world’s leading Keynesian has begun to recognize that time and markets are a more reliable solution to economic crisis than government intervention.

[C]onsider the plunge in auto sales. Again, that’s bad news for the near term. But at current sales rates, as the finance blog Calculated Risk points out, it would take about 27 years to replace the existing stock of vehicles. Most cars will be junked long before that, either because they’ve worn out or because they’ve become obsolete, so we’re building up a pent-up demand for cars. The same story can be told for durable goods and assets throughout the economy: given time, the current slump will end itself, the way slumps did in the 19th century.

Calculated Risk’s calculation is quite interesting in light of the auto economy I described in last week’s column, in which the 80 excess cars produced in five automotive boom years required eight years for replacement. The truth is that all slumps end themselves as the contraction burns out the malinvested sectors; the only reason that slumps have not ended themselves the way they did as late as 1921 is due to futile government attempts to battle the symptoms rather than the central disease. And since the primary justification supporting these futile attempts is the failed economic theories of John Maynard Keynes, it is a good sign that even long-time liberal Neo-Keynesians are beginning to question them.

The Great Depression finally came to an end in the United States because millions of men were removed from the unemployment rolls and put to work smashing the means of production and reducing the labor pool on two foreign continents. There is no great secret behind the incredible economic growth of the ’50s and ’60s; if GM were to blow up all of the automotive factories in Japan, Germany, Korea, India and China, it would be able to assure itself of similarly explosive growth in its auto sales for the next decade. If Obama wants to end, rather than exacerbate, the current economic contraction, he has two effective choices: Resist the impulse to intervene in the economy or attack foreign lands.

The fact that larger troop deployments and tax increases were announced by the administration last week tends to indicate that Obama will lean toward war rather than wu-wei.

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