By Richard Vedder
Economic downturns probably have less real impact on universities (e.g., on output --enrollment, research activity) than they do on the private business sector. But they do hurt --state appropriations fall, private donations turn down, etc. We may be going into a recession --who knows? No one, however, believes 2008 will be an average or above year for the economy. In other words, the short-term fiscal prospects for American colleges are not particularly good. The dazzling endowment returns of the last few years are over for a while, for example.
However, I am worried that funny money monetary and fiscal policy of a quasi-Latin American variety is about to cause longer term damage to the economy. Ben Bernanke is no Paul Volcker; and George Bush, Nancy Pelosi and company are not the match of the typical political leader of either party of even 20 years ago. We are forgetting the lessons of the past, engaging in reckless and self-defeating economic policies that typically result in stagflation --remember the 1970s?
To stimulate the economy, we are dropping dollars out of airplanes (tax rebates), financed by borrowing funds and/or printing money. On the monetary side, Ben Bernanke panics every time Bob Rubin or others of his ilk plead that the New York financial center is in precarious shape. Bumbling Ben's solution is to turn on the monetary spigot, ordering the fed to buy bonds to lower the federal funds interest rate. This will allegedly help those poor speculators who bought million dollar houses with a nickel's down payment, those stupid bankers (e.g., Rubin) who promoted go-go banking practices at places like Citigroup, etc. But it will also raise inflationary expectations, interfere in market processes, lead to malinvestment (to use the Austrian economists' favorite term), ultimately lead to greater uncertainty, higher interest rates, and stagflation. Already, the inflation rate is creeping up as an academic (Bernanke) disregards the real world wisdom of his predecessors (Volcker and Greenspan). Unemployment is also creeping up. The Phillips Curve is shifting rightward, a sign of stagflation. The Fed's and Administration's answer so far is vintage Juan Peron --cut interest rates more, drop more dollars from airplanes, and turn the world's leading economy into the economic equivalent of a Banana Republic. Is it any wonder that the dollar is tanking worldwide?
Stagflation hurts colleges in numerous ways. Of course, real resources decline (which does not probably impact proportionately on quality, but leads to anguish on the part of the campus communities used to continuing rising opulence). During the 1970s unanticipated inflation actually muted the real increase in tuition prices because colleges did not move fast enough to keep up with rising prices (partly because they only change their prices once a year). Real faculty salaries actually fell for a while. Contributions tanked. Real university endowments fell as the decrease in the value and increase in uncertainty about the future led bond and then equity prices to tank. The go-go endowments managers at Yale, who thrived on multiplying the increments of growth, may have vital body parts removed (figuratively) in coming years as the nation moves into an unanticipated downward spiral.
Am I being too pessimistic? Maybe --probably, even. But I am rapidly becoming pessimistic, not because of the stupidity of our private business leaders or the alleged imperfections of markets, but because of deterioration in our macroeconomic policy in the direction of the failed Keynesian policies of a generation ago.
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11 comments:
For once I find myself agreeing. Stagflation seems to be back. It really hammered the universities in the 70s -- some of them never really recovered, probably most of the public universities.
Another accomplishment of our "conservative" President (with help from Congress, but the President is supposed to lead).
A related issue is the falling dollar. A disaster coming if it continues.
It will really be something if Bush is remembered as Nixon/Ford/Carter on the economy.
tka -- thanks for the exegesis of my comments here. I had forgotten that he referred to academics as "rats" -- in addition to "whores" -- if I am being quoted correctly quoting him correctly.
as for admonition? of what?
It's hard to believe that the money supply is the issue here. I can tell you from first hand experience that it's nearly impossible to get some of the biggest banks to open up the purse strings right now. Consumers seem to be weary as well. So the Fed can pump all the cash into the markets it wants but, if the banks and consumers don't "spend" it, the velocity of money is probably slowing, and would not be behind an inflationary trend.
I think the real drivers of higher prices are supply and demand. Food and energy obviously stand out. Farm subsidies (like Ethanol-this one is especially dumb) don't help. Neither do the SUVs we Americans adore (imagine what happens to gas prices as more Chinese and Indians start to drive). There is simply more worldwide demand for commodities b/c economies worldwide are growing at a good clip. Productivity growth is also slowing and projected to slow domestically.
A falling dollar isn't necessarily a disaster, some parts of our economy will flourish with a weak dollar. That's the beauty of a relatively free market economy, strengths offset weaknesses.
Patrick -- I'm no economist (though I think I'm better than some with the credentials, hah hah). But the falling dollar certainly has an effect on prices, especially energy. In my opinion, it's a disaster for the United States.
An interesting point you raise about the lack of credit versus the argument that there is too much money. But look at food prices. They're driven by the ethanol craze with its subsidies. Does that amount to a form of money creation? I don't know, but it seems plausible to me. Does the huge U.S. deficit and accompanying trade imbalance constitute a form of money creation and concurrent dollar devaluation? Seems plausible too.
sciencedoc, I don't think the falling dollar is as bad as you think. Remember that US assets are now cheaper for overseas investors. For instance, I wouldn't be surprised if some of them are buying dollars and investing in domestic real estate (which of course helps buoy that market). It also means the "rust belt" as it is called is able to compete more effectively overseas since again US export production is cheaper in foreign currencies. There was an interesting piece on TV recently on how our loss of manufacturing jobs is somewhat overblown. In fact, some manufacturers end up coming back to domestic production after failed forays overseas. We still have some comparitive advantages in manufacturing-don't believe the hype.
Taxing and spending (subsidies) doesn't necessarily create new money since all the government is doing is taking $ from the economy and reinvesting them back in our economy. This Fiscal Policy doesn't create new money, however, Monetary Policy does if banks lend and consumers spend those new dollars.
I also don't think that the trade imbalances that are always touted on TV reflect the truth about foreign trade. We have a deficit with China, but they wouldn't accept our dollars in payment for their goods if they couldn't turn around and invest those dollars in our economy. They buy our financial assets like US Treasuries, etc., with the dollars we use to buy their goods (they help finance our economy providing the capital for things like business expansion/investment). I don't think buying financial assets gets reflected in the trade imbalances you speak of. Anybody know the answer to this question (I've been meaning to understand this better)?
I believe the financial instruments is the mirror image, perhaps the exact mirror image eventually, of the trade deficit. They ship us goods and we ship them back "dollars" some of which they "loan" the U.S. government. Whether it amounts to a form of money creation, I don't know, but I suspect so.
I am quite convinced, however, that the runup in energy costs is largely due to the devaluation of the dollar. If the dollar had maintained its value relative to the euro, $100 oil would be something like $78. Not great, but we wouldn't be hearing predictions of $4 gas.
I am very skeptical that degrading the currency helps a country, even helps it to compete overseas in the long-term, even does any good for the balance of payments in the long term.
But I firmly believe that if we allow the dollar to be degraded, we are going to pay for it in the form of deflation, loss of willingness to accept dollars, end of the dollar as the world's reserve currency.
Personally, even if it helps the rust belt, which I doubt, I don't want my own wealth to be degraded in that cause.
I learned some time ago from experience that inflation is a monetary phenomenon. That you can't inflate your way to prosperity. I believe also that a country can't devalue its way to prosperity.
Bush says he wants the market to determine the value of the dollar. Of course.
But the dollar devaluation is a signal from the market that we are doing something terribly wrong with our finances. It's time to heed the message.
We need to let nature run its course here sciencedoc. The last thing we should be worried about is the falling dollar. The banks and investors need to lend, or we're going to have a much more serious problem on our hands. These people are the foundation of money creation, if they fail, well, you know what happens. Bush and Bernanke have done all they can to prop up the investor phsyce-the first-mover (bold) investors have to do the rest.
In the meantime, perhaps Americans need to think about economizing when it comes to fuel. I have to laugh when I hear people say fuel demand is inelastic. That may be true in the short-run, but not in the long-run. People can buy more fuel economical cars and take less long-distance trips, more public transportation, and so on. I was discussing this with a friend of mine not too long ago. Our dummy politicians never point out the obvious things we can do by ourselves to be more economical. There's always some dumb new legislation to be enacted (e.g., ethanol) that compounds the problem. The SUV isn't an inalienable right! I think a little self-sacrifice is a foreign concept to most Americans these days.
I guess we just don't agree. The dollar hit a big new low against the euro today. We are courting disaster. It's not just letting "nature run its course". Currency debasement is not a natural phenomenon -- ask a science doc -- it's a deliberate choice.
Stagflation is not something you can inflate yourself out of. Ask anyone who lived through it back in the late seventies. It took Paul Volcker and Reagan to get us out of it. Tight money and tax cuts and some government spending restraint. It worked. There was a very bad recession. I don't think there's an easy way out. But the further this goes, the harder it is going to be to get out.
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