News From Terre Haute, Indiana

March 19, 2009

Arthur Foulkes: A free market answer to calls for government ‘stimulus’

Recently, an Indiana State University economics professor wrote a letter published in the Tribune-Star critical of my economic analysis of the current recession. Or, as he put it, what I claim as economic analysis.

My critic used the words “outrageous,” “fallacious,” “ludicrous,” “fundamentalist,” “dogmatic,” “historically inaccurate” and, my favorite, “crackpot” to describe my arguments.

(I wonder how he really feels?)

To refresh some memories, my arguments were that the Federal Reserve , by printing massive quantities of money, especially after the dot-com bubble burst and after 9-11, essentially laid the groundwork for the housing bubble (actually, my critic seems to have overlooked this argument).

I also wrote that Fannie Mae and Freddie Mac, both government-created enterprises, helped subsidize home purchases, further inflating the housing bubble.

My column also stated that the government should keep its hands off the economy. Having gotten us into this mess, neither the Fed nor the rest of Washington are competent to get us out. Rather, the market should be allowed to adjust to reality without new distortions introduced by lawmakers and bureaucrats, I argued.

And, as I’ve done many times in this column, I contended that a free-market money, such as money backed by gold, would be superior to our fiat money system. Our fiat system lends itself to the boom-bust business cycle in general and market-distorting bubbles in particular, I also argued.

As far as my “historical inaccuracies” go, I stated that Japan’s experience in the 1990s with a long recession and America’s Great Depression show that government intervention can prolong, rather than shorten an economic downturn.

Several times in this column I’ve tried to explain why I favor a gold-backed money over Fed management of money supply, so I’ll limit myself to writing that when folks in Washington inject large amounts of new money into the economy, they create important distortions. Most important, interest rates can be badly distorted by these injections, and interest rates – believe it or not – are an important market signal. Government tampering with interest rates is, in effect, no different from tampering with any other market signals. The results are just as bad.

My belief that Fannie and Freddie played a role in causing the housing bubble is based on the idea that when government subsidizes something, you get more of it.

For example, if medical bills are paid in part by somebody besides the patients, you’ll see more consumption of medical services. This is based on the law of demand that states that, other things equal, when a price is lowered, consumption rises.

Fannie and Freddie were designed by government officials to purchase mortgages. Because they had implicit government backing (and the perception of safety that the implicit guarantee brings), Fannie and Freddie were able to borrow money at interest rates that were well below what even the most credit-worthy corporations could get.

As a result, these government-sponsored enterprises had little trouble raising lots of capital at a relatively low cost. This gave Fan and Fred the ability to buy more mortgages than could its purely private competitors. It also created a bigger secondary market for mortgage loans, even ones with high default risks. This implicit subsidy, I contend, helped inflate the Fed-generated housing bubble.

As for my interpretation of Japan’s “lost decade” and the Great Depression, I think they are both defensible. The New Deal, which my critic said failed to end the Depression because it was too “timid,” included numerous measures that seriously reduced private property rights and otherwise interfered with market signals.

The New Deal included massive price- and wage-fixing measures that cartelized huge sections of the economy, payments to farmers to take land out of production, fixing many crop and other prices, and jailing producers who tried to sell at their own prices. Indeed, economic historian Robert Higgs lists 40 New Deal acts of Congress that substantially attenuated or threatened private property rights.

All this, in addition to higher taxes and anti-business rhetoric from President Roosevelt, created an atmosphere in the 1930s discouraging to private investors. In fact, Higgs notes, net private investment in the U.S. was actually negative in the decade of the 1930s. In other words, real private capital – the stuff that allows for increased productivity – dropped during the New Deal.

As economist Joseph Schumpeter, quoted by Higgs, wrote in the early 1940s, “The subnormal recovery to 1935, the subnormal prosperity to 1937 and the slump after that are easily accounted for by the difficulties incident to the adaptation to a new fiscal policy, new labor legislation and a general change in the attitude of government to private enterprise…”

So what my critic calls “timid” I view as colossal intervention that crippled the most important engines of economic prosperity: Private property rights and economic freedom. Of course, if you favor near-total government management of the economy, the New Deal, I suppose, would look timid.

Contrary to what my critic wrote, Japan attempted several big fiscal stimulus packages during its “lost decade.” These created lots of opportunity for politicians to buy support, but did little or nothing to create long-term growth. As during the New Deal, private investment in Japan lagged during the 1990s. Per person, Japanese private GDP actually dropped during the 1990s.

It’s true I strongly favor free markets and have great faith in economic freedom combined with respect for private property rights to generate economic prosperity. The richest nations on Earth are also the economically freest. My critic calls my views on this “fundamentalist” and “dogmatic,” but I’m not sure why a similar faith in government intervention is not also dogmatic?

Apart from generating more wealth, I also believe economic freedom and minimal government promotes a healthier society. Economic freedom and private property rights imply that all exchanges between individuals must be peaceful and voluntary. When government becomes involved, force is implicitly or explicitly used. Growth of government necessarily involves the politicization of more and more of society and reductions in individual freedom and, I believe, responsibility.

So my critic and I disagree in our interpretations of history, our values and, I suppose, on fundamental economic theory. And his views almost certainly represent much better than mine those of most (but certainly not all) university professors. But I don’t know that that means my views are necessarily wrong, let alone “crackpot.”

Arthur Foulkes is a Terre Haute native and long-time resident. The Tribune-Star reporter writes a column on business and economics. He can be reached at (812) 231-4232 or