America went through an economic malaise during the 1970s. Personal incomes grew faster in those days than they have under the current regime. But inflation was even higher. Real progress was ephemeral. That didn't stop the stock market. It doubled, coming off a low base. Those gains evaporated, though, as the financial engineering of the day reached the end of the line. It took Ronald Reagan to display the necessary courage to restore the economy to a normal footing. And that took Milton Friedman, the leading economist of that era, to design a common sense solution. That approach was termed "monetarism." It was implemented in practice by Federal Reserve chairman Paul Volcker. They scuttled the Keynesian nonsense used by Jimmie Carter's team. In it's place they installed a traditional market based system that let the people decide for themselves where interest rates belonged. Volcker increased the money supply by 5%-7% per year. That accommodated 3%-4% real economic growth, split half and half between productivity improvement and more people working. The remainder provided some inflationary grease to the system. Interest rates fluctuated according to the market's demand for money. Price changes accelerated and then decelerated. Economic activity ebbed and flowed. It all stayed within a normal band. The only real blow-up that occurred was the Savings & Loan collapse. That was the result of federal regulations imposed during the Carter Administration that guaranteed the S&Ls would go broke. The free market worked fine. President Reagan was no genius. But he was smart enough to know that the American people don't need Washington to decide how they should live their lives.
The 2007-2008 financial crisis was treated with Keynesian theories similar to the ones Carter tried. The details were different. But the basic strategy of appropriating the people's freedom of choice is identical. The Federal Reserve decided what the level of interest rates would be. It also created $2.8 trillion of Bernanke Bucks, cash that's been squirreled away in the bowels of the bank. But that's cash that could resurface as the quantitative easing strategy unwinds. Ever since Benjamin Bernanke gained control of the economy immense capital dislocations have taken place. Productivity is below average. Wages are below average. Employment is below normal. Everything is below normal, essentially, except for the people and who benefited from the Government's intervention. Today's situation is completely different from how it would be if the American people been left on their own. That was the case in Carter's time, too.
The question Wall Street is starting to contemplate -- What's going to happen if interest rates return to normal?
Even a minor hike could send the stock market into a significant pullback. Unwinding Bernanke's quantitative easing program will be uncharted territory. Several options are available. None have been used in practice, though. Printing the money was the easy part of Quantitative Easing. Even that scared investors for a while. Un-printing it, aka "removing the punch bowl," usually is less fun. Doing that with techniques that never have been tried before might create real problems. Even if nothing horrible does occur, the uncertainty is bound to exert pressure on market valuations.
A knee-jerk reaction could present an attractive buying opportunity. It could be a great one. Perhaps it's by design. More likely it's just coincidence. Either way, today the M-2 money supply in the U.S. is expanding at a 5%-6% rate. Just like Reagan. The natural short term interest rate might actually be 1%-2% at this stage of the game. It could be that's where it belongs. The unwinding may not represent much of a threat after all. There are any number of explanations. The most obvious is that the rich people really do have too much money now, they won't spend it, and they can't invest it because there aren't enough places to put it. So they stash it in existing stocks and bonds, art, and real estate. The corollary is that Government regulations are deterring investment. It's hard to get a loan. It's hard to get a permit. It's hard to avoid prosecution for violating obscure rules. The supply of investment opportunities is much lower than it should be.
A return to a less centrally controlled economy could unleash another Golden Era. The newspapers and television shows always look at politics as a matter of Democrats against Republicans, or liberals versus conservatives. The real battle in 2016, if you're interested in economics, will be Keynes versus Friedman. Central control versus freedom of choice.
Frankly we've had enough of Bill Clinton and his bond traders. The fellow who reversed Reagan's approach was Robert Rubin, previously the head of Goldman Sachs. "The stock market means nothing. It's all in the bond market." Rubin shoved down interest rates and kept them there, like a tried and true bond guy. He had a few good years as the U.S. technology sector exploded by coincidence, revolutionizing the way people live. Productivity went through the roof. Rubin attributed all that innovation to low interest rates. If you're a hammer everything looks like a nail. If you're a bond trader, it's all low interest rates.
Mitt Romney planned to heave the money changers out of the temple and restore Reagan's formula for growth. He ran a terrible campaign in 2012, though, and lost an election he couldn't lose. Hopefully the Republicans will nominate another pro-growth candidate in 2016. If they don't -- this may sound a little hard to believe -- the best person to get the country moving again could be Elizabeth Warren! Her personality probably rules out any chance of winning. And even if she did, Senator Warren might shoot herself in the foot by over-regulating the economy. But the bond traders would get the boot. That would be a major accomplishment.
Walter Ramsley
Executive Editor
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