Rx for Economic Pain

It's time to face some uncomfortable truths

Steve Chapman | August 4, 2008

Former Texas Sen. Phil Gramm got in trouble when he said Americans are mired not in an economic contraction, but a "mental recession." He soon had to step down as co-chairman of John McCain's campaign for committing the ultimate political sin: telling the truth about a misperception that happens to be very popular. In politics, after all, it doesn't matter who's right—it only matters who has the most votes.

Americans feel as though the economy is in a recession and want the government to do something about it. In reality, it is expanding. In the second quarter, it grew at a respectable inflation-adjusted rate of 1.9 percent, double the pace of the first quarter. Unemployment was up, but it's still a pretty mild 5.7 percent.

The recession cures being bandied about by the presidential candidates and others miss the real source of our current pain and what can be done about it—which is not much.

"There's a great misunderstanding of what's happened," says economist Allan Meltzer. The main trouble, in his view, is not that Americans are suffering from weak or negative economic growth. It's that they have suffered a loss of wealth, a very different ailment.

Meltzer, a professor at Carnegie Mellon University and a scholar at the American Enterprise Institute, explains that the loss stems from two major factors. The first is high oil prices, which are the equivalent of a huge tax increase. The second is the housing bust, which has vaporized more than a trillion dollars worth of assets.

What does all this mean? Our standard of living has declined. Or to put it bluntly, as Meltzer does, "We're poorer than we were, and it's unpleasant, but it's a fact." We can no longer afford all the things we used to, because so much of our income is now going to pay for gasoline.

In the past, we might have cashed in our rising home equity to keep consuming at the same rate as before, but you can't do that when your home equity is shrinking. Plus, we are under pressure to save more, since we can't count on real estate profits to finance a comfortable retirement.

When the economy contracts, the government may use sound monetary and fiscal policy to help revive growth. But when wealth goes up in smoke, the government can't necessarily bring it back. If it tries, the effect is likely to resemble what happens when you give a recovering alcoholic a drink: deceptively pleasant at first, but ultimately calamitous.

In the 1970s, the Federal Reserve reacted to soaring oil prices by creating more money and spreading it around. When you have more money, it doesn't hurt so much to fill your tank. But when everyone suddenly finds themselves with more money, the consequence is inflation. In the 1970s, instead of seeing just the price of gas climb, we saw the price of everything climb.

Today's Fed faces the same temptation. It could ease today's discomfort by rapidly expanding the money supply, and some experts (including Meltzer) think it has already made that mistake. This course is particularly tempting because it could also keep home prices from falling further.

But the remedy is illusory. Homes are not worth what they used to be, and for the Fed to attempt to disguise the fact would create even more uncertainty in a turbulent market. That, in turn, would merely postpone the day when prices hit the inevitable bottom.

When you have a loss of wealth, the best way to cope is to accept it and adapt to a lower standard of living, sooner rather than later. Sending out rebates, eliminating gas taxes, bailing out homeowners and accelerating monetary growth, among the proposed remedies, do exactly the opposite. They spare us the obligation of dealing with reality by making us feel richer so we can keep on as we were before.

But they don't change the stark fact that we are poorer now and will remain that way for some time. And they ultimately backfire by wasting money, igniting inflation or both.

In the long run, we will adapt to the new realities, the economic impact will moderate, and the pain will fade. Till then, our least destructive option is to do something no politician would dare suggest: Suck it up.

COPYRIGHT 2008 CREATORS SYNDICATE, INC.

Comments

|8.4.08 @ 7:05AM|#

An article about the dangers of the fed increasing the money supply that doesn't mention the gold standard? Cosmotorians!

Merna Moose|8.4.08 @ 7:21AM|#

If we were on the gold standard we wouldn't have all these economic problems. Oh wait I almost forgot.

And we have to let in ALL the Mexicans. And we have to let gays marry, adopt kids, and whatever they want. If we could just keep the government out of our bedrooms, we'd never have any economic problems.

Yeah, that's it.

|8.4.08 @ 7:44AM|#

And then you get the WaPo publishing a letter today from some DC moron who said that we need to enact Nixonian price and wage controls to keep gas at $2.50/gallon. Who cares if it hurts the oil companies. Give 'em another one where it hurts!

When people are at this level of stupid, there isn't much you can do to save them from their bliss...or us from their vote.

VM|8.4.08 @ 8:20AM|#

hay merna.

ever since you behaved the way you did at the reunion, you've been kicked out and returned to the Cow family.

ptttfff.

"gold standard"... mein gott. just wait for those types to show up!! hooooooo-wheeee!

squarooticus|8.4.08 @ 8:32AM|#

The linked article is a decent analysis. Inflation isn't about paper money; it's about a growing money supply. The issue for "gold bugs" isn't that it's theoretically impossible to manage a paper money supply well; it's that it's practically impossible, because that would require the people in charge to ignore the state of the economy and concentrate only on the size of the money supply. Good luck: these people are appointed by politicians and increasingly are politicians themselves. Once a central bank decides preventing recessions or "growing the economy" is part of its mandate, an inflationary spiral is inevitable.

|8.4.08 @ 8:40AM|#

Phil Gramm's comments were stupid and wrong for most Americans even if they were statistically correct in macroeconomic terms. Fact is, a majority of Americans are hurting or hurt by higher energy costs, are scared by falling home costs, and really want government to reassure them. Telling them it's all in their head just isn't what they want to hear, isn't actually true, and won't be a winning strategy.

I understand the urge here to tell government not to react or overreact, but there's a big problem with that approach: they'll continue to do what's already gotten us into this problem. The tough solution isn't to not make it worse, but to fix the problems. Sometimes things need maintenance, sometimes they actually need to be fixed.

Nigel Watt|8.4.08 @ 8:59AM|#

Yeah, the economy's growing if you believe the government's inflation numbers.

squarooticus|8.4.08 @ 9:08AM|#

Nigel Watt | August 4, 2008, 8:59am | #
Yeah, the economy's growing if you believe the government's inflation numbers.

Yeah, I forgot about that part. :-/ Strange how few people question the government's financial numbers, when the government is the primary beneficiary of those numbers being artificially high.

adrian|8.4.08 @ 9:38AM|#

why should i suck it up for a problem that i didn't create? who is responsible for the wealth destruction? who is responsible for the increasing money supply? war - dollar value - instability due to foreign policy, none of these are my fault.

|8.4.08 @ 10:00AM|#

Fact is, a majority of Americans are hurting or hurt by higher energy costs, are scared by falling home costs, and really want government to reassure them.

The higher energy costs are biting, sure, but for most people the actual impact is probably less than they think. As for falling home costs, unless your house is on the market, or you are (stupidly) financing your lifestyle by borrowing against your house, what impact does it have?

Telling them it's all in their head just isn't what they want to hear, isn't actually true, and won't be a winning strategy.

The impact of rising energy prices is probably overestimated in their heads, the impact of falling home prices is entirely speculative for most people (and thus, yes, in their heads not their pocketbooks), and wanting the government to reassure you is, in fact, entirely in their heads. I don't see where he was wrong. Impolitic, sure, but not wrong.

|8.4.08 @ 10:08AM|#

This clearly isn't an economic downturn. I only know 4 people who have been laid off due to downsizing.

|8.4.08 @ 10:17AM|#

I like the Democrat idea of tapping into the strategic oil reserve, because supply matters. I don't like the Republican idea of more drilling, because supply doesn't matter.

But what I want most is a gradual and sustained increase in energy price:
http://www.youtube.com/watch?v=AJLdHfIBnr0

RC, how much is a gallon of milk?

|8.4.08 @ 10:21AM|#

Democrat,

How much is a gallon of milk relative to the overall disposable income of your average American family?

|8.4.08 @ 10:29AM|#

The GOP has foisted the greatest tax increase of all time on the US public by doubling the national debt - it matters not that the bill has yet to be handed off to the gullible taxpayer.

But it will be - by some do-gooder elected realist attempting to right the budget someday. I pity that poor fool.

|8.4.08 @ 10:44AM|#

MP, maybe that was too subtle. I was suggesting RC is out of touch. Remember when Bush the elder was asked how much a gallon of milk cost, and he had no idea? Just because you or I can afford to piss away an extra $200 per month on gas (booze, drugs, whatever) doesn't mean everyone or even most people can. (cue violin music) A single mom with 3 crotch-fruit who only earns $8.50 per hour brings home about $300 per week. This times that minus some expenses, throw in some evil Republicans and their tax cuts for the rich, and she's screwed.

|8.4.08 @ 11:02AM|#

FWIW, a gallon on milk, after a brief uptick, has fallen back to $2.99 at my local NH Market Basket. In fact, most of the food inflation I've seen recently has been with beef products, and that has even retracted lately.

But yes, commodities inflation hits hardest on people who live paycheck to paycheck. But still, I wonder if there's been some deflationary trends in residential rent rates that would offset that? You can't have housing prices drop through the floor without a corresponding drop in rents.

|8.4.08 @ 11:24AM|#

Wouldn't increasing the nominal value of housing through inflation help since the amount of debt is fixed? It wouldn't make people wealthier, but it would have the effec of allowing people who are underwater and can't afford their homes the ability to sell as opposed to default/foreclosure.

Kolohe|8.4.08 @ 11:54AM|#

You can't have housing prices drop through the floor without a corresponding drop in rents.

There was a spike in housing prices without a corresponding rise in rents.

|8.4.08 @ 11:59AM|#

RC, how much is a gallon of milk?

Beats the hell out of me. I only buy a half-gallon at a time, and only as part of the weekly grocery run, where it is a very small part of a very full basket. Over the last year, my monthly outlay for groceries has been essentially flat (its kind of a noisy metric, varying as much as 20% from one month to the next.)

Just because you or I can afford to piss away an extra $200 per month on gas.

I have a 50 mile round-trip daily commute, and my monthly gas bill has only gone up about $50-60 dollars. How much (and what) are you driving?

I track all my expenses in Quicken, so my gas and grocery outlays are not impressions or anecdotes, BTW.

This times that minus some expenses, throw in some evil Republicans and their tax cuts for the rich, and she's screwed.

How on earth does a tax cut for someone else make life harder for a single mother?

|8.4.08 @ 12:03PM|#

Or to put it bluntly, as Meltzer does, "We're poorer than we were, and it's unpleasant, but it's a fact."

Or as swill puts it, we're poorer than we thought we were.

All of you advocates of returning to a gold standard need to learn the difference between real and nominal prices. A gold standard is not going to positively impact your standard of living. Fiscal control in Washington...that's another story.

Kolohe|8.4.08 @ 12:03PM|#

Wouldn't increasing the nominal value of housing through inflation help since the amount of debt is fixed?

Helps everyone who has the debt, yes. Helps everyone who is owed the debt, no. Helps everyone who sat on the sidelines, no. Helps everyone who is looking for 'affordable housing' no. Helps everyone who is retired and living off their savings, no. Helps everyone who doesn't save and lives beyond his/her means, yes.

LarryA|8.4.08 @ 12:30PM|#

Wouldn't increasing the nominal value of housing through inflation help since the amount of debt is fixed?

No. Inflation reduces the value of money, which raises the price of everything, not just houses.

LarryA|8.4.08 @ 12:53PM|#

Wouldn't increasing the nominal value of housing through inflation help since the amount of debt is fixed?

Oh. You didn't really mean "inflation?"

There are basically three kinds of people in the housing market. Those who want to sell their house, those who want to buy a house, and those who want to hold what they've got. (Home equity loans are a form of selling a house, particularly if you default.)

Those who want to hold, whether that means continuing to own a house or continuing not to own a house, are largely unaffected by housing prices.

Increasing the nominal value of houses will hurt buyers.

Increasing the nominal value of houses will help sellers only if they can find a buyer. Therefore the positive effects of raising the nominal value of housing for sellers are offset by the negative effects on buyers. This is aggravated in the case of most homeowners, in that if they sell the house they're living in, they have to find a new place to live. Therefore many of the sellers will immediately become buyers, and get shafted again.

In the real world, of course, what should be a simple economic equation gets screwed up by government intervention.

squarooticus|8.4.08 @ 1:00PM|#

A gold standard is not going to positively impact your standard of living. Fiscal control in Washington...that's another story.

I think the primary argument the small-government advocates of the gold standard make is that fiscal control in Washington is not possible when the government can print money without restraint. A gold standard (or at least a free market in currency where "gains" made by saving in a currency that doesn't lose real value are untaxable) reinstates that kind of restraint.

|8.4.08 @ 1:15PM|#

I find it particularly important for people to understand that as Steve Chapman says "eliminating the gas tax will make all of us poorer". The gas tax is a gret thing, it helps us maintain the wealth that we have and America would be a desitute place today if we had never implemented the gas taxes we now enjoy. Only old fashioned simpletons with outdated economic theories believe that americans can be trusted to spend their own money...no we need to make sure to keep as many taxes around as possible or else we will not learn to get used to a lower standard of living and this would be a real tragedy.

|8.4.08 @ 1:26PM|#

I think the primary argument the small-government advocates of the gold standard make is that fiscal control in Washington is not possible when the government can print money without restraint.

I agree that there is no evidence that elected officials in Washington will be held accountable to their oaths to the Constitution, but unfortunately the presence or lack thereof of a gold standard is not going to change the amount of work you have to do to purchase the fruit of someone else's labor. The government does a lot to determine how much work you have to do to have enough left over to purchase the fruit of someone else's labor, however.

|8.4.08 @ 1:39PM|#

Heh.

|8.4.08 @ 2:28PM|#

All valid points, except the author misses that our wealth before was illusionary. We lived beyond our means for too long, and must now start living within it. Both as individuals and as a nation. We tried to consume our way to a wealthier nation, but that's not how wealth is created. Wealth is only created through hard work and savings. Those are the values that America was founded on, and the values that made it great. When we get back to those things will start to turn around.

squarooticus|8.4.08 @ 2:37PM|#

I agree that there is no evidence that elected officials in Washington will be held accountable to their oaths to the Constitution, but unfortunately the presence or lack thereof of a gold standard is not going to change the amount of work you have to do to purchase the fruit of someone else's labor.

Who's arguing that? What advocates of gold-as-money argue is that a gold standard (or free market money/competing currencies) eliminates the ability of the government to steal from you behind your back by devaluing your savings, making saving money more appealing and going into massive debt much less appealing. If the government eventually had to obtain all of its revenues through taxation-as opposed to through taxation plus inflation-the amount of debt it could take on would be far more limited than it is today.

The government does a lot to determine how much work you have to do to have enough left over to purchase the fruit of someone else's labor, however.

Sure. But as we've seen over the last 45 years, reducing taxes is (generally) a political winner, while reducing spending is (generally) a political loser, because there is no incentive to do so: the two are not incompatible when the government can counterfeit the money that everyone else is forced to use.

Of course, deficit spending only works for so long before our creditors wise up and realize that we're never going to pay them back. It remains to be seen whether the great Foreclosure of the United States has arrived or not.

squarooticus|8.4.08 @ 2:39PM|#

Minor revision to my last post: "the two" = "lowering taxes and spending more".

|8.4.08 @ 2:52PM|#

"Beats the hell out of me."

RC, Ha! My little yellow journalism 101 trick worked. You don't even know what all the poor people pay for a gallon of cow juice. Just like that no good ol man Bush.

"How on earth does a tax cut for someone else make life harder for a single mother?"

You greedy bastardo - just play along, it sounded good with the violin music. You need to give up some of your guns too. And a few other freedoms I can't think of right now.

But, I was serious about the fuel increase. There are a lot of people in rural areas hit very hard by this. There are lots of these areas where driving anything on rims under 15 inches is a joke. Rural Arkansas comes to mind - you will shred small tires on Arkansas gravel (if you consider 3 inch sharp rocks to be gravel) roads. 50 miles per day comes to roughly 1000 miles per month only counting a daily commute. At 20 miles per gallon thats 50 gallons per month - $200 per month at current price of $4/gal vs. $65 per month at $1.30 per gallon. I spent $120 partying yesterday, but for many (cue single mom violin music) that is the grocery money.

I drive a 2007 mid-sized pickup because I (obviously) don't give a shit about the environment or anyone but myself, except for all the people I help move every thrid weekend or whenever its raining, snowing, or 95 degrees outside;( For work I only drive 20 miles per day round trip. But I'd estimate twice that counting all my playing. I like to play a lot.

|8.4.08 @ 3:13PM|#

What advocates of gold-as-money argue is that a gold standard (or free market money/competing currencies) eliminates the ability of the government to steal from you behind your back by devaluing your savings, making saving money more appealing and going into massive debt much less appealing.

It's still just a nominal illusion. The government faces the same prices on the goods they purchase with the money they have devalued as you do. Which leads me to:

If the government eventually had to obtain all of its revenues through taxation-as opposed to through taxation plus inflation-the amount of debt it could take on would be far more limited than it is today.

What leads you to believe this? The only constraint on the amount of debt the Federal Government seems to be willing to burden the citizenry with is the ability of its elected officials to retain their office and their lifestyles.

|8.4.08 @ 4:36PM|#

I could be wrong, but if Vermont is king of the millk boozers; wouldn't it be cheaper to get milk in NH, relative to say some place not next door to cow country. 3.49 or 3.29 here, didn't buy it because i prefer half a gallon, and i don't think the cows are too far from me either. SOrry this has been bugging me all day. Im at work and the L key doesn't work and i refuse to fix my misspeed mik

squarooticus|8.4.08 @ 5:15PM|#

It's still just a nominal illusion. The government faces the same prices on the goods they purchase with the money they have devalued as you do.

False: the government gets to spend the money right after its creation, before percolation through the economy devalues it. They and the big banks have a distinct advantage over the rest of us.

What leads you to believe this?

Math.

Without the ability to counterfeit the currency, the government would have to issue debt certificates denominated in something that it can't capriciously devalue over time, e.g., gold. In such an event, investors would price such debt certificates based on the government's perceived ability to pay out the face value in gold bullion at the end of the term, something that would be readily evident from the government's stated gold holdings plus estimated tax revenues minus outstanding debt certificates.

Under a fiat system, the government can never be nominally insolvent, because it will simply print as many dollars as it needs to in order to satisfy all maturing bonds. Of course, this leads to hyperinflation, but such hyperinflation will occur at the very end of the dollar's useful lifetime, probably within the course of a few months, which makes pricing long-term bonds very difficult because one cannot see exactly when the train wreck is going to occur.

Peter Schiff has been waiting about two years for long-term bonds to price in higher inflation, and writing every few months about how astounding it is that this has not happened. I agree with him that long-term bonds should be much cheaper, but I assert it's perfectly rational that they haven't moved lower yet. Nonetheless, I stand by my assertion that, at some point, shorting 10 year treasuries will be a fantastic investment; the key is that "at some point" is unpredictable for reasons I stated above.

Ben|8.4.08 @ 5:47PM|#

...accelerating monetary growth...

What is wrong with that?
Savers caused this mess and they should pay the price. Why should some dirtbag who could have bought a home at anytime in the last 5 years be let off scot free to buy a depressed home from a hard-working borrower who can't make the payment.
No bargains for those scum. Inflation is like a targetted tax for those who fail to invest in society.

|8.4.08 @ 5:58PM|#

I don't own a home with a depressed price, I have a job and $4 gas doesn't phase me. How am I and 95% of employed Americans poorer ?
Housing prices are trending up the last 4 months. Gas is trending down. This article is a month late ...

|8.4.08 @ 9:14PM|#

Part of the reason why I barely visit H&R is because too many people here lament the fact that we're not on a gold standard system. Go read some John M Keynes or some Milton Friedman. Or better yet, go open up an introductory text on macroeconomics and fiscal policy. A gold standard is a lame idea.

squarooticus|8.4.08 @ 10:17PM|#

Part of the reason why I barely visit H&R

DRINK!

Go read some John M Keynes or some Milton Friedman. Or better yet, go open up an introductory text on macroeconomics and fiscal policy.

I'm guessing I'm way more familiar with Keynes than you are familiar with Rothbard.

Douglas Gray|8.4.08 @ 11:33PM|#

The real inflation and unemployment figures are much higher than those cited by Chapman.

|8.5.08 @ 10:12AM|#

Actually, the major reason for our financial woes is that the dollar is worth sh*t today.

|8.5.08 @ 10:14AM|#

Kroneborge wrote: "We lived beyond our means for too long, and must now start living within it. Both as individuals and as a nation. We tried to consume our way to a wealthier nation, but that's not how wealth is created."

I didn't. Why did you live beyond your means, Kroneborge? Weren't you smart enough to see it coming? Didn't you know how to create wealth? Did you just learn? If you were so blind then, why should anyone listen to you now?

|8.5.08 @ 10:22AM|#

"The real inflation and unemployment figures are much higher than those cited by Chapman."

Most agree that real GDP growth has been negative for more than two quarters. If so, the US is in a "technical" recession and Phil G's comment was wrong. One can make a great case that a technical recession is not very meaningful, and an ever better case that the government shoudn't over-react to such data, but it is what it is.

bob|8.5.08 @ 4:14PM|#

i think the problem and solution is here.
Government as defined by Webster's dictionary; the system or policy by which a political unit is governed. Govern being defined as; to guide, rule, or control by right or authority. All governments rule their people with controls (laws), and they vary greatly in the different governments. All governments guide their people, to live as the government desires. This does not vary much, for all governments guide and control the majority of their people to live so that the minority can live in extreme excess.
For example in the U.S.A., the wealth is distributed as in this way: 60%for the top 5%, 35% for the next 35%, with 5% left for the last 60%.
does this mean there should be enough for all to have as the 35% do?
John Locke's theory
Given the implications of the Law of Nature, there are limits as to how much property one can own: one is not allowed to take so more from nature than oneself can use, thereby leaving others without enough for themselves. Because nature is given to all of mankind by God for its common subsistence, one cannot take more than his own fair share.

|8.5.08 @ 9:11PM|#

Nobody lost any wealth when home prices corrected, the appearance of this wealth was illusory in the first place. When a piece of real estate goes up 50% in market price in two years, did it also gain 50% additional utility? Of course not, it's still the same home, being utilized in the same way, providing the same quality of shelter in the same location. The only thing that has changed is people perception of that house. The actual value of the house (providing a place to live) never changed.

economist|8.6.08 @ 9:51AM|#

Capt. Obvious,
Thank you for pointing that out.

economist|8.6.08 @ 9:53AM|#

bob,
You're confusing wealth with natural resources (although they overlap) and initial acquisition with continued ownership.

bob|8.6.08 @ 10:28AM|#

where am i confused?

|8.7.08 @ 2:48AM|#

Tommy,

I think that your acknowledgment of technical recession is of greater importance than you realize. I also believe that when our own leadership understated interest rates (much more than usual) to show growth, this is an attempt at minimizing what is and will be a great contraction in our economy. You acknowledge that growth has actually been negative for two quarters. This problem will only grow more acute as the overwhelming majority can no longer afford the cost of living. In accordance with Locke's theories this schism between the classes cannot continue to grow.
There will be an inevitable redistribution of wealth. This may occur through reconstruction of progressive tax system and a realization that we simply cannot expect to grow our economy at 7%/year.
This may occur in a much uglier fashion if the schism is allowed to grow and the masses are suppressed in progression towards a police state. This is entirely unsustainable and would result in a great deal of suffering, pain and bloodshed.

bob|8.7.08 @ 9:59AM|#

VWesty
This may occur in a much uglier fashion if the schism is allowed to grow and the masses are suppressed in progression towards a police state. This is entirely unsustainable and would result in a great deal of suffering, pain and bloodshed.

no one should dought this to be true, for we can see examples all over the world and throughout history.

|8.7.08 @ 6:59PM|#

I can't believe how stupid most comments are. If the value of your house goes down, that doesn't mean rents go down. They've been going up because all utilities have gone up by 50-100%. That's why most people have no money and are hurting. It's not just gas for the car, it's trying not to freeze in winter or have the electricity and phone shut off. If my social security goes up by 2%, but my propane bill is up by 30% and the electric company just got a 50% raise, do you jerks think the problem is merely one of perception?

bob|8.8.08 @ 7:28AM|#

sharon

bravo, do you jerks think the problem is merely one of perception?
that is the biggest problem, people only percieve through there eyes, ignoring or blind to other truths.
i understand your position,when peopl stop looking at only theirself, things will change