The election is over, and now the bill has come due. The Federal Reserve has announced that it will be printing an extra $600 billion of new money under the guise of something called “Quantitative Easing 2,” a sequel which is indeed more frightening than the original. Federal Reserve Chairman Ben Bernake seems keen on inflating his way out of the growing pile of government debt, which is technically one method of defaulting. So now the dollar is sliding on foreign currency markets, and the World Bank is arguing that economies should adopt a modified gold standard for their currencies – which would be a “Bretton Woods 2.”

The founder and managing director of Pimco calls Quantitative Easing a “ponzi scheme.” I like to think of it as “a thieving menace” which comes from an article in The Economist about immigration issues in Europe, but applies here as well. Quantitative Easing is a process that starts with the Federal Reserve crediting its own bank account with money that is conjured out of nothing. Or, as Shakespeare would say, the Fed “…gives to airy nothing a local habitation, and a name.” Over the next eight months, the supply of money will increase by $600 billion.

But first, some background…

When the “Great Recession” began in December 2007, the government turned to Keynesian economic theory and went on a spending spree. The recession officially ended in June 2009, but I realize that is hard to believe. Like the latest fashion, politicians and economists were quick to quote Milton Friedman and Richard Nixon declaring “…we are all Keynesian now.” Friedman first used the phrase in 1965. In 1971, when Richard Nixon scrapped the original Bretton Woods, which was an agreement that regulated the international monetary system, and took the U.S. dollar off the gold standard, he said “I am now a Keynesian in economics.”

John Maynard Keynes was a British economist whose most significant work, The General Theory of Employment, Interest and Money, was published in 1936. Keynes felt that fiscal and monetary policies could be used by governments to mitigate the effects of economic recessions and depressions.

Using monetary policy, governments stimulate the economy through some combination of a reduction in interest rates or the printing of money. This can be thought of as controlling the supply of money. Fiscal policy involves spending and taxation. With fiscal policy, governments typically invest in infrastructure or modify tax law by increasing or decreasing the flow of money into government coffers. Therefore, each policy has a set of tools designed for a specific purpose, much like a formal table setting may have a dinner fork, a fish fork and a salad fork.

At the monetary policy table setting, Quantitative Easing is usually the last to be used. As such, it is the desert of monetary policy, although not very tasty. Which is a shame, because the main course of monetary policy (interest rates) was overcooked by the Fed. You’ll recall that the Federal Reserve kept lowering interest rates while the housing bubble inflated thanks to an almost paranoid aversion to inflation under Alan Greenspan (who served from 1987 to 2006). Thus, when the Great Recession began, interest rates were already at historical lows with nowhere to go. This firmly put us into something economists call a “liquidity trap” – a situation where monetary policy is mostly ineffective.

So how is the fiscal policy table setting looking? Our government has been tinkering with the menu for a number of years, causing the silverware to look a bit tarnished. Students of economics will realize that we have worked our way through the fiscal policy palate, upon which you can increase spending by issuing more debt or twiddle with income taxes. There has been a considerable amount of twiddling.

Recently, tax legislation has been masquerading as health care reform. The Internal Revenue Service is responsible for overseeing a significant portion of the Health Care Act, such as the administration of additional taxes and penalties on individuals and employers, determinations of various exemptions from those taxes and oversight of new information reporting requirements. It is estimated that the Act will generate $437 billion in new taxes, fees and penalties. This is an inflow of money into government coffers, and hence is off the fiscal policy menu, and is more a tax increase than health care reform.

What other surprises will appear on the fiscal policy menu in the coming months? The current row in Congress is over what to do with the expiring Bush tax cuts. If nothing is done, income taxes will rise in 2011 and provide even more money for government spending. This extra tax revenue will be needed because Quantitative Easing will increase the cost of servicing debt. As the United States dilutes the value of its currency, investors will demand higher interest rates on government debt to reflect a higher default risk and to compensate for the devalued dollar. This will increase the interest expense component of the federal budget, leaving less of the pie available for normal programs.

All the recent “stimulus” programs have been fiscal in nature, since they involve spending. Under George Bush, there was the Troubled Asset Relief Program (TARP). With Barack Obama, it has been the American Recovery and Reinvestment Act (ARRA). Consequently, the U.S. deficit has become alarming. As of July 2010, the “Debt held by the Public” was approximately 60% of Gross Domestic Product (GDP). When you add intra-governmental borrowing, such as from social security, the “Total Public Debt Outstanding” was approximately 93% of annual GDP (it was approximately 56% of GDP in 1990). This would be rather like running your personal credit card up to a balance equal to one year’s wages.

It appears to me, however, that we are not properly spending stimulus money. State governments are using stimulus dollars to fund budget shortfalls in providing the usual services. Driving around California, you notice signs advertising the use of stimulus money on various road projects. But the roads are merely being repaired. ARRA spending does not appear to be creating anything new, and this is a problem. As soon as the spending is withdrawn, the economy will suffer again because new self sustaining industries and technologies have not been created. Repairing infrastructure does create jobs. But only short term jobs.

Deficit spending during the Great Depression literally electrified the county through massive dam building programs. There was the Hoover Dam on the Colorado River, and in 1933, Congress passed legislation creating the Tennessee Valley Authority which provided electricity to homes and farms in what was a malarial, third-world, back corner of the United States. Also started during this period were the Bonneville and Grand Coulee Dams in Washington and Oregon, and the Shasta Dam in California.

The deficit spending during the Great Depression greatly improved the standard of living and created jobs that would last once the stimulus was withdrawn. This caused the U.S. to become a major economic power, and our increased industrial output (thanks to electricity and a little bit of oil) helped to win the Second World War. Such is the power of deficit spending when it is properly understood and rightly applied.

So what would I do to invigorate the economy? I’d go to Mars…

The last time the U.S. was the envy of the world, when we captured the imagination of its inhabitants and believed that anything was possible, it was when Neil Armstrong walked on the Moon. Although Kennedy was primarily taken to the decision because of Cold War considerations, it was all thrilling nonetheless.

For many reasons, we need to inspire the world again. The Apollo program created or improved many technologies that we cannot imagine living without today. The short list includes: flame resistant textiles, water purification technology, new lubricants, athletic footwear, heart monitors, solar panels, kidney dialysis machines, cordless power tools, and freeze dried food. OK, perhaps not this last one.

My point is that stimulus spending should be directed towards creating new industries and technologies that benefit lives and strengthens the economy. This is how deficit spending was directed in the Great Depression. A mission to Mars will force the country to overcome obstacles which are at present insurmountable. The solutions to the unique problems facing spaceflight to Mars are unlike those encountered when we journeyed to the Moon. As such, surmounting them will require innovative thinking that will result in radical new energy, medical, environmental, agricultural and computer technologies.

Let’s be bold and go to Mars. Otherwise, we’ll just be stuck with repairing all these roads again in another twenty years.


A Keynesian-Tocqueville Theory of Fiscal Policy

Alexis de Tocqueville, in On Democracy in America, talked about the “Doctrine of Self-Interest Properly Understood.” In describing this Doctrine, Tocqueville observed that “American moralists do not hold that a man should sacrifice himself for his fellow man because it is a great thing to do…such sacrifices are as necessary to the man who makes them as to the man who profits from them.” Since a democracy must balance the needs of the community with the needs of the individual, it is in the interest of the individual “…to sacrifice a portion of their time and wealth for the good of the state.”

So what does this have to do with economics? What I would like to propose is a Keynesian-Tocqueville theory of fiscal policy titled “deficit spending properly understood.”Under this theory, government spending is directed away from maintenance and repair and towards a goal that requires the development of new technologies by undertaking projects that are bold, fresh and impossible to achieve with current technologies.

For instance, aside from going to Mars, President Obama could make it the avowed policy of the United States to be off oil as an energy source by the end of the next decade.

From John F. Kennedy:

“We set sail on this new sea because there is new knowledge to be gained, and new rights to be won, and they must be won and used for the progress of all people. For space science, like nuclear science and all technology, has no conscience of its own. Whether it will become a force for good or ill depends on man, and only if the United States occupies a position of pre-eminence can we help decide whether this new ocean will be a sea of peace or a new terrifying theater of war…We choose to go to the moon. We choose to go to the moon in this decade and do the other things, not because they are easy, but because they are hard, because that goal will serve to organize and measure the best of our energies and skills, because that challenge is one that we are willing to accept, one we are unwilling to postpone, and one which we intend to win…”

Apollo 11