The Best Stimulus? Spend Less, Borrow Less
FORTUNE -- Of all the highlights of Allan Meltzer's half-century as a distinguished monetarist -- advising Presidents Kennedy and Reagan, producing celebrated books on John Maynard Keynes and the history of the Federal Reserve -- none proved more memorable than a crisis session at 10 Downing Street in mid-1980.
A group of 346 noted economists had just written a scathing open letter to Prime Minister Margaret Thatcher, predicting that her tough fiscal policies would "deepen the depression, erode the industrial base, and threaten social stability." Thatcher wanted to make absolutely certain her unpopular attack on huge deficits and rampant spending, in the face of high unemployment and a weak economy, was the right one.
So Thatcher summoned Meltzer, along with a group of trusted advisors, to explain why the experts were wrong. Even leaders of her own party advised Thatcher to make what they called a 'U-Turn,' and enact a big spending program to pull Britain out of recession. "Our job was to explain why lower deficits and spending discipline were the key to recovery," recalls Meltzer.
Thatcher was regally unamused by arcane jargon. "Being right on the economics wasn't enough," intones Meltzer. "She made it clear that our job was to explain it so she could understand it. If we didn't, she made it clear we were wasting her time. She'd say, 'You're not telling me what I need to know.'"
Thatcher stuck with draconian policies, invoking the battle chant "The Lady's Not for Turning." She launched Britain years of balanced budgets, modest spending increases, falling joblessness, and extraordinary economic growth.
Misunderstanding Keynes
For Meltzer, the courageous, damn-the-sages stance that Thatcher took three decades ago should guide President Obama today. "If Obama announced a strategy to deal with the long-term debt and stopped doing things to increase the uncertainty that businesses face, it would do a great deal to stimulate the economy," declares the 82-year old Meltzer.
Meltzer is right, and most of the "experts" -- from Paul Krugman to Ben Bernanke -- are wrong. The best stimulus is a solid, credible plan to radically reduce government spending, starting right now.
To be sure, President Obama frequently advocates shrinking deficits in future years. The problem is that he wants to keep spending heavily today, in what's supposedly a classic Keynesian formula for charging a weak recovery and lowering unemployment.
But that formula isn't what Keynes recommended. "Keynes championed temporary deficits to stimulate consumption during recessions," says Steve Hanke, an economist at Johns Hopkins. "But he also insisted that deficits disappear during recoveries, so that budgets would be balanced or in surplus during most of the business cycle."
Today, the administration is pursuing a totally different policy. It's sharply raising expenditures when the U.S. already faces gigantic, chronic deficits that barely shrink even in a recovery, and burgeoning debt. "Keynes specifically warned against structural deficits when both U.S. and British economists were pushing for them at the end of World War II," says Meltzer. "He never said that more spending on top of chronic deficits was a stimulus. Just the opposite, in fact."
The Obama administration is calling for an extra $316 billion in "stimulus" spending in addition to the $862 billion already appropriated. The rub is that the all of the "stimulus" money is being borrowed, and that's adding to already mushrooming debt. Right now, the CBO forecasts deficits of $1.25 trillion or an immense 5.6% of GDP in 2020 -- and that's following a strong recovery. That year, the federal debt will reach 90% of national income, putting the U.S. in the fragile position of a Greece or Portugal. Interest payments will absorb one dollar in every six of federal spending.
The rub is that the shadow of inexorably rising debt, with no plan to curb it,
isn't a stimulus at all, but a heavy depressant. The solution is to sharply reverse course and bring the budget into balance over the next decade. That solution will require either a 50% increase in taxes, a 35% reduction in spending, or some combination of the two. The weight should fall heavily on the spending side.
That blueprint would prove a powerful tonic for the economy for four reasons -- call them the four growth factors. First, it would dramatically raise the labor supply by allowing Americans to pocket more of their pay. Second, it would prevent real interest rates from soaring and crippling private investment. Third, it would encourage companies to stop hoarding cash and make the big investments in factories and computers that always drive a recovery. And fourth, it would enormously boost investors' confidence in America's future by showing that, like Thatcher long ago, our leaders won't get swamped by chaos, and really have a plan.
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