Prophet Without ProfitThinking Non-Linear

“Just as in the late stages of the Roman Empire, magical thinking abounds. This is America, the capital of can-do! We are audaciously hopeful because we always arise, newly envigorated by the unquenchable spring of American innovation….” Nothing has Changed, Charles Hughes Smith

How ironic that we live in an age of magical thinking.  We have never had more information and commentary a mere computer keystroke away.   With all this information, one would think that we could easily accept reality and think critically.   Perhaps reality is so discouraging and the consequences of our current path of behavior so awful to contemplate that we prefer magical thinking, hoping against hope that a solution will appear.

Nowhere is magical thinking more evident than in our current economic plight.

The Land of Endless Deficits

Paul Krugman, Professor of Economics, influential Democrat and New York Times columnist, is the high priest of deficit spending.  His philosophy in short:

Spend now, while the economy remains depressed; save later, once it has recovered.  How hard is that to understand? See Now and Later

First, we never save later, as Congress would rather keep spending to buy votes than be fiscally prudent.   Second, the US is absorbing a large portion of the world’s savings to fund the ongoing $1.3 trillion dollar per year deficit.  Third, even Krugman realized that our debts are growing exponentially.  His view is that with high unemployment this is the not the right time to become fiscally prudent.  Fourth, taxpayers have paid $3.7 trillion over the last year to achieve a modest economic recovery which is currently fading.   In the 1950′s one dollar of debt added a dollar to GDP;  recently it took $5.57 to add a dollar to GDP.  Source Contrary Investor. We have reached the point of debt saturation.

Why Not Cut Taxes?

Republicans have an equally magical mantra:  “just cut taxes.”   Back to the Reagan era, Republicans have been enthralled by the Laffer Curve:

Economist Arthur Laffer made a very interesting supposition: If tax rates are high enough, then cutting taxes might actually generate more revenue for the government, or at least pay for themselves. (In one of life’s great coincidences, he first sketched a graph of this idea on Dick Cheney’s cocktail napkin.) If the government cuts taxes, then Uncle Sam gets a smaller cut of all economic activity — but reducing taxes also generates new economic activity. Laffer reasoned that, under some circumstances, a tax cut would stimulate so much new economic activity that the government would end up with more in its coffers — by taking a smaller slice of a much larger pie.  See Debunking One of the Worst Ideas in Economics

If the US had a 99% marginal tax rate,the rate paid on the last dollar of taxable income, Laffer’s theory might work.  But, we do not:

We don’t have a 99 percent marginal tax rate. Or 70 percent. Or even 50 percent. We start with low marginal tax rates relative to the rest of the developed world. (Yes, I understand that it may not feel that way after the check you wrote last month.)

So cutting the tax rate from 36 percent to 33 percent is not going to give you the same kind of economic jolt as slashing a tax rate from 90 percent to 50 percent. There’s no huge black market to be shut down, no big supply of skilled workers to be lured back into the labor market, and so on.  See Debunking One of the Worst Ideas in Economics

The ultimate problem is that even if the economy grows, government revenues shrink, government spending continues and deficits widen.

Bring in the Grown Ups

Former Reagan budget director David Stockman recognizes that, if honestly measured, the budget deficit would be a Greek-like 120% of GDP by 2015.  Stockman excoriates the Republicans for cutting taxes and failing to balance the budget.

…the new catechism, as practiced by Republican policymakers for decades now, has amounted to little more than money printing and deficit finance — vulgar Keynesianism robed in the ideological vestments of the prosperous classes.

This approach has not simply made a mockery of traditional party ideals. It has also led to the serial financial bubbles and Wall Street depredations that have crippled our economy. See Four Deformations of the Apocalypse

His prescription is both simple and logical: “…balanced budgets, sound money and financial discipline — is needed more than ever.”

Without Keynes, Laffer or Friedman

Keynes’ “pump priming” through endless deficit spending and Milton Friedman’s monetarism call for expansion of money supply to ward off deflation.  These flawed strategies have captured our Treasury Secretaries from Republican Henry Paulson to Democrat Timothy Geithner.  Reviving Laffer’s arguments, and ignoring widening deficits, Congressional Republicans argue for extension of the Bush tax cuts.  Unfortunately, these theories have not extricated us from the current economic morass.

Faced with reality, the political elite would rather delude themselves with hope and magical thinking than confront the harder realities of austerity and living within our means.  We appear doomed to repeat these failed policies until it is too late.  Perhaps an economically rational adult will arrive to break the magic spell.