“Can we do it again?” asks Amity Shlaes in her introduction to this book. She is asking about the Reagan revolution of the 1980s. In his final chapter George Melloan answers yes. But it won’t be easy because of the great expansion of government in 2008-09. He calls for a new vision of “Supply-Side Prosperity.” In the intervening pages, he examines the origins of the Crash of 2008 and a way to restore not the false prosperity of the bubble economy, but the genuine prosperity that characterized the Reagan years.
Melloan recently retired from a 54-year career with the Wall Street Journal. He is a superb wordsmith, able to turn the dry details of finance into highly readable prose. He has a story to tell and tells it very well.
Bad economic policy and troubled times often stimulate good economic ideas. That was true of the 1970s and stagflation: the simultaneous appearance of recession and inflation. It was a crisis for Keynesian economics and a crucible for revisionist economic thinking. It led to Reaganomics and a renewal of the American spirit.
For Melloan the core principles of supply-side thinking and the Reagan revolution (“a repeat of the American Revolution”) were cutting marginal tax rates and restoring sound money: “Sound currency is essential to the health of an economy.” He correctly characterizes supply-side economics as “a revival of classical economic theory.” The classical view is that production not consumption is the engine of economic growth. The supply-siders focused on government policies that would stimulate production. They wanted to extricate the U.S. economy from the inflationary and recessionary abyss of the 1970s.
Supply-side thinking triumphed and justified Reagan’s tax cuts and Paul Volcker’s assault on inflation. The ensuing prosperity lasted through the 1990s.
So what happened? It’s now a familiar story and begins in June 2003. After a series of rate cuts, the Fed decided to do one more and bring the fed funds rate down to 1 percent. “It was a bridge too far,” in Melloan’s words.
The rate cuts ignited the great money binge. “Everyone joined in the fun”: banks, mortgage brokers, the Republican Congress, and state legislators. Spending of all kinds exploded. Add an ill-conceived policy to promote homeownership, institutionalized in Fannie Mae and Freddie Mac, and you understand why the money binge channeled through housing finance and home building.
Melloan criticizes the Fed for its policy blunders. He observes that the Federal Reserve System was founded in 1913 to stabilize the banking system. Only 17 years later, the new central bank presided over the Great Depression. One could add that numerous recessions followed, accompanied by an inflationary bias in monetary policy only temporarily interrupted under Volcker. Melloan has a realistic view of the Fed’s role today: “Claims that it operates independently of political influence have little basis in fact, but give politicians deniability when it errs, as it often does.”
Melloan strongly criticizes President Obama’s policies, especially his spending. He described Obama’s 2010 budget as “more like a revolution than a mere change.”
There was perhaps a fiscal revolution, but it began under the second President Bush. Melloan lets Bush off with little more than an observation of his fiscal “permissiveness.” Bush comes off sounding like an indulgent grandfather to Congress, rather than the author of a great spending binge.
The saga of the Bush administration reveals a fatal flaw in supply-side thinking, if not as originated, then as practiced. In preaching the magic of tax cutting, supply-siders took their eye off the spending side of the budget. Tax cuts and sound money foster entrepreneurship and economic growth. But the process is not unbounded.
Government spending measures the real resources appropriated by the government and constitutes the true burden on the private sector. Spending can be financed by current tax collections or borrowing. Borrowing must be paid by future taxes. The Fed can inflate away some of the real value of government debt, but that substitutes an inflation tax (loss of wealth) for a conventional one.
Culminating in the Crash of 2008, Bush’s spending binge paved the way for Obama’s victory. Rather than bringing “change,” however, Obama has ushered in the third Bush term.
In his final chapter Melloan outlines a multistep program for an American renewal. To be effective, however, a multistep program must begin with recognition of the problem. The economic problem did not begin with Obama but with the easy-spending policies of the Bush administration and the easy-money policies of the Fed. Both fiscal and monetary profligacy must be recognized and reversed.
Notwithstanding this criticism, I heartily recommend The Great Money Binge for a highly readable account of the Crash of 2008 and the largely misbegotten response.