Economics

The New Normal

Forget the naysayers. Happy capitalism is here again.

By From the December 2009 - January 2010 issue

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On April 14, 2009, in a speech at Georgetown University, President Obama made reference to the Bible: "There is a parable at the end of the Sermon on the Mount that tells the story of two men. The first built his house on a pile of sand, and it was destroyed as soon as the storm hit. But the second is known as the wise man, for when ‘...the rain descended, and the floods came, and the winds blew, and beat upon that house...it fell not: for it was founded upon a rock.' We cannot rebuild this economy on the same pile of sand. We must build our house upon a rock. We must lay a new foundation for growth and prosperity-a foundation that will move us from an era of borrow and spend to one where we save and invest; where we consume less at home and send more exports abroad."

The storm that President Obama was referring to was mentioned earlier in his remarks that day, when he said, "This recession was not caused by a normal downturn in the business cycle. It was caused by a perfect storm of irresponsibility and poor decision making...." He then went on to propose new rules and regulations for Wall Street, plus huge new government spending initiatives for education, nationalized health care, and a carbon-based energy conservation tax. He suggested that each of these was a "pillar" of our new house upon a rock.

The president was, and is, clearly willing to blame the problems we have experienced in the past few years on capitalism, which he refers to as the sand. And with this argument he makes the case that government is the rock. This argument is helped along by conventional wisdom that the United States is either in the midst of the next Great Depression or it will experience years of subpar growth, with above-average unemployment and below-average wage growth.

Many, on both sides of the political aisle, think capitalism is broken or, at the least, has just become so complex that we must use government power to hold it in check so that it doesn't wreck everything. And no matter which one of these arguments you grab onto, the bottom line for the pessimists is that you can no longer really trust anyone or anything.

It's hard to tell who lost faith faster -- the intellectual elite or the rank and file. But trust in the system broke down pretty darn quickly. Part of the reason for that is that just about every player in this saga has a dog in the fight.
• Politicians want power, and they get it when people are scared.
• Short-sellers like to make money, and they make it when stock prices fall.
• The press likes to report outlier stories of financial trouble and they get this in spades from short-sellers, who are a huge source for journalists.
• The Panic of 2008 convinced the press that the short-sellers and the pessimists were geniuses, even though many of them had been bearish for many years prior to the panic and market crash.
• Talk radio likes a good enemy. And what better than socialism? With U.S. policy imitating France, it's easy to drum up fear and negativity.
• With the mainstream press, talk radio, politicians, and the short-sellers getting exactly what they wanted -- negative excitement surrounding every broadcast -- the "end of the world" dance was hard
to stop.
• Finally, even people who wanted to be optimistic but had been scared into holding cash and missed the first 40 percent of the rally wanted the market to go back down so that they could get in at those low prices again. They then convinced themselves that this would happen.

It was the perfect storm of negativity. Just about every opinion maker had a reason to believe in the conventional wisdom and remain firmly ensconced in the echo chamber of economic collapse. Anyone who dared to differ from the consensus was chastised and dismissed as out of touch. Even after the stock market had melted up in 2009, the bearishness continued because no one could believe it. This great confluence of negativity just couldn't be stopped.

One interesting response was that television journalists refused to call a 40-plus percent rise in stock prices a bull market. When equity prices were falling in 2007 or 2008, the first time the market closed 10.0001 percent below its previous high, they were putting brightly colored banner headlines on television announcing the official onset of a bear market. But this didn't happen on the way up.

Pessimism was rampant, and capitalism was the whipping boy. And this fit perfectly into the populist drift of politics. The fact that the Obama administration and a Democratically controlled Congress are willing to blame capitalism is not a surprise. Many of them have spent their careers arguing for more government control of the economy.

What is a surprise is that typically conservative columnists, politicians, economists, journalists, and intellectuals have been smitten by this conventional wisdom as well.

George W. Bush told CNN, "I've abandoned free market principles to save the free market." What can an economist say to that? We never did have completely free markets; it was government interference in them that caused the crisis. But Treasury Secretary Hank Paulson had convinced President Bush, just as he had convinced many other people, including most of the key journalists on the East Coast, that the U.S. financial system was about to fail. Paulson argued that intervention like this was the last thing he wanted to do. He didn't want to take over companies and risk hundreds of billions of dollars, but he had no choice. The system -- capitalism -- had let us down.

The underlying belief here is that consumers and businesses went off half-cocked and without proper supervision. They then made a hash of the world. Government argued that the economy needed "creative" public solutions to complex problems because it was the worst crisis in 80 years. And most importantly, we had to put aside our beliefs about free markets and capitalism for the time being to keep the system from completely collapsing.

David Brooks, conservative columnist for the New York Times, wrote that classical economic thinking didn't work and people weren't rational. He went so far as to call people "stupid." Peggy Noonan, conservative writer for the Wall Street Journal, wrote a column titled "Goodbye Bland Affluence," in which she highlighted a couple who had moved to a farm in Michigan in an attempt to get away from the consumer-driven bland affluence of recent decades. In that column she wrote, "Many think that no matter how much money is sloshing through the system from Washington, creating waves that lead to upticks, the recession is really a depression. We won't ‘come out of it,' as the phrase goes, for five or seven years, because the downturn is systemic, global, and because the old esprit is gone."

Noonan wrote this in April 2009, disparaging the month-long equity rally as an "uptick." What Noonan referred to as the "old esprit" is a reference to what people thought was normal. Many others call what is going on today a search for "the new normal" -- as in "Now that the system has completely crumbled, what will it look like when it is rebuilt?"

The list of those who gave up on capitalism is breathtaking. Somehow, many pundits began to equate capitalism with fragility, fraud, and failure. They not only lost faith in their fellow man, but they then turned on him as well-calling him bland, untrustworthy, and stupid.

No wonder government exploded in size in such a short time frame. Government spending rose from 20 percent of gross domestic product (GDP) in 2007 to 28 percent of GDP in 2009, and hardly anyone batted an eye.

All of this is complete foolishness. Consumers are not irrational, and the economy is not broken. The vast majority of people are completely trustworthy. And those who understand capitalism -- where it comes from, what causes it to work -- have not lost faith. Capitalism is robust and reliable. It does not "fail." Nonetheless, capitalism has brought so much good over such a long period of time that people have begun to take it for granted. They have forgotten that capitalism is the end and the means. The fruits of capitalism are so overwhelmingly delicious that we forget that the best part of the system is that it provides personal dignity. It allows men and women to find their most productive place in the world, while it lifts living standards to new heights.

Nonetheless, many "conservative" columnists have joined with many politicians to make an argument that this crisis is so severe that the government must intervene. Even if we don't like what government is doing, it must be done.

Another interesting twist in the emotion department is that conservative politicians and pundits have become massively bearish as well. This is a reaction to President Obama's agenda, which leans pretty dramatically in the liberal direction. More government spending, higher taxes, and regulation all hurt the economy. The pundits are right that the direction of policy is negative for the economy over the long run, but I am afraid most of them do not make the distinction between long and short term.

Their bearishness is going to look pretty foolish in the next 12 to 18 months as the economy booms. The Fed is so easy that it will overcome any policy problems in the near term. This is reminiscent of the early 1990s, when President Clinton raised taxes and proposed a new health care plan. Talk radio predicted the Clinton recession, which never came. Why? Because the Fed was super-easy in the early 1990s.

The immediate data we see every morning when we roll out of bed have not been pretty. The unemployment rate is near 10 percent; defaults and foreclosures continue to rise; that house (or houses) down the street isn't selling. It has been a nasty recession. But it's not the end of the world. Because the panic took economic activity to such low levels, the bounce alone from that will lift economic activity dramatically in the quarters ahead.

But, more importantly, capitalism itself will reassert itself and lift growth in the quarters beyond the bounce. The economy is set to surprise the conventional wisdom in dramatic fashion. It's not as bad as the punditry or you think.

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About the Author

Brian Wesbury is chief economist for First Trust Portfolios, L.P.