GOP: Generations-Outdated Policy

F.T. Columnist, economist Martin Wolf -- with whom one argues with only at one's philosophical peril -- offered the paradoxically, but nevertheless economically-valid theory that, We can only cut debt by borrowing more.

Tea Party members, conservatives, and Republicans will no-doubt shudder at the above, but investors/readers should keep in mind that most in the conservative camp have shown concern primarily for: 1) cutting taxes and 2) cutting government spending -- not the plight of the more than 15 million Americans seeking full-time work. Now, if in the process unemployment goes to 15% or 20% -- which would likely be the consequence of additional spending cuts that reduce already low aggregate demand further -- so be it. In other words, if the free market says unemployment should be that high, then unemployment will rise. Just cut taxes and cut spending, so the conservative mantra has been the last three years.

Keynes Is Right, Again

Wolf, on the other hand, like most liberals, Keynesians, and others who believe in a more-perfect union in this United States, is concerned with sustainable GDP growth and employment gains, and he argues, quite persuasively, in so many words, that the reduction in private sector lending and debt has to be met by increased borrowing and debt from institutions capable of it -- namely government -- in order to maintain and increase aggregate demand.

Then, once sustainable GDP growth occurs, the ratio of public debt to GDP can be reduced through the normal process of GDP growth.

In short, not only can we deal with the private sector debt overhang by increasing the fiscal deficit, but we must do so, Wolf said. It is the only way of avoiding a deep slump and the immense disruption of mass bankruptcy.

Now, the Obama administration did its best to eliminate the GDP hole triggered by financial crisis and the Great Recession -- it passed a $786 billion fiscal stimulus package in 2009 and intervened in other ways, including the successful auto manufacturer loans that saved the U.S. auto sector, and those actions have prevented an even worse fate for the U.S.: a depression with a much higher unemployment rate.

What's more, the economic expansion strengthened in late 2011 / early 2012 and is now showing signs of becoming a self-sustaining expansion with adequate job growth of at least 200,000 new jobs per month. The private sector created 2 million jobs in 2011, compared to the loss of a staggering 3.6 million jobs during the last year of the Bush administration. Similarly, the stock market in 2012 is off to its best start since 1998.

Obama's Overture: Stay the Course

However, while the U.S. economy is showing signs of becoming a self-sustaining expansion, we're not there yet. Hence, any effort to cutback automatic stabilizers like unemployment compensation would be counter-productive. The Obama administration and most Congressional Democrats understand this; most Congressional Republicans do not. Not satisfied with stopping a larger stimulus package in 2009 that would have ended the recession sooner and led to even strong GDP growth today, the Republicans and Tea Party faction members want to try and hurt the current expansion, by prematurely cutting back on essential spending and economic supports. Obviously, for those interested in reducing unemployment and moving forward, as opposed to backward, the Republicans should be stopped at every turn.

The conservatives' argument is rooted in the flawed premise that the primary economic problem is supply: just cut taxes, and spending to make economic conditions better.

To some degree, that theory is valid for the capital gains tax, but the literature is mixed regarding cutting income tax rates.

Still, the problem in the U.S. is not 'supply' -- the U.S. has a massive amount of capital -- corporations alone are sitting on about $2 trillion in cash. The problem is demand -- too few consumers, or not enough consumers making enough dough. Moreover, cutting spending amid inadequate demand conditions, high unemployment, and with interest rates already low is not only wrong, it's absurd.

Hence, if the Republicans hope to maintain a majority in the U.S. House and not lose too many seats in the U.S. Senate in the November election, they should do the prudent thing regarding their supply side economic theory: quit while they're behind.

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