Fear the Bubble and Bust

I wrote this on July 28, 2010.

John Maynard Keynes advocated using tax code to control the “animal spirits” of the market. He advocated increasing taxes during economic booms to keep the economy from inflating bubbles. For example, Keynes would have supported tax increases during the dot-com bubble in the 1990s and the housing bubble since then. Frankly, high taxes on stupid investment isn’t a bad idea. It was malinvestment in ill advised technology plays and inflated housing that caused the bubbles to grow and then burst driving the boom and bust cycle.

Of course the inverse is that Keynes supported lowering tax rates during recessions in order to free up money, increase its velocity and diminish what he called a “liquidity trap.” Raising taxes during recessionary periods, Keynes would argue, would just exacerbate the recession lengthening it and making it worse. Keynes would strongly argue that increasing taxes during a downturn in the business cycle when unemployment is high would be a disastrous policy.

Keynes argued that, during recessionary periods government needs to “prime the pump” by spending stimulus money and lowering taxes. During boom times, the government should scale back spending and raise taxes to keep the economy from overheating and asset bubbles from forming. There is a logic to this.

So, right now the stock market is at an all time high and Trump is bragging about high levels of economic growth. Bearing that in mind, what is the Keynesian prescription? It is, of course, to decrease government spending and, perhaps, edge up taxes.

Now, let’s take a look at that Economist interview with the president.

But beyond that it’s OK if the tax plan increases the deficit?
It is OK, because it won’t increase it for long. You may have two years where you’ll…you understand the expression “prime the pump”?

Yes.
We have to prime the pump.

It’s very Keynesian.
We’re the highest-taxed nation in the world. Have you heard that expression before, for this particular type of an event?

Priming the pump?
Yeah, have you heard it?

Yes.
Have you heard that expression used before? Because I haven’t heard it. I mean, I just…I came up with it a couple of days ago and I thought it was good. It’s what you have to do.

It’s…
Yeah, what you have to do is you have to put something in before you can get something out.

So, which is it? Is the economy screaming along with new jobs, a sky-high stock market and impressive growth or is a moribund recessionary economy that requires pump priming and decreased taxes?

This is important to know because increased government spending, lower taxes and artificially low interest rates during boom times lead to the inflation of asset bubbles as occurred during the dot-com 1990s and the Housing Boom 2000s and that leads to…. POP! This is exactly what Trump is promoting.

As for Trump inventing the term “priming the pump” to describe economic stimulus: Um, not so much. It’s been used for about a hundred years in that context.

The reality is that the Keynesian theory of how to manage the economy is flawed and “pump priming” whether it is done by Barack Obama or Donald Trump is bound to be failed policy. Obama, at least, wanted to prime the pump when it wasn’t flowing well. Trump wants to prime a pump that is already pumping like crazy.

Government stimulus, low interest rates and easy credit are mistaken for real investable funds and this, always and everywhere, results in wasteful malinvestment. Actual savings require higher interest rates to encourage depositors to save. The artificial stimulus during boom times causes a generalized speculative investment bubble that grows until it bursts and all hell breaks loose.

This then, is the boom and bust cycle to which, like Sisyphus, we are bound to relive over and over and over. Stupid politicians take us on drunken periods of bubble inflation, busts and hung over periods requiring hair-of-the- dog curatives. It never ends and we are always surprised at our “bad luck”.