The New Great Society

To speak of a New New Deal, whether in approval or disparagement, is to perform an exercise in economic crisis management. Specifically, one that places no trust in the ability of the private sector to recover from crisis on its own. A New Dealer, be he Rooseveltian, Bernankian, Paulsonian, or Obamian, is someone who thinks the government is required to do extraordinary things, in order to prevent economic crisis from creating widespread disruption in the lives of ordinary people.

The just-enacted $787 billion stimulus law is an example of (New) New Deal thinking. But the budget is coming from a different philosophical place altogether. It's not about crisis. It's about where we go from here.

This budget was conceived by a mentality which assumes two key things together: first, that government SHOULD take a positive and sweeping role in setting the national priorities of the United States. (This is something which, for the last thirty years, we've understood as a prerogative of individuals acting in freedom.)

Second, that government CAN take such a positive and sweeping role. As we'll see, the budget assumes at its core that policymakers have the resources to afford an enormous expansion in the scope of government, and the tools to keep the economy from being disrupted by it.

We've seen hubris like this before, and it wasn't during the Great Depression. It was during the Sixties, the heyday of the Keynesian technocrats. Obama isn't thinking about rebooting the New Deal. He's proposing a New Great Society.

The net result of the stimulus package was to direct huge amounts of new money to programs that will be largely controlled by the states. This will certainly result in a lot of wasted spending on things no one needs, but more importantly it will permit strapped state governors to avoid crippling tax increases. Since states and cities don't print their own money as the Federal government does, they generally run into fiscal trouble as the economy slows. Thus the stimulus will act very much like a tax cut.

But Obama's first budget is full of new programmatic spending. Among much else, there is a $643 billion "down payment" on universal health-insurance coverage, new spending on alternative energy projects, and significant budget increases for federal agencies including OSHA and the SEC.

So what the budget is telling us is that nationalized health care and a nationalized "green economy" are on the horizon, and the Federal bureaucracy will be considerably beefed up to handle their new responsibilities.

Gone is any hesitation that the government should do these things, or any thought that they would not necessarily do them as well or as efficiently as the private sector. This is the philosophical shift contained in this moment, and it matches that of the Great Society.

One senses a broad new impatience with the approach of the past two decades, which held that government could achieve its objectives by modulating the incentives presented to private actors, and the "magic of the market" would do the rest. This budget says To heck with that, and just plans to do things itself.

The other large new idea in this budget relates to what the President calls "fiscal discipline." This is the quaint idea that you should pay for what you spend, and more specifically that you should prefer to pay for it with current income rather than with borrowings.

For two decades, the United States has benefited from a singular (and somewhat mysterious) desire by global investors to lend money to us at extremely low real interest rates. This has fueled a boom in consumption and investment in both the private and public sectors, but the money spigot has been shut off to the private sector.

But the Federal government (and its extensions, including Fannie Mae and Freddie Mac) continue to have access to plentiful amounts of borrowable funds, from the rest of the world and also from Americans unwilling to buy into the stock market. It's no longer fully true that the interest rates at which we borrow are historically low in real terms. But that doesn't mean the money is unavailable. We should have no trouble continuing to borrow money against Obama's budget priorities indefinitely.

However, he wants to step the borrowing down as quickly as he can, and replace it with much higher taxes on high incomes, business income, and returns on capital. He also wants to impose a large economy-wide tax on energy consumption (the "cap-and-trade" regime).

The problem, however, is that by so severely penalizing any activity which produces returns on investment, Obama is shooting right at the heart of the economy's ability to return to robust growth. This is a fatal flaw.

So what is the result when you depress organic economic growth by taxing its drivers, but simultaneously import and borrow less capital? You get a smaller economy overall, or at least one that strongly underperforms its capacity.

But that would also imply that Obama will need to scale back his ambitious plans for national health care, a green economy, and a larger government headcount. Unless he's willing to do that, he will necessarily need to continue borrowing, and fiscal deficits will remain very high indefinitely. The combination of high fiscal spending with low organic growth means that we face an inflationary future (more dollars chasing fewer goods).

This was the same flaw that defeated the Great Society. This was a word that President Johnson first used in 1964, and became a legislative program in 1965. At the time, the US was facing grave social problems and an incipient war in Vietnam, but a relatively healthy economy. The question economists posed was whether we could afford guns and butter, or a costly war and a vast expansion of social spending. The answer was judged to be yes.

But as early as 1965, the first signs appeared of an inflationary tendency that persisted until it was forcibly killed (at the cost of a brutal recession) in 1982. Stagflation (high inflation with low growth and high unemployment) was the fatal flaw that defeated the Great Society, dogged the Seventies, and overshadowed the tenure of President Carter.

But today, we don't have the same benign economic conditions that prevailed in 1965. Instead, we're facing the worst financial and economic crises since the Thirties. And into this environment, the President boldly and innocently proposes to enact a New Great Society, with broad new spending and powerful disincentives to economic growth.

It's hard to expect a better outcome this time around.