demandside

Business school, Larry Summers is on board, commodity speculation, Robert Lucas and other non-sequiters

Confetti

Our object here at demand side is to assault the conventional wisdom that is not very wise, dispute the accepted facts that are simply not true, and lampoon the insightful analysis that is just fuzzy thinking.  All from the Demand Side.  Needless to say it is a work program far too ambitions, so in honor of 2008 and to be able to start fresh for 2009, we have conceived here at demand side of the following in-box cleaning exercise.

I have placed in a pile the ideas and issues I would have liked to visit or re-visit during the year.  I have listed them on a spreadsheet.  Now with the help of a random sequence generator, I will order them and get to as many as I can in fifteen minutes.

I originally tried to do this extemporaneously, but that bogged down quickly.  Sitting in a room talking to the wall is not very conducive to anything except I suppose ruminations on the tragedy of one’s childhood.  So I have taken each in order and will make a few notes and come back and read them.

First:

37 Commodities Speculation

For the first six months of this year the issue on the news and in the coffee houses was the price of oil.  The accepted fact was that demand was outstripping supply.  No less than T. Boone Pickens came up with the idea that supply was constrained at 185 million barrels and demand wanted 187 million barrels.  The new cars of China and India would take whatever they could get.  Subsidies from other governments was keeping demand unrealistically high.  Never mind the subsidy in the U.S. implicit in low gas taxes on a substance which is burning up the planet.

In any event, talk that speculation might be driving prices higher was not considered appropriate for polite company.  Anybody could see that peak oil and the rest was finally coming home to roost.  Might the tripling of the price in a year be a bit too much to lay to supply and demand?  Particularly considering that the economy was slowing down?  No, no, no.  Well a few brave voices did object.  At a Senate hearing, which we podcast nearly in its entirety here on Demand Side, chaired by Maria Cantwell of Washington, Michael Greenberger, a representative of an oil retailers association, and George Soros made noises.  Greenberger, in particular, pointed out the Enron loophole had — with the aid of a compliant Commodities Futures Trading Commission — survived Congressional action and was providing speculators with a dark market.  We also noted that Goldman Sachs had classified trading floors and the largest holdings of real heating oil in New England.  Goldman Sachs was also the author of the call that oil would reach $200 per barrel in the near term.

Ms. Cantwell promised some direct messages to the CFTC.

Less than two weeks later, the commodities bubble began to fall.  We should note it was not simply the Goldman Sachs style trading in commodities futures, but the advent of the Exchange Traded Fund, ETF, which allowed investors from individuals to pension funds to play the commodities markets and actually own the commodity.

It’s unfortunate this was number one on our list, because we spent too much time on it.

3 Toyota is King, Long Live the Dead

Let’s make short work of this.  A month ago the Big Three auto makers came hat in hand to the Congress and had their hat handed to them.  It was the incompetence of the management or the greediness of the workers that had brought them to this pass.  Well, it was the oil bubble and the credit crisis.  Not to say I approve of the products of the Big Three, but even I was feeling sympathy.

No more proof is needed than the demise of Toyota, the king.  35 percent off on sales in November and looking at the first losing quarter in several decades.  They had made money on their hybrids when gasoline spiked.  But Mr. Senator, now nobody wants to buy their products either.

It is possible the history of this event will be written as a grand pratfall by the Big Three, but it won’t be too long before the exchange rate and the credit freeze will make Toyota and the others get in the same line.

6 Larry Summers

Last winter, in late 2007, Larry Summers came down from Harvard to Brookings and to Stanford and made dark noises about the economy.  It was sobering.  Not as dark as Nouriel Roubini or Joseph Stiglitz or Demand Side, but Summers was welcome in polite circles.

His targeted, timely and temporary mantra carried the day for the first fiscal stimulus.  Defeating calls for productive, permanent and paid for, I might add.  That targeted, timely and temporary turned out to be timid and tepid.  That its best-known cheerleader was George W. Bush should give us some pause.  In any event, there is still a debate whether it did anything at all, as people were thankful, but paid down debt and saved, as rationality might suggest, rather than spend.

Now Summers is back.  He is incoming head of the White House National Economic Council, a parallel to the National Security Council.  We suspect he would have been named Treasury Secretary but for the prospect of embarrassing confirmation hearings.  But he is on board with the Obama camp.  He is now ….  Here I have a clip.

From a press conference last week with Joe Biden and the new administration’s economic team.

16 Business School

In the 1990s all the bright young people went to computer school and spent their family’s money becoming computer scientists.  Now they are manning help desks at the local industrial site or governmental agency.  After that all the bright young people went to business school.  It was worse.  People cheated and bribed their way in, because a degree from Wharton or Booth could make your millions.

Somebody’s senior thesis made its way into innovation and derivatives and now the economy has collapsed.  The fancy mathematics should have been left to thermodynamics.  Not only has the economy collapsed, but it collapsed on top of these bright young people with their tens of thousands in student loans.

And all those students are now turning back to their professors and saying, “Who is this John Maynard Keenes guy?  You never told us about him.”  Well.  It’s Keynes (KANES), and I’m sorry, you were being taught pre-Depression pap.  Is there a law that could get these kids their money back?

Probably not.  Greed is its own reward.

45 Robert Lucas

Here’s another Chicago School Nobelist.  Champion of Rational Expectations, a kind of Friedmanesque fantasy that people have perfect foresight and will alter their behavior, for example, when the government borrows money, because they realize that social security is no longer viable.  This was the example I heard most of.  So Lucas later changed his mind.  And his is still changing his mind.  Kept the Nobel prize money, though.

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Talk on the current crisis, Q&A, December 19, 2008

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No more business as usual on Wall Street or at the Chicago School

The current crisis of American capitalism and the international order which it supports ought to be the end of the free market fundamentalism.   Its practice.  Its theory.  Its proliferation.

An enormous self-prescribed overhang of leverage has frozen the banking sector and is dragging the world into deep, uncharted waters.  The self-correcting markets did not, are not and will not correct themselves.  The only stability from market action will be the sick stillness after it hits the bottom.

But

John Kenneth Galbraith said it best:

“Faced with the choice between changing one’s mind and proving that there is no need to do so, almost everyone gets busy on the proof.”

It is discouraging being a Keynesian economist.  For many years you could not get a job without believing in the mathematics, the stylized models, or the invisible hand.  Now that these are proving as effective in holding back the roll of economic forces as toilet paper holding back the tide, the jobs one might have had are disappearing.

Which is not to say I do not like my position here, boss.

But there is a more serious problem here, and that is that the entrenched interests in both academia and the business community will not give up the field willingly.  It will not be a case of, “Oh yes, we see our mistake, now we are converts.”

It is essential to clear away the error while the light of history is shining full on it.  There has been a certain ruthlessness of greed that has established itself on Wall Street and in the nation’s economic life.  It is essential to be as ruthless in dealing with it, for the sake of the society.  Otherwise it will eat away any reforms.

In a moment we’ll look at the collapse of the Chicago School in terms of economics, a

Robert Reich raised the pertinent issue with respect to the corporate culture in his commentary this week.

REICH

“All successful revolutions are the kicking in of a rotten door. The violence of revolutions is the violence of men who charge into a vacuum.”

again a quote from John Kenneth Galbraith

So it is not that the corporate elite have any defense, they simply have a desire not to change, particularly not their bonuses.

Now, turning to an article by John Lippert appearing on several blogs earlier in the week, we see that the theoretical base  of the Wall Street madness is also rotten.  This piece is heavily edited and if Mr. Lippert does not want to claim responsibility, it would be understandable.

He wrote under the head:

Friedman Would Be Roiled as Chicago Disciples Rue Repudiation By John Lippert

Cochrane had been teaching at the bastion of free-market economics for 14 years and this struck at everything that he — and the school — stood for.

“We all wandered the hallway thinking, How could this possibly make sense?” says Cochrane, 51, recalling his incredulity at Paulson’s attempt to prop up the mortgage industry and the banks that had precipitated the housing market’s boom and bust.

During a lunch held on a balcony with a view of Rockefeller Memorial Chapel, Cochrane, son-in-law of Chicago efficient-market theorist Eugene Fama, and some colleagues made their stand.

They wrote a petition attacking Paulson’s proposal, sent it to economists nationwide and collected 230 signatures. Republican Senator Richard Shelby of Alabama waved the document as he scorned the rescue. When Congress rejected it on Sept. 29, Cochrane fired off congratulatory e-mails.

The victory was short-lived. Lawmakers approved the plan four days later, swayed by what Cochrane calls a pinata of pork-barrel amendments.

“We should have a recession,” Cochrane said in November, speaking to students and investors in a conference room that looks out on Lake Michigan. “People who spend their lives pounding nails in Nevada need something else to do.”

…

Off campus, the global meltdown is stirring anti-Chicago economists, who were voices in the wilderness during decades of lax government oversight of markets.

…

Joseph Stiglitz, who won one of Columbia’s economics Nobels, says the approach of Friedman and his followers helped cause today’s turmoil.

“The Chicago School bears the blame for providing a seeming intellectual foundation for the idea that markets are self- adjusting and the best role for government is to do nothing,” says Stiglitz, 65, who received his Nobel in 2001.

University of Texas economist James Galbraith says Friedman’s ideology has run its course. He says hands-off policies were convenient for American capitalists after World War II as they vied with government-favored labor unions at home and Soviet expansion overseas.

“The inability of Friedman’s successors to say anything useful about what’s happening in financial markets today means their influence is finished,” he says.

Instead, Galbraith, 56, says policy-makers are rediscovering the ideas of his father, Harvard professor John Kenneth Galbraith, and economist John Maynard Keynes of the University of Cambridge.

Keynes, who died in 1946, argued that governments should spend to combat the unemployment that free markets tolerate. Galbraith, who died in 2006, rejected mathematical models and technical analyses as divorced from reality.

…

Nobel Dominance

For half a century, Chicago’s hands-off principles have permeated financial thinking and shaped global markets, earning the university 10 Nobel Memorial Prizes in Economic Sciences starting in 1969, more than double the four each won by Columbia University, Harvard University, Princeton University and the University of California, Berkeley.

Chicago’s laissez-faire imprint underpins everything from U.S. President Ronald Reagan’s 1981 tax cuts and the fall of communism that decade to quantitative investment strategies.

In 1972, Friedman helped persuade U.S. Treasury Secretary George Shultz, former dean of Chicago’s business school, to approve the first financial futures contracts in foreign currencies.

Such derivatives grew more complex after Chicago economists created the mathematical formulas to price them, helping spawn a $683 trillion market that’s proved to be a root of today’s financial system breakdown.

… Friedman, who died in 2006 at age 94, defined the Chicago School in 1974 as he spoke to a board of trustees dinner.

“‘Chicago’ stands for a belief in the efficacy of the free market as a means of organizing resources, for skepticism about government intervention into economic affairs,” he said.

Friedman was explaining a movement that had taken hold in the U.S. and was percolating in Europe and South America. When Friedman joined the faculty in 1946, he allied with Friedrich Hayek, a London School of Economics professor who later transferred to Chicago. They sought to discredit Keynes, who argued that deficits in government budgets could revive demand in recessions. They viewed rising government power as a step toward left-wing totalitarianism and wanted to stop it, says Philip Mirowski, a University of Notre Dame economist.

Friedman challenged Keynesian orthodoxy with work that culminated in a Nobel Prize in 1976. He argued that consumers decide how much to save based on earnings prospects throughout their lifetimes, not on short-term government efforts to manipulate demand. Friedman demonstrated that inflation and unemployment may rise in tandem and that governments cause inflation by printing too much money.

Demand Side Aside.  Consumers and virtually all forecasters of future earnings or product operate on a simple extrapolation model, identified by Keynes.  They have a much better chance of being right if the government maintains a stable economy and full employment.  End aside.

…

Friedman was chief economic adviser to Republican presidential candidate Barry Goldwater in 1964. He began attracting nonacademic audiences with a Newsweek magazine column that ran from 1966 to ’84. When Reagan was governor of California, Friedman campaigned with him in 1973 for limits to property taxes that had fueled government growth in the state.

In 1975, Friedman traveled to Chile and met dictator Augusto Pinochet, who’d seized power two years earlier in a coup in which thousands died, including Socialist President Salvador Allende. Pinochet practiced “shock therapy,” including monetary controls, to tame inflation.

Friedman’s friend Alan Walters, later an adviser to British Prime Minister Margaret Thatcher, went to Chile to monitor what he viewed as laboratory-like conditions for shock therapy, says Andy Beckett in “Pinochet in Piccadilly” (Faber & Faber, 2002).

DEMAND SIDE:  WALTERS SUBSEQUENTLY ADVISED EASTERN EUROPEAN STATES IN THE  AFTERMATH OF THE SOVIET ERA, PROMOTING SHOCK THERAPY AND ASSISTING MATERIALLY IN THE IMMENSE SOCIAL AND HUMANITARIAN DISASTER.

“By the mid-1970s, there was a whole generation in government and academia who’d trained at Chicago or places influenced by it,” says Ross Emmett, a Michigan State University professor who’s written three books on the school.

Today, 10 percent of Chicago undergraduates study economics. Alumni of Chicago’s graduate business school, now called the Booth School of Business, run states and companies.

Jon Corzine, the former chief executive officer of Goldman, Sachs & Co. who earned his MBA in 1973, is governor of New Jersey. Peter Peterson, who graduated with an MBA in 1951, co-founded Blackstone Group LP, the world’s largest private equity firm.

David Booth, a 1971 MBA graduate for whom the school is now named, donated $300 million in November, the largest endowment given to the university.

Booth, who founded Dimensional Fund Advisors Inc., bases his funds on [a Chicago] theory that a market digests information affecting prices so well that even professional investors can’t outsmart it for long. Even with his U.S. Micro Cap Portfolio fund down 40 percent in 2008 through Dec. 22, Booth says quantitative investing is less vulnerable during a slump than stock picking that relies on human judgment.

“This supports our theory in that predicting the market is even more difficult than we expected,” he says.

Unlike Booth, 62, much of the academic world is reassessing Chicago School hallmarks.

…

Douglas Diamond, a finance professor at Chicago since 1979, declined to sign Cochrane’s petition damning Paulson’s bailout. Diamond says he knew the Sept. 29 vote against the rescue would spur investors to pull assets from banks. He says governments have no choice but to provide safety nets for banks and tougher oversight.

“The vote was the beginning of people believing crazy stuff, like the U.S. might find it politically expedient to let its financial system go,” Diamond, 55, says.

Diamond rejects Friedman’s view that banks failed in the 1930s because the U.S. money supply contracted as panicky Americans started hoarding cash and the Fed reacted too slowly. Diamond sees the money supply as less significant than Friedman did.

Banks failed, he says, because their assets weren’t readily converted into the cash that depositors were demanding.

During the 1980s, Diamond’s research was similar to that of Fed Chairman Ben S. Bernanke, 55, whom he calls a good friend. The two postulated that because bankers accumulate experience in assessing risk, they play a key role in the economy.

In the past decade, bankers failed to properly grasp risk because of a “witch’s brew” of mistakes, Diamond says.

Robert Lucas, a Chicago economist who won a Nobel in 1995 for a theory that argued against governments trying to fine-tune consumer demand, says deregulation may have gone too far.

Depression-era laws that separated commercial and investment banks helped depositors decide if they wanted secure accounts or riskier investments. Today, without these distinctions, people can’t be sure if their investments, or those of their customers, are safe.

“I’m changing my views on bank regulation every week,” Lucas, 71, says. “It was an area I saw as under control. Now I don’t believe that.”

Lucas says he voted for Obama, the only Democrat besides Bill Clinton he’d supported in 44 years. He concluded the candidate was comfortable talking with professional economists. He describes Goolsbee, whom he has met in faculty workshops, as a serious scholar.

…

In 1977, Friedman reached the then mandatory retirement age of 65 and left for the Hoover Institution at Stanford University.

While wrapping up his Hyde Park career, he reviewed the early research of professors Fischer Black and Myron Scholes, who gave Chicago theories a bigger and more direct role in financial markets.

The pair provided a foundation for trading call options on stocks by creating a formula to link the value of the options to share price and volatility, time remaining on the option and interest rates.  The Black-Scholes model helped spark the global derivatives market.

At the time, [Chicago School leading light Eugene] Fama was positing that securities prices reflect the collective wisdom of all participants. This “efficient market” theory helped make him the No. 1 scholarly business writer, with 250,828 downloads of academic papers as of Dec. 22, according to Social Science Research Network.

Fama’s theory helped pave the way for the recent economic crisis by sanctioning limited government, Notre Dame’s Mirowski says.

“Fama taught that no human being knows enough to understand how resources should be allocated,” he says. “All you can do is let the market have greater and greater ability to repackage information and risk. The result is, people bought mortgage-backed securities with no idea whether borrowers could repay.”

…

Fama, now 69,  says he never denied the possibility of unexpected events even though he’d spent a lifetime showing that markets effectively digest information. He was stunned that American International Group Inc., once the world’s largest insurer, sold $441 billion in unhedged and undercapitalized insurance on securitized debt, much of it tied to mortgage values.

“No one expected a player like AIG to take a long position and not hedge themselves,” Fama says. He says the government may have been able to stabilize the U.S. financial system at a lower cost by letting AIG collapse.

…

We conclude Lippert’s piece with his note:

Bank Failures

On Oct. 14, about 250 students and professors debated an administration-backed plan for a $200 million research center to be named for Friedman. The protesters argued that the institute would enshrine policies that have brought economies near collapse.

“When Friedman’s Platonic ideas of free-market virtues are put into practice, they have too often generated a systemic orgy of competitive greed — whose remedies, ironically, entail countermeasures of nationalization,” Marshall Sahlins, an emeritus professor of anthropology, said during the debate, speaking in a room adorned with murals of female students parading through the campus in medieval gowns.

Sahlins, 77, noted a few weeks later socialist and capitalist countries alike are regulating or nationalizing financial institutions in a rebuff to Friedman.

Now the bad news, President Barack Obama and one of his leading economic advisers, staff director of his economic advisory council Austan Goolsbee, are both from Chicago.

Goolsbee is quoted as saying among other things

“If the president-elect were not a ‘University of Chicago Democrat,’ then the natural response would be to just try to turn back the clock to what was there before,” he says.

“Because Obama comes out of a framework where the market is not the enemy, there’s a possibility we can create new institutions to guard against excess without going back to what was wrong in the old regime.”

…

“Getting us out of the hole we’re in, promoting oversight and making investments so the economy can grow doesn’t make you anti- market,” Goolsbee says. “It’s totally pro-market.”

Goolsbee describes the plan Obama is formulating — tax relief for workers, investment in technology and infrastructure and more oversight of financial markets — as pragmatic and data-driven. He says Friedman would approve of Obama’s determination to keep policy making rooted in the economic methodologies developed at Chicago.

There, a very liberal adaptation of John Lippert’s “Friedman Would Be Roiled as Chicago Disciples Rue Repudiation”

On Monday, because I’m falling behind, we’re going to reproduce Paul Krugman’s address to the National Press Club December 19.  We gave you Krugman’s Nobel speech earlier in the month, and we have to note again that Paul Krugman is nice.  He is right about a lot of things.  But don’t put too much stock in the Nobel.  After all, Friedman won the Nobel and John Kenneth Galbraith did not.  And Krugman can be wrong.

Rather than muddy up Monday’s podcast, I’ll just note one example here.  When Mr. Krugman says an economy does not need a middle class, he is apparently overlooking the consumption function.  The consumption function for the middle class is much higher than for the upper class.  An extremely stratified society would suffer from this.  And of course, we also have the empirical evidence of the match between the 1920s and the 2000s in terms of income inequality, both leading to crises in capitalism.

But that is Monday.

Ending with a Keynes quote:

“The difficulty lies, not in the new ideas, but in escaping the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.”

John Maynard Keynes

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Plus Robert Kuttner on Industrial Policy and the Obama Administration

Today is our collection of great stories that did not happen. Let’s call it a bunch of stocking stuffers, from the past year.

Our tradition, insofar as one year counts, is to concentrate on the biggest stories of the year that did not happen.

For example, the low-hanging fruit this year is the high and perpetually high price of oil. “We’ve seen the last of two dollar gasoline,” was the received wisdom. Tens of thousands of intelligent consumers traded in their SUVs for Priuses and congratulated themselves for several months. Now Oil $200 is as remote as Dow 36,000.

And you know we called it a bubble ….

But I’m sure we’ll have more on that later.

The point is that these stories were written and reported as gospel, with more authorities than you can imagine providing the quotes. When they didn’t happen, like the bottom in the housing market widely reported in the second half of 2007, the media simply went on. And the authorities were more than happy to go on with them, perhaps trailing a bit of their convicted opinions behind them, like toilet paper from a shoe. But even that was the exception.

What’s another big story that did not happen? Ethanol. What a mess. Ethanol backers point to the fact that it was apparently not ethanol that was driving up the price of food. Ethanol critics have moved on to pointing out how ethanol is not better, but worse, in terms of carbon footprint.

We’ve had wave after wave of Fed and Treasury rescues. But after sharp cuts in interest rates, brand new lending facilities, bailouts of banks and no bailouts of banks, special asset purchases from the Treasury and now direct purchases of securities by the Fed. Guess what, No rescue. The story was that the Fed would do whatever it took to address the crisis. That is still the story. It is not happening, because the Fed is married to a scheme that cannot work.

Most remarkable is the story that Ben Bernanke will do everything necessary to avoid a deflation. He wrote the playbook. And so on. Trememdous crash in housing prices, tremendous crash in stock prices, tremendous crash in other asset prices, crash in commodity prices, exactly what deflation is he avoiding with this monetarist nonsense?

How about, the market anticipates the downturn or its recent corollary, the market anticipates the recovery. If I call up my charts here, it looks like the S&P was near its highs in December, after the recession began, and that it has been following the data, not leading it. It was still over 1,300 in August. To say that the rattling around near the bottom here is any sign of recovery is highly optimistic.

How about the great decoupling? New data from China this morning indicate that this is nothing to make light of. The issues in China could be worse than we imagine today. I guess I should interject a story that should have happened — a New Deal style social safety net for the Chinese people.

But the fact remains that when everyone has to be an exporter and the importer is the country whose currency is the standard or reserve currency, we are going to have a problem.

Which leads us to Bretton Woods II, or III, if you count the non-regime of floating currencies as II? This didn’t happen. In my review of the necessity of it last fall, I focused on the need for an exchange regime that balanced trade and minimized the destructive typhoons of the free — meaning unrestricted — flow of capital. Obviously the capital in and out practice that leaves nations worse off than before is not costless, so perhaps we should choose the word restricted instead of “free.” Better perhaps to make the same substitution in free market. Unrestricted market. Yes, better. Free has such a sense of costlessness and liberty that are all too seldom associated with market excess.

Now, a reform in the farm bill. Did not happen. Bllions in crop subsidies go to the wealthiest farmers, or at least 85 percent of the subsidies do, and the excercise cripples competition and does nothing to save the family farm. You will remember we offered the idea of support to farmers, not crops, as a way out of this international debacle.

Accountability for the big banks? No. Free money from the Fed and Treasury if you will only do your job. Can’t? Okay, please take some more.

Resilience of American capitalism? No. The consumer economy that is American capitalism is falling as hard as it can. The occasional idiot still wants the government to let it go, but the occasional idiot thinks his job is safe, I guess. It’s amusing that the American Enterprise Institute, the Heritage Foundation and the Cato Institute still have something to say. But it’s what they’ve always said — it’s the government’s fault. The only governmental fault lies in the non regulation, non taxation, non stuff it has done. When government begins to do something again, as looks likely under Obama, watch for these political hacks to claim credit in some way.

Enough from me today. A little Scroogey on Christmas Eve.

Will Barack Obama Commit Industrial Policy?

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A demand side answer does not mean the resurrection of Shoe Pavilion

Is it really so difficult?

We could have pushed this on into Wednesday, but the growing evidence is that the Keynesian stimulus now in prospect with the advent of the Obama administration is still out of the reach of the understanding of the mainstream business media.

Schooled so long on premise that the market is infallible or  that business creates value or that government is always an unwelcome intrusion or that the oracle of enlightenment resides in the Federal Reserve, perhaps by reason of proximity to money, all too many media representatives are at sea when confronted by the reality of unintelligent and destructive markets.  They imagined an Invisible Hand not too far removed from that of the Almighty.

In shorter sentences:  The Fed continues to get kudos for good effort by the media.  Fed policy is wholly ineffective.  Here we have a couple of excerpts from people who should know better:  Businessweek’s JIm Cooper and the New York Times Louis Uchitelle.

First audio from a recent Businessweek podcast, featuring Businessweek’s Jim Ellis and that magazine’s Business Outlook columnist Jim Cooper.

BUSINESSWEEK

In order, the Fed cut its overnight federal funds rate to near zero and began buying mortgage backed securities in an effort to … well, create inflation, or avoid deflation.

Point One:  the rate cut is meaningless, since rates were already too low and were having no effect.  Ellis describes the Fed as “determined.”  I think the operative adjective is “desperate.”

I am reminded of a story involving the redoubtable Mullah Nasrudin, perhaps the oldest and best-loved comic figure in the world, the subject of innumerable stories throughout Central Asia and the Mid-East.

The mullah had a donkey and times were hard, so he conceived the idea of training his donkey to do with less.  Each day he would reduce the feed allowed to his principle assistant in life, and the beast each day grew thinner.  One day, sure enough, the donkey died.  Nasrudin was nonplussed.  “Too bad,” he said.  “I almost had him down to living on air.”

In a similar way, the economic authorities have watched the economy grow ever weaker and finally begin to die, all the while feeding it ever more of nothing.  One might imagine if Ben Bernanke were Nasrudin, he would be buying a bigger harness for his donkey, in hopes of making him fat.

Point Two:  Buying mortgage backed securities is not the radical new program that will avoid deflation.  It is more of the same.  It has two parts, it seems to me:  Pushing money into the economy by the purchases and creating demand for these securities in order to generate lower interest rates and some spark to the housing market.  More money is just more air.  The economy needs effective demand, not more money.  Trying to restart the housing boom by meddling in the middle of what was a half-baked market to begin with is not going to work.  As we’ve said, the only floor to housing has to be found with each mortgage and the time-consuming labor of unwinding the great innovations of securitized debt one case at a time.

MORE BUSINESSWEEK

Now Jim Cooper describes exactly the situation we face:  An accelerating downturn.  How much sense does this make.  The Fed and Treasury have spent all their time on the Financial Sector.  The financial sector is frozen.  Whatever they have done has not worked.  The institutions may — some of them — still be extant, but the flow of credit is not happening.

Keynesian prescriptions are often greeted these days with an arched brow and a tone of doubt, but they are in fact of a much stronger economic tradition than the mix of monetarism and ad hoc market manipulation now being employed by the Fed.

The weak Keynesian stimulus of jobs programs turned the crash in employment around during the Depression, no matter what any of the historical revisionists says.  Under Roosevelt, after he took office in 1933, only the year 1938 saw a higher unemployment rate than the previous year.  Of course the great public works project of the Second World War ratified Keynesianism in the minds of the economists of the time.

And I’d like to point out that economics had attracted the best minds of the generation.  The calamity of the Great Depression was the global warming of the time, and drew in the intelligent and dedicated.  These people were a cut above the economics practitioners of this era.

But Keynesianism flowered most prominently in the postwar period.  And there were no Republican economists.  Even Eisenhower, when he looked around for somebody to staff his Council of Economic Advisers, had to appoint the Democrat Arthur Burns.  After two decades of unparalleled prosperity and growth, in the 1960s economists were held in high opinion by everyone.

That Keynesianism was a kind of specialized and limited Keynesianism, however, and its practitioners were not up to the task of explaining or solving the stagflation of the 1970s, particularly since they were not in positions of power with regard to policy.  The Nixon wage-price freeze and the oil-induced inflation of the 70s led into the Supply Side nonsense of the Reagan era.  At the same time, Monetarism arose from the work of Milton Friedman and Anna Schwartz.  These two were the first great historical revisionists.  Alan Greenspan brought deregulation into the mix, and Ben Bernanke is in a direct line from them.

But the flood of money only pumped up the bubbles and now there are no more bubbles to pump up.  The authorities in the Bush Administration and at the Fed really have no internally consistent strategy.  It is monetary expansion and save the banks.  This is being proven day by day to be futile.

Expansion of aggregate demand by government spending is the Keynesian principle.  Raising the consumption function by strong social insurance is the New Deal principle.  The combination of these two is what we call Demand Side economics.  We look forward to a concerted effort by the new Obama administration to employ these methods.

Meanwhile we need to ask for better from the media.  Here, for example, is Louis Uchitelle, writing in the New York Times on Saturday.

Maybe It Can’t: A Trap in Obama’s Spending Plan

By LOUIS UCHITELLE Published: December 20, 2008

I am not sure which public investment projects he is referring to here.  The primary ones were the Interstate Highway System begun under Eisenhower.  Parenthesis which was sold as a national defense project end of parenthesis, the Korean War, the Viet Nam War and the defense build-up under Reagan.

This is just wrong, if he is referring to private investment.  The whole road lined with strip malls metaphor is just wrong.  This is not the mechanism.  It is the jobs created which echo through the economy by demand for public and private goods, tax payments and spending on the range of economic activity.

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