When CNBC’s Rick Santelli went to the floor of the Chicago commodities exchange and started shouting that we need to “stop the spending,” he was touching a raw nerve.
Santelli knows about raw nerves. He was the guy whose call for a tea party helped launch the movement. All across the world, it seems people are feeling that the government should cut spending.
Faced with staggering debt loads, such feelings are understandable. At President Obama’s June meeting in Toronto with other G-20 leaders, he seemed like the lone wolf in calling for more government spending.
German Chancellor Angela Merkel wants more cuts. In Britain, the new Conservative-Liberal coalition government is planning on across-the-board spending cuts of 25 percent along with tax increases.
Obama is both right and wrong on this spending issue. He is correct in believing that spending cuts right now at this critical juncture could be disastrous. Paul Krugman, the liberal economist, is even warning that the recovery is so tepid we could be facing “a third depression.” But Obama has been wrong on the type of stimulus spending needed and he failed to embrace structural reforms that would reduce entitlement programs and the power of public employee unions.
The idea that government spending can solve recessions comes from the John Maynard Keynes school of thought. This famed British economist argued that government was a powerful engine that could “prime the pump” and stimulate the economy when consumer and investor confidence ebbed.
Essentially, Keynes was right on his theory. Government spending can increase economic activity. But the people who embrace Keynes, like Obama, always forget the second half of Keynes’ view, which is that when the economy recovers, the government should pay off its public debt.
Keynes used the analogy of a household that was suffering during difficult economic times and went into debt. Once their economic fortunes returned, they would pay off their debt. All would be equal in the end.
Keynes must be turning over in his grave to think his theory was used to create endless deficits and mountains of national debt — perpetual pump priming. As the U.S. debt careens over $13 trillion, many are beginning to realize the fiscal Ponzi scheme has to end at some point.
Supply-side economists, I believe, offered the best approach. They understood that new government programs simply never end.
Instead, the supply-siders argued for massive tax cuts that pump cash directly into the economy, stimulating economic activity without long-term government obligations. But Obama hates tax cuts, especially for the affluent.
His $787 billion stimulus package has not been successful because at the same time Obama wanted to put cash into the economy, he also worked to punish the rich, many of whom spend a lot of money and invest.
The wealthy are now holding back on spending and investment, and this is why the economy appears to be stalling.
UCLA economist Edward Leamer tells me that of the $787 billion in Obama stimulus money, only about $10 billion has been stimulative to the U.S. economy, and most of that comes from a relatively small housing tax credit that Obama and Congress reluctantly included in the bill.
So hold off on spending cuts for the moment, but restructure entitlement programs such as Social Security and healthcare, using more free enterprise solutions like private pension programs and health savings accounts. At the same time, cut taxes across the board for individuals and companies, and the American economy would boom as never before.
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