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Over the past few months the Distress Index had fallen slightly from an alarming 61.7 in June, which marked the highest economic distress in over 30 years. Many had hoped this would lead to a full economic turnaround. But rising unemployment and the return of consumer price inflation dashed those hopes and confirmed the economy is still in deep distress.

“The minor excitement about turning the corner and coming into a recovery may have been premature. Even the President is now warning of a double-dip recession,” said Prof. Paul Cwik, co-creator of the index. Cwik, an associate professor of economics at Mt. Olive College in North Carolina, warned that the “current recession is far from over” and noted that the trillions of dollars that have been pumped into the economy are now “starting to have an effect on some prices, which will only hinder the necessary liquidation process.”

To learn more about the Distress Index, visit (http://fee.org/distress-index/) or contact Mike Van Winkle at (708) 289-3136 or mvanwinkle@fee.org.

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Yes, the Federal Reserve and the Obama administration have pulled us “back from the brink” — the title of a new paper by Christina Romer, who leads the Council of Economic Advisers. She argues convincingly that expansionary policy saved us from a possible replay of the Great Depression.

But while not having another depression is a good thing, all indications are that unless the government does much more than is currently planned to help the economy recover, the job market — a market in which there are currently six times as many people seeking work as there are jobs on offer — will remain terrible for years to come.

As if on cue, the Times editorialized two days later:

If successful, ambitious goals like health care reform and energy legislation may generate jobs, but officials have not persuasively linked them to job growth. Congress and the administration also have not done enough to directly create jobs. That could be done with more stimulus to spur job creation, or a large federal jobs program, or tax credits for hiring, or all three.

The truth is elsewhere. First and most important, the economy continues to shed jobs more than two years into the recession because government has increased the burdens private firms and individuals must bear. From tax increases to a gaggle of new rules and regulations to the bailouts, government has done nearly everything it should not be doing if it wants a real recovery to take place.

Second, it is clear that the politicians in Washington are just getting started. From the appointment of numerous “czars” over different sectors of the economy to the “ambitious” plans for remaking medical care and imposing huge new environmental burdens, it is clear that President Obama and Congress believe that the economic downturn is an excuse for an upturn of State control of our lives.

If there is any “recovery,” it is a false recovery, one based not on any tangible economic progress but rather on financial trickery and printing money. Our “recovery” is a fraud perpetrated by Washington and its Amen Chorus in elite higher education and the mainstream media.

For the U.S. economy to have a real recovery, the economy first must shed the huge number of malinvestments that piled up like garbage on New York streets during the last unsustainable boom. Unfortunately, as the economy dumps these failed investments, that means people who were employed in those areas also lose their jobs, which simply is unacceptable to the political classes.

Had the Bush and Obama administrations left the economy alone, those malinvestments would have been shed quickly and the economy now would be moving toward a real recovery that could be sustained over time, employing new people in those sectors. Alas, the political classes believe that “inactivity” is anathema, so Bush and Obama engineered hundreds of billions of dollars of “bailouts,” which have served to prop up whole sectors of failing enterprises.

What does that mean, economically speaking? It means that instead of being directed into those sectors that could have grown without aid from the government, resources are being shoveled into the economic equivalents of bottomless pits. Americans are forced to prop up domestic automakers that are bankrupt, keep zombie financial institutions going on life-supports, engage in energy policies that literally destroy wealth and produce less energy, and to be taxed even more so government can destroy the part of the medical sector it has not already ruined.

In other words, Americans in productive entities are being forced to give up a large chunk of their own wealth o prop up firms and institutions that might be bankrupt but also are politically connected. While the New York Times and its elite economists in tow might claim the government needs to continue this course with another “stimulus,” commonsense economics is telling us that this is a policy that benefits the political classes and their allies and no one else.

In a rational political and policy environment, the implication of all this [the fading economy] would be clear: we need more stimulus. Yes, it would add to federal debt — but isn’t that worth doing to help reduce an output gap that’s wasting our potential at the rate of more than a trillion dollars a year?

The “solution,” Krugman says, is for government to create more debt and print more money.  Since he already publicly claims the printing of money creates a “free lunch,” he would approve of nearly any way the money appropriated by Congress would be spent, just as long as there is spending.

Lest anyone think the “stimulus” is spent wisely, think again.  One building block of economic analysis is “utility theory” in which people rank their preferences from highest to lowest.  For example, while I might want to take a vacation, it is more important that I spend my income first on my house payment, then food and other expenses that will support my family.

If there is money left over, perhaps then I can take my trip.  Likewise, when we want governments to spend money on various projects, we assume that the most important items will be first in line.  (One can make a case that just about all government spending is foolish and reckless, but for purposes of this article, I will assume that at least some government spending has social value.)

According to the promoters of the “stimulus,” the money has gone to hard-pressed states and localities to fill in the gaps caused by declining tax revenues.  In some places this has meant that lower-valued projects have been abandoned or put on the back-burner, which fully reflects the human valuation process.

If the “stimulus” were about helping states and localities through hard times, the government would want them to spend it on the most-important projects, or perhaps even hold that money in reserve to ensure solvency through the recession.  Instead, Congress has directed that money be spent on things that local and state governments would never consider to be priorities.

I have to do nothing more than drive to work to see this foolishness in action, as two “stimulus”-funded projects are in my backyard.  I live in Garrett County, Maryland, and have to drive over Big Savage Mountain, a 3,000-foot-high ridge, to go to Frostburg State University, which is five miles east of my home.  If I take U.S. 40 over the mountain, I often have to stop and wait for several minutes while work crews expand the drainage ditches along the steep road on the mountain’s east side.

If ever there were a make-work project, this is it.  In the more than eight years I have lived in this area, I never have witnessed any problems caused by the old drainage ditches and there really did not seem to be any problems there caused by cascading storm water.

However, the other project on I-68 on the east side of Big Savage Mountain makes the drainage undertaking look to be fiscally sound.  The interstate highway has a narrow median with a guardrail down the middle.  This past week, drivers going east and west were shuttled into one lane to accommodate workers putting down rolls of new sod in the narrow median strip.  If ever there were a worthless project, this was it – and even my children commented on its uselessness.

If these “stimulus”-funded undertakings are typical of what the Congress directed for states and localities, then the “leaders” of the U.S. government are even more delusional than I had imagined.  Not only are they handing out money in a manner that imperils our future, but they also are demanding that it be spent on phantom things that intelligent people never would need in the first place.

This is not “change we can believe in.”  This is government as usual.

The Stimulus Helped the Economy? Not So Fast!

“The Forest Service has directed that $2.8 million in ‘Wildland Fire Management’ funds, approved under the economic stimulus law, go to groups that will create ‘green jobs’ in the District of Columbia. The projects are intended to restore public parks and watersheds in the city and highlight the value of urban parks, including a park 2 miles north of the White House that once was plagued by crime.” (AP, Thursday)

“Green” jobs aren’t free.

FEE Timely Classic:
“Why Government Can’t Create Jobs” by Mark Ahlseen

Actually, a government bureau is the nearest thing to eternal life we’ll ever see on this earth! –Ronald Reagan

FEE (Instant) Classic:
“Transforming America: The Bush-Obama Stimulus Programs” by Randall G. Holcombe

“Throughout the summer, the administration had averaged about $4 billion in new spending obligations per week, but went on a two-week $25 billion spree just in time to meet the president’s $225 billion goal for the first 200 days. Spending plummeted to less than $4 billion in the week of Sept. 5 through Sept. 11.” (Washington Times, Monday)

Plummeted to $4 billion? Gives “hair of the dog” new meaning.

FEE Timely Classic:
“A Government Program for All” by Paul Cwik

“The road signs, which let motorists know the paving and construction projects they see are being paid for by the $787 billion economic stimulus program, have popped up across the country. In a 52-45 vote, the Senate decided the signs should stay.” (Washington Times, Thursday)

Sign should read: “The Destruction and Reconstruction of Perfectly Good Roads. Paid for by the A.R.R.A. of 2009″

FEE Timely Classic:
“The Mythology of Roosevelt and the New Deal” by Robert Higgs

Although no serious discussion is occurring in the nation about the desirability of shifting economic power from individual decision-makers to the national government, that shift is a basic characteristic of virtually every policy proposal being debated in the Congress.

Take tax policy.  A 131-page document (pdf) issued by the Treasury goes way beyond recommending the extension of some of the expiring Bush administration tax cuts.  For example, the fine print contains over a dozen ways of discouraging American firms from doing business and investing overseas.  Supposedly minor technical changes also would have a severe impact.

For example, eliminating LIFO (last in-first out) inventory accounting will raise business taxes over $60 billion in one decade.  The Treasury also wants to revive four corporate environmental taxes that were eliminated in 1969.  These four arbitrary taxes have no relation between the tax burden imposed on a company and the pollution that it generates.  This bears an uneasy resemblance to Willie Sutton, who robbed banks because that was where the money was. Inevitably a variety of technical tax provisions will increase the paperwork burden on business.  The penalties for failing to file information returns (such as Form 1099) promptly and accurately are raised in a very complicated fashion involving three tiers of penalties.

On the expenditure side, the typical stimulus project increases the power of government in private business decision-making.  The bailout of the automobile industry is really an inefficient method of financing union pension and health plans.  The stockholders are zapped and the bondholders poorly treated.  The taxpayers are left holding the bag, especially considering the restrictions on General Motors importing the really fuel-efficient cars they produce overseas.  Apparently, the new General Motors factory for building compact cars was chosen on the basis of “carbon footprint” and “community impact.”

It is hard to keep a straight face when analyzing the new “cash for clunkers” program.  For example, owners of the biggest old clunkers get a $3,500 credit for trading in the old vehicles for a new one with an improvement of just one mile per gallon.  Surely, it would save energy if the Treasury just mailed the $3,500 checks directly to Detroit!

Of course, the Obama administration is making some reductions in federal spending.  It is reportedly imposing a 9 percent reduction in the budget for the division in the Labor Department that polices fraud and other illegalities on the part of labor unions.  As noted below, a simultaneous expansion of business-oriented antitrust enforcement is taking place.

Turning to regulation, one of Ralph Nader’s biggest disappointments during his heyday as a consumer advocate was the failure of his proposal for a new Consumer Protection Agency.  However, the administration’s financial regulatory plan creates a powerful new Consumer Financial Protection Agency (CFPA).

This new free-wheeling agency takes authority now divided between the Securities and Exchange Commission (SEC) and the Federal Reserve System.  In a change guaranteed to cause confusion, the CFPA will share authority with the Federal Trade Commission.  The new regulatory agency will also have a mandate to give consumers more economic education.  Educators find that especially scary.

Moreover, the agency will have its own money pot, independent of the normal congressional appropriations process.  It will be financed directly by fees assessed on “entities and transactions” across the financial sector.

The Treasury’s financial plan contains many other expansions of government power over business.  The Federal Reserve System is given new authority to oversee any large financial entity whose failure the Fed thinks could generate “systemic risk.”  The Treasury heads a new Financial Services Oversight Council to “resolve” the inevitable jurisdictional disputes among federal agencies.  A new Office of National Insurance is to be established in the Treasury to monitor “all aspects of the insurance industry,” a sector of the economy traditionally under the province of state governments.

The SEC will require the registration of all advisers to hedge funds and other private pools of capital with assets over a given threshold.  It also will have the power to inspect the books of the advisers and to ensure compliance by their clients.  In addition, the power of the SEC will be expanded by legislative proposals to give it a more active role in guiding the compensation committees of all public companies.

The Federal Deposit Insurance Corporation will have new authority to take over and shut down financial institutions (not just banks) whose failure is deemed to pose “systemic risk.”

Viewed in their totality, these technical financial changes would represent a historic expansion of government.  Sadly, there is little comfort in the Treasury’s warning in its 88 pages of detailed proposals:  “More can and should be done in the future.”  Comparisons with the New Deal of the 1930s are too timid.  Shades of Alexander Hamilton!

The complicated climate change bill that recently passed the House of Representatives is a dramatic example of expanding government power over the economy.  Again, the fine print deserves far more attention than it has received.  For example, buried in the 1,201 pages of detail is a provision authorizing the Department of Transportation to require automotive manufacturers to produce vehicles that can run on methanol (wood alcohol), a fuel not widely available.

Other provisions, as expected, have little to do with the subject of global warming.  For example, contractors on some energy projects must pay employees at least the locally “prevailing wage.”  It is well known that, in practice, that means paying higher union wage scales.

Many federal departments are trying to climb aboard the economic stimulus bandwagon.  The Department of Justice wants to help out by showing that antitrust should be a “frontline issue” in the response to the problems facing the economy.  Apparently, business is not getting sued often enough.  Incredibly, one new assistant attorney general views antitrust enforcers as “key members of the government’s economic recovery team.”

When we step back and try to add up all the tax, spending, and regulatory actions and proposals of the new Obama administration, the result is clear: a cumulative squeeze on private decision-making and a more slowly growing economy in the years ahead.

In the process, private businesses will be discouraged by a host of government policies from making major new investments, especially those of a long-term nature with payoffs far in the future.  Key negative factors are the likelihood of higher taxes and greater inflation resulting from the huge budget deficits that are likely to arise in the next several decades, abetted by lax monetary policies.

The American public is likely to have a long wait until the national unemployment rate gets back down to the 7.6 percent that was reported when President Obama took office in January 2009.

One fundamental point deserves to be stressed.  In the inevitable tension in public policymaking between economic prosperity and income redistribution, for the next several years the American people can expect that income equalization will get the government’s priority over improvements in people’s living standards.  The average American, at best, will receive a more equal slice of an income pie that will be far smaller than the public expects.

For the past 30 years, we’ve been told that government spending is bad, and conservative opposition to fiscal stimulus (which might make people think better of government) has been bitter and unrelenting even in the face of the worst slump since the Great Depression. Predictably, then, Republicans — and some Democrats — have treated any bad news as evidence of failure, rather than as a reason to make the policy stronger.

In dealing with the crude analysis that accompanies such Keynesian thinking, I use Krugman’s columns because he is the most popular exponent of that viewpoint. If one wishes to learn Keynesianism, read Krugman’s columns.

The Keynesian economic “theology” holds that only spending matters. Keynesians believe that it does not matter who does the spending, although it is preferable for government to do it, since politicians love to buy votes with other people’s money.

A recent quote in a Krugman column demonstrates this point. He claims that since private borrowing is down, even with the government’s current rapid accumulation of debt, overall borrowing is less than what it was during the boom. Thus he concludes the overt worrying of some over the massive increase in government debt is just another tale of woe from the “economic Cassandras.”

In other words, Krugman does not differentiate between private and government borrowing, even though business borrowing mainly is done for capital investment and government borrowing is done so governments can spend more than they take in with taxes. Keynesians seem to believe that the only benefit business borrowing provides is the spending that takes place, so if government does the borrowing and spending instead, then all the better.

Now to deal with the quote from Krugman’s column. Austrian economists do not respond negatively to what Krugman says because we “hate” government for “ideological” reasons (even though most of us look askance at government and its coercive ways), but rather because we understand the differences between private and government spending. They are not mirror images of each other, no matter what Krugman says.

In the Keynesian viewpoint, all assets and all capital are homogeneous. It does not matter if one spends money on a “bridge to nowhere” or invests in a new line of production; what is important is that money is spent.

Furthermore, in Keynesian thinking, as long as there are “idle resources,” then government spending — if it is enough and enough money is printed — ultimately can result in “full employment” of those resources. Why those resources might be idle in the first place is not up for discussion; the important thing is that government “stimulates” enough spending to put those resources back to work.

This is short-sighted and crude analysis. In the real world, capital matters, for it is in the development of capital that we make workers more productive, thus increasing individual wealth and the overall standard of living in a society. Capital spending is not just money dropped from a helicopter; it is undertaken for a specific productive purpose.

Austrians hold that typical Fed-created credit booms are not sustainable and that when once-productive assets become idle in the downturn, it is because the capital was malinvested. Granted, to understand the entire concept of malinvestment, one must be able to differentiate between the kinds of capital investment that can be sustained and what will have to be abandoned. Keynesians, unfortunately, have decided to ignore that kind of thinking or unilaterally to declare it “discredited.”

Yet when one applies simple logic, it is not hard to see which set of economic ideas should be discredited, and it is not the Austrian theory.

It takes some sophistication to follow Henry Hazlitt’s economics lesson and trace the consequences. Under the new supply and demand conditions, if prices cannot rise beyond a certain arbitrarily set level, supplies will run short, since people have no incentive to conserve and entrepreneurs have no incentive to divert goods from where they are relatively plentiful to the stricken area where they are relatively scarce.

Similarly, most people think the minimum-wage law is a good thing because they dislike that unskilled workers are paid very low wages. What could be more humanitarian than to set a floor beneath which wages cannot fall? If they thought like economists, they would realize that a mandatory minimum wage set above the marginal productivity of unskilled labor creates unemployment or less-desirable jobs for the workers it is intended to help.

But lately an idea has been floating around that anyone should be able to see through because it has no superficial logic whatsoever. It goes like this: The government hasn’t been able to spend $500 billion fast enough to stimulate the economy, so the only thing to do is . . . give the government even more money.

Huh? How does that make sense?

The Obama administration, for now, seems to grasp the weakness of this reasoning, but the same cannot be said for some members of Congress. There is talk of a second “stimulus” package. We shouldn’t discount the possibility that the congressional backers of a new bill know it’s a ridiculous idea but that they stand to benefit from passing it anyway. That’s how incentives work in the political system.

The first “stimulus” package under Obama was no such thing. As has been noted many times, any money the government spends must be acquired from somewhere in the economy first through borrowing or taxation. While moving money around may stimulate a given activity, it comes at the price of the other activities to which that money would have been directed. And since bureaucrats, not entrepreneurs, direct the “stimulus” projects, this redirection of scarce capital is detrimental to consumer welfare. If the projects served consumers and thus were profitable, they would have been undertaken privately and more efficiently than bureaucracies could have accomplished them.

The money in the earlier bill was supposed to be used for what we were assured were “shovel-ready projects.” But the truth seems to be that precious few were shovel-ready. They won’t get started for a year or more.

Edward Lazear writes in the Wall Street Journal, “By June 26, about $56 billion [out of about $500 billion] was spent on the stimulus from the American Recovery and Reinvestment Act of 2009, passed Feb. 17. A large proportion of that actually reflects mere transfers from the federal government to state governments, so the amount that has gotten into the economy is significantly lower.”

What Were They Thinking?

Thus even if the “stimulus” plan had been sound in theory, back-loading the spending to such an extent undermined its stated purpose: immediate job creation. It makes you wonder what the bill’s architects had in mind. Did they actually believe what they were saying? If so, their actions make no sense. When the bill passed in February, the unemployment rate was 8.1 percent, Today it is 9.5 and rising. That doesn’t seem terribly stimulating. Obama might claim he saved some number of jobs, but he wouldn’t be able to prove that.

Administration spokesmen are now asking for patience, but they are the ones who created a public expectation of quick stimulus. They have only themselves to blame for the disappointment showing up in the popularity polls.

Outside advocates of stimulus, such as Paul Krugman, will say the unabated rise in unemployment only proves what they said all along: The spending package was too small. But that is not a satisfying rebuttal. First, as noted, if government agencies can’t disburse a half-trillion quickly enough to jolt the economy, logic compels us to conclude that they can’t disburse a trillion. Should they fly around in helicopters and drop the money? (That wouldn’t work — people would do unpatriotic things like save or pay off debts.)

Second, economic theory refutes the Krugmanian claim. Since government can spend only what it has first taken from someone else (by borrowing or taxation), the spending can’t create jobs on net. So even if the government-created jobs were real jobs — in the sense that they ultimately contributed to consumer well-being according to consumers’ own priorities — they were created at the cost of other productive jobs that would have been created in the absence of government intervention. Resources are scarce; government spending displaces private economic activity. There is no way around that.

If the Stimulus I was a bad idea, Stimulus II is even worse.

This error also involves individuals. It holds that what is true for one individual will be true for all others.

The example has often been given of one who stands up during a football game. True, he will be able to see better, but if everyone else stands up too, the view of many individual spectators will probably worsen.

A counterfeiter who prints a million dollars will certainly benefit himself (if he doesn’t get caught) but if we all become counterfeiters and each print a million dollars, a quite different effect is rather obvious.

Many an economics textbook speaks of the farmer who is better off because he has a bumper crop but may not be better off if every farmer has one. This suggests a widespread recognition of the fallacy of composition, yet it is a fact that the error still abounds in many places.

The good economist neither sees the trees and ignores the forest nor sees the forest and ignores the trees; he is conscious of the entire “picture.”

In looking at policies coming from Washington, D.C., I employ this fallacy in two ways.  First, I apply it as written; second, I show how economists and pundits wrongfully apply this fallacy, and make false claims with it.

The latest “stimulus” package has governors, mayors, farmers, college presidents, auto and steel executives, scientists, and other interest groups lining up.  Auto executives claim that bailing out domestic producers will “save American jobs.”  The “alternative energy” crowd does one better: they claim that they will “create new jobs.”

Indeed, new government money given to these groups will benefit people who receive the dollars first.  One benefactor is Al Gore, who is a partner in an investment fund that helps bankroll these subsidized industries.  Obviously, he believes that these subsidies are “good for the country,” when, in fact, they are good only for a small group of people with a huge public relations machine.  Those who are forced to pay higher energy costs (in order to buy inferior ethanol fuel and high-priced electricity) are made poorer, and no amount of rhetoric can change that sorry fact.

However, the wrongful use of the “Fallacy of Composition” also must be addressed.  Perhaps the worst example is the “Paradox of Thrift,” coined by Keynesians, but really goes back to the Mercantilists of the 16th and 17th centuries.

The “Paradox of Thrift” states that saving money might be good for a few people, but if everyone saves, then it retards economic growth and drives the economy into recession.  (The Wall Street Journal recently had an article blaming savers for not spending “just as the economy needs their dollars the most.”  The article referenced the “Paradox of Thrift” as though it were legitimate.)

Obviously, economists and pundits who cite this faux “paradox” are ignorant of how capital formation occurs and how a boost in the savings rate will lessen the impact of a recession and help bring about a real recovery.  These economists, however, are looking at only the immediate impact of spending and saving (I will deal with “short-run” thinking in a future column), not the longer-term effect of capitalization and economic growth.

Economists tend to be divided into two groups.  The first sees the economy as a perpetual motion machine that magically grows even as people consume down the capital stock (which replenishes itself and even expands on its own, just as long as consumers continue to spend).  The second sees economic growth occurring only because people save for the future and create new capital that matches with consumer needs and desires.  It does not take a genius to recognize the “bad” economists and the “good” ones.

Not surprisingly, the “bad” economists fall over the Fallacy of Composition on both ends.  They fail to recognize it when it comes to government spending and misuse it when examining consumer behavior.

Next week: The Fallacy of “Money is Wealth.”