A Most Dangerous Inflection Point

“If we don’t act swiftly and boldly, we could see a much deeper economic downturn that could lead to double-digit unemployment.”
President-elect Barack Obama
January 3, 2009

There is a major economic battle underway pitting the resurgent Keynesian forces of President-elect Franklin Delano Obama against the monetarists and the remnants of the laissez faire/supply side crowd. To exemplify this policy struggle, consider the following two recent quotes from Paul Krugman:

“The biggest problem facing the Obama plan, however, is likely to be the demand of many politicians for proof that the benefits of the proposed public spending justify its costs — a burden of proof never imposed on proposals for tax cuts.”

“(Milton) Friedman’s claim that monetary policy could have prevented the Great Depression was an attempt to refute the analysis of John Maynard Keynes, who argued that monetary policy is ineffective under depression conditions and that fiscal policy — large-scale deficit spending by the government — is needed to fight mass unemployment. The failure of monetary policy in the current crisis shows that Keynes had it right the first time.”

To help complete the picture of this economic/political battle royal we have the factions of the newly empowered Democratic Party and its liberal wing seeking to spend the political capital they think they have earned courtesy the recent election results. Then, on top of all this is the stickiness of Washington business as usual and the reality that entrenched power is rarely ceded without a fight.

Needless to say, the task before Mr. Obama is daunting. And we will all learn if his campaigning skills can be translated into effective policy decisions and leadership.

Investment Strategy Implications

The central question is not whether all the money being thrown at the global economy (both fiscal and monetary) will produce positive results. It will. Rather, the key question is whether the policy actions under vigorous (and potentially divisive) debate involving trillions of dollars ends up stabilizing and then turning things around or merely mutes the decline to an era of lessened living standards and a lower quality of life. If the former, a new era of growth ensues. If the latter, get ready for the Great Depression II and a highly dangerous future.