The U.S. Economic System faces Recession
Institute for Public Science & Art
1075 Olive Drive #5, Davis CA 95616 USA; jli@davis.com
Conference Theme: Systems Science in the Service of Humanity
45th Annual Meeting of the International Society for the Systems Sciences
Asilomar Conference Center, California, July 8-13, 2001
Abstract: To sell its tax cut proposal, the new Bush administration’s initial rhetorical emphasis has been to fight off an economic recession. The Federal Reserve Board’s adjustment of the prime interest rate is currently the most powerful tool the government has to attempt to manipulate the economy. The question becomes how to make large population centers more liveable and improve the quality of life.
Key words: recession, definition of a recession, interest rate adjustments, city quality of life, polis, metropolis, computerized community, decentralization
BUSH LEAGUE: An Economic Chronicle
Chapter 1, submitted March 6, 2001
“Wall Street indexes predicted nine out of the last five recessions.”
Paul Samuelson, Newsweek, September 19, 1966
This is the benchmark for an ongoing discussion on the Bush economy.
The economy is in for rocky times. The purpose of this commentary is to develop tools to analyze what is going on. I want to explore changes in the psychology of the country’s economic expectations. Economics needs to shift from being the dismal science to life affirming vitality. I invite your comments.
This installment starts out with a recent news article that Wall Street already expects the Federal Reserve to institute a third half percent cut in the prime interest rate at its meeting later in March. That is followed by ECONOMIC INDICATOR, my initial reaction to Bush’s using the word “recession” to leverage his tax cut proposal (January 5), and news articles about recent sales in the computer sector, and the stock market’s reaction to the Fed’s initial half point drop, which was unexpected. A second piece, PROVIDENCE, was written the first week of February, about the non-reaction to the Fed’s second half point drop.
The first half point drop jolted the unsteady market into action. The second half point drop was so expected that it only made one line in the next day’s news story about the stock market. It was as though the Fed hadn’t even met. The rebuttal is that the market had responded in anticipation during the week prior to the announcement.
One organic point is that each time the Fed drops the interest rate a half it loses its ability to have the leverage to do so in the future. This diminishes its potential influence to further stimulate the market.
Since I wrote the first piece, I have re-read the bible of the new Bush administration, Capitalism and
Freedom, Milton Friedman’s 1962 response to the wild Keynesian antics of the Kennedy administration, and then re-read a rebuttal, The Age of Uncertainty, a book from a 1985 BBC tv series on the history of economics by John Kenneth Galbraith. On page 218, he states he “was singled out [by the Conservatives] as the Crown Prince of ‘Keynesism,’” and was greatly pleased and hoped his friends would be properly resentful.
Galbraith was a Canadian farmboy. In 1939, shortly before receiving his Ph.D. at UC Berkeley, Ken spent spring semester at UC Davis as the entire faculty for the departments of economics, agricultural economics and range management. I will conclude with some relevant quotes about cities by him and Lewis Mumford, and my own concerns about multi-national corporations. This is in response to Friedman’s ideas which are dominating the front page of the newspaper reports on the domestic agenda of the Bush administration.
“STOCKS: LOOKING FOR A THIRD RATE CUT”
Sacramento Bee daily news story about the national stock activity, February 10, 2001
“Another impetus for a rally could be the year’s third interest rate cut, a move the Federal Reserve is expected to make when it meets in March.
“But despite two rate cuts so far this year, the market has failed to sustain upward momentum for long. Consider that the Nasdaq rallied in January, gaining as much as 15 percent, after the Fed lowered rates.
“And then, it petered out, said analyst Dickson of Scott & Stringfellow.”
ECONOMIC INDICATOR
(written January 5, 2001)
The long term question about the national prime interest rate is how long the Fed will wait before they drop it another half a percent, and whether or not it can stabilize at that level. The optimistic forecast is that the single recent drop will bring long term (12 month) stability, without the need for further adjustment. The moderate position is that the Fed will decide at its January 31 meeting to drop it another half point, and then hold it there.
When the interest rate is stable, it is not news.
When it becomes unstable, it becomes a measure of the short term efforts to encourage institutional self-correction throughout the U.S. economy. For those who depend on the interest rate to do their business, like bankers and lenders as well as capital investors in real estate, manufacturing and infrastructure development, the changed rate becomes an important point in jawboning towards the close of a sale or a deal. The prime sets the base for most other U.S. banking rates.
A year ago, people were relieved for having survived the Y2K scare which was an excellent example of pro-action. So much was done to correct computers that very few caused problems by going from 1999 to 1900. (Institutions also made tremendous investments in computer upgrades, which is one of the reasons why computer sales were down a year later – see article which follows).
Between June 1999 and May 2000, the Fed boosted interest rates six times in an effort to slow down the red-hot economy and prevent an outbreak of inflation. For most of the year 2000, the U.S. economy coasted along on the prosperity of policy wonk Bill Clinton’s micromanagement. In October, in the peaking presidential election campaign, George W. Bush’s candidacy surged ahead of Gore’s, as the national media suggested that W. wasn’t worse than the minimum and the country could survive his election, and they kept reminding voters about potentially questionable things about Gore. And Gore had to pay the price for Clinton’s reputation.
After a year of orchestrated boredom between the front runners, the November Florida vote count captured the national spotlight. Attention drifted, as both nominees said as little as possible. The national economy had a rough enough month that retailers anticipated problems with December holiday sales. While December sales were not as bad as anticipated, they were only ok at best.
Shortly after the U.S. Supreme Court ruled that the Florida vote count would stand, the new President Bush and his Vice President each made statements that the economy was shifting into a recession, laying the groundwork for their massive tax cut proposal. After the Fed lowered the rate
January 3rd, Bush immediately responded by saying it wasn’t soon enough, and it should have been more. This continued his father’s attitude about airing dirty laundry with the Fed, which lowers both institutions’ credibility and therefore impact.
This commentary was provoked by the Thursday Sacramento Bee’s business articles on computer sales and the volatility of the market, which follow.
The cybernetic/system question is about relaxation time. If the interest rate is set for six to twelve months, then the economy will have a chance to stabilize with confidence as the rate becomes a non-issue. But if the rate is dropped more half points within the next six months, it will lose some of its impact and sensitivity to create responsiveness in the national economy, putting pressure on other parts of the Federal government in the executive branch (starting with the Treasury) to shift into a more activist role, and even become Keynesian.
“COMPUTER SALES CONTINUE THEIR DOWNWARD TREND”
Clint Swett, Sacramento Bee Staff Writer, January 4, 2001
“If anyone needed further evidence that PC makers are struggling, new sales figures make it perfectly clear. Sales of computers at retail outlets and via mail order fell 24 percent in December from the previous year, according to PC Data. It was the fifth straight month of year-over-year decline and the second in which the drop-off hit double figures.
“PC Data analyst Stephen Baker said a number of factors contributed to the December drop-off, including the success of rebate plans in 1999 that coaxed numerous people into buying PCs. He also cited signs of a slowing economy, slightly higher PC prices and the lack of a compelling technological reason to upgrade a computer bought during the past few years.
“All was not bad in the high-tech sector, however. According to PC Data, sales of other gadgets rose sharply. Sales of hand-held devices, including Palm, Visor and Pocket PC, more than doubled in November from the previous year. Other categories showing substantial revenue gains in November over 1999 included MP3 players (400 percent), Web PC cameras (68 percent), CD burners (65 percent), blank CDs (32 percent), digital cameras (26 percent) and mice (15 percent).”
“RATE CUT SPURS OPTIMISM BUT VOLATILITY IN AIR”
Jack Sirard, Sacramento Bee Business Editor, January 4, 2001
“Wall Street's case of the blues ended in a nanosecond Wednesday with the Federal Reserve Board's stunning half-point interest rate cut. The Fed's unexpected move could reward individual long-term investors with a healthy dose of capital gains.
“But for Wednesday, the Fed's action was the perfect antidote for an ailing market that had cost investors billions of dollars since peaking in 2000. What started out as another dreary and lackluster day on Wall Street turned dramatically different at midmorning after the Fed announcement.
“The Dow Jones industrial average, which had been shellshocked by Tuesday's horrific start to the new year, shot up 300 points — nearly 3 percent – in typical Wall Street overexuberance. The Nasdaq did even better, rising 325 points, or 14 percent, as 3 billion shares changed hands. Talk of a recession was suddenly drowned out by renewed talk of a bull market.
“Nowhere was that more evidenced than in the personal computer sector, which has been on the decline for months on news of slumping demand. IBM shares rose 11.6 percent, Dell Computer shot up 14.3 percent and Intel gained 10.2 percent, despite an earlier ratings downgrade by Lehman
Brothers. High-tech heavyweight Microsoft soared 10.5 percent and widely battered Cisco Systems rocketed ahead 24 percent.
“Stuart Freeman, chief equity strategist for A.G. Edwards, says ‘this rate cut is the catalyst to get everything moving in the right direction. Investors should feel more comfortable knowing the Fed is on their side, based on today's action.’ He points out that the current economic environment most resembles the 1995 time period. ‘Stocks should now perform quite well post-correction over the next 12 months. If you look back at the first rate cut we experienced in 1995, stocks did just that, with the Dow Jones industrial average increasing roughly 20 percent in the 12 months following the first rate cut in 1995.’ His favorites for the year ahead are the technology, health care and financial sectors.
“Veteran Sacramento money manager Joe Milam's take on the market Wednesday was simple: ‘The punch bowl has been brought back to the party.’ But the Legacy Capital executive was as puzzled as anyone by the stock market's actions in the first two days of 2001. ‘What this tells me is that there's clear evidence that there is no such thing as smart money in the market today,’ he says.
"’If you look at both the violent action of the market yesterday to open the year and the equally strong reaction today, then you have to think that no one has been paying attention to the dialogue on The Street. Everyone knew that the Fed was going to cut rates, and there was no need for Tuesday's steep decline or Wednesday's strong advance.’ Milam says that this may signal that Tuesday's action ‘was the bottom of the market, and we are building a base to grow on from here.’ His advice to investors: If you have the discipline to stick with your long-term program, it's a great time to invest. But if you're prone to abandon your long-term objectives as investors have done for the last few years, then you're better off staying on the sidelines.
“Steve Young, senior market strategist for Banc of America Capital Management, shares Milam's concerns about the steep movement in the market over the last two trading sessions. He calls it ‘a sobering reminder that we're in a transitional environment for the stock market.’ But, he says, ‘it's clear that we need these rate cuts to complete the transition to resume economic growth.’ The Fed's move was a strong signal that it was taking steps to avoid a recession, and when you combine that with stabilizing oil prices and the possibility of tax relief with the new administration, that bodes well for the economy, Young says. A good economy, he says, is good for the individual investor because, with the Fed's action, there is an increased possibility that we've seen the bottom of the stock market. Still, investors need to remind themselves that it's not a stock market where everyone makes money. Eight of the 30 components of the Dow Jones industrial average saw declining stock prices Wednesday.”
PROVIDENCE
(written February 2, 2001)
We have seen a climate change in national economic discussion during the last two quarters. The Clinton era prosperity and unequaled continuous growth has been so steady that people forgot about the business cycle. Many have forgotten what it is like in a contracting economy, how to work towards recovery. The new generation has never actually had the experience to remember. People took the stable expansion for granted to the point of assuming it would never end.
As President-elect, the Second Bush defined his new administration with the “Recession” word as the leverage point to push through his large tax cut. This is in reaction to declines in the national growth rates that Bush points all the way back to last autumn, in an effort to attach the blame on to the Democrats.
With Republicans now in control of the White House, a narrow majority in the House of Representatives and the Vice Presidential tie-breaker in the 50-50 Senate, the national media will shift its attention towards even greater emphasis on the governmental tools that are supposed to micro-manage the economy. In particular, Alan Greenspan will be raised from being the most powerful person behind the scenes to prominent media levels not seen since Arthur Burns and Henry Kissinger in the Nixon administration.
Congressional committees on banking, finance and commerce will receive greater attention. Speeches by the President and members of Congress will seem to use economic problems as the filter for their analyses and proposals.
President Bush intends to follow his hero Reagan, and occupy the Presidency as a CEO who has excellent staff and runs a good meeting. He intends to maintain control of his daily calendar with relatively little stress (where Clinton was probably bored if he wasn’t dealing with some crisis.)
Bush wants to be able to keep his eye on the big picture – talk moderate and govern right wing. And not have the vision thing problem his father had.
The Bush foreign policy team of Colin Powell, Condi Rice and Don Rumsfeld has a first rate national reputation. Like Nixon with China, and Bush’s father with Desert Storm, W. appears to be developing a strategy to define his administration by establishing himself on the international stage as the hallmark of his presidency.
The office of Presidency has a lot more latitude and discretion on foreign policy, because it is about trying to influence other people someplace who can’t retaliate as easily. The White House believes it is the ethical prerogative of the most powerful nation on the planet. But if the U.S. economy is shifting into a recession, then foreign policy is only a luxury that Bush will have little time for because of the press of domestic concerns.
The term “recession” is a 20th century invention for politicians to describe how to regain control of the business cycle, as though there was one. But the term business cycle is only applied when the economy is going down.
So, what happens during a contracting economy? Successes are not as frequent, nor as taken for granted. People are more conservative in their choices and willingness to risk.
Businesses which have not made frugal commitments find their expenses exceeding their revenues, to the point of identity crisis, bankruptcy and shut down. Other businesses emerge and survive.
It is a cleaning out period for the larger economy. When the Japanese bubble burst in 1989, it had such a severe effect on the U.S. economy that it helped force the last recession. But unlike the Japanese, during the past decade U.S. firms adapted. The new Personal Computers (PC) transformed work requirements so much that layers of middle level management were no longer needed and were eliminated, called disintermediation. Institutions became much more adaptive. IBM went from selling mini-mainframes to selling operating networks and customized applications. So the way the U.S. came out of the last recession was to become more organizationally streamlined and user friendly. This is my explanation for U.S. economic success during the entire two terms of the Clinton administration.
This Bush enters his presidency by taking a tremendous risk of naming a recession before he is forced to by the media. If the U.S. is not in a recession, as still suggested by continuing low unemployment and slowed but still positive growth, then Bush’s recession rhetoric may actually hurt the efforts to achieve sustained GDP growth.
The term recession is now defined as a two quarter drop in the Gross Domestic Product. That definition of a recession popped out of William Simon when he was then-President Gerald Ford’s Secretary of Treasury in late 1974. The CommerceDepartment quarterly report showed a drop, and the press confronted the Secretary. In an effort to avoid the historic stigma implied in the label “recession” and hope that it was just a temporary weakness, Secretary Simon said, “Oh, no, it takes a TWO quarter drop to call it a recession.” Which is how the press & academia were given an operational definition of a recession.
That recession lasted through 5 quarters of declining GDP.
While the rhetoric changes from expansion to recession, business still needs to be done – people committed, as well as resources and money. Organizations empowered. Actions accomplished. While being a recession makes it more difficult to succeed, the challenge is to pick worthwhile projects, and lay the foundation for the next stage of the economy, just like the U.S. did in 1991-2.
Bush is using bad news to push his tax cut, painting an optimistic scenario. The fear is that he is only looking for a rosy outcome, and not reading the small print. In its recent prediction of a non-Social Security surplus of $3 trillion over the next decade, the Congressional Budget Office acknowledged that, under a pessimistic scenario, there might not be any money at all for a tax cut and that deficits in the non-Social Security budget could return as early as 2003.
The new president is an advocate for business who hopes his tax cut will create new prosperity the way he believes Reagan’s tax cut led to Clinton’s era of prosperity. When Republicans are challenged with the reality of Clinton’s unparalleled success with the domestic economy, they blame the information revolution which Clinton had little to do with, and then they cynically say that the President and the Executive branch have no real influence on the economy at all. And Bush, even more than a lot of Republicans, believes the government should take a laissez-faire approach to the economy, so there is not much he is prepared to do to intervene directly.
Statistically, the 1990-91 recession only lasted 3 quarters, coinciding with Desert Shield. This President Bush’s intention is to expand military spending for expedient deployment anywhere in the world, and oh by the way to stimulate the economy. Hopefully his skillful diplomatic crew will keep him on the high road and prevent the country from becoming invested in foreign military entanglements. His initial bombing of Iraq does not suggest a cautious philosophy.
Bush has a lot to deal with, and while he may be able to delegate just about anything, he cannot escape the pressure of everything, all the time. Unless the roller coaster national economy responds to Bush’s pronouncements and policies, it may start acting like it has jumped off the tracks. Bush hopes he will be known as the President who brought the country out of the recession and not the next Herbert Hoover.
HUMAN CONVERGENCE: CITIES
The Republicans in general and Milton Friedman in particular bring a fairly limited view of the role of government to the discussion. Galbraith [1985] concludes his chapter on Keynes:
“There are other problems. Keynesian support to the economy has come to involve heavy spending for arms. This, we’ve seen, is blessed as sound while spending for welfare and the poor is always thought dangerous. With time, too, it has become evident that Keynesian progress can be an uneven thing: many automobiles, too few houses; many cigarettes, too little health care. The great cities in trouble. As these problems have obtruded, the confident years have come to an end. The Age of Keynes was for a time but not for all time.” This, from “the Crown Prince of Keynesism.”
The focus of my work is the polis, or town, and the metropolis, or city. Galbraith [1985] presents some of these concerns in his chapter on The Metropolis:
“Where Capitalism Fails
“On two other matters the prospect is more grim. First there is the fact that capitalism performs excellently in providing things – automobiles, disposable packaging, drugs, alcohol – that cause problems for the city. But it is inherently incompetent in providing the things that city dwellers most urgently need. Capitalism has never anywhere provided good houses at moderate cost. Housing, it seems unnecessary to stress, is an important adjunct of a successful urban life. Nor does capitalism provide good health services, and when people live close together with attendant health risks, these too are important. They are made more urgent because, on coming to the city, people no longer accept as inevitable untended sickness and then a quiet death as they would in some lonesome sharecropper’s cabin. Nor does capitalism provide efficient transportation for people – another essential of the life of the Metropolis.
“In Western Europe and Japan the failure of capitalism in the fields of housing, health and transportation is largely, though not completely, accepted. There industries have been intensively socialized. In the United States there remains the conviction that, however contrary to experience, private enterprise will eventually serve. To assert the inherently public character of these industries, even though the practice affirms it, still seems radical. Nothing is now so important as to agree that the nature of these services is public and then to ensure that their performance is not merely a matter of adequacy but of pride. City life will never be good while housing, health care and transportation are poor.
“There is a larger need. That is to see far more clearly than at present the essentially social character of the Metropolis. In its days of greatest elegance, the city was a household, an extension of the domestic arrangements of the ruler. No line then separated private from public tasks. Construction, artistic embellishments and maintenance of the city – what would now be regarded as public tasks – may well have absorbed the larger share of the aggregate public and private income. With the Industrial City it came to be assumed that the payment for public tasks – education, police protection, courts, sanitation, recreation, public entertainment, care of the old and impoverished – would be only a small subtraction from the total revenue. The private household, no one doubted, had the major claim.
“This continues to be the assumption. The consequences all recognize. Among the affluent and even among the poor, services supplied out of private income are far more amply endowed than those provided by the city. Houses are clean, streets are filthy. Personal wealth expands; there are too few police officers to protect it. Television sets are omnipresent; schools are deficient.
“Where capitalism is efficient, it adds to the public tasks of the city; it increases the number of automobiles that must be accommodated in and through the city, adds to the detritus that must be picked up from the streets and makes progressively more difficult the problem of keeping breathable the air and sustaining a minimum tranquility of life.
“This is another way of saying that the social aspect of modern metropolitan life is extremely expensive, far more expensive than we have yet imagined.”
From Lewis Mumford in The Culture of Cities [1938]:
“The city, as one finds it in history, is the point of maximum concentration for the power and culture of a community...
“The city is a fact in nature, like a cave, a run of mackerel, or an ant heap. But it is also a conscious work of art, and it holds within its communal framework many simpler and more personal forms of art. Mind takes form in the city; and in turn, urban forms condition mind.... With language itself, it remains man's greatest work of art.
“The nature of the city is not to be found simply in its economic base: the city is primarily a social emergent. The mark of the city is its purposive social complexity.
“When the city ceases to be a symbol of art and order, it acts in a negative fashion: it expresses and helps to make more universal the fact of disintegration.”
INSTITUTIONAL TRANSFORMATION
The problem is size. Cities have become too large. They have become unmanageable. So have nations. Driving the lack of political/social control are multi-national corporations with their over-riding economic power. Where Milton Friedman would argue that the market should be given freer reign, it is the market economy which must be blamed for environmental degradation and global warming. The U.S. Environmental Protection Agency was invented in the Nixon administration to minimize governmental control of corporate largess.
We have come to think of social problems as inherent because we have not been able to resolve this set of problems, when they are inevitable only given this particular set of circumstances, and not necessarily inevitable for ever. As Stafford Beer points out in Platform for Change, “If you were starting from scratch, knowing the current state of the art… do you think you would come up with a system remotely resembling the one we have today?”
Specifically, the only long term legal solution is to eliminate corporate limited liability, the shield which allows them to collectively skirt most of their social and environmental consequences, thus avoiding individual criminal prosecution.
Generally, the solution is to eliminate the right of corporations to exist in more than one country. And then look at countries becoming smaller.
A healthy future would be smaller – smaller cities, smaller countries, smaller companies. The global Internet makes it all do-able.
The North Pole is liquid – Global Warming is a fact, not just a theory. We need to heal the planet. We need a system that works.
References
- Beer, Stafford, 1975, Platform for Change, 1994 edition includes Reader’s Guide by Jon Li, Wiley: Chichester.
- 1981, Brain of the Firm, 2nd edition, Wiley: Chichester.
- 2000, Falcondale tapes transcript, describing the Viable System Model, John Moores University: Liverpool.
- Boulding, Kenneth, 1964, The Meaning of the 20th Century: The Great Transition, Harper Row: New York.
- Callenbach, Ernest, 1975, Ecotopia, Banyan Tree Books: Berkeley.
- Daly, Herman, and John Cobb, 1994, For the Common Good: Redirecting the Economy toward Community, the Environment, and a Sustainable Future, Beacon Books: Boston.
- Deming, WEdwards, 1992, The New Economics for Industry, Government, Education, MIT Center for Advanced Engineering Study: Boston.
- Friedman, Milton, 1962, Capitalism & Freedom, University of Chicago Press: Chicago.
- Galbraith, John Kenneth, 1958, The Affluent Society, Houghton Mifflin: Boston.
- 1967, The New Industrial State, Houghton Mifflin: Boston.
- 1985, The Age of Uncertainty: A history of economic ideas and their consequences, Houghton Mifflin: Boston.
- Illich, Ivan, 1973, Tools for Conviviality, Harper Row: New York.
- Jacobs, Jane, 1984, Cities and the Wealth of Nations: Principles of Economic Life, Random House: New York.
- 1992, Systems of Survival: A Dialogue on the Moral Foundations of Commerce and Politics, Vintage: New York.
- 2000, The Nature of Economies, Random House Canada: Toronto.
- Meadows DH, Meadows DL, Randers J, 1972, The Limits to Growth: A Report for the Club of Rome’s Project on the Predicament of Mankind, Universal Books: London.
- Maslow, Abraham, 1966, The Psychology of Science: A Reconnaissance, Harper Row: New York.
- Mumford, Lewis, 1938, The Culture of Cities.
- Odum, Howard, 2000, Systems Self Organization for the Prosperous Way Down, ISSS, Toronto.
By Jon Li in previous Society for General Systems Research/ISSS proceedings:
- with Donald Dean, 1979, So What if the Economy is Collapsing, California Politics Post Proposition 13, Evaluating General Systems Theory as it relates to creating a new California State Constitution, London
- 1980, decentralization: Exploring the Prospects for a Consumer Oriented Economic System, San Francisco
- 1993, Tomorrow will be here soon enough, Asilomar
- 1994, The Computerized Community, Amsterdam
- 1995, Systemic Trauma: The Troubled Prospects for Managed Care in California and the United States, Louisville
Other past titles include:
- A Prospectus for Humanizing the System
- What Good is Artificial Intelligence ?
