If you're not familiar with the term, I cannot take credit for it. Paul Krugman deserves the accolades for 'confidence fairy.' It originated as a childish straw man he used to mystify the not-so-popular belief that confidence can actually help an economy to recover without fiscal (or even monetary) interference. It is Krugman's best (or at least most well-liked) defense of his Keynesian tilt.

While he doesn’t say it explicitly, he instead believes a slightly different fairy – the Keynesian confidence fairy – offers the only way to stimulate an economic recovery. In other words: let the government spend money; let them implement stimulus packages; let the Federal Reserve pump liquidity. The ultimate aim is to embolden aggregate demand so the consumer is back consuming, the businesses are back producing and willing/needing to hire.

The Keynesian fairy argument is simple enough. And it sounds like the way to go, doesn’t it?

The faith-in-the-market (FTM) confidence fairy, on the other hand, believes that deregulation, a clear and fair tax code, limited fiscal involvement, and market-driven interest rates will instill the necessary confidence to embolden an economic recovery. It sounds a lot laissez faire because it is; well, at least as much as possible in the quasi free market in which we operate. It is a hands-off approach that lets the market forces dictate the speed, quantity and origination of resources moving through an economy. It is an approach with which those like Krugman cannot seem to identify or believe in.

In the minds of Keynesians, why not let the Federal Government and Central Bank take up the task of catalyzing an economic recovery? The market gets “broken” at key points in the cycle, or so the argument goes; so government must fill the breach. Sadly, this is common wisdom and a false argument because we have never really (in the modern era) had a test of the Austrian School approach of letting a deep recession clear the market quickly so fresh real growth can resume.

I noticed this recent Reuters interview with Dallas Fed President Richard Fisher; to paraphrase:

We know what the Fed is doing and has done; what’s needed is to lift the uncertainty in other areas.

Fisher explained what he meant by other areas – primarily the public sector and fiscal policy. His ultimate message: the Fed has a dual mandate; they can fairly easily and quickly influence prices [but we have learned in this cycle yet another core belief of central bankers has been falsified]; but they cannot so easily influence employment [again, this cycle proves this to be very true]. It is time for the government to adjust policy in a way that builds confidence among businesses and encourages them to hire [if he means get the government out of the way that is a policy adjustment I can endorse]. Government doesn’t need to shower the system with cash. Businesses have plenty. Consumers will get it from the jobs businesses create. From The Absolute Return Letter:

It is a fallacy that there is a shortage of capital in the world today; there is actually plenty of dosh around. What the world lacks is not money but risk appetite and that could take a long time to change - a very long time.

But rather than hire or invest in new projects, companies are sitting on that dosh. Why? Because business worried about future demand, which ironically is being hampered precisely by the policies of government tinkerers who say they can stimulate demand [any wonder why they call it the “dismal science”]. Let me say this very loudly so all can hear: GOVERNMENTS DON’T CREATE JOBS!!!!! GOVERNMENTS DON’T CREATE WEALTH!!!! However, they can at least institute policies that help foster job and wealth creation; or they can keep summoning the Keynesian confidence fairy. [A side note: Jack told me he had an email from a reader who was incensed because he pointed out that small business was being crushed by the policies of the Obama administration. She said the government has little to do with it, I guess in some attempt to defend the current administration. For the record, the prior administration was nothing to write home about to say the least, but I digress. The numbers Jack identified were not subjective; they came from government figures and were reported in a research piece by our friends at Leto Research:

…[I]n the US, the heavy hand of regulation has killed (temporarily, one hopes) the entrepreneurial spirit: during the nearly three years of the Obama administration, the rate of new business formation collapsed from a growth averaging +720,664 business establishment per year in the pre-Obama decade to a decline averaging -408,775 per year during the Obama tenure.

I make this point for this reason: economics cannot be separated from politics. They are hand in glove. And in fact, before John Maynard Keynes emerged with his master piece— The General Theory—which mathematicians and those with a collectivist bent seized upon as the new way government could scientifically control business cycles, the study of economics was referred to as “Political Economy.”] The market is giving businesses plenty of reason not to deploy cash. They are unsure of a whole host of things; these are the top four on my list:

1) A future tax code that seems targeted to punish those who have been successful in America; the same people who create most of the new jobs.
2) A regulatory environment that lacks common sense and is filled with disincentives to grow business and jobs.
3) Any willingness to seriously cut the federal deficit instead of demagogueing to one’s base of voters and assorted moochers.
4) Trade policies that at times make it more advantageous to manufacture offshore instead of here in the United States.

I could add to the list, and I know you could. But the point is a dogmatic belief the Keynesian stimulus fairy is the magic that will get us out this mess seems incredibly misguided to me.

The free market confidence fairy has left the building.

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