Archive for November, 2010

The US Needs a Weaker Dollar

I’ve been particularly bearish on the economy in my last couple posts, calling this the equivalent of a depression and a crisis that risks civilizational failure.  However, there are signs that we can avoid the worst.   The news came out today that Consumer debt fell by 7.4%, or nearly $1 trillion dollars in the last two years.   Though the pace of repaying that debt is declining, it means that our total consumer debt now stands at $11.6 trillion.   There are also fewer credit cards, and in general it appears that at least the American public has come to grips with the fact that the wild consumerism of the 00’s cannot continue.

So, a piece of good news hits, and my first reaction is to rethink my position about this crisis.  Is it possible that I’m far too bearish and concerned, under estimating the capacity of a country as large and rich as ours to bounce back and recover from the long debt-driven party of the last thirty years?

Some signs of sanity are real: people are paying down mortgage debt, delinquencies in consumer loans are down, as are home foreclosures.    Families across the country are starting to put their household finances back in order,  adapting to the uncertainties of the recession.   Home lending practices have been tightened, as has credit access to the sub-prime market.   In fact, this is how a recession should look — the economy is slow as we recover from a credit binge.

A best case scenario would involve a gradual increase in economic growth,  and a tightening in what to me is still the most important statistic: the current account.   In the second quarter of 2009 the current account deficit hit a ten year low, at $84.4 billion.   However, the latest figure (released in September, Q2) is $123.3 billion, the fourth quarterly increase in a row.     The current annual GDP is $14.73 trillion.    The current account deficit now is at about 3.4% of GDP, up from 2009, but still a sustainable number compared to the 7% of GDP hit back in 2006.   We’re still consuming more than we produce, but not to the extremes of a few years ago.

Ultimately I think the US needs to see this number stabilize closer to 0.   Treasury Secretary Timothy Geithner recently proposed that the G-20 set targets capping current account surpluses at 4%.   The argument the US is making is that China bears some fault for the current global crisis by how it has kept its currency under valued while running constant trade surpluses.  One could even accuse China of engineering a mass transfer of wealth from the US to China, using our belief in free trade to flood the market with cheap consumables we’d go into debt to keep acquiring.  They were, however, simply playing by our rules (and we’ve been willing consumers).

Yet the US can’t play hardball with China because we do still need them to buy our bonds, and if they got really made and started dumping bonds, stocks, and US currency, they could do severe damage to the US economy.   Arguably they could weather such a storm better than we could.  So what does the US do?  Quantitative easing.

To do this the Federal Reserve board created $600 billion out of thin air, put them on their accounting sheet, and then used that money to purchase US bonds.  That, of course, has the impact of driving down the interest rates on those bonds, which negatively impacts countries like China who holds them.    China originally complained about this, but apparently in exchange for Geithner to quiet down on current account surplus targets, they’ve also muted their criticism.   This also isn’t the first time the Fed did this; since the crisis began nearly $2 trillion have been “created” in that manner.

Colloquially “quantitative easing” is simply “printing money.”  The risk, of course, is inflation and even hyperinflation.  It is a form of stimulating the economy that is often used when lower interest rates fail to generate more economic activity.   In the US that and a fiscal stimulus have so far failed to generate growth.   That’s seen as bad, though given the rate in which consumers have been paying down debt, one wonders what would be happening to the economy without the stimulus!   Quantitative easing was used by Japan a decade ago, but didn’t work to stop Japanese deflation.   Indeed, Japan’s high government debt, low interest rates and then quantitative easing should have risked inflation.   It hasn’t because  low unemployment means there is not a reserve of new workers ready to go into the system and generate income.

Japan has maintained its industrial base (unlike the US), has vast foreign capital reserves, and has had a current account in surplus (meaning it invests in the rest of the world).  The relative “comfort” of Japanese deflation — it remains a wealthy low unemployment country — isn’t cause for comfort here.   The key for us remains to increase production.  Without increasing production the only way out of the recession is through consumption of foreign goods, and that would require more debt.   In other words, the problem would intensify and set up another crisis.

Paying down the debt is an important step — and private debt is perhaps even more important than worrying about government debt at this point.   My fear would be that quantitative easing could induce more consumption of foreign goods, thereby increasing the risk to the dollar moving forward.   My hope would be that somehow we find ways to increase production at home so that ‘new’ money is spent improving America’s productive capacity rather than just causing more consumption.

Ultimately, I don’t see any way that can happen without a decline in the value of the dollar.

A falling dollar would mean foreign goods would get more expensive, and we’d consume less of them.   American goods would get relatively cheaper, and there would be incentives to produce more of them.  More Americans and even people abroad might find it cheap to “buy American.”     This would produce problems in emerging markets, many of which rely on the US to buy their goods.  This also would wreck havoc with the bond markets and the US ability to sustain debt and deficits.   The result could be such global uncertainty that a call for a “new Bretton Woods” would be quite persuasive.

The Bretton Woods system is the monetary and institutional system of free trade and fixed exchange rates created after WWII, named for the location in New Hampshire of a July 1944 meeting setting the framework for the post-war system.  Bretton Woods II is often used to discuss the changed nature of the system after the end of the fixed exchange rate system in 1973.   Robert Zoellick of the world bank has talked opaquely about an internationalization of capital accounts, perhaps a “Bretton Woods III,” that could even reintroduce gold as a benchmark against which currencies are measured.   Though this is not necessarily a call for a new ‘gold standard,’ it does reflect growing concern about the ability of humans to successfully handle fiat currencies.    To me this signals recognition that currency instability is likely in our future; a dollar crisis may be the next phase of this global slowdown.

So yes, Americans paying down the debt is a good thing.   But we also have to increase production and stop  growing the current account deficit.  I doubt that can happen without a weaker dollar — perhaps substantially weaker.   Now that it’s clear that the Euro is not in existential crisis, I would not be surprised to see the dollar start to decline in value.   How hard and how far the fall is uncertain.   Whether or not the global system can handle all this in a stable manner may determine how deep this global economic crisis ultimately becomes.

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The Nature of This Crisis

“Each time we bathe our reactions in artificial light
Each time we alter the focus to make the wrong move seem right”
– from “Stick it Out” by RUSH (lyrics Neil Peart), Counterparts LP, 1992

For all my posts on the economy, I’ve not spent a lot of time on the underlying cause of this crisis.   The true nature of the current crisis is far deeper in our culture than most people realize, and although it sounds alarmist, the US and perhaps western civilization in general may be on the verge of something akin to civilizational failure.

This is not due to outsiders.  Many point to China, Arab Muslims, India, or even Russia as doing things globally to undercut the US.   No, we can’t blame others.   This also is not due to nefarious insiders.   When Hitler rose to power he blamed socialists, internationalists and liberals, saying that these folk were betraying German values, internal traitors against a “real” Germany.   Jews were also a convenient scapegoat.   Some extremists on the far right use similar rhetoric against the left, with Hispanics replacing Jews as the “parasite” destroying the country from within.   No group inside the country is bringing us down.  This is also not due to Republicans or greedy corporations either.   Many on the left want to dismantle corporate America, and blame banks and business for greed and taking a far greater portion of the pie.  Yet blaming big money is wrong too.

The reality is that this crisis comes from how we think.  It is a cultural crisis, with its roots in the enlightenment.   It is also not a new flaw.   We can look back and see colonialism, bureaucratic socialism, fascism, world wars, and a Cold War where in which the world hung under threat of nuclear annihilation.

The enlightenment gave us a world view that allows us to interpret reality in whatever way suits our interest.    By positing reason and rational thought as the ideal, it gives us a tool to twist reality and construct meanings that justify what we do.  Colonialism is spreading civilization to the benefit of the “primitives.”    Bringing war and chaos to Iraq is ‘removing Saddam’ and “spreading democracy.”  Destroying indigenous cultures is “bringing them Christianity,” and living off cheap resources and labor from the third world is “using free trade to help them develop.”

We are very good at rationalizing things; we do it in politics and in every day life.    Should we cut taxes to the wealthiest when the gap between the rich and poor is at its greatest in 100 years?   Sure, some will say, it will help the economy and the poor will benefit.    And if there is a real danger, such as global warming — well, we’ll find a couple naysaying scientists and then use media and propaganda to make it seem like the deniers are brave critics against “big science.”   We are to believe that the vast majority of climate scientists are simply lying to ‘try to get grants.’   And on the left people rationalize increasing the scope and size of government programs, even though the economy is in recession and we have an unsustainable level of debt.

Yes, we are always able to rationalize what we want to believe.   There are enablers built into our society — bankers who sold and often pressured people to take subprime loans they really couldn’t afford, advertisers telling people “you deserve” this — go a little more in debt, this product is worth it.  Credit card companies pushed cheap easy credit on us, and the cultural insanity was defended by simply blaming those who lost out.   When the subprime mortgage goes bad or credit card debt buries someone, “well, they should have known better.”   Shifting blame allows us to keep alive arguments, beliefs and ideas that justify convenient cultural delusions.

We do this to ourselves all the time.   That is why we gain weight, rationalize mistreating or cheating on friends and family, purchase goods we don’t need, and produce massive amounts of trash even as we say something has to be done about pollution.   We also create cultural narratives to rationalize and make seem “normal” something which is anything but.  The narratives hypnotize, they are with us from birth, they speak to our basic desire to pursue our interests while avoiding cognitive dissonance in justifying the cost.  They are narcissistic and myopic, and our culture reflects that.

The enlightenment gave us the ability to create rational arguments by use of reason.  In science this, of course, allowed the development of new technologies and knowledge about the world.  But in culture and politics it is a dangerous capacity.  The problem is that reason needs to be grounded — there need to be core values and principles underlying the use of reason, otherwise it is literally sophistry — building arguments to justify whatever we want to justify.   And our sophists are more sophisticated than was the case in Socrate’s time!

Although colonialism was rationalized through a variety of discursive strategies (persuasively argued by David Spurr in Rhetoric of Empire), tradition, religion and custom were strong enough to keep the most negative forces in check.   Starting in the 20th century and aided by the rise of propaganda and mass media, our ability to create narratives to rationalize anything became unhinged.   Be it Communism, Nazism, Consumerism, Libertarianism, class warfare, interventionist foreign policies, or the recent rise in debt due to easy credit, we’ve learned to use reason like a drug — it can cause us to see as good and rational anything we feel like we want to believe or do.   Moreover, we don’t even know we’re doing it, we really think our arguments are correct!   It’s emotion that gives us that certainty, but we believe it is our rational thought.

That’s why we’re in such deep trouble.  It’s not primarily the economy, or militarism, culture wars, or anything else.  Unless we can find a way to ground reason and use it wisely, we’ll rationalize and see as good and necessary the very things which will bring down our civilization.    The key for individuals is to recognize and understand the danger, and try to resist the tempting self-serving justifications.   We can do that, though it takes practice.  For our culture, though, there needs to be a shift in values.   We won’t bring back traditional society, nor will religion play the same role it did in the past.  But somehow we have to find a way to humble the use of pure reason and rediscover values, principles, and ethics outside of using reason as a tool.   Reason can be used to rationalize any ethical belief, after all.

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Markets Fail

In his book The End of Wallstreet, Roger Lowenstein writes:

“Rates were guided in their downward path by the person of Alan Greenspan, the economic consultant and Ayn Rand disciple turned interest-rate guru who served as Federal Reserve chairman from 1987 to February 2006…It would be an oversimplification to credit (or blame) Greenspan for everything that happened to interest rates over that period, but it was his unmistakable legacy to stretch the boundaries of tolerance, to permit a greater easing of credit than any central banker had before…It was a central tenet of the Greenspan worldview that market excesses — ‘bubbles’ — could not be detected while they were occurring.  This stemmed from his faith in the seductive doctrine of the new finance, a core element of which was that financial markets articulated economic values more perfectly than any mere mortal could.   People might be flawed, but markets were pure — thus ‘bubbles’ could be ascertained only after the markets had corrected them.  Greenspan’s was a Rousseauean vision of markets as untainted social organisms — evolved, as it were from a state of nature.  (It overlooked the obvious point that markets were also human constructs — made by men.)”
– pages 3-4

In my first year seminar “The Future of the US,” we’re now talking about the economic crisis we’re facing, one that started with policies in the early eighties when the US started amassing massive government and private debt, setting up a series of bubbles that persisted until the financial meltdown of 2008.   Fundamental to the errors that caused the problem was a flawed view of markets as being the best regulator of economic activity, and superior in all ways to government bureaucracy.

Greenspan was appointed by Ronald Reagan, who first broke with the old orthodoxy by instituting a massive wave of tax cuts, while at the same time stimulating the economy with an unprecedented increase in government debt.   The “borrow and spend” mentality spread to the public.   Naysayers like David Stockman, Reagan’s first budget director who later harshly criticized the total disregard of the Reagan Administration for fiscal constraint, were brushed off.   The economy is growing (how could it not, if you deficit spend during a boom!) and inflation was absent.

The dirty secret behind this apparent capacity to borrow, spend and avoid inflation (thus keeping interest rates low and igniting the hyper-consumerist era of the 90s and 00s) is that there was a massive shift in who produced the goods Americans consumed.   Instead of being produced by well paid union workers in the US, production shifted to third world states and by the 90s, China.   Inflation didn’t increase because the cost of goods went down.   The quality went down as well — compare, say a toaster made in 1975 to one made in 2005 — but quality wasn’t really considered in the consumer price index.

Lowenstein’s book, of course, focuses primarily on the bizarre world of credit default swaps, collateralized debt obligations (explained very well here) and the financial collapse of 2008.   While “mere mortals” were warning of high debt and the de-industrialization of America, high profits on Wall Street and a faith in the wisdom of markets guided policy makers.   Policy makers, especially at the highest levels, get disconnected from average folk.   They are connected to the movers and shakers on Wall Street and in big business, and that’s who they take advice from.   Bill Clinton — while at least not deficit spending during a boom (under Reagan debt increased from 30% of GDP to 60% of GDP, it held steady under Clinton who ultimately balanced the budget for a couple years) — seemed to worship the advice of ‘big money.’

China and other sellers of consumables to the US rode the credit wave for all it was worth, even buying bonds to help finance its continuation.   It was a good deal for China — they got the power to totally subvert the US economy if they wanted to, became America’s top creditor, and the money flowed back to them when consumers bought stuff at Walmart.

An example of the shortsightedness of this market faith is the fate of the effort of Brooksley Born (detailed in this Frontline video) to start regulating a vast market called “over the counter dervivatives.”  This involved markets for bonds, swaps, and other financial instruments which had absolutely no transparency.   Massive amounts of money were moving into derivatives, with no one knowing exactly what was happening.    Derivatives are transfers of risk (the most common form being a futures market), and the new trading was unprecedented, exotic — and ultimately toxic.   Greenspan, Summers and Rubin got Congress to shut her down.  Markets get it right, Greenspan extolled.

Just as mere mortals were ignored when they warned about high debt and lack of production, they were also warned when they wanted to regulate the fastest growing part of the bond market.   They were ignored when they warned about the housing bubble.   “Just let the market handle it.”

Well, at one level Greenspan was right — the market will ultimately adjust.   And now we’re seeing how it adjusts, with a major recession and a fundamental weakening of the US economy and US position in the world.   If humans had intervened, we’d maybe still be producing, we’d not have got caught up in the housing bubble, and the derivatives market would not have threatened to take down the entire global financial system in 2008.   If we had not run up debt and unleashed cheap credit, we’d have not become addicted to cheap foreign goods, and the hyperconsumerism which has damaged society on so many levels (detailed in Benjamin Barber’s aply titled book “Consumed: How Markets Corrupt Children, Infantalize Adults and Swallow Citizens Whole“), might have been avoided.

Rather than the roller coaster bubbles followed by a deep recession, we might have more mills and factories still open in Maine, and we’d not be facing the risks we face in this global economy.   It’s not so much that markets are bad, only that without regulation and control they get manipulated by the powerful whose interests are usually not those of average folk.   Their interests are myopic and short term — profit in any way possible.  The faith that how the wealthy structure the game to profit themselves will work out “best” for society is irrational.   The idealization of markets has been thoroughly disproven many times in history.

The theory is seductive and yields a very simple, objective world view, one in which many people find comfort.  A lot of people don’t like the complexity and nuance of how a very diverse world of imperfect humans with flawed judgment functions.   Many prefer to cling to Hayek, Rand, and Greenspan who offer a clear vision of the morality and superiority of markets.   Seductive theories, be they communism or market libertarianism are dangerous.

So let markets operate — they do a good job of communicating demand through price, and stimulating innovation.  Markets create incentives and allow people to make choices and adapt.  But especially in the world of high finance, big business and global trade, they need strict oversight and regulation.   Without that regulation markets fail, and instead a rigged game that benefits the elites take over, ironically defended by many who are their victims, but yet believe the system is market driven.   Markets cannot function properly without such regulation.   Unfortunately, even with some significant reforms, the Obama Administration has not yet made the changes we need  to try to really get on the right path.   Tim Geithner is smart, but he’s also a Wall Street insider.  True, Wall Street is not the enemy, but it’s driven by a conventional wisdom that distrusts needed regulation.   Perhaps Obama should tap Brooksley Born to come back to government and help design a new regulative scheme.

With the GOP taking control of the House, it’s unlikely the lessons we should have learned in 2008 will be turned into policy.  That bodes for more economic bad news down the line for a country far deeper in crisis than most Americans realize.

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Time for Political Responsibility

The elections last night seem to show an almost schizophrenic American public.   In 2008 they embraced change, giving Barack Obama a massive victory and convincing many on the left that the US was embracing a progressive agenda.  In 2010 the public embraced change again, giving the GOP control of the House by a healthy margin, convincing many on the right that the public was embracing conservatism.    The good news is that the two sides now share power, and that’s a necessary condition to being able to have the long term capacity to solve the problems we face.  The bad news is that this would require the two parties to do something they haven’t been adept at: compromising to pass legislation making tough choices.   Now is the time for political responsibility.

Those reading this blog since 2008 know that I have been intensely bearish on the US and global economy.   I believe we are in the midst of what I’ve labeled “Global Depression II,” the effects of which can be masked for awhile with fiscal and monetary policy moves.   Ultimately we have to deal with a  massive debt, and an imbalance between too much consumption and too little production.   The US in some ways has a harder task than many other industrialized countries.   While other countries have debt — the entire world is in tremendous debt — our imbalance between consumption and production is intense.  Germans still produce more than they consume; we’ve been consuming far more than we produce.

This was not a problem President Obama and the Democrats could fix, and the belief that the stimulus would work makes some sense.  If you stimulate the economy by investing in projects that will increase future production then you might boost growth enough to start restructuring the economy.   However, the drawback of such an approach is increased debt, which risks inflation and currency devaluation.   Since we accumulated so much debt by deficit spending in booms (1982-90; 2002-07), the risks of increasing debt are magnified.

The Republican solution — to balance the budget and live within our means (though that requires more cuts than they’ve suggested) — is good in theory for addressing the debt problem.  Ultimately our debt level is unsustainable, and we need to restructure our spending to take into account economic realities.   However, cutting spending during a recession could drag the economy down further.   One thing Republicans are wrong on is that tax cuts would help.   Tax cuts are an inefficient stimulus, likely to simply increase consumption of foreign goods.   Over consumption of foreign goods is part of the problem.

Simply, the world is in an unprecedented crisis.   Never has so much debt been globally accumulated, and never have domestic policy tools seemed so unable to deliver a solution.    Not only that, but it’s a global crisis, so even if the dollar should lose value due to high debt, the alternative currencies are also weak.   Ultimately, this may be a grand restructuring of the global political economy to the detriment of the US and Europe in favor of Asia and Latin America.    If so, we are only in the first phase.

So what does this have to do with the election?  The public, quite simply, doesn’t understand the depth of this crisis.  They’ll go to Obama in 2008 then to the GOP in 2010, and seem impatient that nobody can fix the problem.   People want things to get back to “normal.”  The opposition arguments, be they Democratic in 2008 or Republican in 2010 are persuasive because chosen policies are if not failing, show no appearance of working.

Although there is no obvious solution to the crisis, a few factors seem clear: a) the US needs to increase production, creating jobs in sectors that produce stuff people want to buy.   This not need be traditional manufacturing jobs — it could be intellectual property or high tech — but it has to be something that can be sold on the world market; b) US debt (and the debt of the industrialized world in general) is unsustainable and must be cut; and c) US consumption of foreign goods must be cut (but not via protectionism).

A Republican claim that tax cuts can grow us out of debt is non-sensical.  Tax cuts could have a positive effect back in the early sixties when we still had primarily a national economy, but even by the 80s and 00s the Reagan and Bush tax cuts were augmented by higher debt.   Tax cuts in a globalized economy lead to higher consumption of foreign goods.   Yet Democratic dreams of expanded government programs and spending also is unrealistic.  In fact, the traditional Democratic “go to” arguments — we will protect social security and medicare — have to called into question.   It’s unrealistic to alter the economy without entitlement reform of some sort.   In fact, it may be necessary to both increase taxes and cut spending.

The problem is that such an “austerity program” would be hugely unpopular.   Republicans who vote for something like that would be in jeopardy in 2012, and Barack Obama would face a serious primary challenge and perhaps become unelectable if he signed something like that.   When the medicine tastes bad, the public yearns for a message “psst, here’s some yummy stuff that will fix you up just fine with no pain.”   Politicians first pay attention to their own careers, and unpopular decisions are avoided.

There is one way it can happen.   A core group of Republican and Democratic leaders — including younger ‘stars’ from each party — need to focus on finding a way to pass legislation that can try to achieve the above goals.   While the Democrats may want an activist government focused on investments and stimulus and the Republicans prefer to leave it all up to the market, they need to find a middle ground.   Military spending needs to be slashed, perhaps requiring a complete rethinking of US foreign policy.    Entitlements need to be reformed and perhaps means tested.   Tax increases may be necessary, both to repay the debt and to cut over-consumption of foreign goods.  Spending cuts on discretionary spending need to be thoroughly reviewed.

Simply, both parties need to agree to sacrifice some of their holy cows.   Both parties have to compromise their core principles.   Both parties have to stop pretending that there is an easy solution — that the market will magically fix things, or government policies will undo the damage.

The result will be a severe recession.   People will suffer.  The hang over from the thirty year party we started around 1982 will be intense.   Structural transitions are heartless.   Republicans will have to accept that we need to care for the people being displaced by the recession, Democrats will have to recognize that this can’t just be transfers of wealth.   In fact, we need to create new productive capacities, and that needs to involve government investment and training.   (To “let the market do it” may not only not work, but could cause unrest and political instability).  Ultimately, the transition will take place.   We can put it off with political theater and electoral shifts from right to left to right to left, or our political leaders can come clean about the scope of the current crisis, and the need for the country to rethink the conventional wisdoms of the last thirty years.   As with any problem, the longer we put off dealing with it, the greater the difficulty in overcoming it.

Too gloomy?   Too extreme?  I hope so.   But I don’t think so.

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GOP Wave or Cultural Groupthink?

I’m hoping the Democrats defy all odds and hold the House, though not primarily because of politics.   True, I like Obama and Pelosi, and would prefer the House in Democratic hands.  But given the economic condition of the country and the need for policy change, it’s probably a good thing for the Republicans to share policy responsibility.    Moreover, this is normal — when the economy gets bad, voters want change.

What I’d really like to see is the collective reactions of all the prognosticators if they got this election so wrong.   I’ve scoured the news for any optimism about Democratic possibilities and have found only one, a New York Daily News article about the possibility of high black and Latino turnout changing election dynamics.   Democratic insiders and Republicans alike are quoted as expecting loses of 50 to 70 seats.   Most think the Senate will remain in Democratic hands, but see the possibility it won’t.   There is remarkable consensus, and little if any Democratic wishful thinking.   People consider this a done deal.

Yet the polls are very close in most individual races, and at least 70 to 80 races still show leads so small that a slight mistake in methodology or miscalculation in turnout dynamics could give us a GOP gain of a range from 20 to 80 (or even 0 to 100, but that gets in very improbable territory).   We could be watching a case of cultural group think in place, and it would be wild and entertaining to watch an election night where that got thrown asunder.

But can the experts all be wrong?   If pollsters/analysts from Rothenberg to Cook to Rasmussen to Gallup all expect massive GOP gains, and Nate Silver hurls everything into his computer model and predicts 53 seats (though, to be fair,  he’s been consistent in warning about the uncertainty in this election), who can doubt that the Republicans will pick up massive numbers of seats?   After all, the pollsters were right about Obama in 2008.

Yet, there is some reason to doubt.   First, the Republicans (and the pollsters/analysts) are assuming a “wave.”  A wave happens when all the races break one way — the toss ups go almost completely Republican, and ones with small Democratic leads (2 to 4% in late polls) swing GOP as well.   Waves happen; in 1980 and 1994 the GOP enjoyed a classic wave election.   Yet most waves aren’t predicted in advance by so many people (in ’94, when the GOP picked up 52, most prognosticators thought they were set to win 20-25), and sometimes expected waves peter out (e.g., 1982).   So the breadth of the assumption that all these close races will go Republican may be off base.   In 2008 I published a state by state prediction of the Presidential race, predicting Obama would ride a wave.   He didn’t, and I over-estimated his margin of victory by about 40 electoral votes.

If there is no wave, the Democrats could still lose the House, but it would be close.  If there is a small wave, we get into the 45-55 seat loss margin (which is what the most cautious prognosticators seem to expect), and if there is a massive wave, GOP gains could be over 70 (which is what many Republicans expect, and Democrats fear).    Given the dynamics of the race, it looks like a wave year, so it’s rational to assume a wave probable.    But it’s not certain.

There are a couple reasons why the wave may be small or non-existent.  First, Republicans peaked early, and Democratic malaise was intense most of the election season.  Only recently do Democrats seem to be paying attention, and it’s hard to increase GOP enthusiasm from what it’s been for months.   Granted, independents are tending Republican and they are the “stuff” of the wave, but in very close races with previously popular incumbents, I don’t think you can assume a tsunami.

Second, groupthink can be contagious.  Look how many financial analysts predicted housing price increases back in 2007, declared fear of economic breakdown as misplaced in 2008, and told Americans that the economy was healthy and sound.  They believed it, and the consensus was so broad that naysayers were laughed at or ignored — or presented as a token opponent of the consensus (a ‘devil’s advocate’) — and the public was shocked by the depth of the crisis.

Cultural groupthink is different than standard decision making groupthink.  In the standard version, internal group cohesion makes unanimity a goal, and leads to self-censoring and a lack of realism.   Decision making in the Bush White House in 2002-03 on Iraq showed traditional Groupthink, even to the point that Vice President Cheney and UN Ambassador Bolton distrusted CIA information and sought their own, so certain they were that they were right.

Cultural groupthink involves the mass media and experts who for various reasons grab the same narrative.   Democratic leaning pollsters and analysts don’t want to be accused of wishful thinking so they embrace what seems to be a very clear electoral analysis.   Others see that too, and it gets echoed in media, blogs and the like.    On the right, blogs talk about the “wave” as inevitable, a force of nature as certain to hit as a category five hurricane bearing down on a city.   On the left there had been hope in early October that things would turn around, but now there is resignation, as if they’re attitude is ‘two years ago we had a great time with an awesome election, they say, now it’s the Republicans turn.  2012 will be different.’

Yet early voting does not show a wave (yet does not show a Democratic resurgence either).  It’s ambiguous.   Late polls are ambiguous.   So what do we know?   We know that there are up to 100 seats in play, and most of these are held by Democrats.  Its not rocket science to realize that makes the Democrats very vulnerable.    About 40 races look promising (or even certain) for the GOP, so if they win what they’re expected to win, they’ll have a good night.  If they win their fair share of the toss ups, they’re in 50 – 55 seat territory.  If they sweep the tossups, it’s a wave and Democrats then have to worry about the seats they’re expected to win.   If the GOP wins many of those, it’s the Republican tsunami.  The Democrats would have to run the table on the toss ups to keep the House, and pick off close races now leaning Republican.

I see no reason to expect the Democrats to keep the House — the consensus does exist for a reason, the signs point to a massive victory for the Republicans.   Hope that late enthusiasm or perhaps the “Restore Sanity” rally would provoke a late Democratic mini-wave seems implausible, but we really don’t know.  It would be entertaining to see what happens if the Democrats defied the pundits and held the House.   Everyone looked back and said, “what the hell did we get wrong?”  And, to be sure, it’s in the voters hands.  Enjoy the election!  (Here is my guide to the competitive election night races).

UPDATE: Another entertaining scenario is put forth by Nate Silver who sees the possibility that the Republicans may win in such a landslide that it confounds the Democrats and goes beyond conventional wisdom in the other direction.   Indeed, that “GOP Tsunami” theory is more likely than the Democrats keeping the House.  And that’s why, ultimately, this election is so much fun to observe.  The range of possibilities is immense.  After the fact it will seem like a sure thing (and those who predicted it will say “duh, it was obvious to me,” but in reality the realm of possibility going into tomorrow is greater than in most off year elections.

UPDATE 2: Silver gives a second scenario similar to what I describe above, focused on potential flaws in polls leading up to the election.   Now, let the voting begin!

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