Out of the Woods?

Last quarter the economy grew at 5.7%, one of the highest rates of growth in six years.  With inflation nearing 3%, it appears to many that the economy is starting to move forward again.   Moreover, the dollar is showing surprising strength, going under the $1.40 per Euro rate for the first time in a long time.   The current account deficit has stabilized at 3.0% of GDP, a vast improvement on the 7% of GDP figure reached in 2006.   New jobless claims, a lagging indicator, are starting to fall.  Could we be seeing the light at the end of the tunnel?

In a word: No.   But a qualified no.   President Obama had a bad hand dealt to him when he took the oath of office.  The US economy faced collapse in September 2008, saved only by a massive bailout.   For all its downsides, that bailout probably prevented a catastrophic seizing of the credit markets.  As unemployment was rapidly climbing and the US sinking fast into recession, Obama gambled.   He used political capital to rush through an emergency stimulus package designed to push the US into economic growth by the end of 2009.   It appears the stimulus has worked, and the US economy has turned around.

All other things being equal, one could expect this growth to take and the economy to start another cycle.   However, all other things are not equal, structural problems that both existed before and in part caused this current crisis need to be addressed before we can say we’ve accomplished a sustainable economy.

The biggest problem, of course, is the debt.   There is no easy way to cut spending, but already US debt and deficits are at the border of what can be financed without risking a steep decline in the value of the dollar.   Increasing the debt was the stimulus gamble — the idea that we have to spur growth again before structural reform of the economy can begin.   If there is economic growth, it should be possible to start significantly trimming deficits to get the budget back at a sustainable level.   However, there is a risk: the spending cuts and tax increases needed to balance the budget (or at least limit deficits) could stifle growth.

Politically the problem is made worse by the fact that tax increases have less of a harmful effect on growth than spending cuts.  Spending injects money directly into the economy, and thus economists tend to see government spending as a much more effective stimulus than a tax cut.  Conversely, tax increases are less likely to slow economic growth than spending cuts.   Spending cuts are easier to sell politically than tax increases, however, so Obama will have to find a politically acceptable balance.   And, while it is expected that these priorities might cause Republicans to howl (if military spending is cut and taxes increased), it’s likely liberals who will be most put off by cuts in government programs moving forward.   Obama will have the continuing attacks from the right to fend off, while trying to keep together his Democratic coalition — all of this in an election year which is likely to see Republican gains.

One thing Obama can’t do is simply take the Reagan approach — continue to increase the debt and not worry about deficits.   Right now Obama is experiencing a situation similar to Reagan in 1982 — increased debt is helping stimulate the economy, creating short term unpopularity (Reagan’s approval numbers were in the 40’s in his first term) but setting up a rebound — something Reagan called “Morning in America.”   But while Reagan had a country with relatively low debt and a low current account deficit, Obama starts with staggering debts.   While Reagan was governing as the baby boomers were heading into their most productive and prosperous years, Obama is governing as they start to retire, and pull money out of the system rather than put it in.  Obama does not have the luxury of simply continuing to borrow and spend, unlike Reagan’s second term.

It will take bold leadership to pull this off, and it’s not yet clear Obama is up to the task, if anyone is.   I have more faith in his capacity to make these tough decisions than I’ve had for any recent President, however, so there is hope.  First, Obama has to finish the job of ending US involvement in Iraq, get Afghanistan to a point that we can cut commitments there, and then start downsizing the US military.   It’s a fallacy that we need to spend half the world’s military budget for our own defense – our interventionism probably does more to make us a target than keep us safe.    Bases need to close,  Congress has to stop funding projects the Pentagon doesn’t want, and the US has to accept that we can’t afford to try to be a dominant super power.

Second, somehow Republicans and Democrats have to set up a sustainable set of priorities for budget cuts and tax increases.   Both sides will have to swallow some bitter poison they’ve avoided in the past.   I do not know if this is possible.   Until recently the “compromise” was that Republicans would accept spending increases in exchange for tax cuts.   Each side gets something, even as the country drifts further into debt.   Now they have to find a way to share pain and avoid economic populism.  If Obama can facilitate that happening, he would right there become one of the greats.

Third, the US has to make a real shift in economic policies to support new technologies that will position us for the inevitable shift away from oil towards solar and other alternative energy sources.   The EU has already marched ahead of us on that, thanks to their implementation of the Kyoto accords.   The US complained that agreement would hurt the economy, but clearly in the EU it actually boosted new economic activity.   We can’t be left behind.   Real productive capacities in new technology needs to be a core of US economic activity — real production, not just consumption and wealth ‘on the cheap.’

Finally, the US has to avoid slipping back into ‘bubble’ economies where speculators bought the “something for nothing” mentality that you can get rich quick if only you invest in the hot market of the day.   People have been trying to get rich by being clever — investing in stocks, flipping real estate, etc. — rather than actually producing.   Investment has its role, but it cannot alone produce mass amounts of prosperity without increases in productive capacity.   The bubble economy hid the structural imbalances that have been building the last thirty years, and contributes to our current problem of massive public and private debt, and unsustainable budgetary practices.  The US needs tough financial regulations, closer monitoring of markets (especially things like derivatives) and transparency in the banking sector.

If Obama and the Congress can move on these fronts, we may start solving these problems.  But even if we make all the right moves, the challenges ahead are so deep that it may take more crises to truly force the changes that need to take place.  Obama has made a good first step, but it was the easiest step.   The path forward will be very difficult.

Advertisements
  1. #1 by Mike Lovell on January 29, 2010 - 17:39

    We do have a long road ahead of us, as a country. I do not believe we are out of the woods yet, not by a long shot. And a big part of that is what you mentioned in addressing our cyclical bubbling of the economy.

    We are going to have to maintain and raise some taxes, while I believe others need to be cut, such as the estate tax, which is nothing but the government taking free money on already taxed items. The government has to get away from the idea of “easy money” as much as Wall Street does. I think we need to reinstate the Glass-Steagel Act and keep our money from being used in a way that can end up having us pay dollars on the penny just to recover the system.

    While I’m not a huge fan of regulations, I think some are necessary….I wish we’d just quit wasting time and money throwing feel good regulations out all over the place that essentially do nothing but make things difficult.

    I think we also need spending cuts, and not just a freeze on a sliver of our total spending, but a lot across the board. I’m sure if anyone actually looked they could shave hundreds of billions without actually affecting much, but naturally the politician doesn’t relish the idea of doing anything that can cause his or her seat of power to be lost. I’m pretty sure (and maybe I’m wrong here)we can go back to pre-Bush expenditures with little actual pain.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: