Archive for November 3rd, 2010

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.