Archive for category Economics
Former President Ronald Reagan’s name gets bandied about as either a mythic hero for the GOP or a dottering old bogeyman for many Democrats. The reality, of course, is that he was neither, and the fallacies of both the left and right can be shown by looking at two especially misguided myths about Reagan. The first is that Reagan’s economic policies brought the US a period of economic growth and prosperity, proving that smaller government works best, and the second is that Reagan shifted US foreign policy to be tougher on the Soviets, thereby hastening the end of the Cold War. Both myths are dead wrong.
The truth about Reaganomics: Ronald Reagan and the Democrats in Congress had an implicit deal: taxes would be cut and spending would increase. This meant that the economic boom in the 80s was built on debt. The debt to GDP ratio went from 30% when Reagan took office to just under 60% when he left. Given that the GDP grew during that time, this is a doubling of debt. That is a stimulus package that puts Obama’s 2009 effort to shame. If you double your debt it’s not hard to have an economic boom — but it was built on a house of cards. Moreover, oil prices decreased dramatically during this time frame, meaning that the government stimulus of the economy was augmented by declining oil prices.
Simply: the supposed prosperity of the 80s was an illusion. It was the functional equivalent of any one of us taking out credit and living very well for awhile. It feels good while it lasts, but when it ends you’re left with debt. It was unnecessary too — falling oil prices would have stimulated the economy naturally. Moreover, this is the time frame when the US went from having a current account surplus (being a net investor in the world, with trade in balance) to a current account deficit (mostly a trade deficit). We shifted from producing as much as we consumed to consuming more than we produce — with credit coming mostly from overseas. This was the start of the great crisis we’re now enduring.
Yet Reagan doesn’t deserve all the blame. The Congressional Democrats and Republicans found this path easy in the short term. Just as Reagan didn’t veto spending (indeed, his administration famously said budget deficits don’t matter — something Dick Cheney would repeat in 2005), both parties of Congress found the ‘cut taxes, increase spending’ formula politically convenient. This was a bi-partisan effort.
Still, the fact is that Reaganomics was a myth. Government grew massively, debt grew, and so did spending. All the 80s proved was that if you increase debt you can stimulate the economy. We knew that already.
The truth about the end of the Cold War. When the Soviets invaded Afghanistan in December 1979 President Carter announced a massive shift in US policy. This included an increase in defense spending which he projected to be at higher levels than actually occurred under Reagan. Moreover the Carter doctrine, announced on January 23, 1980, made it clear that the US would, for lack of a better term, fight a war for oil. Keeping the flow of Persian Gulf oil going was made a primary national interest.
The shift of policy towards the Soviets was bi-partisan, with Reagan continuing the policies Carter put in place. He did increase the amount of aid to the Afghan “freedom fighters,” something Carter didn’t want to do because he wasn’t sure it made sense to get in bed with Islamic extremists. Reagan also shifted US policy in Nicaragua, supporting the Contras trying to overthrow the Sandinista government (Carter hoped to win the Sandinistas over). Still, those changes did not lead to the collapse of the USSR.
The Soviet Union, stymied by a lack of leadership from 1981 to 1985, as Yuri Andropov and Konstantin Chernenko were both ill and ineffective in each of their brief tenures, imploded from within. In Eastern Europe the crisis was worse, and by 1989 Hungarian and Polish Communists started a path to undo communism out of economic necessity. Regardless of what US foreign policy would have been in the 80s, communism was collapsing and could not be saved. Communism was an utter and completely failure on its own terms.
However, if Reagan didn’t cause the end of Communism, he also doesn’t get enough credit for helping assure Gorbachev could succeed. As I noted in an earlier post about the two of them, Reagan should get credit for recognizing that Gorbachev was the real thing and acting in ways that helped him stay in power. In 1986 the US military build up halted, as US defense spending stopped rising (in real terms). In 1987 Reagan and Gorbachev signed the treaty eliminating intermediate nuclear missiles from Europe after the Soviet military concluded that SDI (the Strategic Defense Initiative designed to try to protect US strategic missiles from Soviet attack) was not a threat.
At that time, Reagan’s most vocal credits were from the right wing of his party. Few remember how Reagan was attacked for ‘going soft,’ with some on the right claiming that Weinberger and Shultz weren’t letting “Reagan be Reagan.” Others thought Reagan was being fooled by Gorbachev who was just a slicker and more effective Communist. True to his principles, Reagan shifted from a hard line to a helpful line when he saw that Soviet reform was real and a chance existed for Communism to either reform and die from within — a war wasn’t necessary.
This wisdom and insight of Reagan gets lost if one focuses on the myth of Reagan’s toughness somehow bringing down the USSR. Many on the left attack Reagan as a hard core war monger whose approach was disproven by Gorbachev’s ability to push change. In reality, Reagan and Gorbachev were a team, each needing the other.
In the fog of historical amnesia, Reagan’s rhetoric has become reality for most, both right and left. Few realize that the 80s saw a doubling of US debt, with massive deficits during a boom — something that makes no economic sense. Few realize that Reagan’s wisdom was not in standing tough against the Soviets (Carter started that policy) but shifting course after correctly understanding that Gorbachev was the real thing. The ideological rhetoric used by Reagan covers up the fact that at base he was a pragmatist and a deal maker, someone who had the notion that he could reach an agreement with just about anyone. He’d start with a tough sounding stance, but then negotiate. People remember the former and forget the latter.
Historical reality shows that almost all Presidents and leaders are far more complex than the myths that survive. Nuance, complexity and paradoxical information gets swept away in favor of a packaged simple narrative. But it can be dangerous; those who say they want to be like Reagan on the economy don’t realize that means embracing more debt and economic stimulus. Those who focus on Reagan’s alleged toughness don’t see his ability to shift when an opponent appears willing to embrace change. Those who focus on Reagan as principled miss that he was also extremely pragmatic. And as far as I’m concerned the real Reagan was a far better President than the mythic Reagan ever could have been.
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.
(Another post motivated by good discussions in my “Consumerism, Politics and Values” course readings today from both Benjamin Barber’s Consumed: How Markets Corrupt Children, Infantilize Adults and Swallow Citizens Whole, and Don Slater’s Consumerism and Modernity).
In past posts about the economy I noted that the unsustainable trends that have brought about this crisis really took root in the early 80s. Until then we had a current account surplus, a strong industrial base, and had been paying off government debt as a percentage of GDP, even though 1968 had been our last balanced budget (we also had ones for 1999 and 2000, but those were enabled by the bubble economy). As we delve into consumerism and in particular consumer culture, this also seems to be the point in which our culture took a wayward turn.
The problems and dangers of consumerism are immense for individuals. It de-humanizes us in a way, limiting our freedom and our scope of action even as we believe we have complete free choice. One poignant way it does this (noted by both Barber and Slater) is to privilege individual freedom and the “private” over societal good and the “public.”
To free market true believers the private is, if not the only relevant thing (Thatcher infamously claimed that there is no society, only individuals and families), at least the most important. The public sector, or government, is bureaucratic, dangerous (it starts most wars and has a legal monopoly on violence) and as Hayek notes, unable to process the vast amount of diffuse information that a market can. Therefore, the public sector is to be as limited as possible, and most decisions that are socially relevant should be made by free autonomous actors in a voluntary manner mediated by markets.
As an abstract argument, the appeal of such an approach is obvious. State power is more obviously and blatantly violent and oppressive, bureaucracies are notorious for not only not effectively processing diffuse information, but actively preventing clear and known information from being acted upon. Markets have proven their worth by creating an unprecedented amount of wealth and prosperity, and where they govern, states are generally at peace. So why would a privileging of the private over the public be an error?
First, there is the obvious problem of dualistic thinking. A dualistic thinker sees two opposite options and believes one must be chosen. It’s either a free market or a planned economy. To be sure, the dualistic thinker recognizes that there is a middle ground, but by definition that middle ground is suspect. If one aspect of the dualities is superior to the other, then one should get as close to that aspect as possible. However, this dualism is impossible to maintain. The difference between private and public varies in function and impact depending on context. It’s logically wrong to say either a free market or a planned economy is globally superior; rather, depending on the case, it might be better to plan (e.g., the military, the police, or the legal system) or to let the market operate (setting prices for most goods and services, etc.)
Given that the arguments against state power and bureaucracies are valid arguments, the issue really becomes when is the need for public action important enough to risk the dangers and disadvantages of governmental activity. This also means to compare those risks and dangers — in some cases they may be immense, in others the risk may be tiny. This complicates the question, of course, but shows a failure in logic of those who argue pure ideology. This is also true for those who posit markets as morally superior choices because they allegedly allow for the most liberty. That claim again varies by context; a market in sex trade of abducted women is quite different than a market for peanut butter.
Often free market ideologues try to claim that governments or sex trade folk use physical force and thus that is immoral, but it is not logical to simply declare physical force as bad when non-physical forms of coercion — economic, psychological, manipulation by powerful elites, etc. — are more profound and damaging to freedom than mere physical force. And once that obvious line is muddied, it really becomes a complicated effort to make moral judgments balancing different factors.
So there is no logical reason to assume that the success of market economics means the private is always better than the public, only that in many cases government power can be abusive and counter-productive — communism certainly proved that!
The problem with simply letting private choices determine public outcomes has been noted by Mancur Olson (the free rider problem) and what Kenneth Waltz called “the tyranny of small decisions.” Our short term direct wants lead us to rationally choose something that actually goes against our longer term, broader interests. We want downtown to survive, but choose to buy a TV at Walmart. We want a clean environment, but choose to drive a large SUV because we want to pull our boat to the lake for recreation.
In the recent economic housing collapse, short term interests made it rational to make loans that people couldn’t afford: it generated assets on the balance sheet, earned fees, and given rising home values, default was unlikely. Many people noted the long term negative consequences of these acts, especially as mortgages were being bundled into financial products sold as “very safe” investments, but the power of the short term direct interest to trump the longer term “true” interest was immense.
Moreover, private choice will always privilege those with the money. Their choices matter more. Hence capitalism does little to meet real needs in much of the world — it may be in our long term interests to have a broader base of prosperity and avoid situations where large majorities would have a rational interest in destroying the system, but it serves no short term interest. The public good — civil society and social stability — gets destroyed by an emphasis wholly on the private. That leads to less charity, less solidarity with the community, and a ‘something for nothing’ mentality that somehow if we selfishly do what we want, the longer term broader interests will take care of themselves. The magical market will somehow make it all come out right.
The answer, however, is not to veer strongly towards government control. Rather to recognize that the prosperity we have came from a kind of balance between markets and government action to try to provide equal opportunity, address free rider issues, and look at the broader public interest over crude short term individual interests. That’s why we have regulations on pollution, credit practices, and the like — powerful actors can exploit and manipulate less powerful ones, and that is not good for the public over all.
The current crisis is time to finally put aside that cult of the private. Yet, in so doing, we need to seek balance, and not deride or denigrate markets or private interests. We need to ask serious questions about where and to what extent public interests are being corrupted by privatization, and to what extent government action unduly limits effective market solution to problems the market is best in a condition to solve.
President Obama has taken steps towards recapturing space for the public sphere, and limiting the ‘cult of the private sector.’ His rhetoric suggests he does not want to shift to a ‘cult of government’ as an alternative. Yet for this to work there needs to be open and honest dialogue over the role of government, the importance of broad public goals, and how we make the calls on how much and what to do. Most people believe such calls now depend on who contributes to campaigns — other people’s private interests, not true public interests. To overcome this crisis and develop a sustainable future economy we must move away from a culture dominated by consumerism. Finding the proper space and role for the “public” is a good first step.
I’m currently teaching a winter term topics course on German unification. It’s a three week course, taking place during that time that is usually the semester break. There are only eight students in the course, so it’s a nice time to really get into the issues surrounding German unification and its aftermath.
One thing that studying Europe has shown me is that both communism and capitalism have very dark sides, and either one can exploit, enslave and abuse. I have come to absolutely reject the views of those true believers who either embrace the state and government as the key to ending the ‘tyranny of big money,’ or those who embrace the free market as somehow able to create the best result possible. Moreover, our culture tends to see the world in dichotomies, where one “side” is good and the other bad. In such a world view the obvious evils of bureaucratic socialism (aka communism) means some take it as a matter of course that the other extreme is best. If totalitarianism is complete lack of individual freedom, then wouldn’t free market capitalism be its ultimate expression?
Looking at the case of Germany, it’s hard to keep up that dichotomy. First of all, no one in their right mind denies the evil that bureaucratic socialism created. People were spied upon, their individual initiative thwarted, and basic freedoms denied. Bureaucracies are inherently conservative and resist change. Communist economies thus tended to reproduce past practices rather than innovate, and individuals with creative, intriguing ideas learned to suppress or at least keep quiet about those ideas. The result was an economy that, after growing gradually from 1949 to the mid-sixties, started to stagnate, and then after 1971 lived beyond its means on borrowed capital, mostly from West Germany. By 1989 the economic system was near collapse, mirroring conditions in the rest of the East. The fall of communism had a clear cause: as an economic system, communism cannot work.
To be sure, it could have ended with a bang rather than a whimper. If Gorbachev had not been a true humanist, more willing to see Eastern Europe break away and his reforms fail than to use force, the system could have persisted perhaps quite awhile longer in some form. If Ronald Reagan had not changed his policies to stop his defense build up and work to build actual nuclear disarmament — in his second term he was actually quite “liberal” in that regard, and while they seem now to forget it, conservative Republicans were angry at him for becoming soft on communism — then perhaps Gorbachev would have failed and an actual war could have ensued. Gorbachev and Reagan worked well together to prevent that.
But the failure was economic. You can’t deny people their individual expression and initiative while running an economy through bureaucratic planning and have it keep up with dynamic market economies which use the market to gather diffuse information from every individual who participates. But does that mean that market economics taken to an extreme are best?
No. Communism emerged for a reason — a response to European sweat shops and exploitation that would appall anyone with a conscience. And, while in the comfort of ones’ easy chair it’s easy to sniff, “well, they had to go through that to get to where they are today,” that’s an exceedingly arrogant and inhumane position to take. Individual lives were involved, children killed in factories, people used simply to make money for those elites who thought nothing of abusing other humans for personal gain. It was abstraction of humanity in the extreme, as evil as the abstraction used by dictators like Stalin to rationalize their horrors.
The most profound problems with markets are basic: First, humans lack perfect information and in fact often deal with misconceptions and misleading information. Those who can control or gain better information have a profound advantage. Second, those who “win” in the market can use their advantage to structure future games to benefit them, usually through better access to information, as well as the capacity to do things others cannot. The result is an inherently unjust system that gets manipulated by a few “winners” to create real class divisions and structural exploitation. Socialists are right in how they diagnose many of the core problems of capitalism. Capitalists are right in how they diagnose many of the core problems of socialism.
Modern market capitalism avoids most of the evils of pure market capitalism through regulation, whether prohibiting most forms of child labor, passing labor safety laws, protecting unions, limiting work weeks, and various other laws that try to create a more even playing field. Nonetheless, the gap between the rich and poor has been increasing. And while the poor may be doing better in absolute terms, politics operates through relative relations, not absolutes.
In Germany Christian Democrat Ludwig Erhardt pioneered the notion of a “social market economy,” as a compromise between capitalism and socialism. Erhardt, archetect of the German post-war economic miracle and Chancellor of West Germany from 1963 to 1966, argued that market economies operate best, but must be steered to assure that the people are put first, not the profit or the bottom line. People deserve fairness, they deserve health care, they deserve education, they deserve true opportunity. This can be achieved without socialism. Some call any government program socialism (e.g., the misnomer ‘socialized medicine’ for a health care system like those throughout Europe — that’s not socialism), but it’s really a mixed economy, with markets operating under loose regulation. If the regulation gets too tight the economy veers towards the mistakes of bureaucratic socialism, if it is too light, the dangers of unrestrained market activity occur.
And to me that’s the key: put people first. Ideologies are nice, but people get lost in the abstractions of arguments, concepts, claims to act on principle (for most people principle is the term they give to the ideas they are emotionally connected with — I ran into that in debates with an emotion driven anarchist way back in the 90s) so much that they forget that life is not just about justice, freedom, equality or material goods. Life is about people.
By that I don’t mean life is about giving people material stuff, whether it’s health care, education, or jobs. Life is also about allowing people freedom to create, work, express, and thrive. Pure market capitalism can lead some to deny material needs to others through exploitation, rationalizing the inhumanity by market ideology. Communism can lead leaders to strip people of that which makes life worth living — freedom and individuality — in order to service the “ism.”
So forget the ideology, forget trying to intellectualize and rationalize ones’ perceptions of reality in order to find out what the “right” system is. The mind misleads, it rationalizes one’s emotional whims, and allows us to create logical edifices to protect whatever we want to believe in. That is why ideologies consume people whole, causing them not to live as fully or appreciate their world. In many cases they lead people to hurt, kill and abuse others.
Focus on people — practical ways in the every day to put people first. No single policy path, no clear rational way to determine the role of government, markets or choice. Erhardt’s social market economy was an effort to work on that principle. But beyond economics it’s a good principle for life: people first, then do the right thing.
Lately my posts on the economy have been full of gloom and doom, so as a change, why not look at it from the other side — what is a best case scenario? To be sure, it has to be a realistic best case scenario, simply fantasizing that suddenly all the fundamental problems will go away makes no sense. It also has to take into account that this is no ordinary recession; not since the 1930s has there been such a global rebalancing of an out of whack economy. But it need not be like the 1930s. What can turn things around?
First, it did not have to get this bad. If the economic fundamentals were dealt with earlier, either after the 1992 recession or more likely after the 2001 recession, we could have rebalanced in an easier manner. It would have been painful, much like 1979 – 82, but it could have been done. Instead the bubble economy, built on a stock bubble followed by a property bubble, created a false sense of prosperity alongside a belief that all was well. Speculative bubbles create their own imbalances which, alongside the current accounts deficit and increasing public and private debt make this a very difficult economic crisis to bounce back from. What must be done?
Few emphasize that back in the 1930s there was an answer. If the world had embraced the kind of increased free trade and stable currency markets that were ultimately created after the war in the Bretton Woods system, we might have pulled out of the depression early and avoided World War II. If Briand and Streseman’s ideas of a kind of European economic bloc had been tried in 1929 instead of 1958, perhaps fascism could have been avoided. Some say the war ended the depression, but that’s baloney. If not for the dramatic shift in economic thinking heralded by the Bretton Woods system (fixed exchange rates based on the gold standard — which lasted in some form until 1971 — and a free trade regime, which persists today), the war could have fostered either a return to depression or, more likely, socialist revolutions in the West.
So let’s assume that there is an answer. The answer is not within our current realm of conventional wisdom, and may not be seen as feasible; a call for a Bretton Woods like system would have been laughed at by most in the 30s as a political pipe dream — we needed a war to get people to move beyond their own thinking. But it’s a different era than the 30s, the information and technology revolution is real, and globalization is much farther along. The kind of nationalist wars of conquest promoted by Japan and Germany are obsolete. Only the US has remotely tried such a thing, and it has proven to be a costly failure.
So maybe we can be forward thinking now. One thing a solution would have to be is global, and inclusive. In other words, we would need the kind of shift away from parochial nationalist economic thinking that we had with Bretton Woods. This means an even more intense embrace of multilaterialist ideas, and a recognition that success has to be more than just success of the West — only an economic system that truly gives hope and prosperity to those in the third world who currently suffer poverty and malnutrition can work.
That means two shifts: go into negotiations without national interests (and interest groups) in mind, and see third world development as necessary for renewed first world growth. Moreover, the US would have to recognize the unviability of the old “leaving beyond our means.” Increasing debt and trade deficits made us seem much better off than we were. We have to accept that the public and government will have to make major concessions in terms of expectations.
Luckily, we have the capacity to do that. The fake economy of the last 26 years has created pockets of fat that can be trimmed in order to transition to a sustainable system. That fat is in corporate and financial sectors, and the wealthy need to be taxed far more than they have been, with loop holes cut. In the past, tax increases on the wealthy have been rejected because that will decrease investment, and we need investment to grow. But that investment turned out in recent years to be mostly illusary paper gains based on financial speculation, and NOT efforts to build economic capacity and production. Government will have to take a more active role in making sure investment is directed into productive sectors. Those sectors should not be government run, but the market left to its own devices ends up serving those few who are able to manipulate information and regulation.
The latter means that Washington will have to do business differently. Transparency rather than inside deals with lobbyists needs to become the stanard operating procedure. The budget must be cut even as we try to increase production. That means redoing the budget from the ground up, completely restructuring the United States governmental bureaucracy to be more efficient and less encompassing. Most importantly military spending, mislabeled defense spending (we don’t need much to defend ourselves from invasion), needs to be slashed. This will be politically difficult, but in times of economic crisis things can be done that otherwise would not have been politically possible. Someone like Obama could pull it off.
So Internationally: a major international agreement designed to increase supranational regulation of credit markets, hold global financial and corporate actors accountable, create rules that transcend borders (to end a race to the bottom and companies shopping for governments who will deregulate and reduce taxes), and emphasize pathways for third world development. That will require a political aspect to induce effective governance in corrupt third world states. It won’t be easy, but third world development is a long term project, it only has to begin for the economy to start forward. This absolutely necessitates the US being willing to compromise on previously unacceptable matters, embracing a level of internationalism that had been anathema to most Americans in the past.
Domestically, a reorganization of government, with a focus of government resources on developing productive capacity, taxing wealtheir folk and ending a regulatory set up based on powerful and wealthy lobbyists is necessary. At the same time the American people will need to accept a decreased standard of living (since the old standard was built on debt and foreign labor/trade deficits), but one that can be made acceptable by undoing the massive increase in the maldistribution of wealth over the last quarter century. The recession need not be as painful overall if the cost is paid fairly. Technology to deal with global climate change and long term energy concerns could be key to helping reshape the American economy.
All that together sounds politically impossible. Our thinking would have to change dramatically, the break from the past would have to be profound. But who would have thought that a black man who had a Kenyan father and grew up in Hawaii and Indonesia, with the name Barack Hussein Obama, could be President? Unlike past politicians, Obama has the capacity to make a major break with the past, and do so in a way that doesn’t lead the old elite to torpedo his changes. Hence its important to have the Clintons, Jimmy Buffet and other current elites on board. And the recession and war in Iraq have caused Americans already to question the conventional wisdom of the last 25 years. I’ve heard many times in conversation and the media that “this is a different world than the one we’re used to.” That recognition that this is a new world is the first step to embracing a new kind of thinking.
And, if done well, we could find that by the end of Obama’s first administration the global economy could be showing signs of promise few could have imagined in the dark days of late 2008. And you know, it is possible. Not just because of Barack Obama, but because of what his election represents: an American public ready for real change. Remember, things are always darkest before the dawn.
What a week! I am chapter President of the faculty union here, and we had five faculty lay offs this week. It made for a rough week, full of meetings, deliberations on how to respond, and, of course, intense meetings with some of the people affected. Hard to be in the holiday spirit. In all, over a dozen people on campus lost their jobs.
50,000 lost their jobs at Citibank, 30,000 at Bank of America, and comparatively the loses here were minor. Moreover, I was never in any danger, so the tension people felt upon hearing that cuts were coming wasn’t as intense. My job was more to be there for people, to learn the contract, and try to make sure everyone is treated fairly.
The university is also going to go through “transformational change.” Although some people are very angry about this, most seem to realize that the world we’re in now is not the same world as a few years ago. The University of Maine system is unsustainable as it’s currently structured. In this there is an opportunity to shape the change into something positive; that opportunity doesn’t exist, though, for those who are leaving.
Unemployment is rising, and the cost of this crisis is starting to be felt at every level. The events of this week give me a taste of what this means in human terms. Not only those affected, but the entire campus was impacted by the shock of the cuts, plus far more feared they were on “the list” when word came out that cuts were coming.
I know have a stack of papers to grade, a winter course to prepare for, and am worn out by the week. So I apologize for not posting more.
I’ve been an economic Cassandra for so long that for awhile I got a sense of satisfaction that I was being proven right. That sense is gone. This economy hits people in real ways. One can only feel good about having been right if one can detach oneself from the reality of the conditions around us. That misplaced detachment is gone.
This week the federal reserve lowered interest rates to “near zero,” (a range of 0 to .25%) in an effort to stimulate the economy and borrowing. I think this is a dangerous action since one of the problems of recent years has been unsustainable debt and low levels of savings. Given the deflationary numbers on consumer prices out (the largest drop in consumer prices ever, I believe), it’s understandable. But we could be on the verge of this crisis getting yet another level deeper.
In a post last month, “What’s Up with the Dollar” I warned that the dollar was at unsustainable levels. A dollar collapse isn’t inevitable, but the combination of increased spending and cheap credit in an already debt ridden economy could ultimately cause a loss of confidence in the dollar. Then the dollar was at about $1.25 per Euro. It hoovered around there, but after the Fed’s rate reduction it has plummeted to $1.44 per Euro. That’s still better than it’s lows earlier this year, and it’s still not a crash, but we may be inching towards the next stage of the crisis.
Most observers believe the dollar will remain reasonably strong because there is no alternative. The Euro doesn’t have the track record of the dollar, and European economies are also week. Moreover, the US still dominates the financial markets and most investors have no choice but to put significant amounts of money in US markets. And while one can imagine an alternative to the dollar being developed, it would take time and for now the dollar will keep value despite and in part because of the slide to global recession.
I believe there may be two flaws to this argument. First, markets may be unpredictable but they react to demand. There is a demand for securities and investments that are not dollar based, and more quickly than one can imagine alternate investment possibilities may spread globally, especially in Asia where economies are not in as severe straights at this point. Second, the fundamentals are against the dollar. I tend to go with the fundamentals over speculation on what investors are going to do.
If credit is dirt cheap — the Fed is even talking about direct lending to make access to credit easier — the money supply expands. That should make the dollar less valuable. Although the trade deficit is finally starting to contract, and we’re off our highs in our current accounts deficit, we still are out of balance, with a dollar artificially high in value. The collapse of the bubble economy makes it harder to defy those fundamentals. High debt, cheap credit, high trade deficits are a triple whammy against a currency.
The result could be a contracting economy suffering inflation. The inflation would come from foreign goods — the kind we’ve been over-consuming — going up in price due to the increasingly less dear dollar. It also would lead to a tightening of the money supply as the feds would have to battle inflation as well as a recession. The practical effect on our society would be a markedly decreased standard of living and rising unemployment.
Believe it or not, if that happens, it may be the start of a recovery. At a point where foreign goods become expensive, American goods will be able to compete. The trick will be to find a way to capitalize new production of actual goods that people want. Here, inflation would be our friend. There would be lucrative foreign markets that could suddenly use cheap American goods. As the US starts exporting more the current account would come into balance, and soon the growth in the export sectors would start spreading and the US could begin a real recovery.
It will not be a return to the heady 1990s. As the global economy rebalances, the US will no longer have the capacity to party at the expense of others. Rather than consuming far more than we produce, we’ll have to have balance.
Such a rebalancing doesn’t happen overnight. We could see unemployment hit 15%, be vulnerable to terror attacks by those seduced by the thought of bringing down a wobbling economy, and we’d have to treat China carefully, given its ability to dump American currency and assetts in a manner that would devastate the US. It would hurt China too, so it’s likely we can convince them not to, but we’d be the weaker party in the relationship. We could see a recession last long enough that the “D” word becomes more common than the “R” word.
But absent a political crisis that severely destabilizes the planet, this rebalancing is simply necessary — and does give us some respite from potential oil shortfalls and global warming. US demand for oil was down 12% last year, a record drop. That also means fewer CO2 emissions, and just as sudden jumps in demand can trigger quick oil price spikes, sudden drops in demand have an opposite effect. Demand for oil is inelastic, so changes in demand not based on changes of supply can have a quick and dramatic effect on the price.
However, this is going to very hard on the lives of real people, many of whom never dreamed they’d be facing the kinds of conditions and choices they face. One question: can we as a society do things, either through policy, volunteering, or in communities to avoid families and lives being destroyed by economic crisis? This kind of suffering may not be as dramatic as that in a war, but it can a severe psychological shock that scars people and their families even long after the crisis has past. That will be the subject of future blog entries.
You don’t get something for nothing
You can’t have freedom for free
You won’t get wise
With the sleep still in your eyes
No matter what your dreams might be
– Neil Peart, (Rush), from the album 2112, 1976
In all the gnashing of teeth and moaning about the economy and the deep recession we find ourselves falling head first into, the clear solution is easy to ignore. We have to make stuff.
A society is prosperous if it produces. In the last twenty or so years, the emphasis has shifted from producing stuff we could trade and sell to, bluntly, trying to get something for nothing. In part this is reflected in the tremendous growth of the service sector. While the service part of the economy is important, the shift away from production to service became, in recent years, unsustainable. It was in essence a fake economy. Much of the service sector was in trying to make a quick buck — mortgage brokers, financial operators, and in general people working in the fields of credit and investment.
Don’t get me wrong. Credit and investment are essential to economic growth; we need those sectors of the economy or we won’t have a functioning economy. In recent years those sectors themselves bubbled as the “wealth effect” fooled people into thinking all you needed to do to make money is be clever and take advantage of short term circumstances.
A case in point: Pistol. I don’t know who Pistol was. I “talked” with him (or her?) back in the late 90s in internet debates. Pistol was a statistician who had quit his/her job to make money in the stock market. Pistol bragged about the amount of money made and said only stupid people aren’t getting rich. Anybody with a basic income base (or credit) could get into the stock market and then simply grow assetts and life off a portion of that growth. It literally was something for nothing — you need not produce, you need not even serve, just speculate.
That bubble burst, but the same thing happened with property. People earning $30,000 a year might reasonably have said that they couldn’t afford a $100,000 house. But when told by mortgage brokers that if they could manage to get that loan and buy that house, its value would increase to $150,000 or so in just a couple of years. Free money! But only if you can find a way to get a loan. So it was made easy — high interest rates because of low income, but the first couple years could be planned to be interest only or some low starter rate. Then, before the rates would rise, one could refinance using equity in the home to get a lower rate. That scheme, which made banks, mortgage brokers and others a lot of money, led to the subprime mortgage collapse, which was the first part of the ‘fake economy’ of recent years to fail. And, of course, we know that many others in the financial sector bundled these mortgages into securities and made money on them — again, something for nothing — sending toxicity into the global financial system.
We in America, enjoying trade deficits (others making stuff for us cheap, while we didn’t have to reciprocate thanks to our dominance of global finance) and budget deficits (borrowing from our childrent o party today), also were in the pursuit of something for nothing. Our savings rates plummeted as consumption increased. More! Now! If we can’t drive the car off the lot today, well that’s unacceptable. Personal debt skyrocketed, credit card debt went from just over $200 billion in 2002 to over $900 billion now. People borrowed against the increasing value of their homes to live a lifestyle beyond their means.
In short, we were caught up in an orgy of consumption, believing that we can have what we want with no sacrifice. Getting something for nothing became a kind of national delusion.
That’s shattering all around us. Like after a wild party where one drinks and eats far too much, the hangover from this consumption binge is causing real pain. And, just as those who overconsume food and drink for decades end up with diseases that threaten ones’ life and physical capacity, this over consumption has created a weaker, debilitated economic system. Trying to get something for nothing may seem to work for awhile, but ultimately we pay the price. Unfortunately in a social system like ours the price isn’t always paid by the same people who indulged — I’ll address that issue of social justice another time.
Just as an alcoholic or morbidly obese person can recover and change their lives, so can we as a society recover from our binge. The first lesson to learn is that we don’t get something for nothing. We need to produce. Yes, we need banks, credit markets, mortgage brokers and the like. But to work to help those who produce build their lives, not as a route to cheap quick wealth. Investing in infrastructure the way President elect Obama plans can be a useful first step, but only if it’s part of an effort to get America producing stuff people want, not just enjoying cheap goods from abroad.
Ultimately, we can’t prosper by valuing consumption over production. Our status as a superpower and our dominance of the financial sector made it seem we could for the last quarter century. I’m not sure how we recast our economy, especially given how we are starting in immense governmental and private debt. But as complex as the problem is, the answer is crystal clear: produce. Reject the idea that we can get something for nothing.
I have to admit to a kind of perverse satisfaction about the financial collapse taking place all around us. Not that I like what is happening — it negatively effects me, my family and my children’s future. Yet there seems to be some justice in having a distorted system finally start to rebalance. Part of it is that I’ve been one of the Cassandras for so long now, I feel vindicated that gee, I called this right (along with quite a few others, to be sure). But more importantly, I’m becoming increasingly convinced that the system we had became a cancer to the body politic and even the spirit of the United States, and that as painful as it is, we’ll be better off if we can shed it and move a new direction. The key will be, of course, where we go.
Other countries have been in positions like this and have not chosen wisely. Germany in the late 20s found a broken and untenable Weimar Republic collapsing into depression and chose a way out which seemed to make sense at the time. Adolf Hitler promised to unify the country, put people back to work, undo the disastrous Versailles Treaty that mistreated Germany and gave it second class status, and to make people proud to be German again. For six years, he seemed like the real thing. Germans were working, their economy was taking off (unlike the economies in the rest of Europe), and he ditched the Versailles Treaty with bold foreign policy strokes, all of them peaceful and successful.
By late 1938 Germans were convinced that fascism was the right approach. They were proud again, their country stood tall, their factories were working, people had a strong sense of patriotism, and they were at peace. Germans didn’t want war. Sure, the intellectuals complained by authoritarianism, and the government came down on those who “weakened the country from within,” — the pacifists, socialists, liberals, internationalists and jews. Yet the fear of Bolshevism was strong enough, and European anti-semitism intense enough that these were easy to ignore. Ridicule the intellectuals, parade the plain spoken every day hero, and embrace German cultural values. Gone were the “sex, drugs and cabaret” of the twenties, in were patriotic marches, youth camping and hunting adventures, and virtuous German activities.
Earlier Russia also saw its entire system break apart. The Czar pushed the country into collapse in World War I. The Empire was already weak and anachronistic. When the war started Russian soldiers were only armed in the front lines, those behind would carry sticks and then pick up the dropped weapons of the soldiers who would fall in front of them. The war broke the Russian economy. People lacked food, villages lost a generation of young men, and the Russians won nary a battle against the Germans. The people had enough. They ultimately rallied around a leader who promised a new world, a utopia where all would share the fruits of their collective labor, and the state would wither away. It rested on an rational, objectivist philsophy which posited itself as the true understanding of how society and history operates. Within a decade this belief in having the “true, proper” understanding of politics and governance would lead to totalitarianism, tyranny, and poverty. For awhile it appeared strong, a superpower challenging the United States. But that was an illusion, the system rotted from within, destroying the economy and peoples’ spirits.
Humans create when things have been destroyed. That creates opportunities and dangers. We can avoid the lessons of the 20th century.
1) Avoid an emotional desire to create an artificial sense of nationalist unity, demonizing those voices who question the cause or the people, in a desire to create an order reflecting some kind of mythological sense of what society should be. Fascism was like fantasy, a grotesque piece of social artwork, whereby the leaders built an narrative where their people were superior and strong, others were inferior and dangerous, and society was unified by a common ideal, culture, and support for the leader. Fascism was about emotion, using rhetoric and propaganda to create a sense of unity and solidarity. It appealed to the masses, it was anti-intellectual, sort of like talk radio on stereoids. In essence, the fascist mantra is “we are great, all our problems are blamed on others.” Fascism is a social manifestation of the same thinking that takes over an insecure individual who can’t accept that he or she screwed up and created problems and instead needs to feel the victim and lash out at others. We are great, we just have problems because there are enemies who hate us!
2) From Communism we need to distrust any ideology that promises a utopia, or claims to be the one, true, proper way to think about politics and the world. In some ways, Communism and fascism represent truly opposite ends of the spectrum. For fascism there was no truth but power; power forms truth, with power you can determine truth. For Communism there was one true set of historical and social laws, and if you used reason and had the proper premises you would inevitably be drawn to the conclusion the Communism was the only system that promised true human liberty and an end to exploitation. In the name of utopia and the “right” system government took all power. After all, if you have the “right” ideology, shouldn’t you do what you can to make sure you have the power to implement it fully? And, once that power was centralized it could be abused and freedom could be taken away in the name of a system. Instead of utopia, it was tyranny. It is the social manifestation of the perfectionist personality which wants to create the right system, and control it absolutely.
Ideologies are inherently vast simplifications of reality based on assumptions that can be questioned, and contestable definitions of terms. If anyone claims they have the right ideological view, run away as fast as you can. That kind of thinking becomes cultish, and rationalizes actions otherwise clearly irrational. Appeals to emotion alone, however, can be manipulative. In Consumerism and fascism I noted how similar the appeal of Madison Avenue is to that of fascist propaganda. Finally, those who posit a utopia or a perfect world should not be trusted either. If we build a society that looks utopian by today’s standards it will be through a long process of cultural transformation, it can’t be done on somebody’s masterplan, an ideology dreamed up by a human mind, abstract and absolute.
That said, America has built in advantages that Germany and Russia did not. We have a strong tradition of individualism, democracy, and distrust of power. While we have sections of society prone to militarism and nationalism (witness the hyper-emotional appeal of talk radio, which is reminiscient of fascist propaganda), and others that believe government can create the best and proper system (witness the strident appeal of far left blogs which belittle conservatives and claim to offer the only reasonable understanding of reality), most Americans are at heart pragmatic. Americans have never given in to the ideological fervor that has too often driven European politics. We prefer to problem solve, and hold close the notion that those who hold different opinions can talk and compromise.
But let’s not understate the danger either. If we are facing a coming dollar collapse on top of the current set of economic woes, the infrastructure of our socio-political-economic system will be under seige. The US was one of only a couple states that held on to a stable democracy during the Great Depression, our cultural values immunize us a bit from the appeal of utopian tyrants or blame hurling fascists, but the going could get tough. We’ll have to hold on to the values in our constitution, the communities we have around us, and a belief that we look to each other to solve problems, not abstract philosophies or emotionally appealing rhetoric.
We have been spending a lot of time in my classes talking about the causes, consequences and possible cures for the current economic crisis. It’s especially scary for students, realizing they are getting ready to enter the work world, and that they are being handed a debt of well over $10 trillion and an economy way out of sync.
Good students that they are, they maintain a bit of skepticism as to what their prof is telling them. One astute student suggested that if my analysis was right, the dollar should be far weaker than it is. The dollar, in fact, has been rallying. Does that mean that perhaps our economy is better than many believe, and there is cause for optimism? That is a very good and insightful question.
To be sure, I’m glad the dollar has shown strength recently. We’re planning a travel course to Italy in February, and I hope the dollar rally lasts at least another quarter year. We hope to offer a major travel course to Germany and Austria in May 2010, a high dollar then would be nice too.
Right now the dollar is at about $1.30 per Euro. Historically, that is rather weak. At one point back in 2000 it was 80 cents for a Euro, and for a long time a 1:1 ratio seemed like a relatively weak dollar. Yet recently the dollar fall to about $1.60 per Euro, before the rally after the economic crisis began brought it up to almost $1.20 a Euro at one point. At one level, given the bailout money, the weakened economy, and poor growth prospects looking forward, a strengthening dollar seems bizarre. Can it last?
No. The strong dollar is an illusion, a short term phenomenon caused by a variety of technical factors but most importantly the fact that the crisis is global and at least for now, dollars are trusted more than other currencies in a time of uncertainty. There is also a belief by some that the US will actively pursue a strong dollar policy in order to spread the recession pain more widely. However, when it comes to economics, the fundamentals can’t be denied.
First, the US still has a large current account deficit. It is unlikely that foreigners will continue to finance that as American assets lose value. A dirty little secret in the swiftness of Congress and the Executive to prop up many of these financials is the fear that if they are allowed to fail, foreign investors will be burned and start pulling out of the US, causing a run on the dollar. Also, with investments declining and people selling, they needed to become liquid, and the dollar was a logical choice. This points to a short term panic rally of the dollar, followed by a longer term dollar collapse.
So I have to say that I think the dollar’s current strength is, if not an illusion, a short term phenomenon. At some point as the fed lowers rates, as US deficit spending grows, and it’s clear there isn’t going to be a sudden burst of economic activity in the US, there will be a dollar panic and we could see $2 to a Euro. Now, the European economy isn’t exactly all sweetness and joy right now either, but they aren’t going to have to correct for a massive current accounts deficit like the US.
Practically, what does this mean? First, oil will go back up in price when the dollar starts depreciating. OPEC still prices oil in dollars, and if the dollar loses value, oil increases in dollar price (though the increases are slower in other currencies). The current drop in oil prices have been greater for us than the Europeans because of the dollars strength — it works both ways. Second, we’ll get inflation. Right now the concern is deflation due to decreased economic activity. In a recession, with higher unemployment and decreased economic activity, inflation is usually not a problem. Yet markets are now global, and so these things operate under different rules. The only way to balance our current accounts is to depreciate the currency — the market will do that whether we like it or not. Perhaps now is a good time to purchase some needed home goods or a new car, before inflation starts driving prices up. If I had the money I’d dump dollars and American securities and go into foreign equities and currencies. Oil stocks are a bargain now too — oil prices will go up. Alternate fuels are being hit by current low oil prices, but they’ll come back too.
As investors decide to move from quick gain US investments in stocks and property (the ‘bubble investments’ of the last decade) to investments in actual production capacity and various global markets, the dollar has nothing to prop it up. One student asked if all these massive bailouts might be setting up another bubble — throw so much money into the economy that credit remains cheap and speculators are able to find some new creative way to re-bubble the economy, lure in foreign capital to finance our trade and budget deficits, and keep the party going.
I think not — and I certainly hope not! Every time we delay having to deal with the reality of our economic fundamentals, the ultimate price we’ll have to pay gets higher. The higher the debt, the deeper the current accounts deficits, the more unstable both the dollar and the US economy becomes. I think we were able to go from bubble to bubble in the last decade because the financial pundits and analysts never had a glimpse of the dark side of the economic illusion they were creating. They convinced themselves that wealth creation was enough to offset debt, and wealth creation was measured in portfolio and investment values. These were never real, they were artificially inflated buble values. Now that it’s collapsed and people have been burned, I can’t imagine they’ll allow themselves to be burned again. And even if enough short term greed were to allow some new bubble to form, peole would be quick to get out at the first sign of danger.
The fundamentals are clear and have been for about a decade. We have been financing a life style beyond our means through unsustainable current accounts and budget deficits, using the power of our financial instutions and control of financial markets to allow this to be financed by foreign capital. Such a situation cannot continue forever. The painful rebalancing should have started with stock market crash, but after 9-11 credit was made so cheap and so much money poured into the system to prevent terrorism from bringing down the economy that we financed an even more dangerous bubble — a property bubble existing alongside bizarre financial instruments sold as investment grade securities. Now, we pay the price.
If we’re entering a storm, we’re still at the outer bands, starting to feel the force of the winds, but with much more to come. Once the dollar starts falling, foreign capital will bail from US markets quickly — as will American capital, since markets are global. This will create a deep recession, accompanied by inflation, which will have the practical effect of lowering all our standards of living, and causing severe crisis to national, state and local budgets. At some point, the storm will pass, and we’ll have to clean up the mess and find our place in a rebalanced world economy.
But there are two bits of good news here: 1) We’ve been living in a kind of illusionary or fake economy for awhile now, the sooner we can get back to reality the better it will be in the long run; and perhaps the best news: 2) While I stand by analysis and note I’ve been talking about the current accounts deficit, hyperconsumerism, and the ‘fake’ nature of our economy for years now, I’m a political scientist and not an economist. I study political economy, but don’t get into the technical analyses. So maybe I’m wrong. I hope so. I don’t think so, but I hope so!