Archive for category Economy

Energy, Finance, and Geopolitics

As the EU leaders work with the IMF, various central banks around the world and China to figure out a way to prevent a Euro collapse and treat the causes rather than just the symptoms of the crisis, it’s clear that four years into this economic crisis — which would be akin to another Great Depression if not for the capacity of government to intervene more effectively in the economy — the core problems remain unresolved.

The core issues revolve around a triad of energy, finance/debt and geopolitics.   The solution summed up in one sentence:  We must restructure our energy usage so as not to be dependent on oil, restructure debt and the global financial regime so as to return to sustainability, and restructure the world system to give new prominence to rising powers such as China, India, Russia and Brazil, while the US and the EU take important but diminished roles.

Despite all the hoopla around “drill, baby, drill” and oil finds everywhere from North Dakota to off the western shore of Mexico, nothing yet denies the fact that if we are not now at the peak of production, we still will be.   This isn’t as dangerous as some would have you believe.   The traditionalist peak oil school looks at production like a regular normal curve:

This alarmist example posits a quick drop in oil production, leading to crises ever more serious and devastating

The alarmist approach could be a bit early — the peak may still be ten or fifteen years off.  But right now the data does show flat production, even when prices spiked in 2007-08, so there is evidence to support a claim we are now at peak.   The late Matthew Simmons’ book Twilight in the Desert makes a persuasive yet indefinitive case that Saudi Arabia is already peaking and hiding the fact their real reserves are not as plentiful as claimed.   Still, the normal curve shown above is based on how US reserves were depleted — the US peaked in 1973 and production declined dramatically.   The global peak will probably not play itself out in the same way.

The US peaked in an era of cheap oil; with oil expensive and the global economy as dependent as ever on it, the search for new reserves and thorough extraction from existing wells can stretch out the peak potentially quite a while.  The graph could stay around the peak for ten or twenty years and then decline at a much slower pace.  Still, switching from an oil based economy to one that runs on a diverse set of sources ranging from coal to solar, nuclear, geothermal, wind power and others will be difficult.   Waiting for the market to force change will likely assure a period of twenty years of imbalances where real crises and shortages cause political unrest and could yield dangerous movements akin to fascism of the 1930s.    Proactive efforts to actively promote alternative energies alongside efficient exploitation of remaining reserves could help make a safe transition possible; unfortunately it’s hard to find political will to do that when there is still denial that we’re in crisis.

The second issue is global debt.  Thanks in part to cheap energy and seemingly relentless growth, banks grew comfortable making large loans to governments, corporations and individuals without worrying too much about the ability to pay back the money.   The technology revolution helped rationalize this exuberance, technology means you can get more bang for the buck — more growth with fewer resources.  Governments and the private sector got addicted to a debt that could only be maintained so long as growth was rapid, requiring both cheap energy and technological advances.

All of this debt did two things; first it spurred on investment bubbles as lack of regulation (meaning the insiders could rig the game to their benefit) alongside easy credit led to investment for the sake of making “easy money” rather than investing in companies likely to grow the economy.   This created short term jobs in the bubble sectors, but those were unsustainable.  I’ve called this the ‘something for nothing‘ mentality.

What is alarming about this graph is that except for early in the Great Depression when total debt (government and private debt) hit 300%, the average has been about 150% or lower.   Through 2009 it was reaching 380% an amazing debt burden.   Since the debt to GDP ratio of the US government is about 100%, most of it is private or corporate debt.   Much of this run up was during a boom, a sign of an unsustainable economic run up.    The US is doing worse than most in this regard, but Japan, another of the largest economies, is also burdened with high debt.   One can quibble with the statistics used (at least in interpretation) and argue that the graph exaggerates the burden.   Even then the number comes out at near 300% of GDP instead of 380%, still Great Depression levels.   Clearly there is a debt problem, and it’s not limited to governments.

So here’s the deal: how do you pay down the debt without causing a deeper recession?   The only way to do that is through growth.  Spending can be cut, but realistically the best bet is to slow down spending growth.   Moreover, cutting spending during a recession can be disastrous — it does far more harm than raising taxes.  Then if high energy costs return as demand rises economic recoveries can be stopped in their tracks.

The most dangerous issue is the third, however: geopolitics.  It’s also the most promising.   The emerging markets have a lot of under used resources and human talent, and the expansion of Asian and potentially other developing world economies could lead to a global boom.   That could provide the capital to help the developed world restructure its debt.  The problem is that the first world also have to acknowledge relative decline — the balance of power would shift towards countries like Brazil, Russia, India, China and South Africa, the so-called BRICS.

The trouble is that rising powers tend to get over confident and take risks while declining powers choose to fight to try to hold on to what is slipping away.   The so called “power transition theory” may be less viable now when economics dominates and nuclear war is all but unthinkable, but the careless talk in recent Republican debates about policy towards China suggests that many in the US may not get just how vulnerable we are, and how much damage has been done to the economy over the past decades.   The good news is that the BRICS don’t want the West to collapse, economic interdependence is real.  They want to shift towards investment and a greater say in the world economy and, in exchange for helping bail out western states in various ways, influence on our domestic economies.  China is already gaining that through heavy investment in both the EU and the US.   It’s often not noticed, but it results in a real shift of power.

These aren’t the only issues of course — global climate change is still potentially a game changer, and the Mideast could explode and create an oil crisis unrelated to so-called ‘peak oil.’   High energy costs could still undermine the BRICS and thus the world economy.    Still they keys towards the future remain transitioning to new energy sources in a timely manner, turning around the build up in public and private debt in the West likely by a mix of ‘haircuts’ (simply eliminating debt) and capital support from BRICS and other emerging markets.  In exchange control of global financial institutions shift away from western dominance (though maintaining western influence).   Managed right, there is no need for on going crisis, fear of war, or concern that civilization will collapse.   But can we trust the politicians to handle this with any wisdom?

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Building Systems

It started with the mathematicians and the scientists  — Galileo, Descartes and Newton.  The idea that the universe could be conceptualized as a system following universal and natural laws created a world view that threw medieval thought and Aristotelian scholasticism in the trash heap of history.   Instead of a world of particulars there were universals, the same laws of physics apply everywhere in our space-time universe.

Before long such thinking was applied to human behavior, yielding both powerful insights and dangerous dogmas.   Giambattista Vico’s theory of history published in Scienza Nouva (1725) is one of the first, yielding a theory of historical evolution and class struggle that influenced diverse thinkers from Karl Marx to James Joyce.   Building systems to explain human behavior created a new way of thinking that would change the world.

Adam Smith, author of "The Wealth of Nations"

Adam Smith was a moral philosopher whose 1758 book Theory on Moral Sentiments brought him to prominence, but his system building classic Wealth of Nations changed everything.  It showed both the power, and the potential pitfalls, of system building.

Throughout history merchants knew that if you increased the supply of something while demand stayed steady the price would drop.   The “law of supply and demand” was part of the practical knowledge of doing business throughout history.   Yet Smith took and it formalized it into a law and along with notions like the importance of the specialization or labor created a systemic view of market economics which came to be called capitalism.   He published Wealth of Nations in 1776 and it became a smash hit.   It described the workings of the industrial revolution, and for the first time argued that as individuals pursued their self interest they would inadvertently yet in a very real way be promoting the public good.   The idea that individual self-interest was not bad (greedy, selfish, etc.) but rather good (it allowed the market to create prosperity and adapt) was knock out stuff.

Of course, if you read Smith carefully, you see that the system builder recognized that his system was not self-sustaining and perfect.  Unlike Newton’s mathematically precise world, markets are human constructs and do not operating magically or naturally.   Smith argued that the wealthy can collude and circumvent markets, exploiting labor and using their power to benefit themselves.   Self-interest has limits, if capitalism is to work.   Indeed Smith skewers the wealthy of his day, often with rhetoric that is more fitting for Occupy Wall Street than the University of Chicago.

The problem is clear:  human system building simplifies a myriad of variables into a model that works well, all other things being equal.     Because human behavior is variable across cultures and time, any system that generalizes by definition has limited applicability.   Moreover, due to complexity the simplification is a good starting point for basic principles, not for claims of universal truth.   Smith understood this.

But those who came later made the fatal flaw of turning systemic thinking into ideology.   Theories of how reality work came to be grasped with a religious zeal as being the truth.   That rationalized looking at the world abstractly.   Perhaps the best example is the response of Great Britain to the Irish potato famine of 1846-51.    The Irish were starving in droves (over a million perished) but a libertarian philosophy led them to rely on the market rather than to intervene.   To this day when there are crises people say “individuals can help if they choose.”   That sounds good in theory, but in reality not enough ever choose to do so.

Once you embrace a system as an ideology, you lose the capacity to recognize that the system itself is an imperfect model of reality that doesn’t always work.   One further interprets reality through the system, and finds reality always fits ones’ ideological world view.   With a complex reality that one can interpret in a variety of ways, one can always support ones’ pre-existing view.  If one holds on ideology with a kind of religious fervor, there is never any reason to doubt one is right.

System builder Karl Marx

Karl Marx, writing 50 years after Smith, admired Smith’s work and considered him his “favorite economist.”   Most importantly, Marx (who also admired Vico) tried his hand at system building.   Like Vico he tried to explain the broad flow of history, using the tool of the dialectic borrowed from Georg Hegel, the German Philosopher he had studied.   Hegel’s dialectic was used to examine ideas, Marx used it to examine economic history — historical materialism.   Like Smith Marx used his system to look at how the economy functions, getting an explanation of why capitalism was leading to sweat shops and working class misery rather than prosperity.

Marx’s system suffered all the flaws that Smith’s did, perhaps more so due to the methodology of relying on the dialectic.  Moreover, Marx was not just a theorist like Smith, but a political activist who hated the poverty and misery he saw in the working class.   This led him to make a fundamental error: he extrapolated his system into the future without supporting his vision with evidence.

Marx’s insights on how capitalism function are still used today by people analyzing the political economy.   They’ve been altered and updated, but like Smith, his theory has proven resilient.    Both Smith and Marx – as well as others – have contributed to our capacity to make sense of how the economy functions.   But Marx’s extrapolation into the future imagining a perfect class free society without any exploitation led to horrific abuses of power by revolutionaries determined to achieve this just and utopian future.

System building leading to ideology is dangerous and misguided.    Ideology leading to dreams of utopia and a desire to make that utopia real are dangerous.

Ideology is not the same as having a perspective and a set of beliefs.   Everyone needs perspective and beliefs to make sense of the world, but you don’t need ideology.   Ideology comes from taking a systemic representation or model of reality and using it as the framework through which to interpret reality.

The systems are themselves not bad; they are useful.    In fact, Smith and Marx both provide useful systems that are not in contradiction to each other, even if they focus on different factors as relevant in different contexts.    It is useful to understand, try out and explore the potential and limits of a lot of abstract systems of thought, efforts to model and make sense of reality.   The danger comes when one mistakes the system for a true representation of the actual laws of nature.   The mistake intensifies when the ideology is grasped with a religious fervor so that the holder of the “one true ideological belief system” sees battling the others to be just and necessary, just as the religious soul might believe she must defend the one true faith.

Now is the time to step back from ideological delusions.   Building systems is a good thing, they help us understand, analyze and try out theories about how reality works.   But all systemic thought has limits, and the sophisticated thinker can try out different systems and explore where they lead, not needing to think he or she has the one true world view.   Moreover, humans construct culture and worlds; how the world changes, even human nature, is somewhat malleable in light of those activities.   As we move forward into the 21st Century job one must be to shed ideological dogma and think creatively about the transformations taking place.

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Economy Turning Around?

The stock market broke 12,000 for the first time in a long time on news that Europe had reached a deal on the Greek debt crisis, the US economy grew by 2.5% last quarter, and first time unemployment claims fell slightly.  It’s possible the economy may be turning around and we’ll avoid the dreaded “double dip” recession.

If true, this is the best news President Obama could receive.  If next year there is a palpable sense that things have turned around, Obama’s chances of re-election grow considerably.     Still, The recession currently is in its fourth year.   Yes, there has been growth so it’s not technically a recession, but in terms of high unemployment and a tough economy things have been in the dumps since 2007, even before the September 2008 crisis.

President Bush and Obama get little credit for how they mitigated the worst of the crisis.   President Bush’s “bailout” of Wall Street was necessary in order to prevent a further credit squeeze, perhaps pushing us into the Great Depression.   The banks also paid it back, meaning it turned out to be “cost free.”   President Obama’s stimulus package also turned around the bleeding of jobs and prevented states from becoming insolvent in 2009.   Since we never experienced the reality that would have happened without the stimulus it’s easy to dismiss it since it didn’t “fix” the economy and make everything better.   But in 2009 nothing was going to do that.

There is a good chance this spurt of growth will cause economic tailwinds to push the economy forward in 2012.   But while this may save the President’s job, it doesn’t mean the economy is “returning to normal” or that the problems are solved.  It does suggest that we may be able to handle the crisis without total collapse.

Here’s the deal.    Global debt is still way to high, and that’s going to hinder economic growth.   Moreover, states like the US have been consuming more than we’ve been producing, thinking this is OK because we lured in outside investment (the capital account surplus balanced our current account deficit).

At a national level, the US needs to expand its productive capacity and reduce consumption to the point that it more or less balances production.    The trade deficit needs to drop, either through currency devaluation (inflation) or less consumption.   At a global level the issue gets murkier.   Total debt (public and private — one can’t blame governments alone for this) is over 300% of GDP for the industrialized West.   High debt levels have funded a sustained period of living beyond our means.

The good news is that the year to year deficits (how much we’re living beyond our means) have not been dramatically high.   But if you earn $50,000 a year and spend $52,000 a year, in 20 years your debt is probably near $30,000 (thanks to interest).   Small deficits repeated yields high debt, both for governments and for the private sector.   Because yearly deficits were relatively small, and the economy seemed to be growing thanks to the bubbles, people had the illusion that growth would solve the debt problem.   In the US a brief surplus in the federal budget at end of the 90s made it seem like a solution was easy.   The high federal budget deficits in the last decade got rationalized by the aftermath of 9-11.

The brief budget surpluses were thanks to the bubble economy, and did not extend to the private sector — private debt kept growing, in part because no one identified it as a problem.   High debt and cheap credit created this crisis.   It’s different than the classic Great Depression crisis of over production.   Yes, easy credit was a factor there (margin calls, etc.), but the level of pervasive debt was nowhere near what it is now.   That makes this crisis unique and difficult to solve with traditional means.

Obviously it’s important to de-leverage — to pay down debt.   That’s been happening, especially in the private sector.   Governments have not paid down a lot of debt yet, in part because of macroeconomic pressure to stimulate recession weary economies.

Another lesson is the need to reform and re-regulate the financial sector.   The bubble and the extent of the collapse in 2008 was completely avoidable.   If over the counter derivatives had been subject to regulations of reporting and transparency, the big financial institutions could have never packaged dubious mortgages into bonds that confused ratings agencies stamped “triple A”.     That in and of itself would have done a lot to prevent the crisis since it was demand for mortgages to be packaged as bonds that created the intense increase in real estate prices.

Beyond that, incentives matter.   In the past lenders had incentive to be careful about who they lent money to.   If someone can’t pay their mortgage the bank stood to lose a chunk of money.   But when the demand for mortgages was high and brokers did not bear any of the risk, then there was an incentive to just provide the mortgage no matter what — even if it meant lying and arranging absurd loans to people who had no means to pay it back.    That also was engineered by the big banks, who then did all they could to try to decrease their risk (thereby creating systemic risk).

So three things need to be done:  pay back debt (de-leveraging), increase production, and create a functioning regulatory regime for the financial sector to prevent future credit orgies.      Increasing productive capacity usually involves investment, which works against paying back debt.    However, at a global level if the economies of export led growth countries like China start switching towards more internal consumption and less reliance on trade (something the recession is forcing them to do — bankruptcies are growing in China), then rebalancing is possible.   Things won’t be as cheap in the US so consumption will decline, but domestic production will grow, as will jobs.

Regulating Wall Street is a tougher nut to crack, thanks to the intense lobbying power of the big financial institutions.   Public pressure like “Occupy Wall Street” helps, and President Obama’s new found populism could give him support to push effective reform in a second term.    One can understand his coziness with Wall Street in the depths of a recession — you don’t want to scare the big economic actors.   But if the economy starts growing so too does the governments independence from big money.

So far my worst fears about this recession/depression have not been realized.   It’s not been the quick recession many predicted back in 2008.   It’s not just another business cycle recession.   There still is a long way to go.   But perhaps we’re turning a corner and it’s possible to see a way out of this that avoids catastrophe, even if there will be no return to the heady consumerism of 2006.    And just maybe we’re relearning the importance of virtue — focusing on the importance of work, family and values rather than material consumption.

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Mitt Mondale?

In 1983 the Democrats were sure they had a candidate that would send Ronald Reagan, whose approval ratings reached as low as 38% that year, back to Hollywood.   Walter Mondale was the consummate politician.   Polished, careful, and connected, the former Minnesota Senator and Vice President had been successful at every level.  His professionalism, intelligence and poise would be the perfect foil for Reagan.   Reagan had proven himself not ready for prime time by a series of gaffes and an apparent inability to handle the recession.

The problem with Mondale can be best summed up by a Bloom County comic from 1984.   The Meadow Party is about to nominate Bill the Cat for President, even though Bill had apparently died.  At the same time, the Democratic party is starting its convention.  A Mondale supporter with a sign and Mondale pins and stickers comes up to Opus the Penguin:

“This isn’t the Democratic Convention?”
Opus:  “No.  That’s across the street behind you.  We’re the Meadow Party.”
Mondale supporter:  “Yeah?  So who have you guys got to go up against Reagan in the fall.”
Opus:  “A dead cat.”
The Mondale supporter looks behind him, thinks, then enters the Meadow party convention saying, “Oh, what the hell.”

In short, Mondale was such a professional politician that he was boring.   He was connected, a Democratic insider, had all the credentials, but ultimately when people looked at him next to the rugged, charismatic and charming Reagan he didn’t stand a chance.

President Obama, like President Reagan, inherited a deep and serious recession.   Unlike President Reagan, he inherited high debt levels, a massive current account deficit, and total foreign debt of over $12 trillion (now at $14 trillion).   Reagan came into office with the lowest debt to GDP ratios since WWII, a current account still in surplus, and little foreign debt.   As oil prices fell, naturally stimulating the economy, Reagan could afford to mix low interest rates with a huge jump in deficit spending and debt to hyper-stimulate the economy.   Obama doesn’t have that luxury.  This suggests that even if the economy improves in 2012 the “morning in America” ads proclaiming the end of the recession for Reagan in 1984 aren’t in the cards for Obama.

Right now, Obama is considered likely to be re-elected because of the weakness of his opposition.   While Reagan could mix conservatism with charm and pragmatic appeal, today’s Republicans fall short.   Reagan was popular not because he stood on principle, but because of his optimism.  It was contagious.  You could tell he believed Americans could achieve anything, and that’s something people wanted to hear.   Obama doesn’t have the same kind of charm, but he’s an inspiring speaker, performs very well in debates, and can still inspire hope.

From the GOP the negativity coming out of the various camps is palpable — Rick Perry’s book is called Fed Up, crowds at GOP debates boo a gay soldier and then cheer someone dying because he didn’t have insurance, and a kind of angry frustration shapes their message.   Knowing that the primary voters and convention goers want red meat, the politicians fall over themselves trying to sound more true conservative than others.   Jon Huntsman, who refuses to go that route, gets ridiculed and even demonized by some on the right.

Standing above it all at this point is Mitt Romney.   Romney is an unlikely front runner.   His health care program in Massachusetts is much like the Obama plan the GOP condemns, he’s a Mormon (distrusted by some evangelical groups), and he’s seen as the ultimate insider — connected where it counts, but lacking in deep convictions.  In the first election after the tea party sweep of 2010 many in the Republican party hoped for that special someone who would come and be the perfect mix of conservative principles and charming electability — another Reagan.

To be sure, the Ronald Reagan of 1980 would be positively left wing by the standards of many in the tea party today.  But the former actor turned politician focused on optimism and a disarming charm to convince people his ideology wasn’t as scarey as the left claimed it was.   Bachmann, Palin, Perry, Cain and Santorum seem petty and pessimistic by comparison.  They can be scary without help from the left.   While Santorum battles google over what gets shown when his last name is googled on their search engine and the others try to position themselves just to the right of all the rest, only Mitt Romney has been able to rise above the fray.   Add to that his popularity in New Hampshire, and he could quickly position himself as not only the clear front runner, but the only one with a chance at beating Obama.

But will he be a repeat of the Mondale candidacy — an insider who is seen as a safe choice against as supposedly weak opponent, but one who does not inspire loyalty and intense support?  Will Obama end up not getting the kind of blowout that Reagan got in 1984, but a win that seems unlikely given the mood of the country now, in 2011?

That’s a question impossible to answer now.  If the economy ticks upward in the next year, Obama could well be a shoe in.  If it plummets deep into a double dip he might lose to even Bugs Bunny.   If things remain on the edge this could be a year where the campaigns truly matter.   That should make Republicans nervous.   While Romney is a smarter campaigner this time, and isn’t leaving a trail of land mines behind him set to go off during the general election campaign, it will take a lot to match and counter the Obama machine.   Yes the big funders are hesitant and the small donations aren’t coming in as fast as they used to.   But Obama had to fight Hillary in the 2008 primaries; now virtually all his money will go to the general election.

Obama has already begun to arouse his base — even as the Republicans scream it’s class warfare.  As the campaign heats up, image, style, and even substance will all make a difference.   Is Mitt up to the challenge?   He’s no Ronald Reagan, the Republicans realize.   He’s too aloof, east coast and intellectual for that.   He’s more comfortable in the board room than on a saddle.   But is he a Walter Mondale — an insider with connections and political finesse who cannot arouse the interest, imagination and devotion of the voting public?    Assuming the dynamic of the primary season stays steady, that’s a question we’ll be in a better position to answer next year.

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Lessons from the Wisconsin Recall

The recall elections in Wisconsin are almost finished — the final two Democrats up for recall are not considered in serious trouble — and overall it looks like the Democrats managed to recall two of six Republican Senators, not enough to put the State Senate in the hands of the Democrats.

Republicans are happy with the result.  They kept control of the Senate and can claim a victory despite losing two members.    Democrats can take solace in the fact that they were going against Republicans who had won their districts in 2008, a year when Obama took Wisconsin and the public was in a far more Democratic mood.   The fact that the Democrats could bat .333 in such districts — and come within two percentage points of taking a district that hasn’t gone Democrat since 1896 — should give them pause.   They didn’t get a victory so much as dodge a bullet.

Democrats privately had admitted they were only likely to win two — though they hoped for the third (and got close).  But many on the more liberal wing of the party had convinced themselves that public rage against Governor Walker and the GOP, along with voter enthusiasm on the left, would give them more — some thought a sweep possible.   For them this is disappointing, their chance to send a message failed.

The other day I had a post critical of a group Norbrook named the “Frustrati,” — progressives convinced that the only thing Democrats lack are leaders willing to take strong liberal stances and refuse to compromise.  They believe the public will reward strength and principle, and that Obama and Reid have been too willing to work with the GOP.    This election should give them pause.   Even with a very energized and hard working base fervently trying to win at least three elections voters didn’t vote that much different than they did before.   Republicans can also argue that the two who lost were in trouble for personal reasons, that stronger candidates would have won.

Put bluntly: people on both sides of the political spectrum over-estimate how much the voting public agrees with their side.    Each will cherry pick issue polls, look at particular races (e.g., the Democratic victory in a Republican district in New York earlier this year) and read into them a national mood or trend.  The fact is that the country voted overwhelmingly Democratic in 2006 and 2008, willing to elected an untested Barack Hussein Obama who was accused of being far left and somehow not truly American.   Then in 2010 an admittedly smaller electorate turned around and voted a stunning number of Democrats out of office in the House to take control.    The only reason the Democrats held the Senate was that they had few seats up for re-election.   If the 20+ seats up in 2012 had been on the line in 2010, Mitch McConnell would again be Majority leader.

There’s only one way to read that.   The voting public is neither liberal nor conservative.   People do not equate political ideology with principle.   Principles are what guide every day personal choices and ethical perspectives.   Politics is about making deals, compromising, and solving problems.   Pragmatism is the quintessential American philosophy.    People will vote one year for someone whose principles are informed by liberal or even Social Democratic values, then turn around the next time and vote for someone who embraces very conservative views.

Any party that over-estimates the appeal of its own ideology risks overreaching and causing the public to correct the situation in the next election.   Any party that refuses to compromise or show an understanding of different perspectives will be seen as intransigent and unable to govern.   And, though parties must keep their bases in line, giving their base too much power can doom them in the next election.

Right now the Republicans believe Obama is vulnerable in 2012 and the GOP can gain control of the Senate.   They see the potential of repealing the health care reform, dramatically cutting spending, and steeply downsizing government.   Many think that’s the only way to deal with the economic crisis.    If they hang around right wing blog sites and talk with like minded folk, they’ll bolster each others opinions and start to believe their view is self-evidently correct, and that compromise is therefore weakness and wrong.     But so far the more Social Democratic countries of Scandinavia are in less economic trouble than we are, their way is one way to respond, but not the only way.

Obama is vulnerable (though not dead in the water as some believe), but it’s not because Americans have done an ideological flip flop.   Rather, Americans are frustrated about the economy and if they see Obama as ineffective they’ll consider trying something else.    If the Republicans over-reach or show too much ideological stridency, they could lose the House (many tea party Congressfolk are in clear danger) or even cause people willing to vote against Obama to see him as a safer bet.

Democrats have to take from this that the energy of their base is not enough to win the hearts and minds of  voters.   President Obama isn’t having trouble because he’s weak or a bad President, anyone would be having trouble with this economy.  Moreover, you can’t just give beautiful speeches and stand firm and expect the other party to crumble.  The Republicans control the House — some on the left fall victim to groupthink and under estimate the ability of the GOP leaders in the House to play a high stakes game.   Obama can’t force them to vote for what he wants.

Rather, they have to recognize that given the current economic conditions the ideological appeal of big government is probably at a low ebb.  The public wants someone who will talk seriously about reducing debt, solving problems and making compromises.   Despite the problems Obama’s had with the economy, his approval isn’t any worse than Ronald Reagan’s was in the third year of his Presidency.   Obama’s obvious pragmatism and patience is one reason he is still favored by many to win re-election — people may be upset he hasn’t been able to fix the economy, but the 2010 image of Obama as an over-reaching liberal has given way to Obama as a conciliator.     The Democrats best bet in 2012 is to grab the center and hold it as firmly as they can, allowing the tea party rhetoric sure to be flying furiously in the primary season define the GOP.   That doesn’t guarantee victory (though if it were combined with a rebounding economy in 2012 it could come close), but it assures a competitive election.

The Republicans dodged a bullet but risk not learning their lesson.  The bravado of John Boehner saying he got 98% of what he wanted may mollify the base, but risks turning off a public not keen on ideology.    Did 98% of what he wanted guarantee a downgrade?   They have every reason to believe that 2012 will be the second part of the kind of two election cycle the Democrats enjoyoed in ’06 and ’08.   But it’s not guaranteed — and too much red meat for the base may come back to haunt them, they could be their own biggest obstacle to a successful 2012 election.

Both sides should take Wisconsin seriously.   Democrats have to realize the country isn’t mad at the GOP and willing to march boldly to the left.   Republicans shouldn’t think the US embraced tea party ideals and is swinging to the right.   Whoever occupies the center in 2012 is most likely to win.   For the Republicans that would be the safest strategy.   For the Democrats it’s essential.

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The Age of Austerity

It wouldn’t make for a good song by the 5th Dimension, but the “Age of Aquarius” is giving way to the “Age of austerity.”  This is a dramatic shift.   The last time we faced such a dilemma was when the great recession of 1980 hit, and President Carter gave a much maligned, but now prophetic speech on the dangers facing the US at that time due to consumerism, oil dependence and an emphasis on material self interest rather than community values.   Carter was ignored.   The solar panels he installed on the White House were taken down.   Ronald Reagan defeated President Carter in the 1980 election with the promise that we can ‘have it all.’   There is no need to cut back, we only need to cut taxes!

Reagan succeeded, thanks to declining oil prices and a massive increase in debt.   Private debt, credit card debt and government debt all took off in the 80s, while the current account went into deficit.   Reagan’s “morning in America” was the start of a country  living beyond its means.

Private and public debt increase dramatically after 1980 - it is now about 400% of GDP

The first question, and one many liberals are asking, is why can’t we do what Reagan did?   Why can’t we just stimulate the economy with more debt until it starts producing jobs and economic growth.? (Conservatives refuse to acknowledge that this is what Reagan did — they want to hold on to the myth that he was fiscally conservative, not the reality.)

There are economists who think that a new stimulus could work.   They recognize we can’t use the kind of hyper-stimulus Reagan employed, but believe that another jolt of spending could get the economy moving, with the debt to GDP declining due to a higher GDP.    This argument relies on speculative and technical economic models which ignore political reality.   Due to almost certain credit downgrades and a devaluation of the dollar should such a route be taken, the risks to the economy are enormous — and could create long term stagnation.   Russian President Putin called the US a “parasite,” noting that we get away with high debt while pushing costs on to other states due to the reserve currency status of the dollar.   Countries aren’t going to let us get away with that; if we add yet more debt we’ll see countries dump dollars and treasury notes.  Again, this would damage the economy severely — and aren’t considered as variables when economists try to make the “more stimulus” argument.

Thats why most analysts who take into account both politics and economics say a decline in growth due to less government spending and higher taxes is preferable to running up a higher debt.   And if we do it right, it doesn’t mean that a recovery will be stymied.

First, though, a bit of cold water.   Remember the heady consumer utopia of the mid-00’s?  You know, low interest rates, home values rising (cheap home equity loans!), easy credit, buy buy buy!?   Those days are gone.   If by recovery you want to go back to the world of 2006, it’s not going to happen.   Recovery now simply means more people getting back to work producing goods and services people value.   The current account has to go into balance, and personal as well as public debt needs to decline.  We also have to come to grips with the fact that the number of people retiring will go up dramatically in coming years — needing social security and medicare, and the sad fact is over half of the people retiring have debt.

That’s why this will feel like the “age of austerity.”   The military will be forced to cut back its global role as the US will realize we cannot afford to try to dominate world affairs.    The dollar’s value will decline, and as foreign goods ultimately get more expensive, American products will rebound.   If government programs can effectively target spending into areas that create production and jobs, recovery can build even without increased government spending.  It will take time, and instead of flipping houses even well to do households will start to pay down debt and build savings.   The uncertainty factor is high, no one wants to be caught out of work and out of money.

As long as the re-balancing takes place with safety nets in place and government action to help facilitate growth (what Obama calls ‘investments in America,’) it won’t feel like the Great Depression.   The government and the federal reserve board have enough policy options to prevent massive unemployment and reliance on soup kitchens.    The tax rates on the wealthy are so low that raising them will not harm investment or stifle growth.  Yet it won’t be the booming bustling economy we’ve been used to.   Prices will likely go up faster than wages.  People will stay in their homes longer, keep cars until they start to wear out (and buy used ones rather than new ones), and live a bit more like we used to before the consumerist binge took off with the ‘something for nothing – borrow and spend’ mentality.

Ultimately, we will not be in good shape until the debt to GDP ratio is back under 60%, and even at that point we’ll still need to continue reducing debt.  I’ll be comfortable only when we hit about 30%.  To reach just 60% will require growth, cuts and tax hikes.  There is no other way.   And if wild cards like global warming or peak oil enter the fray, they’ll create more risk, but also provide opportunities.

The bubble growth that defined so much of the last 30 years was unsustainable.   The wealthiest benefited most, people were deluded into thinking they had more wealth than they did through bubble investments, and the apparent “growth” was built on the finance industry and services that offered little in real value.   It was a kind of “fake economy” which addicted us to the illusion that we could have something for nothing.

Although Americans think we’re immune to the kind of collapse states of Europe experienced in the early 20th Century, the massive gap between rich and poor plus the growing partisan divide and hyperbolic rhetoric, do show risk.  If the wealthy try to pay as little as possible and ignore social responsibility, the poor and middle class may turn on them in class warfare.  The right will then demonize minorities and foreigners, creating a  kind of neo-fascist rhetoric to keep the support of the working poor against intellectuals and “liberal elites.”  (One sees signs of this already in some of the more extreme tea party rhetoric).     If both left and right think that the need for austerity is false, foisted upon them by the ill will and misdeeds of the other side, the country’s bickering will prevent real solutions to fix our broken economic and political systems.

I hope it doesn’t come to that.   Re-balancing our economy will take years, but not decades.   We may not have the hyper consumerism of the 00’s, but we can have the comfortable middle class life styles that had been eroding even as the bubble economy grew.   Things seemed grand, but the reality was life was getting more difficult for the middle class and poor.    We can do it.   But the first step is to recognize the crisis is real, we’re entering a new era whether we like it or not, and we can’t just blame the other side for the problems.     There is no quick fix.

But given the consequences of hyper-consumerism on the environment, community, peoples’ psychological states and the political system, these changes could turn out to ultimately lead to a better place than where we’ve been.

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Political Pragmatism

You want to make me dictator?  OK, here’s what I’ll do:

1) Slash US military spending, start an orderly but fast withdrawal from Iraq and Afghanistan, leave the NATO alliance, and instead focus on enough military to defend the homeland, and a long range plan of intelligence sharing and operations to counter terrorism and other threats;

2) Abolish the current tax code and create a progressive fair tax that had marginal rates lower than the current ones, but wipes out almost all tax breaks and loopholes.   The new system would be a revenue generator, but would not place a greater burden on families earning less than $125,000 a year;

3) Restructure the health care system to guarantee care to every citizen through state run programs with federal benchmarks and requirements.   States will have considerable leeway how they do this, and we can learn from their different experiences.   Medicare as we know it will be subsumed in this new system.   Costly duplications and pharmaceuticals will not be covered unless absolutely necessary (and generics will be the only drugs covered where they’re available);

4) Social welfare programs would be restructured to be results-driven — not simply transfers of income but actual opportunity creators focused on jobs, education/apprenticeship, and community action.  This would be done with a focus of community organization rather than federal bureaucracy with the idea of building community solidarity;

5) A blue ribbon panel of economists will focus on economic investments that are designed to return the country to sustainable economic production to replace the hyper consumerism of the past thirty years (especially the 00’s).

Of course, I’m not about to be made dictator, and even if President Obama privately agreed with all that, he couldn’t do much to turn it into reality.

The US was founded on the core governing value of political pragmatism.   The founders knew that competing interests and ideals meant that conflict and disagreement would be at the core of the American political soul.   Moreover, they felt that such conflict and disagreement could be good — it could force people to have their beliefs critically challenged, and have to find common ground with people of different interests.   The only way the US can undertake major political initiatives is through compromise.

The right wing of the Republican party and the so called “tea partiers” (at least the radical ones) are the most virulent and dangerous wing of the current anti-pragmatists.  Using that old canard of “standing on principle” (which all too often means ‘calling my subjective beliefs principle and refusing to look at any evidence that might call them into question’) they enthusiastically and with the demeanor of a self-righteous crusader out to slay Satan’s hordes hoped to force the country into a crisis.   They lied to themselves that the US “wouldn’t really default” and that they could somehow bring back fiscal sanity.   They wanted to get their way completely.   If they couldn’t then they’d cause so much damage that the whole system would collapse.   One person equated it to an alcoholic whose life has to hit rock bottom before he changes.   The country needs default and a currency collapse before it will change its habits.

President Obama and House Speaker John Boehner learned that if a large enough contingent of such radicals make it into Congress and refuse to play by the tradition of American pragmatism, they can make the entire government dysfunctional.   On the left, a lot of liberals want to reject the agreement for only slightly less insane reasons.   They’re mad that a radical cadre of Republicans could force this down their throat, and believe that they only way to respond is in kind.    The President should do what’s necessary to fight them — risk default, risk a constitutional crisis by invoking a 14th amendment not meant for this kind of case, and go the mattresses in partisan war!

In some ways this is typical for the House.  It’s always more partisan and rowdy than the stoic Senate.   The President, by comparison, is meant to be a unifying symbol and has to look out for the long term good of the country.   If the US didn’t raise the debt ceiling, and more importantly if the US didn’t show signs of making progress cutting the debt, our credit rating would have sunk.   That sounds bland, but the consequences would have been severe, perhaps catastrophic.   Pushed by their own core constituencies into a difficult situation, they realized they had to compromise.

The compromise is the essence of pragmatism.   No major decisions were set in stone — the cuts they agreed to were agreed upon early on in the process and were probably a minimum to avoid a downgrade.   A no-cut scenario was out of question, without progress on the debt a downgrade was virtually certain.  The bi-partisan commission who will report recommendations includes all the top players, assuring no one can get steamrolled by something like the “Gang of Six” Senate moderates who had true independence.   They rigged the deck further by making consequences for not acting on that bi-partisan committee report painful to both parties.     They had enough votes to allow the more partisan in both parties to complain loudly.  But they did what they had to do.

The left simply cannot get its way in this political environment.   Not only is there no chance for tax increases or a new stimulus, but not cutting deficits will lead to a downgrade with a further drag on the economy.   The right is simply out of touch with reality — they’ll never get entitlement reform and deeper cuts without tax increases and the closing of loopholes.  It cannot happen.

Little was decided with the debt ceiling compromise.  This was an opening skirmish in a political battle that will continue.   The 2012 election will be a war, followed by diplomacy to determine how the relative balance of power decides what kind of policy will prevail.  It’ll be slow, agonizing, and the advantage will shift from left to right quite often over coming years.  There will be emotion, anger, and new compromises and deals that will satisfy no one.

Leaders will be blamed for the political reality they inherit.   Populists will make it sound like an easy solution exists if only the politicians would grasp it.   I don’t know how the future will turn out, who will win in 2012, or where the economy is going.  I do know that if political pragmatism ever loses out partisan warfare of the kind we saw flashes of here, we may shift to a very destructive phase of America’s democratic experience.

The tradition of pragmatism is strong; it is the American way and has been for generations.   Tradition and political culture are resilient, especially in a country this stable and old (yes, in terms of functioning democracies we’re older than European states).   The spectacle was exciting, the anger on the left and right over a compromise neither like is palpable.   But pragmatism won the day, and assures that the battle over the future simply moves to another venue down the line.   That’s what the founders intended.

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Did the Democrats Cave?

If look at the left side of the blogosphere, word of an agreement between the White House and Republican leaders was met with despair and anger.   Rather than stand up to the Republicans the President gave in again, sacrificing Democratic principles of protecting the elderly and poor, while getting no tax increase at all.   It was a ‘cuts only’ approach, the same thing that he spoke out against just last week.    If this were a game of chicken, they say, the President swerved first — and before he had to.

However, a few things stand out in listening to the President announce the deal.  First, he said leaders of both parties in both chambers of Congress have approved the deal.  I assume this means that Nancy Pelosi, who has been the most adamant in not wanting the President to give in too much, must have signed on.   Moreover, the $1 trillion of cuts agreed upon over the next 10 years is something both parties agreed to early on in the process.    Everything else is uncertain.

Apparently a bipartisan commission will meet to recommend how to cut the deficit further, and report to Congress in November.   Congress will vote up or down on their proposals or have to face automatic cuts that would be very painful for both liberals and conservatives.   Speaker Boehner can’t demand revenue increases be removed, Senator McConnell can’t threaten a filibuster, and the only person who could stymie this would be President Obama, should he choose to veto the legislation.

I certainly can understand objections to this.  From the right, of course, this makes the possibility of tax increases extremely likely, something they’ve vowed to oppose.  It also suggests that spending cuts will not simply be on programs they hate, but might include favorites of the right, particularly the Pentagon.

The left has more serious objections.   First, many believe this will stifle the already limp recovery, not only dooming President Obama’s re-election, but harming the economy.   Some evn want a “stimulus II,” believing budget cuts are the wrong thing at this time.  Others point out (as I have) that the wealthiest Americans have been virtually the only ones who have benefited from the boom times of the last 30 years.   Cutting domestic spending to the “lowest level since Eisenhower was President” while taxes rates tax the rich at much lower levels than during Eisenhower’s tenure could be termed the worst of both worlds.   More money should be spent to help the poor and middle class, provide college education to students, help out states in trouble, and assure our elderly have quality lives, paid for by relatively large increases in marginal tax rates.   Finally, others note that due to the loss of productive capacity over the last thirty years of economic mismanagement, real investments in infrastructure and productivity need to be made.   You have to spend money to make money, and the only real cure to our debt is a growing economy, not just cuts.

I am sympathetic to all these arguments.  However, reality bites.   Our government debt to GDP ratio is nearing 100%.   Our total debt as a country (public and private) is about $60 trillion (about 400% of GDP), with almost $15 trillion foreign held.    Because of the hyper-consumerism of the last thirty years, particularly the last decade, we’ve created an unsustainable economy that ultimately went from bubble to bubble deluded by the ‘wealth illusion’ before things collapsed in 2008.  These are real problems requiring rapid and even radical solutions.

If President Obama had refused to make a deal, maybe the GOP would have surrendered.   Given the radicalism of especially many in the House, that’s unlikely.   More likely is that either the US would have defaulted, catapulting us to a global depression, or the President would have invoked the 14th amendment, leading to political turmoil.   That would have included impeachment, mutual anger, and no common ground at a time of immense danger to our prosperity and way of life.   Perhaps the President could have come out on top; but mutual fighting would have insured a long term partisan divide.   Either way, it was a gamble.

With this deal, the President has claimed the middle ground.   It’s clear that he gave a lot to get a deal.  The left may hate it, but I suspect independents, scared by recent tea party hyperbole, may respect it.   The US has proven that its political system is not collapsing and it’s likely we’ll keep our AAA rating.   Moreover, a big debate is set up to begin the next election campaign.   When the recommendations come out in November, members of both parties will have to take a stand, choosing between two options which neither will like.  Demagoguery will be difficult to maintain.

Here is where I simply differ with many of my friends on the left.  I do not think our debt to GDP ratio can be raised, and in fact am convinced that for the long term health of the country we need to work to start lowering it immediately.   Given the partisanship and sometimes radicalism in our political discourse, a bipartisan body of respected experts seems to me the best path towards making tough choices.    The sooner we can make those choices, the sooner we’ll re-create economic stability and shift towards a sustainable path forward.

I also think that the experience of getting here has lessons for us.   The right was wrong to embrace deregulation and radical tax cuts (let alone the Iraq war!).   Without the Bush tax cuts we’d be in much better shape.   However, government programs embraced by the left have often been dysfunctional.  Class mobility remains low in the US.   We haven’t spent wisely to create real opportunity.  Finally, with the information revolution, there are ways to envision cheaper ways of making money go farther by allowing localities more power in determining what is needed and how to implement it, rather than centralized bureaucracies in Washington creating standard operating procedures which can add red tape and cost.

This might also spur the left to engage in grass roots campaigns to reinvigorate the labor movement; relying on the government isn’t enough.   Both parties betrayed workers over the last 30 years, labor unions have to become grass roots movements again.

In short, this forces the country to start a path of renewal and revitalization.   It makes clear that while neither party has truly won, the future needs to be shaped with a different vision than the past.   Tax cuts and de-regulation were a too good to be true solution.   But government programs and regulation also didn’t solve our problems.

I do not think the Democrats caved.  I believe President Obama has put the Democrats in a fine position for the 2012 national debate on these issues.   The wildly fluctuating results of the last two elections have created a break from business as usual.   We’re starting to address the severe problems facing this country created by 30 years of bi-partisan economic mismanagement and a culture driven by consumerism and superficiality.  Transitions are never easy and usually require a break in old ways of thinking.   The optimist in me believes that’s starting to happen.

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Understanding the Economic Crisis

I posted much of this back in 2009, but given the circumstances I’d like to again note what the nature of this economic crisis is — and thus how the circus in Washington totally misses the boat and in fact is risks real economic collapse.

In 1980 the US economy entered its worst post-war recession, one that would last until 1983.  The pain was real — high unemployment, high interest rates to fight inflation, and major manufacturing sectors going out of business, most notably the steel industry.   Nonetheless, the economic fundamentals were not all that bad.  The US government had gone from total debt of 120% of GDP at the end of World War II to only 30% of GDP, budget deficits were small, and the US ran a current accounts surplus, meaning that we were a net investor in the world.   The US could have responded to that recession by saving the manufacturing sector and investing in national infrastructure.   Instead, the Reagan Administration made a series of bad decisions, starting a process that would yield increasingly unsustainable economic imbalances for the next thirty years.

First, the recession was ending in 1983 due to a dramatic drop in oil prices, which stimulated the economy.  The oil price drop also eased inflationary pressures, allowing interest rates to go back down.   All other things being equal, we were going into a clear recovery.  Yet the Reagan administration increased budget deficits radically.   Total debt went from 30% of GDP in 1980 to 60% of GDP by 1990.   This hyper-stimulated the economy, creating an illusion of economic prosperity — you can think of the country as the equivalent of a family whose costs are declining but yet spending beyond their income through increased credit card debt.

Starting in 1981 US debt climbed rapidly as the Reagan Administration decided deficits and debt were OK; the trend has continued except for the mid/late 90s

Second, believing in the free market, the Reagan Administration allowed industries like the steel industry and manufacturing jobs to die out, to be replaced by jobs supposedly fitting our comparative advantage.   It was thought these would be high tech jobs that would benefit our advanced economy, but it turned out to be mostly service sector jobs, often in the financial industry, which did not produce any goods.   We started consuming more than we produced, as our current account went into deficit.

A current account deficit (not to be confused with a budget deficit or debt) means that we take in more from the rest of the world than we put back.  For us, this was mostly a trade deficit.  You can’t do that unless this is financed by foreigners buying US assets — property, bonds, stocks, currency, etc.    In this case China, Japan, and the Arab world were willing to buy US bonds and currency.  They trusted the dollar and thought these were good investments.   More importantly we were purchasing goods from them, and they knew the money would cycle right back to their economy, bolstering their industrial sector.  For China especially this was a win-win situation — they get a stake in the US economy, and we use that money to buy their goods, further stimulating their economy.   At this point China has about $2 trillion of US assets, and the US relies on China to help finance the deficit.  If China wanted to, it could launch a crippling blow to the US economy.   That would hurt China too, but if you ever wonder why the US doesn’t ever really pressure China, this is the reason.

 

The current account deficit becomes a problem at 3% of GDP.  The US hit that by 1990 and it kept growing.   We kept consuming more than we produced.   Moreover, the country as a whole went into debtor mode.   Saving rates dropped, personal debt (credit card and otherwise) increased, to the point that now the country is about $60 trillion in debt if you take all sectors into account (with nearly $15 trillion of that held by foreigners).  Credit card debt alone is $1 trillion.  Savings rates hit zero in 2006.   Some economists sounded alarms over this, but the wealth illusion made it seem like savings were unnecessary.  Instead of having money in savings, we had it in stock portfolios (in the 90s) and real estate (in the 00′s).   That theoretically meant that we could dip into our wealth if we needed funds, and thus low interest savings accounts were irrational.

Yet the wealth illusion was built on bubbles.   First was the stock bubble, where people literally believed all they had to do to get rich was buy some stock and watch it grow.   We got addicted to the notion of something for nothing.   People were borrowing to buy stocks, knowing they’d earn enough to pay back the loan and make money.  It was quite literally too easy.   And in 2000 (over a year before 9-11-01) the inevitable occurred:  it crashed.   The tech-heavy Nasdaq collapsed, and stocks started reeling.   The current account deficit was up to 5% of GDP, and the only good news is that we briefly had small budget surpluses rather than deficits.

At this point in time a painful recession like that of 1980-83 might have been enough to correct the imbalances and force us to increase production to bring it in line with consumption (and balance our current account).   Yet after 9-11, the US decided that we could not let terrorism bring down the economy.  President Bush said the patriotic thing to do was to go shopping, interest rates were kept very low, and thus a new bubble formed, the housing bubble.

Again, a something for nothing mentality took over.   Making money on real estate became easy, people could borrow from the equity on their home to buy more property, knowing it would go up in value.   Or at times people would borrow against their home just to have a better lifestyle, invest in a company, or pay for college.   Again, a wealth illusion spurred greater consumption, and by 2006 the current account deficit reached a whooping 7% of GDP.   Budget deficits started to rise again as well, as a mix of tax cuts and war (I still cannot comprehend cutting taxes in a time of war) led to rising debt and deficits.

With the financial markets deregulated, bizarre financial products were put on the market.   Mortgages were bundled and sold, and then those bundles were rebundled and resold.   These ‘derivatives’ were wholly unregulated, and produced huge gains as people saw them as both safe (rated triple AAA), and rising in value by 10% or more a year.  The perfect investment!   To keep creating these derivatives for which there was so much demand, mortgage brokers stopped caring if their clients could pay, leading to fraud and a massive decline in lending standards.  This wasn’t because of the government, this was deregulated capitalism!

The housing bubble was so dramatically out of line with historical housing prices people should have expected a collapse!

When the housing bubble burst, this started a chain reaction.   Note: the bad mortgages or subprime sector could not alone bring down the economy.   If it wasn’t for how these got bundled up and turned into complex financial products, the housing bubble could have burst with containable damage; easy mortgages alone were not the problem.   Rather, these complex and little understood financial products came crashing down, bringing the entire financial industry with them.  Bear Stearns felt it first in March 2008, then the biggie came when Lehman brothers had to declare bankruptcy in September 2008.

By September 18, 2008 credit markets had seized completely, the financial system stood at an abyss.   That’s why free marketeers like Treasury Secretary Hank Paulson were forced to go for a massive government bailout, and why Alan Greenspan admitted he was wrong in trusting the market to “get it right.”

However, that is only the tip of the iceberg.   The imbalances in the US economy not only are unsustainable, but it’s clear that China and the rest of the world are no longer willing to continue to finance a completely out of balance US economy.   We need to start producing more, or we will be forced to consume much less.    Even as we try to stimulate the economy, we do so by increasing debt, now at about 90% of GDP, and likely to rise to over 120% of GDP by 2015.

This is why the US cannot afford this fiasco about the debt ceiling.  The imbalances are real, and with the US no longer seen as a safe investment, interest rates could skyrocket causing a downturn that makes the last few years look minor.   This could be as bad or worse than the Great Depression.     The cause has been debt (especially in the 80s and 00s) and de-regulation.   I won’t go into taxes here (click here for more on that), but tax cuts to the wealthy have led to a dramatic increase in the gap between rich and poor, while adding to the debt.   That needs to be fixed.

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Obama’s Big Mistake

In May President Obama should have made a forceful, definitive statement:

“There is some talk about making an increase in the debt ceiling a partisan fight.    That is unacceptable.   The debt ceiling is not about authorizing new spending, but about paying for what Congress already authorized.   If Congress doesn’t want the money spent, they should not put it in their budget — they cannot have their cake and eat it too.     The debt ceiling has been routinely raised whenever we need to borrow more to pay the bills run up by Congress.   President George W. Bush raised it seven times; President Reagan raised it 17 times.

So let me be clear.   I will only accept a clean increase in the debt ceiling.  I will not negotiate on this point, and I will veto any bill that attempts to connect the debt ceiling to other issues.   That would be playing Russian roulette with the American economy, allowing partisan bickering to put at risk our low interest rates, good credit rating and economic recovery.   However, this summer I call on Republicans to join me for a serious discussion on the future of the budget, with the goal of serious deficit reduction as soon as possible.   However, I will not tie that to the debt ceiling, or accept any legislation which does.”

Such a statement, clear and forthright early on in the process could have altered the way in which this discussion has played itself out.   First, real talk on budget cuts could be proceeding without an arbitrary deadline that does not leave time to really think about the implications of perhaps trillions of dollars of cuts in coming years.  Second, America’s economy would be safe from the severe consequences of default.   Finally, the US would not be in a position where the party in the majority in one of the chambers of Congress could use the potential for economic crisis as a way to ram its narrow agenda through.    The Republicans in the House are literally holding the US economy hostage.  It should never have come to this.

President Obama, by deciding he could negotiate and perhaps use this issue to pressure Democrats into accepting cuts, walked into a trap.   It is a trap that goes beyond him personally.   This sets the precedent for a party that does not have the votes to get something done through the usual process to find a way to use threat of real disaster to dictate their agenda to the rest of government.   Rather than trying to win in 2012 (both the Presidency and the Senate will be in play), they want to put a gun to the nation’s head and dare the Senate and President not to give in to their demands.

I’d expect that in a third world state or an emerging democracy in the former Soviet Union, but not in the US.  If politics sinks to this level, then the US is truly in severe decline.    Former Presidential standard barrier for the GOP John McCain lashed out at the House “tea party” Republicans, claiming they were irresponsible and in his words “bizarro.”  Other Republicans have also expressed horror at the events unfolding.   As Senate Majority Leader Harry Reid said, the GOP needs to go back to being the party of Ronald Reagan.   Reagan was an optimist who worked with people to convince them to go along with him.   The current gang in the House are bitter and angry, and want to use threats to get their way.

Speaker Boehner is an enigma.    The most friendly read on his tactics is he simply wants to strengthen his hand and show the tea party brigade that he’s fighting to get the most he can get.   Then when a compromise comes, enough Republicans will join with Democrats to pass it, even if the tea party folk demur.    But to do so in this manner and with this level of incompetence (you don’t announce a plan on national TV when you aren’t sure you have the votes) not only damages the country but hurts his own party — and his chance at keeping his majority.    He may really think he can ram this through, in which case he’s putting the dreams of the American people on the line.

It would be irresponsible for President Obama to give in on this, even if it means default.   The President simply cannot allow the House to dictate policy under threat of disaster.   If he gives in, then the political game sinks to a new low and could get much uglier down the line.   He should have never let it get to this point.

It’s probably too late to demand a “clean” debt ceiling vote.   He’s publicly urged compromise and it would seem erratic to shift now.   But it’s not too late to draw a new line in the sand and mean it.   Compromise that is bi-partisan means something that gets significant support from both parties.   That can happen, and I suspect will — though one gets the sense that process is getting a bit out of control and the principles aren’t really sure where its going.

When a compromise is finally reached, on signing President Obama must harshly condemn the whole spectacle as being an embarrassment to the American people.    He must take his share of the blame, and state that never again will he be party to some negotiation tied to an issue like the debt ceiling.   He must say in late July or early August what he should have said in May.    The US economy cannot be held hostage so that one group can get its way.    That is a threat to the very foundation of our democracy.   They should go through the normal legislative process, including making it an issue in the next election.

President Obama made a mistake opening the door to allow the issue to be used this way.  He must slam it shut, and refuse to open it again, not even a crack.

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