Archive for category Global Depression
Alayne Fleischmann is risking her career and all her assets by going public with information about the fraud perpetuated by JP Morgan Chase, a Wall Street bank.
If you really want to read about how dirty the big banks are, take the time to read through this piece, published in Rolling Stone by Matt Taibbi. Here’s a very condensed version. Everyone knows that the 2008 economic crisis was caused not by the real estate market or sub prime loans, but by a nearly $700 trillion dollar per year market in unregulated derivative bonds.
The banks were making so much money with these bonds that they got in bed with dirty mortgage brokers (i.e., the biggest ones) who engaged in inflating the incomes of people applying for loans, approving without documentation, and creating wild mortgage packages that would have payments low the first two years then kick in to incredibly high rates. All of this created a massive bubble, as people saw prices rising and wanted in. The banks then doubled down and made more money. By 2005 these bonds were backed by mortgages that would never be repaid.
In short, the crisis of 2008 was a free market creation, caused by unregulated big Wall Street banks selling bonds they knew were bad – leaving investors from schools, fire departments, retirement accounts and the like holding the bag. Moreover it caused a massive recession and structurally weakened the world economy. Never has there been a more convincing case that proves capitalism does not work without regulation, and that big money will game the system thinking only of itself if allowed the opportunity.
Yet there is more. Once the collapse hit, the US was faced with the real possibility of a credit crunch that would not only hit banks and the mortgage market, but also even the ability of consumers to buy cars or use credit cards. That was a looming threat in October 2008, and the immediacy of that threat was handled through TARP – the so called bail out.
So act one: bail out the players who gamed the system, whose executives made billions, leaving both investors and the world poorer. Yet not to bail them out would have intensified the crisis to the point of causing a great depression.
Act two: the Justice Department of the new Obama Administration would work with the banks to try to avoid them having to pay massive fines, or have the extent of their corruption made public. That’s what Fleischmann’s case shows. Rather than go after the big banks for their fraud and crimes, Attorney General Eric Holder choose to get in bed with them and help them cover their tracks. Why?
Again, to avoid a credit crunch and not to gum up the recovery. With the big banks on the ropes, the recovery could fade. If trust in the remaining financial institutions started to fail, we again would risk depression. The big banks were not only too big to fail, but too big to even hold accountable.
Consider this brief monologue from the film Syriana in which corruption is defended – it’s a more common view than we might want to believe:
In Syriana the government wants the merger of two oil companies to go through, despite clear corruption. “We’re looking for the illusion of due diligence,” one attorney declares. But because increasing access to oil is so important, they really don’t want to dig. In this case, the settlements with Chase and other banks created only the illusion that the Justice Department wanted to keep the banks accountable. Fleischmann’s revelations we know how deep and thorough the corruption had become.
So what next? Will JP Morgan Chase set out to destroy Fleischmann as an example for anyone else who might want to come forward? Will others come forward to give her cover and tell the full story? Will her courage create a desire to really dig to the bottom of what happened?
Alas, this stuff is complex. That’s why so many people don’t get the reality of what caused the crisis, and find it easy to blame things like government policy on home loans. Yet the more we learn, the more we see that Wall Street has immense control over US policy, in part because of their dominance of the economy. If the banks fail, the world economy is in peril.
Yet this is unsustainable. As the big banks again gain record profits, with only a meager effort to regulate them after the collapse, we’re setting up the next big crisis – perhaps worse than the last one. One can only hope that heroes like Alayne Fleischmann show the courage to tell the world what’s really going on, and how whether Republican or Democrat, no one has the guts to take on Wall Street.
A piece of the fabric of space-time fractured in my office today and a description of a course to be offered in 2279 slipped through. Weird, that.
It is the year 2279. Here Professor Hubert Morgan talks about the popular history course on the era of transition from 1985 to 2065 when somehow the global system survived a series of crises without collapsing. Instead, the basis for the peaceful global union we have today was forged.
People come to the course with a variety of expectations. They know that this was the era of globalization, economic crisis, the collapse of the sovereign state as a system of governance, intense global warming, energy crises and famine, but they also know that the story had a happy ending. Not only did they solve their problems through a mix of technological ingenuity, political creativity and adaptation, but they forged an ongoing era of peace, known as the Global Union.
In my course I try to as much as possible get them to experience that era the way the people living through it did — not knowing for sure what was happening, finding it hard to let go of old concepts and ideals, and fearful of the future.
We start at 1985 – the year when both globalization and the information revolution started to take off. We spend time there, learning about the culture, the state of the world, the films (students especially enjoy one called “Back to the Future”), the games, and the music.
People choose various media experiences – that was the age of motion pictures, television, and the emergence of music on compact discs – large cumbersome devices that nonetheless opened the door to the era of digital music. The idea is to immerse themselves in this strange but fascinating past before heading onto the roller coaster of the next eighty years.
Students take awhile to understand ideology. Ideology is now seen as a kind of mental prison forcing people into stagnant modes of thought, but politics was ideological in those days. Students need to understand the bizarre “Cold War” and why it was so difficult for people to think outside narrow political or national boundaries. It’s not that people were stupid or bigoted, they simply saw that world of ideology, ethnicity and states as natural.
We also explore why warnings on the growing economic imbalances, the loss of oil as a major energy source, and global warming were ignored and even denied. One student described it as “cultural group think.”
I think the part that often most startles them is the “trips” to virtual farms to see how animals were treated and food produced. Even though they know it’s not real, when talking to the farmers the odors, inhumane treatment of the animals and the way in which chemicals and other additives are simply dumped into the food chain sometimes makes some students physically ill. Of all the things that make life 300 years ago so wretched, most say food production is the biggest reason they wouldn’t want to go back!
Of course, the worst part of that era — 2015 to 2045 — can’t help but grab attention. Looked at as a thirty year “era” it’s easy to understand it and figure out why things worked out the way they did. In our course we try to accentuate the uncertainty people living through that era experienced – they truly feared global instability, mass warfare, disease and even human survival.
We follow the side stories of the scientists, politicians, thinkers and cultural icons that strove to keep civilization together and built ties between the impoverished suffering states of Africa and parts of Asia with the technologically advanced people in Europe and North America. Students recognize how fragile these connections were, especially early on, and how easily they might have been destroyed by fearful nationalism and bigotry. The wisdom that global cooperation was necessary was a hard sell only on!
The final era is that of consolidation, from 2045 to 2065 when the Treaty of Global Union was signed and most of the severe problems of the 21st Century were solved. This includes the new economics in which the ideologies of capitalism and socialism were jettisoned for a pragmatic approach that combined ideas from all, but focused on human liberty and opportunity as the core values. Massive debt was wiped out as all old currencies were simply abolished and the world started a new with a global currency and blank slate. In retrospect all that seems to have been inevitable, but students learn how gut wrenching and scary it was while the issues were debated.
In the course we trace how the information revolution led to the capacity to massively decentralize government and bring it closer to the people, making possible a “Global Union” of core shared rules but little centralized power. They realize how odd such an arrangement would look to an early 21st Century human so used to seeing centralization and de-centralization as mutually incompatible.
The new science of energy, food and climate is perhaps the most intriguing. We all learn it as natural, and look back at the materialism, consumerism, pollution and poisonous chemicals as a barbaric aspect of the old era. In this class students learn how that was taken as natural, and how dramatic the change in thinking was — so dramatic that absent global catastrophe it might never have happened.
The virtual trips to the era are life like. It is as if we have traveled back in time, our ability to use holography to create worlds that appear completely real to our senses makes this possible.
This course reminds us of crises caused by the era of greed, corruption, materialism, lack of respect for the environment and pursuit of pure self-interest without regard for the common good. By learning about the past we can better understand our present, appreciate what we’ve accomplished, and remind ourselves that humans do best when we understand we share a common destiny, both with each other and with our planet.
I found this diagram on politico.com, which linked it to this site, belonging to James Sinclair who writes:
Yeah, I’m oversimplifying, but only a little. The greatest threat to our economy is neither corporations nor the government. The greatest threat to our economy is both of them working together. There are currently two sizable coalitions of angry citizens that are almost on the same page about that, and they’re too busy insulting each other to notice.
Mr. Sinclair has a point — not only are the roots of both movements similar, but neither side really sees the true problem, it’s the nexus of corporate and government interests that create the most problems. Therein lies the possibility of a true alternative to politics as usual.
This doesn’t mean a new third party or some rising independent candidate. Rather, the two major parties have gotten into a rut. When the economy was booming and it appeared the US was doing it right through deregulation and lower taxes, the parties got lazy. Democrats like Bill Clinton embraced Wall Street and an economics team that was more laissez faire than even Reagan’s cohort. To keep their ‘base’ the Democrats played interest group politics while pushing for programs like an overhaul of the health care system. They didn’t get much accomplished on that front, but with the times good it didn’t matter.
The Republican party played similar games with social conservatives. They gave lip service to issues like abortion and gay rights, but overall it was ineffective and just enough to keep the base in line. So while the spectacle of intense partisan rancor filled the airwaves, the reality was that the two parties were becoming more alike than different. Issues dear to social conservatives were not prioritized by the GOP, and the Clinton Administration ended up partially dismantling rather than building up social welfare programs.
Perhaps because of the growing ideological convergence of the two parties politics turned to personal stuff. Did Clinton (or Bush the Younger) evade service in Vietnam unfairly? Clinton was impeached for nothing he did as President but for an affair with a younger intern. The personal trumped the substantive in a politics that was more about illusion and spectacle than substance.
During all that time both government and private citizens fell into the debt trap, driven in part by illusions of wealth thanks to the dot com craze and the real estate bubble. The hypnosis of consumerism blinded people to the decay right before our eyes. Day trading, flipping real estate and get rich quick schemes trumped hard work and imagination. But unemployment was low and the GDP rising. What me worry?
As more money flowed into campaigns a nexus between big business and big government formed. As the middle class eroded thanks to the decline of manufacturing and the rise of the service sector, only the bubble economy and cheap goods from China prevented people from grasping how their country was changing into something less democratic with leaders less accountable than before. Then in 2007 the housing bubble burst, starting a period of economic stagnation which turned into crisis in September 2008.
Now the veil’s been lifted from our eyes. Now we see the corruption on Wall Street, the scandals in government, the links between big money and the Administration, touching both Obama and Bush. President Obama’s election came because people thought he represented change. But fearing a revolt from the elites of Wall Street, he embraced the same advisors that worked for Clinton, and took a very establishment approach.
Campaigns now are more marketing than an exchange of ideas. Candidates are packaged and speak in bland generalities. They have to, because if they break from the script they might make a gaffe and have it spread until it destroys their candidacy. Spectacle over substance; illusion over reality. Talk radio peddles emotion over reason, demonizing and mocking rather than engaging in real political discourse. Politics becomes a “contact sport,” where one chooses a team and gets into the game, or one takes the view of Dennis DeYoung in his song “I don’t believe in Anything”:
I hate the bloody liberals and the neo-cons, they’re all so full of shit
Oh the way they talk to us, I think they think we’re idiots
What a bunch of hypocrits!
Obama’s approval ratings are low, but those of Congress are far lower. We’re in crisis and our political system is unable to respond. 20th Century thinking doesn’t cut it, the bubble years are over, so now what?
Now we have the Tea Party and Occupy Wall Street representing two different movements driven by similar concerns. The Tea Party has lost some of its luster, and no doubt that will happen to OWS as well. But the two movements signify a desire of the electorate to change the nature of politics in the US. It should be closer to the people, less bureaucratic, less in service of big corporate interests, and more respectful to average citizens. Take away the fringe social conservatives on the right and socialists on the left, and you have a broad range of agreement between the two groups.
The agreement is this: big money and big government have gotten too cozy with each other and have too much power. The only way to counter this is not to dismantle the corporate world and introduce socialism, nor to dismantle government with faith that markets can work magically. The answer is to increase accountability at all levels by making both government and business decision making transparent. We need to decentralize power – both governmental and in the private sector.
There will still be fights about proper tax rates, social welfare programs, abortion, gay marriage and all that. But the potential for agreement on the need to restructure our socio-economic-political system is real. The left needs to stop defending governments at every turn, the right needs to stop defending big money. When power is concentrated it is always dangerous, whether in the form of a private corporation or a state.
We have the technology to decentralize and force greater transparency. One aspect of both the Tea Party and OWS is their ability to use social media to build their movement and get the message out. The partnership between big government and big money needs to be derailed. Now if the activists on each “side” can put aside their differences long enough to focus on what they agree upon, maybe both movements can be a force for positive change.
Alarming words from the head of the IMF: a global economic collapse could occur within weeks if something isn’t done head off the ongoing crisis in Europe. The warning may seem overblown, but the danger is real.
Here’s the problem: unless investors are convinced that bonds issued by Greece, Spain, Portugal, Italy and Ireland are safe, they’ll start selling them off in the bond market. That will drive down the price (supply increases, demand will be low). When the price of a bond falls, that increases its interest rate. An Italian bond set to pay off 1000 Euros in three years might normally cost 940 Euro, meaning you’d earn 60 Euro (about 2% per year) on your investment. But if people start thinking the Italian economy is going to tank then the price may drop dramatically — the 1000 Euro bond might cost only 850 Euro, meaning a 5% yield, or go even lower. Right now the Italian 10 year bond has a 5.5% yield rate.
By comparison, US Treasuries have about 2% yield on the ten year bond, as does Germany’s. This means that if the US and Germany sell bonds to finance government debt, the cost is relatively low — 2% a year. If Italy wants to run deficits, they pay a much higher interest rates. Now, guess what Greece’s 10 year bond yield rate is. 23%. That is simply unsustainable even in the short term. It shows that people are expecting a Greek default and thus dumping bonds to those who want to take a big risk to potentially pocket a 23% investment gain.
Spain is also at about 5%, but Portugal’s bond yield is 11%, and Ireland’s at near 8%. Those are getting into very high risk territory. Now, at this point all these yields are kept somewhat low (relative to what they could be) by the hope/expectation of an EU bailout. The EU has intervened in Greece, Greece has undertaken a very unpopular austerity program (after all you can’t keep running up debt borrowing at 23%!), and the panic has been minimal.
But what if the EU can’t save Greece? Then the Greeks will likely default, they simply can’t make payments on their bonds. The bond holders — banks throughout Europe (including Germany) will then be under stress, as some of their assetts become worthless. Still, if it stopped there, that wouldn’t be that big of a crisis. The danger is Contagion. Holders of Portugese, Italian, Spanish and Irish bonds would realize that the world has changed: default is possible. Yields on all those bonds would likely rise dramatically creating default threats across southern Europe. At that point bank assets would be so stressed that credit markets would dry up and the European economy would be hit by a crisis larger than what hit the US in 2008.
US and British banks are relatively unexposed, but the economic impact would be to sink the world deeper in recession. But it doesn’t end there.
Banks, including those in the US and UK, have been issuing credit default swaps on these bonds. These swaps can be seen as akin to a life insurance policy. Let’s say your neighbor confides with you that he has cancer, even though he’s young and fit. You then go to an insurance agent and buy a life insurance policy on him for $1 million. You pay a policy of $300 a year, but if the cancer kills him you could get $ 1 million.
Insurance companies sell these policies because statistically they don’t expect to make large payments. Most of us go through life paying for insurance “just in case.” But in the world of finance it’s more like a casino. The credit default swaps are cheap, but have a potentially very large payoff. It’s like placing a bet on a long shot horse — you’ll probably lose, but if you win the earnings are big. So if you decide to bet against the EU and Italy, you can buy credit default swaps on Italian bonds. If the bonds mature and Italy pays their value, you get nothing and lose the “premium” you paid to buy the swap. But if Italy defaults, you get the value of the bond — potentially a huge pay off. That happened back in the US when owners of credit default swaps on mortgage backed bonds made a killing when the real estate bubble burst.
The thing is, we don’t know how exposed banks are in terms of credit default swaps. If they’ve felt confident that the crisis would be contained, they may be very exposed. So even banks that don’t directly hold bonds might be on the hook if defaults spread. That would add to the depth of the crisis and could spark a breakdown in the entire financial system of the kind that the bail outs of 2008 managed to avoid. In such a case credit would be very difficult to come by, even for “safe” auto loans, perhaps even credit cards would be hit.
If the EU doesn’t manage to convince investors that Greece will not default the whole thing could spread quickly — within weeks. If the EU came up with a very comprehensive package they could allay fears and Greek yields would come back down to earth and overcome the crisis. It would be a couple years before deleveraging would get them out of the woods, but investor confidence would return and the system would survive.
However, although this may look like a no brainer in those terms, in political terms it’s a tough sell. Any kind of package that saves the system would appear to be a bail out of countries who had been irresponsible in their borrowing and spending, and protection of banks who made irresponsible loans. That would be very unpopular in countries like Germany, which would pay a lion’s share of the cost. But it would also be unpopular in Greece, whose people protest cuts in spending and increases in taxes. In their eyes they’re being made to suffer for mistakes of bureaucrats and banks, and a mix of spending cuts and tax increases assures a deeper recession and more pain. They’d rather default than suffer austerity. So the moves needed to save the global political economy are by nature very unpopular and arose anger.
Most people don’t know how bonds work, wouldn’t know a credit default swap from collaterized debt obligation, and have no sense of just how interconnected the financial industry is world wide. The argument supporting such “bailouts” is only persuasive if you really work through the intricacies of how the financial system functions. Most voters don’t do that, so any politician who tries to save the system will probably lose their job.
With so much on the line I think they’ll find a way to avert catastrophe. The stakes are just too high, and the insiders know what the stakes are, and how inaction could mean utter catastrophe. Still, the danger is real. That’s why stories about European bond yields and bailout plans may be the most important news to follow in coming weeks. Global economic collapse is still unlikely, but quite possible.
The historic downgrade of US Bonds by Standard and Poors — with a threat of a further downgrade if nothing is done to reduce debt, is a moment that should wake Americans up. This crisis is serious and it’s real. We can’t stimulate the economy with greater spending because bond downgrades will do more harm than the good any stimulus might do. There are structural flaws in the US economy that need to be fixed, and the only politically possible way to do so is for both parties to find a way to compromise.
The economic imbalances are real. Government debt to GDP is at 100%. Private and government debt to GDP combined is near 400%, and foreign held US debt is between $14 and $15 trillion. This is serious. Years of debt, current account deficits and bubble economy delusions have led us into a pit from which there is no easy way out. It’s not just “another recession,” or part of the business cycle. It’s not something we can stimulate ourselves out of and return to growth.
President Obama should call on Congress to return and take decisive action. Standing in the way of doing this are two groups. The tea party folk are well known — they oppose all tax increases (and would prefer cuts) and many wouldn’t have minded if the US defaulted on its debt. They generally believe government is bad and thus demand massive spending cuts. Another group, called ‘the Frustrati’ by blogger Norbrook, believe that the President needs to stand up for purely progressive ideals, protect virtually all government spending, raise taxes and cut only defense.
Both the frustrati and the tea partiers think the establishment of their parties has sold out to “Washington insiders,” and by being more ideologically pure they can achieve true success. Many on the left are furious with Obama for agreeing to spending cuts at all, and believe that if only he had been stronger and more forceful things would be different.
However, Obama has stared down the frustrati and made it clear that he isn’t giving in to their demands, no matter how much they threaten to withhold money and support. He knows that the progressive wing of the Democratic party is no more popular than the tea party; Americans want compromise and centrism. John Boehner, on the other hand, worried about the fragile state of Republican unity in Congress, has done everything he could to keep the tea party satsified. Boehner has not led, he has followed.
Many on the left don’t really recognize the true scope of the crisis and tend to interpret things in partisan political terms. They think the problems we face came from President Bush’s wars and tax cuts, and all we need to do is fix that and get back to the happy days of the late 90s when the country ran a surplus. The problem is that the brief surplus was built on a bubble, while private debt, accumulated foreign debt, and the current account deficit continued to build. Things weren’t all rosy and sweet in 1999.
The tea party, however, is even more off base. During the last thirty years we’ve also seen a hollowing out of the middle class, a vast shift of wealth to the wealthiest, and a consumer base that survived on debt and cheap Chinese products at Walmart. One chart that demonstrates how the growth we did have was misdirected is here:
Note growing productivity since 1989 — that produces more wealth and value. But middle class and working wages stayed low, both public employees and private sector workers barely kept up with inflation. This is not what happened in most other countries; in Germany working class wages have gone up significantly since 1985. I’ve posted other charts that show the same thing: the gap between the rich and the poor has been growing dramatically, during the recent boom most of the country’s income hasn’t even kept up with inflation.
This state of affairs is very bad for the economy. The wealth imbalance fed the bubble economy, but didn’t grow the economy at home. A huge chunk of that wealth goes to consumption of foreign produced goods; even the argument that it gets invested back in the economy is misguided — in our global age most investments do not stay in our borders. If that wealth was being spent by a viable middle class consumer base it would do far more to stimulate growth and create a sustainable economy. This shifting of wealth to the elite resembles third world economic relations, and has led to a fundamentally dysfunctional economy.
This is where the tea party is way off base. We need to address this imbalance in part by taxing the wealthy in order to create incentives for job creation and increased wages for the middle class. To cut government spending in a way that hurts the poor and elderly while protecting the wealth gains of those who have made off so well in the last twenty years is utterly insane. The tea party’s core ideals are based on a complete fantasy — it’s ideology on steroids, resistant to facts, evidence and reality.
The President needs to address the nation again and lay out the seriousness of the challenge. He has to tell Congress that they must undo the damage done by the downgrade by agreeing to his $4 trillion deal and accepting tax increases. He has to make it a priority to not just create jobs, but to assure that the working and middle class get paid fairly. Relying on the market to do it alone doesn’t work; markets are not magic. The frustrati have to accept entitlement reform, cuts to programs they believe are valuable, and a downsizing of federal government. The tea party has to accept higher taxes, more regulation of the financial sector, and cuts to military spending.
That’s not easy. If a couple has been living beyond their means, how do they adapt? At first each one might want to keep doing what they’ve been doing and have the other cut back. Ultimately, that doesn’t work. Politically there is no other alternative then a compromise than neither side finds acceptable — but one that actually works to address the problem rather than put it off.
Restructuring the economy will take time. As I noted in January, power may shift from the federal government to state and local control. It may be years before we get back to unemployment levels back at 5 or 6%. It may be a decade before we see the economy described as “healthy.” This is real and the longer we wait to do something significant, the harder it will be to pull ourselves out of the hole we’ve been digging.
The term “Modell Deutschland” was coined by the Social Democratic party for the 1976 election campaign: Germany as a model economy. Europe and the US had endured a recession in 1974-75 that had a whiff of the deeper recession that would come in the early 80s — stagflation, an oil shock, and high unemployment. In Germany, however, Helmut Schmidt’s Social Democratic party managed to handle the recession with aplomb. Germany fared well, and in fact the Social Democrats expanded worker co-determination (giving workers a say in how companies are run, and seats on the boards of directors).
Based on this New York Times piece, the phrase still fits, this time with Angela Merkel’s Christian Democratic party. Germany’s success so far in handling the recession even while paying the lions’ share of bailouts for Greece and Ireland is the envy of the industrialized world. While Germans themselves grumble about the difficulties of the Euro and trying to keep the economy going during a global depression, they’ve managed to keep growth going and out perform most other countries.
Chancellor Angela Merkel (CDU – the right of center Christian Democratic Party) was in a “grand coalition” with the left-of-center Social Democrats when the crisis hit in 2008. Together the two parties passed a balanced budget act, requiring the Bundestag and German Länder (states) to limit budget deficits to .35% of GDP by 2016 and to have them balanced by 2020. There are exceptions in the case of national disasters and emergencies, but the point was clear: there is German consensus that debt has to remain under control.
Most economists are uncomfortable when debt to GDP ratios rise above 60%. By that point increasing the debt does little to stimulate the economy (and actually becomes counter-productive when you get to about 100% of GDP) and creates long term damage. After getting budgets under control by 2007, the recession pushed them back up over 70% of GDP. Given that 60% is the proscribed (but ignored) Eurozone limit, the high debt level was embarrassing. The Germans wanted to send a clear message that this was short term, with both the left and the right united in vowing to cut debt moving forward.
President Obama urged the Germans to pass a stimulus in 2009 to help get the European economy going. Merkel, a physicist by profession, simply could not see the logic in Obama’s view. While the US with the dollar as a global reserve currency and massive economic clout might be able to get away with debt to GDP ratios nearing 100% (though she had her doubts on that too), it would be reckless for Germany to take that approach. Instead, after securing re-election and joining the FDP in a new center-right coalition, her government passed an austerity program at home, even as it had to pay to help the Greeks and Irish. Merkel was hesitant to help (her hesitancy was criticized as making the situation worse), but it’s hard to tell your own citizens to take cuts while paying for countries that had little economic discipline.
Merkel’s program was what Obama would call balanced — revenue increases and spending cuts. However, the Germans did things differently than the Americans. First, they weren’t driven by ideology. You didn’t have people condemning government “as the problem” and trying to blame either the right or the left for the situation, making it a political football. They approached it rationally.
There is a recession. The debt is too high. Our demographics show our population is aging. It is a part of Germany’s moral and ethical character to have a stable social welfare system that guarantees health care, helps the unemployed and assures that the elderly do not suffer. It is essential for Germany to educate its children well in order to compete in the future. How can we make reforms that allow us to adapt to the recession, cut debt, but not endanger our population and our social welfare system?
The answer, of course, was to look at their spending and determine where there were inefficiencies, what areas could be cut, and to set priorities. Yes, a modern industrialized state without a quality social welfare system may be barbaric, but you can’t allow social welfare programs to remove incentives to work, to cost more than the people can afford, and undercut rather than support social solidarity. Of course, cuts aren’t all it takes – when you’ve got debt, you also have to increase revenue, so taxes had to go up. This also was done pragmatically — rather than just a “tax the rich” vs. “taxes or evil” debate, they had to figure out how to raise revenues in ways that didn’t hurt the economy or create inequities.
Tax increases are a less harmful way of reducing debt than spending cuts. Spending cuts slow the economy more than a tax increase. But too many taxes alongside wasteful spending creates a lose-lose situation. These are not decisions for ideologues or political pontificators, they are decisions to be reached with a cool rational eye on the facts.
To be sure, Germany has advantages. It does not have the gap between the rich and the poor that the US has. While America’s middle class has had stagnant wages the last thirty years, all Germans have seen consistent income growth. While the gap between the rich and and poor has been growing here, that hasn’t happened in Germany. There are still people who are very rich, and there are poor people — and there are incentives to innovate, produce and invest. But the power hasn’t shifted completely to the wealthy elite. Strong labor unions especially assure that more equitable relations are maintained — business and labor have more a partnership than separate classes. Germany proves that those who hate or demonize labor unions are misguided.
Germany also avoided the housing bubble, even if many of its banks invested in dubious CDOs. Germany’s financial and economic sectors are heavily regulated, and therefore resist the kind of wild fiascos that engulfed Ireland, the US, Iceland, Spain and all the others who believed the 1990s myth that de-regulation was good and the ‘market gets it right.’ A good strong regulatory regime has helped Germany stay afloat.
Finally, Germany didn’t let it’s industrial sector die off in the last recession like the US did. While the US went towards service industry and financials — producing less and consuming more through debt — Germany maintained a current account surplus (consumed less than it produced), and supported its industrial base. That means that Germany lacks the huge imbalance the US suffers; the US has been living beyond its means, for the most part the Germans have not.
Germany has challenges — if you talk to Germans they’ll be vociferous in the need to still reform the health system, concern about the Euro, worries about high subsidies to industries, etc. There are ideological differences between the left and right, though not usually pitched in the emotional ‘good vs. evil’ way of American politics. There are vast differences between the US and Germany, and the US does do many things better. Still, given the situation, there’s a lot we can learn from “model Germany.”
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.
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.
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.
I’ve not been following the negotiations on raising the debt ceiling very closely. Besides being on vacation and teaching two on line courses, I am simply assuming that they will find a way to raise the debt ceiling. My thinking is similar to why I had little fear of nuclear war during the Cold War — the leaders are not so dumb and irrational as to do something that would guarantee a catastrophe.
Moreover the tidbits I have been hearing — that Boehner and Obama are developing a good working relationship, and that a deal is all but done (and if a big deal falls through the fall back is a small deal) — suggest that they are on course to making a deal and raising the debt ceiling in time to avoid default. But what if I’m wrong?
The worst case scenario is US default and a global unloading of US treasury bonds and currency. The dollar’s value would collapse and the resulting chaos would spiral into a deep global depression, making the last three years seem like a minor pre-catastrophe bump. This could be remembered as an irrational self-inflicted wound that would mark the end of US economic and political dominance in global affairs. But would that really happen? There are a number of scenarios.
The 14th amendment solution: Section four of the 14th amendment reads in part: ” The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.” One could interpret that to mean that the US cannot default, and the President could unilaterally raise the debt ceiling. The Republicans have had a hostile response to this possibility, noting even that it could be an impeachable offense, threatening to go to court if President Obama tried it. That might avoid economic collapse, but would cause a constitutional crisis with unforeseen political ramifications going into 2012. Even if President Obama were to do that and it were upheld by the Supreme Court, the result would be a loss of power to Congress and even more power in the Executive branch. This isn’t likely to happen, but would be extremely interesting to watch if it did!
Prioritization: The Executive branch could also avoid default by paying interest on current debt and then prioritize the rest of the spending based on what the Treasury department deems most important. If military spending and important programs like social security continue to get funded, there would be little money left to run the rest of the government. This would mean something akin to a government shutdown — though theoretically the Executive branch could prioritize in a way that would punish Republicans. This may be the most likely course of action in the cause of not raising the debt ceiling, with the prioritization both real and political — designed to maximize pressure on the Republicans.
Short term default: Republicans and Democrats could play a game of chicken, each thinking they can wait to the last minute to get the best deal. They may even think a symbolic one or two day “default” will cause minimal damage. That would be a very dangerous game. First, if there isn’t a clear deal in sight by late July, interest rates will start raising on speculation, and once that happens even a timely agreement might not stop an unraveling of the dollar. That’s why most people think the sooner this is passed, the better. Moreover, such thinking could be a path to a longer term crisis, should each side push the envelop and believe they can’t back down without gaining something significant.
Ultimately, the issue comes down to taxes. Most Republican insiders are willing to see tax rates on the wealthiest go up slightly, especially for a short term, and the closing of loopholes also gains support. However, the Republican base sees any tax increase as a defeat, claiming it will harm the economy. (Reality check: spending cuts do more harm to the economy than tax increases since in each case money is taken out of circulation, but government spending is mostly domestic while tax savings go towards consuming foreign made goods or paying down private debt). The Democrats understand spending cuts are necessary, and deep down recognize that entitlement reform is the only way to get long term traction in reducing debt.
A “grand compromise” would see Democrats make concessions on entitlements, perhaps raising the social security retirement age, while Republicans would accept tax increases on the wealthy. Each would risk the ire of their base, but they could claim they did what is best for the US. It appears Boehner and Obama were heading towards such a deal, but the Republican base reacted vehemently against the idea of any tax cuts. Boehner then retreated on the idea of signing off on tax increases, meaning that the Democrats now offer a smaller array of spending cuts, with entitlements fully protected. The bases of each party will be satisfied, both sides hope, even though the deal will be smaller and less profound than either side claimed to want.
The Republicans will risk having it said that Obama just made symbolic cuts and they should have been willing to refuse to raise the debt ceiling to force deeper concessions. Democrats will complain that tax cuts should have been part of the deal, and that Obama was too willing to give in to the Republicans just to get a deal. “He’s not confrontational enough,” they’ll complain. After all, leading Republicans know the danger of not raising the debt ceiling, ultimately they would have likely backed down. Still, such a compromise would be the best way to make sure irrationality doesn’t become policy and we risk economic meltdown.
If the small deal is made, the Democrats might benefit most politically. That will make “taxes on the wealthy” a big 2012 issue, and the Democrats can probably make a reasonable case that this isn’t “class warfare” but asking those who have done very well to pay their share turning around our deficit. Moreover, by not accepting entitlement reform, the Democrats can make that an issue in 2012. That may mean they’ll make promises they can’t keep — I expect entitlement reform will come — but thats a concern for 2014 or beyond.
Right now most of the country isn’t paying attention, and that gives the political junkies a louder voice. Immigration reform had much more support than it appeared in 2007 when the GOP base turned out to kill it. That is the danger — will the leaders refuse to lead, bringing our country into a needless economic crisis at a time we can ill afford more risk? I can’t imagine that a deal won’t be reached, the stakes are too high and the insiders know it. They just need to come up with the appropriate political theater to avoid a backlash from their respective constituencies.
Recent economic news convinces me that we are not in just another recession, but the early days of what could be a significant and extremely painful depression. Historians may call this era “Great Depression II” and analyze the causes and impacts the same way we look at the 1930s. If so things may get much worse before they get better.
The other day I posted four charts that illustrate the problems we face. We have gone into deep debt — both government and the private sector, — have less than 10% of the population involved in manufacturing, and hyper-consume foreign goods, running up massive current account deficits. This has been going on for thirty years, including unconscionable deficit spending during economic booms in the 1980s and early 2000s. Private citizens have been if anything as bad if not worse than the government, the US lived on debt, stopped savings, and believed in the bubbles that popped one by one. It’s not just the government’s fault, we citizens have done this to ourselves.
It’s a depression because there is no quick way out of it. In a recession rebalancing can be painful, but happens quickly. It’s caused by short term economic factors usually led by inflation. Since inflation rates were so low during the thirty year period we engaged in building high debt and overconsumption/under-production, the economy did not have any “natural” way to rebalance. The imbalances grew, and as long as the short term outlook seemed good, people decided they could live with debt. Economists even made excuses for the current account deficit, arguing that if it’s private sector driven that’s no problem. The loss of manufacturing? No problem, the US was making up for it with the service sector, especially stocks and banking. The idea was our financial system provides a global service and thus we do not need to produce. That was an illusion.
In retrospect the question would be why people didn’t see this coming — or why those who did were ignored. How could people really believe thirty years of growing government and private debt with hyper-consumption and little production work? But if a delusion is enjoyable, it’s easy to grasp for as long as possible. Now the last bubble has burst.
Here’s the deal: since the imbalance is debt driven, it cannot be fixed until that debt is paid down. Let’s set aside government spending for a moment, since that debt might have to rise if we are to fix this. What is really problematic is the high levels of private debt. Savings rates remain low, equity in homes is at historic lows, and credit card and other personal debt remains high. To rebalance we have to simply repay debt and get back into a structurally sound condition.
You might think that this also means cutting government spending, and we do have to do that. But it’s tricky. There is no guarantee that this will right itself quickly, we could be looking at long term malaise, even if the public pays down the debt over time. The government has to cut wasteful and unnecessary spending, diminish commitments abroad (military spending should be cut dramatically) and focus spending on a mix of infrastructure improvements and direct benefits to people starting businesses or working to build productive capacity.
The problem, as I noted earlier, is that we have been consuming beyond our ability to produce. To repay debt and maintain an enjoyable level of consumption (but not insane as in the mid-2000s), we have to increase production in goods and services that have global demand. Here is the problem with the two favorite “fixes” from the political parties:
a) GOP — cut taxes and people will invest. The problem is, if you cut taxes people will consume. That used to indirectly cause production since you have to produce first what is consumed, but now that the economy is global tax cuts benefits may be exported. The rich will consume more foreign goods, but the domestic economy will continue to falter, and there won’t be investment in new productive enteprises.
b) Democrats — stimulate the economy. In a normal recession this is even better than tax cuts because it directly stimulates the economy in focused areas, rather than simply providing tax cuts. It also is more likely to get money directly to those most hurt by the recession. However, if not spent right, it will have the same impact as a tax cut — rewarding consumption without promoting production. In fact, that seems to have happened with the first stimulus, as some of it was geared towards investment, but much was to bail out states and create jobs.
If I were President I’d give a national speech to talk about the depression. I’d use the D-word, it’s too late to worry about “talking down” the economy. It’s down and talked down as much as it can be. I’d mix a list of spending cuts — significant ones, ones that hurt interests on both sides of the aisles, with a set of incentives for investment plus targeted infrastructure improvements. We also can’t give in to the temptation to cut spending on our future — education, early childhood programs, and help for families in need. The President should also call for an effort of national renewal, perhaps tying receipt of government assistance to having people “give back” in some way.
The problem is that whether rich and earning big off the stock market, or poor and surviving with food checks and welfare, a something for nothing attitude permeates our culture. Perhaps prosperity spoiled us, perhaps we simply got too fond of our delusions. The President needs to make clear that we have to work together to revive our economy and live up to our national values. The problem can’t be fixed by the government, and no one can expect magic from President Obama. It took thirty years to get into this mess, we’re now mired in what still could be the early days of a depression, and unless we boldly come together and start making hard choices, giving up our something for nothing attitude, things could get much worse. If we act wisely, we can turn it around. President Obama, the country needs your leadership. Now is the moment — this is what you were elected for, stop playing it safe and focus intently on the economy and bringing the country together.