Archive for category Political Economy

Global Economic Collapse Imminent?

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.

7 Comments

Occupy USA?

w

For over a week protesters have been growing in numbers on Wall Street, with unclear demands but clear rage.  Hundreds have been arrested as they shut down the Brooklyn Bridge and sympathy protests spread to other cities.   Left wing notables such as Chris Hedges, Michael Moore and Matt Taibbi have described this as the start of a new movement (Hedges said it was the ‘best hope’ for America to recover from this crisis) and slowly the media is starting to take note.

So what’s happening?   First, the left has been silent for much of this economic crisis because until early 2011 the Democrats held power in Congress and the Presidency.   As health care reform passed, “Don’t ask don’t tell” repealed and other changes made, most on the left held out hope that Obama would pursue a truly progressive agenda.   To be sure, the Hedges, Moores and Taibbis gave up on Obama long ago.  He stayed in Iraq and Afghanistan, had policies very friendly to Wall Street, and the call for tax increases on the wealthy — something which gets labeled class warfare on the right — is seen as pathetically trivial.    The far left wants real class warfare because, they argue, it’s been waged on the US by Wall Street and the business elite for years.

Students and others whose hope was kindled by the Obama candidacy, and who look at the tea partiers as almost anachronistic, wanting to go back to America like it was decades ago, had drifted towards apathy.   Now a movement is starting that might ignite their interest again — sort of an anti-tea party.

The cause of their ire is clear: Wall Street and big money.   These are firms that created the debacle of 2008 thanks to unregulated derivatives trade and what in retrospect can only be called fraudulent but legal deals.   They raked in hundreds of millions of dollars of bonuses for deals that were setting the stage for a crisis as serious as the Great Depression.   Then when all hell broke loose and Americans were out of work and unable to keep up their mortgages, the government made sure the financial sector did not collapse.   Soon they were back making record profits, even as the world economy sunk.

Beyond that the wealthy have managed to create for themselves a zone of safety where their wealth is not at risk and they don’t have to do anything special to be a top earner.   Just being born in the wealthy class virtually guarantees you will stay there unless you really screw things up.   Meanwhile being born poor assures you’ll remain poor unless you undertake a heroic effort with luck and creativity.   Some accomplish that, but overall class mobility in the US is low.

In the last thirty years as the wealthy have received record tax cuts to the lowest levels in history (and have loopholes and other ways to avoid more), the top one percent have had their income grow by 281%

This chart shows that the more you earn, the greater your income growth.  For the nearly thirty year period the bottom 60% — more than half of the population — had earnings increase by 25%, the bottom 20% only 16%.    Politics is about relative gains and loses, and obviously there has been a relative shift of wealth to the highest earners.   281% for the top 1%, only 25% for the bottom 60%.   For the last thirty years the wealthy have done very well, even as the rest of the country has stagnated.    As unemployment officially lingers at near 10%, but if you took into account everyone who would want to work could be close to 20%, it’s very clear that Americans are hurting, even as the wealthy hold on to their gangs and Republicans scream “class warfare” whenever someone wants to increase their taxes even a little.

This is going to get people mad.    People accepted the massive growth in income disparity over the last 30 years (we were most equal in 1976 in the last year of the Ford Administration, now income distribution is like that of the late 19th Century) thanks to lower prices via foreign goods and the illusion that the economy was a success.   Now that illusion has faded and people are coming to grips with the fact that the US is in decline, with an economy based on consumption rather than production.   Massive debt by both the government (100% of GDP) and the private sector (total debt government and private sector: 400% of GDP) have created a structural crisis, one that can’t be fixed with a quick stimulus or a few policy changes.

The tea party’s rage is real, but they so far have gone for illusory solutions.   If only government spent less and cut regulations, then “job creators” would move in and magically fix the economy.  It sounds so easy, so painless, and thus they are angered by those ignorant Democrats who can’t see that they are standing in the way of a simple, clear solution to America’s ills.  If only it were so easy!    That solution is pure fantasy.   Of course, the Democrats had their painless solution.   Spend more money, save jobs, help out states and don’t worry about the debt — we’ll pay it off when we’re growing again!   They are angered by those ignorant Republicans who don’t understand that cutting spending slows the economy even more than tax increases would!

The “Occupy Wall Street” movement, which is starting to spread, seems to recognize the folly of the “easy solutions” have been fed to us by an elite which wants to protect its advantage and avoid anything that might get in the way of continuing to profit without significant competition.    They call themselves capitalists but they do all they can to avoid having to undertake the risks capitalism is supposed to entail.  They’ve convinced many people that the choice is “capitalism or socialism” and they’re the good side of that false dichotomy, while “big government” (by definition socialism in that world view) is the bad side.

President Obama until now has tried to reform rather than radically alter the system.   As an outsider, he’s been keen to reassure the moneyed elite that he’s not a threat, believing that will be more effective than creating animosity from those who have the power to make or break his Presidency.   While the tea party complains about “establishment Republicans,” Obama remains an “establishment Democrat.”

So the protests grow.   The left is starting to counter the right in both rage and demands for radical change.   Beneath the surface organizations are being built that can be mobilized for political action going forward, the infrastructure of a true progressive movement is starting to grow.   Just as the tea party irritates establishment Republicans, this group will be a thorn in the side of establishment Democrats.

To many people the idea of protesters in a prosperous democracy modeling their movement after protests that overthrew an oppressive dictatorship in Egypt is silly.   Yet they have felt helpless as both parties have courted the business elite, had the same insiders (Clinton’s economic team was more free market than Reagan’s had been, and many of them were brought into the Obama Administration), and stood back as jobs moved off shore, the middle class lost ground, and the country drifted into decline.

These folk are finding their voice as this crisis, now three years old, enters a new stage.

6 Comments

A New Bretton Woods?

Thanks to government policies we’re unlikely to have bread lines and unemployment reaching over 30%, the current “recession” is looking more and more like the kind of economic event that heralds the end of a particular economic era.  We will get through it and a new era will begin, but things will have to get a lot worse before they get better.   The reason is politics:  people interpret the world through their political lenses and so far have not yet been convinced that real change is needed.

The boom of 1948 to 2008, sixty years of prosperity and growth, can be divided into two parts.  The recession of 1979-83 marks the break between the two.   In the first part the industrialized West produced as much if not more than it consumed, budgets were for the most part in balance, debt accrued in the war was being paid down, and income disparities were narrowing.   The standard of living went up, political stability grew.   However, since the great recession ending in 1983 the industrialized West has gone further into debt than had ever been imaginable, production has shifted to the third world and a series of bubble economies have created the illusion of sustainable prosperity.  In those three decades imbalances were being built that would ultimately ignite a global economic crisis.   It’s far worse than 1980 because debt is massively higher, infrastructure much more out of date, and globalization has altered the nature of the global economy.

Globalization is a mix of the internationalization of global capital and the growth of information technology.   Before 1980 it was difficult to merge companies across borders, invest in foreign markets, and go anywhere on the planet to find the best return on investment.    Now capital has been unleashed from its national borders meaning that business and capital no longer had national loyalties.   Whether this is good or bad is hotly debated.   What is clear is that the global institutional structure that worked so well up through the 80s is no longer adequate.  It was a state-centric approach now serving a world where state sovereignty is weakening.   Current institutions were created when the dominant economies were in the West, closely linked, and relied on the US as the global hegemon to assure defense, provide the global reserve currency (the dollar) and promote free trade.

That old order began with a meeting of economists at the New Hampshire resort of Bretton Woods in July 1944.  They were determined to completely reorganize the entire global economic system.   Their goal was simple: save capitalism.   Capitalism had been thought to have led to the great depression, fascism and systemic collapse.   They believed that with US leadership and the proper institutional infrastructure capitalism could lead to true prosperity.   The resulting “Bretton Woods system,” including fixed exchange rates (through 1971), the General Agreement on Tariffs and Trade (GATT – now the World Trade Organization), the International Monetary Fund (IMF) and the World Bank.   Together these institutions formed the foundation of this new system.   Free trade was the lynchpin and the key to igniting the most impressive economic expansion in world history.

Those institutions are no longer adequate.   The gold standard and the fixed exchange rates were jettisoned when they’d served their purpose in the early seventies.   Once trust in currencies was strong enough so the market could handle currency valuation, there was no need for the gold standard.   The rest of the institutions were built on two principles: a)  state sovereignty; and b) American hegemony.

Hegemony is long gone.   The dominant role of the US had faded by the late 60s, and since then the rise of the EU, Japan, China and others has created a real counter balance to US economic strength.    With $14 trillion of foreign debt and a large current account deficit, the US no longer can snap it’s fingers and expect the world to comply with its wishes.   Sovereignty is vastly overstated.   True sovereignty never really took in much of the third world, while even the develop countries find that globalization vastly limits their capacity to develop national responses to problems.   If the problems are global, a national response is inadequate.   The US used to think that our size made us immune to this; the current crisis shows that is not the case.

The world needs a recasting of global economic institutions designed to function in a world of complex interdependence, powerful non-state actors, and the need for coordinated policy.

If we learned anything from the Great Depression, it’s that markets alone don’t magically fix a broken economy.   To address the current imbalances, there needs to be a global effort to stimulate the economy and adjust the structural imbalances.   This might include a new global reserve currency, acceptance of a weaker dollar, and a massive well orchestrated global intervention in the economy designed to stimulate growth and regenerate markets.   That won’t happen until the situation gets much worse than it currently is.

In the US a huge chunk of the political discourse is run by people who equate any kind of government activism with “socialism,” an absurd charge but one which so tinges the political atmosphere that President Obama can’t even propose higher taxes on the wealthiest without being charged with class warfare.     Right now the Republicans are waging class warfare on the poor, telling them to suffer unemployment and want while protecting the elite who are doing very well.   The Democrats have to make that case boldly, with no apologies.   They have to note that cutting spending stifles economic growth far more than tax increases on those wealthy who now pay historically low rates.

Despite the sloganeering, the goal is not to build socialism, but to correct imbalances that now prevent markets from functioning adequately.   Markets have always needed a regulatory structure of some sort to work — even Adam Smith realized that.   That structure could be a set of local customs and norms in a small setting, state laws and regulations in the post-war setting, and now transnational agreements and policy action.

At some point it will happen.   If President Obama were to lead a call to bring top world economists back to Bretton Woods to plan a new global order, and states had the will to make it happen, it might quickly be as successful as the original Bretton Woods system.   More successful, even, as now third world states would be part of the solution to global problems.   But it’s not going to happen any time soon, thanks to a political mindset that still thinks primarily in terms of independent states rather than an interdependent global system.   That mindset may be strongest in the US, but it exists across the planet — old ways of thinking resist change, even if the world is clearly in transition.

Last time it took a 10 year depression followed by a bloody six year war before the world embraced a new order.    The success of the original Bretton Woods system is clear — never before has so much wealth been created so quickly.   There is no reason to think this can’t be done again, this time involving the resources and dynamism of the entire international community, not just the West.    First there has to be the political will to make it happen.   Things will have to get a lot worse before that political will is evident.   How much worse?    Ten years of depression and six years of war like last time?  I hope not.

15 Comments

A Bit of Optimism

It is now August 2011 panic grips the financial sector.   Despite budget cuts and new austerity, Italian bond yields rise and investors flee.    Will southern Europe take down the Euro?   Can and should the wealthy European states bail them out?  In the US politicians fight over simply approving the borrowing of money to pay bills that need paying; and bring the world’s largest economy on the edge of default, and to a credit downgrade.  The Dow gyrates at a pace not seen such the crisis began in 2008 as panic sets in on fears of further downgrades and a ‘double dip recession.’

Given my continual bearishness on the global economy, you might expect an “I told you so, now its really going to hit the fan.”    Yet I’m starting to think that the worst may be over.    Job growth was up in July, especially in the private sector.   New unemployment claims came in lower than expected in the last two weeks, under 400,000.   Corporations are starting to report plans to hire and that they are seeing an uptick in business.

Governments have recognized the seriousness of this crisis world wide and have proven remarkably capable of compromising and acting to try to change policies and turn the global economy around.   The idea that this is ‘just another recession’ has given way to the recognition that it is a ‘depression like crisis’ with no quick and easy answer.  Realism is trumping ideology in most of Europe, and I suspect it’s about to do so in the US.   Average people are making better choices too.  They are saving, planning, and adapting to new conditions in a very practical and sensible way.  Hyper-consumerism, rather than being a cultural depravity set to bring down the West, may have simply been a fad that blossomed due to the bubble years.

To core cause of this crisis is crystal clear and easy to understand.    We are in a recession that is a natural part of the business cycle.   However, this recession coincides with the fact that the accumulated debt of the industrialized West — public and private — has become unsustainable.     This debt helped avoid the recessionary corrections necessary in 1991 and 2001, but increases the scope and intensity of the one we are now experiencing.   Think of high debt as steroids — we’ve got a recession on steroids!

Originally, people thought the recession was simply another downturn and that much like the ones in 1991 and 2001; a strong stimulus along with cheap credit would again put us back on track.   This led to a belief that a stimulus alongside expansionary federal reserve policies would catapult the economy back into overdrive.   That didn’t work.   Debt had become unsustainable and counter-productive.

Others, mostly on the right, focused on debt as the sole cause of the problem, not recognizing the reality of a deep recession (correcting imbalances that began at the end of the last true recession in 1983) and the fact that spending cuts could spiral us down into depression.  To them the solution was to cut spending and get the budget in order.     They don’t get that alongside fiscal discipline there is a need for government to actively combat the recession and invest in the country.   Even though tax increases harm the economy less than spending cuts, ideology pushes them to demand only the latter, making it more difficult to reach political agreement.

In other words, many have very clearly seen half the problem, but ignore or deny the other half.  That’s starting to change.   The President embraced a strong and I believe relatively well designed stimulus program which has paid dividends.    The country was bleeding jobs in the early months of 2009, now it has gone to creating them.

And compare it with this longer term view:

(See these graphs came from this site, which also had an interesting discussion: Reflections of a Rational Republican.)

A couple of things stand out.   First, job growth late in the Bush Presidency (before the recession) was about the same as job growth after we came out o f the recession.   The recovery may be weak, but it’s symmetrical.  The decrease in job loses was swift in 2009 when the stimulus took effect.   With the good numbers for July and new unemployment claims dipping below 400,000 two weeks in a row, the economy is perking up.

Now, if you want it to grow faster you could say “add more stimulus” and expect the numbers to rise.   However, that ignores the debt issue, part two of this crisis.   There would be no down grades, no fear of defaults, and no difficulty in addding stimulus if the debt to GDP ratio was considerably lower.   That means that stimulus is not the answer to the second step of solving this crisis.   The budget must be restructured.

I expect job growth to continue into 2012, mostly because cuts will not take affect before then and the stimulus is starting to take hold.   Despite the fear and uncertainty on Wall Street, we have reached a point of capitulation where the markets stop reacting out of panic and start truly assessing the state of the world economy.

If the US passes a mixture of tax increases and budget cuts that promise a significant dent in debt, not only will the AAA rating be restored, but private investors will be more comfortable taking risks in the economy.   If the Europeans stabilize the Eurozone (or, less likely, make it smaller), countries like Germany, the Netherlands, Sweden and Norway — all of whom are handling the recession relatively well — can help motor Europe forward.   Lost in the whole controversy is that the unhealthy European economies are the minority, dragging the majority down.   As a continent, Europe is actually in better shape than the US.

However, the result will be continued slow growth as the global economy rebalances.   More power and wealth will shift to countries like China, Brazil and others.   Globalization will limit the impact of domestic policies — does a tax cut in the US stimulate the American economy, or does it stimulate the Chinese economy if the money is used to be Chinese consumables?   We won’t be partying like we did in 1999 (or 2006) when growth appeared permanent — bubbles create wild illusions!  That economy was a house of cards built on sand.   But a slow restructuring with jobs dribbling rather than surging back could mean the development by the end of the decade of a strong, restructured stable US and world economy.

Anyone who has read my blog for the last three plus years knows I’ve been pretty bearish on the economy.  I was a contrarian back in the heady days of 2006 when people believed that deregulation of financial markets and American innovation had heralded in a new economy.   It was debt, the current account deficit and hyper consumerism that caused that view.   Now the current account is back to just over 3% of GDP — too high, but tolerable.  Consumerism has given way to saving and paying off debt.   Both parties are serious about debt reduction.   In Europe and the US illusions of this being “just another recession” have given way to recognition that this is a time of systemic transition rivaling the 30s.

It’s always darkest before the dawn.  It may well be that August 2011 is remembered as the turning point in restructuring the global economy.   We won’t get the rah-rah consumerism and bubble games of the 00s, but we might get a sustainable economy and even learn that community trumps consumption.

1 Comment

Downgrading America: Frustrati vs. Tea party

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.

26 Comments

Modell Deutschland

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.”

Leave a comment

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.

9 Comments

14th Amendment a Serious Option?

President Barack Obama claims to have ruled out using the 14th amendment, and if you read the statements of his Press Secretary and the President’s own words, you’d be forgiven for believing that it’s not an option.

However, in politics you never look at just what the principles are saying, you look at what they are doing, and the potential impact of what they say.   For instance, President Obama clearly doesn’t want to invoke the 14th amendment.   But if he threatened to do so, the left wing of the Democratic party would mount a concerted effort to stop any negotiated settlement that includes significant debt reduction in the Senate.  Obama had to convince his own party that they did not have the 14th amendment as a fall back should negotiations fail.  That would be necessary to get them to vote for a last minute compromise.

This also suggests that Obama wanted to reach a “grand compromise” with significant budget cuts, and may still through back channels and secret talks be headed in that direction.   His public schedule has been empty, but full of private and unpublicized meetings.    Things are brewing, but we don’t know what.

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.   The President could say that the constitution by stating that the validity of the public debt should not questioned, requires that it be paid.   The only way to do that, and continue spending money the Congress voted to spend, is to raise the debt ceiling.   The interpretation is plausible enough to not be “over the top,” even if weak.

I do not think it is a winning argument.  Article 1, Section 8 gives Congress the power to pay debts and borrow money.  One could argue that Amendment 14 altered this by adding to the President’s power by saying the validity of the debt should not be questioned.  An historical read of this amendment, however, clearly weakens that claim — it is focused on the Civil period and its aftermath.   Nonetheless a literal interpretation (e.g., just the text, not historical context) at least creates an opening for that argument.

Some people claim that President Truman invoked the 14th amendment to raise the debt ceiling.  That isn’t true.  He used the amendment to integrate the military, but during his Presidency there was no increase in the debt ceiling.   In fact, since the debt ceiling was created in 1939 Truman is the only President not to have raised it.    Most have raised it five to seven times, though Ronald Reagan’s years brought 17 debt ceiling increases – not surprising since the Reagan years saw the biggest relative growth in debt in US history.

But for politics the issue becomes murky.    First, President Obama knows the constitution well, having taught it.  He may believe that it is his duty not to violate the interpretation he believes correct, and thus he may have already completely ruled out using the 14th amendment.   That would make him a politician of rare integrity, since for most the question of legality gets replaced by one of political realism — will it work, and can I get away with it.

To the latter, despite Republican calls for impeachment should he go that route (something that might actually help Obama in 2012), he can get away with it legally.   The Senate will never convict him if impeached, and at least until the Supreme Court rules, he could do it.    Could it hurt him in 2012?   That’s harder to say, and separate from the legal issue.   The President would frame it as a matter of leadership and doing what is necessary to protect America from Republicans who would be accused of threatening to do more harm to the US than Osama Bin Laden did on 9-11.   The Republicans would frame as a power grab by a leader who wanted to do things his way, regardless of the rules.   If the country believes the President, he’d win in 2012.   If the GOP convince the public he was out of line, he loses.

The GOP position now is weak due to the reputation the House has of extremism and refusing to compromise.   The GOP is in danger of looking as they did back in 1999 against Clinton when their over the top attacks backfired and helped the President increase popularity.   Of course, Clinton had a booming economy going for him, something Obama lacks.   If the Court ruled against him (something I would consider likely) that would aid the GOP argument and send a weakened Obama into the election.   In fact, if things got that bad Obama might give an LBJ like shock speech, announcing he would not seek the nomination due to the divisiveness of economic battles, perhaps opening the door for Hillary.   (That is not a scenario likely at this point!)

However, looking at the possibilities, it comes down to this: how serious is the threat to the economy, and how well can the US handle either a default, government shut down (which would come from using the available money to avoid default — a huge chunk of the government could not be paid for), or downgrade in the bond rating.   If the threat is serious, the President might decide that it’s worth risking his re-election on doing whatever possible to avoid that outcome.    He could try to couple that with a renewed effort to get significant spending cuts passed to get a debt limit ceiling raised (for longer than six months — which would do no good, really).   If that got passed before the court ruled, it would be worth it.   But more things could go wrong for the President than right, under that scenario.

On the other hand, new voices calling for invocation of the 14th amendment might have a political aim.   If this option once again appears plausibly in the Presidents arsenal, House Republicans (especially moderate Republicans) would realize that their capacity to force the President to do their biding by holding the economy hostage declines.   This would create a real push for an alternative deal that saves face for everyone and avoids clear winner/loser scenario.

Politically, Speaker Boehner has staked everything on his plan, and the drama of getting his own party support it sends a message to the White House and Senate — this is as good as you can get, we had to work to get this!   President Obama has vehemently opposed setting a rehashing of this chaos six months from now.   If either one gets their way completely, one comes away wounded.   Neither will accept that, making a stand off likely.    However, if McConnell, Reid and other power brokers can figure out a face saving deal that can pass and cannot be seen as a clear victory for either side, that will resolve the crisis.

So is the 14th amendment a serious option?   Yes, but only as a last resort, and perhaps not even then.   If it comes to that, it’ll be a very entertaining year in politics coming up, but that would not be good for the country.

35 Comments

Obama vs. Boehner

As John Boehner was leaving from giving his response to the President’s speech on the debt, he was heard to say “I didn’t sign up for mano-a-mano with Obama.”  Even he knew that his speech was small minded and weak compared to the President’s appeal to the public.

Regardless of who you think is right on the facts, Obama won the rhetorical war Monday night.   After admitting that the debt was a bipartisan problem resulting from not living within our means, he described the situation like the average American would:

“This is no way to run the greatest country on Earth. It’s a dangerous game that we’ve never played before, and we can’t afford to play it now. Not when the jobs and livelihoods of so many families are at stake. We can’t allow the American people to become collateral damage to Washington’s political warfare…Yes, many want government to start living within its means. And many are fed up with a system in which the deck seems stacked against middle-class Americans in favor of the wealthiest few. But do you know what people are fed up with most of all?

They’re fed up with a town where compromise has become a dirty word. They work all day long, many of them scraping by, just to put food on the table. And when these Americans come home at night, bone-tired, and turn on the news, all they see is the same partisan three-ring circus here in Washington. They see leaders who can’t seem to come together and do what it takes to make life just a little bit better for ordinary Americans. They’re offended by that. And they should be.  The American people may have voted for divided government, but they didn’t vote for a dysfunctional government.”

Speaker Boehner’s short five minute rebuttal was red meat for the tea partiers, using one liners like “Obama wants a blank check.”  Never mind that the money has already been appropriated by Congress and Obama isn’t asking for more spending.   It was partisan, put blame on Obama, and essentially gave a performance that looked like the kind of thing most Americans, especially independents, are sick of.

Don’t get me wrong.  I like Boehner and Obama both.  I think one reason Boehner’s performance was poor is that his heart wasn’t into the speech.    It had to be written before they knew what Obama would say, so it was full of blame for the Democrats and claims that Obama was unwilling to make cuts.   But that was in direct contradiction to what the public had just heard from the President:

“Let’s live within our means by making serious, historic cuts in government spending. Let’s cut domestic spending to the lowest level it’s been since Dwight Eisenhower was President. Let’s cut defense spending at the Pentagon by hundreds of billions of dollars. Let’s cut out waste and fraud in health care programs like Medicare — and at the same time, let’s make modest adjustments so that Medicare is still there for future generations. Finally, let’s ask the wealthiest Americans and biggest corporations to give up some of their breaks in the tax code and special deductions.”

I daresay that if Obama is serious about this — and I suspect he is (much to the dismay of many in his own party) — then most Republican rank and file would be thrilled.    Yet the reason major cuts can’t happen is because Obama wants revenue enhancements — eliminating tax breaks and other so called loopholes — as part of the solution.  It would only touch the wealthiest, and amount to only 15% of the spending cuts.

In that the GOP is playing a dangerous game.   The gap between the middle class and the wealthiest Americans has been rising.    The budget cuts and poor economy will cause continued and increasing pain among the poor and working class.   Pain may be a metaphor, but in this case it’s also real — families will see their lives fundamentally altered in ways they would not have imagined just a few years ago.   The argument that the wealthiest shouldn’t pay part of the price, given they’ve gained the most in the last 30 years (while the bottom 60% haven’t even kept up with inflation), will lose its appeal.    When times are good the Republicans can say “they’re playing class war” and most people recoil.  When times are bad, there very well could be “class warfare.”

Right now we’re at an historic point.   We have a Democratic President who says we need severe budget cuts in order to stay solvent and be able to adapt to the demands of the 21st century.  He’s taking on the left of his own party to make that case.   He says we need structural reform of medicaid and medicare.   He is calling for deep cuts in domestic spending.   And all that Boehner can do is give a partisan speech and reject the package because the tea party wing in his own party won’t accept any new revenues?

Obama won the rhetorical war on Monday night with a call for citizens to contact their representatives and urge them to compromise (apparently the Congressional websites crashed from heavy volume right after his speech.)    Boehner vowed to try to win a partisan war to avoid tackling the issues and put off the question to another day.   His “super Congress” idea probably won’t yield anything not already discussed, it just buys him cover from the tea party faction of his own party.

I believe Boehner is better than that.   He knows not making an historic compromise now will threaten the American dream and risk putting the US on a path towards further dysfunction and severe economic crisis.    He has a good chance to win the partisan short term war and get his plan passed — but that might cause him to miss out on the long term compromise that’s needed to really get the country on the right track.    It’s time to put political posturing aside and make an historic compromise.   The economic future of the country is on the line.

46 Comments

A Game of Chicken With the Debt Ceiling?

When I was 16 a friend of mine challenged me to a game of chicken.   I had my 1963 Chevy Bel Aire, he had a 1966 Chevy Nova, both old cars.   He described the game — we’d go to a parking lot, start driving toward each other at high speeds, and the first to veer away would lose and have to buy the other a pizza and root beer.    After thinking it over we decided not to, and just went for the pizza.

In a game of chicken the key to winning is to convince the other person you are actually crazy enough to keep going straight ahead even if it means a potentially fatal head on collision.   The other person, realizing that his or her opponent might actually refuse to swerve will ‘chicken out’ and swerve away first, losing.   Two top quality players will wait until the last possible second and both swerve away in time to narrowly avert a crash.   That’s exciting!

Right now in Washington it appears  something analogous to a game of chicken is taking place.   The Republicans, in control of the House but neither the Senate nor the Presidency, what to use the debt ceiling issue to push through legislation that they would otherwise have no chance to pass given their relative lack of power.    The President, recognizing that the House needs to pass something, has tried to broker a compromise, promising significant spending cuts in exchange for both letting the Bush tax cuts expire and closing some loopholes.

Many Republicans, especially those in the Senate and probably House Speaker John Boehner, recognize that this is a good deal for them.    The cuts are significant, the revenue increases minor (still far below what taxes were after Reagan’s tax cut) and the people most upset are Obama’s own liberal base.   Take this deal and the GOP might be setting up a split in the Democratic party.

Speaker Boehner, however, has a problem with his own party — many of them seem to believe that compromise is a lack of principle, and they should stand firm.   So what if the government defaults — most of them don’t like government anyway!    Going into 2012 with the Democrats potentially threatening to take back the House, Boehner doesn’t want a Republican civil war, so he has to get a deal acceptable to his majority.

President Obama’s efforts to negotiate a deal went far, but ran into a barrier when the “Gang of Six” put forth their ideas.  This group of moderate/conservative Democrats and Republicans apparently had more revenues in their plan than Boehner and Obama had been talking about.   Politically, Obama now realized that to get a plan past the Democratic Senate he could not be closer to the GOP side than the Gang of Six was.   He had to increase the new revenues in his compromise plan, causing Boehner to walk out.

Realizing that the Senate rather than Obama was the big hurdle, Boehner sat down to work out a deal with Senate Majority leader Harry Reid.   After all, just as the Republicans in the House want something they can support, the Democrats in the Senate aren’t going to sign on to a partisan Republican bill.   Yes, the House has to pass it, but so does the Senate — and then it has to be something the President can sign.

Sunday night those meetings broke up without a positive conclusion, causing markets in Asia and Monday morning in the US to go down, fearing that the world’s largest economy and major super power might become insolvent.   Symbolically, this would mark the date when the US officially lost its perch as the world’s dominant power.   The potential chaos this could cause in markets scares even the most seasoned investors and bankers.     No one wants this, and some of the biggest donors in the GOP have sent a message to Senate Minority leader McConnell and Speaker Boehner that this would be catastrophic for the US.

Headlines Monday morning told of the talks breaking down, Boehner accused Reid of not bargaining in good faith, and Reid shot back that the Republicans want it “their way or the high way,” unable to compromise.   Meanwhile both the Treasury department and the Federal Reserve are working on contingency plans of what to do if the US defaults, silent about the specifics so as not to cause more market speculation.

To me this looks like a high stakes game of chicken.  Both sides know a head on collision would be potentially fatal to the US economy.     The Democrats come into this a bit stronger.   Besides having both the Senate and the Presidency, they’ve successfully cast this as the Republicans trying to simply get their way, unwilling to compromise.   Indeed, most Democrats in the House believe that compromise proposals out there already give too much to the GOP, they’d prefer the President to be less willing to compromise.

With time running out to reach an agreement to have it passed and signed by August 2nd, the two cars are racing towards each other.   Reid and Boehner stare coldly at each other as they step on the gas, determined to get the other to swerve first — to give in to their demands.   The analogy isn’t perfect.   To “swerve at the same time” they have to find ways to craft a compromise that each side can accept, even without enthusiasm.   There could be some creative flourishes (agree to consider a Balanced Budget amendment later?) or symbolic victories that can allow each side to “save face” for the concessions they make.

It appears the GOP would like to have the debt ceiling raised for a short period, to bring the issue back around election time.   That’s risky for both them and the Democrats.   It also could get a very negative reaction from markets.  The Senate probably will not back down on that — at least not in the form of  the GOP would prefer.

My prediction is that they will “swerve at the same time,” an argument will be made, each side will claim they gave up more than they wanted to, but it was necessary for the good of the country.   They’ll then say that if the voters strengthen their side in 2012 they’ll be in a stronger position, and this will become a campaign issue.   President Obama will hail the compromise, and this bit of political theater will pass.

Then again, sometimes in a game of chicken the two cars crash, even if both drivers realize too late that they’ve waited too long and try to swerve away.   Small miscalculations can have devastating consequences.   So now is the time that Reid and Boehner have to show they’re competent to steer their parties vehicles in this high stakes game.

Though as entertaining as this is, one has to wonder if this really is the best way to obtain compromise and help the country out of an economic crisis?

6 Comments