The Sunday Times (London)
August 14, 2011
by Irwin Stelzer
Stock markets gyrate, gold heads to $2,000 an ounce, America's credit rating is downgraded and politicians confer, pronounce and fulminate. How did we get here? And more importantly, where are we going?
We got to where we are because of bad policy-making. In America, the president decided to expand the reach of the state and use his grandchildren's credit cards to pay for it. The reaction was not long in coming: in the first congressional election after Barack Obama moved into the Oval Office, voters gave Republicans control of the House of Representatives and enough Senate seats to block any legislation the Democrats might try to ram through.
So we have a Democratic president determined to expand the state — the last budget he submitted called for a $10 trillion (£6.15trillion) increase in spending — backed by a party that sees its historic mission as preventing any erosion in the benefits promised pensioners, the sick, students and a host of other constituencies. In the opposing corner is a Republican party dominated by a faction that opposes all tax increases and is equally determined to shrink the state.
The result is a stand-off and rising double-digit, Greek-style deficits, with total government debt on a path to equal the value of all the goods and services the economy can produce in a year. That, say experts, means interest payments on the debt will claim so much of the nation's income that there will be less left over to sustain living standards.
In short, we in America got to where we are in much the same way that Britain got to where it is: through government spending so high as to require massive borrowing because, even though tax revenues were rising, they could not keep pace with faster-rising spending.
The similarities end there, however. Britain has a parliamentary dictatorship. If the opposition doesn't like the government's spending plans, it can vote "no" and write press releases and pamphlets. America has the checks and balances of the constitution — the president sends a budget to Congress, which immediately marks it dead on arrival. Then the bargaining begins. And with elections every two years, whatever one Congress finally agrees to can't bind the next one, making any long-term, credible deal difficult to come by.
The institutional arrangements in the eurozone are even less conducive to good policy-making. Unlike Britain and America, eurozone countries do not have control of their own economies — they surrendered that when they signed up to the euro. No eurozone country can print money, so monetary easing is not an option unless the European Central Bank decides it is — and the ECB will do so only if Germany doesn't object, which it most often does.
And no eurozone country has a currency that it can allow to depreciate, as Britain has done with sterling and America with the dollar, to drive growth by increasing exports. Greece and colleagues can become more competitive in our globalised economy only by cutting wages and increasing productivity, the latter a long-term process opposed by entrenched interests.
So we got to where we are by policies — made by man, changeable by man — that first assumed there is no tomorrow That process creates the danger of what economists call the austerity trap. This can happen if a cut in government spending forces the economy to shrink, in turn increasing the burden of debt payments, which do not shrink. That, say shadow chancellor Ed Balls and Obama, is what the economist John Maynard Keynes warned would happen, and what his acolytes say will happen unless both our countries, and the eurozone bureaucracy, ease up on austerity and continue borrowing, at least for now.
The anti-Keynesians respond that no country can borrow its way to prosperity or grow if it increases the tax burden on private-sector wealth producers instead of reining in spending: cut spending and borrowing and lower taxes, and ride the resultant growth to a new era of prosperity.
So we got to where we are by policies — made by man, changeable by man — that first assumed there is no tomorrow, or that if there is, future generations would pick up the bills for this generation's party. And because holders of differing views prefer to hurl at each other copies of Keynes and Friedrich Hayek, his arch rival, rather than compromise.
The underlying assumption that someone out there would indefinitely accept our IOUs is not as barmy as it sounds. China needs to keep its export machine humming. To do that, it undervalues its currency to keep its exports cheap for America's Walmart customers, and accepts pictures of American presidents printed on bits of paper in return for the products of its workers. It then uses those dollars to buy US Treasury IOUs.
That's why it is so unhappy that the ratings agency Standard & Poor's downgraded Treasury bonds. But other bond markets simply cannot absorb the more than $1 trillion that China must invest, so China will continue to buy US Treasuries.
As for the euroland countries, they, too, know — or at least assume — they have a creditor of last resort: Germany. Germany can let Ireland, Greece, Portugal, Spain and Italy wallow in their debt-ridden, no-growth economies until the bond markets declare them bust or bail them out. It has chosen bail over fail.
Why? Because Chancellor Angela Merkel knows that German banks hold a lot of dicey IOUs from those countries and might collapse if that paper is devalued or worthless.
So everyone is unhappy. Germany is angry with slothful residents of Europe's sunnier countries; eurozone politicians are unhappy with Germany for not lending still more to stricken countries; China is angry with the Americans because its loans might be repaid in devalued dollars; Obama is unhappy with the Republicans for refusing to raise taxes, and they with him for refusing to cut entitlements; Labour is unhappy with the government for inflicting too much pain on Ed Miliband's "squeezed middle" (everyone except bankers, it seems); and investors — except so-called "gold bugs" — are unhappy with just about everyone as the value of their pensions and portfolios follow the downward spiral pioneered by the value of their houses, and fluctuate unnervingly.
Most of all, America's voters are unhappy: only 40% approve of how the president is doing his job, only 10% approve of how Congress is behaving and about two-thirds think the country is on the wrong track.
That's the good news. Britain's voters more or less have to live with their government's policies for the next four years. Europe's voters have been effectively disenfranchised by a cunning bureaucracy that finds ways to avoid consulting them. And China's masses ask: "What is a voter?"
But America's voters will go to the polls in November next year and have an opportunity to choose between conflicting visions of their future. Their decision will be the first of two that will answer the question: where are we headed?
Voters will have an opportunity to endorse Obama and his party's vision of an America more like social democratic Europe: higher taxes, smaller cars, a high-cost energy economy run on wind and sun, government-run healthcare, slower growth and redistribution of income to increase equality. Or they can opt for a return to entrepreneurial capitalism with higher levels of inequality than Europeans and Obama find acceptable, and more rapid growth that would generate a flow of funds to the US Treasury with which to pay down debt.
The role of growth is important: it is common gossip in Washington that the Congressional Budget Office is about to lower the 3.5%-4.5% annual growth forecast embedded in the last budget the president submitted. The result: our $14 trillion deficit will increase not only by the $2.4 trillion called for in the recent debt-ceiling deal but by an additional $1.5 trillion over the next decade if growth forecasts are lowered by about two percentage points.
So development of pro-growth policies that might let America return to its traditional role as the engine that could drive the world economy is one part of the solution — and not beyond our grasp. These could include fewer regulations, especially on small businesses that can provide millions of new jobs; taxes that encourage growth and discourage pollution; removal of restrictions on the development of indigenous energy resources; anything else that imaginative politicians can think of.
The second decision will be whether to mount a sensible assault on the debt mountain, or continue borrowing until the only solution is to run the presses and pay creditors with depreciated dollars. That the first of these alternatives is feasible and available to policy-makers there is no doubt. There are plenty of examples from history.
Canada eliminated a huge deficit over three years when a conservative government stopped funding programmes not essential to future growth; Germany did it after reunification imposed the burden of a clapped-out East German economy on the more prosperous West; Britain did it when Margaret Thatcher reversed "inevitable" economic decline by restructuring the economy; America did it when Ronald Reagan substituted pro-growth tax and other reforms for Jimmy Carter's policies that had lumbered the nation with stagflation and malaise.
All of which brings us to Standard & Poor's decision to downgrade American debt. It is not true that there is no use in shooting the messenger: if he brings a wrong and unfounded message that does damage to a lot of people, shooting is an appropriate recourse. S&P has surely deserved its designation as a target.
It bases its downgrading of America not on its presumed competence as a financial analyst, but on its hitherto unnoticed expertise as a political analyst. S&P based its downgrade in good part on its view "that the effectiveness, stability and predictability of American policymaking and political institutions have weakened". It purports to have special insight that the commission created as part of the recent deal will be unable to cut the deficit, that pro-growth policies will not be introduced and that Congress will not find a combination of tax increases and spending cuts that will satisfy a majority and the president. Suffice to say, it has no inside track.
Fortunately, the down-rating will in the long run prove of little consequence for US borrowing costs, as markets will decide how much America must pay to borrow money: when Japan was down-rated, its borrowing costs fell rather than rose.
Unfortunately, the down-rating adds to business and consumer reluctance to spend in the face of a slowing economy. Which is why the Federal Reserve is doing what it can to shore up confidence, while the politicians put their minds to creating the policies that can bring talk of American and western decline to a screeching halt.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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