On the Contrary

I was clicking through the news shows and I picked up this snippet:  “Our problem is that we have overspent and have too much debt.”  This will be mantra of the talking heads who will advise us on what we are to do to fix our problems.  It is the conventional wisdom gone extreme.  Ask yourself this:  If we have spent too much and borrowed too much then is our fix to quit spending and don’t borrow anymore?  Only if you want to see the Great Depression repeated.

Republicans will take the political lead on this saying that the reason they failed and are out of favor is that they lost their way.  They allowed spending to get out of hand while they let government grow.  This is the same problem said another way.  By spending and not taxing, they had to borrow.  But once again, is this the root cause of our problems?  I don’t think so.  Let’s look at some of the underlying assumptions.

If your deficit gets too large and you have to continue borrowing, the theory is that you are taking too much money out of the economy for government use and you force the raising of interest values and shrinking of the economy.  Is that what is happening.  Credit dried up because banks were holding on to worthless paper that the mortgage bankers sold them, and they are holding on to their money because they don’t know who holds the rest of this paper and don’t want to incur any further losses by making bad loans.  Interest rates are quite low and the rest of the world is quite willing to buy our treasury bonds at historically low interest rates.  So much for that theory.

In reality conservative economic theory just doesn’t address the real issues: out of control and unregulated greed that put our whole financial system at risk with worthless investments in search of ever higher rates of return.  There was plenty of innovation, but it was in tricking ourselves that this bubble of increasing profit would not bust.  What the Republicans did was pretty much in line with their beliefs; they reduce regulation and lowered taxes to historically low rates and still we are facing a depression.  All the deficit spending did was give us less a pad to spend our way out of this problem.

So if you believe these hysterical pundits of old thinking, then our fix is to cut spending and pay off our deficit.  Yet almost every economist will tell you that what we really need is massive spending to get the economy rolling again.  Secretary of Treasury Paulson has been throwing money at the banks with no effect.  His classic mistake is conservative thinking:  If markets have liquidity, they will use the money in ways that will benefit all of us.  Instead they are all taking the money, backing up their bad bets, and hunkering down.  Adam Smith, the father of capitalist thought (Wealth of Nations) would have recognized this behavior:  self-interest and selfishness.  Conservatives will never bring themselves to actually planning and directing in the market place because they still believe in that magic hand and in these times that is their fatal flaw.  That is why during the Presidential election John McCain could not come up with some economic plan for our future.  Tax cuts and less regulation have run their course.  Cutting government now would be the death Nell for our economy.

I think everyone, except for conservatives who learned nothing from Herbert Hoover’s mistake in 1929, understands that President-Elect Obama’s call for a massive investment in infrastructure is a long overdue way to stimulate the economy and to start our recover.  It will require spending and borrowing to sustain it.  That is just the opposite from what the conventional wisdom is telling people.  We as a people have an important role to play in how our economy develops in the future if want a better life for our children.  So we as a people must decide where we want the market place and competition to go.  The past has been the assumption that the market place will find our path.  The new approach is that we will decide the destination and then let the market place operate within those constraints.  A simple example is alternate energy.  Right now the price of gas has gone down, and without guidance the market place is taking us back to oil dependence.  That is not where we want to go again so government will have to guide the market place by raising taxes on gas and then let the market place operate.

It really is no longer your father’s economy and whole new assumptions and understandings need to enter into our public discourse.  James Galbraith, in his book “The Pedator State”, has started that discussion, but you don’t see him on the cable news shows as they continue to spout the old slogans and reinforce the old beliefs that got us where we are today.  It is kind of like the Salem Witch Trails.  We still believe in the old voodoo and we are burning suspected heretics at the stake.  Our hope is that our new President has a brain and he is practical, not dogmatic.  He may just see this new truth.  Hopefully he can educate the rest of us.  At least I can hope.

Most Americans are starting to understand what deep doo-doo we are really in.  This economic crisis isn’t some minor hiccup that could pass.  It could bankrupt all of us.  Tom Friedman has been trying to wake people up to the fact that next year at this time things are going to be worse, a lot worse.  In his Sunday column, “We Found the WMD”, he tried to wake up America to the problem.  They will eventually do just that as businesses close and many of us face losing our homes and economic security.  But what will come next is the anger.  In his column on Wednesday, “All Fall Down”, he started to identify what happened.

“So many people were in on it: People who had no business buying a home, with nothing down and nothing to pay for two years; people who had no business pushing such mortgages, but made fortunes doing so; people who had no business bundling those loans into securities and selling them to third parties, as if they were AAA bonds, but made fortunes doing so; people who had no business rating those loans as AAA, but made a fortunes doing so; and people who had no business buying those bonds and putting them on their balance sheets so they could earn a little better yield, but made fortunes doing so.”

But it gets worse.  He quotes Michael Lewis of “Liars Poker”, a classic if you want to know how little morality there has never been on Wall Street, how the mangers were either grossly stupid or were in on the deal and knew it would all fail, but were in it to get their loot.  And as more people start to understand that these “Lions of Wall Street’ and the wonders of the marketplace was nothing more than a ponzi scheme to screw the rest of us there is going to anger, a lot of anger.

Now the initial problem is that banks won’t loan and the theory was that if we give them an infusion of cash, then they will loan.  But the Banks know something the rest of us are ignoring:  We have only seen the tip of the iceberg.  Banks know there is still a ton of bad paper out there not yet identified, but they don’t know who has it, so they don’t want to start the flow of cash to an institution that may not be around in a couple of months.  As Tom points out, we have no choice, we have to save them or we all go down.  But it hurts to bail out the people who really caused this thing.

The real problem right now is that the bailouts are based on old economic theory that you give the markets money and then you get out of the way or you hinder the invisible hand and screw up the whole thing.  What we really need is a piece of the action where the U.S. Government (we the people) can say here, have some money, lots of money, but you morons that got us into this thing, you are fired, there will be no bonuses, and if you don’t loan x% of what we give you, we will let you fail, and oh by the way, here are the new rules you will have to operate by.  Certainly we don’t want to go overboard and stop some investing that might look risky, but may be the venture capital for the next round of innovations.  But in the short term, we are going to have to take control because you need training wheels again to relearn you are part of the human community.

But here is the real lesson as your anger grows, that will be obfuscated by our friendly conservative zealots that got us into this mess who want to “cut spending and lower taxes”:  Conservative economic theory doesn’t work.  What we have had since Ronald Reagan is a belief that government has no role.  And they have proved it by, as James K. Galbraith put it in his book, “The Predator State”, “the systematic abuse of public institutions for private profit or, equivalently, the systematic undermining of public protections for the benefit of private clients.”  They have made greed king and they have promised you a free ride with the magic of the market place and trickle down economics.  It’s low taxes and no government and everything will be fine.  Let the Masters of the Universe create wealth for all of us.  And after 28 years of this nonsense we are in deep doo-doo.

And one last thing that may really make your head spin around.  Balanced budgets may not be a good thing.  Every time we focused on reducing the deficit to zero we killed our economy (this discounts the aberations of the Clinton years when the Dot Comm bubble had revenues up).  Savings may not be related to economic health on a macro-economic level.  Government spending isn’t necessarily bad and could in fact be the path to our salvation if it is invested in our future, not some hand out, stupid frivolous war, or tax cut.  The magical hand of the market place will not insure that the just get rewarded.  Putting money in the hands of citizens is not always the best answer, and governments have a major role in determining our path forward.  It’s called planning and our future depends on it.  Please don’t fall back on old ways of thinking that have put us right where we are right now, and that is in deep doo-doo.  Politicians are only good at spouting conventional wisdom to make you feel warm and fuzzy.  The way out of our economic disaster is going to be new thinking that makes you feel very uncomfortable.  Comfort is how we got here.

Paul O’Neil, then Secretary of State for George Bush, has told us that when he warned the Bush administration of a looming economic crisis in 2002, Dick Cheney replied, “Ronald Reagan proved that budget deficits don’t matter.” During the Carter years, the federal deficit had averaged $54.5 billion annually.  During the Reagan era, deficits skyrocketed, averaging $210.6 billion over the course of Reagan’s two terms in office.  Overall federal spending nearly doubled, from $590.9 billion in 1980 to $1.14 trillion in 1989. In those eight years, the United States moved from being the world’s largest international creditor to the largest debtor nation.  (Washington Post)

Right now we are in a real economic crisis and we have already authorized over $1 trillion in bailouts ($700 million for the banking crisis, and over $300 million for AIG). What many of us are calling for is a massive investment in infrastructure, alternate energy, R&D, and support of state programs to kick start our economy and get us back on track.  So if we are in such massive debt where is this money going to come from?  The answer is that we are going to borrow it.  Right now, deficits don’t matter.

Now there are a couple of reasons for this.  First it is one thing to create massive deficits so that you can cut taxes while partaking in frivolous foreign adventures, i.e. the Dick Cheney approach.  It is totally another thing to create a large deficit to invest in your future.  One is a free ride that will someday have to be paid for and the other is an investment in our future that should pay the dividends to pay for this investment.  Maybe this example will help.  Some students, especially doctors take out six figure loans to get through school.  For most of them it is a good investment, because in the future their income will allow them to easily pay off that loan and it will secure their future.  As James K. Galbraith, the economist professor at the LBJ School of Public Affairs at The University of Texas, stated in his interview with Bill Moyers last week:

“One of two things can happen. The government can take action and help stabilize the economy in which case we will have more spending but also more employment.  Or the government cannot take action and let the economy collapse in which case we will have much less tax revenue. The deficit is going to be larger either way. There is no way of avoiding that. The only question is do you work to have a good economy or do you accept a terrible economy?”

The second point is that the deficit, although larger than it was in the Bush or Clinton years, is not significantly growing as a percentage of GDP (Gross Domestic Product).  That is kind of like saying when you buy a home if your monthly payment is below a certain percentage of your monthly income, the bank figures you can afford the loan (these were the rules they blew off to create the current housing crunch).  Or as Professor Galbraith pointed out:

“Well, the deficit isn’t beyond sight. The deficits in the Bush administration in relation to the size of the economy were never all that large. They were certainly larger than they were under Clinton, but that was in part necessary because of the changed economic situation, the collapse of the dot-com bubble in 2000.”

And where are going to get that money?  It turns out that the dollar is remaining the anchor currency of the world economy; right now the euro is falling rapidly as the dollar rises.  Again as Professor Galbraith points out:

“Uncle Sam’s credit is excellent. Uncle Sam can borrow short term for practically nothing these days. Everybody wants to have Treasury Bills and bonds because they’re safe. Uncle Sam can borrow for 20 years at 4.3%. That’s the same rate that the United States could borrow at for 20 years in the last month of the Eisenhower administration. So from our point of view, we’re actually well placed, I mean, as the government of the United States is well placed to take the lead in pulling the country and the world out of this crisis.”

The biggest problem is going to have the political courage to stand up and convince America that the way out of our crisis is in the short term to increase the deficit.  Note that in all the debates the moderators all tried to push the question, what are you going to cut so you can afford your spending program.  The right answer is only those programs that do not work or are wasteful but we are not going to worry about the deficit right now.  If either candidate had said that, although exactly what we need to do, there would have been a media circus and attacks from the other side.  I am not the only one who thinks this way. Martin Wolf, the widely read columnist for the “Financial Times,” and the author of a new book, “Fixing Global Finance,” said (Fareed Zakaria GPS):

“ I do actually think that, though governments are heavily indebted, we are going to spend ourselves out of the recession. We’re going to have fiscal deficits in the Western world as a whole, which are going to be, as it were, unimaginable for some years. And the markets will swallow it, because they’ve got no other assets to buy now which they trust.”

It is going to be an uphill battle convincing our citizens and getting Republicans who have been nothing but obstructionist for the last 2 years, to understand this new dynamic and go along with it.  Hopefully Barack understands this and the voters will neuter the Republicans.