till the post S= kamp collapse and the clinton frugal miracle
then gwot ..now another squeeze down this one largely local
speaking of tranfer payments
For those who are interested in comparing and contrasting the current Great Recession with the Great Depression, Wikipedia has several interesting articles on the Great Depression. They are fact-filled; for instance, we were surprised to learn that in 1933 a group of millionaires, led by the Du Pont and J.P. Morgan empires, and alarmed by Roosevelt's plan to redistribute wealth from the rich to the poor, plotted to overthrow the Roosevelt administration by means of a military coup "and install a fascist government modeled after Mussolini's regime in Italy." Fortunately, the general whom they recruited to lead the uprising ratted on them to Congress. Since then, I suppose the would-be fascist businessmen have consoled themselves with fomenting military dictatorships abroad, in Latin America and elsewhere.
Wikipedia has a long, fact-filled and quite theoretical discussion of "The Causes of the Great Depression." It notes that some economists at the time (and later John Kenneth Galbraith), "popularized a theory that had some influence on Franklin D. Roosevelt. It held that the economy produced more goods than consumers could purchase, because the consumers did not have enough income. According to this view, in the 1920s wages had increased at a lower rate than labor productivity. Most of the benefits of the increased productivity went into profits, which went into the stock market bubble rather than into consumer purchases. Thus the unequal distribution of wealth throughout the 1920s caused the Great Depression.
"According to this view, the root cause of the Great Depression was global overinvestment while the level of wages and earnings from independent businesses fell short of creating enough purchasing power. It was argued that government should intervene by an increased taxation of the rich to help make income more equal. With the increased revenue the government could create public works to increase employment and 'kick start' the economy.
"In the USA the economic policies had been quite the opposite until 1932. The Revenue Act of 1932 and public works programs introduced in Hoover's last year as president and taken up by Roosevelt, created some redistribution of purchasing power."
We couldn't have said it much better ourselves, except perhaps to point out that the solution we favor, or at least would put on a par with putting more money into the hands of government to fund public works programs – as well as infrastructure, education, etc. -- is a set of fair wage policies that would put more money into the hands of working Americans.
"The Coming Crisis" Last Time Around
In June 2005, Lewis Lapham of Harper's Magazine hosted a forum on "the coming crisis." The three discussants included Paul Krugman and Glenn Hubbard. Predictably, Krugman thought that "there is a 50 percent chance that the outcome is pretty calamitous"…while Hubbard said that "nothing in this story suggests to me any kind of imminent crisis."
Nothing remarkable here, right? Both pundits were just taking their standard positions, Hubbard the incrementalism of the Chicago style of economics, and Krugman a Keynesian approach. And one could then go on to attack Hubbard for being out of touch with reality and to laud Krugman for being prescient?
But economic ideology and economic reality are not so neat. The feared crisis they were talking about was NOT the bursting of the domestic U.S. housing-centered financial bubble and the ensuing Great Recession, but the much-anticipated crisis of the debt-burdened dollar. If we had disclosed that the third person in the forum was Peter G. Peterson, we would have given the game away, because he has of course been the most outspoken critic of the government deficit, and the most apocalyptic in his forecasts of the consequences of debt.
We now know what crisis these experts should have been focusing on at the time. In 2007, about two years after this forum was held, the U.S. housing market collapsed, taking mortgages and other risky assets with it, and by 2008 the whole U.S. financial system was in crisis.
By March 2009 U.S. stocks had lost half their value. But not the dollar! And not U.S. Treasury bonds! When risk spread from the U.S. to investments across the world it was, paradoxically, the dollar that was increasingly seen as a safe haven. And U.S. Treasury securities were seen as the least risky assets, not the worthless paper instruments of a state desperately trying to fund endless deficits, like some banana republic. Part of the reason is that, while Americans have been preoccupied with their own financial and economic problems, people abroad have placed more emphasis on the problems in other countries like the weaker members of the euro bloc, and seen the U.S. economy in a more favorable light as relatively stable , and Treasury bills and bonds as "risk-free" securities.
Consider the record of the last seven years. As regards U.S. Treasury debt, the interest rate on the 30-year Treasury bond has fallen, not risen. It has hovered around 4% for much of that period, and is currently below 3%. True, the U.S. dollar index, reflecting the average price of the dollar in other currencies, has fluctuated considerably, but as of today it is down by only 10% or so (from a level of about 90 in 2005 to about 80). Taking a somewhat longer perspective, the index had admittedly peaked at around 120 in 2002, and from that point it had already fallen by about one third (to about 90) by the time of the forum in 2005. But these declines were relatively gradual and orderly.
By no stretch of the imagination, then, has there been any kind of dollar crisis, and the debt crisis that occurred in 2007-2009 and caused the economic depression was not a crisis of government debt but one of household and private financial sector debt. From the perspective of mid-2012, Paul Krugman deserves lower marks than Glenn Hubbard in this debate, predicting a dollar crisis that didn't happen. And Pete Peterson comes across as Chicken Little; so far, the sky hasn't fallen, as far as debt and the dollar are concerned.
The Coming Crisis This Time Around?
But somehow one gets a feeling that the financial markets are hiding more than they are revealing, that all is not hunky-dory with debt and the dollar. It is not only a matter of the sluggish state of the U.S. (and world) economy. There is a growing sense of unreality in the current economic debates, which are mostly of a short-term Keynesian nature, focused on whether the amount of government stimulus is enough to get us out of the Great Recession, or whether the spreading call for "austerity" in Europe and the U.S. could soon take the world economy in the other direction, toward a second dip of the recession.
Meanwhile, while most economists have remained focused on the Great Recession, the federal government deficit has still been there, averaging over $2 trillion a year during the four years 2008 to 2011. And the international trade deficit (including other "current account" items) has still been there – averaging $500 billion a year in those four years. But the financial markets don't seem to care, with investors now willing to buy 10-year U.S. Treasury notes with a coupon of under 2%, and Treasury bonds with a coupon of under 3%. Since inflation is expected to run at 2 or 3 percent a year, it appears that investors have such confidence in the financial probity of the United States that they are willing to invest in its sovereign debt at rates that are not hardly expected to keep up with inflation.
In fact, the only people who seem to care about this situation are hypocritical Republican politicians who, after turning a blind eye to the profligacy of the Bush years, want to use debt as a stick to beat down liberal budget proposals and "starve the beast" of government.
Meanwhile, as in the early stages of a horror movie, we in the audience sense that the protagonists are in great danger, while they are going about their lives in blissful ignorance. Our friend Martin Kenner likes to say, "It's the blow you don't see coming that knocks you down."
Trying to anticipate the blow that we haven't seen coming, we ask the direct question: at some point, won't the world's creditors say enough is enough when it comes to lending to the U.S. government? The U.S. government deficit is extending as far as the eye can see, but as Herb Stein said, "If something cannot go on forever, it will stop." Won't it be more and more clear to lenders that this is a case of good money following bad? Won't they knock U.S. Treasury securities from their "Risk Free" pedestal and demand an increasing risk premium?
It seems that there are two issues that will determine the feasibility of U.S. fiscal policies in the medium term. One is whether there are or will be credible signs that the U.S. is shifting from debt-dependence to fiscal prudence, i.e., from cyclical deficit in the short run to structural surplus in the long run. And the answer to this question at the present time must be no. Right now, the federal government has a valid cyclical reason for continuing with deficit financing, namely of course the need to stimulate the economy and bring it out of the recession. But the magnitude of the recession is such that there seems to be no end to the need for fiscal stimulus. Accordingly, the need for deficit spending will remain.
But the calls for prudent fiscal management are bound to grow. The easy part is behind us. From here on, politicians will increasingly attack the government for running an endless deficit, and they will also, inconsistently, resist the need to increase taxes on the wealthy and on business to pay for it. It is always easier for Congress to spend money beyond the government's means than to raise taxes. If and when, finally, the time for raising taxes comes, will Congress – and the American people -- be up to the challenge? And will they try to put the burden on those who can afford it, rather than on the poor and the middle class, who are already struggling?
The other issue is the relative confidence that investors and governments have in the U.S. economy (and polity) compared with that of the other major currency blocs. Today, the euro is the dollar's chief potential rival, but Europe is in a state of deficit and disarray. However, it is only prudent to expect that if and when Europe begins to stabilize and the euro becomes a more respected reserve currency, there will be an increase in the cost of borrowing by the U.S. And what about the relatively stable Japanese yen? And the rising Chinese renminbi?
So, after all, it seems the U.S. must sooner or later experience a time of reckoning in which it becomes hard to find buyers for the dollar or for Treasury bonds. The dollar must fall and inflation and interest rates must rise. But it is hard to predict the timing and shape of these and other associated developments.
One thing is clear: it will become much more difficult to finance the U.S. debt, and fiscal responses to that problem could be crucial. Government debt could be a huge drag on the economy, just as private household debt is now. In other words, while exports should help to strengthen the economy, the debt load could severely depress it.
The kind of partial analysis presented here focuses on a few economic and financial variables, and there are many other variables that will affect the developments discussed here, and in turn will be affected by them. To the extent that we experience a large fall of the dollar, it is likely that U.S. import prices and inflation will rise. U.S. exports will be more competitive internationally and should do well. To the extent that interest rates payable on fixed-interest investments rise, the cost of borrowing by Main Street firms will rise, which must have a depressing effect, other things equal. And bond prices (which move in the opposite direction) must fall, and investors will lose a lot of money during the transition to a higher-rate environment. Stock prices may hold up, however, if exports and earnings are rising. Much will depend on the responses of other countries. If U.S. exports gain market share, and the U.S. fends off competitive imports, the U.S. will succeed in exporting recession, but the reverse will be the case if other countries competitively devalue their currencies and there is a trade war in which the U.S. loses market share. Clearly, there is a complex set of interactions here. Not least, the accumulated national debt could have a potentially crippling effect on the economy, despite the boost from exports. Hopefully, however, this brief analysis will provide an introduction to some of the issues.
Joseph Stiglitz's new book, The Price of Inequality: How Today's Divided Society Endangers our Future. (W.W. Norton, New York, 2012) is a very important contribution to the debate about the harmful economic and other effects of extreme inequality. The book is broad and deep, and our quick review here will hardly even touch the surface. We would encourage people to read this well-written book in its entirety.
Stiglitz has no illusions about the way in which the market economy is working in the United States. He has lengthy discussions about rent seeking and market imperfections as sources of income of the 1%, and little confidence in the labor market as a mechanism for setting fair wages in the policy framework that has prevailed in the country in the last three or four decades.
Stiglitz's discussion (at pages 85 et seq.) of the harmful macroeconomic effects of inequality is worth quoting at length, because it decisively breaks rank with today's timid market economists:
It is perhaps no accident that this crisis, like the Great Depression, was preceded by large increases in equality: when money is concentrated at the top of society, the average American's spending is limited, or at least that would be the case in the absence of some artificial prop, which, in the years before the crisis, came in the form of a housing bubble fueled by Fed policies. The housing bubble created a consumption boom that gave the appearance that everything was fine. But as we soon learned, it was only a temporary palliative.
Moving money from the bottom to the top lowers consumption because higher-income individuals consume a smaller proportion of their income than do lower-income individuals (those at the top save 15 to 25 percent of their income, those at the bottom spend all of their income). The result: until and unless something else happens, such as an increase in investment or exports, total demand in the economy will be less than what the economy is capable of supplying – and that means there will be unemployment. In the 1990s that "something else" was the tech bubble; in the first decade of the 21st century, it was the housing bubble. Now the only recourse is government spending.
Unemployment can be blamed on a deficiency in aggregate demand (the total demand for goods and services in the economy, from consumers, from firms, by government, and by exporters); in some sense, the entire shortfall in aggregate demand – and hence in the U.S. economy – today can be blamed on the extremes of inequality. As we've seen, the top 1 percent of the population earns some 20 percent of U.S. national income. If that top 1 percent saves some 20 percent of its income, a shift of just 5 percentage points to the poor or middle who do not save – so the top 1 percent would still get 15 percent of the nation's income – would increase aggregate demand directly by 1 percentage point. But as that money recirculates, output would actually increase by some 1 ½ to 2 percentage points. In an economic downturn such as the current one, that would imply a decrease in the unemployment rate of a comparable amount. With unemployment in early 2012 standing at 8.3 percent, this kind of shift in income could have brought the unemployment rate down close to 6.3 percent. A broader redistribution, say, from the top 20 percent to the rest, would have brought down the unemployment further, to a more normal 5 to 6 percent.
Stiglitz explains how the government's response to weak demand – low interest rates – led to bubbles in tech investments and housing – how deregulation made things worse, and how what we now call "austerity" has reduced government spending, the reverse of what was required.
One should note, however, that Stiglitz's argument on the effects of inequality is more descriptive and less analytical than that of Michael Kumhof and Romain Ranciere, which was reviewed on this blog on May 15: Inequality, Leverage and Crisis, IMF Working Paper WP/10/268, November 2010. Their paper really nailed the issue by developing a model that traced the causation from inequality to leverage (excessive mortgage borrowing) and crisis when the mortgage bubble burst.
A footnote on the OECD Economic Survey of the U.S.
The OECD's June 2012 Economic Survey of the United State contains a much weaker discussion than that of Stiglitz or Kumhof and Ranciere. It is agnostic regarding the macroeconomic damage caused by inequality, concluding that "there is no consensus in the economic literature that reducing inequality would be harmful to economic growth." Which falls short of a finding that reducing inequality – at least, reducing extreme inequality -- would actually be beneficial to economic growth, as clearly shown by Stiglitz, and Kumhof and Ranciere, and argued in the founding paper of this blog (see Home Page, click on "Read the Paper").
Needless to say, waiting for consensus on inequality among wobbly-kneed economists would be like waiting for consensus on climate change or the theory of evolution among Kentucky Republicans. The closest the OECD gets to the nub of the recent problems is the half-hearted statement that "Some have identified income inequality as one of the causes of the financial crisis since it may have encouraged subprime borrowing by households who tried to make up for their lack of income." It does not mention the complementary problem that the excessive savings of corporations and the wealthy provided the supply side of the subprime bubble, and the way in which the Fed enabled the growth of unsustainable subprime mortgages by its policy of easy money and lax regulation.