Barack Obama must choose between high unemployment or large fiscal deficits. It’s one or the other. If he chooses to increase government spending and provide a second round of stimulus; unemployment will fall, the output gap will narrow, business confidence will strengthen, and the economy will continue on the path of recovery. If he refuses to provide more stimulus; unemployment will hover around 10 per cent, credit will continue to contract, confidence will flag, and the economy will underperform for years to come. And–surprise, surprise–the deficits will balloon anyway, because household deleveraging is going to continue regardless of what the administration does. That will slow consumer spending and reduce tax revenues which will only add to the budget shortfall. So, it’s not a matter of whether we will have deficits or not. We will, no matter what. The question is whether we’ll suck-it-up and do what needs to be done (by investing in our future and putting people back to work) or follow some monkish austerity program which will only make matters worse.
The media has played a big role in fueling deficit hysteria. It’s all part of a well-funded public relations campaign aimed at putting the government on a starvation diet. The long-term goal is to privatize public assets, crush the labor movement, and dismantle the social safety net. A recent article in CounterPunch by Ellen Brown exposes some of the people behind the “fiscal responsibility” movement and shows that what they really want is to divert Social Security benefits into a “mandatory savings tax” that would be automatically withdrawn from workers paychecks into an “investment pool” that Wall Street bankers would manage. Nice, eh? The banksters would rather skip the niggling task of fleecing their victims themselves and, instead, have the remittances posted directly to their accounts. It’s more efficient that way. Here’s an excerpt from Brown’s article:
“When billionaires pledge a billion dollars to educate people to the evils of something, it is always good to peer closely at what they are up to. Hedge fund magnate Peter G. Peterson was formerly Chairman of the Council on Foreign Relations and head of the New York Federal Reserve. He is now senior chairman of Blackstone Group… Peterson is also founder of the Peter Peterson Foundation, which has adopted the cause of imposing “fiscal responsibility” on Congress. He hired David M. Walker, former head of the Government Accounting Office, to spearhead a massive campaign to reduce the runaway federal debt, which the Peterson/Walker team blames on reckless government and consumer spending. The Foundation funded the movie “I.O.U.S.A.” to amass popular support for their cause, which largely revolves around dismantling Social Security and Medicare benefits as a way to cut costs and return to “fiscal responsibility. “
To summarize, deficit hysteria is a hoax concocted by far-right demagogues who are trying to advance their socially-destructive agenda for their own personal gain. Fortunately, the opposition has mounted an impressive counter-attack and refuted many of the spurious claims made by the deficit worrywarts. New York Times columnist Paul Krugman has done a particularly good job of educating the public on the issue and analyzing the movement’s supporters. Here’s a clip from his article titled “Fiscal scare Tactics”:
“To me …the sudden outbreak of deficit hysteria brings back memories of the groupthink that took hold during the run-up to the Iraq war. Now, as then, dubious allegations, not backed by hard evidence, are being reported as if they have been established beyond a shadow of a doubt. Now, as then, much of the political and media establishments have bought into the notion that we must take drastic action quickly, even though there hasn’t been any new information to justify this sudden urgency. Now, as then, those who challenge the prevailing narrative, no matter how strong their case and no matter how solid their background, are being marginalized.
“True, there is a longer-term budget problem. ….But there’s no reason to panic about budget prospects for the next few years, or even for the next decade (because) interest payments on federal debt; according to the projections, a decade from now they’ll have risen to 3.5 percent of G.D.P. How scary is that? It’s about the same as interest costs under the first President Bush.
“Thanks to deficit hysteria, Washington now has its priorities all wrong: all the talk is about how to shave a few billion dollars off government spending, while there’s hardly any willingness to tackle mass unemployment. Policy is headed in the wrong direction — and millions of Americans will pay the price.”
The basic problem is not hard to grasp; the private sector (us) cannot save unless the public sector (the government) runs a deficit. The surpluses of the Clinton era were produced by private sector deficits. In other words, the buildup of household debt during the late 1990s and early 2000s, (remember all that debt-fueled consumption?) allowed the federal government to run a surplus. Now that the bubble has burst, the process has switched into reverse. Consumers are no longer able to spent at pre-crisis levels because the value of their main assets–their homes and their retirements funds–has dropped precipitously. Thus, households will have to cut back on their spending and either pay-down their debts or set more money aside to repair their balance sheets. The slowdown in spending, along with the reduction in bank lending and consumer credit, will push the economy back into recession unless the government steps up its spending and increases the deficits. So far, Obama’s fiscal stimulus has performed as well as can be expected by reducing the output gap and increasing employment by roughly 2 per cent. But the original stimulus (\$787 billion) was not nearly large enough to fill the capital-hole created by the financial meltdown. We need another jolt. Also, the effects of the stimulus will begin to diminish in the second half of 2010. That’s why economists are so concerned, because without additional stimulus, more slack will build-up in the system and a large portion of the workforce will remain jobless.
US households sustained huge losses during the recession; nearly \$12 trillion has been slashed from home equity and personal savings in the last two years. Millions of baby boomers, who believed they had sufficient savings for retirement, now must either put off their retirement and work longer, or cut back sharply on spending to pad the nest-egg. The process of deleveraging typically lasts for 6 to 7 years following a financial crisis, according to McKinsey Global Institute. Unfortunately, recent data show that US households have barely begun the process. Their debt-to-disposable income ratio is still extremely high and must return to its historic trend. That means they will not be able to spend as freely as they did before. As private spending slows, businesses will be forced to reduce inventory, lay off workers, and curtail investment. (There’s no need to reinvest when the system is already saturated with overcapacity.) When consumers can’t spend, and businesses have no incentive to invest; the economy nosedives. The government can either boost stimulus to make up for the loss in activity or cut spending and risk another recession.
Traditionally, liberals have aligned themselves with progressive economic theory (Keynes) which recommends running large fiscal deficits during downturns. Past experience indicates this is the most effective approach, although the strategy does have its critics. Many of those same critics, however, believe that the United States is at risk of a sovereign default, which is a ridiculous idea that demonstrates a basic lack of understanding about the monetary system. When a nation pays its debts in its own currency, like the US, it can inflate its currency, but not default. This is just more demagoguery from deficit hawks similar to their nonsensical blather about looming hyperinflation. That won’t happen either. In fact, in the short term the biggest danger is disinflation leading to outright deflation. Now that the Fed is winding down its lending facilities and ending quantitative easing (QE) and Obama’s stimulus is dissipating; the signs of contraction are becoming more and more apparent. Consumer credit is shrinking, M3 is dropping, unemployment remains stubbornly high, and core inflation is falling fast (which, in effect, raises real interest rates.)
What does it all mean? It means the Fed has backed itself into a corner and may have to resume its bond-purchasing program to pump more liquidity into the financial system to avoid a downward spiral. We are not out of the deflationary woods yet. Not by a long-shot.
So we need more stimulus and we need it now. Unfortunately, the deficit hawks have persuaded a narrow majority of the people that, what the economy really needs, is a systemwide debt-purge that will drive down assets prices, increase defaults, and send blood running out into the streets. “Liquidate everything!” Somehow this claptrap has even caught fire with people on the left. It makes the prospect of a double dip recession even more likely.
Be careful what you wish for …
But there are pitfalls to budget surpluses as economist Randall Wray points out in his article “The Federal Budget is NOT like a Household Budget” on New Deal 2.0:
“The US federal government is 221 years old, if we date its birth to the adoption of the Constitution….With one brief exception, the federal government has been in debt every year since 1776. In January 1835, for the first and only time in U.S. history, the public debt was retired, and a budget surplus was maintained for the next two years in order to accumulate what Treasury Secretary Levi Woodbury called “a fund to meet future deficits.” In 1837 the economy collapsed into a deep depression that drove the budget into deficit, and the federal government has been in debt ever since. Since 1776 there have been exactly seven periods of substantial budget surpluses and significant reduction of the debt. From 1817 to 1821 the national debt fell by 29 per cent; from 1823 to 1836 it was eliminated (Jackson’s efforts); from 1852 to 1857 it fell by 59 per cent, from 1867 to 1873 by 27 per cent, from 1880 to 1893 by more than 50 per cent, and from 1920 to 1930 by about a third. Of course, the last time we ran a budget surplus was during the Clinton years. I do not know any household that has been able to run budget deficits for approximately 190 out of the past 230-odd years, and to accumulate debt virtually nonstop since 1837.
“The United States has also experienced six periods of depression. The depressions began in 1819, 1837, 1857, 1873, 1893, and 1929. (Do you see any pattern? Take a look at the dates listed above.) With the exception of the Clinton surpluses, EVERY SIGNIFICANT REDUCTION OF THE OUTSTANDING DEBT HAS BEEN FOLLOWED BY A DEPRESSION, and every depression has been preceded by significant debt reduction….our less serious downturns have almost always been preceded by reductions of federal budget deficits. I don’t know of any case of a national depression caused by a household budget surplus.” (Randall Wray, “The Federal Budget is NOT like a Household Budget: Here’s Why”, New deal 2.0)
Repeat: The seven periods of budget surpluses in the US were followed by six Depressions. Will this be the seventh? It depends on whether sanity prevails and Obama pushes another stimulus package through congress. Otherwise, we’re toast.
MIKE WHITNEY lives in Washington state and can be reached at [email protected]