Before the release of the employment report last Friday the stock market futures were indicating a modest drop at the open. The putative cause of the downward bias was a report on potential debt problems in another backwater of Europe, this time Hungary. While it is possible that the Hungary issue could have continued to weigh on the market it seems unlikely that it would have caused the 3%+ drop in stocks we got as a result of the lousy employment report. And that is something to remember the next time you hear some talking head pontificating about an event that common sense tells you is peripheral -at most -to the US economy. If this stock market correction turns into something worse it will not be because of Europe’s or any other region’s mis-steps. It will be because the counter-cyclical macro economic policy of fiscal and monetary stimulus has finally failed. It will be because decades of trying to avoid the consequences of previous policy mistakes has finally caught up with us. It will be because our leaders refuse to hear the message of the market.
The US economy is still the largest, by far, in the world. We are the 800 pound gorilla and no matter what transpires in the Club Med countries or Eastern Europe or anywhere else, we control our own fate. Other countries do not have that luxury but we do and frankly we have abused the privilege. The economy has been recovering over the last year which is what economies always do after a recession, usually in spite of the ministrations of whatever political party is in power. During that time I have been diplomatic about the Obama administration’s policies, as I was about the Bush administration’s, because until now I’ve always thought of politicians as only having the ability to affect things at the margin and I didn’t think the Obama administration could or would do any more damage than past administrations. I’ve always believed that both sides tend to overstate the effects of their preferred policies to gain political advantage and I still think that is true, but President Obama had the poor luck to gain office at a time when there was little room for error. Unfortunately, I think he has overstepped the limited bounds of acceptable policy choices given the conditions he was confronted with when he took office.
The employment report caused the market to drop over 3% on Friday because there is a fear that the policies of the current administration are no different in substance than the policies that produced a debt crisis in Greece and maybe the rest of Europe. While the Obama administration continues to claim that their spending and deficits are temporary and a result of the economic condition, there is a fear, fed by unrealistic health care budget assumptions that are now being revealed as false and possibly deceptive, that the administration is playing fast and loose with the facts - again - to gain mere political advantage. There is a fear that the employment report is a precursor to a return to recession and that the course of policy makes that a more, rather than less, likely outcome. There is a fear that the entire political class and not just the Obama administration just doesn’t get it and after decades of essentially following similar borrow from the future policies, that neither political party will have the will to make the necessary changes to improve our standard of living. Keynes said that in the long run we are all dead but I believe the long run is pretty short right now and may have in fact already arrived.
If it hasn’t dawned on the political class yet, allow me to introduce them to reality. Whether the party in power borrows from the future to fund tax cuts for the present or whether it borrows from the future to fund spending for the present is irrelevant now. What matters is the borrowing and the build up of debt that is approaching a level that we cannot ever afford to pay. Those who fear that a premature removal of the “stimulus” will cause a return to recession have it exactly backwards. The risk at this point is that we wait too long to address our debt addiction and the market forces our hand as it continues to do in Europe. If we wait as Greece, Spain, et. al. have, the fiscal contraction will have to be larger than if we get ahead of the curve by making the necessary changes now.
What the US needs right now - what the world needs - is leadership rather than the pursuit of narrow political advantage. We need a leader willing to make hard decisions that will involve a lot more than the composition of another toothless commission to study what no longer needs studying. It isn’t just the deficits that matter but how they are addressed. Simply raising taxes and pretending that it won’t affect economic behavior will not yield the expected market response. Returning the budget to anything resembling responsible will require a combination of changes that are much more drastic than anything being currently considered. It will require actually cutting spending rather than just cutting the rate of increase and pretending that something has been accomplished. It may require re-thinking the composition of the health care reform changes. It will undoubtedly require a change in the composition of taxes - less on capital and wages, more on consumption - if a deep recession is to be avoided. It will require a complete reassessment of our military commitments. Leadership will mean confronting Congress and the lobbyists who write the legislation they pass. It must mean confronting the financial industry and passing simple reforms such as higher capital requirements that will no doubt reduce their profits. It must entail a break up of the way too cozy relationship between big business and big government.
The problems facing the US economy are not insurmountable but they have been allowed to fester too long. Decades of accumulating debt and borrowing from the future have brought us to this day of reckoning but it doesn’t have to mean more pain. It should be seen as an opportunity to finally make changes that a public pacified with another dose of credit would not allow. There is plenty of evidence that cutting government spending at this point does not have to be an economic drag and indeed may be an actual stimulus (see here and here). The market will respond positively to real cuts in government waste and other pro growth policies but attempts to reach balance by taking more from the private sector are likely to be self defeating. Furthermore, a contractionary spending policy can be offset by an expansionary monetary policy since it would likely be accompanied by a capital inflow that supports the value of the dollar. An expansionary monetary policy that stabilizes the dollar would more than offset any drag caused by the reduction in spending.
It is time for President Obama to reject the failed policies of both political parties and take bold action. A policy mix of reduced spending, reduced taxes on capital and wages and a rise in consumption taxes would allow the Federal Reserve to pursue a more expansionary monetary policy while stabilizing the value of the dollar. The result would be higher growth, lower deficits and stable inflation expectations. Achieving this result only requires that President Obama do what he was elected to do and has failed at so far - make real changes and do what is right regardless of whether it is popular. And make no mistake, spending irresponsibly and raising taxes in the teeth of a feeble economic recovery isn’t right, popular or effective.
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very good commenatry, as always :)
Thanks, john b.
I toatlly agree with you but the chances of anything changing is nil.
I’m not so sure about that. We need to just keep throwing out the entrenched politicians until they all get the message. We threw out the Republicans four years ago because they didn’t get it and now we need to throw out the Democrats because they don’t get it either. Politicians like everyone else will act in their own best interests. We need to make sure that their best interests - getting re-elected - can only be protected by acting in our best interests.
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