Buy a link now!
Illustration by Mario Hugo
As Americans celebrate the 235th anniversary of their independence, the country is embroiled in a typically noisy debate. This time, the argument centers around whether Congress should raise the ceiling on national debt in the interest of preventing a potential government default. The issue has proved to be partisan catnip. The GOP opposes any new taxes to pay down the U.S. debt, which is close to 95 percent of the country’s gross domestic product, on the basis that government has created this problem and that more government cannot be the answer. The U.S. debt burden, House Speaker John Boehner says, “can be traced to a misguided belief by politicians that the American economy is something that can be … influenced positively by government intervention and borrowing.”
Republicans want deep cuts in government spending to be part of any deal to raise the debt ceiling. Democrats counter that such measures would imperil the recovery. And they insist that robust government remains a key element of future growth. “We can’t cut our way to prosperity,” President Barack Obama recently said.
Government as the problem, government as a solution: The impasse over the debt is new, but the debate is old. From the Progressive Era of the late 19th century through the laissez-faire of the 1920s, from the New Deal and the Great Society to Ronald Reagan’s declaration that “government is the problem,” perhaps the only thing the left and the right have agreed on is that government matters. Liberals believe that if government does its job well, prosperity will follow. Conservatives argue that good government is less government, but they are no less obsessed with the role that Washington plays. Our entire political and economic debate takes place in the context of a shared assumption that government determines the nation’s collective economic success or failure, either because of the harm it does or because of the good.
But what if this assumption is wrong? What if government is neither a solution nor a problem? What if, when it comes to dealing with the economic challenges facing the U.S. today, government actually doesn’t matter?
When Herbert Hoover refused to intervene in the wake of the financial crisis in 1929, he was adhering to a 19th century worldview: Government’s role in the life of society was less important than the natural ebbs and flows of the market. The Great Depression and New Deal banished that philosophy to the extreme periphery. In the decades since, the consensus among policy makers pretty much everywhere—from Washington to Brussels, from the former Soviet Union to present-day China—is that government pulls the levers that determine economic health.
That’s no longer true. Today, the ability of any state to govern and control its own domestic economy is severely constrained. One key area is interest rates. In 2005, Alan Greenspan, then chairman of the Federal Reserve, confessed that he was stumped. Under his direction, the Fed had been steadily raising short-term interest rates, with the expectation that long-term rates would rise in response, thereby moderating economic activity, reducing the risk of inflation, and cooling off the steady rise in home prices in the U.S. Yet, long-term rates refused to budge much, staying stubbornly in the range of 4 percent. Greenspan dubbed this anomaly a “conundrum.”
Actually, the conundrum was the product of static models trampled by a changing world. When the U.S. economy was a closed system, as it was for the bulk of the 20th century, the decisions of the central bank shaped the cost of capital and interest rates along the entire curve. Now, however, a global market of buyers and sellers sets interest rates, and short-term rates (which are all the Fed can directly control) are only one factor. This became even more evident after the 2008 financial crisis, when the Fed slashed short-term rates to zero. Again, long-term rates remained in the range of 4 percent. Although they have since declined to around 3 percent, they have done so because that is the level at which capital is priced by a global market of institutions and not because any single government has pegged them there.
©2011 Bloomberg L.P. All Rights Reserved.
Read Full Article »