President Obama, deficit terrorism is not the answer!
Friday, 11/13/2009 - 4:28 pm by Marshall Auerback | 19 Comments
Has Obama fallen victim to deficit mythology that will cripple our recovery? Marshall Auerback thinks so.
Oh dear, there he goes again.
After sensibly calling for a jobs summit to deal with the problem of rising unemployment, President Obama’s Herbert Hoover-like alter ego has re-emerged again to warn us again about the evils of government deficit spending. According to Politico.com, the President “plans to announce in next year’s State of the Union address that he wants to focus extensively on cutting the federal deficit in 2010 — and will downplay other new domestic spending beyond jobs programs, according to top aides involved in the planning.”
The President and his economic advisors are now being driven by the polls, which, in turn, are being driven by the deficit myths of their own creation. It is a case of the blind leading the blind down the rabbit hole. They impose political constraints on their own actions in a manner which is highly destructive in terms of securing their prized legislative goals (like the health care debate, where all decent policy proposals have foundered on the question of “how are we going to make this ‘deficit neutral’”?).
The Administration fails to understand that the “solution” of cutting back government spending is not a solution at all. It won’t actually achieve the “desired” result because the destruction of tax revenue through a declining economy — caused by the cutbacks in spending — will run counter to the President’s stated (and misguided) goal. There are two ways to obtain large budget deficits: the “ugly” way and the “virtuous” way. Like Japan during it’s “lost decade,” we have mostly gotten the deficits the bad way–by destruction of tax revenue caused by a collapsing private sector. Early fiscal measures have done enough to stabilize aggregate demand, but done little to generate sustained recovery. So they get discredited and public debt trap questions keep getting raised, which in turn inhibits a fiscal response properly sized and held. The economy waffles through stagnation.
Now, I realize that some of the economic moralists amongst us think that cutting back government spending is a wonderful thing because we will “purge” the system of its “socialistic” tendencies (see Governor Rick Perry of Texas) and end “malinvestment.” But that’s an interesting social experiment I hope the President is not prepared to undertake.
At the core, we have a problem of insufficient aggregate demand. The government is the only entity in a position to remedy that problem, because only the government can create new net financial assets via spending. There are any number of measures which would have an almost instantaneous impact in terms of improving aggregate incomes and demand. A national payroll tax holiday, revenue sharing with the states (so as to preclude additional cuts in state spending which offset the Federal fiscal stimulus) and a government as employer of last resort (an idea we plan to expand on further in a subsequent New Deal 2.0 posting) would all do the trick.
In the 1930s, we had a president who was unafraid to embrace bold experimentation. He wasn’t always right, but by the end of 1934, more than 20 million Americans (one out of six) were receiving jobs or public assistance of one form or another from the “Welfare State”. The system remained viable thanks to FDR. As I’ve written elsewhere, the government hired unemployed Americans to work on projects that advanced our society during the Great Depression:
“The government hired about 60 per cent of the unemployed in public works and conservation projects that planted a billion trees, saved the whooping crane, modernized rural America, and built such diverse projects as the Cathedral of Learning in Pittsburgh, the Montana state capitol, much of the Chicago lakefront, New York’s Lincoln Tunnel and Triborough Bridge complex, the Tennessee Valley Authority and the aircraft carriers Enterprise and Yorktown.
It also built or renovated 2,500 hospitals, 45,000 schools, 13,000 parks and playgrounds, 7,800 bridges, 700,000 miles of roads, and a thousand airfields. And it employed 50,000 teachers, rebuilt the country’s entire rural school system, and hired 3,000 writers, musicians, sculptors and painters, including Willem de Kooning and Jackson Pollock.”
On housing (a huge contributor to the current crisis), both L. Randall Wray and Eric Tymoigne have argued,
“A more effective way to restart the economic process on the solid ground is to deal with the underlying cause of the problem: borrowers cannot meet the required payments. This implies sustaining their income and employment and, if necessary, drastically modifying their debt service burden. The whole boom of the 2000s (and more broadly the growth process that emerged at the in the early 1980s) was based on household borrowing and the continuation of negative saving trends (that is, household deficit spending).”
One good place to start would be loan modifications, which would have a much more beneficial impact than what we’re doing now. Today, when the homeowner stops making payments, the mortgage company that services the loan makes the payments that are then distributed to the securities holders, so the economic incentives actually discourage active loan modification and worsen the home owner’s personal balance sheet. It is in the interest of the mortgage companies that service mortgages to maximize the number of delinquencies as well as the amount of time each household is delinquent.
A vastly superior alternative would be a Home Owners’ Loan Corporation (HOLC) type of entity, advocated as early as January 2008 by Paul Davidson:
“In 1933, the Home Owners Refinancing Act created the Home Owners’ Loan Corporation (HOLC) to refinance homes to prevent foreclosures, and also to bail out mortgage holding banks. The HOLC was a tremendous success, making one million low-interest loans which often extended the pay-off period of the original loan, thereby significantly reducing the monthly payments to amounts that homeowners could afford. In its years of operation, the HOLC not only paid all its bills, but it also made a small profit.”
To be sure, any program designed to increase incomes and aggregate demand will certainly require a major increase in government spending, precisely the opposite of what Obama is calling for right now. Even a focus on the “jobs deficit” is misguided because the President fails to understand that it is the overall growth in government spending which will facilitate private sector deleveraging, not the selective application of government. But if the President is genuinely concerned about spending too much money, he can simply redeploy part of the $23.7 trillion committed to help the banks to finance the programs above.
In any event, the President’s single-minded focus on the budget deficit is profoundly misguided. Why? Because a sovereign government can always afford to buy anything that is for sale in its own currency –whether that is unemployed labor, real estate, or bad financial assets. This focus on “affordability” and “fiscal sustainability” is ridiculous: these are empty phrases which mean nothing when divorced from the economic backdrop. The size of the deficit is irrelevant in itself. There is no meaning in the terms a large deficit or a small deficit. You have to relate them to the extent of labor and capital underutilization, which is a human measure of the aggregate demand deficiency. The fact that labor underutilization is now in excess of 17.5 per cent in the US (combined unemployment, underemployment and hidden unemployment) and capacity utilization is in the 60-65 per cent range rather than 90 per cent range sends one very clear message - the deficit is not large enough.
In a year Obama has gone from “we cannot afford not to do this” to “we’ve run out of money”.
If we continue down this path, such that robust recovery does not begin for many years, we will have large budget deficits for many years to come. Of course, it could always get worse –if Obama is serious about his singular focus on the deficit, which I fear he is.
Roosevelt Institute Braintruster Marshall Auerback is a market analyst and commentator.
Hm, I wonder what we should expect when most of his economic advisers are from the Clinton presidency, and they’re probably still basking in the conventional wisdom that the Clinton-era budget surpluses were wonderful.
Posted by Zach P | November 13th, 2009 at 9:11 pm
That’s the problem, Zach. In many respects, it’s even worse than that. In the first 2 years of the Clinton Administration, there were a few genuinely progressive voices in the Cabinet, such as Robert Reich. Similarly, in FDR’s first cabinet, he had fiscal conservatives like Lewis Douglas and Henry Morgenthau, but he also had figures such as Frances Perkins, Harold Ickes, Henry Wallace, and Harry Hopkins. Who are the progressive figures in Obama’s administration? There are none.
Posted by Marshall Auerback | November 13th, 2009 at 11:24 pm
He is always trying to compromise (mostly with lunatics) and find the middle way. I don’t understand how we are going to combat Peak Oil/Climate Change with such timidity. I believe it was in february when Obama declared the need for a fiscal responsibility summit. My God! Does the Pete Peterson crowd have some sort of Obama voodoo doll? What happened to the guy I voted for?
Posted by nope | November 13th, 2009 at 11:41 pm
I have a good friend, who’s a conservative (although a very open-minded one, he’s against the wars, supports equal rights for gays, etc.) who I discuss politics with almost daily. But he cannot get his mind out of the “affordability” box that has been built around his head and pretty much everyone else’s. I’ve linked him to several of yours and Wray’s posts but he is determined to believe the nation cannot “afford” universal health care, at least until the wars end.
Posted by Zach P | November 13th, 2009 at 11:59 pm
It’s a hard concept to understand. But as a point of logic, under a fiat currency system, spending logically precedes tax collection. It’s like printing up tickets for a Super Bowl. You buy the tickets, and it looks like the purchase brings forthe the production of the ticket and “funds” it, but the tikcets were printed first before you bought one. Same thing with government spending. The government must likewise spend sufficiently before it can borrow. Thus, government spending must also, as a point of logic, precede security sales. To cite a ‘real world’ example, market participants recognize that when Treasury securities are paid for, increasing treasury balances at the Fed, the Fed does ‘repos’ on the same day; the Fed must ‘add’ so the Treasury can get paid. Since the currency issuer does not need to borrow its own money to spend, security sales, like taxes, must have some other purpose. That purpose in a typical state money system is to manage aggregate bank reserves and control short-term interest rates (overnight inter-bank lending rate, or Fed Funds rate in the U.S.).
Posted by Marshall Auerback | November 14th, 2009 at 12:12 am
I remember an interview with Paul Samuelson some time back. He said that a run on the dollar would happen eventually. Marshall, what exactly does that mean? I’ve heard the usual Austrian-gibberish about Zimbabwe hyperinflation. What’s the truth? Please explain.
Posted by nope | November 14th, 2009 at 7:31 am
“The fact that labor underutilization is now in excess of 17.5 per cent in the US (combined unemployment, underemployment and hidden unemployment) and capacity utilization is in the 60-65 per cent range rather than 90 per cent range sends one very clear message – the deficit is not large enough”
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Your thinking is bass-ackwards. The US has created chronic and structural over capacity by the wealth illusion of private debt. Without consumer debt continuing it’s parabolic and unsustainable rise, this over capacity can’t be absorbed. The US has too many workers, dollars, debts,strip malls, office complexes, houses, etc.
Posted by Mark G. | November 14th, 2009 at 10:05 am
Nice post Marshall. For “Nope”: Remember that Paul Samuelson also announced in the late 1960s that he and fellow economists had resolved the problem of the business cycle once and for all. He did not understand the operation of the economy back then, and he still does not.
The US is the biggest economy in the world and is used by the world’s exporters as the “buyer of last resort”. Note the most recent data showing US net imports rising–as the world turns to its buyer. The dollar did take a hit as global financial players worried about all our bad (private) assets; however, US Treasuries always looked good and will look better as the players come to recognize default risk on Euro nation debt. China is strong, but their financial markets are too risky for outsiders. Yes, the dollar floats and there will be ups and downs, but a wholescale run out of the dollar (which requires a run into something else) is not going to occur.
Posted by L. Randall Wray | November 14th, 2009 at 10:52 am
“Note the most recent data showing US net imports rising–as the world turns to its buyer. The dollar did take a hit as global financial players worried about all our bad (private) assets; however, US Treasuries always looked good and will look better as the players come to recognize default risk on Euro nation debt”
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Oil led the import rise,dollar taking hit not due to global financial players but to the actions of the Fed, Treasury to de-value dollar. US and UK default risks are much higher than those of EU nations, save Spain and Italy whose debt is a drop in the bucket
Posted by Mark G. | November 14th, 2009 at 11:06 am
The point about the “run on, run to” is very well made. There’ll be no run on the dollar as there’s really no other leading currency globally. There may be a gradual shift away from the dollar - which would be healthy, in a lot of ways - but no run on the dollar and no hyperinflation. It’s deflation that’s the problem… that’s been evident for a good long while now… why can no one handle this concept??? Too many WW2-era documentaries, I imagine.
Posted by James Call | November 14th, 2009 at 1:33 pm
There’s another point, James. What would the people who fret about the dollar have us do about it? Should we raise rates to defend its value? There’s no guarantee that this would work. In fact, given the levels of private debt, the interest rate increase could well deflate the economy into the ground and trigger capital flight.
Japan is a perfect illustration that there is no obvious link between a currency’s strength and its level of interest rates. Their rates have been close to 0% for decades and yet the yen remains strong. Their public debt has climbed from 68% of GDP in 1991 to 250% today, and yet the currency is strong.
Very hard to gauge or respond to the ever changing portfolio preferences of private investors or central banks.
Posted by Marshall Auerback | November 14th, 2009 at 2:23 pm
Thank you Marshall and L. Randall Wray.
Posted by nope | November 14th, 2009 at 4:17 pm
(I - C) / G in the asset development phase;
I + C + G + E in the liquidation phase;
(it’s a propagation wave)
Government spending is going to drop parabolically, following Consumption. That is a done deal.
The Internet is just a prototype. The full roll-out is going to enable self-regulation, by allowing individual talent to “see” the entire system, and insert itself, without the gatekeepers, through a free, fully democratic, global, public education utility.
In a world of abundance, with instantaneous, global communication, that requires less than 20 hours of the individual, on average, per week, there is no need of agency.
The constitutional answer to the mob is not dictatorship by a cabal of multi-national cartels. In the current prototype test, monetary finance is like a magnet, collecting maladaptive behavior, for ultimate evolutionary recycling.
The Internet was designed as a temporary learning tool, and look where it ran. Imagine if we had installed AI.
It is both amusing and disheartening that people fully expect to have an economy, to exploit, with little or no work on their part. Natural selection doesn’t work that way.
Replacing agency with agency is not the answer. When real labor gets 51% return, the new economy will kick over, just like it did last time, after the Great Depression and WWII, which were monumental wastes of human resources, in misdirection. Until then, the old economy will liquidate, with decreasing volume and increasing pressure.
The only relief valve is purely municipal interest. The old economy must be disassembled from the bottom up and reconfigured.
Without talented Labor, there is no economy, because capital becomes inert, and all the vested interests currently calling themselves labor are either corporate, government, or both.
Government is a fulcrum, and the new system will require governments to self-adjust on the basis of effectiveness, with transparent calculation of multiplier effects, to gain participation of communities in virtual economies.
Re-writing History is to be expected, but the old economy will recursively disassemble until we get back to the foundation error and correct it.
Government shorted the Retained Powers and Establishment Clauses of the US Constitution to implement Family Law and liquidate new family formation, ensuring its own maladaptive future, maximizing short-term revenue and minimizing short-term costs to itself, liquidating public assets for income in the process.
The future is here now, with penalties and interest. Real estate prices and tax receipts will continue to fall, social demand will continue to rise, and the remaining captured pension funds will be liquidated in the friction.
The days of seperating producer and consumer, for the purpose of installing a financial holding company pyramid for the benefit of a few, is, once again, coming to an end. Without stable new family formation, the self-adjusting mechanism of economics, economies automatically liquidate into accounting sinks as designed. That’s History.
The old system of incremental improvement becomes a center of gravity for a quantum catapult. Basic physics.
Ignorance is contageous by nature. Breeding it is cancerous.
Posted by kevinearick | November 14th, 2009 at 8:16 pm
Mark G,
Agree that private debt has been a huge problem. But I would contend that you have it “bass-ackwards”. The private debt build-up is a function of restrictive fiscal policy. For example, in 1998, 1999 and 2000 (increasing each year), the US government “virtuously” ran budget surpluses. And guess what happened? The private sector became more heavily indebted than before as the fiscal drag squeezed liquidity and destroyed aggregate demand and incomes. Along with our misconceived embrace of financial deregulation, the combined result was sharply rising unemployment and a major recession in 2001-02 with unemployment rising sharply and the automatic stabilizers pushing the budget back into deficit. (As an aside, as my friend, Warren Mosler likes to point out, the last 3 years in which the US gov’t ran 3 consecutive years of fiscal surpluses were 1927-30 - do those dates ring a bell, Mark G?)
Unfortunately, what happened in the earlier part of his decade was the yellow flag for what was to follow, a warning signal blithely ignored by our economically illiterate policy makers. Instead, we perpetuated a massively leveraged financial system via Frankenstein financial products such as collateralized debt obligations, and credit default swaps. And so we stand today.
Posted by Marshall Auerback | November 15th, 2009 at 5:38 pm
Mark G,
Default risk for euro zone remains substantially higher than the dollar.
Government spending is financed through the issue of currency, taxes generate demand for that currency that results in sales to government, bond sales merely substitute bonds for cash, and central bank operations determine interest rates and defensively add or subtract reserves. The relation of member countries to the European Monetary Union (EMU) is more similar to the relation of the treasuries of member states of the United States to the Fed than it is of the US Treasury to the Fed. In the US, states have no power to create currency; in this circumstance, taxes really do ‘finance’ state spending and states really do have to borrow (sell bonds to the markets) in order to spend in excess of tax receipts. Purchasers of state bonds do worry about the creditworthiness of states, and the ability of American states to run deficits depends at least in part on the perception of creditworthiness. While it is certainly true that an individual state can always fall back on US government help when required (although the recent experience of California makes that assumption less secure), it is not so clear that the individual countries in the euro zone are as fortunate. Functionally, each nation state operates the way individual American states do, but with ONLY individual state treasuries.
The euro dilemma is somewhat akin to the Latin American dilemma, such as countries like Argentina regularly experienced. Deficit spending in effect requires borrowing in a “foreign currency”, according to the dictates of private markets and the nation states are externally constrained. That’s why Iceland and Latvia are in a mess and suffer from solvency issues. It’s also why California suffers from a solvency issue or Italy or Spain. Not the US or Japan.
In many respects, the EMU policy makers desired this, particularly the Teutonic bloc. They hated (and still despise) the notion of “crass Keynesianism” (in the words of Axel Weber, the President of the German Bundesbank). But the absence of a “United States of Europe” entity that could conduct fiscal policy on a supranational scale means that regional disparities (which have been present since the inception of the euro) remain in force and have been exacerbated by the recent credit crisis. It’s Wilhem Buiter’s blind spot. He always used to argue that operating under a common monetary regime would lead increasingly to economic convergence, but this is crap in the absence of a supra-national fiscal policy. This is why credit spreads between the so-called PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) have expanded so dramatically vis a vis Germany, even though all are part of the euro zone. Yes, they’ve come down from the peak, but still well above pre-crisis levels.
By the same token, for the euro to act as a viable reserve currency alternative to the dollar, the euro zone countries would have to tolerate running sustained current account deficits, thereby facilitating the ability of foreigners to hold euro denominated financial claims. Unfortunately, given the fiscal constraint and resultant national solvency issues, the euro zone nations feel compelled to run current account surpluses (this is a particularly prevalent view in Germany), so that questions of national solvency never arise. There is certainly a compelling economic logic for Germany’s desire to run significant trade surpluses (even if left unsaid), but it does undermine the objective of the euro ever emerging as a serious reserve currency alternative to the dollar, assuming the maintenance of this odd bifurcated fiscal/monetary structure within the EU.
You can see more of this in a post I wrote at UMKC:
http://neweconomicperspectives.blogspot.com/2009/10/how-financial-balances-approach-can.html
Posted by Marshall Auerback | November 15th, 2009 at 5:41 pm
Thanks for the discussion of Euro solvency issues, Mr. Auerback. I (am embarrassed to admit that I) didn’t quite realize this fundamental weakness of the euro.
Posted by James Call | November 16th, 2009 at 11:36 am
I don’t know if the following reasoning is correct, but I have used it with some friends to try to illustrate our upside-down thinking. I need some feedback.
I can usually have people agree that there is bank money and that banks issue the money with a corresponding offset. So I ask, how does someone own something free and clear? The answer I usually receive is “they pay it off”. So then I ask “With what?” and get an answer “The money they earn from … (whatever)”.
So we go around a few times and we finally get to a point where the economy is either a no-net gain situation - everyone who owns something free and clear must be offset by someone in debt (a position that isn’t hard to get to given the current crisis) or money must be introduced some other way.
Only then can I introduce the government (e.g., the public) as the source of this money - I call it unencumbered money - introduced via spending. Either the light goes on and there is a discussion about what public debt means, or there is a violent disagreement and we spend considerable time trying to find out where this hidden money comes from.
I know this is a simplification, but if I go horizontal and vertical on people, I lose them real quick. Let me know what I am missing here.
Posted by pebird | November 17th, 2009 at 12:03 pm
Marshall,
Why are so many insistent that a run on the dollar is a clear and present danger? Are they fanatically anti-government(Austrian School) or is there some other motivation?
Posted by kevin | November 17th, 2009 at 6:47 pm
The headline reads “President Obama, deficit terrorism is not the answer”…
Well, that depends on the question you ask, doesn’t it?
If you ask, “How will the financial class seek to create a permanent class of debt slaves?” it’s certainly one answer, right?
Posted by lambert strether | November 21st, 2009 at 12:45 pm