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The fine line between economics and politics has frayed this last week in the aftermath of the Massachusetts election result. I never thought the line was substantial anyway, but that only served to place me on the edge of economics rather than invalidate what I thought. After all for the first hundred and fifty years of its existence the study we know simply call ‘economics’ was called ‘political economy’. The greats of the 1800’s – Ricardo, Marx, Bentham, Malthus, and John Stuart Mill – would all have thought of themselves as working within political economy. Indeed their primary motivation was to place economic thinking at the service of the burgeoning industrial societies of the western world. This began to end in 1870 with the beginnings of neo-classical economics and its founders – Jevons, Menger, and Walras – who conceived of economics as a science and dropped the political attachment to emphasize that point.

And what’s this to do with Obama?

Simple: the message, to the extent there is a coherent message, he should have received is that it is the ‘economy stupid’.

Fancy words and strategies in Iraq, Afghanistan, and anywhere else simply don’t count. People want jobs. Period. Survey after survey. Poll after poll, say the same thing: the number one issue in the minds of voters is the economy and its continued deplorable state. Foreign policy and even security is a minor side show by comparison.

And let’s get reasonable: Obama’s ratings are still very strong. He outpaces both Reagan and Clinton by good margins in his popularity. He is not about to collapse. If my memory serves me correctly both those gentlemen emerged as two term presidents. I expect Obama will as well.

So cheer up Obama.

There is one thing to focus on. Which makes life simple. Indeed the politics of the next year is uncomplicated.

Economic policy is the only battleground that the voters want to see energy expended on. So get to it.

The damage from that election is not all that great. Health care reform can still get done, albeit in roundabout ways. Indeed the loss of a seat may focus the Democratic leadership on being more inventive than they have been. A big ‘if’ I realize. Especially with the level of mistrust that has emerged between the House and Senate Democratic caucuses. All the Democrats have to do is copy the way in which George Bush forced through legislation. Use all the rules to your own advantage and marginalize the minority.

Simple.

Now about the economy …

Let’s begin by harnessing all that popular anger at the banks. Get out in front of it. Stop being seen as stooge of the banks. Too many of the administration’s key players are seen as bank insiders – Geithner in particular. His unfortunate comments after Obama’s speech last week introducing the ‘Volcker Rule’ as policy shows that he doesn’t get it. The days of playing nice with the banks are over. The public wants blood, they should get some. The key is to deliver what the public wants without ruining economic policy. My view is that the public is right on this one: the banks screwed up, they have shown no ability to self reform, and they continue to spit in the face of regular people. The banking industry has not cleaned up its act at all. None of the senior managers who oversaw the implosion have been fired. The only leadership change has been at Bank of America, and there it is only skin deep.

When banks lose billions the entire executive team needs replacing. Even the blameless get thrown out.

Obama pulled the plug on GM’s febrile leadership, why not on Citibank’s? Especially since the social cost of Citbank’s failure is far greater than that of GM’s.

By failing to deal with the banks Obama has cast himself as an insider insensitive to the hardship that the greed of Wall Street flooded the country with.

Being a Wall Street insider is not a popular place these days. Hence the quick pivot on economic policy and the Volcker Rule.

But.

Words are easy. Sometimes too easy for Obama. Now he needs to force some action.

He needs to change his economic team to get it into line with popular demands. Geithner must go. So too must Summers.

The case for getting rid of Summers is even more clear in my mind than that for Geithner. Summers is tainted by his years as an advocate of banking deregulation under Clinton. His conversion to regulation appears skin deep. Plus his advocacy of caution last year when the stimulus was being put together was a major error: that failure alone has caused much of the political pain the administration is now feeling. A larger stimulus would have eased the unemployment situation. Instead we are now caught in no man’s land, with a new stimulus ruled out for political reasons – although I would like to see that tested – and the jobs market stuck.

Lastly we need honesty. The economic recovery will be slow. Let’s be straightforward about that. Voters know how tough it is. They want to make sure that the toughness is not focused on them while others make off with scarcely a scratch. But more than that the voters need to hear that all this pain will not be pointless. The adjustment in the economy that we are going through is to make a long term improvement: less debt reliance and less finance. More basic industry and investment in the future. Less trickery and more service. Less marketing hype and more useful stuff that people both understand and want.

And they need to be told that the economy cannot support all the things we want simultaneously. We cannot afford expansive foreign policies and an unreformed health care system. Offense Defense spending needs to be reined in and made more cost effective.

The middle class has been squeezed over the last two decades: health care, education, and housing costs have all escalated way more than wages. The stress of maintaining a decent standard of living showed up in those ludicrous real estate loans, and in ever increasing credit card debts.

One little noticed comparison in the current crisis is how similar education and health care costs are: both are driven up by industries in which normal incentives of cost control do not work. Both are essential to a middle class way of life, but both are impervious to change. As a result both are corroding the American dream.

Economic policy needs to address the realities that voters feel. Those realities extend beyond the short term erosion of work stability and jobs. It reaches into the destruction of the employment contract by employers who protect short term rather than nurture long term profit – the result being a more volatile work experience and heightened risk for average workers. This volatility came right at the time health care and education costs exploded without any real increase in service. The shift in the economy was asymmetric: workers were forced to absorb all the risks without getting any of the rewards. It is no accident that the only economic measure to match historic growth rates during the last decades was corporate profit. Shareholders offloaded risk onto the workforce who got nothing but short shrift.

A natural consequence was that voters turned increasingly towards self destructive pattern of behavior: voting for tax cuts that scarcely affected them yet bled the Treasury dry; attacks on government services that were badly conceived and delivered instead of seeking to improve them; a reliance on debt rather than equity; a mistrust of the soundness of safety net inherited from the New Deal; and an uninformed reliance on market magic as the salve for all ills. In short the Reagan illusion. People kept voting for policies that heaped responsibility on the individual, but which also stripped those same individuals of the power to compete. It was a doomed enterprise. They were doomed to drown as those with privilege raced ahead. The result is a return to pre-New Deal levels of inequality and an attack on the middle class. The voters forgot that the New Deal was the foundation upon which the post war middle class was built, and that free markets are vicious places for the relatively weak.

Obama now has the task of turning back that tide.

He can begin by harnessing the popular, and justified, anger at the banks and starting the long road toward re-establishing a better balance between regulation and laissez faire.

He is helped by the fact that his opposition is embedded deeply in the Reagan world: the GOP has no economic policy other than that we just saw implode. They should be easy targets. As long as Obama frees himself from Wall Street.

This was never going to be an easy year: all the evidence pointed to a jobless recovery. That Summers and Geithner failed to respond with strong action and preferred the safety of the trade methods tells me that they misjudged the depth of the problem. They want to tinker, when we need reform.

So three things will save the day. Three actions. Three steps and Obama is assured of two terms.

One: get a jobs program now.

Two: go after the banks. Reform them and cut them down to size.

Three: replace Geithner and Summers.

It’s the economy stupid. It always is.