A Deeper Illness
The current crisis is not one that has shallow roots. The economy has had a series of imbalances for a long time. The deficit on foreign trade has been persistent for over a decade. The Federal deficit has ballooned during the last eight years. Domestic savings have fallen to unsustainable levels. And then, of course, we had two huge destabilizing bubbles. It seems as if the American economy has had an illness for a while. Never rotten enough to make us really sick, but never cured. All the while we looked away and hoped that the issues would take care of themselves.
Well they didn’t.
On reflection the trouble we now have cannot be s surprise to anyone looking at the data over the last few years. The tax cuts that were touted as an injection to spur the recovery from the mild post 9/11 recession were wrongheaded. At no time since their enactment did any vital statistic perk up enough to justify plunging the country into debt to the degree they did. Those tax cuts were an unmitigated failure and hopefully put to rest once and for all time the notion that there is such a thing as ‘trickle down’. It was snake oil theory when it was first talked about and so it remains.
Similarly the quiescent attitude of the Federal Reserve towards the bubbles now seems amazingly naive. Alan Greenspan is at the center of this piece of the puzzle. His failure to use monetary policy, by raising interest rates, to nip out the explosion in asset prices that constituted the dot com and real estate bubbles is now legendary. He is as culpable as anyone, especially in the real estate debacle. His concern seems to have been that the recovery from the 9/11 recession was so fragile that raising interest rates would have been more damaging than the home price inflation was. He was correct in assessing that fragility, he was hopelessly wrong in his evaluation. A managed recession, similar to that Paul Volcker inflicted on us in 1981/82 may have prevented the real estate disaster. It would have undone the weak growth of the period between 2002 and 2007, but it might have staved off the mess we are now dealing with. Instead, Greenspan played an overtly political role, possibly fearful of being criticized by his Republican sponsors, and eventually he succumbed to the pressure to do nothing. Remember that many Republicans still blame Greenspan for George Bush senior’s defeat at the hands of Bill Clinton, so a certain sensitivity on his part would be natural. But unforgivable in the light of current events.
Nor is Washington innocent. The deregulatory bias of the last three decades has left us not only with a poor defense against obvious felons like Madoff, but also against the legal, but unstable, activities of the major investment banks and hedge funds. Everyone rails against the banks and their greed. Few people realize that the current storm has its origins in the unregulated zones of our financial system: the mortgage originators and investment banks. Fewer still recall that when efforts began to regulate derivative trading in the late 1990’s it was the Clinton administration including Summers and Rubin, who along with Greenspan and Phil Gramm put an end to them. Why? They had bought the free market economics mantra: regulation stifles creativity, and creativity is a source of wealth.
It is also, apparently, a source of disaster.
Also hidden amongst the data that no one paid attention to is the long term neglect of our infrastructure. America just didn’t invest in its basic public goods. Huge amounts were spent on roads. Practically nothing was spent on rail or education, and basic scientific research was cut to the bone. At least at the Federal level. In part this was due to the prevailing anti-government and anti-tax ideology, and in part it was due to the fact that our attention span had become so short term. Infrastructure decay takes a long time to manifest itself. Our rickety railroads and poor schools do not get that way in a week, a month, or even a year. It takes longer periods of deliberate under-funding to produce what we have today.
Yet the economy looked as if it was growing. The real estate boom produced a distortion in almost every aspect of growth. It was the largest driver of jobs for the last few years. It was a source of cash via home equity lines, and so became our main locus for consumption. And, perhaps paradoxically, we came to look at housing as our primary savings vehicle. So even as we convinced ourselves we were saving we were actually consuming faster from the same source.
All the while foreigners loved us. Our consumption fueled Chinese growth. They recycled our dollars back to buy the debt we issued to pay for our deficits. Imports rolled in and our competitive base washed away in the wave of globalization that we ourselves had unleashed. Except that unlike other countries we neglected to erect a safety net to protect ourselves against the ills of globalization. On the contrary our anti-government ideology drove us to reduce that safety net. We are still without health care for all our citizens. We have worse worker re-education than most. We have weaker workplace protection than almost everyone else. And we even cut supervision over the safety of imported goods.
We truly let it rip.
So the deeper illness that pervades the discussion over the stimulus package is that these imbalances still remain. Re-balancing will take time and will inevitably cost money. It will require a slower growth pattern and higher unemployment for a while. The benefit is that eventually the economy will recover and that the growth then generated will not depend on massive debt, or the illusory wealth of our homes, but on stable productivity gains. Which is the only way an economy can grow without major periodic collapses.
