I’ve been meaning to write this post the last couple of weeks but couldn’t figure out an angle. The basic premise is that I agree with Obama’s economic vision nearly 100% ideologically, but am increasingly believing that it cannot be implemented due to sins from our past. This post isn’t just an explanation, but also a question: what do you do when you agree with the basic premise of a policy in general, but feel that it could lead to failure if implemented at the current time?
I’ll just start by saying that if Obama was elected in 1992 and implemented all his ideals, I feel our current problems would be greatly diminished. Of course, it’s a bit of a fools errand to even think about it that way, since there was no national hunger for the reforms that are taking place; politics is completely reactionary and thus exacerbates problems by paying attention too late. But that revised history is short hand for “Obama’s ideas about regulation, health care (although I am more left than him), energy investment, etc. would work beautifully in the moderately expanding domestic and greatly expanding international economies that we experienced in the 90s.” That’s not what we’re facing in the next decade.
My greatest worry is still that we are going to have another depression over the next couple years (total of -10%+ GDP, so it might only be half as bad as the Great and still count) and we will start seeing the next leg down in late summer-fall. This talk of getting back to normal and “green shoots” is alarming, especially because it’s what I’ve been expecting for the last three years. Looking at the Great Depression, I figured that we’d see a massive collapse in the fall, followed by a pause or even mild growth in the following spring — leading the people that survived the first plunge to jump in to buy “generational bargains” and then get creamed the following fall/winter when the biggest leg down occurred. This second cleansing is what destroyed the investment capacity in the private sector in 1931-1932 and contributed to the depths of the Great Depression. Even though I originally thought this would occur one year earlier than it did (I thought the mild panic in 2007 starting in July was going to turn into what happened in September 08), the pattern we’re seeing is what I anticipated, and if you look at the underlying labor/credit data then it is clear that things are still getting worse under the surface at an alarming rate. By focusing all our attention on programs that assume return to completely preposterous growth (4%!) our government risks missing this upcoming calamity and having things be much worse than they could have been.
But that’s not what this post is about. I want to talk about how even if we avoid a depression in the short term, I don’t see anyway that our country can get out of its fiscal mess. We just have too much debt and too many structural deficits. Period. If the Debt:GDP ratio gets too high, then the government will be using vast amounts of revenue to simply service the debt instead of putting it into services or letting people keep it. This will greatly inhibit growth moving forward and eventually put pressure on the dollar. Obama has definitely contributed some to the problem, but his contribution is relatively minor: only about 20% or so of the deficit and even that is spent pretty wisely (the intent at least). The bulk of the problems are inherited and will need to be confronted in the next 10 years, but they will also short circuit Obama’s new programs and make me question whether those new ones are worthwhile.
I came across this article that articulates many of my concerns (although I wouldn’t have said Obama Is Leading Us, I’d say that the US has been down that road for a long time) although I disagree with its conclusions. The traditional Keynesian theory that Obama’s main advisors are operating on is that we can afford to take on another $10 trillion in debt over the next 10 years, because that money will filter out in the economy and raise GDP enough over time that the Debt:GDP ratio will be kept down. The article correctly points out that government stimulus has diminishing returns (the money multiplier decreases as it gets used on less productive aspects) and that due to massive amounts of consumer debt, there is little pent up demand. I think that their projection of 2% growth per year and 100% debt increase over 10 years is very realistic compared to the White House which is projecting 3%+. That 1% per year leads to nearly a $2 trillion difference in GDP.
The article claims that this high Debt:GDP is alright as long as policies are put in place that will eventually lower it. This is exactly Obama’s argument as well. The author obviously disagrees with Obama about what raises growth (he goes the deregulation route while Obama goes the strong working class route…my money is on the latter over the long term) but they both agree that smart infrastructural spending can greatly raise productivity.
I find the argument that the high Debt:GDP is OK to be unlikely. He mentions that after WWII the US had an enormous Debt:GDP and Krugman has used that example, as well as Japan’s now 180% Debt:GDP to argue that industrial economies can carry a lot. These comparisons are specious. After WWII, the US was the only industrial power that didn’t have large parts of the country destroyed, and there was a full decade of people saving enormous amounts of money. Further, the west wasn’t that populated, and inventions utilizing oil and day to day efficiency were just coming into play, which led to the rise of the suburbs and consumerist culture. These factors combined to create an enormous opportunity for massive growth over the following decades that naturally lowered Debt:GDP and won’t be repeated this time. When it comes to Japan, their “lost decade” occurred primarily during the largest global expansion in history, and they are a major exporting country. Even though their Debt:GDP increased to amazing levels, it was primarily domestic. Now that trade has collapsed and Japan’s trade surplus has vanished, they are in big trouble. All that stimulus and domestic rebuilding, and they were still so vulnerable that their GDP has contracted over 7% the last two quarters (that’s a real contraction of 7%, imagine seeing a -15% GDP headline number here!) and will almost surely enter a depression level of contraction.
With the amount of private debt (and massively leveraged assets) that already exist, there is little room for economic growth, regardless of policies. The deregulation/no minimum wage/pro trade rhetoric in the article ignores these debt and natural resource constraints, which is very odd considering the article started talking about debt and natural resource constraints. However, I also agree that we won’t see enough growth to help restore the middle class, like Obama is trying to do. And that’s only focusing domestically; the proper focus is internationally.
Looking at the EU, US and Japan there is a combined government debt of around $27 trillion. Meanwhile, global GDP is $61 trillion. I think over the next 10 years, a global growth rate of 2% is realistic (meaning around 1% in industrial countries) and a rate of 3% would be fantastic. It will be very hard to get much more than this when there is still so much deleveraging that has to occur. A rate of 2% will lead to $74 trillion GDP in 2019 and a rate of 3% will be $80 trillion. In the meanwhile, US debt will double, Japan will go up another $3-$4 trillion and the EU will most likely double as well. That is a combined $20 trillion+ of debt issuance by the major countries. That means that every single cent of global growth in the next ten years will be sucked up by the industrialized world’s governments. This will have two effects: a decrease in standard of living as the population grows faster than private growth and also the complete drying up of credit to the emerging markets…rolling back many of the gains over the last two decades.
I believe that the government can be a positive force in the economy, but not when its debt burden is larger than the entire economy with little hope to pay down it down.
This post has gotten a bit long, so I’ll save my conclusion for another one, but the gist is that the government will have to get much smaller than it is currently and explore in detail the best way to make that happen.