We’re experiencing an economic recession as a result of several global economic imbalances that have been building for years now.
Since sometime in the Clinton Administration, growth in US consumption has been funded by steady increases in the private “balance sheet,” or the net level of indebtedness. During the Bush years, growth was also supported by accomodative monetary policy and fiscal deficits.
Since the early Clinton years, we’ve been running a growing current account deficit with the rest of the world. Countries like China, Japan, and the oil-exporting states run corresponding surpluses. In effect, surplus countries need to import demand from deficit countries.
Over the last three or four years, we’ve allowed this imbalance to become extreme. Yet, continuing, steady increases in private credit formation have made this sustainable. Now, however, the global credit crunch which began in mid-2007 has caused net private indebtedness in the US to fall by something approaching $2 trillion.
That has an automatic, negative impact on our ability to consume, and on economic output overall. That produced a recession with rising unemployment in the US.
But since the surplus countries depend on us for the demand that keeps their economies growing, they’ve hit the wall as well. Now it turns out that China, in particular, probably will not suffer any decline at all in its surplus position. That’s because their economy is so export-driven (perhaps about 40%), that imports of raw materials and intermediate products have fallen even more sharply than exports have. Their dollar reserves will probably continue to grow, even as unemployment and the potential for social unrest also grow.
Much has been made of the need to get banks to start lending money to consumers again. But there’s been extraordinary damage to the US banking sector, caused both by declining asset values, and also by the government response. (If every bank is too big to fail, then eventually every bank is the US government. And we don’t know if the US government knows how to be a banker, although the betting is that they don’t.)
Therefore, there’s no clear path to get a healthy flow of credit back into the economy. (That could change, of course.)
Just as important, it’s not yet clear how much of the net reduction in private indebtedness arises from demand impairment. We know banks don’t want to lend, but do we know that consumers and businesses want to borrow? Maybe they don’t. That would make sense considering that consumers have also been hit with a massive reduction in asset values, in the stock market and in housing.
All of these factors have led the regulatory authorities to run around like chickens without heads, responding ad hoc to every part of the crisis. Congress and the FDIC are trying to prop up housing values artificially. The SEC temporarily banned short-selling to stem stock-market declines. The Treasury nationalized all the big banks and many of the small ones. The Fed is now out there directly lending to businesses and consumers.
And the biggest response of all is the fiscal stimulus proposed by Obama.
The idea here is to plug the gap in output (thereby reducing unemployment) by borrowing and spending about 5% of GDP in each of the next two years.
Many economists have run the numbers, and concluded that a stimulus of 8 or 10 percent of GDP is a closer match for the expected reduction in output, both here and in the surplus countries. (Yes, the rest of the world is counting on a certain amount of “leakage” of our stimulus to make their economies healthy again, too.) In other words, the biggest stimulus in memory will be too small by about half.
That means we will necessarily face lower growth and higher unemployment in the next few years. The stimulus will make the problem less bad, but won’t solve it. That’s the current crisis.
The next crisis is what happens when we run out of stimulus. We simply can’t borrow 10% of GDP indefinitely. Particularly when the things we will have to spend that money on are not economically productive.
Note that tax policy has been neutral in all of this. We’ve been financing the gap between savings and investment, or production and consumption, by importing foreign capital. If we had tried to do so by raising taxes, that wouldn’t have reduced overall consumption to make a big enough difference. We’d still be running huge deficits.
But when we start paying pensions to the baby boomers, buying universal health care for everyone, and heavily subsidizing battery-powered automobiles, the net productivity of the US economy will fall precipitously. That’s the coming crisis.
Over time, we will simply need to find a way to increase production in the US. Forget, for now, about the tremendous amount of friction this will cause with our trading partners, who depend on being able to sell us their surplus goods and services. The question is how we can get production of US goods and services back up to a level that can meet a larger proportion of our demand, without requiring huge fiscal deficits.
And this is where tax policy comes in. Unfortunately, Obama Dogma holds that the US isn’t a fair place, and people who make a lot of money need to be paying a lot more of it over to people who make less.
Obama needs to realize that fairness and social justice are luxuries that are only affordable when there’s a high level of wealth in the country. Both in the current crisis and in the next one, we don’t and will not have that luxury.
Tax policy needs to be comprehensively overhauled in favor of producers. We need to cut the tax rates on capital gains, on business profits and on exports to the lowest levels they ever have been. We can keep the personal income tax progressive, as long as it doesn’t become punitively so. And we need to sharply expand and liberalize all of the desultory programs which allow people to save money in tax-advantaged ways.
In short, we have to liberalize tax and regulatory policy to make it possible for Americans to get rich again. In all candor, I won’t have a problem if the financial sector is excluded from this. We don’t need to make it possible for a 24-year-old with nothing but an Ivy League MBA to make $10 million a year.
But we do need to make it possible for a small-business owner who employs a thousand people to make $10 million a year. And we need thousands of people like him.