Yesterday I posted a blog here arguing that we should not conflate a sovereign government’s balance sheet with that of a household. One is the issuer of the currency, the other is a user. That makes a big difference. The currency issuer can spend by “financing” its purchases through credits to bank accounts, issues of new currency, or new issues of sovereign interest-paying debt that is considered to be the safest dollar-denominated asset in existence. Households cannot do that. I also argued that there is no “piper-paying” due date on which government needs to repay its debts, hence, no financial imperative to ever run a budget surplus (or even a balanced budget). Further, even if the government were to try to run surpluses to repay debt, that would (based on historical experience) throw the economy into a depression that would only increase budget deficits. Empirically, budget deficits are correlated with growth; budget surpluses precede depressions. Based solely on the historical record, only a fool would recommend budget surpluses as a policy goal. Yes, that implies that Robert Rubin and Pete Peterson advocate foolish policy.
Still, many responders object that there must be some “sustainable” size of government deficit, perhaps one that relates government debt to a maximum permissible ratio to GDP. And that excessive budget deficits cause inflation and depreciation. Or, worst case scenario, that budget deficits and growing debt ratios could turn the US into a Botswana (or a Greece).
Somewhat ironically (at least from my point of view) the shrillest critics come from the left. When I try to explain how government “really” spends, or why government is not like a household, or why the focus on budget deficits is misplaced, the loudest objections come from those who claim to be progressives. Indeed, on the matter of deficits, the only discernable difference between the “progressive” position and the “deficit hawk” position of a Pete Peterson is over the short run. Both agree that deficits today mean higher taxes and less government spending in the future—more burdens for our grandkids. Both agree that spending more now to relieve the pain of unemployment only means more pain in the future. The only difference of opinion comes down to the willingness to “party now” and “pay later”. Conservatives would forego the party to avoid the hangover; “progressives” would party like it is 1999, then deal with the migraines and stomach upsets later. I must say that if I had to choose between the two strategies, I would go with the conservatives: take the pain now and enjoy lower taxes later. Indeed, I cannot think of any justification for taking the party now and putting the burden of the aftermath on our children in the future—if that is what the choice really involved.
But here’s the deal. The “progressives” are wrong. Nay, they are dangerous. They are the worst enemies we face. At least with the Pete Petersons you know what you get: they oppose deficits precisely because they oppose any progressive policy that might help the average American today—the pain in the future is just a bogeyman to prevent progress today. Indeed, that is, by definition, the position of conservatives who want to return to the idyllic past when the poor suffered their deserved fate and the deserving enjoyed their privileges.
Progressives are supposed to be, well, progressive. But almost all of them constrain progressive policy to a Puritanical trade-off: anything that leads to improvement today is bought by more suffering later. They are far worse than the conservatives because no one who wants to improve the position of the average American would ever take the deficit hawk position of Pete Peterson seriously. We all know what he stands for. So the position of the progressives on deficits, which is identical in all important respects to that of the deficit hawks, is far more dangerous precisely because they appear to prefer progressive policy but warn that in the long run it will bankrupt us.
Why do they adopt a position that is fundamentally inimical to the progressive agenda?
Let me proffer an informed hypothesis. It is all politics. Back during the waning days of the Clinton administration, a high ranking economist of a major labor union laid it all out in public at an economics conference. Union surveys showed that voters trusted Democrats far more to protect Social Security than they trusted Republicans (a finding that is not surprising, given the efforts of Republicans dating back to the early postwar period to kill the program). As they have long argued, Republicans claimed that Social Security faces an Armageddon because when baby-boomers retire, payroll tax revenues will not cover Social Security benefit payments. This labor union economist assured the assembled crowd that this is not really a problem because Social Security is a government program, and as government is a sovereign issuer of the currency it can and will make all Social Security payments as they come due simply by crediting bank accounts. I was practically dumbfounded, having thought that I was just about the only economist who understood this.
But he went on. Democrats needed a campaign issue, he said, something candidate Gore the Bore could sink his teeth into. (Recall that this was before Gore had become the global warming messiah we all now love.) So the Democrats had decided that “save Social Security” would be his main campaign theme. Problem: Social Security did not and does not need saving because it does not and cannot face any financial problems. Solution: join the Pete Petersons and Senator Judds of the world, and claim that Social Security is going bankrupt. This would be a “two-for”. First, Gore could rise from the near-dead as savior of Social Security, garnering the support of voters fearing that Republicans would gut the program.
More importantly, Gore could collect the campaign contributions of Wall Streeters, who desperately wanted to privatize Social Security because the dot-com bubble was running out of steam. They wanted to manage a growing Trust Fund, charging huge fees from whence to pay Wall Street sized bonuses. And thanks to Clinton, the Democrats had become the official Protectorate of Wall Street’s cash flow (with Rubin and Summers the anointed minions). So Gore promised to save Social Security from the evil-doers on both the right and the left. The right wanted to slash benefits, the left wanted to use Social Security’s surpluses to finance other government spending. Gore would protect those surpluses by locking up Greenbacks in a safe, to be taken out later when the babyboomers retire. Not only that, he would have the federal government kick in some extra bucks by double counting Social Security’s surpluses. It was accounting nonsense, but Wall Street drooled in anticipation of obtaining access to the overstuffed safes.
But a funny thing happened on the way to the election: the population could not understand what the heck Gore was talking about, but it sure sounded scary. Baby Bush seemed to be a safer choice—he had lots of happy talk about making us all “stakeholders” in a new “ownership society”. That sounded a lot better than Gore’s scare mongering. Americans like to be scared about foreigners—immigrants, Reds, French fries—but they do not want to listen to incomprehensible plans to rescue near and dear entitlement programs to which they had become accustomed. Better to kill the messenger. (The same thing happened to Kyoto and cap-and-trade, but that is an issue to be left for another day.)
And so it goes. The “left” simply will not give up on the scare tactics. They want to terrorize the population about budget deficits, so they can propose some deficit-cutting policies in the distant future—preferably left for the next administration. More party today, more pain later. Who gets to party? Well, obviously, Wall Street—the main benefactors of the Democratic party and, no surprise, the main beneficiaries of bail-outs.
And what if Wall Street did not get its bail-outs? Armageddon, as Bernanke, Paulson, Rubin, and Geithner have been claiming for two years. In reality, there would have been no collapse, indeed, we would have been in far better shape had we simply closed down all of the insolvent financial institutions (which would have included all of the big ones). But the Wall Street rescue operation never had, and never will have, anything to do with saving the economy, dealing with retiring baby-boomers, or indeed with resolving any real world problems. It is all about stoking the flow of cash from Wall Street to Democrats.
Unfortunately, it is a strategy that will fail. Scaring voters and funneling money to Wall Street only generates distrust. Voters voted against Gore, against Kerry, and for change—that they thought they would get with Obama. They want honesty, not terror. They want action, not threats of deferred pain. They want jobs now, not excuses about “affordability” or “sustainability”. They don’t need nonsensical lectures about why the government can afford $23 trillion in promises to Wall Street, but it cannot afford to support Main Street. They want the sure recovery now, not scary talk about burdens this will place on future generations.
They will not accept the argument that because of some hypothetical revenue shortfalls 75 years from now, government cannot keep teachers employed and schools open now. They will not sit idly by as Haiti suffers from the same governmental near-paralysis that New Orleans experienced under the previous President. They want government to spend, now, on the necessary scale to deal with our problems, and those of our even less fortunate neighbors. They recognize that the problem is not one of “money”—something that costs the government nothing to create—but rather a failure of will to mobilize the ample and underused resources we now have to accomplish the tasks at a hand.
While more than two generations have passed, memories of WWII are still strong. Government ramped up its spending to 50% of GDP; its deficit reached 25% of GDP—almost twice as high as the ratio today. We shipped our highest tech products out of the country and we sent some of our most motivated and productive workers off to fight the war—many of whom never came back; we mobilized our labor force and went far beyond what anyone thought to be full employment—with the help of female workers that many had believed to be incapable of the work they successfully undertook; and we constrained our domestic consumption sector to preserve resources for the war effort. Still, living standards rose, inequality, racism, and poverty fell, and we emerged from the experience stronger than ever. The next generation experienced the “golden age” of US capitalism as we put resources to work producing for domestic consumption, and the rest of the world grew faster than it ever had before.
With the New Deal programs and constraints in place, the financial system played a secondary role, with no significant crises for a whole generation after the war. By design, Wall Street was tiny, and our financial institutions were simple, but they financed the most rapid and sustained growth of output and living standards our nation had ever seen. Over the course of the 1930s, we had downsized, strangled, and constrained Wall Street. It took a half century for it to fully recover—and once it did it returned to its old destabilizing ways. To make a long story short, finance gradually returned to the dominant position it enjoyed on the eve of the Great Depression—and duplicated the result.
In this current crisis, Wall Street refuses to downsize. It wants to emerge as the still dominate force that it had enjoyed before the crisis. Its biggest threat is the recognition that it is not needed, that it plays no important social function. Not only can the financial system be downsized by two-thirds or more without ill effects, the economy would actually perform better.
From Wall Street’s perspective, if government finance were truly understood, there would be little room left for the “financialization” that Goldman Sachs (GS) and others have been promoting. Securitization of mortgages and of other consumer debt is superfluous. Private pensions managed by Wall Street are unneeded–Social Security is safe and can be expanded as desired to provide decent and secure pensions. Health care insurance does not need to be reformed or expanded, instead, it needs to be eliminated and replaced by a single payer system. Government does not need to beg or bribe finance to fund efforts by entrepreneurs to create jobs because a federal job guarantee program can ensure continuous full employment. And Wall Street does not need to choose our candidates for us, as voters are perfectly capable of electing representatives of their interests. In short, it is difficult to conceive of any positive role for outsized finance to play.
Lest anyone think that I am advocating a bigger government, I want to make clear that I am actually arguing for less government intervention into the economy. The market wants to eliminate the biggest financial institutions. I think the market is correct. It wants to get rid of the riskiest financial instruments, such as credit default swaps and securitization. The market is correct on that score. The market would eliminate bonuses for Wall Street traders and CEOs—only Bernanke and Geithner stand in the way, providing government bail-outs that fund the outrageous rewards paid to the crooks and fools that created the crisis. The market would wipe out the mortgage debts of underwater homeowners—it is only the inducements provided by government that keep the mortgage servicers and first and second lien vampires afloat so that they can suck some more blood. And no rational market would have developed private employer-based pension plans or use of employment-related insurance as the dominant method of providing healthcare services. Both of these anomalies were created by partnerships of Government and Wall Street acting against the interests of the vast majority of Americans. I believe that we can have decent and rationalized retirements, health care, and jobs programs without increasing the size of government.
But the first step is to get beyond the deficit bogey. A government budget is not like a household budget. A government deficit—by itself–is neither good nor bad. And in any case government deficits are mostly not discretionary—they do not result from government policy but are largely “endogenously” determined by the nongovernment sector’s behavior. That is a topic for another blog. The most important thing to recognize that there is no “party today, pain tomorrow” trade-off. If government needs to spend more today to create jobs, provide healthcare, and support education, that simply means we can enjoy the benefits of fuller use of our resources. It does not impact our ability tomorrow to similarly use government spending as necessary to create jobs, provide healthcare, and support education. Indeed, it will make it easier because our nation will be in better shape tomorrow than it would have been if we had gone without jobs, healthcare and education today.