POLITICS NOVEMBER 25, 2009
If there was one thing that seemed certain about the Obama administration, it was their commitment to Keynesian deficit spending to boost the economy out of its slump. But Keynes beware: With unemployment at a whopping 10.2 percent, and probably rising, the White House has begun trumpeting its commitment to Hoover-style deficit busting. On November 13, the White House warned cabinet departments of a spending freeze. The next week, while in China, Barack Obama told an interviewer the United States could suffer from a “double-dip recession” if it didn’t restrain public debt. And just this week, the White House declared its displeasure with House Democrats’ plans for a new job stimulus.
If the administration does block a new stimulus program--either directly or by reinforcing Republican complaints about government spending--that will have severe repercussions, not only on the economic recovery but also on Obama’s political standing. In a Gallup poll last week, Obama’s popularity dropped below 50 percent for the first time. That reflected, perhaps, the turmoil on Capitol Hill over the health care bill, but it seems primarily due to rising unemployment--which, without a new stimulus, will continue to rise over the next year.
Many previous recessions have been cyclical events precipitated by government efforts to stem the inflation created by a boom or other external events, such as an energy crisis. The severe Reagan recession of the early 1980s, for example, came about when the Federal Reserve under Paul Volcker jacked up interest rates to choke off inflation. As inflation eased, the Fed lowered interest rates, and the private economy quickly revived.
But the current recession, like the depression of the 1930s, did not result from the Fed’s attempts to curb inflation. It was the product of a slowdown in industrial production, which was caused by global overcapacity and foreign competition. According to a recent report from the management consulting firm Deloitte, all American industries except for healthcare and aerospace/defense--both of which government heavily regulates and subsidizes--have suffered from declining rates of profit since 1995. A slowdown in the telecom and other core private industries contributed to the recession during 2001-2002. This slowdown--epitomized most recently by autos, but not limited to them in the least--underlies the current recession.
This recession is often described as a financial crisis--and it’s true that the bursting of the housing bubble did precipitate the sharp downturn that began in late 2008. But the bubble itself was a product of global savings (particularly from the Chinese) seeking investment outlets in the United States, finding few in industrial sectors, and turning instead to Treasury bills and derivatives from the inflated housing market. That is, again, similar to the depression of the 1930s, which was precipitated by the stock market crash, but which was underlain by a downturn in auto and other key industries of the 1920s.
This kind of core industrial downturn has proven resistant to the usual remedies for recessions. By drastically reducing interest rates and pumping money into banks that teetered on the edge of insolvency, the Treasury and Federal Reserve did prevent the kind of crash that leveled the financial sector during the early 1930s. But low interest rates and infusions of cash haven’t revived the industrial sector. That is evident from the Federal Reserve’s quarterly survey of bank lending practices. One would expect normally to find that the monetary easing has encouraged lending, but that has not occurred.
In the April and July surveys, 40 and 35 percent, respectively, of loan officers said they had tightened their standards for approving commercial and industrial loans, while 3 percent in the July survey and zero percent in the April survey said they had eased standards “somewhat”. In the most recent October survey, 14 percent of lenders surveyed by the Fed said they had tightened their standards, 86 percent said they had stayed the same, and exactly zero said they had eased. So over the last ten months, loan standards have generally tightened and not eased. What about the demand for loans? The survey showed that 34 percent of loan officers experienced weaker demand, only nine percent “moderately stronger,” and none “substantially stronger demand.”
This portrait of an ailing private sector is mirrored in figures from private investment. According to the Commerce department, private fixed non-residential investment has steadily declined from the second quarter of 2008 through the third quarter of 2009. So where is the growth in gross domestic product--now revised downward to 2.8 percent for the third quarter of 2009--coming from? It’s coming primarily from government spending and investment. Obama’s $787 billion stimulus proposal, which Congress passed last February, contributed some of the jobs as well as slowing the loss of jobs in construction. The principal areas of new employment have been in government-subsidized health and education.
We face an economy that, like that of the mid-1930s, depends primarily on government spending for its growth. Reduce government spending in order to curb the deficit--as Franklin Roosevelt did in 1937--and you’ll cause new and even greater job loss. This is why it is pure folly for the Obama administration to encourage talk about curbing the deficit. What’s needed is exactly the opposite: greater stimulus, greater deficits, and stimulus programs and budgetary expenditures directed not just toward creating jobs, but toward encouraging new areas of private industrial growth, without which the United States is never going to extricate itself from this slump.
Won’t greater deficits lead to greater debt, which will burden our grandchildren with intolerable obligations? They will in the short term, but they are also the only way to avoid even higher debt in the longer term. The current deficits are much more the result of lost revenues than of increased spending--and they will begin to diminish only when revenues (wages and profits) begin to rise again. That won’t happen without deficit spending now.
Won’t greater deficits lead to higher interest rates, which will choke off investment? This might happen in the future, but not currently, as interest rates remain near or below zero and are not expected to rise until the private economy begins to grow. The Chinese and other foreign holders of dollars could, of course, force interest rates upward by dumping their dollars, but they would lose in the process, as the value of their existing holdings would plummet. So while greater deficits might imperil investment in the future, the United States still has a window of opportunity to use deficits to revive its economy.
Much of the current confusion about jobs, deficits, recovery, and recession may pivot on wrong-headed semantics. The economists’ definition of recession assumes that recession and recovery are mutually exclusive categories. If the economy is growing--even at an anemic pace, and from a deep trough--then it is no longer in recession. That would suggest that, with recovery under way, policy-makers can proceed as if there were no recession. But that’s a misleading conclusion.
It’s best to think of a recession, and particularly this one, as one might thinks of a severe illness and recovery. One can be recovering from pneumonia, for instance, but still be very sick with a very high fever and susceptible to a relapse, or, in the language of recessions and recoveries, a “double-dip” recession. The current slump is exactly of that nature. There are positive signs that a recovery is occurring, or could occur, but the underlying signs of weakness in private industry persist. If Obama and his economic advisors neglect them, they could put the country, and the Democrats’ political future, in peril.
John B. Judis is a senior editor at The New Republic and a visiting fellow at the Carnegie Endowment for International Peace.