Why Donald Trump Can't Stop a Recession

A recession may be on the horizon.  The Federal Reserve doesn't think so.  Some others do.  Only time will tell who is right.  But if there is a recession, President Trump can't stop it before the 2020 election. 

The principal tool for the President to fight a recession would be to partner with Congress and put together a package of spending bills that would increase federal expenditures.  This sort of program, called fiscal policy, sometimes includes tax cuts, but not always.  The greatest fiscal stimulus in U.S. history, military spending for World War II, included a massive tax increase and an even greater increase in deficit spending.  The result was both victory in the war and an economic revival at home. 

Today, however, there is an almost complete absence of agreement between the President and the Democrats in the House as to how to deploy fiscal policy.  Although both sides speak of infrastructure spending, agreement on the fine points and details has remained elusive since the President was inaugurated and won't be achieved before November 2020.  For more than the past 20 years, the federal budgetary process has been largely dysfunctional, and it has grown more so as political divisiveness has increased.  With only one full budget cycle remaining before the election, it's simply too late to implement fiscal measures in time.

To make things worse, the President would likely seek a tax cut as part of the stimulus package.  But, having alienated the Democrats by ramrodding through the 2017 tax cuts with nary a shred of consideration for Democratic views, the President has essentially no good will left with the House majority when it comes to tax policy.  The Democrats will agree to tax changes only if there is a substantial rollback of the 2017 cornucopia of tax cuts for the wealthy, and the President won't agree to that.  So no deal on tax legislation is possible.

Of course, central banks can endeavor to combat recessions.  But the President does not control central bank policy.  Monetary policy and other economic management measures such as quantitative easing and the setting of bank reserves lie within the purview of the Federal Reserve.  The President attempts to influence the Fed with shrill demands on Twitter for much more aggressive interest rate cuts than the Fed seems inclined to make.  But the Fed strives to maintain its independence, and the President would be wise to back off.  If the financial markets lose confidence in the independence and integrity of the Federal Reserve, stocks will crater and the economy will get a tummy ache.   Moreover, Fed interest rate adjustments often take 18 months or longer to affect the economy.  Although they may almost instantaneously be reflected in asset prices in the financial markets, they take a long time to wend their way through the processes of the economy.  There isn't enough time before November 2020 for interest rate cuts to have a big impact. 

The prospects for a recession remain uncertain.  Unemployment is at a 50-year low, a remarkable development that no doubt informs the Fed view of the economy.  The stock market is dancing near its all-time highs.  Transportation and manufacturing are slowing, and the business community is pulling back on new investment because of confusion and caution arising from President Trump's trade wars.  It's difficult to tell how things will go.  But if a recession is coming, it's coming.

How to Stimulate the Economy

With current economic indicators mostly signaling a slowdown in the economy--and perhaps a recession--a lot of attention is focused on stimulating the economy. The dialogue revolves around central bank accommodation (via lowering interest rates and bond purchases in the form of quantitative easing) and fiscal policy (i.e., deficit spending).  Fiscal measures are essentially impossible because of political gridlock.  And central banks, having devoted the past decade to accommodation, have only limited ammo left.  So what can stave off recession and renew economic growth?

There's no simple answer.  But one important factor is the availability of inexpensive energy.  Modern life is dependent on vast amounts of cheap energy.  The Industrial Revolution that created our high tech lives was the result of the development of inexpensive ways to harness and utilize large amounts of energy.

Let's begin in A.D. 1700.  Living standards in A.D. 1700 worldwide were about the same as they were in A.D. 700 and 300 B.C.  In other words, things had hardly improved over thousands of years.  But within the 150 years following 1700, people had developed the steam engine and learned how to harness electricity for commercial use.  These developments were followed by new ways to extract large amounts of fossil fuels that could be sold inexpensively.  Then, after 200 years (i.e., by 1900), people had developed the internal combustion engine.  The internal combustion engine could be used widely in transportation, manufacturing and many other ways.  Large scale generation and distribution of electricity became feasible, and the widespread availability of electric motors greatly enhanced living standards.  Economic growth and improvement of living standards accelerated at an exponential pace.  In essence, access to inexpensive energy sources (carbon based fuels and electricity) triggered a monumental amount of economic growth and a phenomenal rise in living standards in a historically short amount of time.  Of course, we now have pollution and other byproducts of the Industrial Revolution to contend with.  But the simple truth is the astounding economic growth of the past 300 years resulted to a large degree from ever increasing access to cheap energy.  Cheap energy and the technology developed to exploit it made modern life possible.   

Why is energy so important to economic growth?  Because energy is a key input into all economic activity.  From manufacturing to transportation to farming to fast food to government offices to hair salons to slimy corporate lawyers peddling excuses for their greedy clients to sordid lobbyists plotting to kill health insurance coverage for all to the performances of rock stars in large arenas, energy is an input into essentially all economic activity.  If the cost of energy is lowered, all economic activity gets a boost and economic growth in all sectors of the economy is facilitated.  

It's no accident that America's economy grew briskly in recent years concurrently with a drop in the price of natural gas, solar and wind energy, and to some degree, oil.  The proliferation of fracking not only has capped the price of oil, but also created demand for a lot of drilling equipment, trucks of various kinds, and so on.  So it boosted the manufacturing and transportation sectors. 

We use enormous amounts of energy stored in the past to make our current lives more comfortable and enjoyable.  We now understand we can't keep relying so much on energy from fossil fuels.  We have to develop more sustainable lifestyles.  However, in order to maintain and improve our lives, we need to continue our access to cheap energy in better ways.  After decades of frustration, solar and wind energy have actually become cheaper than fossil fuels.  That is a very positive development.  More technological advance is needed. 

The policies needed continue the availability of cheap energy would be varied and sometimes controversial.  Increased federal funding of basic research is an obvious one, although the GOP has done much to cut this from the federal budget.  Republicans seem fear science.  But ignorance will not spur economic growth.

Building more gas pipelines is obviously controversial to the NIMBY crowd.  But we do need better distribution systems for gas--and electricity as well.  All the windmills and solar farms in the Plains states won't do much good without power lines to transport the electricity to the big cities that need the power.  These power lines entail a huge NIMBY problem.  But this will have to be dealt with somehow, because distribution systems have to be enhanced if there is to be growth.  We need not bow to big, bullying energy and power companies and give them everything they want.  But we should acknowledge the need for better distribution systems.

Fostering greater fuel efficiency also helps to lower energy costs.  It may not lower the stated price per unit, but it reduces the number of units people have to buy.  So it would help to pursue efficiency as well as reduce unit costs.  One hidden cost of efficiency, though, is people consume more energy when it effectively becomes cheaper--many ordinary cars and SUVs today have engines that are as powerful as those in the muscle cars of the 1960's, since engine technology has improved so much, and people drive more miles per year.  So greater efficiency isn't an improvement if it doesn't reduce the use of fossil fuels.

There are many other factors besides energy that affect economic growth.  But a lot aren't controllable by any branch of the government.  Energy policy, though, can be implemented through government.

In the 1940's, 50's and 60's, the U.S. had ultra-high marginal tax rates, not that much deficit spending (the government focused on reducing the deficit, not increasing it), a rather inactive Fed, relatively high wages that provided for a comparatively equitable distribution of wealth and income--and an era of brisk economic growth and low unemployment.  This is an era still remembered as a golden age in America.  Why?  Because oil was damn cheap.  What happened after the first OPEC oil embargo in 1973?  A decade of economic stagnation followed by decades of economic uncertainty.  When we had cheap energy, we had lots of prosperity.  When energy rose sharply in price, prosperity as we had enjoyed it went away and still hasn't returned.  We don't need to sell our souls to the fossil fuels companies.  But we need to recognize that our standard of living and future improvements to our standard of living are dependent on access to cheap energy.  And we need to find responsible and sustainable ways to keep that gravy train rolling.

How Donald Trump Could Create a Stock Market Crash

Stock market crashes, such as in 2008, emanate from inflated asset prices.  While economic recessions and other events, such as war, can trigger market downturns, large, sharp market drops (a/k/a crashes) are the result of artificially high asset prices that often have started bubbling.  In 2008, the asset bubbles resulted from overly generous prices being paid for real estate, the resulting mortgages, stocks that seemed like good bets in light of all the real estate activity, and stocks generally because market averages kept rising.  It didn't help that the U.S. government guaranteed almost all mortgages on a de facto or de jure basis.  The easiest way to get people to pay too much for an asset is to make it seem like a sure bet.  Con men know this and profit from it because, despite all the evidence that there is no such thing as a sure bet except taxes and death, people remain suckers for sure bets. 

Donald Trump bet the image of his Presidency on the rising stock market.  Stocks rose briskly right after Election Day in 2016 and maintained their upward momentum for over a year.  Trump noisily celebrated the huzzahs he thought he heard from the financial markets and wore out the fabric of his suit jackets patting himself on the back.

But Trump, despite decades as a New York businessman, hasn't absorbed a simple lesson that he should have learned about stocks a long time ago:   that stocks go up and stocks go down.  There is no such thing in the stock markets as continuing upward momentum.  There is no endless applause.

So, when the stock markets got tummy trouble in 2018, and began to burp, belch and make other inelegant noises, Trump became discombobulated.  He berated the Federal Reserve Board for raising interest rates, manipulated oil prices down by persuading the Saudis to keep pumping large volumes, and condemned American businesses that closed down domestic operations.  Sometimes, on down days in the market, he made statements about trade talks that turned out to be optimistic or premature.  He seemed indifferent to widening federal deficits, instead suggesting a further tax cut for the middle class.  All of these actions seem linked to a desire to support stock prices.  But stocks have remained gloomy.  So we can expect that Trump will keep searching for some way to boost the metric that he thought made him look so good.

Persistent efforts by governments to support and boost asset prices have tended to end badly.  There is no free lunch, and governmental distortion of asset prices inevitably leads to misallocation of capital and other resources.  Pushed far enough, this mispricing eventually becomes too much for investors to stomach, and they back away from the asset. Then, bad things happen to the asset's price. That happened with real estate and mortgages in 2008 and it may be happening with stocks now.  If Trump pushes too hard on maintaining and increasing stock prices, he could foster a bubble in the stock markets, and nothing good for him will result from that.  If you're an investor, don't bet on governmental action to make stocks great again.  Remember:  in the final analysis, stocks go up and stocks go down.

Where Is the Stock Market Headed?

With the Dow Jones Industrial Average having dropped over 2,000 points since its peak a week and a half ago, this is the $64,000 (or more) question.  The recent market surge resulted to a large degree from too much optimism.  Market players have selectively focused on the good news (strengthening economy, big corporate tax cut, rising employment levels), while shrugging off the bad news (growing signs of inflation, rising interest rates, and increasing political discord).  Life is like a rose--pretty petals, but thorns as well.  If you ignore the thorns, you'll get an ouchie sooner or later.

So what happens after today's ouchie (1175 points off the Dow)?  The recent market surge seems similar to the valuation-driven bull markets of 1987 and 2000, which resulted in sizable drops of 25% to 30% in the Dow followed by gradual recoveries that took two to three years.  But we should bear in mind an earlier drop off. In 1973, the stock market (measured by the S&P 500) peaked after a long run up, not unlike the one we've had since 2009.  Then, it declined some 40% or more and didn't recover until some seven years later.  The 1970s were also a time of rising inflation and political scandal (Watergate), with the only resignation of a President.  Political turmoil affects economies and stock markets (look at Venezuela, where a lot of folks can't even get a square meal because of political strife).

Expect more market turmoil tomorrow, the next week, the next month, and maybe the next year.  The market could easily drop some more.  We're running out of good news.  There may be little major legislation coming out of Washington, given the political quagmire.  The Fed may go easy on the tightening, but it's not going to cut interest rates simply to support stock prices.  It's already done that, perhaps too much--and today's drop was likely a consequence.  The economy seems to be slowly gaining altitude.  But there's nothing going on that will provide it a quick major boost.  The federal government can't increase the deficit, given its recent deficit-funded splurge with the tax cut bill.  Corporations seem not to be rushing to increase reinvestment of their tax savings.  The Trump administration may spark a trade war with China and other nations.  And the stability of the federal government cannot, in these times that try our souls, be taken for granted.

History teaches that it's not a great idea to sell your stocks in an effort to staunch losses.  People who try to time the market generally fail to get back in and enjoy the resurge that will likely come (although the resurge could be a long time coming). Instead, try to spend less and save more.  Keep your investments diversified.  And don't stop knocking on wood.

Can the Republicans Govern?

With the postponement of the House of Representatives' vote on repealing Obamacare twice in two days, one must ask whether the Republicans can govern.  They control Congress and the White House, but they weren't able to fulfill one of their signature promises from last year's elections.  Dissidents on the far right and in the moderate middle couldn't, for different reasons, sign up for the repeal measure.  President Trump, drawing on his dealmaking experience in business, gave them a take it or leave it compromise--and they left it.  In business, if you pass on a good deal and go for a great deal, you can blow the deal.  But in politics, as Trump may be learning, you can often score points with your constituents by going for a great deal and losing the deal instead of compromising.  Politicians get ahead by telling voters what they want to hear--indeed, that's how Donald Trump got himself elected President.  But doing things that leave voters with mixed feelings--like compromising--places politicians at risk in the next round of primaries.  It's better to look and sound good than doing anything that could leave you open to criticism.

Obamacare will now become a permanent part of the American landscape.  Its essential features--universal access to coverage, subsidies or Medicaid for those unable to pay, no exclusion of pre-existing conditions, and substantial coverage of health problems--will form the foundation of American health insurance for the future.  Surely, Obamacare will be modified over time.  But Barack Obama's greatest legacy will live on.

For the Republicans, the Party of No, a more important question is whether they even understand what it takes to govern.  It's necessary to compromise, and to take the heat from compromising.  The Republican Party, like the Democratic Party, is a coalition.  If coalition members don't work together, governance does not happen.  The next great challenge for the Republicans will probably be the budget bill and tax reform, which will have to go hand-in-hand if the Republicans hope to accomplish everything they've promise.  Their problem is they've made too many promises for the amount of tax revenues the federal government will collect.  They can't boost defenses spending by $54 billion, build the Wall at the border with Mexico, cut corporate taxes, cut taxes for the wealthy (which is an unstated but obvious goal of theirs, given that the proposed repeal of Obamacare was more a bill to cut taxes on the wealthy than improve the health insurance system), and rebuild America's infrastructure, all at the same time.  Something has to give.  Either taxes are raised, federal deficit spending increases, and/or the Republicans give up on some of their goals.  The Republicans will have to compromise to accomplish anything.  But their failure to work out a compromise to repeal Obamacare does not portend well for their future.

Although virtually powerless right now, the Democrats must have gotten a lift today.  Their fortunes have started to turn around.  As devastating as their defeat in 2016 was, it's not the end of the world, or of their party.

Will Donald Trump Be a Traitor to His Class?

The most important legislative priorities of the Trump administration--tax and health insurance reform--will be enacted within a matter of months.  Both of these measures will greatly impact the working class whites who propelled Trump to the White House--either for better or for worse.

Preliminary assessments of the proposed tax reform indicate that taxes for the middle class will drop about a couple hundred dollars.  One percenters can look forward to many thousands in tax savings.  This isn't exactly what folks in small town America were hoping for.  To make up for the loss of income tax revenues from these cuts, the President may endorse a border adjustment tax (basically, a tariff on imports that would likely increase the prices of the inexpensive food and goods that low and moderate income Americans rely on).  To many, this might feel like another kick in the teeth.

Health insurance reform is turning out to be a very tough nut to crack.  President Trump has said he wants to preserve the protections that many low and moderate income Americans count on--guaranteed acceptance, coverage against pre-existing medical conditions, and subsidies for those unable to pay full freight.  But these conditions are very expensive.  How will the President cover the costs?  There seems to be little consideration of progressive taxation of the wealthy or increasing the federal debt.  Yet there's no free lunch.  One possible "solution," so to speak, would be to offer low cost policies with skimpy coverage--prior medical conditions would be covered but total coverage might go only up to $25,000 or $50,000 a year.  This would be expedient, but would effectively deprive people of coverage when they needed it the most.

On top of this, the President's desire to turn Medicaid into a program of block grants for the states has significant potential to reduce coverage for the low income.  Many of these people voted for him.  Where will they go for care without health insurance? Medicaid covers around 74 million Americans--almost 1 in 4.  Cuts to this program could mean many millions of people mad at the President.

President Trump's problems are exacerbated by his proposal to increase military spending by $54 billion.  Where will this money come from?  The Republicans in Congress won't agree to more deficit spending.  So the President can either raise taxes, or piss off many millions of voters by cutting other federal programs.

Donald Trump is President at a time when stark choices are necessary.  He was elected as an insurgent.  But he's stacked his cabinet with establishment Republican types, people who have no demonstrated concern or sympathy for his core constituents.  The Republicans who control Congress gave him scant and faint-hearted support during his campaign.  But today they stack the legislative agenda with bills that would make the rich richer and offer the working class hardly more than a crumb or two--and stale ones at that.  

If the President really wants to help his constituents, he'll have to be a traitor to his class.  He'll have to offer substantial improvements in life to the working class, and sorry to say, but wealthier people will have to pay for them.  America got itself into its current mess by believing that somehow everyone can get more of everything all the time at no cost to anyone else.  The last two large nations to subscribe to this notion--the Soviet Union and Communist China--had to abandon their illusions and now struggle with the consequences of the their wishful thinking.

Franklin Delano Roosevelt, the greatest President of the Twentieth Century, was labelled a traitor to his class.  And he was.  He endorsed legislation like Social Security and a strengthening of protections for workers and labor unions that uplifted many millions of ordinary Americans out of poverty and into the middle class.  The cost was born to a large degree by a sharp increase in federal income taxes paid by the well-to-do.  The rich grumbled and plotted against him.  But he ushered in the prosperity of the 1950's and 1960's, now viewed as a golden age in America.  America's perceived decline from those days also correspond with ever increasing inequality of wealth and income.  If Donald Trump really wants to make America great again, he'll have to make it great for the working class.  That isn't the direction he's been going in since his inauguration.  The next few months, when his most consequential legislative initiatives will be enacted, will likely make him both a traitor--either to his core constituents or to his class--and a hero--to the wealthy, many of whom didn't support him but are glad to free-ride on his policies and program, or to the working class that vaulted him into office.  The choice is his.

Greece, the EU and the Power of Fiat Currency

Greece is evidently going to hit the financial skids next week.  The EU appears to have stopped bargaining (as have the Greeks, who now want to put the issue of austerity in exchange for another EU bailout to their voters).  Without bargaining, there won't be a deal.

How did things end up this way?  One perspective is that, by entering the Euro Zone, Greece gave up a lot of power and put itself under the control of the EU.  When a country issues its own currency (i.e., fiat currency), it has considerable control over its currency's value in relation to other currencies.  If the country slides downhill economically speaking, it can devalue its currency and export its way out of trouble.  The Japanese have done this for decades, and the Chinese and other developing nations are endeavoring to emulate the Japanese. 

But what if the country, instead of issuing its own currency, uses another medium of exchange?  Historically, gold and silver, and sometimes copper, served such a role.  But a country that uses an independent medium of exchange can't devalue its way out of a recession.  It has to find another way; and sometimes it can't.  That's why the industrialized West moved off the gold standard in the 20th Century.  It prevented them from using central bank policies to recover from economic downturns.

Fiat currencies have a very bad image among many in the political right.  Gold standard conservatives fear that governments will inflate the wealth of citizens away for reasons of political expediency.  They rightly point to the morass of post-World War I Germany, when the Weimar Republic did that, resulting in widespread malaise and paving the way for fascism. 

But gold standard adherents forget a basic principle of economics:  goods become widespread in the market because people demand them.  Fiat currency is simply another good, and people demand a lot of it.  It serves as a medium of exchange, and no major economy can exist without a copious supply of the medium of exchange.  Gold was extremely scarce in Colonial America, and deer skins (i.e., buck skins, from whence came the term "buck"), tobacco and other goods served as an alternative to gold.  Various commercial promises to pay, such as drafts, promissory notes, banker's notes, and the like, also came to be used in lieu of gold.  Fiat currency was government's way of simplifying the problem of lack of gold and silver that could be used as media of exchange.

Fiat currency also conferred power. When the American Revolution began, the Continental Congress issued paper money in order to finance the rebellion.   This paper was subject to inflation, and considerable controversy eventually surrounded its use.  Nevertheless, the Continental Congress' ability to issue fiat currency helped to sustain the Revolution.

The U.S. government in the 19th Century outlawed the issuance of bank notes and other private currency and substituted the greenback in their stead.  Although the U.S. government clung to the gold standard, it devalued the dollar against gold once the Great Depression began, and took the dollar off the gold standard during the economic difficulties of the early 1970's.  In other words, gold wasn't really the standard.  The dollar was worth what the government said it was worth, not what the market price of gold happened to be.

The power of fiat currency became vividly clear during the Great Depression and World War II.  The U.S. government began to borrow in large amounts (i.e., engage in deficit spending) in order to alleviate the Depression.  Then, it borrowed enormous amounts to finance the war and defeat fascism.  After World War II, the U.S. government flooded the free world with dollars, so that there would be a currency to replace the British pound as the world's reserve currency.  The U.S. government derives enormous power from the fact that the dollar is the world's reserve currency.  People in other countries have to pay attention to America, because America's currency keeps the world's economy going.  Even in the Communist bloc, the dollar mattered.  As Communist economies flagged, the dollar became the underground, but de facto real, currency in many Communist nations.  Communism's legitimacy was in part undermined by the strength of America's fiat currency.

Greece is in a real fix, because its citizens don't want austerity, but they want to remain part of the EU.  Reality is that they are damned if they do and damned if they don't.  Staying in the EU will require agreement to the EU's demands for more austerity, which will probably worsen Greece's depression.  Leaving the EU will also likely mean that the Greek depression will worsen.  Who's at fault for this mess is a complicated question, but the answer, in short, is like Agatha Christy's novel, Murder on the Orient Express.  Everyone involved in and with the EU is responsible.  And there's no easy way out of the mess, for anyone.

But a larger point is that fiat currencies aren't good or evil.  They are a tool, one that can be used productively or counter-productively.  We need to watch what the Fed is doing--closely.  But let us recognize that much of America's strength comes from its fiat currency. 

The Shrinking Deficit: a Plus for the Market

The federal deficit is projected by the Congressional Budget Office to be just under $500 billion this fiscal year (the year ending Sept. 30, 2014). (See http://www.cnbc.com/id/101581648.) That's a lot of money, but only one-third the deficit of five years ago.  In other words, the deficit is lower by a trillion dollars, compared to half a decade ago.  That's a whopping huge drop, which leaves this year's deficit at 2.8% of GDP, below its historical norm of 3%.

When deficits fall, the government competes less in the credit markets against private sector borrowers.  This makes it easier for private interests to secure investment capital, a key predicate to economic growth.

Stocks tend to rise during periods of falling federal deficits.  The late 1940s and the 1950s are one example.  The 1990s are another.  The fact that stocks have risen steadily from their 2009 lows indicates that we are in another period of falling deficits and rising stocks. 

The future direction of the deficit is unclear.  The CBO predicts that it will fall a bit more next year and then begin to rise.  However, five years ago CBO didn't come close to predicting the deficit reduction we now have.  The weird, dysfunctional cognitive dissonance that is today's federal governance somehow managed to produce this beneficial result.  Who knows whether it might stumble its way to more good outcomes.  If the deficit stays moderate (near 3%), the markets will probably benefit.  While there are many other factors fueling volatility today, the federal deficit, improbably, isn't one of them.

Why the Economy Could Grow: the Peace Dividend

Contrary to the expectations of many economists and financial market professionals, the U.S. economy seems to be growing reasonably well.  In the third quarter of 2013, growth was 4.1%.  For a mature, industrial economy, a 4.1% rate is good.  The Cassandras among pundits warn that it can't last.  They could be right--but they also could be wrong.

When one looks at what would impel further growth, many of the usual suspects don't seem to be helping much.  Business investment is tepid.  Income growth in the aggregate is even more tepid.  Only the the top few percent have no fear of the Grinch this Christmas.  The federal government is reducing its spending growth--primarily due to sequestration, but even the new budget deal doesn't offer major spending increases.  U.S. exports have been an economic bright spot the last few years, but America isn't an export driven nation and exports can't turn the economy around by themselves.

What, then, could be producing the growth?  The Federal Reserve's accommodative policies no doubt play a role, although much of the case for reducing quantitative easing is that its marginal impact is diminishing, and very possibly evaporating.  The Fed hasn't done anything lately to produce a growth spurt.  Its primary role has been to keep a thumb in the dike until other forces cause the economy to perk up.

But one factor to bear in mind is that America may be starting to enjoy a peace dividend.  The end of major wars is almost always followed by a period of prosperity.  The Civil War was followed by the rapid growth of the Gilded Age.  World War I was followed by the Roaring Twenties.  World War II was followed by decades of prosperity.  And the conclusion of the Cold War in 1990 was followed by the prosperity of the 1990s.  Only the end of the Vietnam War wasn't followed by a growth spurt, and that might well be attributable to the oil price shocks administered by OPEC, which transferred a great deal of wealth to oil producers and away from the consumers who comprise two-thirds of the U.S. economy.

Even though America remains embroiled in seemingly never-ending conflict, we have a peace dividend in the offing.  The war in Iraq is over.  The war in Afghanistan is winding down.  Although U.S. military and security personnel continue to confront challenges in the Middle East, Africa, Asia and Latin America, none of them involve the expenditure of hundreds of billions of dollars, as did the recent Iraq and Afghan wars.  Large amounts of America's wealth that were being spent on weapons and fighting overseas can now be shelled out for double bacon cheeseburgers, big screen TVs, three-quarter ton pickup trucks, smart phones, Legos sets, kitchen re-modelings, really big cups of soda in New York City, vacuous tattoos, frisbees, pre-mixed cocktails, trips to Graceland, and doggie pedicures.  And a lot of other stuff as well.  Giving peace a chance could be the best federal economic policy of the times.  Even though there surely will be ups and downs in the economy in the coming years, the peace dividend offers a powerful reason to hope for the best.

Why the Republicans Blinked

The Republicans, especially those in the House of Representatives, are rapidly giving ground in their fiscal battle with the Democrats.  A resolution is pretty likely within a week or less.  It will probably provide a short term delay of the debt ceiling and re-open the government, while the parties negotiate over long term fiscal issues.

Why did the Republicans blink?  Because they tried to manufacture a crisis out of a non-problem and a long term problem.  The non-problem is Obamacare.  The truth is that Obamacare offers valuable benefits to millions of people.  The huge traffic jams on health exchange websites demonstrate that lots of people understand Obamacare's value and want to participate in the program.  The Republican attempt to de-fund Obamacare would take away something millions of people want, and that's usually a very poor political strategy.  The Republicans seem to have belatedly figured this out, but not before forming a circle and firing volleys inward.

The long term problem is the federal deficit.  It is a serious problem.  But it's not an immediate problem.  The Republican effort to create a crisis at this moment over something that will play out years and decades from now is too obvious a political ploy.  The minority party wants to call the shots by gratuitously inflicting damage on the economy with a government shutdown and coercing an unnecessary default on the most important financial instruments in the world, U.S. Treasury securities.  Political parties thrive by winning over a majority of voters, not by wrecking economies and financial systems.  The fiscal deficit is not an immediate crisis.  It needs to be addressed, and will be, over the next years and decades as it becomes more pressing.  But the Republican tactic--give us everything we demand or we will destroy your government and wreck your finances--is bound to, and in fact did, alienate a majority of the electorate. 

After Barack Obama's re-election last year, the Republicans launched a process of reflection and reconsideration.  It's unclear that they made much progress, and the fiscal brawl of the past few weeks has surely left the party more damaged than before.  The Tea Partiers have prevented the Republicans from doing the thing that's necessary to political domination--shifting toward the middle.  Since political power abhors a vacuum, the Democrats have easily moved into the breach. 

From the Fed: Short Term Gain, Long Term Pain

As the Fed's ultra low interest rate policies grind on for a fifth year, we can see ever more clearly that there is no such thing as a free lunch, even when it comes to central bank policies.  The benefits of the Fed's low interest rate policies were easy to see at first:  cheap credit, stimulus to housing, a boost to the economy.  The costs didn't seem so great. 

However, by persistently favoring borrowers and heaping mulch on income-seeking investors for five years, the long term costs of the Fed's policies are emerging--and painfully so.  Detroit is in bankruptcy, and other cities teeter on the brink. Corporate defined benefit pension plans are becoming less common than the ivory-billed woodpecker. It's no wonder why.  Pension funds rely on safe long term investments that provide solid returns.  U.S. Treasury notes and bonds used to be crucially important components of pension fund portfolios.  AAA-rated corporates, which would have to pay slightly better than Treasuries, also were favored investments.  But pension plan returns came under stress as the returns on these low-risk investments nosedived.  And pension fund deficiencies, calculated on the basis of long term returns, balloon when returns fall.  Plan sponsors have to increase contributions--sometimes enormously--to keep the plans solvent.  Corporate executives intent on making the big score with their stock options see little upside to signing off on these contributions.  Shrinking cities like Detroit have little ability to make them.  Something has to give, and pensioners seem to be doing a lot of giving these days.  Detroit's problems go well beyond low long term interest rates.  But the city really didn't need the Fed to push it closer to the abyss. 

Neither did a lot of corporate employees whose retirements are less secure after losing their defined benefit pensions or seeing the plans capped.  Most people aren't skilled at managing their finances.  When fewer have defined benefit pensions, more are likely to end up with just Social Security, even if they start retirement with good-sized 401(k) account balances.  When people have fewer or no private resources, cutting benefits from the government becomes political anathema. 

Low interest rates hurt older folks in other ways.  As income from their interest-bearing investments dries up, fear drives them to become serial economizers.  That's a hard habit to break even after rates rise again (assuming they do).  Consumption may be impaired for a long time.  In addition, long term care insurance is getting scarce and expensive.  While poorly conceived estimates by insurers of the cost of care have much to do with that, the inability of insurers to obtain decent, safe returns on investments has added to the problem.  Fewer people are able to afford such policies.  So we have a ticking demographic time bomb, with lots of uninsured elderly likely to need Medicaid in a decade or two or three instead of being able to rely on their own resources.  Low interest rates are beneficial to the federal government's borrowing costs right now, keeping the budget deficit lower.  But positioning a lot of people to need Medicaid in decades to come means we'll have pressure toward an increased deficit in the long term.

 The Fed is taking a page from corporate America:  focus on short term returns at the risk of increasing long term costs.  The great corporate success stories don't follow this plot line.  But there's not much chance the narrative will change.  The Fed's easy money merry-go-round keeps the stock market buoyant.  With mid-term Congressional elections coming up next year, the Obama administration needs to keep the market feeling chipper.  Ultimately, everything in Washington happens for political reasons.  And politics dictates that Janet Yellen, a monetary dove, will be Obama's nominee as the next Chairman of the Fed.

The Good Deficit

You already know we're in Oz.  The government manages the federal deficit by making across the board cuts everyone thought would be so extreme that both Democrats and Republicans would work together to find a more rational solution.  Ha ha ha.  The joke's on us.  The government manages the debt ceiling by kicking the can down the road every few months.  The can is getting awfully dented.  And most tellingly, a surprisingly large number of the members of Congress bear a distinct resemblance to the flying monkeys in the movie.

But even as there were bad witches in the movie, there were also good witches.  There are good deficits as well.  Government spending for things that government is particularly good at is generally desirable, even if it requires deficit spending.  For example, government is good at national defense, education, law enforcement, and building or subsidizing transportation systems.  Government is also very good at funding basic research.  Deficit spending to pursue these goals is money well spent because it fills gaps that the private sector leaves open.  These kinds of spending protect and enhance the national wealth and welfare.

There's another problem that should be tackled, even if it requires deficit spending.  The unemployment rate for Gen Y (a/k/a the Millenials) is much too high.  It's generally about twice the level for Baby Boomers, and the less educated Millenials have even higher rates of unemployment.  Those that are African-American and lack college degrees need not apply, especially if they are male.  Large numbers of the better educated Millenials are burdened with heavy educational debts.  The ones with debts of $100,000 or more could face decades of 21st Century-style indentured servitude to their creditors, whose claims they cannot oust in bankruptcy proceedings except in extremely distressed circumstances. 

Millenials who are unemployed and underemployed represent wasted human capital. Modern economies are knowledge based, and human capital is the most important form of national wealth.  A vivid example of the overarching importance of human capital can be found in the aftermath of World War II.  Germany and Japan, the devastated losers (who deserved to lose), had only limited industrial capacity and not enough food to feed their populations.  But they also retained the advanced industrial knowledge they had acquired in building and supporting their massive and highly capable war machines.  Required by Allied occupation authorities to turn that knowledge to peaceful purposes, the two losing nations rebuilt their economies rapidly, and within three decades became industrial powerhouses.  Because they still had their human capital after the war, they could rebuild their tangible assets and prosper.

As a nation, we can't afford to let the human capital of Gen Y atrophy.  They are starting their working lives now, a crucial time for developing the skills of a self-supporting adult.  It's in your twenties and thirties that you learn how to apply all your book learning to the practical needs and purposes of the working world.  Learn those lessons well, and you'll be productive for 40 or more years.  Failing to learn them can result in permanent stunting of one's career.

Add a heavy load of school debt to the mix, and we can see how unemployed and underemployed Millenials could become a permanent economic underclass, unable to escape a shadow world of part-time jobs and episodic contract work, trailed by the baying of creditors hounding them at every turn. 

It's time to revive the Civilian Conservation Corps, 21st Century style.  The CCC of the 1930s employed some 3 million young Americans over the course of its decade of existence.  They were paid very modest wages, most of which were given to their parents (although the employees also received food and housing in addition to their pay).  They did mostly physical labor, as such work was integral to America's 1930s industrial economy.  The program was very popular with the American public, as it gave young people a chance to develop work skills and get a start in adult life.

A comparable program today could include jobs requiring manual labor.  America's highways, bridges and other infrastructure need a lot of maintenance.  America's cities need to be cleaned up, and abandoned buildings torn down, so that redevelopment can begin.  But there are many white collar jobs that need to be done as well.  Rural areas and inner cities lack physicians and other health care providers.  Many school districts are strapped for funding and need more teachers and staff for everything ranging from special education to music and drama.  Many jurisdictions have gravely inadequate funding for public defenders.  Criminal defendants, whom the law in its majesty presumes innocent until proven guilty, have little means to defend themselves and give their presumption of innocence tangible effect.  The poor need legal services for civil matters as well, such as battling indifferent landlords.  The list could go on.

CCC-21st Century jobs should be real jobs, not make work.  We can't ask taxpayers to pay people to dig holes and fill them up.  The pay should be low, because these aren't meant to be career jobs.  They are a way to give young people a start.  Part of the compensation should include generous provisions for government assistance in repaying school debt.  In effect, the government would help young people offload their school debt so they can get a fresh start in life.  Yes, yes, yes, there are countervailing considerations about holding people responsible for their debts and not bailing people out, etc., etc.  But we let egregious spendthrifts stiff their creditors for non-education debt as a matter of course in bankruptcy.  And we bail out really large financial institutions run by millionaire executives.  The burden of educational debt is getting to be too much.  As some guy put it about 400 years ago, the quality of mercy is not strained.  Let's be realistic instead of Puritanically moralistic.

Those CCC-21st Century employees who haven't gone to college could be compensated with the right to educational subsidies, akin to the GI Bill.  These young people could then go to college with less need for debt.  Their human capital would be enriched.

This isn't a perfect solution, and won't solve all the problems of Gen Y.  But it would give many of them a start.  And that's what they need.  Deficit spending for another CCC would be money well-spent.  The private sector isn't helping these people.  Government action is the only alternative.  We don't need more stimulus in the form of Federal Reserve money printing.  We could benefit greatly from stimulus in the form of deficit spending invested in our young adults.

How Is GDP Financed?

It may seem strange to ask how GDP is financed.  GDP simply measures the total market value of final goods and services that an economy produces.  It is a way to measure national income, not a measure of assets on a national balance sheet. 

But the way GDP is paid for does matter.  If large quantities of borrowed money finance GDP, then GDP in future years may be less sustainable than GDP produced by organic growth (i.e., GDP derived from people and companies spending their earnings, rather than borrowings).  The pauper nations of the EU, mostly located on the southern rim, are good examples.  They borrowed heavily (or their banks borrowed heavily) to finance consumption.  For a while, their GDPs grew.  But debt, unfortunately, has to be repaid.  A nation's whose GDP is heavily dependent on borrowed money will eventually have to pay the piper.  If those payments are burdensome enough, the nation's GDP bubble will burst, and recession will follow.  That isn't hypothetical; look at Greece, Ireland, Cyprus and Spain.  Indeed, look at the EU as a whole, which is sinking into recession even as we blog.

In America, the picture ain't pretty.  Even though GDP is nominally growing, in the first quarter of this year at an annual rate of 2.5%, the question of sustainability looms.  The federal government is constraining its borrowing (partly because of sequestration and partly because of Social Security and income tax increases).  Thus, the federal budget wouldn't be a source of GDP growth. 

But the Federal Reserve's quantitative easing program is.  The Fed is pumping $85 billion a month into the economy through purchases of financial assets.  Over a full year, the QE program would pump $1 trillion into the economy.  That's equivalent to about 6% of America's $16 trillion GDP.  It wouldn't be accurate to say that $1 trillion spent on QE results in $1 trillion of GDP.  Much of the money printed by the Fed for QE is recycled back to the Federal Reserve System in the form of member bank deposits at Federal Reserve banks.  This process is a near wash (except that it gives the depositor-banks riskless profits).  But QE is boosting the economy.  Our stock market--bizarrely exuberant in the face of a tepid economy--needs its regular fix of QE to maintain and increase its high.  The real estate markets seem to be getting a boost from the Fed's purchases of mortgage-backed securities.  Increases in asset values such as these appear to be creating a wealth effect that boosts spending (mostly by the top 10%).  That is probably a primary source of GDP growth today. 

But QE is similar to borrowed money.  At some point, the Fed will start selling down its more than $3 trillion balance sheet.  This akin to debt repayment.  It will remove money from the economy.  When there is less money to spend, there may well be less economic growth.  The Fed is hoping that the economy will be organically growing briskly by the time it goes into QT (i.e., quantitative tightening).  But there's no way to know for sure that will be the case.  The Fed may have to shift to QT because of a rise in inflation, whether or not growth has revived.  Whatever the reason for QT, it will constrain growth.  In some circumstances, it could produce a recession. 

Like toothpaste and genies, QE on the loose isn't easily put back into the place where it came from.  There's no riskless way to execute QT.  It's possible that continuation of the Fed's QE program could stimulate the economy to resume vigorous growth.  But that's far from certain.  And every additional month of QE heightens the risks that our economy is becoming overleveraged.

Political Risks of Social Insecurity

The financial press has reported that the United States ranks 19th worldwide in the retirement security, lagging behind Slovenia, the Czech Republic and Slovakia, among other nations.  http://www.cnbc.com/id/100534205.  We're one step ahead of Britain, but well behind France and Germany.  The Scandinavian countries rank at the top, along with Switzerland, Austria, the Netherlands and tiny Luxembourg.  Even Japan, after more than two decades of economic malaise, ranks 15th, four steps higher than America.

This probably doesn't surprise many Americans, particularly those who are approaching or in retirement.  They have probably already viscerally sensed their comparative insecurity.  Herein lies great risk for politicians who would reduce America's social safety net.  Our net is modest compared to the protections offered by most of the industrialized world.  If it's cut, the pain--particularly for moderate and lower income Americans--could be pronounced.  It's one thing if your retirement benefits may not cover as many restaurant meals as you would like.  It's another if your cost of living increase is so paltry that you can't afford needed prescription medications.

That we have a fiscal imbalance is because our taxes are even lower on a comparative basis.  (See http://usatoday30.usatoday.com/money/perfi/taxes/2009-11-25-oecd25_ST_N.htm.)  America could without enormous pain pay for its current social safety net without having to borrow.  We just don't want the taxes it would take to get there. 

Many politicians in Washington sound off about cutting Social Security and Medicare benefits.  This isn't just Republicans.  President Obama has been quick to offer reductions in Social Security.  One is to change the Social Security inflation adjustment from the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) to the Personal Consumption Price Expenditures Index (PCE).  The effect of this change would to gradually erode the relative value of Social Security benefits, with the most elderly being the hardest hit over time.  Is is really a good thing to whack the most vulnerable, who may have exhausted their savings and be unable to work? 

Consciously or subconsciously, Americans know that their retirement benefits aren't great.  And many of them won't be happy with politicians who make their retirements bleaker.  If the President and the Republicans somehow reach a Grand Bargain to stabilize or even balance the budget, the political impact may surprise them.  As Republicans clumsily attempt to embrace diversity, their core of older, white Americans may abandon them if they lead the charge to cut retirement benefits.  President Obama, instead of being viewed as a latter day FDR, may end up appearing to fall into the mold of Herbert Hoover.  And the liberal left, annoyingly shrill as they can sometimes be, may end up inheriting the White House in 2016. 

No Fiscal Discipline in the Stock Market

As the federal government belly flops into sequestration, the stock market merrily rolls along.  Europe is sinking into recession, an inevitable result of its austerity and deleveraging policies.  Japan is in recession, and has pledged to worship at the altar of monetary accommodation in an effort to revive its economy.  American consumers are creeped out by continued government dysfunction, continued economic dysfunction and an increase in Social Security taxes.  Retailers are reaching for the little paper bag in the seatback on front of them.  But stocks are delirious.

Of course, it's all because Federal Reserve Chairman Ben Bernanke yesterday swore up and down that central bank accommodation is next to godliness, or something to that effect.  If the most powerful agency in the United States government promised to subsidize you indefinitely, you'd be delirious, too. 

By ignoring real world problems, and flying high on the Fed's fiat paper meth lab, the market is letting Congress off the hook.  Without someone or something twisting their arms behind their backs, the members of Congress have little or no incentive to get real and work out the nation's fiscal problems.  The stock market has the leverage to make Congress devote its full attention to a problem. In the fall of 2008, when the financial system teetered on the brink, Congress voted down a rescue package.  The market promptly nosedived, and squashed 401(k) accounts from sea to shining sea.  Constituents deluged Congressional offices with negative commentary (that's putting it mildly).  Congress immediately reversed course and enacted the TARP rescue legislation.

Today, however, fed by the Fed with printed money, the market romps.  Congress fiddles.  And the rest of us get nervous about the smell of smoke that waffles through the air.  By not holding Congress accountable, the market enables government dysfunction.  The market can be quite effective when it imposes discipline.  But an undisciplined market is scary.

Politics Keep the Economic Crises Going

We are vividly reminded today that the economic crises bedeviling the world are political in nature.  The election deadlock in Italy, with leftists likely to control one house of the Italian Parliament, and rightists and leftists apparently in  a draw in the other house, is a vote against austerity and centralization of the EU's governance. Although the political nuances differ from Greece's initial anti-austerity vote last year, the Italian election, like Greece's, signals that numerous voters have yet to learn the words of the pan-European version Kumbaya.  Another election in Italy may well be needed, or the country will be unable to stay on track to meet the EU's expectations.

In America, sequestration now seems almost a certainty.  The arbitrary cuts imposed by sequestration were supposed to be unpalatable to either party, and would therefore incentivize both parties to cut a real deal.  Fat chance of that in these days of political dysfunction.  Truth is there won't be a real deal.  That's why the Dems and Republicans kicked the can down the road when the fiscal cliff loomed and the debt ceiling threatened to descend like the Sword of Damocles.  The government right now can do little more than bring its foot back for another kick.  The one silver lining in the clouds is that the economy seems to be recovering to some degree.  The better the economy does, the lower the deficit will be.  We should hope and work for economic growth, because that is the only politically feasible solution to the budget deficit.  The federal government needs to repair and upgrade infrastructure, adopt a pro-growth immigration policy, work hard to cut the growth of health care costs (perhaps the biggest expense in future federal budgets), and work toward supporting and expanding educational opportunities while reducing the cost of education.  (Internet-based instruction may be a great way to educate at much lower expense, and should be encouraged and supported.)  The current squabbling in Washington over budget cuts and tax increases is a game of musical chairs that no one can win.  We have to take a different approach.

Reducing the Deficit: Should the Fed Monetize the Federal Debt?

Desperate times call for desperate measures.  We've seen yet another dysfunctional mess from the political process, and have to think expansively.

The recent fiscal cliff deal was largely a failure.  It raised taxes on most Americans, while doing virtually nothing to reduce federal spending.  While income taxes were not increased for the middle class, Social Security taxes were increased for all workers at all income levels.  The well-off (the $400,000 plus crowd) face a higher income tax rate of 39.6% (20% on qualified dividends and capital gains) and wealthy dead people now pay a 40% tax rate (instead of 35%) on the portions of their estates exceeding $5 million ($10 million for married couples).  The automatic spending cuts required by the cliff were deferred for two months (except for $24 billion in cuts that do go into effect), so spending largely continues apace.  Presumably, there will be a second face off over spending cuts when the President asks Congress to increase the debt ceiling in the next few weeks (even though the White House insists it won't negotiate over the debt ceiling).

One thing to take away from the cliff deal is that spending cuts are really hard to agree on--so hard that the Dems and Republicans simply kicked the can down the road.  But they will be even harder to agree on two months from now.  The Republicans have lost significant leverage by agreeing to tax increases now.  The tax side of the fiscal cliff has been resolved, more or less favorably to the Democrats (although some liberal Dems are still unhappy).  What incentive do the Dems, who control the Senate, now have to agree to spending cuts?  Of course, the Dems would agree to some spending cuts (the defense budget would be their target number one).  But Republicans are focused on hurting core constituencies of the Democratic Party through Social Security, Medicare and Medicaid cuts.  With the Dems having largely won on the tax issues, they have little reason to make concessions on the social safety net.  Even if the President is willing to give the Republicans some of what they want (which he seems to be), he may have a problem in the Senate, where Social Security, Medicare and Medicaid were stoutly ring-fenced and defended during the fiscal cliff talks.

Realistically speaking, we shouldn't expect our dysfunctional elected government to find grand solutions to the fiscal deficits.  Due to a variety of bad and intractable political dynamics, that simply won't happen.  We have to look elsewhere for solutions.

The next logical candidate to get the hot potato would be the Fed.  The central bank has played a central role in combating the Great Recession, not without some success.  In the course of its massive quantitative easing programs, it's accumulated a balance sheet of close to $3 trillion.  This total is likely to grow as the Fed continues to purchase debt on the open markets.  Slightly over half of the balance sheet consists of U.S. Treasury securities.  Total federal debt is about $16 trillion.  Thus, the Fed holds about 10% of all federal debt.

Why not have the Fed simply forgive some or even all of the U.S. Treasury debt it holds?  In other words, it would declare that the Treasury wouldn't be required to pay the debt.  That, by definition, would reduce the federal deficit by reducing the amount of federal debt outstanding.  And it's what happens anyway.  When the Fed receives debt payments from the Treasury (usually consisting of interest payments), it simply remits those funds back to the Treasury Dept. (except for a small amount retained to finance the Fed's budget).  Debt forgiveness by the Fed would simply expand on what happens in the ordinary course.   

Of course, such debt forgiveness would be tantamount to monetizing the debt, and has the potential to be inflationary.  But precisely what the heck do we think is going on now?  When the Fed launches repeated quantitative easing programs, with ever more asset purchases but not the tiniest hint of when, if ever, it would unwind its Brontosaurian balance sheet, it has functionally monetized the debt.  With the economy expected to be a sick puppy for years, reality is the Fed may hold a lot of its current inventory of U.S. Treasury securities until they mature.  When they mature, it will remit the principal payment it receives from the Treasury back to the Treasury (or use the funds to make more open market purchases of Treasury securities).  The federal debt has been monetized, even though no one on the government's payroll is going to admit it. 

Such debt forgiveness wouldn't fully resolve all the deficit problems.  But it could reduce the scope of the crisis, and would amount to little more than accurately accounting for what is actually going on.  If inflation flared, the Fed could suspend debt forgiveness and raise short term interest rates, combating inflation as it traditionally would.  But as long as inflation is subdued, debt forgiveness could contribute to resolving a problem that politicians clearly won't be able to solve, at least not comprehensively.

Ultimately, the best solution to the deficit problem is to boost economic growth.  Greater growth means higher employment levels and more income and corporate profits to be taxed.  If the economy were growing briskly and unemployment were around 5%, we probably wouldn't feel we have a deficit crisis.  Housing seems to be stabilizing, although its long term prospects remain clouded.  So we can't count on housing to be the engine for growth.  Measures the government could take include:  (a) rebuilding infrastructure--this is something the government has historically done well, and should do more of given the crumbling state of our infrastructure; (b) loosen up immigration restrictions for well-educated people and people who can invest substantial capital in America to create jobs--we need more innovators and entrepreneurs; (c) improve education, not by handing out loans to anyone who has a pulse and a signature (there's way too much student debt already, and it will be the next big debt bubble), but with measures to make education more efficient and inexpensive, like expanding Internet-based educational programs.  Achieving greater economic growth will take time, but it's a lot easier than trying to use the political process to agree on budget cuts. 

Over the Fiscal Cliff and Through the Woods

Over the cliff and through the woods,
To a grand recession we go.
Congress knows the way to waste its last day,
raising taxes and adding woe.

Over the cliff and through the woods,
To a grand recession we go.
The Fed is on deck, printing money like heck,
Investors are losing dough.

Over the cliff and through the woods,
To a grand recession we go.
The Dems go their way to make the rich pay,
Republicans say no no.

Over the cliff and through the woods,
To a grand recession we go.
Where the deficit shrinks, while the jobless drink,
Eating cake is for the po'.

Happy New Year.

Political Risks of the Fiscal Cliff

Who faces the greatest political risks from the fiscal cliff?  It ain't the Democrats.  They could do nothing, and watch the pre-Bush tax rates go back into effect in 2013.  While this would have a near term negative impact on consumer spending, it would lower the federal deficit.  That would promote long term economic growth.  The President would take some heat for the economic slowdown, but the Democrats would have four years to recover before facing the 2016 Presidential election.  By then, the economy might well be improving.

If there is a deal on the fiscal cliff, it would probably include some cuts to Medicare and Medicaid, and perhaps to Social Security (although the latter is less likely, since Social Security is actually much less of a fiscal problem and more visible to the voting public).  The Democrats would blame these cuts on Republican insistence (of which there is plenty).  Meanwhile, the Democrats would take credit for whatever tax increases or enhancements or whatever else would be part of the deal, which probably would fall more heavily on the rich than the 99%.

The Republican insistence on no tax rate increases allows President Obama to replay his winning electoral strategy of advocating tax increases for the rich.  Republicans believe too much in their own P.R., that all taxes increases are invariably bad and that spending cuts would somehow be made to prevent taxes from increasing.  A majority of the electorate thinks otherwise, and the Republicans conceded these voters (let's call them the 51%) to President Obama. 

 The baseline problem with the Bush tax cuts is that they reduce federal revenues to the point where Social Security and Medicare--the two most sacred bovines of American politics--are imperiled.  It's one thing to attack federal funding of bridges leading to nowhere.  It's another to take away bread and butter from the elderly.  Republicans have managed to put themselves in a corner where they seek to protect low taxes for the wealthy while trying to squeeze pensioners having modest incomes.  They ultimately can't protect the wealthy from a tax increase--the Democrats can do nothing and those increases will take effect at midnight, Jan. 1, 2013.  But the Republicans can manage to look like Scrooge during the Christmas season as they advocate cuts for moderate income retirees.  Politically, it won't be the Democrats who tumble over the fiscal cliff.

All That Noise, All Those Robocalls, and Nothing Changed

We had the elections, and nothing changed.  Barack Obama was re-elected President.  The Democrats kept control of the Senate.  The Republicans kept control of the House.  After all the accusations, attack ads, junk mail, robocalls, soaring campaign rhetoric, and lies, we can look forward to . . . more gridlock.

This election was the comeuppance of all the money bag men who nonymously or anonymously tried to buy their way into political power.  Hiding behind secretive nonprofits, monied interests barraged users of every type of media with relentless harangues and unending fear mongering.  While Democratic war chests were very large, Republican funding was Brobdingnagian.  But all that spending, and counter-spending, produced very little change.

That's a great result.  It shows that the American voter isn't a dumbo who can be cynically manipulated by unnamed puppet masters with zillions to spend behind the scenes to instill subliminal fears.  Politicians and political parties must, however difficult it may be, offer something that is in the public interest.  They need to demonstrate that they have something positive to say and do.  The political process remains a means for societal concerns to be debated and resolved.  The rich may not get richer.  The poor may not get poorer. 

Many problems lay ahead.  The fiscal cliff approaches anon.  The economy remains in first gear, and unemployment levels feel like the real bad hangover that comes from drinking the worm as well as the tequila.  The federal deficit must be dealt with.  As difficult as these problems may seem, the defeat of the monied interests is a sign of hope--hope that politicians may try doing something constructive for a change, rather than cater to those that offer to hand over the biggest checks.