Sunday, April 24, 2011

The Debt & Deficit Story

Here's a nice post by Dean Baker setting the record straight in the midst of all the hysteria about the US's debt and deficit:
Steven Pearlstein did his part for the Wall Street crusade to get people to surrender their Social Security and Medicare. He warned readers that if we don't follow the Wall Street deficit reduction agenda, the dollar could enter a free fall.I would say that this is one of the silliest things the paper has ever published, but this is the Washington Post that we are talking about.

Anyhow, let's put on our thinking caps and try to envisions what Pearlstein's scare story would look like. Currently, the euro is equal to around 1.45 dollars, there are approximately 6.5 yuan to a dollar and around 80 yen. Suppose we don't follow the Wall Streeters wishes. Will the dollar fall to 3 to a euro, will it only be worth 3.5 yuan and 40 yen?

Does anyone think this story is plausible? We supposedly have been begging China to raise the value of its currency by 20 percent, is China's leadership suddenly going to sit back and let the yuan rise by 100 percent? What happens to China's export market in this story? The same is case for our other trading partners. Europe will lose its export market in the U.S. and suddenly U.S. made goods would be hyper-competitive in its domestic market. Japan, Canada and everyone else would face the same situation.

These countries will not allow their economies to be destroyed by the loss of the U.S. export market and a surge of imports from the United States. They will undoubtedly take steps to stop and reverse any free fall of the dollar, if we did begin to see it.

In other words Pearlstein and the others are peddling total nonsense when they try to push this scare story. The bottom line is that they want to cut benefits to the middle class. They don't have a good story to sell a policy that will be harmful to large segments of the population, especially when the Peter Petersons of the world are making out like bandits. So they make stuff up.

As every economist knows the story of our deficit in the short-term is the downturn created by the collapse of the housing bubble. The deficit is propping up the economy following the loss of $1.2 trillion in private sector demand.

The deficit story in the long-term is health care. Our health care system is out of control. Fixing health care would end the deficit problem, but this would reduce the income of the insurance industry, the pharmaceutical industy and other powerful interest groups. So, the Washington Post would rather just see people go without health care. Hey, someone's got to pay.
To get the embedded links, go read the original post.

The reality is that if the US government didn't sustain a deficit right now, the Great Recession would be the Great Depression II. But nobody in the debate is willing to admit to that. Instead, they scare up the bogeyman to ensure that deep-pocketed interest groups come out of this mess with their pockets full while most Americans have their pockets picked, yet again, by those with the politician's ears.

Here is a post by the economist Mark Thoma that lays bare the truth about corrupted politics:
Jon Faust of Johns Hopkins Center for Financial Economics:
Reject Greenspan’s Bleak Vision, by Jon Faust: Alan Greenspan recently argued in the FT that the Dodd Frank Act fails to meet the test of our times. In defense of this view, Greenspan paints a disturbing view of the modern world as a financial dystopia in which humans are at the mercy of a financial machine they have built but can no longer hope to manage. Greenspan argues,
The problem is that regulators, and for that matter everyone else, can never get more than a glimpse at the internal workings of the simplest of modern financial systems. ... With notably rare exceptions (2008, for example), the global “invisible hand” has created relatively stable exchange rates, interest rates, prices, and wage rates.
... Greenspan’s bleak vision, like Orwell’s before him, may prove correct. My view is that the financial crisis was not a sad by-product of modernity but rather a new episode in a very old story: systems that allow risk taking and innovation are inherently subject to periodic crises. We can surely avoid another crisis by outlawing all risk taking. The alternative is to strive provide a stable backdrop in which productive risk taking can flourish. The history of progress financial progress has, arguably, been one of generally increasing stability -- in economies where development has been allowed to occur -- supported by an evolving system of market and political institutions, laws and regulations.

Greenspan is right that the Dodd Frank Act, like every hasty response to upheaval, is grossly imperfect. The Patriot Act comes to mind. The Federal Reserve Act of 1913 was itself a crisis response and was substantially modified over more than 20 years before reaching the form we recognize today.

We should continue the job of reform and not surrender to Greenspan’s dystopian vision.
Greenspan is yesterday's news, and the substance of what he says won't have much impact on policy. But what he is arguing is notable because it represents a common point of view that Dodd-Frank will do little except reduce economic growth and, to the extent possible, it should be reversed.

And the financial industry is taking advantage of this. While our attention is diverted to other matters, e.g. protecting social insurance from the latest onslaught from the right, the financial industry is quietly -- and in many cases successfully -- pushing to ease the restrictions in Dodd-Frank (you can track changes to Dodd-Frank here). Too many people still believe that anything that's good for the bottom line in the financial sector is good for America despite recent evidence to the contrary.

I don't think we'll ever be able to completely prevent crises, but we can reduce the damage that a crisis can do, and we can make crises rarer than they've been recently. However, that requires doing things that the financial industry does not like. With both parties dependent upon financial industry money to fund their reelection campaigns, and with so much of this under the public's radar, it's not at all clear that Congress will take the steps that need to be taken, or even hold the line on the regulations that are already in place.
Go read the original post to get the embedded links.

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