Two acclaimed political economists explore the origins and long-term effects of the financial crisis in historical and comparative perspective.
Welcome to Argentina: by 2008 the United States had become the biggest international borrower in world history, with almost half of its 6.4 trillion dollar federal debt in foreign hands. The proportion of foreign loans to the size of the economy put the United States in league with Mexico, Pakistan, and other third-world debtor nations. The massive inflow of foreign funds financed the booms in housing prices and consumer spending that fueled the economy until the collapse of late 2008.
The authors explore the political and economic roots of this crisis as well as its long-term effects. They explain the political strategies behind the Bush administration's policy of funding massive deficits with the foreign borrowing that fed the crisis. They see the continuing impact of our huge debt in a slow recovery ahead. Their clear, insightful, and comprehensive account will long be regarded as the standard on the crisis.
The Treasury can cry foul all it wants, but the decision by Standard & Poor’s to downgrade America’s credit rating by one notch last
Friday, and the subsequent plunge in the stock market, are serious
symptoms of a loss of confidence—an assessment that is fundamentally
political, not economic.
There is little question about the technical ability of America to make
good on its debts—but there are grave questions about the political
system’s ability to resolve our nation’s financial problems.
The debt-ceiling deal between President Obama and Congressional
Republicans merely staved off a crisis of confidence for the moment. It
does not address our immediate need to avoid falling back into
recession, or our longer-term need to raise enough revenue to pay for
the social spending Americans want.
Moreover, the deal sidesteps the fundamental challenge the country now
faces: who will pay to fix what was broken during the past decade by
irresponsible tax cuts, ruinously expensive wars, failures of regulation
and the resulting housing and financial booms and busts?
In the short term, the plan cuts a bit of discretionary nondefense
spending, a category that in fact has not grown particularly rapidly.
This is a mistake. With unemployment at 9.1 percent, and long-term
joblessness at record levels, we need more spending, not less. But the
agreement all but rules out new spending to boost the economy, at a
dangerous time. The chances of a double-dip recession are growing—and a
further slowdown will increase, not reduce, the budget deficit.
The longer-term spending and revenue commitments are no better.
Certainly spending, in particular on Medicare and Medicaid, needs to be
restrained. But the deficits cannot be reined in without tax increases,
and the “framework” does little or nothing in this regard. The S. &
P. decision to downgrade reflects, in large part, the expectation that
Republicans will not allow the Bush tax cuts to expire.
The recent skirmishes all dance around the central issue: the United
States is in the midst of the world’s largest debt crisis. The Treasury
now owes the public almost $10 trillion, including $4.5 trillion to
foreigners—and that doesn’t include what households and companies owe.
For decades to come, Americans will face the core problem of every
heavily indebted nation: who will bear the burden of adjustment?
Countries borrow for many purposes: canals and railroads in the 19th
century, factories and highways in the 20th, and in the last decade, a
housing and financial boom in Europe and America. When the projects
don’t pan out and the debtor country falls into crisis, what happens to
the accumulated debts? Who pays? Creditors or debtors? Workers or
investors? Rich or poor? The European Union is tearing itself apart over
this question, which divides creditor nations from debtor nations and
which divides groups within nations. The American variant of this
conflict is just beginning.
Perhaps, some Americans believe, we can shunt the adjustment costs onto
foreigners. Indeed, our creditors worry that the United States will
reduce its debt burden the old-fashioned way, by inflating it away. A
few years of moderate inflation, and a weaker dollar, would
significantly lessen the real cost of servicing the country’s debts—at
our creditors’ expense.
But adjusting to the reality of America’s accumulated debts will
inevitably require sacrifices at home. The battle over who will be
sacrificing has already begun, albeit under veils of rhetoric. The
Republicans seem unconcerned about stimulating recovery, and primarily
concerned that none of the long-term costs of balancing our budget be
paid by upper-income taxpayers. No surprise: unemployment among the
one-third of Americans with the highest incomes is barely 4 percent,
while for the lowest third it is more than four times that level.
The Democrats, for their part, seem content to insist that the
adjustment burden not fall on beneficiaries of government spending,
whether public employees or recipients of social spending. This reflects
their base in the labor movement, the public sector and the poor.
We lost the first decade of the 21st century by squandering our wealth
and borrowing as if there was no tomorrow. We risk losing this decade to
an incomplete recovery and economic stagnation.
An economically responsible, politically feasible distribution of the
costs of working our way out of the crisis will require higher taxes, a
more efficient tax code, and restrained growth of social spending,
particularly Medicare. To ignore these realities, and the contentious
choices they entail, is merely to postpone the inevitable day of
reckoning—and probably to make it worse.