News & Politics

Obama, Let the Economy Shrink

For Obama to artificially support American growth at the unsustainable current levels is an ill-advised waste of money

Obama's election is transformative, not just because of his race, but because of his ideology. This election represented a clear break with recent administrations for a whole lot of reasons. Since Ronald Reagan was elected in 1980, the United States has been led by presidents who are more concerned with the health of our corporations and our elites than with average Americans. Supporters of Bill Clinton may take offense, but it was Bill Clinton's administration that transformed the Democratic Party into a centrist organization highly dependent on big corporate campaign contributions. No, it is only with the election of Barack Obama that for the first time in a long time America has a president who genuinely cares more about average working Americans than about our biggest corporations' profits.

But there will be no long-term if Obama is not successful in getting us through the short-term. I have been one of the most pessimistic forecasters on the economy for a decade now. But for the first time it is looking as if my forecasts were too mild. The economic collapse that has enveloped the globe is going to be worse than anything I have predicted in my writings. In the last six months alone what was a housing and mortgage problem has spread to the entire global financial system, has infected the ability to get credit on all assets and businesses, and is now causing what I believe to be the worst economic downturn since the Great Depression.

The stock market in the United States, measured broadly by the S&P 500, has seen a decline from its peak of more than 50%. The Bush administration's reaction to the economic collapse has been poorly planned, sporadic and nearly criminal. It has bailed out some of America's largest institutions with taxpayer money without asking creditors to those companies to lose a single dollar of their capital. It has asked the Congress for $700 billion, supposedly to buy underwater mortgage assets from financial institutions, but turned right around and ended up suspending that program before it began and instead giving $250 billion to six of the largest financial institutions in the United States. How this was justified given the stated uses for the capital is impossible to understand. If institutions like J.P. Morgan were healthy, why were they given taxpayer funds? And if institutions like Citigroup were in trouble, why weren't we asking their executives to return hundreds of billions of dollars of bonuses they had received over the previous five years, or asking their creditors to take some financial hit before taxpayer funds were injected?

It is disappointing that Barack Obama came out in support of this $700 billion TARP bailout plan. To give him the benefit of the doubt, we can assume that he was told by the Bush administration, just like the rest of us were, that the financial markets would cease to operate if we didn't agree to give them this money. But simple economic analysis refutes the logic of this: buying distressed mortgage assets from financial institutions at a further loss doesn't help those institutions avoid yet further losses and insolvency. That the crisis worsened during the lame-duck period, after the election but before Obama was inaugurated or had named his economic advisers, is unfortunate. But the most disturbing aspect of the $700 billion TARP and the bailouts by the government of Fannie Mae, Freddie Mac, AIG and Bear Stearns, is that it all smells of business as usual right when we all have committed ourselves to change. From the perspective of American taxpayers, it is hard not to walk away with the impression that the same bad managements that got us into this mess are being rewarded for their ineptitude. Why would you reward the very companies that caused this crisis? Why would you think these completely inept management teams would be the ones to get us out of this mess? Unfortunately, the only answer I can come up with is that these are the very same companies that were the biggest contributors to our president and to our congressmen in their election campaigns.

Experts agree that deregulation of the financial industry led to the global meltdown of the world's financial system. But the experts don't tend to be quite as clear in stating the connection between that deregulation and the fact that the financial industry and its lobbyists were the largest campaign contributors in Washington, DC. So, now, in searching for a way out of this mess, our elected representatives in Washington are still held hostage by the corrupt campaign contribution system that got us where we are today. It is one thing for Americans not to have understood how unregulated Wall Street and the banks had become over the last two decades, but most Americans realize by now that it was wrong to bail out these same financial companies and their executives with taxpayer money. Public opinion in the United States was running 95% against the TARP plan when Congress was debating passing it, but that had no effect on congressmen who have learned to take their marching orders not from the American people but from the very institutions that are paying them the big bucks—big corporations, big banks, hedge funds and the rest of the Wall Street gang.

The financial crisis has now officially spread to Main Street. The government has announced that the United States has been in recession since December 2007. Unemployment has increased for nine straight months and 1.2 million people have lost their jobs in the last year in the United States. GDP growth has turned negative, as has personal consumption and the CPI index is deflating for the first time in decades. The three companies that make up the U.S. automobile industry, GM, Ford and Chrysler, will get some sort of temporary bailout. Again, unfortunately, Barack Obama has thrown his weight behind supporting their appeal. Obama understands the importance of a healthy automobile industry to the supply of jobs in America and it has been estimated that as many as 3 to 5 million jobs may be lost if the industry went away. In addition, the UAW, the United Auto Workers union, was a major supporter of Barack Obama in his candidacy for president.

But, yet again, this type of appeal makes little economic sense. These three American automobile companies are losing approximately $25 billion in cash each quarter, so a $25 billion bridge loan from the American taxpayer is a bridge to nowhere. Again Congress is talking about injecting monies into companies before any formal bankruptcy proceedings, before any formal restructuring, and before creditors take a single dollar of loss from their debt investments in these companies. It makes no sense to inject $25 billion of hard-earned taxpayer money into an industry that is so poorly organized. Before the American taxpayer is asked to invest money in the U.S. auto industry, the U.S. auto industry needs to completely restructure. It has 70% more dealerships than it needs. It has six or seven major manufacturing plants that are obsolete and need to be closed. It pays its workers a fully loaded wage of $74 an hour while Toyota pays its workers here in the United States under $36 an hour and the average American in the private sector earns only $26 an hour, including benefits. U.S. auto industry retirees earn more than $4,200 a month while elderly Americans not in the automotive industry try to squeeze by on Social Security payments of $600 to $800 a month. Its executive management team is considered one of the worst in the world. These are the same executives who opposed the introduction of seatbelts in automobiles, opposed the introduction of airbags for safety purposes, opposed The Clean Air Act, opposed the introduction of more fuel-efficient cars, opposed the introduction of electric vehicles, opposed the introduction of hydrogen vehicles, and opposed mass transit as a means of reducing automobile pollution. When they finally introduced hybrid technology to their automobile lineups, seven years after Toyota, they put the hybrid technology on the egregiously huge Cadillac Escalade and GM's Yukon, driving their fuel efficiency from an immoral 8 miles per gallon to in an immodest 10 miles per gallon. It is these managements that are now proposing that they receive only one dollar in salary each year, but of course they are saying nothing about the huge number of stock options and stock grants they will take out of these companies that will end up being worth hundreds of millions of dollars if the American taxpayer financed bailout is successful. And make no mistake, the cost of a bailout of these companies is hundreds of billions of dollars, not $34 billion.

Obama, as we speak, is putting together his big economic plan that he plans to unveil after his inauguration. While including some tax cuts for average Americans, it appears the main emphasis of his plan is a trillion dollar plus multi-year fiscal stimulus of the United States economy from its government. Interest rates are already at 1% and cannot be effectively lowered very much more. Bank lending has pretty much ceased. The stock prices of most financial institutions are off more than 75%. It certainly looks like something has to be done.

But America is hamstrung. We already had approximately $10 trillion of debt going into this crisis, and now it looks like Bush and Paulson have spent or made guarantees of an additional $8 trillion, and this doesn't include the $5 trillion of questionable Fannie Mae and Freddie Mac assets they have absorbed. It may come as a surprise to you, but even the United States government's debt capacity has a limit. Because Americans do not save, there will come a day when foreign governments and foreign institutions simply say no mas, no more, we have had our fill of U.S. treasury debt. With a total economy of $14 trillion that is dropping in size each day, that day may not be that far off in the future.

I don't blame Barack Obama for his desire for massive fiscal stimulus in this economic environment. I don't even blame his economic advisers specifically. It is the entire field of economics that is wanting. For too long, economists have fallen in love with their theoretical and mathematical models of certainty and have ignored how poorly these models truly reflect the uncertain real world. Both Bush's economic advisers, who wanted to emphasize trickle-down tax cuts to America's biggest corporations and our wealthiest citizens, and Obama's economic advisers, who wish to cut taxes on working Americans and increase government spending tremendously through fiscal stimulus plans, have it wrong. Tax cuts, fiscal stimulus plans and taxpayer bailouts increase government debt that must be repayed by our children in an attempt to keep GDP and corporate earnings at their current, unsustainable level. The problem we have is too much debt-financed consumption overall, and the proposed solution by both parties is to finance more consumption with debt we cannot afford.

GDP growth in America, and for much of the world, during the last 20 years has been somewhat illusionary. Increased consumption by both individuals, corporations and the government that funded this GDP expansion in the United States was financed with an increase of debt from $25 trillion ten years ago to $60 trillion today. Individuals, companies and our government spent beyond their means and used debt to purchase things they could not afford. There is no way the current level of GDP is sustainable given that it was achieved through massive borrowing. Individuals, banks and corporations are now all going to have to de-leverage, pay back their debts, so they will not have the monies needed to make additional purchases of goods and services.

This means the real GDP of the United States is going to shrink. It has to return to the more sustainable level we saw before all this borrowing and debt financed consumption. Just as home prices must return to the level before the introduction of crazy mortgage terms, so the GDP of the United States has to decline to a level that balances purchasing activity with savings by its citizenry.

For Obama or Bush or Paulson or the U.S. Congress to try to artificially support GDP at these unsustainable current levels through tax cuts, fiscal stimulus plans and bailouts is an ill-advised waste of money -- money that our children and grandchildren will have to repay. There is nothing wrong with allowing GDP to return to its levels of eight years ago other than that corporations today have too much debt to be solvent under those conditions. What is needed is not artificial support of an unsustainable level of GDP by our government, but a dramatic de-leveraging of our banks, our corporations, our citizens and our government that will allow them to be solvent in a slightly smaller economy.

What can government do if the citizens, our corporations and banks and the government itself all have too much leverage? The answer may surprise you. The way out of this difficult time is through inflation of our currency. Inflation, which no one likes and which can be very damaging to an economy, is the only way to deflate the value of debts on everyone's balance sheets at the same time. As the government prints more money and causes general inflation and prices to increase, debtors, whether they be individuals or companies, banks or our government, get to repay their debts in less valuable inflated dollars, a godsend for out-of-control borrowers.

The second thing the government should do to help us get through this crisis more quickly is to develop a very rapid personal and corporate bankruptcy process. There is no reason why restructuring and bankruptcy should take years. The major overhaul required, which is a simple diminution of creditor claims, can be accomplished in weeks, not years. Poorly run banks and companies need to claim bankruptcy and emerge in weeks with new and better managements and less debt. Individuals need to be able to enter and emerge from bankruptcy quickly with smaller homes and more sustainable living arrangements and family budgets. And the process needs to insure that creditors take their investment losses before the taxpayer is asked to invest his hard earned money in a losing proposition.

Barack Obama is a good man. Over his presidency he will do great things for America's standing in the world, for our foreign policy, for our war posture, for the education of our citizens and for their healthcare and other needs. But, he is a self-described incrementalist. He believes that you cannot get the broad support you need from all of your citizens if you attempt too radical a change all at once. Many call this pragmatism and him a realist.

But in a world that is on the brink of financial collapse, we cannot afford to be incrementalists. Do we have the time to take small steps to try to solve major problems? Incrementalism may be the right approach to solving global climate change as even worst-case scenarios do not foresee us succumbing to higher temperatures on the planet for decades. Unfortunately, there is no guarantee our financial system will survive months, much less years. We have very little room for error. The U.S. economy, the global economy and social stability across the entire plan hang in the balance. We must make the right decisions and we must make them quickly.


 

John R. Talbott is the author, most recently, of Obamanomics: How Bottom-Up Economic Prosperity Will Replace Trickle-Down Economics. His previous books include The Coming Crash in the Housing Market, and Sell Now! His essays and OpEds have appeared in The Wall Street Journal, The Financial Times, The Boston Globe, and The San Francisco Chronicle among others.