Thomas Palley

Bernie's no radical: he's an American constitutionalist

Fear is the enemy of change and the friend of hate. That is why both sides of the political establishment, Democrats and Republicans alike, are now running a full-blown campaign of fear-mongering against Bernie Sanders.

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The stock market boom hides a toxic reality

The US is currently enjoying another stock market boom which, if history is any guide, also stands to end in a bust. In the meantime, the boom is having a politically toxic effect by lending support to Donald Trump and obscuring the case for reversing the neoliberal economic paradigm.

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Trumponomics: Neocon Neoliberalism Camouflaged With Anti-Globalization Circus

A key element of Trump’s political success has been his masquerade of being pro-worker, which includes posturing as anti-globalization. However, his true economic interest is the exact opposite. That creates conflict between Trump’s political and economic interests. Understanding the calculus of that conflict is critical for understanding and predicting Trump’s economic policy, especially his international economic policy.

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Debate Continues, but There's Little Doubt Speculators Are Adding to Pain at the Pumps

Until a few weeks ago, while oil prices were surging, debate raged about the relative roles of economic fundamentals and speculation in boosting oil prices. Although oil prices have now fallen back from their peak, that debate must not be forgotten, for it has profound policy implications that government officials would be derelict to ignore.

Of course, if higher prices are due to fundamentals, oil markets are working as they should. But if they are due to speculation, then policymakers must act to rein in behavior that has imposed huge and needless costs on the global economy. And, when the evidence is confronted, it points to speculation as a culprit.

Whereas many oil market participants have blamed speculation, most economists defend how oil markets have performed and point to economic fundamentals. One argument of economists is that higher prices are due to the weak dollar. Because oil is priced in dollars, a weak dollar makes oil cheaper to users in other countries, which increases global demand.

A second argument is that higher oil prices are due to lower interest rates and anticipations of higher long-term prices. That supposedly reduced supply by encouraging producers to store oil in the ground and pump it later.

A third argument is that if speculation were to blame for price increases, there should have been an increase in oil inventories, because speculators do not consume oil but instead store it for later sale. Since there has been no rise in inventories, there has been no speculation.

All three arguments are weak. The price of oil has risen far more than the dollar has fallen. That means that oil prices have increased in other countries, which should have reduced, not increased, demand. Moreover, it is high oil prices that weakened the dollar, not vice versa. This is because high oil prices raised inflation in the United States, worsened the U.S. trade deficit, and increased the likelihood of a U.S. recession by acting as a tax on consumer spending.

Nor have there been any reports of unusual production cutbacks -- the linchpin of the second argument. Indeed, the spike in oil prices actually gives independent producers an incentive to boost production. The last time real oil prices reached current levels was 1980, which shows that hoarding oil in the ground can be bad business. OPEC also has a strong interest in maintaining production. It wants to keep prices lower to maintain the global economy's oil addiction and deter technological substitution of alternative energy sources.

Finally, the storage argument fails to recognize different types of inventory. Thus, record-high speculative prices have likely caused bunker traders to release inventory, but those releases may have been purchased by speculators who are now active lessees of commercial storage capacity. The implication is that speculators can drive up prices and increase their inventory holdings even as total commercial inventories remain little changed.

Additionally, oil market speculation may have induced "echo speculation," whereby ultimate users buy refined products in advance to protect against future price hikes. They then take delivery on their premises so that overall refined inventories rise, but that increase is not part of reported commercial inventories.

Proving that speculation is responsible for higher prices is always difficult, because it tends to occur against a background of strong fundamentals. However, there is considerable evidence that strongly indicates rampant speculation in today's oil markets. One key sign is the documented change in the character of oil trading, with speculators (i.e., financial institutions and hedge funds) now accounting for 70% of trades, up from 37% seven years ago.

With regard to market fundamentals, there have been no changes in demand and supply conditions that explain the scale of the unanticipated jump in oil prices. Moreover, the actual behavior of oil prices is consistent with speculation. In June, oil prices leapt by $11 in one day, and in July they fell back by $15 in three days. Such volatility does not fit a fundamentals-driven market.

Despite the oil market's size, speculation can move prices because of the inelasticity of demand and supply. Oil demand is slow to change because of behavioral inertia and fixed technology, while adjusting production takes time. These features make the oil market vulnerable to speculation.

Such speculative purchases may barely register in inventories, because the purchases are small compared to the overall market, and because of the global storage system's many margins of accommodation. As a result, speculatively driven high prices can persist for a considerable time before economic fundamentals bring them down, as finally seems to be happening.

With prices falling, the imperative to act inevitably tends to recede. That is the nature of the behavioral response to crisis and why a bad status quo can persist. But leaving the system unchanged will maintain the global economy's vulnerability to future bouts of speculation that we cannot afford.

Just consider how the current bout has raised global inflation, lowered incomes of the global poor, weakened the dollar, deepened the U.S. trade deficit, aggravated global financial instability, and increased the likelihood of a global recession. That is an overwhelming indictment that merits urgent policy action.

Bush Gives Big Iron a Steely Grip on a Key Sector of the Economy

Iron ore prices have recently been in the headlines, having jumped eighty-five percent. This news is troubling as such price increases threaten to raise steel prices, which will add to cost inflation and further undermine economic activity.

Behind these price increases lies the unusual structure of the iron ore market which is best characterized as bi-lateral oligopoly. That structure makes enormously troubling the Bush administration's decision to give regulatory clearance to a combination of the number two (Rio Tinto) and number three (BHP Billiton) ore producers.

Unlike other commodity markets, iron ore prices are set through annual negotiations between the ore producers (Big Iron) and the ore users (Big Steel). Recent contractual negotiations have resulted in huge price increases that reflect the ore market's structure.

On one side is Big Steel, consisting of an increasingly few large steel producers. On the other side is Big Iron, made up of an even fewer number of ore producers. Thus, the top three producers -- Vale do Rio Doce, Rio Tinto, and BHP Billiton -- account for seventy-five percent of total global production. Moreover, the oligopolistic power of the producers is reinforced by geography. Vale do Rio Doce is Brazilian and located in the western hemisphere, while Rio Tinto's and BHP Billiton's operations are in Australia. That creates a geographic split that helps Big Iron's profits.

In recent years steel production has been marked by significant mergers and right-sizing of capacity, combined with growth of state-directed steel capacity in China. The result has been a huge boom in steel profits that is reflected in steel company stock prices. For instance, consider U.S. Steel that traded at twelve dollars a share five years ago, and in June 2008 peaked at one hundred and ninety-six dollars a share.

Big Steel's earnings rolled in first, being at the end of the production chain. Now, Big Iron is trying to muscle in on the action and grab a share of those profits for itself. It is able to do so because of its bargaining power, and it would be no surprise if there also were some informal collusion among ore producers given their small world.

With limited alternatives, Steel has been forced to cough up some of its oligopoly profits, turning them into Iron's mining rents. That is a bad switch. Higher earnings in iron ore mining will have negligible impact on their economic plans as the industry was already earning large excessive profits. However, higher ore prices will raise steel prices, undermining manufacturing and causing inflation. Meanwhile, lower steel profits will reduce steel investment.

Lastly, speculation may also have contributed to the jump in ore prices, albeit not the speculation associated with other commodity markets in which speculative trading is rampant. Since iron ore is not traded on global commodity markets, financial speculators cannot be responsible for higher prices.

Instead, iron ore speculation is best characterized as 'joint speculation' by the ore producers and users about the continuation of steel profits and the ability of steel companies to pass on higher costs. In this light, the jump in ore contract prices can be viewed as a combination of profit capture by the ore producers plus a big bet on future macroeconomic conditions.

Such user-producer speculation is hard to argue against, but one can argue against an oligopolistic market structure that amplifies speculation's destructive effects. That makes the Bush administration's decision to approve a Rio Tinto-BHP Billiton combination another terrible public policy decision.

The approval of combination reveals the worst proclivities of the Bush administration, which is peppered with extractive industry boosters, particularly oil. The quest for combination shows that the much maligned Karl Marx was right about capital's proclivity to combine.

Beating the Oil Barrons

Over the past eighteen months, oil prices have more than doubled, inflicting huge costs on the global economy. Strong global demand, owing to emerging economies like China, has undoubtedly fueled some of the price increase. But the scale of the price spike exceeds normal demand and supply factors, pointing to the role of speculation -- and underscoring the need for policy action to clean up the oil market.

Reflecting their faith in markets, most economists dismiss the idea that speculation is responsible for the price rise. If speculation were really the cause, they argue, there should be an increase in oil inventories, because higher prices would reduce consumption, forcing speculators to accumulate oil. The fact that inventories have not risen supposedly exonerates oil speculators.

But the picture is far more complicated, because oil demand is extremely price insensitive. In the short run, it is technically difficult to adjust consumption. For instance, the fuel efficiency of every automobile and truck is fixed, and most travel is non-discretionary. Though higher airline ticket prices may reduce purchases, airlines reduce oil consumption only when they cancel flights.

This illustrates a fundamental point: in the short run, reduced economic activity is the principle way of lowering oil demand. Thus, absent a recession, demand has remained largely unchanged over the past year.

Moreover, it is relatively easy to postpone lowering oil consumption. Consumers can reduce spending on other discretionary items and use the savings to pay higher gasoline prices. Credit can also temporarily fill consumer budget gaps. Although the housing boom in the United States -- which helped in this regard -- ended in 2006, consumer debt continues to grow, and America's Federal Reserve has been doing everything it can to encourage this. Consequently, for the time being the US economy has been able to pay the oil tax imposed by speculators.

Unfortunately, proving that speculation is responsible for rising prices is difficult, because speculation tends to occur during booms, so that price increases easily masquerade as a reflection of economic fundamentals. But, contrary to economists' claims, oil inventories do reveal a footprint of speculation. Inventories are actually at historically normal levels and 10% higher than five years ago. Furthermore, with oil prices up so much, inventories should have fallen, owing to strong incentives to reduce holdings. Meanwhile, The Wall Street Journal has reported that financial firms are increasingly involved in leasing oil storage capacity.

The root problem is that financial markets can now mobilize tens of billions of dollars for speculative purposes. This has enabled traders collectively to hit upon a strategy of buying oil and quickly re-selling it when end users accommodate higher prices -- a situation that has been aggravated by the Bush administration, which has persistently added oil supplies to the US strategic reserve, further inflating demand and providing additional storage capacity.

Absent a change in trader beliefs, the current oil price spike will be broken only by a recession that exhausts consumers' capacity to buffer higher prices, or when the slow process of substitution away from oil kicks in. Thus, economic fundamentals will eventually trump speculation, but in the meantime society will have paid a high price.

Whereas oil speculators have gained, both the US and global economies have suffered and been pushed closer to recession. In the case of the US, heavy dependence on imported oil has worsened the trade deficit and further weakened the dollar.

This sobering picture calls for new licensing regulations limiting oil-market participation, limits on permissible trading positions, and high margin requirements where feasible. Sadly, given the conventional economic wisdom, implementing such measures will be an uphill struggle.

But some unilateral populist action is possible. A major form of gasoline storage is the tanks in cars. If people would stop filling up and instead make do with half a tank, they would immediately lower gasoline demand. Given lack of storage capacity, this could quickly lower prices and burn speculators.

Copyright: Project Syndicate, 2008.

Taxes and the Cult of Home Ownership

The bursting of the recent house price bubble has focused attention on the failures of monetary and regulatory policy. However, tax policy also likely played a role in our current mess by providing tax subsidies that contributed to a cult of home ownership. This policy is flawed. However, it is politically difficult to change because households see the benefits of tax subsidies and higher house prices but do not recognize the accompanying costs. By showing the downside of high prices, the housing bust provides an opportunity to escape this political trap.

Current tax law exempts capital gains on private homes up to $500,000 and treats mortgage interest as a deduction. Both measures are intended to help middle-class families, yet the reality is they distort the economy, are costly, and likely do little to make working families better off. That speaks for changing housing's tax treatment.

The mortgage interest deduction is extremely expensive, costing the Treasury approximately eighty billion dollars in 2007. Moreover, it is highly regressive because high-income taxpayers get to deduct their interest payments at top marginal tax rates, whereas others deduct at lower tax rates. That means high-income taxpayers get a higher subsidy rate, and their subsidy is further increased because they also tend to have larger mortgages. Meanwhile, many poor workers get no housing assistance because they rent and rental expenses are non-deductible.

Both the mortgage interest deduction and housing capital gains exemption encourage home ownership. Mortgage interest deductibility encourages switching from renting to owning, while the capital gains exemption encourages owning housing instead of other forms of wealth.

This tax treatment has increased demand for houses, raising prices. However, higher house prices entail larger mortgages so that households end up with larger gross interest payments that offset much of the interest deduction. Additionally, larger mortgages make households more vulnerable to losses if they have to sell under unfavorable conditions - as is now happening.

Since most households lack capital, higher house prices also make it difficult to come up with down-payments. That has encouraged risky non-traditional mortgages such as zero-down products, and these products are a significant factor in the current housing crisis. Furthermore, these mortgages carry higher interest rates that further offset the benefit of mortgage interest deductibility.

At the social level, higher house prices mean both spouses have to work, which undermines family structure. It also puts downward pressure on wages by increasing labor supply. However, the system gives every family an incentive to buy a house to lock-in ownership, even though the system may make them collectively worse off.

Higher home prices are also very unfair from an inter-generational standpoint. Increasingly, younger workers cannot afford houses, and that promises to undermine the market with those buying last losing most.

Finally, excessive home ownership may increase unemployment. This is because workers become tied down to their homes by attached financial obligations, reducing responsiveness to changing job market conditions.

The tax system has helped create a cult of home ownership, and that cult appears to have been an ingredient in the recent house price bubble. Rather than creating wealth, the tax treatment of housing redistributes wealth inter-generationally and makes households financially vulnerable. That means tax policy should change. Here are some suggestions.

First, the capital gains exemption should be abolished for all new home purchases. Instead, the base cost of houses should be indexed to inflation so that homeowners are not taxed on inflation gains. Existing homeowners should be grand-fathered under current law to discourage selling to protect unrealized gains, which would destabilize the housing market.

Second, the ceiling (currently $500,000 per taxpayer) on mortgages qualifying for interest deductibility should be gradually lowered to zero over a ten-year period. Such a gradual phase-out can actually help existing middle-class homeowners because it will make top-end homes relatively less affordable compared to mid-market homes that retain the tax subsidy. That will shift demand toward the mid-market segment, helping maintain mid-market prices and thereby mitigating the housing slump.

Third, since everyone needs housing, the Federal government should phase in a refundable housing cost tax credit available to all, regardless of whether they own or rent. That credit can be financed with revenues generated by phasing out the mortgage interest deduction. During the transition every taxpayer should have the choice between taking either the available mortgage interest deduction or receiving the housing tax credit.

Current tax treatment of housing is intended to benefit working families, but it actually creates bad outcomes. The reality is current tax law distorts the economy, promotes house price speculation, renders households over-indebted and financially vulnerable, and undermines wages and family structure. There is a better way to help working families afford decent housing, and now is a good time for policy to transition in that direction.

The Curse of the Clintons

Speaking the truth is discouraged in Washington DC. For journalists there is the fear that truth telling will mean not being invited back for the next press conference or another exclusive interview. For political insiders the fear is that speaking up will injure their careers by costing them political appointment. This dynamic has helped keep the lid on the curse of the Clintons.

From the start of the 2008 primary campaign many political experts have believed Hillary Clinton would have difficulty winning the general election even if she sailed through the primaries. This is because polls have consistently shown she has exceptionally high negative ratings, which matters enormously as it is very difficult to win-over people holding negative views. The best that can be done is persuading them not to vote. If winning were difficult before, current conditions make a Clinton general election win even less likely. Her slick assist in letting the race genie out of the bottle has alienated African-Americans, and without their turnout a Democratic win is almost impossible.

Equally importantly, should Senator Clinton manage to wrest the nomination from Senator Obama by insider dealings, she stands to alienate the young and independent voters that he has attracted. These voters will probably not vote for John McCain, but their enthusiastic support is also critical for a Democratic victory.

That begs the question of why Senator Clinton persists in running. One reason is hubris prevents her from acknowledging the political facts, so that she really believes she can win. A second more cynical reason is that Senator Clinton's political ambition is best served by having a bruised and battered Senator Obama run in November, thereby facilitating a McCain victory. That would allow her to run again in 2012 on an "I told you so" platform.

For Democrats this is a terrible curse. If Clinton persists with her campaign, Obama is weakened in November. And if Clinton actually gets the nomination, Democrats stand to lose the election and also forfeit Senator Obama's extraordinary political bequest.

In political science one of the best established facts is that the way a person votes the first time is a strong predictor of how they will vote the rest of their lives. Senator Obama has attracted droves of first time voters, setting up the prospect of a generation of Democratic political dominance. Depriving him of the nomination risks so disenchanting these new voters that they may return to political apathy. That would cheat Democrats of a bright future, which is something super-delegates with political futures of their own should ponder.

In the 1990s, when Bill Clinton turned his back on progressive politics, many speculated Hillary was the real progressive among the two. The reality is both are cut from the same cloth, which is marked by unbridled ambition and desire for power for power's sake.

Bill Clinton lied under oath during the Lewinsky investigation. Senator Clinton lied about being under fire in Bosnia. Bill Clinton abandoned unions and working families with his promotion of NAFTA, free trade with China, and the elimination of the right to welfare assistance in hard times. Senator Clinton initially endorsed this policy legacy, and only changed her tune when John Edwards' call for real change started gaining traction. Bill Clinton's middle name is "triangulation". Senator Clinton shamelessly sought to profit from Barack Obama's casual observations about the link between economic disenfranchisement and "guns and bible" politics. In doing so, she showed a willingness to keep alive right-wing conservatives' major wedge issue just to damage her rival.

The cruelest irony concerns women and women's rights. Many women champion Senator Clinton as a defender of women's rights, including the right to an abortion. However, her ambition is increasingly jeopardizing that right. Mrs. Clinton cannot win in November, and her refusal to bow out has done damage to Senator Obama's prospects. That sets up the conditions for a McCain victory, the price of which will be the Supreme Court.

Truth telling is difficult in Washington, and the truth is also often stranger than fiction. When it comes to the Clintons, the truth is they have become a curse for Democrats and not an asset.

AlterNet is a non profit organization and does not make political endorsements. The opinions expressed by our writers are their own.

How the Right Hijacked America's Economic Model

Communist revolutionary Che Guevara rapidly became an inspirational figure for revolutionary socialist change after his execution in Bolivia in 1967. Forty years later, Che lives on but his image now adorns t-shirts that have become popular fashion statements. This transformation reflects the extraordinary power of markets to capture and transform, turning an avowed enemy of the market system into a profit opportunity.

The process of capture also holds for economic policy, which has witnessed the conservative capture of Keynesianism. This capture is now on display as U.S. policymakers struggle to contain the effects of a collapsing house price bubble that was recklessly funded by Wall Street. The sting is that the full powers of Keynesian policies are being invoked to save an economy that no longer generates Keynesian outcomes of full employment and shared prosperity.

The political economic philosophy of Keynesianism emerged after World War II following the catastrophic experience of the Great Depression. The new paradigm advocated an economy with full employment and shared prosperity, and gave government the critical role of regulating markets and adjusting monetary and fiscal policy to ensure levels of demand sufficient to generate full employment.

These Keynesian tools are now being applied forcefully. The Federal Reserve has dramatically cut its interest rate target in response to financial sector weakness. Its goal has been to shore up asset prices, prevent further financial losses, lower mortgage rates to make houses more affordable and prevent further defaults, and to stimulate spending by lowering the cost of capital. Moreover, the Fed has done this despite consumer price inflation being above four percent.

Simultaneously, the Bush administration has pushed for fiscal stimulus, albeit with its usual preference for tax cuts benefiting business and the rich that deliver little bang for buck. The Democratically controlled Congress has also gotten in on the act with stimulus packages that are better designed, but still contain plenty of expensive and relatively ineffective tax cuts.

On one level, policymakers are absolutely right taking these measures, as the costs of a financial and economic meltdown are so large. But true Keynesian policy would also address the failure to generate full employment and shared prosperity. The current U.S. economic expansion looks like being the first ever in which median household income fails to recover its previous peak. Job growth has been tepid for much of the time, and the employment-to-population ratio has remained well below its previous peak. This dismal experience comes on top of three decades of wage stagnation during which household income only grew because of longer working hours and having both household heads work.

The capture of Keynesianism has been a gradual process. In the 1950s military Keynesianism became the hallmark of American policy, with defense spending becoming a huge and permanent component of government spending, to the benefit of the war industry. President Reagan continued the process of capture, pushing rhetoric and policies that undermined working families while simultaneously running budget deficits that kept the lid on unemployment. In the last recession of 2001, the Bush administration again invoked Keynesian stimulus for tax cuts that contained minimal stimulus and were closer to looting of government finances.

In 1971 President Nixon famously declared "We are all Keynesians now." Nixon was half-right. Everyone recognizes the need and efficacy of Keynesian policy instruments, including conservatives who are happy to promote tax cuts and interest rate reductions to support asset prices. However, most have forgotten the Keynesian goals of full employment and shared prosperity.

The result is Keynesian policy instruments remain, but Keynesian policy goals have been abandoned. Both Democrats and Republicans are quick to push for Keynesian stimulus policies when financial stability is threatened, but most (including too many Democrats) are silent when the economy fails to deliver shared prosperity.

Keynesian full employment stimulus policies must be accompanied by Keynesian structural policies that ensure wages grow with productivity, thereby ensuring sustainable demand growth. These structural policies include labor and social insurance laws supportive of unions and worker bargaining power, and international economic policies that prevent inappropriate competition and unsustainable trade deficits. The conservative capture of Keynesianism has both obliterated these structural policies and put a brake on reaching for full employment.

The Fed and Crony Capitalism

The Federal Reserve's recent decision to grant Wall Street access to special borrowing facilities smells of special dealing for special interests. The decision subsidizes the biggest most powerful investment banks, thereby distorting financial markets in their favor. Behind the decision lies the problem of excessive representation of Wall Street interests within the Fed.

The Fed's response to the crisis, combined with its earlier massive policy failure to address asset price bubbles, raise grave questions about its independence and judgment. At this stage, Congress should launch formal hearings into the governance of the Fed, which has remained largely unchanged since the 1930s.

The Fed's new Primary Dealer Credit Facility (PDCF) effectively gives Wall Street's primary government securities dealers, which includes all the large investment banks, access to discount window borrowing. That means access to funding at the bargain basement interest rate of 2.5 percent, and all that is asked is borrowers post some form of investment grade collateral.

This arrangement constitutes a massive subsidy, which would be large in normal times. However, it is especially large at a time of market uncertainty and liquidity shortage. While other market participants are being forced to de-lever at fire-sale prices, the Fed's friends are being given near-free government money to snap up assets.

Wall Street has been quick to embrace the facility, and within four days borrowing reached $29 billion. Erin Callan, Chief Financial Officer of Lehman Brothers, enthusiastically declared the facility to be "incredibly attractive... Our ability to access that form of financing to do more business for clients is incredibly interesting."

Morgan Stanley Chief Financial Officer Colm Kelleher described the facility as being "there for normal business. It's not meant to be there as a last-recourse thing." A Goldman Sachs spokesman declared "we think the Fed window provides a good alternative to the secured funding markets and we welcome the initiative."

The new facility represents a complete break with the past. Previously, discount window borrowing was restricted to regulated depository institutions, and access was always described as "a privilege and not a right." That meant banks could only get access to cover seasonal shortfalls of funds or dire emergency needs, and any borrowing was subject to regulatory disapproval - so-called Federal Reserve "frown" costs. Now, the Fed has apparently made the discount window available to Wall Street as a source of ordinary business finance.

This means the Fed is providing risk capital to the likes of Goldman Sachs at paltry interest rates that confer a significant subsidy. Moreover, the mere right of access enables them to borrow more cheaply from other lenders because of the back-stop reassurance provided by discount window access. It also establishes incentives for future excessive risk-taking.

These subsidies are a travesty. Goldman Sachs, Lehman Brothers, and Morgan Stanley are extraordinarily profitable companies. They have also been the drivers of the worst trends in the American economy over the past generation, pushing excessive CEO pay that has spread like a cancer throughout corporate America, even reaching into universities and non-profits. Additionally, they have pedaled the shareholder value paradigm, that has pushed companies to emphasize short-term gain over long-term investment, and contributed to ripping up America's social contract. Meanwhile, their business model has promoted speculation that is behind repeated asset and commodity price bubbles.

Subsidizing these firms is an insult to Main Street. Many families are losing their homes as part of the mortgage crisis. If they had access to 2.5 percent financing that would not be happening. Likewise, manufacturing firms are being forced to close because of lack of affordable capital, which is destroying jobs and the economic foundation of communities.

The Fed will claim it had to institute these measures to calm Wall Street. That is nonsense. The fair and economically efficient way to deliver emergency liquidity to Wall Street is through an auction facility that is open to all financial firms, and in which participants supply good collateral. Those who need the funds most will bid the highest. That way, taxpayers get properly paid for their support, and the funds go to those who need them most.

Geologists say they learn the most from extreme events like earthquakes that reveal the reality of the earth's crust. For the past twenty-five years, critics of the Fed have been dismissed, and the Fed's high standing has blinded the reality of its revolving door with Wall Street and its class-based conduct of policy. Now, the Fed's response to Wall Street's panic has revealed the reality of its crony capitalist world. That provides an opening for long-needed reform.

How Obama or Clinton Can Win the Edwards Vote

John Edwards' exit from the presidential race puts his supporters up for grabs. Both Senators Clinton and Obama want those votes. Here's how to win them.

The central plank of the Edwards' campaign was restoring a prosperous and secure middle class, which requires ending wage stagnation and having wages again grow with productivity. This must be the central economic policy goal of any candidate wanting the Edwards vote.

The generation long rupture of the wage - productivity link reflects deep structural failings in the economy that must be corrected. Helping hand social policies, such as trade adjustment assistance and the earned income tax credit, are welcome but they are not adequate to the scale of the problem.

Having government try to remedy wage stagnation through after-tax income redistribution does not address the core problem of unfair before-tax incomes. A progressive tax system is critical for fairness, but it cannot ensure a prosperous middle class. That requires decent wages paid in return for a decent day's work.

The starting point for shared prosperity must be full employment, since only then do workers everywhere have the power to bargain increased wages that equal productivity growth. Monetary, fiscal, and exchange rate policy must work in coordinated fashion to this end. The best measure of full employment is when wages steadily rise with productivity.

Restoring the balance of power in labor markets is critical for wage bargaining. This requires labor law reform that ends employer intimidation preventing workers from joining unions and bargaining fair contracts, and government must vigorously enforce the law. The minimum wage must be reformed and tied to average wages so that it provides a true floor that rises as the economy grows. Unemployment insurance must also be reformed so that its duration is extended and coverage broadened.

Modernizing financial regulation is another needed measure. The housing bubble and sub-prime mortgage crisis show the financial system is broken. Today, the only instrument of control is the blunderbuss of Federal Reserve interest rate changes that inflict unemployment or inflation. New ideas exist and should be given space through a national financial markets reform commission that airs all views, and not just those of Wall Street.

The debate over fiscal responsibility must be redefined. That debate should be about containing healthcare inflation that threatens to bust the budget and funding needed public investment. It is time to break with conservatives' definition of fiscal responsibility that attacks government and seeks to cut essential programs like Social Security.

Public investment is critical. The economy sits on the edge of a recession and fiscal stimulus is needed to combat that danger. But beyond that, the country must invest in its future and fill the enormous investment gap resulting from a generation of neglect of public onfrastructure. Public investment in schools, hospitals, roads, bridges, and public transportation is enormously productive. It creates jobs and raises private sector productivity, the key to growth and an essential condition for a prosperous middle class.

Global warming presents new challenges that also call for public sector investment. Those challenges are an opportunity to create a 21st century green economy. To that end there is need for an Apollo-scale commitment promoting energy efficiency through new technologies, incentives for energy saving investments, and improved and subsidized public transportation.

Globalization means international economic policy is more important than ever. The trade deficit has hollowed manufacturing and must be reduced. Policy must put a stop to unfair international competition based on undervalued exchange rates, export subsidies, and unfair trade restrictions. America must also lead in the creation of a new international financial architecture that promotes fair and balanced trade, and only countries that truly join in this endeavor can be allowed full access to the America's markets.

Finally, there is need to tackle the problem of corporate governance and regulation. Corporations have been the major force rupturing the link between wages and productivity growth, and they have also been the major force driving globalization. That calls for a corporate reform agenda that addresses excessive CEO pay, restores shareholder control, and realigns business incentives so that corporations again serve the national interest as well their private interests.

John Edwards' campaign recognized the imminent challenge of recession and advocated fiscal stimulus. Both the Obama and Clinton campaigns have done likewise. However, it is not enough to just change the economic policy dial settings. The Edwards campaign also spoke to the need to change the long-term direction of the economy by restoring full employment, leveling the playing field between workers and corporations, and fixing unfair competition unleashed by globalization.

That's the message that will win the Edwards vote.

Democrats: What is the Meaning of Change?

Many people now believe the United States cannot afford to continue with the policies of the Bush - Cheney administration. Those policies have undermined global support for America that is a key part of national security, and have produced an economic expansion that has by-passed working families and looks like ending in misery with collapsing house prices.

However, if there is agreement that the heavy-fisted Bush-Cheney agenda is no longer acceptable, the question remains what will follow. Among Democratic presidential candidates, though there is much talk of change, its meaning remains unclear.

Beginning some thirty years ago, Ronald Reagan initiated a fundamental re-positioning of American politics that was later completed by Newt Gingrich, Dick Armey, and Tom Delay. That re-positioning shifted the entire political spectrum to the right.

This raises the question does change mean sticking with the political playing field we now have and just giving control of the football to new Democrats like Senator Hilary Clinton? Or does it mean re-positioning the playing field and shifting the political spectrum as proposed by progressive Democrats like Senator John Edwards?

Behind this difference lie vital real world consequences that will profoundly impact America's working families. For Clinton-style centrists, today's economy works reasonably well. Globalization delivers prosperity by providing cheap imports that lower prices; financial boom on Wall Street benefits all by raising stock prices; and higher corporate profits drive investment that increases growth and incomes. However, growth also creates losers which means the market's "invisible hand" must be accompanied by a "helping hand". Consequently, there is need for policies to supplement the incomes of the working-poor and to assist workers who lose their jobs because of trade.

For Edwards-style progressives the picture is very different. Globalization has created a divide between country and corporations, with companies abandoning the U.S. by shifting jobs and investment offshore. That maximizes profits but undermines wages and future prosperity. Higher profits have not raised growth, but have instead come at the expense of wages and increased income inequality. And Wall Street has spearheaded these changes by demanding that companies raise rates of return and rip up the old social contract with workers and their communities.

From a progressive standpoint the problem with new Democrats is they tackle symptoms, not causes. Though helping hand social policies are welcome, progressives believe such policies are not up to the challenge confronting America's working families. Meeting that challenge requires deeper change, which is what the 2008 election is all about.

Yet, surfacing this difference has proved difficult. That is because the Clinton campaign has used the political tactic of "bunching" to obscure differences. That holds for every major issue from healthcare, to trade policy, to taxing Wall Street hedge fund incomes. On each issue the Clinton campaign has bunched up and signed-on, but always reluctantly and late.

This tactical effectiveness of bunching requires progressives to raise directly the question of change and its meaning. For Senator Obama change is a matter of political style. For Senator Clinton it means restoring the economic policies of the 1990s. However, with the exception of tax cuts, those policies are the policies of today. Thus, the 1990s ushered in NAFTA and free trade with China, and cemented trends from the 1980s regarding trade deficits, the separation of wages from productivity growth, and the dominance of Wall Street. What really saved the 1990s were the Internet and stock market bubbles, which is not a sustainable foundation for prosperity.

The 21st century has gotten off to a rocky start with America squandering much political and economic capital. Now, Americans want change. The Democratic primaries offer two visions of change. One changes possession of the political football, the other changes the football field. That's the debate the country needs, and it seems to be finally bubbling to the surface in the last days if the Iowa campaign.

Hillary Embraces "Rubinomics"; Market Fundamentalism Lives

Editor's note: An earlier version of this article appeared in The Nation.

With Senator Hillary Clinton firmly cemented as the front-runner for the Democratic Party's nomination, Rubinomics--named after former Treasury Secretary Robert Rubin, who shaped economic policy under President Clinton--has re-emerged as a critical issue. This is because Senator Clinton has firmly embraced it. Rubinomics rests on faulty economics and embodies bad politics. Progressive Democrats and the nation need to understand this. Here's an explanation.

The central proposition of Rubinomics is that budget deficits reduce saving and increase interest rates, thereby reducing investment and lowering future living standards. However, the record shows that interest rates fell to historic lows over the past several years, a time of large deficits. That fits the common sense observation that the Federal Reserve largely determines interest rates contingent on economic conditions. Meanwhile, a flood of savings has poured into financial markets from wealthy individuals and pension funds, and corporations have been net buyers of stock on the back of record profits.

Nor does the "twin deficit" argument--that budget deficits cause trade deficits--make sense, as evidenced by the fact that in the late 1990s the United States ran record trade deficits as the budget moved into record surplus. Japan and Germany also disprove the argument as they have run large trade surpluses and budget deficits for many years. Rather, the U.S. trade deficit is due to undervalued foreign currencies and export-led growth strategies by many countries that look to grow by selling to the United States while restricting purchases of American-made goods.

Despite these logical failings, Rubinomics still has great appeal because Rubin's tenure as Treasury Secretary coincided with the 1990s boom. That appeal is misplaced. The rooster crows at dawn but does not cause the sunrise. Rubin was Treasury Secretary during the boom, but budget surpluses did not cause it.

The political origins of Rubinomics trace back to the 1970s, when conservative charges about big government and "tax and spend" liberals took deep hold on America's political consciousness. Throughout the 1980s Democrats struggled to respond, eventually settling in the 1990s on a strategy of "fiscal responsibility." That strategy was always transitional and defensive, aimed at blunting Republicans' relentless attack on government and plutocratic tax cuts. The long-term goal was always an alternative narrative to free-market mythology.

The tragedy is that once a myth takes hold it must be lived out to be disproved. That is the price paid for losing the war of ideas. This process has now worked itself out, and America is finally grasping the fallacies of market fundamentalism. That creates a historic opportunity, but Rubinomics risks a tragic second act. Rubinomics worked brilliantly as a political strategy in the 1990s. But its success was political, not economic. However, its supporters have lost sight of this and now credit it with causing the late-'90s boom. Consequently, they argue for sticking with Rubinomics, thereby missing the opportunity created by the dismal failure of Bush's presidency.

Instead of continuing down a mistaken path that focuses on the budget deficit, proponents of a progressive economic policy should focus on increasing investment, which is key to productivity growth and full employment. Rising wages and full employment, in combination with a fairly valued dollar, create a favorable investment climate. That sets the stage for a virtuous circle of shared prosperity. Investment raises productivity, which raises wages and profits, thereby increasing demand and drawing more investment. This is the real basis of a rising tide that lifts all boats. With regard to the trade deficit, the solution is to revalue exchange rates, raise wages abroad so that foreign workers can consume more of what they produce and have countries adopt coordinated policies that stimulate the global economy. That would benefit all, and it is why labor standards and exchange rate provisions must be in all trade agreements.

Rubinomics is not only bad economics but also bad politics. First, by arguing that the problem is a shortage of saving, Rubinomics promotes a conservative tax agenda privileging saving and profits, which primarily benefits the rich. Second, by placing budget deficits at the center of the saving problem, it sets government up as a problem and makes a case for shrinking it. Furthermore, by promising to lock Democrats into a path of fiscal austerity, it exposes future Democratic Administrations to the charge of "flip-flopping." This is because fiscal stimulus will inevitably be needed when the current unbalanced boom ends.

The greatest tragedy of all concerns the potentially disastrous consequences for Social Security and Medicare. These programs are more vital than ever, given America's aging population and retirement wealth inequality. Yet Rubinomics establishes the premise for dismantling them. By claiming the budget must be balanced to increase savings, it sets up a political deal whereby Republicans suspend their unjustifiable tax cuts in return for Democrats putting Social Security and Medicare on the table. This would be the ultimate conservative triumph, the evisceration of the crown jewels of FDR's New Deal and Johnson's Great Society.

The cruel irony is that Democrats would be the agent of this destruction at the very moment when history is proffering the opportunity for a great reversal of market fundamentalism. At a time of significant productivity growth, due to the maturation of the Internet and other technologies, Rubinomics establishes the premise that America cannot afford these great programs. Most bitter of all, once institutions like Social Security are dismantled, they are hard to resurrect, whereas tax cuts can be easily restored. This means dealing Social Security benefit cuts in return for repeal of the Bush tax cuts is both unjustified and a political trap. All of this is worth thinking about if you're thinking about voting for Hillary Clinton.

The New Economics of Trade: Factories on Barges and the Race to the Bottom

The classical theory of comparative advantage has driven US trade policy for the past fifty years. That policy, in combination with technical innovations that have lowered costs of transportation and communication, has opened the global economy. Yet paradoxically, this opening has rendered classical trade theory obsolete. That in turn has left the US economically vulnerable because its trade policy remains stuck in the past and based on ideas that no longer hold.

The logic behind classical free trade is that all can benefit when countries specialize in producing those things in which they have comparative advantage. The necessary requirement is that the means of production (capital and technology) are internationally immobile and stuck in each country. That is what globalization has undone.

Several years ago Jack Welch, former CEO of General Electric, captured the new reality when he talked of ideally having "every plant you own on a barge." The economic logic was that factories should float between countries to take advantage of lowest costs, be they due to under-valued exchange rates, low taxes, subsidies, or a surfeit of cheap labor. Globalization has made Welch's barge a reality. However, in doing so it has made capital mobility rather than country comparative advantage the engine of trade. And with that change, "free trade" increasingly trades jobs and promotes downward wage equalization.

The U.S. and European response to Welch's barge has been competitiveness policy that advocates measures such as increased education spending to improve skills; lower corporate tax rates; and investment and R&D incentives. The thinking is increased competitiveness can make Europe and the US more attractive to businesses.

Unfortunately, competitiveness policy is not up to the task of anchoring the barge, and it can even be counter-productive. The core problem is corporations are globally mobile. Thus, government can subsidize R&D spending, but the resulting innovations may simply end up in new offshore factories. Moreover, competitiveness policy easily degenerates into a race to the bottom. For instance, if the US cuts corporation taxes, other countries may match to stay competitive. The result is no gain for the US, while profit taxes are lowered and tax burdens shifted on to wages, which widens income inequality. Worse yet, capital mobility prompts countries to adopt unfair policies to increase their relative business attractiveness. These policies include disregard of environmental damage; suppression of labor to keep wages low; direct subsidies; and under-valued exchange rates. All are visible in China, which is the poster-child for such abuses.

A critical consequence of Welch's barge is the creation of a "corporation versus country" divide. Previously, when corporations were nationally based, profit maximization by business contributed to national economic success by ensuring efficient resource use. Today, corporations still maximize profits, but they do so from the standpoint of their global operations. Consequently, what is good for corporations may not be good for country.

When companies raise profits by rearranging production according to global cost patterns, those shifts can lower country income. For instance, when Boeing transfers production to China, the US loses high value adding jobs and national income can fall. Moreover, though Boeing makes larger short-run profits on its Chinese production, even it may lose in the long run if it inadvertently creates a rival Chinese aircraft producer.

From an American worker perspective, the global economy has always had abundant supplies of cheap labor. In the past American workers were still able to compete and benefit from trade. The critical difference today is American corporations are taking their capital and technology offshore and equipping low-wage foreign workers. Those investments undermine American workers because that foreign production is intended for the US market.

The emergence of barge-like corporations has reduced the scope for effective competitiveness policy, increased the temptations for unfair policy, and created a wedge between corporate and national interests. This poses two critical policy challenges. First, there is need for rules against unfair competition, which is where exchange rate rules and labor and environment standards enter. Second, there is need to close the wedge between corporation and country. In the U.S. that calls for such measures as ending preferential tax treatment of profits earned offshore; making it illegal for corporations to reincorporate outside the US to escape US tax laws; and new tax arrangements that encourage jobs and value creation within the US.

Addressing globalization's challenges poses enormous analytical difficulties. Unfair competition must be prevented and companies re-anchored. But this must be done without losing the benefits of real trade based on comparative advantage or ending investment that fosters development.

These economic challenges are compounded by political difficulties. In Washington, elite policy thinking is funded and lobbied for by corporations. Consequently, corporations control trade policy at a time when corporate interests differ from the national interest. That is also increasingly true in Brussels. Fifty years ago what was good for GM may really have been good for the US. With Jack Welch's barge, that may no longer hold.