The fiscal cliff is only the first step in extricating the US from a fiscal mess created over the past decade.
a quick-and-dirty modern economic history…
…that is, my account of how the US got into the precarious position we’re in now
The decades immediately after WWII were an extraordinary time for the US economy, for several interconnected reasons:
–the global war had been waged primarily in Europe and the Pacific, so American industrial productive capacity was virtually untouched. Practically speaking, if anyone wanted a piece of industrial machinery or a consumer appliance, he had to buy from a US company.
–as part of its efforts to rebuild war-torn nations–through a mix of altruism and the desire to create useful allies against the Soviets–the US became banker to the world. This gave Washington the ability to issue loans to itself without the same scrutiny that countries would normally be subject to.
–efforts to help the rest of the world rebuild earned the US a huge amount of good will that lasted for a generation. Europe humored us for a long while. Japan, influenced by the guilt of having lost the war, twisted itself into a pretzel to accommodate the US far longer–until relatively recently.
For decades, then, the US maintained a substantial house advantage over the rest of the world.
Most Americans don’t regard this period as one of extraordinary good fortune. We think this is normal–even though it isn’t. We also don’t realize that this lucky era is already in the rear view mirror.
This was a time of considerable GDP=boosting structural change for the domestic economy–the move to the suburbs, the rise of specialty retailing, the emergence of the computer, the revamping of many older, stagnant world trade-oriented companies in the Junk Bond era.
more structural change–mobile phones, PCs, the Internet–to boost GDP.
But this decade also marked the rise of China as an industrial competitor–hungry, fast-growing and without the warm feelings toward the US generated by WWII. In a world where there previously had only been Michael Jordan (us), suddenly an Asian LeBron James appeared as a competitor on the scene.
The US opened the 21st century with a government budget surplus. In fact, the Congressional Budget Office predicted that surpluses would likely continue as far as the eye could see.
For a number of years, Congress had been strongly encouraging banks to make mortgage loans, so more Americans would become homeowners instead of renters. It put Alan Greenspan, then the Fed Chairman, in charge of supervising this activity, but (so Mr. Greenspan now intimates) with strict instructions to do nothing to slow down lending.
Eyeing financial services as a new area for US economic expansion, in the late Nineties Congress had also repealed the Glass-Steagall Act, the Depression-era legislation that prohibited commercial banks from doing brokerage house trading.
Washington spent the putative surplus right away by cutting income taxes, raising entitlement spending and attacking Iraq and Afghanistan.
A combination of too-low interest rates, rampant real estate speculation and reckless trading by the banks in toxic mortgage derivatives they created with their new freedom caused a near-collapse of the global financial system and the deepest economic downturn in the US since the 1930s. Yes, we made out better than the EU, but that’s a cold comfort.
Washington has borrowed and spent over $5 trillion during the past four years in an effort to stabilize the economy, forfeiting its AAA credit rating in doing so.
where does the fiscal cliff come in?
The US can’t continue to borrow and spend a trillion dollars a year indefinitely. At some point potential lenders will balk. (By the way, that happened in 1987, when domestic lenders, not foreigners, refused to buy more Treasuries.) So Washington devised a first step to begin to close the budget gap. It has two parts.
Emergency tax cuts that boost consumer spending end on December 31st, unless Washington extends them. Legally mandated cuts in Federal government spending amounting to $100 billion a year go into effect on January 1st. Ben Bernanke termed this the “fiscal cliff” to convey his belief that the US is currently still too weak economically at present to take this fiscal contraction in stride.
Though the current budget deficit should narrow somewhat by itself as the economy eventually strengthens–through more tax receipts, less government assistance–it’s hard to see how the US will be able to grow fast enough for it to disappear entirely. And then there”s the $5 trillion tab that the rescue effort has run up. The fiscal cliff proposals are only a drop in the bucket–a big drop, maybe, but still…
The bet on banking as a new source of economic growth has gone badly wrong. The emphasis on residential real estate has provided a lot of construction jobs and a ton of McMansions, but hasn’t helped to develop the highly skilled labor needed to justify customary wages in an increasingly competitive world. Nor has it added to our industrial manufacturing base. Neither housing nor defense (fully 1/4th of Washington’s spending) yields an economic return.
Washington doesn’t appear to have much of a clue, either about what to do about the problem–or perhaps even that it exists. And, like Japan in the 1990s (and beyond), we continue to return the same inept players to office. Part of the Washington problem is that until recently the patronage pie has been increasing every year. It’s much more difficult to allocate who has to cut the most during an era of diminished resources. But that’s the situation we’re in today.