April 30, 2012
For more than six decades, the U.S. and its pre-eminent economy have played the dominant role in global finance. Yet at the International Monetary Fund’s recently concluded annual meeting, the U.S. did not contribute to the new $430 billion “firewall” fund to backstop European banks, should the sovereign-debt crisis take a turn for the worse. Meanwhile, the U.S. is heading for a “fiscal cliff” next January that could throw the global economy into turmoil.
Are we witnessing a long-anticipated U.S. retreat from global leadership?
While Treasury Secretary Timothy Geithner said the U.S. is already doing plenty to help Europe by leaving the Federal Reserve Bank’s Euro-dollar swaps window open (to be repaid in full with an equal amount of dollars no matter what the exchange rate), the reality is that the Obama administration refused to participate because it knew it could never convince Congress to go along with a special infusion of cash for the IMF.
Simon Johnson, a former chief economist at the IMF and now a professor of global economics and management at the Massachusetts Institute of Technology, says the IMF situation is only one of the leadership defaults he sees flowing from the increasingly dysfunctional U.S. political system. He and co-author James Kwak’a latest book, “White House Burning,” warns that the U.S.’s failure to deal with its out-of-balance fiscal policy will further undermine the U.S.’s global leadership role by reducing jobs, lowering living standards, increasing inequality and forcing drastic reductions in government services.
In his interview with The Fiscal Times, Johnson, who writes regularly for the New York Times’ Economix blog and his own Baseline Scenario, gave some surprising answers to how the U.S. should deal with these twin crises, one home and one abroad:
The Fiscal Times (TFT): Should the U.S. have participated in the new IMF “firewall” fund?
Simon Johnson (SJ): No. I think the IMF has enough firepower for what you want it to do, which is protect more vulnerable, smaller countries. The Europeans are capable of sorting out their own problems and giving them more of a firewall will only encourage them to postpone sorting out their own issues. I did support IMF lending to Greece because Europeans were completely asleep at the wheel. But at this point, I would not do more bailouts for Europeans. They are perfectly capable of doing it. They are rich people. They have hard currency – the Euro, used by many people as a reserve currency. They don’t need a loan from the IMF.
TFT: Yet you’ve written that American taxpayers are on the hook anyway. How?
SJ: We are the largest single shareholder in the IMF. We have 17 percent ownership stake. We’re the only individual country that has a veto over all IMF decisions. . . .If the IMF takes a hit, the first people to take a hit are the shareholders, not the people who lent to the IMF. It’s like a bank that way. Traditionally it was not a leveraged institution. But they have not seen fit to increase the shareholders’ funds to make a difference. Instead, they’ve borrowed. But any time you leverage, you create a potential liability for shareholders.
That leads to the bigger issue. What is the contingent liability? The IMF is not backed by the full faith and credit of the U.S. Treasury. But the US has a lot to lose. The $430 billion was a set of loans. If you increase the IMF’s exposure to some part of Europe that goes wrong, the shareholders have some liability. It’s not huge. But it should be subject to Congressional scrutiny and should be scored by the Congressional Budget Office.
TFT: Let’s turn to the U.S. budget crisis. What will happen to the economy if Congress does nothing and the U.S. walks over the “fiscal cliff” next January by letting all the Bush-era tax cuts expire, including the ones on the middle class, and allows the sequestration cuts to go into effect?
SJ: I don’t think it will be as traumatic as people claim. I think a lot of the hysteria around the fiscal cliff is coming from people who want to keep taxes low. Would it have some contractionary effect? Yes, but not as much as people are claiming. But if you’re worried about it, you should rescind all the Bush tax cuts and replace it with some kind of temporary payroll tax cut linked to employment relative to population. As employment rises to pre-crisis levels, that tax cut should fade away.
TFT: So you’re in favor of a substantial tax increase?
SJ: That’s the point of our book. We need a substantial increase in revenue to meet our obligations over the next several decades because we cut the revenue base too much at the beginning of the 2000s. There was the view that there was a surplus that could be spent. The Baby Boom then was at its peak earning years. We should have been bringing down our debt to pay for their retirement. But we went the other way. Ideally you could phase in that tax increase over a decade. But it’s impossible to get the Republicans to agree on any tax increase. You can’t do a nuanced package with them. So you have to have a confrontational approach.
TFT: On the broader issue of tax reform, you argue in your new book for phasing out or reducing tax subsidies like deductions for home mortgage interest and state and local taxes. Should this be tied to lower rates or be a pure revenue raiser to lower the deficit?
SJ: A lot of what passes for tax reform right now in Washington is actually tax cutting or revenue cutting. On the corporate side, you could do a deal where you broadened the base and reduced rates. It could be revenue neutral because there’s not that much revenue there. But on the individual side, we think top rates need to be put back to where they were before the Bush tax cuts and eliminate or phase out the deductions. But you should rebate about half of it to low income people or people you want to compensate for their losing in those phase-outs.