October 17, 2012
After last night’s debate, are you convinced that either party has a plan to create jobs? Let’s look at the real economy. Stock prices are rising despite a looming fiscal cliff that would immediately throw the economy into recession. (Have Wall Street traders collectively donned their Alfred E. Newman caps and tee shirts?)
The more benign interpretation is that financial markets are signaling the economy has some underlying strengths that will reemerge once the political uncertainty lifts. If that were to occur, get ready for President Fill-in-the-Blank to take credit for a modest recovery next year.
But underline the word modest. Every major factor that has made recovery from the worst economic downturn since the 1930s a long, drawn-out process is still dragging down growth and will continue to do so for the foreseeable future.
The huge overhang of bad mortgages and empty houses from the burst housing bubble has finally hit bottom. Prices are starting to come back in most markets while remodeling is picking up. But nobody would call the housing and construction markets robust.
Households have been working off excessive debts for nearly four years and would finally appear ready to spend. But most families’ net worth – the sum of their property and financial assets after subtracting their mortgage and credit card debts – remain well behind where they were before the financial crisis hit in 2008.
That reverse wealth effect continues to leave many workers, especially aging baby boomers trying to get ready for retirement, far more interested in socking away savings than in splurging for a Caribbean cruise or another widescreen TV. Meanwhile, young families and new entrants in the labor market, many of them overburdened with student debt, continue to have trouble climbing onto the first rung of the economic ladder in a job market where older workers can’t afford to retire.
The picture isn’t any prettier abroad. Europe remains a zone in crisis, riven by a north-south split that parallels America’s divisive politics.
Germany and other rich countries in the Eurozone do not want to pay for the bubble-era profligacy of the southern tier, where Greece and Spain are already suffering from depression-era levels of unemployment caused in part by European Union-imposed austerity measures. One can’t imagine a whole lot of U.S. exports heading that way anytime soon.
China, meanwhile, is gearing up for another export push to counteract its slowdown, experts in the region say. Indeed, exporters across East Asia and the rest of the developing world have been hungrily eyeing the U.S. market to solve their own economic woes.
While President Obama has issued three World Trade Organization complaints against China and Republican nominee Mitt Romney wants to brand China a currency violator “on day one,” China is far from alone in engaging in currency wars, according to Joseph Gagnon, a former Federal Reserve Board economist now at the Peterson Institute for International Economics. Countries like Malaysia, Singapore, South Korea, Brazil and Israel have been buying U.S. dollars, which depresses their own currencies, makes their goods cheaper in dollar terms and facilitates greater exports to the U.S.
No wonder growth in the U.S. manufacturing sector, which led the recovery in 2010 and 2011, flat-lined this year. “We’d have a zero trade deficit right now if it wasn’t for this currency manipulation,” Gagnon said. “I estimate it has cost us two to three million jobs.”
Mr. Next President, this is the global mess you will inherit – rampant beggar-thy-neighbor policies in a world awash in surplus labor and goods, the hallmarks of a classic Keynesian crisis of under- consumption that often follows financial crises.
Now, the classic Keynesian response would be to administer high doses of government spending, which hasn’t been the policy in Europe. It worked for a while in China, but now that government is withdrawing its stimulus. The U.S. is about to do the same despite the consensus among some economists that it stopped the downturn and saved or created millions of jobs.
Most political observers say the most likely outcome of the fiscal cliff negotiations will be expiration of the two-percentage point payroll tax cut and extended unemployment benefits that have been in place for the past two years. Nobody on either side of the aisle has the stomach to continue raiding the Social Security trust fund. And no one talks much anymore about the special problems of the long-term unemployed. Letting those two measures lapse will yank about $100 billion out of the economy next year.
On the tax side, reform proposals by either Romney or Obama are long-term projects. It would take a year to enact under the best of circumstances. The only options left on the table for the year-end debate – the ones that will affect next year’s economy – are between one side fighting to temporarily extend all the Bush-era tax cuts while the other would eliminate them for households earning over $250,000 a year.
Meanwhile, on the spending side, both sides are pledging further austerity, even as they quietly agree that taking a full $100 billion out of government spending in 2013 through sequestration is a non-starter. The only question is how much, how soon and from where.
If Obama wins, the military will share in cuts that Sen. Richard Durbin (D-Ill.) hinted during the Democratic convention ought to equal about $30 billion to $40 billion next year. A Romney win would impose all the cuts on non-defense side.
Either way, the total fiscal austerity package endorsed by both sides – the budget cuts and the expiration of the payroll tax cut and extended unemployment insurance – will subtract about one-and-a-half percentage points from gross domestic product, according to Gagnon. While that’s better than the 4 to 5 percent plunge from a full fiscal cliff swan dive, it’s just another hole that the economy will have to dig out from.
There are optimists, of course, and their mantra has a familiar ring. Wait until the second half. “Europe should stabilize by the second half of next year,” said Diane Swonk, chief economist at Mesirow Financial in Chicago. “As uncertainty dissipates, we’ll get more growth. But we still have to deleverage. It’s hard to know when we hit that tipping point where people start to spend again.”