The Guardian Unlimited, December 6, 2010
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Hollywood used to be the place where creative people went to cook up outlandish horror plots. But Hollywood has been displaced. Now people go to Washington to spin their wild tales of looming disaster.
The national agenda has been dominated by such tales over the last two years. Most recently we have had the story of the bond market vigilantes doing to the United States what they have already done to Greece, Ireland and Portugal. This story requires suspending disbelief, but people who report on economic and political issues for major news outlets are good at ignoring reality.
The plot is that at some date in the not-distant future, if we don’t mend our free-spending ways, no one will buy U.S. government bonds. The United States will be forced to stand before the international community as a helpless beggar and agree to whatever humiliating terms bad guys from China to Saudi Arabia and even France choose to impose.
The plot departs from reality in several ways. The large deficits at present are due to the downturn, not profligate spending. Furthermore, there has been very little growth in government spending as a share of GDP for decades (apart from counter-cyclical spending in the downturn), undermining this key part of the story.
But the real problem stems from the logic of the impending crisis. Suppose that investors in the United States and elsewhere refuse to buy government debt. (Investors keep undermining the plot line by buying massive amounts of U.S. debt at very low interest rates.) In this case, we could have the Fed buy our debt. Unlike Greece, Ireland and Portugal, we have our own currency.
This story can lead to inflation but that is not quite the disaster story the deficit hawks are peddling. Inflation is a process that comes about through too much demand in the economy. In other words we would have over-full employment, with wages rising rapidly, which would in turn push up prices.
Furthermore, we don’t end up like Zimbabwe with hyperinflation. The United States has a huge diversified economy that still produces almost 85 percent of what we consume here at home. We might see creeping inflation, which could in a bad scenario turn into the double-digit inflation that we saw in the 70s. But that still is not quite the disaster that the deficit hawks are using to scare the public into surrendering their Social Security and Medicare benefits.
After all, the economy actually did reasonably well in the 70s, growing slightly more rapidly than in the 80s. And, since inequality did not rise in the decade, the typical family did better in the 70s than the 80s.
The deficit gang also warns about a plunging dollar. Of course a decline in the dollar is exactly what we need to get our trade deficit down. This is why Treasury Secretary Tim Geithner has been asking China to raise the value of its currency against the dollar.
The deficit hawks want us to believe that China, which has been resistant to a 20-30 percent decline in the dollar relative to the yuan, would suddenly tolerate a decline of 50 or 60 percent? They want us to believe that Germany and France will watch the euro rise to a point above two dollars to a euro? And Japan will let the yen rise to the point where there are only 50 yen to the dollar?
This is where the deficit hawks horror story loses whatever credibility it held. This sort of plunge would imply the collapse of these countries’ export markets in the United States. They would also be flooded with hyper-competitive U.S. exports. This is not going to happen; these countries care far more about their domestic economies than trying to be the fiscal enforcers of the deficit hawks’ dreams.
In short, the horror story collapses as soon as anyone gives it any serious thought. The Wall Street gang can hardly be faulted for trying cheap scare tactics for pushing its agenda; after all it worked so brilliantly with the TARP two years ago. At the time the plot line was that unless we immediately gave all our money to the Wall Street banks, with no questions asked, then the whole economy would collapse.
The government turned over not only the $700 billion in TARP money, the Fed also made trillions of dollars of secret loans to the Wall Street banks, as was revealed last week. This support, including guarantees that may have been even more valuable, allowed giants like Citigroup, Goldman Sachs and Morgan Stanley to survive the financial collapse that they had helped to create. As a result, bank profits and executive bonuses are higher than ever.
In short, Wall Street has a proven winning strategy. Come up with an end-of-the-world horror story, get the Washington Post, National Public Radio and other media outlets to hype it endlessly, and then watch the politicians rush to hand over the taxpayers’ money. Their next horror story will not doubt be the most frightening yet.