Obama the first African-American President?

Barack Obama’s stunning victory against Hilary Clinton in the Iowa caucuses last Thursday night is the talk of the international press. That a black man defeated the establishment candidate in a primarily (95%) white state and the fact of a record turnout of Democrat voters suggests that Americans are seeing the need for fundamental change.

Interestingly, former Baptist preacher Mike Huckabee gained support from religious conservatives to stage a victory over Mitt Romney in the Republican race. Huckabee was, like Obama, an anti-establishment outcome. Insurgencies are occurring on both sides of US politics.

Obama’s victory shows that the boundaries of race in US politics have dissolved – an amazing outcome given that slavery was abolished in the US only 148 years ago. Ignoring the partisan issues associated with Obama’s candidature (I think his policy on Iraq amounts to abandoning a people who have turned on the terrorists and who desperately need support) the outcome here is, in itself, cause for celebration. It is noteworthy that Obama is addressing issues facing mainstream America not civil rights concerns. His speeches do not contain much content - most US political speeches do not - but he is a passionate performer who will go over well in the US. He is charismatic, carries an aura of authenticity and carries none of the baggage of disappointment that characterises recent US presidential politics. Clinton in comparison, is a boring hack who represents establishment politics.

In the overall scheme of things the events in a small state like Iowa might not seem important but they do set the tone for the remainder of the US presidential campaign.

Now on to Tuesday’s New Hampshire primary where early polls favoured Clinton and McCain. But those polls were taken well before the Iowa vote. The would-be Clinton dynasty is on the line in New Hampshire and support is turning against her. Yes, it couldn’t happen to a less pleasant person.

Barack Obama has a good chance of becoming the next US President. I think he will because I don’t believe Huckabee is electable and I cannot see who will stand up to oppose the calls for renewal by Obama? It is clear that Americans are disappointed with establishment politics and the current presidency. Obama is seen as a solution.

Obama to be president

I forecast that Barack Obama would be the next US President when it was unpopular to do so.  Of course given the polls I am happy to retain this forecast as evidence of my luck or prowess now. I think Obama is something of a populist visionary/demagogue, has loose ideas on tax and tariffs and defeatist attitudes on Iraq. If introduced I think the illiberal economic policies Obama apparently endorses will harm America and the world - particularly in the face of an imminent severe recession and given two intractable wars.

But as it stands there are only two choices here and I think John McCain has left his running far too late.  He is too old. His selection of Sarah Palin seems to have unnerved America and cast doubts on his judgement. McCain sounds wooden and old. It is interesting that even the conservative Economist endorses Obama.

The positive aspect that Obama does bring is his ability to talk to Americans in an intelligent way.  Whatever you think of the man I cannot recall George Bush doing this.  Bush often read pollie talk from a script.

I believe that race and religion should not be factors that bear on election outcomes but if a black man is elected to be a US President it would say something very positive about America. That also says something about me - I had only just entered university when Martin Luther King Jr. was murdered.  That was less than 40 years ago but then the current situation was unthinkable.

What is clear is that if Obama is elected his visions/demagogary and populism will count for little in providing practical ways of addressing the immense problems that the US faces.  Most immediately a likely severe recession but, down the line, the long-term problem of addressing excessive US debt levels.  One can foresee the likely disappointment that many overly optimistic Americans will experience when it becomes clear that in many respects he must fail. But his intelligence and fair mindedness will help.

Update: Tim Blair comments on moves to deflate unrealistic expectations if Obama wins.

Optimism & the Obama Presidency

Barack Obama will become the 44th President of the United States tomorrow.  Despite the exceedingly tough economic times Americans overwhelmingly see Obama as something positive for America.

'a New York Times poll found 79% think Barack Obama will improve the nation – a level of support that is higher than for any incoming president in 3 decades'.

Cynics might say that this optimism partly reflects disaffection with the current President George Bush.  Maybe true and, in any event, optimism can feed disappointment. It is wonderful news that a black man is entering the White House but we should not assume that a public works program will resolve America's intractable soccial and economic problems:

Ten trillion dollars have evaporated in the greatest stock market crash since the 1930s. Twenty million Americans face negative equity, 30 million Americans are in poverty, 40 million have no health insurance. The numbers just keep piling up.....
And so, pretty soon, we will all probably start to complain that Obama is a man of straw, a media creation, a triumph of style over substance; more a celebrity than a politician - a "polebrity" to use the latest ugly neologism.

Americans must be realistic and demand only the possible. Obama has already begun the difficult task of trying to hose down expectations.

Obama supporter by default

I find it hard to support war hero John McCain and his dud Vice Presidential candidate Palin.  But Obama is no shining angel either. 100 prominent US economists get stuck into Obama's policies on tax and trade (a longer list is here):

'Barack Obama argues that his proposals to raise tax rates and halt international trade agreements would benefit the American economy. They would do nothing of the sort. Economic analysis and historical experience show that they would do the opposite. They would reduce economic growth and decrease the number of jobs in America. Moreover, with the credit crunch, the housing slump, and high energy prices weakening the U.S. economy, his proposals run a high risk of throwing the economy into a deep recession. It was exactly such misguided tax hikes and protectionism, enacted when the U.S. economy was weak in the early 1930s, that greatly increased the severity of the Great Depression'.

What a clown Obama is and McCain at least supports free trade. If I had the chance would I ever think about voting for McCain? Probably 'no'.  Don't ask me to explain my reasons in detail. What a choice!

Barack Obama's presidential acceptance speech

Gracious and serious this is a speech worth listening to. There is much sense amid the rhetoric and Obama is - as everyone now knows - a talented man of enormous charisma. But as I stressed a few days ago the difficulties facing the US and hence Obama are immense*. The positive changes will only take effect gradually - a couple of terms in office at least.

He seemed so relaxed and yet determined. As I have said before I think Obama has the makings of being a great US president. He has buried the race issue because there is no issue of a Obama being an 'accepted' black man - he is an outstanding person, period.

I assume the interest group pressures on him will be as great as for other presidents but there is a backbone there that augers well. I am optimistic.

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* As many have pointed out this was the worst inauguration day in US history for stock market prices. The US banks plummeted (shares of Bank of America, under pressure over its Merrill Lynch takeover shares dived 29%. JP Morgan dropped 21%, Citigroup 20%, Wells Fargo 24% and Goldman Sachs 19%) and as a group seem destined to fail. Nouriel Roubini, is quoted saying 'losses in the US financial system could hit $3.6tn before the credit crunch ends – which, he said, means the entire US banking system is effectively bankrupt".

This is a stunning statement backed up in markets. The Dow dropped 4% mainly because of the banks while, in Australia, the ASX dropped 3.1% with banks again pounded but resource stocks being even more heavily dealt with - BHP-Billiton announced 3400 workers in Australia will be sacked.

What a mess. The US banks may need to be nationalised or put into receivership.

Pessimistic views on the global economy

Stock markets have been strong in recent weeks – in anticipation of an Obama fiscal-led recovery - and many financial analysts are predicting the end of the panic and a reversal toward economic normality. That is a false perspective – the US, Chinese and European economies are in free fall. As with the Great Depression the dramatically low interest rates are not doing the trick and there are inevitable political difficulties in getting an effective fiscal stimulus package to work.

US job losses in 2008 are the worst since the end of WW2 – 2.4 million Americans lost their job in 2008 and yet the severe financial jolts occurred late in the year. Clearly the worst is yet to come as deleveraging throughout the economy occurs to offset decades of excessive borrowing.

Paul Krugman has come out and said it plainly* – this looks like a ‘second’ Great Depression. Janet Yellen has described the downturn as likely to be the longest and most severe since the Great Depression.

I am a pessimist and view the current stock market mini recovery not as a leading indicator of future prosperity but as a false dawn. The real effects of the disastrous financial crisis are only beginning to be felt.

* Excerpts of Krugman's views:

" Let’s not mince words: This looks an awful lot like the beginning of a second Great Depression.

... We weren’t supposed to find ourselves in this situation. For many years most economists believed that preventing another Great Depression would be easy. In 2003, Robert Lucas ... in his presidential address to the American Economic Association, declared that the “central problem of depression-prevention has been solved, for all practical purposes, and has in fact been solved for many decades.”

Milton Friedman, in particular, persuaded many economists that the Federal Reserve could have stopped the Depression in its tracks simply by providing banks with more liquidity, which would have prevented a sharp fall in the money supply. Ben Bernanke, the Federal Reserve chairman, famously apologized to Friedman on his institution’s behalf: “You’re right. We did it. We’re very sorry. But thanks to you, we won’t do it again.”

...Yet credit remains scarce, and the economy is still in free fall.

Friedman’s claim that monetary policy could have prevented the Great Depression was an attempt to refute the analysis of John Maynard Keynes (but) The failure of monetary policy in the current crisis shows that Keynes had it right the first time. And Keynesian thinking lies behind Mr. Obama’s plans....

But these plans may turn out to be a hard sell. News reports say that Democrats hope to pass an economic plan with broad bipartisan support. Good luck with that.

In reality, the political posturing has already started, with Republican leaders setting up roadblocks to stimulus legislation while posing as the champions of careful Congressional deliberation — which is pretty rich considering their party’s behavior over the past eight years.

More broadly, after decades of declaring that government is the problem, not the solution, not to mention reviling both Keynesian economics and the New Deal, most Republicans aren’t going to accept the need for a big-spending, F.D.R.-type solution to the economic crisis.

The biggest problem facing the Obama plan, however, is likely to be the demand of many politicians for proof that the benefits of the proposed public spending justify its costs — a burden of proof never imposed on proposals for tax cuts.

This is a problem with which Keynes was familiar: giving money away, he pointed out, tends to be met with fewer objections than plans for public investment “which, because they are not wholly wasteful, tend to be judged on strict ‘business’ principles.” What gets lost in such discussions is the key argument for economic stimulus — namely, that under current conditions, a surge in public spending would employ Americans who would otherwise be unemployed and money that would otherwise be sitting idle, and put both to work producing something useful.

All of this leaves me concerned about the prospects for the Obama plan. I’m sure that Congress will pass a stimulus plan, but I worry that the plan may be delayed and/or downsized. And Mr. Obama is right: We really do need swift, bold action.

Here’s my nightmare scenario: It takes Congress months to pass a stimulus plan, and the legislation that actually emerges is too cautious. As a result, the economy plunges for most of 2009, and when the plan finally starts to kick in, it’s only enough to slow the descent, not stop it. Meanwhile, deflation is setting in, while businesses and consumers start to base their spending plans on the expectation of a permanently depressed economy — well, you can see where this is going.

So this is our moment of truth. Will we in fact do what’s necessary to prevent Great Depression II?"

Update: earlier views that the recovery of US employment reflected spurious seasonal effects are confirmed. In December US unemployment jumped by 525,000 to 7.2% of the workforce. This is a 16 year high. 2.6 million Americans lost their jobs in 2008. In total 11 million Americans are unemployed. My earlier forecast that US unemployment will hit 10% looks close to the mark - official forecasts are around 9% by end of 2009. The US economy is in freefall.

Limits of redistribution

Barack Obama has an enormously expansionary fiscal program to get demand moving but promises to halve the budget deficit by the end of his (first) term.  This is a tricky promise to deliver on since he has also guaranteed not to tax US households earning less than $250,000US an extra cent.  3.8 million Americans earn more than $200,000 (the $250,000 point is not configured) and paid $522 billion in tax in 2006.  The top marginal rate is 35% and Obama is proposing to raise it only a little to $39.6%. One can see that this would yield something less than about another $68 billion* which is more than a fair bit short of the $1.5 trillion deficit that many expect will prevail over the coming year.

To pull off the halving of the deficit the tax hikes would either need to be draconian (the WSJ argues that even 100% taxes on the top 2% of income earners would not do the trick)  or otherwise taxes will have to be increased on people earning much lower incomes as well.  Nor will unwinding the war in Iraq do the trick though it will help.

Don't forget either that Obama has some fairly large spending plans in health, alternative energy and infrastructure.

I don't think that the good President Obama's economic policies are internally consistent.  I think this guy has the potential to be a great President but he should level with the American people.  They will need to pay much higher taxes to fund the current expansionary moves.

* This is optimistic since many will experience income losses as a consequence of the recession.

Update: Paul Krugman takes a slightly more optimistic view. He notes that the budget will benefit from $645 billion (over the next decade?) and from the sale of emission quotas - a very promising sign. He also notes with approval $634 billion devoted to health reform.But Krugman also notes"And even if fundamental health care reform brings costs under control, I at least find it hard to see how the federal government can meet its long-term obligations without some tax increases on the middle class. Whatever politicians may say now, there’s probably a value-added tax in our future".

Barack Obama the great black hope

I said that Barack Obama would be the US President when it was unpopular to say so.  This video interview with CBS confirms my belief that Obama may well be a great US President. Apart from letting his necktie dangle a bit this interview suggests that real inspiration lies in this man.  It is a big ask to get the US out of its current hole but Obama seems to be a top person with intellectual agility/ability and personal charm.

Obama supports conscription

Gregory Mankiw points out that Barack Obama supports the conscription of youth into community service. I wonder how many aged lefties will now dump on Obama on the basis of past Vietnam Moratorium ideals. Well of course its not this aged lot who now face the prospect of being conscripted so that a certain amount of soundly-justified hypocrisy is plausible.

Maybe spending the last week in China has dented my democratic ideals but I think the Obama suggestion makes a lot of sense.

A Xmas present from America?

The insincerity and deceit of PM Grub Rudd partly mirror the views of the Australian electorate and also Rudd’s perception of international political opinion. Politicians like Rudd just don’t get it – we need massive cuts in carbon emissions and an end to the use of carbon based fuels soon if the earth is not to very likely to experience catastrophic (2 degrees plus) climate change*. Rudd is not alone in his stupidity. The Europeans have reneged on commitments to address climate change seriously despite the leadership role of Germany’s scientist leader Angela Merkel.

French climate scientist Philippe Ciais argues the earth will experience 2 degrees warming even if all emissions stopped today. There is even one notable forecast by NASA scientist James Hansen of record global temperature highs during the first term of President Obama’s office and of the possibility of runaway warming with the destruction of all life on earth and in the oceans.

These are fearful scenarios and will be derided by climate change sceptics but the outcomes they point too as serious scientists are very adverse and are worthy of weight on that account alone. It is not alarmism but prudent regard for a serious risk that endangers life on earth.

Some of Obama’s appointments suggest a new US respect for science. Obama is committed to serious climate change policies and has:

...pledged to create 5 million green jobs and break U.S. dependence on foreign oil, investing $150 billion in the next decade to build an energy economy that relies on renewable sources such as wind, solar and geothermal energy.

Moreover, despite US economic problems these sorts of policies seem like a plausible and reasonable vision. Already the appointment of serious climate change scientists to key positions in his administration has led to forecasts that this will have a positive effect of Indian, Chinese and Brazilian climate policies.

The old US ‘enemy’ may yet arise to save the day - I have already posted that there is a conceivable economic rationale for doing just that. It would be a great Xmas present for the world for Obama to establish his position as a great US President by getting the world’s political leaders to take seriously climate change.

* My own work as an economist interested in climate change policy will emphasise adaptation policies on the assumption that (regrettably) mitigation policies are likely to be ineffectual.  I am also completing work on strategic aspects of mitigation policy.

Barack Obama's speech to Congress

I heard the economist Professor Ed Leamer's rapturous appreciation of the Obama speech (& here, here, here, here) (on the 7-30 Report) before I saw the speech myself.  But this is an inspiring speech on a par with anything by J.F. Kennedy.  Obama sees the need for a stimulus and the need for offsetting the debt implications of the stimulus. I don't know if he can do this but the framework is right and the speech is a skilled effort that will help pull America out of a pessimistic hole.  In fact, however, Wall Street headed lower after the speech but this trend was - as in recent days - driven by frustration with the inability of investors to see a way out for the US banks.

BTW, Leamer was the first major forecaster to warn of the US housing bubble.  I couldn't find a transcript of his remarks tonight but he was surprisingly optimistic.  Leamer sees the tough times now as storing up a lot of latent demand for cars and housing.  Indeed he sees the US economy rebounding strongly in a couple of quarters with even the housing sector recovering strongly.  I find this difficult to understand given the pervasive rottenness of US credit markets.  It is not only an issue of a short-term downturn in demand. Ben Bernanke sees the problem - the US can return to growth this year provided that the financial system is put in order.  Its a monumentally big proviso given that the debt binge lasted for more than a decade.

Mr Ali Allawi on Iraq

Former defense and finance minister in Iraq, Mr Ali Allawi, gave a valuable account of the current political situation in Iraq on last night's Lateline.  According to Allawi the majority of parliamentarians - and probably most citizens*  - would quietly back Obama's policy to withdraw troops from Iraq in 18 months.  At the same time the government feels a debt of gratitude to George Bush - if only because many owe their positions to the US intervention. Of course Bush too has noew stated a commitment to withdraw although there is no specific timetable. The reasons for the improved security situation in Iraq - extra oil money driving a more prosperous economy, the decline in the Sunni Arab insurgency,  the defeat of  al-Qaeda and - paradoxically but unquestionably - the success of the recent surge.

Critics of the US effort in Iraq (including Obama's criticism of the ineffectuality of the 'surge') have been proven completely wrong. 

The transcript is short and very worth reading.

* Not the Kurds and some Sunni who, despite their public opposition, fear the consequences of a US withdrawal.

John McCain is too old to be President

This YouTube outlining John McCain's views on economics, foreign policy and disaster relief amused and frightened me.

I have suggested before that Barack Obama will be the first black American President and, despite my conservative politics, believe this will be, on balance, a good thing. He is the best of a weak field and John McCain is well past his best.

My support as a non-American for Obama would be unambiguous were it not for his support for a 'cut-and-run' Iraq policy. I think his assessment that the US position in Iraq is hopeless is not consistent with current developments. But John McCain lacks credibility on this same issue.

Hat tip to RH for the clip

H.E. Seyed Mohammad Khatami

I heard this remarkable man - ex president of Iran 1997-2005 - speak at La Trobe University this evening.  Mr Khatami is a Muslim cleric whose main interest is political philosophy.  I found his prepared speech, which ran for half an hour, academic and rather dry.  For another 2 hours however he took good-natured, though often pointed questions from his audience with grace, animation and (most of all) an erudite humor that had even the stern-faced security guards in stiches of laughter.  It was the largest public meeting I have attended at LTU with about 1300 in attendance - the audience filled 3 lecture theatres to capacity. 

A most enjoyable evening which touched on the conservatives in Iran, fanatical Muslims, fanatical neocons, Iranian nuclear power, Palestine, Barack Obama.

Khatami's public presence did not support the Jewish Community Council of Victoria's image of him as a Jew-hating supporter of terrorism.  In his public statements tonight he expressed religious solidarity with the Jews - in terms of a common religious heritage - but opposition to their occupation of Palestine, total opposition to religious fundamentalism and absolute opposition to terrorism.  He saw Obama as a positive force that was nevertheless likely to be thwarted by US pressure groups.  He skillfully promoted the Iranian national image - no mean feat given the press it receives.

The JCCV condemned LTU for inviting him but in my view we should listen. In human terms I've got to say that I feel some bond with people such as Khatami. I probably would not agree with some of his specific religious views but to be honest, if I was organising a barbie, I'd like him to come.  Maybe I am gullible and falling for a skilled propagandist! Maybe not.

Climate change - Obama's problems and the Garnaut prescription

Over at the East Asia Forum blog two useful articles on climate change:

Frank Jotzo looks at Barack Obama's climate change problems.  He argues that the double bottom line argument for US pursuing an active mitigation stance (improving global climate, reducing US dependence on imported oil) has become a triple bottom line case given the current financial crisis because the investments required can held driver a revival of the US (and world) economies.  He argues that a model for encouraging co-operation between the super emitters (US, China, India) might lie in the prescriptions of the Garnaut Review with its advocated equal per capita emissions targets by 2050.  Broadly I agree. Increased taxes on US imported oil use could be motivated by the vast costs of stabilising the Middle East to ensure supply.  Moreover, the weak case for emphasising capital intensive expansion strategies in the face of a likely long world recession - the move won't directly target employment - is bolstered by the by the double bottom line arguments cited.

Shiro Armstrong writes a piece defending the Garnaut conditional targets that despite some earlier reservations I support.  I agree with Armstrong that Garnaut has received an unfair press - including initially from me - Garnaut is focusing on what is realistically achievable. Tightened targets - which many in the Green movement support - can be negotiated once weaker targets (that will, in themselves, be difficult to negotiate) are agreed to.  The Garnaut Review has provided a useful input into the UN discussions of a post-Kyoto treaty in Copenhagen in 2009.

The East Asia Forum is a blog well worth bookmarking.

Iraq elections

Ex-president George Bush's Iraq surge seems to have been a success.  Free elections in Iraq where Sunni arabs participated in force and where there was widespread participation - was one of the positive outcomes that can be attributed to the surge.  Contrary to popular opinion Iran is weakened by a strengthened Iraq and the rational basis for the intervention in Iraq is confirmed.  As John Bolton remarks concerning the Iraqi elections:

"...the elections could make a deep impression on the citizens of Iran and its vassal, Syria. Young, educated, sophisticated Iranians, dissatisfied with their country’s religious orthodoxy and economic failures since the 1979 revolution, will draw their own conclusions from Iraq’s peaceful democratic process."

President Obama argues that the successful, peaceful elections provide support for his policy of US withdrawal. That is probably true but it is evidence too that the surge has been far more successful than its detractors would admit.  Let us hope that Obama takes wise and flexible counsel on the Iraq War.  I believe that history will be kinder to George Bush than to his leftist rabble critics.

Sarah Palin a rookie politician she 'aint

Palin provides an old-fashioned rabble-rousing appeal to patriotism but this woman is dangerous. And here and here. Jingoistic stupidity and far more dangerous than the largely empty rhetoric of Obama with its economic stupidity.  Palin reminds me of a scene from Altman's Nashville - 'you may say that I 'aint free but it don't bother me'.  When will America wake up from this nightmare?  Hollywood has consumed Washington.

Update: Paul Krugman sees the Republican tactics as a dishonest, strategy that seeks to encourage resentment.

Barack Obama is Irish

This entertained me.

Thanks Bernd

Rudd the grub

It is obvious that our grubby little ear-wax-munching Prime Minister Rudd has damaged Australia by betraying the embellished form of a conversation he had with President George Bush. The story was embellished in an attempt to make the US President appear stupid (What is the G20?) and our own PM appear smart. The effect of Rudd's loquaciousness in repeating to reporters a personal conversation with Bush was to damage Australia and to destroy the trust that any foreign leader would ever place in our grubby little PM. And Rudd looks like a pretentious, myopic smart-arse rather than anything approximating an intelligent PM. Even Melbourne's Pravda recognises the damage.

BBC News describes the gaffe by Rudd as an attempt to make Bush look like a fool. It is a great way of treating our most important ally! Imagine how the Chinese and other nations see the stupidity and immaturity of the Rudd blunder. No one would trust him again.

Malcolm Turnbull is quite correct in remarking that:

"Mr Rudd's desperate desire to big-note himself has done real harm to our relations with the US.

It is clear enough that the US President has been deeply offended. President Obama and other American leaders in the future will be very wary about saying anything to Mr Rudd and other Prime Ministers, in case what they say winds up on the front page of a newspaper.

"Mr Rudd has sacrificed our nation's reputation for trustworthiness and discretion on the altar of his own vanity.'' (my bold)

Kevin Rudd's glib meaningless 'I will do whatever it takes' assurances, his declarations of war everywhere on every issue and his thin skin when the opposition takes him to task on any of his stupid policy measures - the unlimited deposit guarantee to the banks and the decision to encourage 450,000 Australians to abandon private health insurance - mark him as the worst PM Australia has had since Paul Keating. No qualifications - Rudd is a disaster.

Rudd is unreliable in a crisis and pretentious to the point where he believes the meaningless pollie drivel he offers the media as opinion. Rudd has seriously damaged Australia and I am confident will do more damage.

Update: Catallaxy has a discussion K Dudd a national embarrassment. The Age discusses the meeting between Rudd and Bush - "Rudd looks sheepish. Bush looks prickly".  Scraping the bottom of the barrell of Labor's cheersquad we have Mark Banish from Larvatus who doesn't deny Rudd gossipped about Bush's stupidity to the media - he just argues Rudd has done us all a favour in pointing out Bush's ignorance!

Instrument instability & the global economic crisis

Robert Holbrook in 1972 drew attention to the issue of policy instrument instability.  Essentially an economic policy can become infeasible if policy needs to adjust more intensively to offset past effects of policy - the policy itself becomes an unstable process.  This type of instability is particularly likely if we try to pursue stabilisation of the economy too completely. An example arose when money supplies needed to grow at ever faster rates to try to keep unemployment down. As Jeff Sachs suggests (HT Greg Mankiw) in relation to the current batch of US economic policies:

"Massive deficits and zero interest rates might temporarily perk up spending but at the risk of a collapsing currency, loss of confidence in the government and growing anxieties about the government’s ability to pay its debts. That outcome could frustrate rather than speed the recovery of private consumption and investment. Deficit spending in a recession makes sense, but the deficits should remain limited (less than 5% of GNP) and our interest rates should be kept far enough above zero to avoid wild future swings.


We should also avoid further gutting the government’s revenues with more rounds of tax cuts. Tax revenues are already too low to cover the government’s bills, especially when we take into account the unmet and growing needs for outlays on health, education, state and local government, clean energy and infrastructure. We will in fact need a trajectory of rising tax revenues to balance the budget within a few years".

The source of the current crisis is that US citizens have borrowed too much and saved too little over the past decade partly because interest rates and taxes have been excessively low.  Private citizens have not produced enough goods and services to achieve the lifestyle (and to fund their wars and tax cuts) they wanted, they have not exported enough and instead have financed their consumption binge mainly by borrowing against the value of their real estate whose prices were inflated by a debt-funded real estate bubble.  Equilibrium will be established once debts have been reduced and savings rates increased and once the value of real estate falls back into line with consumer incomes*.  Adding extra government debt (and equivalently, cutting taxes) as well as setting close to zero interest rates might provide a short-term palliative but - whatever else it might do - does not at all resolve the underlying problems.  The danger is apocalyptic - continued borrowing can lead to a US public sector bankruptcy, a consequent (or precedent) collapse of the US dollar that would then destroy large segments of the world economy and a global depression that will make current events look seem like a Sunday school picnic.

A number of policy theorists have described current policy as a 'paradox' - incurring a bit more debt to resolve America's debt-induced problems.  I think it is just dangerous policy and a potential instance of instrument instability. Barack Obama must see something of the same difficulty - he is committed to reducing the US fiscal deficit by half during his first term.  I think he is an able man but this is a very tough objective. 

We are due for a recession and a severe economic downturn. This is inevitable and the attempt to eliominate its consequences too completetely can be futile and induce worse future economic problems.
* The same is true to a less extent for Australia.  Eventually house prices must fall very substantially.  Australian real estate remains some of the most expensive on earth even though we have a small population and abundant land.  That is true even if we live in a 'highly urbanised' country (one of the standard reasons advanced for our high prices). .