Will A Better But Not Yet Good Economy Safe Obama?

Democrats hope in a tight election race that marginal improvements in the economy will persuade voters to back their man over Republican nominee Mitt Romney. With the exception of the parties clashing over Libya, and whether the administration was culpable by neglect in the deaths of Ambassador Christopher Stevens and three other Americans during the September storming of the American consulate in Benghazi, the election has been dominated by the state of the US economy.

The culture wars of the past have dimmed in significance this year. Even the divisive issues of abortion and immigration have faded. With Obama’s fate likely tied to how voters judge his record in restoring economic growth, Democrats have been burnishing any good economic news coming their way. Read my take on this in the Daily Mail.

Let’s Roll — Time for Tax Cuts And More Stimulus

“The movers and shakers of our society seem…oblivious to the terrible destruction wrought by the economic storm that has roared through America.” Thus writes the New York Times’ Bob Herbert, who notes in a weekend column that “nearly 44 million people were living in poverty last year, which is more than 14 percent of the population. That is an increase of 4 million over the previous year, the highest percentage in 15 years.”

And as for the middle-class, Herbert observes, they have “hobbled for years with the stagnant incomes that accompany extreme employment insecurity” and are now in retreat. The economic fear stalking America goes far to explain the severe fall in popularity of President Obama and the rise of the Tea Party.

For all of my fears of the social conservatism that is veined through the Tea party movement, the public focus for most Tea Partiers is on the economy. But their answer is not the right one to deal.

Understandably, they blame government. It was government that gave us the runaway juggernauts of Fannie Mae and Freddie Mac; it was home-ownership encouragement from both sides of the Washington DC political aisle that gave us sub-prime; and it was the administration of George W. Bush that believed “deficits don’t matter” and presided over the greatest splurge of public spending since Lyndon Johnson.

So, why trust government now? For the Tea Partiers it is time to get back to basics – to the U.S. Constitution, to balanced budgets, to limited government. All noble aims. For many of them, though, read “no government” when they say limited government. But this isn’t the time to say “no government” — we need it to sort out the mess it co-authored.

Unfortunately, in the same way that Tea Partiers are going back to basics and mistaking the sky-rocketing deficit as the problem, so various policy-making elites are returning to unsophisticated positions. Free market advocates are becoming more uncompromising; Keynesians more Keynesian. All are over-focused on ideology.

In this fevered political environment the administration is more timid than it should be. The U.S. needs another financial stimulus. Yes, this would add to the federal deficit but when you have cancer, to survive you need to take some poisons as therapy. Convalescence can come later.

For Republicans – and the Tea Partiers – that is heresy. For them “big government” explains the economy’s weakness, and high unemployment is evidence that the President’s fiscal stimulus failed. But this is wrong. As the Economist magazine notes, “the notion that high joblessness ‘proves’ that (the) stimulus failed is simply wrong. The mechanics of a financial bust suggest that without a fiscal boost the recession would have been much worse.”

There has been growing confidence that America will escape a double-dip recession but that is far from certain. The jobs market remains in a slump, recovery is anemic, property prices continue to fall, a further wave of home foreclosures is on the cards.

In 1937-38, fiscal and monetary contraction killed dead a recovery, sending the economy back into a prolonged slump that didn’t end until World War II.  And as Arthur Laffer argued in a Wall Street Journal op-ed earlier this year tax hikes had much to do with the problem. “The damage caused by high taxation during the Great Depression is the real lesson we should learn. A government simply cannot tax a country into prosperity.”

That lesson seems belatedly to have been absorbed by Obama aides, who are now supporting the idea of extending the Bush tax cuts, except for the top 2 percent of earners.

But this crisis is not a normal cyclical one. There are serious structural aspects to it, as the PIMCO chief executive Mohamed El-Erian has been maintaining. His point?  Policymakers must implement a “structural vision to accompany their current cyclical focus. Measures are needed to address key issues, which include the change in drivers of growth and employment creation; the high risk of skill erosion and lost labor productivity; financial deleveraging in the private sector; debt overhangs; the uncertain regulatory environment; and the unacceptably high risks facing the most vulnerable segments of society.”

El-Erian’s recommendations include “pro-growth tax reform, housing finance reform, increased infrastructure investments, greater support for education and research, job retraining programs, removal of outdated interstate competition barriers and stronger social safety nets.”

Yes, in short, a stimulus from tax cuts that can help encourage consumption and unleash animal spirits AND more public spending to get things moving more.

For the Democrats tax cuts – especially for the wealthy – are anathema. But the U.S. needs to grow its way back into prosperity. For Republicans and Tea Partiers, more government spending is just an excuse for “big government.” Of course, federal deficits will need to be curbed in the long run – preferably starting within a couple of years.

Let’s go back to El-Erian’s point about there being a structural part to this crisis and observe the labor market.

According to the GOP Nevada Senate candidate Sharron Angle, people who receive unemployment assistance are “spoiled.” In short, they should just get a job. Easier said than done. Americans have been used to employment snapping back after recessions. But there is clear evidence now that it isn’t just weak demand that’s responsible for stubborn unemployment but something more structural.

For example, unemployment has not fallen in the way it should have with increases in job openings. Many jobseekers do not have the skills needed by employers. This is nothing to do with being “spoiled.” Half of the eight million jobs lost in the recession were in construction and manufacturing. Many of those workers are unable to slot into jobs in education, say, or health services. Add to that the difficulty workers have now in re-locating because they owe more on mortgages than their homes are worth.

Looser monetary policy will not alleviate this problem. Libertarians  argue that government should have no role in trying to sort this out. But the free market will be too slow.

So far no single growth engine has emerged to pull the U.S. towards strong recovery. Consumer spending and business investment have been too weak. President Obama’s hope that the country can export its way to strong recovery looks forlorn. For that to happen, America’s trading partners need to be buying American goods. They aren’t. China and India are eager to head off inflation and are tightening. The PIGS economies in Southern European are cutting spending and raising taxes. So are some of the more robust EU economies, notably Britain. But unlike the European countries the U.S. has some leeway to increase public spending — the yield on 10-year Treasury bonds remains below 4%, well down from the 8% of 1990 and inflation remains weak.

So government has to seek to accelerate growth – by tax cuts, payroll tax holidays and further government spending. The debt can be focused on down the road when growth increases along with tax revenues.

Taxes and Devaluation Prolonged the Great Depression

Politicians on both sides of the Atlantic should take a long hard look at an op-ed by Arthur Laffer in today’s Wall Street Journal. Laffer plots the consequences of federal and state tax hikes and protectionist increases in trade duties in the early 1930s and he takes issue with the current Federal Reserve chairman that the monetary supply was tight. “The strong correlation between soaring unemployment and falling consumer prices in the early 1930s leads Mr. Bernanke to conclude that tight money caused both.” Laffer shows this wasn’t the case: “The 1933-34 devaluation of the dollar caused the money supply to grow by over 60% from April 1933 to March 1937, and over that same period the monetary base grew by over 35% and adjusted reserves grew by about 100%. Monetary policy was about as easy as it could get,” Laffer notes.

Laffer doesn’t blame fed policy on taxes and the money supply for causing the Great Depression — he points the finger at the protectionist Smoot-Hawley tariff of June 1930 as the catalyst that got the whole process going. But he does see tax hikes and loose money supply as worsening the situation and causing the double-dip in the economy in 1937. “Huge federal and state tax increases in 1932 followed the initial decline in the economy thus doubling down on the impact of Smoot-Hawley. There were additional large tax increases in 1936 and 1937 that were the proximate cause of the economy’s relapse in 1937.” In fact, the tax hikes were eye-opening.

“The damage caused by high taxation during the Great Depression is the real lesson we should learn. A government simply cannot tax a country into prosperity. If there were one warning I’d give to all who will listen, it is that U.S. federal and state tax policies are on an economic crash trajectory today just as they were in the 1930s.”

The only way out of the mess in the U.S. and U.K. is for spending cuts but they should targeted away from front-lines services such as schools and hospitals. And in the U.S. government intervention is needed on the health care front to provide affordable health insurance for all and a choice of public and private options. Not only is that a moral necessity but an economic one before the U.S. health system contributes to the bankrupting of America.