Challenging economic dogma

By Weekly Archive On Mar 10, 2009

Challenging
economic dogma

On
spending, debts and currency, the recession forces a re-think of some
cherished American policies

From
The Guardian

A
serious economic crisis can force some rethinking of economic and
political dogma. The current crisis is serious for most of the world:
the IMF is projecting world economic growth of just 0.5% this year —
the worst since the second world war — and this number could easily
be revised downward.

In
the United States, one of the first casualties of the current
recession was the extreme fiscal conservatism that has plagued the
country for decades. It seems like ages since the Clinton
administration, facing projected budget surpluses
of more than $5 trillion, decided that it needed to pay off the
entire national debt before committing to any new social spending.
President Barack Obama’s proposed budget has a deficit for this
year of 12.3% of GDP — twice the size (relative to the economy) of
the next largest deficit in the six decades since the second world
war. (That was Ronald Reagan’s "military Keynesian" budget
of 1983.) Like his successor George W. Bush, Reagan never admitted
that deficit spending was needed to pull the economy out of
recession. Instead he pretended that he was just meeting "defense
needs" and granting tax cuts where tax cuts were due (mostly to
the wealthy).

Today
there is a pretty sizeable consensus that deficit spending is very
necessary, whatever the Republican leadership may think — if they
are thinking at all. This is really just a matter of national income
accounting. With consumption and investment falling, that leaves only
government purchases and net exports to pull us out of this
recession. More on net exports (exports minus imports) in a minute —
but for now this part of our economy is not set to grow enough to
pull us out of the recession. Hence the need for the government to
step in, in a big way.

Of
course, this could be just a temporary change in thinking, with
desperation focusing the mind. But there are some signs that it may
persist. For example, the New York Times reported on Sunday that
Obama’s projected budget deficit for 2013 is "3% of the overall
economy, a level that economists consider sustainable".

Indeed
this is true, and the arithmetic is simple: If the debt grows at the
same rate or slower than the GDP (in nominal terms) it will not grow
as a percentage of the economy. That is what matters, not the
absolute size of the public debt — a big, scary number ($10.9
trillion) that is often thrown around by conservatives. As evident as
this is, the major media have almost never looked at the problem in
this way before.

Another
long-held belief that is currently being challenged in practice but
needs to be rethought is the extent to which the government can
finance a fiscal stimulus through money creation, rather than by
traditional borrowing. The conventional wisdom is that this would
dangerously increase inflation. But inflation is falling in most of
the world, and in the U.S., prices are actually dropping. The U.S.
consumer price index fell at an annual rate of 8.4% over the last
quarter. Even the core index (excluding food and energy) was up by
only 0.9% over the quarter, and the rate of inflation has been
declining.

The
U.S. government has already financed at least $1.2 trillion of
borrowing during this crisis by creating money, which was added to
the Fed’s balance sheet. This technically adds to the national debt,
but since the government owes the money to itself, there is no net
outflow of interest payments from the government on this debt. This
reduces the long-term debt burden of the necessary stimulus. Clearly
there are circumstances under which this "monetising" of
some additional borrowing makes sense because the threat of
increasing inflation is minimal. The present economic free-fall seems
to be such a circumstance.

This
has international implications as well. The Obama administration has
proposed scaling back at least some foreign aid. Of course, much of
our foreign aid is military aid that is often destructive. But it
would be a shame to cut back on such life-saving aid that goes to
fight Aids, tuberculosis, malaria and other diseases that plague the
poorest counties — when this funding needs more than ever to be
greatly expanded.

On
a larger scale, since the dollar has a special status as the world’s
reserve currency, the United States could conceivably contribute to
the world economic recovery by providing dollars to help developing
countries through the international credit crunch and world
recession. Our government has done a little bit of this: e.g., it
created an international currency swap arrangement of $30 billion
each for Brazil, Mexico, South Korea and Singapore, which added to
the hard currency reserves that these countries could tap if
necessary. But many countries are not adopting the expansionary
macroeconomic policies that they — and the world — need, for fear
of running short of foreign exchange.

In
other words, the United States — because of the special position of
the dollar — could to some extent play the role of a world central
bank in the present world recession. This would help stimulate our
own economic growth as well by increasing demand for U.S. exports. Of
course, if the dollar were to lose value internationally in the
process (because of the increased supply of dollars worldwide), this
would be an added gain for the U.S. economy.

That
is because the U.S. dollar is overvalued, and this overvaluation has
artificially stimulated our imports and reduced our exports for many
years. The idea that the United States needs a "strong dollar"
could be the next widely held economic misconception to bend to
reality.

Mark
Weisbrot is co-director of the Center for Economic and Policy
Research, in Washington, DC.

http://www.guardian.co.uk/commentisfree/cifamerica/2009/mar/03/us-economy-obama-currency