There are only four things of significance about the Emergency Economic Stabilization Act of 2008 (EESA), in my opinion (although we do not yet have the final version):
- Drafted in haste, it will have many and serious unintended consequences.
- Its provisions are largely irrelevant to our economic problems, intended to treat the symptoms.
- The economic impact will be minor, or even less than minor.
- The next program (EESA-2009?), taken by the new Administration after another 4+ months of weakening, will be the first important response to this crisis.
The government’s responses so far to this crisis are like beads on a string; each larger than the one before it — but all broadly similar.
- Government approval for fraudulent accounting, to hide the extent of the problem (Section 128, suspending market pricing of assets).
- Happy talk — do you remember the Treasury’s Hope Now alliance, in October 2007?
- Cheap financing and bailouts for injured financial institutions.
The goal of this plan — assuming that there is in fact a plan behind this, and not just ad hoc grasping at straws — is probably to buy time for the economy’s natural mechanisms to work. Unfortunately this misunderstands the key aspects of our situation:
- The scale of the problem, the post-WWII debt supercycle, and
- Time is our enemy, as the global economy slows and the US economy slides into what looks like a severe recession.
- A sufficiently large solution requires an agreement with our foreign creditors.
The last is the key to understanding our government’s actions. They do not want to open such negotiations, hence can take only small actions buttressed by “Rube Goldberg” financial machinations. We cannot pay our current debts and need sums far larger than our currently massive borrowing. This requires an agreement with our creditors to do the following:
- extend the maturity of our current loans, rather than just rolling them over and over,
- provide large loans to fund both our current account deficit (running at 4-5% of GDP) and the needed restructuring costs (this and the next EESA, plus large fiscal deficit during the recession),
- provided at low interest rates (or eventual payment becomes impossible),
- with the first payments due in 3 – 5 years.
This will end our pretensions to be a global hegemon. Plus, our creditors will want concessions. For example, China will want a sphere of influence that includes Taiwan.
Precedents in US History
America has had four major financial events. The government successful responded twice, and failed twice.
(1) Alexander Hamilton convinced the Founders to honor the revolutionary war debts, and successful arranged the means to do so.
(2) FDR’s New Deal mitigated the effects of the Great Depression, but failed to end it. His solution was to end gold convertibility for US citizens, and greatly expand both government spending and regulation. After a bounce, the economy slid back down in 1938. The Depression was ended by WWII.
(3) Johnson’s “guns and butter” over-spending resulted in collapse of the Bretton Woods system. Nixon’s solution was to end gold convertibility for other nations, and increase government regulation and spending. Some examples: price controls, affirmative action (the Philadelphia Plan), the Environmental Protection Agency (EPA) and Occupational Safety and Health Administration (OSHA). He proposed, but the Democratic Congress refused to approve, national health care and a national minimum income (the Family Assistance Plan). These measures stabilized the economy for a few years, although at the cost of rising inflation — leading to the next crisis.
(4) Fed Chairman Volcker plus Presidents Carter and Reagan responded to the accelerating decline of the US economy by forced restructuring (high rates, the 1980-82 recession) plus far-reaching deregulation. This resulted in a quarter-century of economic growth with decreasing inflation.
The fifth crisis
This forms a break with previous US history, as we cannot solve it alone. Years of insane financial management have left us
- addicted to foreign borrowing, which we cannot suddenly stop without severe withdrawal pains, and
- over-indebted, unable to resolve our problems without foreign assistance.
Leaders with steady hands and clear minds can steer us out of this storm. Our job is to elect the right people and support their actions (including criticism where deserved). Prayer might also help.
For a brief analysis of this bill, see “The Bailout Compromise“, David Zaring, The Conglomerate, 28 September 2008
What should we do?
That is a complex question. For a simple answer see A solution to our financial crisis.
Originally published on September 29, 2008 at Fabius Maximus and reproduced here with the author’s permission.