Politics & Policy

Warranted Pessimism

From across the political spectrum, we hear talk of an economic recovery. It is likely more hope than change.

Some smart conservatives are starting to caution their brethren about the dangers of being too pessimistic in the face of what might be a burgeoning recovery. If we overzealously predict that Obama’s economic policies will lead us to disaster, they warn, we risk a repeat of what happened in the early 1990s, when dire predictions about Clinton’s economic policies did not come to pass.

Such doomsaying proved laughably wrong because the economic harm from Clinton’s tax increases was more than offset by the Internet-led economic boom, the GOP’s ability to keep spending in check, and Clinton’s better instincts on issues such as free trade. But regardless of what caused the boom, the GOP’s predictions were discredited. Conservatives naturally don’t want to risk the same outcome this time, and I share that concern. But the recession we might (or might not) be exiting today is far different from the one we were exiting in the early Nineties. Furthermore, we have good reasons to doubt that this recovery will be as robust or long-lived as the previous one. Generations of policymakers from both parties share the blame for the structural mess we find ourselves in today. But it is also true that the Obama administration has done little to address the problems sapping the country’s economic strength; its policies have actually made those problems worse.

Conservatives must continue to criticize the administration’s policies in a smart way. The Dow, the GDP, and the unemployment rate will probably continue to trend upward as we near Election Day. This will make the GOP’s task incredibly difficult, as it risks appearing to root for a double-dip recession. It is nevertheless extremely important to point out how unsound structurally is the house that Obama built; if the Republican party’s leaders lack a good understanding of why this recovery is likely to be weak and short-lived, then — when this rickety structure falls — they will end up looking like John McCain when Lehman fell: lacking a coherent response and losing to a populist Democrat who promises, seductively, to rebuild the American McMansion.

Across the political spectrum, talk of a recovery is underway. On the conservative side, our own Larry Kudlow has written that “while everyone keeps saying that small businesses are getting killed from taxes and regulations out of Washington, the reality is that the Labor Department’s household survey has produced 1.1 million new jobs in the first quarter of 2010, or 371,000 per month.” He cautioned that conservatives “should not lose their cool and blow their credibility over a cyclical rebound that is backed by the statistics.”

On the liberal side, Newsweek’s Daniel Gross has penned a recent cover story titled The Comeback Country” in which he asserted, “The tale of the economy’s remarkable turnaround is largely the story of swift reaction, a willingness to write off bad debts and restructure, and an embrace of efficiency — disciplines largely invented in the U.S. and at which it still excels.”

I think Larry’s instincts are right. I am sure he differs from Gross on the reasons for the recovery, and furthermore he is very concerned about the long-term effects of Obama’s policies, whereas Gross is not. But both articles raise a number of questions: The economy is adding jobs, but are small businesses hiring? Is this really a “cyclical rebound” or something else? The government’s reaction was swift, but was it considered? (To ask is to answer.) And writing off bad debts and embracing efficiency — have those things really happened?

If GOP leaders want to be prepared for the coming months with answers to these questions (to avoid McCain’s fate), then they need to acquaint themselves with the following three terms — quickly:

Balance-Sheet Recession: The recession we’ve just passed through was no ordinary recession; it was not, in other words, an economic contraction caused by a fluctuation in the business cycle. This recession was caused when a debt crisis affecting the finance and housing sectors spilled over into the rest of the economy. Credit vanished after banks suffered major write-downs on their mortgage portfolios, lost a ton of equity in the stock-market crash, and suddenly found themselves with too much debt relative to their dwindling capital. They decided to build up reserves and pay down debt instead of making more loans. Many are still engaged in this process.

Policymakers, including Presidents Bush and Obama, have done everything they can to make this process as easy as possible for the banks (with the exception of the occasional dumb flare-up over bonus pay). Bush established the Troubled Asset Relief Program (TARP), Fed chairman Ben Bernanke cut interest rates to zero and pushed quantitative easing to its limits, and Obama threw his weight behind a gargantuan fiscal-stimulus package. TARP calmed the markets, cheap money allowed banks to borrow for free, and the banks made money off loans to the government, financing Obama’s borrowing bonanza.

It was (and is) a nice strategy for preventing messy bank failures. But it’s a terrible strategy for producing long-term economic growth. Banks are hoarding capital to guard against further write-downs on bad loans, few of which, pace Gross, have actually been restructured. (Another term with which conservatives might familiarize themselves — “extend and pretend” — refers to the government-assisted practice among banks of modifying hopelessly delinquent loans and pretending they will one day pay off.)

Malinvestment: With all this capital tied up in unproductive enterprises, it’s hard for small businesses to grow. The National Federation of Independent Business just released a survey finding small-business optimism at historic lows, and the reason is clear: “After a devastating period of employment reductions, employment change per firm hit the ‘zero line’ in March,” yet only 9 percent of these small-business owners reported unfilled job openings — another historic low.

The current recovery is indeed cyclical — most GDP growth in the last two quarters is the result of businesses’ restocking inventory after taking a long break from doing so during the slump. But it is also true that some businesses, such as JPMorgan Chase, are posting eye-popping profits for this quarter. Much of that, however, is due to the government strategy outlined above. Despite promises to expand small-business lending, CEO Jamie Dimon recently indicated that the bank still plans to hoard a lot of capital as it works off delinquent mortgages — a bad sign for those who hoped this recovery might be ready to walk on its own two feet.

JPMorgan Chase and other financial companies have also been saved by a rising stock market, but this very increase in stock prices is another worrisome sign of malinvestment. Near-zero interest rates have pushed investors into riskier asset classes as they search for acceptable yields. This does not mean that stocks are the best investment right now — by some measures they are way overpriced. It just means that seniors and others dependent on investment income have been pushed out of savings accounts and into the stock market.

Other forms of malinvestment are clearer to conservatives. Gross’s article was full of happy tales about solar-energy companies that are investing in the energy technology of tomorrow, thanks to the stimulus package. But, as Reihan Salam astutely asks, are these companies “more representative of the economy that is emerging or the massive transfers to declining industries, the pressure on GSEs to originate mortgages of dubious value, modification efforts that amount to huge subsidies for the financial sector, and much else besides?”

Debt revulsion: In a must-read piece titled “The Origins of the Next Crisis,” financial analyst and writer Edward Harrison explains the consequences of basing a recovery on endless rounds of monetary and fiscal stimulus. We are pursuing “low-quality growth,” he writes, characterized as growth that is underpinned by debt and consumption rather than savings and capital investment. Now that businesses and especially households are maxed out, we find ourselves in a balance-sheet recession. The government has decided to deal with this by transferring the burden to the taxpayer.

Unfortunately for the naysayers, low-quality growth can continue for a long time. Harrison writes:

A soothsayer who counsels against this type of economic policy, but who warns of impending collapse will surely be seen as the boy who cries wolf. Think back to 2001 or 2002. Did we not witness then the same spectacle whereby the bears and doomsdayers were let out of their holes to warn of impending doom from reckless economic policy? By 2004, unless these individuals changed their tune, they were long forgotten or even laughed at — only to resurface in 2007 and 2008 with their new tales of woe. . . .


The fact is: Low-quality growth does not lead to immediate economic calamity. It can continue through many business cycles. Even today, it is wholly conceivable that we could experience a multi-year economic expansion on the back of renewed monetary and fiscal expansion.

Eventually, however, even the U.S. will discover that there is a limit to how much it can borrow and print — a point at which debt revulsion (creditors’ unwillingness to lend to us at cheap rates) will make future borrowing cost-prohibitive. The conservative case against Obamanomics must start and end by emphasizing that we are closer to reaching this point than most people realize. In the meantime, any economic recovery we experience will be weaker than it would have been had Obama taken a different approach — one that required more short-term pain but offered a more stable long-term outlook.

As Harrison notes, those attempting to make this case must walk a narrow line. If GOP leaders look as if they are talking down the recovery to score political points, they risk losing appeal. And if they make bold predictions — about employment, say — that don’t come true, they risk losing credibility. One way around this might be to assign blame to both parties. The GOP of the last decade did not acquit itself well on spending and homeownership policies, and admitting as much could help the GOP of today put some distance between themselves and their unpopular predecessors. GOP leaders should at the same time note that Democrats’ solutions aren’t working.

Conservatives should also draw attention to metrics that aren’t improving and aren’t likely to, such as the private-debt overhang and the massive public debt. Simply saying that the employment picture could be better is a risky strategy as long as the economy is adding jobs. Better to talk about the plight of small businesses, which are still starved for capital and face an array of new taxes. And above all to focus on the debt, which no longer threatens our grandchildren’s future, but probably our children’s future — and possibly our own.

– Stephen Spruiell is an NRO staff reporter.


The Latest