Anti-capitalism chokes the engine of growth
To turbocharge the economy, we need more than government and consumer spending. We need to encourage business to invest.
NEW YORK (Fortune) -- Only a fool would bet against the American people's ingenuity and persistence in figuring a way out of our economic mess. But the last year has been humbling all the same. Some of our most common assumptions, including the certainty of monetary and fiscal stimulus, are being challenged.
For example, for decades economists including Milton Friedman have argued that if policymakers in the 1930s had not run such a restrictive monetary policy, things might have turned out differently. Likewise, Keynesians add that if Congress hadn't tried to balance the budget in 1936, the Great Depression might have ended a lot sooner.
Today, no one can accuse policymakers of committing such blunders. The U.S. is running the Niagara Falls of fiscal and monetary policies, yet the results to date have been discouraging.
Begin with prices, which have been dropping fast. From August 2008 to June 2009, the Consumer Price Index dropped from 5.3% to negative 1%. During the comparable period in 1929-30, the CPI dropped from zero to only a negative 1.8%.
From July 2008 to June 2009, unemployment jumped from 5.8% to 9.5%. During the comparable period from 1929-30, the rate jumped from 2.3% to only 5% (and later grew much higher).
In other words, prices are dropping and unemployment is rising at a rate worse than during the beginning years of the Great Depression. This is happening despite extraordinarily aggressive fiscal and monetary stimulus, which is sure to have serious unintended consequences, including budget deficits and debt almost beyond belief.
The world is fixated on U.S. long-term interest rates, which have increased dramatically since the beginning of the year. Why did rates rise despite rising joblessness and a weakening economy? The Chinese argue that global financial markets fear that the Federal Reserve will eventually monetize the Obama Administration's quadrupled budget deficits, producing higher inflation.
But nothing about budget deficits is simple. The truth is the deficit in recent decades has actually been an unreliable economic predictor. For example, interest rates (the 10-year Treasury bond yield) never dropped below 5.25% the entire eight years of the Clinton Administration, which produced budgetary surpluses. Yet at one point during the deficit-ridden George W. Bush administration, long-term interest rates declined to nearly 3% -- and at a time when the economy was prosperous.
Running a permanent policy of large budget deficits is a risky way to operate an economy. But remember Warren Buffett's warning several years ago about America's budget deficits? He bet big on a dollar free-fall, arguing that foreign investors would flee the U.S. in droves. Buffett for a time lost a reported $1 billion dollars on the bet (before the dollar switched direction again, which is the volatile nature of a reserve currency).
Why has the deficit been such an inefficient barometer? The experts underestimated America's ability to import capital and to innovate. Foreigners were indeed concerned about America's deficits. Turned out they cared even more about the attractiveness of U.S. asset markets relative to those elsewhere.
America traditionally has been a magnet for global investment and savings. Several years ago, a World Economic Forum survey concluded that despite debt, deficits, and a low savings rate, the U.S. still ranked first in global competitiveness and as a target for the world's capital. The reasons: labor market flexibility, higher education, a benign political environment largely free of class warfare, innovative strategies, quality of corporate management, and predictable legal and patent systems. China ranked 34th.
Yet here's the essential point: Just because we dodged the deficit bullet in the past is no guarantee for the future. That's not only because of the astounding size of today's projected fiscal imbalances and the likelihood of rising global competition for credit, with soaring interest rates, once the world economy begins to recover. There are also real concerns about America's future as a destination for global capital. Washington's heavy-handed decision during the auto bailout negotiations to trample the contractual rights of bondholders can't be globally reassuring. Today's new tax and regulatory climate -- anti-business and anti-foreigner -- doesn't help either.
There is also the question of whether America, even with a plan of long-term fiscal discipline, can grow out from under its massive deficit. We did after World War II, but that was after four years of pent-up demand followed by an unprecedented optimism. By contrast, consumers today are in a gloomy period of long-term deleveraging. American households have been bludgeoned collectively to the tune of $12 trillion. Future U.S. potential growth rates are likely to be modest.
With the consumer sidelined, that leaves business investment as the only engine to provide robust growth for deficit reduction while making America an attractive global investment and savings target.
President Obama is enamored of government investment in new green technologies, but his problem is timing. It could take years for these efforts to come on stream, including the sorting out of likely winners from losers. Meanwhile, our economy, green shoots and all, could go over a cliff.
As Bill Clinton discovered in the 1990s, private investment can turbocharge an economy, quickly and powerfully. That's why Barack Obama needs to strategically pivot. For starters, he must rein in Washington's new anti-capitalist populism. Then he needs to engage in a new love affair with private sector investment, innovation, and entrepreneurial risk. If he pivots now, he can move us out of this quagmire.