Countdown to a Meltdown

America's coming economic crisis. A look back from the election of 2016

January 20, 2016, Master Strategy Memo
Subject: The Coming Year—and Beyond


It is time to think carefully about the next year. Our position is uniquely promising—and uniquely difficult.

The promise lies in the fact that you are going to win the election. Nothing is guaranteed in politics, but based on everything we know, and barring an act of God or a disastrous error on our side, one year from today you will be sworn in as the forty-sixth president of the United States. And you will be the first president since before the Civil War to come from neither the Republican nor the Democratic Party.1 This is one aspect of your electoral advantage right now: having created our new party, you are already assured of its nomination, whereas the candidates from the two legacy parties are still carving themselves up in their primaries.2

The difficulty, too, lies in the fact that you are going to win. The same circumstances that are bringing an end to 164 years of two-party rule have brought tremendous hardship to the country. This will be the first time since Franklin Roosevelt took office in 1933 that so much is demanded so quickly from a new administration. Our challenge is not just to win the election but to win in a way that gives us a chance to address economic failures that have been fifty years in the making.

That is the purpose of this memo: to provide the economic background for the larger themes in our campaign. Although economic changes will be items one through ten on your urgent "to do" list a year from now, this is not the place to talk about them in detail. There will be plenty of time for that later, with the policy guys. Instead I want to speak here not just as your campaign manager but on the basis of our friendship and shared efforts these past twenty years. Being completely honest about the country's problems might not be necessary during the campaign—sounding pessimistic in speeches would hurt us. But we ourselves need to be clear about the challenge we face. Unless we understand how we got here, we won't be able to find the way out once you are in office.

Politics is about stories—the personal story of how a leader was shaped, the national story of how America's long saga has led to today's dramas. Your personal story needs no work at all. Dwight Eisenhower was the last president to enter office with a worldwide image of competence, though obviously his achievements were military rather than technological. But we have work to do on the national story.

When it comes to the old parties, the story boils down to this: the Democrats can't win, and the Republicans can't govern. Okay, that's an overstatement; but the more nuanced version is nearly as discouraging.

The past fifty years have shown that the Democrats can't win the presidency except when everything goes their way. Only three Democrats have reached the White House since Lyndon Johnson decided to leave. In 1976 they ran a pious-sounding candidate against the political ghost of the disgraced Richard Nixon—and against his corporeal successor, Gerald Ford, the only unelected incumbent in American history. In 1992 they ran their most talented campaigner since FDR, and even Bill Clinton would have lost if Ross Perot had not stayed in the race and siphoned away votes from the Republicans. And in 2008 they were unexpectedly saved by the death of Fidel Castro. This drained some of the pro-Republican passion of South Florida's Cuban immigrants, and the disastrous governmental bungling of the "Cuba Libre" influx that followed gave the Democrats their first win in Florida since 1996—along with the election. But that Democratic administration could turn out to have been America's last. The Electoral College map drawn up after the 2010 census removed votes from all the familiar blue states except California, giving the Republicans a bigger head start from the Sunbelt states and the South.

As for the Republicans, fifty years have shown they can't govern without breaking the bank. Starting with Richard Nixon, every Republican president has left the dollar lower, the federal budget deficit higher, the American trade position weaker, and the U.S. manufacturing work force smaller than when he took office.

The story of the parties, then, is that the American people mistrust the Republicans' economic record, and don't trust the Democrats enough to let them try to do better. That is why—and it is the only reason why—they are giving us a chance. But we can move from electoral to governmental success only with a clear understanding of why so much has gone so wrong with the economy. Our internal polls show that nearly 90 percent of the public thinks the economy is "on the wrong track." Those readings should hold up, since that's roughly the percentage of Americans whose income has fallen in real terms in the past five years.

The story we will tell them begins fifteen years ago,3 and it has three chapters. For public use we'll refer to them by the names of the respective administrations. But for our own purposes it will be clearer to think of the chapter titles as "Cocking the Gun," "Pulling the Trigger," and "Bleeding."

1. Cocking the Gun

Everything changed in 2001. But it didn't all change on September 11.

Yes, the ramifications of 9/11 will be with us for decades, much as the aftereffects of Pearl Harbor explain the presence of thousands of U.S. troops in Asia seventy-five years later. Before 2001 about 12,000 American troops were stationed in the Middle East—most of them in Kuwait and Saudi Arabia. Since 2003 we have never had fewer than 100,000 troops in CENTCOM's theater, most of them on active anti-insurgency duty. The locale of the most intense fighting keeps changing—first Afghanistan and Iraq, then Pakistan and Egypt, now Saudi Arabia and the frontier between Turkey and the Republic of Kurdistan—but the commitment goes on.

Before there was 9/11, however, there was June 7, 2001. For our purposes modern economic history began that day.

On June 7 President George W. Bush celebrated his first big legislative victory. Only two weeks earlier his new administration had suffered a terrible political blow, when a Republican senator left the party and gave Democrats a one-vote majority in the Senate. But the administration was nevertheless able to persuade a dozen Democratic senators to vote its way and authorize a tax cut that would decrease federal tax revenues by some $1.35 trillion between then and 2010.

This was presented at the time as a way to avoid the "problem" of paying down the federal debt too fast. According to the administration's forecasts, the government was on the way to running up $5.6 trillion in surpluses over the coming decade. The entire federal debt accumulated between the nation's founding and 2001 totaled only about $3.2 trillion—and for technical reasons at most $2 trillion of that total could be paid off within the next decade.4 Therefore some $3.6 trillion in "unusable" surplus—or about $12,000 for every American—was likely to pile up in the Treasury. The administration proposed to give slightly less than half of that back through tax cuts, saving the rest for Social Security and other obligations.

Congress agreed, and it was this achievement that the president celebrated at the White House signing ceremony on June 7. "We recognize loud and clear the surplus is not the government's money," Bush said at the time. "The surplus is the people's money, and we ought to trust them with their own money."

If the president or anyone else at that ceremony had had perfect foresight, he would have seen that no surpluses of any sort would materialize, either for the government to hoard or for taxpayers to get back. (A year later the budget would show a deficit of $158 billion; a year after that $378 billion.) By the end of Bush's second term the federal debt, rather than having nearly disappeared, as he expected, had tripled. If those in the crowd had had that kind of foresight, they would have called their brokers the next day to unload all their stock holdings. A few hours after Bush signed the tax-cut bill, the Dow Jones industrial average closed at 11,090, a level it has never reached again.5

In a way it doesn't matter what the national government intended, or why all forecasts proved so wrong. Through the rest of his presidency Bush contended that the reason was 9/11—that it had changed the budget as it changed everything else. It forced the government to spend more, for war and for homeland security, even as the economic dislocation it caused meant the government could collect less. Most people outside the administration considered this explanation misleading, or at least incomplete. For instance, as Bush began his second term the nonpartisan Congressional Budget Office said that the biggest reason for growing deficits was the tax cuts.6

But here is what really mattered about that June day in 2001: from that point on the U.S. government had less money to work with than it had under the previous eight presidents. Through four decades and through administrations as diverse as Lyndon Johnson's and Ronald Reagan's, federal tax revenue had stayed within a fairly narrow band. The tax cuts of 2001 pushed it out of that safety zone, reducing it to its lowest level as a share of the economy in the modern era.7 And as we will see, these cuts—the first of three rounds8—did so just when the country's commitments and obligations had begun to grow.

As late as 2008 the trend could have been altered, though the cuts of 2003 and 2005 had made things worse. But in the late summer of 2008 Senate Republicans once again demonstrated their mastery of the basic feints and dodges of politics. The tax cuts enacted during Bush's first term were in theory "temporary," and set to expire starting in 2010. But Congress didn't have to wait until 2010 to decide whether to make them permanent, so of course the Republican majority scheduled the vote at the most awkward moment possible for the Democrats: on the eve of a close presidential election. The Democratic senators understood their dilemma. Either they voted for the tax cuts and looked like hypocrites for all their past complaints, or they voted against them and invited an onslaught of "tax and spend" attack ads in the campaign. Enough Democrats made the "smart" choice. They held their seats in the election, and the party took back the presidency. But they also locked in the tax cuts, which was step one in cocking the gun.9

The explanation of steps two and three is much quicker: People kept living longer, and they kept saving less. Increased longevity is a tremendous human achievement but a fiscal challenge—as in any household where people outlive their savings. Late in 2003 Congress dramatically escalated the fiscal problem by adding prescription-drug coverage to Medicare, with barely any discussion of its long-term cost. David M. Walker, the government's comptroller general at the time, said that the action was part of "the most reckless fiscal year in the history of the Republic," because that vote and a few other changes added roughly $13 trillion to the government's long-term commitments.

From the archives:

"Spendthrift Nation" (January 2003)
It's a precarious situation: U.S. consumer spending is sustaining the economy—but we need to save more to prepare for the surge in retirements. Here's how to boost personal saving without undermining the economic recovery. By Michael Calabrese and Maya MacGuineas

The evaporation of personal savings was marveled at by all economists but explained by few. Americans saved about eight percent of their disposable income through the 1950s and 1960s, slightly more in the 1970s and 1980s, slightly less and then a lot less in the 1990s. At the beginning of this century they were saving, on average, just about nothing.10

The possible reasons for this failure to save—credit-card debt? a false sense of wealth thanks to the real-estate bubble?11 stagnant real earnings for much of the population?—mattered less than the results. The country needed money to run its government, and Americans themselves weren't about to provide it. This is where the final, secret element of the gun-cocking process came into play: the unspoken deal with China.

The terms of the deal are obvious in retrospect. Even at the time, economists discussed the arrangement endlessly in their journals. The oddity was that so few politicians picked up on what they said. The heart of the matter, as we now know, was this simple equation: each time Congress raised benefits, reduced taxes, or encouraged more borrowing by consumers, it shifted part of the U.S. manufacturing base to China.

Of course this shift had something to do with"unfair" trade, undereducated American workers, dirt-cheap Chinese sweatshops, and all the other things that American politicians chose to yammer about. But the "jobless recovery" of the early 2000s and the "jobless collapse" at the end of the decade could never have occurred without the strange intersection of American and Chinese (plus Japanese and Korean) plans. The Chinese government was determined to keep the value of its yuan as low as possible, thus making Chinese exports as attractive as possible, so that Chinese factories could expand as quickly as possible, to provide work for the tens of millions of people trooping every year to Shanghai or Guangzhou to enter the labor force. To this end, Chinese banks sent their extra dollars right back to the U.S. Treasury, in loans to cover the U.S. budget deficit; if they hadn't, normal market pressures would have driven up the yuan's value.12 This, in turn, would have made it harder for China to keep creating jobs and easier for America to retain them. But Americans would have had to tax themselves to cover the deficit.

From the archives:

"America's 'Suez Moment'" (January 2003)
The growing trade deficit threatens U.S. living standards and makes the country dangerously vulnerable to economic extortion. The way out is to make foreigners act more like us. By Sherle R. Schwenninger

This arrangement was called "Bretton Woods Two," after the regime that kept the world economy afloat for twenty-five years after World War II. The question economists debated was how long it could last. One group said it could go on indefinitely, because it gave each country's government what it really wanted (for China, booming exports and therefore a less dissatisfied population; for America, the ability to spend more while saving and taxing less). But by Bush's second term the warning signals were getting louder. "This is starting to resemble a pyramid scheme," the Financial Times warned early in 2005.13 The danger was that the system was fundamentally unstable. Almost overnight it could go from working well to collapsing. If any one of the Asian countries piling up dollars (and most were doing so) began to suspect that any other was about to unload them, all the countries would have an incentive to sell dollars as fast as possible, before they got stuck with worthless currency. Economists in the "soft landing" camp said that adjustments would be gradual, and that Chinese self-interest would prevent a panic. The "hard landing" camp—well, we know all too well what they were concerned about.

Presented by

James Fallows, a national correspondent for The Atlantic, has written three cover stories on U.S. foreign policy and Iraq: "Bush's Lost Year" (October 2004), "Blind Into Baghdad" (January/February 2004), and "The Fifty-first State?" (November 2002). More

James Fallows is based in Washington as a national correspondent for The Atlantic. He has worked for the magazine for nearly 30 years and in that time has also lived in Seattle, Berkeley, Austin, Tokyo, Kuala Lumpur, Shanghai, and Beijing. He was raised in Redlands, California, received his undergraduate degree in American history and literature from Harvard, and received a graduate degree in economics from Oxford as a Rhodes scholar. In addition to working for The Atlantic, he has spent two years as chief White House speechwriter for Jimmy Carter, two years as the editor of US News & World Report, and six months as a program designer at Microsoft. He is an instrument-rated private pilot. He is also now the chair in U.S. media at the U.S. Studies Centre at the University of Sydney, in Australia.

Fallows has been a finalist for the National Magazine Award five times and has won once; he has also won the American Book Award for nonfiction and a N.Y. Emmy award for the documentary series Doing Business in China. He was the founding chairman of the New America Foundation. His recent books Blind Into Baghdad (2006) and Postcards From Tomorrow Square (2009) are based on his writings for The Atlantic. His latest book is China Airborne. He is married to Deborah Fallows, author of the recent book Dreaming in Chinese. They have two married sons.

Fallows welcomes and frequently quotes from reader mail sent via the "Email" button below. Unless you specify otherwise, we consider any incoming mail available for possible quotation -- but not with the sender's real name unless you explicitly state that it may be used. If you are wondering why Fallows does not use a "Comments" field below his posts, please see previous explanations here and here.


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