Forget the Downgrade, Panic About Everything Else
Partisanship has already cost us our AAA-rating. The politics of stalemate can still cost us so much more.
The best-case scenario for the S&P downgrade was the market laugh it off and lawmakers don't. In other words, the Dow would have a hum-drum Monday, and politicians would convene to implement a plan to increase growth immediately and reduce debt over time.
Naturally, we got the opposite.
In the Sunday morning talk shows, Republicans and Democrats used the new news to make an old point. Republicans to Democrats: The deficits are all your fault. Democrats to Republicans: You're all lunatics. Then this morning, the Dow quickly fell by more than 300 points and finished the day with a loss of 634 points.
But the fact that interest rates on U.S. debt also fell post-downgrade suggests the market isn't sweating our big debt. It's panicking about small growth. The recovery has all but stopped. Employment is still growing slower than population. GDP grew less than 1% in the first half of this year. All indicators are returning to stall speed. And rather than discuss ways to turn those numbers around, Washington spent the last month flirting with the idea of not paying our debt.
The last time we were falling in 2008, Congress and the Fed put out a mattress stuffed with trillions of dollars of bank guarantees and fiscal stimulus to soften the landing. If we fall this time, it's not clear who provides the cushion.
A WORLD OF HURTIf you had to capture in one sentence the global panic that's gripped Wall Street and global markets for the last week, you could do worse than this: Between the U.S., Europe, and China, there is too much debt and too little growth.
The Great Recession produced a two-speed recovery. China, India and other developing countries rebounded quickly. Meanwhile, the U.S. and Europe struggled to achieve escape velocity. These two speeds have yielded diverging problems. Higher prices are stinging China and India, where food accounts for up to 40% of a family's budget and the public is especially susceptible to inflation. A very different problem, too little economic activity, is burdening the U.S. and Europe. Slow growth corresponds with more debt, as unemployment rises, revenue falls, and governments spends more to support the jobless.
Economists hoped the two-speed recovery would result in faster overall growth. As the developing world accumulated wealth, they envisioned, their vibrant new middle class would support our stagnating old middle class by buying more products and plowing more money into Europe and the U.S. It was "trickle-up" theory on the worldwide stage.
Instead, we're seeing the opposite. Everybody seems to be slowing down, together. The West, which has lived beyond its means for years, now faces internal political pressure to cut back spending. Meanwhile the developing world, which grew on exports powered by undervalued currencies, is trying to ease the high cost of metals and food for their citizens without freezing their hot economies. The problem with these solutions is that less money, less borrowing, and less spending is a predictable recipe for less growth.
A TIME FOR GLUTTONS
If Western policymakers are looking for philosophical guidance, they should muzzle Grover Norquist and listen to St. Augustine. We need chastity, continence, and austerity ... but not yet. Less-than-one percent growth is a time for governments to govern like gluttons.
That's why the European Central Bank is fighting the contagious debt crisis by promising to buy Spanish and Italian bonds, which will push down their interest rates and allow the countries to borrow more cheaply until investors stop panicking and the ECB can unwind those assets. It's why you're seeing growing pressure in the U.S. to unleash another round of quantitative easing.
These solutions aren't silver bullets, merely good ideas. In the long run, our best friend is time. In 10 of the 15 countries studied by economist Vincent Reinhart, unemployment did not decline to pre-crisis levels even a decade after the recession ended. As consumers build up their balance sheets, and new industries emerge and grow rapidly, the country will almost certainly return to full employment and steady, healthy growth eventually.
And it is precisely that thing, growth, which will both help us reduce our debt and improve our fiscal health, by increasing revenues and reducing the middle class' reliance on government. If we don't get back to steady growth, then S&P's AA+ downgrade will be the least of our concerns. We'll be a Japan without a domestic savings culture, an old country with high interest rates and low dynamism. And you won't need a ratings agency to make the world see it.
Partisanship has already cost us our AAA-rating. But the politics of stalemate can still cost us much, much more.