Will It Get the Economy Going?

San José, CA – On Jan. 7, the Congressional Budget Office (CBO) estimated that the federal budget deficit for this fiscal year (October 2008 to September 2009) would be $1.2 trillion. But the CBO estimate only counted the $68 billion approved for the wars in Iraq and Afghanistan, when they actually cost more than $186 billion in 2008. Given that the wars will cost at least another $100 billion, the federal budget deficit will be $1.3 trillion, or even more if the economy worsens more than expected. This estimated deficit is almost 10% of the Gross Domestic Product (GDP), which measures the value of all the goods and services* produced in the United States in a year, and would be the biggest deficit since World War II.

In addition, the Obama administration’s economic stimulus package will cost $800 billion or more over the next two years. Assuming at least $300 billion will be spent this fiscal year, the total federal budget deficit will be about $1.6 trillion, or about 12% of GDP. Obama’s economic advisors released a report on Jan. 10 estimating that their economic stimulus plan could create more than 3.5 million jobs.

Republicans and conservative Democrats are starting to complain about the size of the deficit. However this is pure hypocrisy, as they helped to double the federal government debt, borrowing some $5 trillion under the Bush presidency. When the deficits went to tax cuts for the wealthy, the invasion and occupation of Afghanistan and Iraq, or lending to banks it was not an issue. But now that there is talk about spending money on the unemployed, helping homeowners and creating jobs, the deficit is all of sudden a ‘big concern.’

This is the real question facing the United States: Will all this government spending work? Mainstream economists from the conservative Martin Feldstein, who served the Reagan administration, to liberal Paul Krugman, who has been a fierce critic of the Bush administration, have backed a huge increase in federal government deficit spending to try to stem the recession. These economists are taking up the ideas of John Maynard Keynes. Keynes argued during the Great Depression of the 1930s that there could be a “liquidity trap” where banks refuse to lend. This would make the monetary policy of trying to lower interest rates ineffective. Keynes said that the government must borrow and spend to get the economy going again. The economy today is caught in a vise between a deepening recession and a growing financial crisis, just as in the 1930s. With the free market economics of the last 30 years buried under the collapse of big banks, many are calling for a Keynesian economic policy.

Following the economic crisis of the 1970s the United States turned to what was known as ‘Reaganomics’ – with tax cuts for the rich (and tax increases for the working class in the form of higher social security taxes), deregulation of industry (laying the basis for first the savings and loan crisis of the late 1980s and then today’s financial crisis), anti-union policies and the offshoring of jobs to other countries. This restored corporate profits and economic growth, as the rich grew richer and the poor grew poorer, while the working class and even many professionals went deeper and deeper into debt to make up for the lack of wage increases. Businesses and the government also went on a borrowing binge, driving total debt from 1.4 the size of GDP in 1977 to 2.25 times the size of GDP in 2007. This big increase in debt was led by the financial sector, whose debt has increased five times faster than the growth of the economy during this time.

This borrowing binge allowed workers to buy more when their wages saw little or no growth (adjusted for inflation). It also provided a profitable outlet for the extra profits that the capitalists were making. However it did not prevent a growing overcapacity, where industry can produce more cars, homes and other goods and services than can be sold. The financial crisis that exploded last year has led to ‘deleveraging’ of many households, who are cutting back on borrowing and starting to pay down their debts. Businesses are also borrowing less, while financial debt is declining sharply due to defaults on loans and banks refusing to lend. This has led to the worst crisis of overproduction since the Great Depression.

Only the federal government has stepped up borrowing, lending and spending to try to prevent the economy from going into free fall. The problem is that a capitalist economy cannot keep going forever based only on more federal government borrowing and spending. When the Japanese stock and real estate markets crashed in the 1990s, the result was years of economic stagnation. The Japanese government has run huge deficits (relative to the size of their economy) for many years since then. The problem in Japan was not the large size of the deficits, nor the resulting increase in government debt, but rather that the huge increase in government spending was not able to get the economy moving again. Even coupled with interest rates that have been less than one percent since 1995, the Japanese economy never was able to get back to steady economic growth. The only sector that had done well was exports, which are now falling due to the worldwide recession.

The United States is now following the same policy as in Japan. But if government deficit spending didn’t work in Japan, why should it work in the United States today? This is particularly true for the U.S. government, which has had to borrow 75-100% of past deficits from investors, insurance companies, pension funds and banks in other countries. In contrast, Japan has a higher savings rate, which makes their government able to borrow at home. At some point the rest of the world could cut back on purchases of U.S. government bonds, leading to higher interest rates and more economic pain in the United States. The only other option would be for the U.S. Federal Reserve to print more money to buy U.S. government bonds, putting the value of the U.S. dollar at risk and possibly leading to much higher inflation.

Many are comparing Obama’s economic stimulus with the Depression-era New Deal. The New Deal started many government programs that helped working people, such as Social Security, unemployment insurance and welfare. However it was not able to reduce unemployment back to pre-Depression levels. More government spending – for the unemployed, homeowners facing foreclosure and jobless workers – will help people, but won’t cure the economy. The economy faces a bleak future of continued high unemployment and/or the threat of higher inflation. Even the Obama economic team admits that with the economic stimulus, unemployment will remain above 7% for two more years! What is needed is an economy not based on private profit – a socialist system that would serve the interest of working people.

*GDP only counts final goods and services, for example the value of a book printed in the United States, and not the value of the paper that went into the book, or the trees that went into the paper, in order to avoid double and triple counting.

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