Jayachandran/Mint

Jayachandran/Mint

Committees that ruined US finances

Committees that ruined US finances

Back in 1998, Time magazine published a cover story titled “The committee which saved the world" with the photographs of Alan Greenspan, then chairman of the US Federal Reserve; Robert Rubin, treasury secretary; and Lawrence Summers, deputy treasury secretary. Time magazine’s description came from the role they were supposed to have played in the International Monetary Fund (IMF)-led external assistance to the crisis-hit countries in East Asia.

In a way, it was an apt description: IMF has been a handmaiden of the US treasury; in a broader sense, the cover title also manifested American arrogance in its power, both economic and military, particularly after the collapse of the Soviet Union.

Jayachandran/Mint

In retrospect, the ideological, deregulatory stance of the committee which was supposed to have saved the world, and the monetary easing following the stock market bubble of the late 20th century (and 9/11), led to the 2008 financial crisis, and put trillions of dollars of burden on the country’s fiscal resources, directly or indirectly—the funding needed for rescuing the system, the fiscal stimulus, lost growth and taxes, and the additional unemployment benefits. The neocon agenda directly led to the invasion of Iraq on false pretexts, adding another few trillions to US deficits and debts.

In many ways, it is perverse that the Republican Right is posing as the protector of fiscal virtue. It was under president Ronald Reagan that the US started incurring then record-high deficits, thanks to the foolish belief in the so-called Laffer Curve (does anybody remember it now?), which convinced Reagan that the lower the taxes for the rich, higher the growth and revenue, and a lower fiscal deficit. The administration of president Bill Clinton brought the budget back into surplus by the turn of the century. The tax cuts for the rich and foolish military adventures of the following Republican administration of president George Bush in the Middle East, led once again to growing, Reagan–like deficits. As Paul Kennedy analysed in The Rise and Fall of the Great Powers (in 1987, well before the wars in the Middle East) “the awkward and enduring fact that the sum total of the United States’ global interest and obligations is nowadays far larger than the country’s power to defend all simultaneously". Clearly, the Republicans bear the maximum responsibility for the current state of US finances and the downgrade of its rating.

The lack of political consensus on how to bring the debt down to a sustainable level, also represents a dysfunctional government with the ultra right elements in the Republican party having a veto power. The so-called Tea Party wing of the Republicans professes religious and constitutional “fundamentalism", rejects Darwin and evolution, and manifests a nostalgia, a yearning for laissez faire capitalism of the 18th and 19th century variety. (They forget history: it was the excesses of capitalism that led to the birth of Marxism in the mid-19th century.) The basic problem is that the Republican Right would allow the deficit cut only through reducing social services, while the President and Democrats would prefer a more balanced approach between increasing taxes for the rich, and reducing expenditure. But cutting expenditure would hurt the already anaemic growth. Unemployment remains stubbornly high (near double digits) and 45 million people have to depend on the Nutrition Assistance Program for their food—double the number in 2000. In the current state, growth and employment would need a Keynesian fiscal stimulus; not expenditure cuts, as Nobel laureates Joseph Stiglitz and Paul Krugman have been urging. In the current political climate, this seems extremely unlikely. Meantime, the rating cut does not seem to have affected the status of US treasury bonds as a safe-haven investment. As other asset classes have become more volatile and risky, bond prices have risen (and yields fallen further), partly also as a result of expectations of low short-term interest rate for a year. Even another round of quantitative easing in one form or another should not be ruled out. But in the current environment, this may well be as effective as pushing on a string. Coming back to Keynes, fiscal stimulus in times of slow growth requires resources to be conserved when times are good and growth is fast: neither of the two largest economies have done this. (Capital regulations expect banks to do exactly this.)

A.V. Rajwade is a risk management consultant, columnist and author

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