Five Economic Lies

[For comment on breaking up corporate conglomerates, click here.]
1. The Obama Budget will move us toward “socialism” and away from private business
2. Big government deficits will destroy our economy
3. Relying on “big government” will destroy private markets
4. Government intervention will make us more like Europe
5. Government intervention in private markets breeds socialism
Conclusion
P.S. Breaking Up is Easy to Do

The Wall Street Journal, which loves Republicans and should know, says the Republican party’s popularity is “near an all-time low.” I wonder why. Could it be that the party’s simplistic ideology has destroyed our economy?

Republicans can explain every catastrophe wrought by true belief with a little sophistry, illogic and historical amnesia. Here are the top five lies and their refutation:

1. The Obama Budget will move us toward “socialism” and away from private business. False. America is a capitalist country, founded and reliant on free markets and private business. It was from the start, and it always will be.

But we have a long tradition of government helping private business by creating the conditions it needs to thrive. Those conditions include a modern, well-maintained infrastructure, sensible regulation and management of markets, and a robust system of universal public education.

Our government has always built or helped finance infrastructure for business and commerce. Its works include the Erie Canal, the locks and levees on the Mississippi, the transcontinental railways, the interstate highways, our air traffic control system, and the Internet, which started [Item 13] as a defense project funded and run by government.

The President just wants to continue that tradition. He wants to give us a modern transportation system not dependent on Mideast oil. He wants to make sure all of our kids are educated and can graduate from college without crushing debt. He wants us to have a modern clean-energy infrastructure and a health care system whose exploding costs don’t drive industry offshore, as they did consumer electronics and are doing with cars. He wants to manage and regulate markets so cataclysms like the subprime meltdown don’t happen again.

That’s not killing private business. It’s creating the conditions private business needs to thrive.

2. Big government deficits will destroy our economy. Wrong again. There are times when failing to invest heavily in corrective action or governmental necessity will destroy our economy. The Great Depression and the Second World War were among those times. Now is another.

Deficits that seem huge at the time become manageable as our economy recovers from adversity and grows. Eventually even scary deficits seem trivial.

So it was with the deficits of World War II. During the period 1943 - 1945, they reached a maximum of 33% of GDP, nearly three times our current maximum projected deficit. [Table 1.2, Page 23] Yet in real money they were less than $50 billion—a minuscule sum by today’s standards. [Table 1.1, Page 21]

Today we’ve already spent more on AIG alone. World War II’s deficits were scary at the time, but we quickly outgrew them as our economy recovered.

If we invest in industrial and market infrastructure, and if we correct the ideological excesses of the last forty years, our economic growth will one day dwarf today’s projected budget deficit, just as today’s ten-trillion dollar economy dwarfs the “scary” $50 billion deficits of World War II. But if we don’t invest and our economy stagnates or declines, we will never dig ourselves out of this hole.

3. Relying on “big government” will destroy private markets. This one is wrong on two counts. First, its implicit assumption is wrong. We’re not been relying on big government, especially compared to the last century. During World War II, deficits nearly reached a third of GDP. [Table 1.2, Page 23] For the war effort, the government nationalized (or built and owned) most basic industries, including autos (for tanks), steel, aircraft, rubber and aluminum. It even rationed basic commodities like gasoline and food: you had to give government bureaucrats little coupons to buy them even if you had money. (If you’re under 60, ask your parents or grandparents about rationing. They’ll remember.) Nothing like that is happening now or even planned.

Second, even the limited government interventions now proposed are temporary, just like the ones in World War II. As soon as World War II ended, the government sold private investors the industries it had taken over or built from scratch. The aluminum plants that it built for aircraft production, for example, became Kaiser and Reynolds Aluminum, private companies listed on the stock exchange. All this happened long before Ronald Reagan came along.

No one—least of all the President—has any designs on private enterprise. No one intends to “nationalize” anything, far less permanently. All the government will do is assert limited control needed to curb our financial meltdown and restore our economy. Then it will put markets and private business back in the forefront, just as Harry Truman did after FDR died, and just as Americans have always done.

There is no secret plan or desire to restrict private ownership of business or downsize private markets. The plan is to make business and markets more successful. If doing so requires the government to tread temporarily where no private investor will, practical people do what needs to be done.

4. Government intervention will make us more like Europe. Wrong again. We will never be like Europe, socially or economically. The reason is history. Today’s Europe arose from centuries of feudalism and monarchy. It had and still has hereditary lands, titles and “nobility.” We never had anything of the kind and never will. Our Constitution forbids hereditary titles. We don’t have any lords, barons, counts, or marquises, or any of their female counterparts. We are an egalitarian society.

But we do have dangerous trends that, in the long run, might make us look more like Europe. For several decades we have suffered increasing income inequality. Our once unmatched system of public education has decayed dramatically and is no longer internationally competitive. And we know that wealth follows education.

So if we don’t fix our disparities in income and education, our rich and their kids will continue to get richer and better educated in their private schools. The rest of us and their kids will get poorer, more ignorant, and therefore poorer still. If this vicious circle continues, we may yet create a durable upper class resembling the hereditary aristocracy of Europe. Far from bringing on social stratification and class warfare, intelligent investment in infrastructure and public education will keep them from happening here.

5. Government intervention in private markets breeds socialism. Oh, so wrong! Government intervention in private markets is what saved us from socialism.

About seventy years ago, our workers and their labor movements were flirting with socialism. At the same time, Russia and large parts of Europe were adopting socialism enthusiastically. (The term “Nazi,” for example, is a German acronym for “national socialist.”) What saved us from creeping socialism at home and dominant, muscular socialism abroad was the policies of FDR. He saved our economy and our capitalist system by creating jobs and widespread wealth. He did that by imposing intelligent regulation on businesses and markets and fostering collective bargaining of workers with management.

Under those policies, we escaped socialism and strengthened our capitalist system. We emerged from the turmoil and destruction of World War II with the world’s strongest and most socially cohesive economy. We have kept that leadership for sixty years.

How did we do it? With a “mixed” economy. We had robust private business and free markets. But we also had a robust government that kept business fair and honest and did what business can’t or won’t do.

Our economy is battered today because for forty years we starved our governmental sector, not our private one. We forgot the brilliant secrets of our mixed economy. We forgot history.

Conclusion

Republicans have led the charge in starving government. But twelve years of Democratic rule did nothing to change the trend. Jimmy Carter was a weak and unpopular president, unskilled in dealing with Congress. Bill Clinton achieved what little he did, and balanced the budget, by joining the trend, not fighting it. Until this very moment, no major national figure has recalled for us how our best days came out of both robust government and robust business.

The consequences encircle us. Now the government that deployed over 500,000 troops to save Kuwait can’t muster even 200,000 for Iraq and Afghanistan combined. Now the government that, among many other things, won World War II, built the atom bomb and the Internet, beat Yellow fever and polio, eradicated smallpox, and developed the world’s air traffic control and communications systems can’t even keep bridges from falling down or save an historic city from a hurricane.

If you’ve starved someone on whom you rely, you have to feed him again. Feeding a government that we’ve starved to emaciation for forty years is going to cost money.

But it’s a necessary expense. It’s not “socialism” or “big government.” It’s restoring balance and our winning hand—our mixed economy.

P.S. Breaking Up is Easy to Do

Every once in a while, a mainstream columnist hits the nail on the head with a perfect ring. David Ignatius’ Washington Post column today did just that.

Entitled “The Right Roosevelt?,” it argues that President Obama should emulate Teddy Roosevelt, not Franklin. Just as Teddy once “busted trusts,” Ignatius says, the Obama administration should break our hideously bloated corporate conglomerates into smaller, more manageable pieces, using bailout leverage to do so.

Ignatius focuses on financial giants like AIG and Citigroup, whose complex structures so defy analysis as to impair attempts to bail them out or even accurately to value them. He’s right on that count, as I’ve written before (1 and 2).

But the benefits of simplifying and streamlining business go way beyond finance. Just today the Wall Street Journal reported negatively on General Electric, one of our nation’s few remaining profitable industrial companies. The reason? Its unregulated finance arm is nearly as complex as Citigroup, and that arm is dragging down the whole. Why should an excellent industrial giant be investing in real estate in Eastern Europe, or in any financial business other than helping customers buy its industrial products?

GM is much the same. In applying for yet another government bailout, it has promised to jettison zombie brands, namely, Saturn, Pontiac, Saab, and Hummer. But wouldn’t it be better to spin off all viable brands as separate companies? Many like me would invest in the new Volt, and it wouldn’t be hard to find willing private investors in GM’s nimbler, smarter Cadillacs.

The last two decades saw an explosion of conglomeration in business. Much of it made and makes no sense. Unwinding it would not only improve financial transparency in bailouts. Breakups would also give investors clarity and certainty and younger, smarter, less tarnished executives a chance to show their stuff.

The antitrust laws that Teddy once used to break up the conglomerates of his day are blunt and tardy instruments. Today it takes years for a big antitrust case to work its way through our courts.

But our financial meltdown provides an opportunity in crisis. Every time a firm like AIG, Citigroup, or GM (or maybe soon GE) comes begging for a handout, the government should ask for a breakup plan. Then smaller, viable pieces could rise like Phoenixes from the ashes of conglomerate excess.

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Shock Therapy Now

Plan A: Control, Quarantine, Slice and Dice
Plan B: Nurture and Empower Local Banks
Conclusion
P.S. Warren Buffet Pans Derivatives

[For comment on the Obama Budget, click here.]

There are times when being right is not a happy feeling. Four days ago I wrote the following:

“[T]he truth is everything is collapsing at once. Credit, banking, finance, industry, housing, mortgages, employment, consumer sales, auto sales, international trade, and confidence in all of the above—all are collapsing simultaneously. The world is in economic free fall. So far that free fall is in slow motion, but it could accelerate without warning.”

Little did I know: the acceleration already had started. Yesterday the Commerce Department reported that our GDP shrank 6.2% last quarter. To people who think in numbers, that’s a deathly scary report.

What does it mean? That’s one quarter’s contraction. In the rosiest of all possible scenarios, in which the economy flatlines by this spring, it means our current quarter will be similar or worse. So in the best of all possible worlds, we will have suffered a cumulative economic contraction of at least 6%, and probably much more, for half a year by the end of March. (Successive quarterly drops in GDP do not add up because each is relative to the corresponding quarter in the previous year.)

Furthermore, the best of all possible worlds is extremely unlikely. In the Great Depression, the stock market took three years to bottom out, at about 10% of its peak. Our multiple crises began with housing-related finance. Housing moves much slower than stock, and we haven’t even begun to address the housing crisis or the derivatives crisis that it spawned.

What does this mean for Geithner’s “stress test” plans? Through no fault of his own, he’s a quarter late and several trillion dollars short.

The idea of the “stress test” is to guess whether big banks will meet regulatory capital and liquidity requirements under the “stress” of a prolonged downturn. The trouble is, the “worst case” scenarios in Geithner’s “stress tests” assume an economic downturn for 2009 that is at least twice as shallow as what this new GDP number suggests. The obvious conclusion: few big banks, if any, will pass a realistic “stress test” based on current and reasonably projected economic conditions.

So in their present condition, our big banks can’t possibly do the heavy lifting, anytime soon, that we need to raise our economy by its bootstraps.

What can we do? Here are two very different plans for shock therapy that might work:

Plan A: Control, Quarantine, Slice and Dice.

According to Yahoo Finance, Citigroup’s market capitalization as of Friday was $ 8.18 billion. On Monday it may be lower. After Geithner consummates his recently-announced conversion of the taxpayers’ preferred to common stock, “we, the people” reportedly will own 36% of Citigroup. The next 15%—which gets us to absolute numerical control—will cost $1.2 billion at Friday’s price.

That’s pocket change today. So we should do it. The government should buy numerical control of Citigroup on the open market (secretly, of course, so as not to disturb the markets or overpay). That act would bypass all the ridiculously irrelevant debate about “nationalization,” which, according to Bernancke, means wiping out shareholders by government fiat.

All by themselves, our free markets have virtually wiped out the shareholders already. But never mind. This plan will make them no worse off. For those willing (or forced) to hold for the long haul, it might even give them an upside. I don’t think we need cry for speculators who bought recently hoping to make a quick profit.

So much for the shareholders. What this plan will do is allow the government, with minimal expense, to fire the directors and officers and assume control. For a mere $1.2 billion in additional investment, the government can have absolute control and manage trillions of assets. That’s leverage!

Once the government assumes control through fair market purchases (not government fiat), the plan is simple. The government restructures Citigroup to quarantine its bad assets. Then it slices and dices the company into viable portions or lines of business in which private markets will invest.

The heart of the problem is so-called toxic assets, principally securities backed by bad or shaky mortgages and the derivatives that split them up or attempted to insure them against default. These assets are probably worth something, but nobody knows how much. Nobody will know until the housing market, if not the economy as a whole, stops free falling. That may take years. In the meantime, the big banks that hold these assets are not lending or borrowing.

So the government quarantines the toxic assets and sits on them until: (1) the markets figure out what they are worth, (2) the economy recovers and they are worth more, or (3) both. The government can do this because it’s not a private investor and doesn’t have to worry about stock market fluctuations or the next quarterly report.

With toxic assets quarantined, the rest of the plan is easy. Government sells as much of the rest of Citigroup’s assets as private investors are willing to buy, all at fair-market prices. If necessary, it breaks up Citigroup’s subsidiaries to do the same thing: quarantine their bad assets and slice, dice and sell the rest.

Surely Citigroup has some lines of business untainted by the mortgage crisis and irresponsible securitization. The goal of this plan is to get those lines of business in the hands of new private investors and under sound management as quickly as possible. Control, quarantine, slice and dice.

Bank of America is next. It’s current market capitalization is $18.82 billion. Fifty-one percent control will cost under $ 9.6 billion, less whatever “we, the people” already own after converting our current “investment.”

Buy control, quarantine, slice and dice. Continue through as many of the top ten banks as the government has to manage to get all their viable lines of business in new hands and soundly managed. Shoot for a deadline of thirty but no more than sixty days.

What’s left in the holding companies will be toxic assets, proceeds from the sale of viable lines of business, and whatever else may be unsalable. The government probably should hold these assets until the economy recovers in several years and then liquidate them (slowly, carefully and responsibly) for the shareholders’ benefit.

For example, the primary shareholders in Citigroup reportedly will include the governments of the United States, Singapore and Saudi Arabia. These are long-term investors. They probably won’t mind waiting a few years to maximize their return and to help save the global economy in the process.

Plan B: Nurture and Empower Local Banks

One of the best-kept secrets in this banking crisis is that our country has over 9,000 banks. (No, that’s not a typo.) Unfortunately, the top ten currently control the overwhelming majority of banking assets and credit. Concentrating all that financial power in the hands of so few financial managers was, of course, an idiotic idea. It was an important cause of our current collapse and yet another example of government being asleep at the switch.

So why not use the current crisis to reverse this disaster and re-establish a healthy, geographically diversified, decentralized banking system? Here’s how.

A second best-kept secret about our banking system is that there are conservatively managed, well-run banks among the “little guys.” The Washington Post ran a wonderful story about one of them in its own backyard a few months ago. Not only were these banks untouched by the subprime meltdown. Many of them remained profitable throughout our multiple crises and still are today. And they have a vital advantage over the big national banks: they know their local communities. They understand who is likely to weather the economic storm and to whom to lend responsibly.

At the moment, the “big boys” are in stasis. They claim they are sound, but they won’t lend or borrow. They don’t really know what their assets are worth, and they don’t even trust each other. So why not bypass the whole rotten system and build a new one, based on local control, proven competence, and community support?

No government mandates need be involved. The government already knows who the “good little guys” are through its bank examination process. It simply asks each of them, “would you like to be bigger—and to help your nation’s economy survive—by taking low-rate government loans?” Then it publishes the names of those that say “yes” on the Internet and provides (in the form of low-rate, flexible-term loans) whatever resources they need to expand their lending in their local communities as rapidly as possible. The government waives its capital requirements temporarily, for the duration of the emergency, for banks that agree to participate in this plan, meet stringent requirements for safe lending, and agree to stricter-than-usual, minute-by-minute government supervision.

Then people who need credit can go their local banks. Small businesses, home buyers, and students can. Big businesses can. Even GM can, if it can convince any good small banker that it’s a viable business.

Best of all, American’s banking system will return to its roots. Once again bankers will be conservative, stodgy folk who lend money carefully and know their local communities up close and personally. And even if many still fail, the decentralized system will provide greater strength, flexibility and resilience as our economy recovers.

Conclusion

Probably both of these plans are worth pursuing at the same time. If the big banks have enough viable lines of business now, Plan A will probably work faster. Plan B has the advantage of producing, in the medium term, a much healthier, more resilient banking system.

Both plans avoid the bugaboo of “nationalization” and the sterile debate about the role of government. In Plan A, government would be a market participant of last resort, not a market usurper or controller. In Plan B, government wouldn’t even do that much. It would just encourage good, small bankers to expand their activities rapidly, give them loans to help them do so, and give them free Internet publicity to help them reach potential customers.

Plan B, however, would tie up far more government money than Plan A, for Plan A relies on the enormous leverage that current low market valuations of supposedly sound big banks provides. If government uses that leverage, it can achieve sufficient control over the big banks to rationalize their holdings and business without ever muttering the word “nationalization,” even under its breath.

P.S. Warren Buffet Pans Derivatives

It’s nice when a certified investment oracle, in effect, confirms your analysis. Today Warren Buffet released his annual investment letter, explaining (among many other things) the biggest decline in 43 years in his iconic Berkshire Hathaway holding company.

Here’s what he wrote about derivatives:

“Improved ‘transparency’—a favorite remedy of politicians, commentators and financial regulators for averting future train wrecks—won’t cure the problems that derivatives pose. I know of no reporting mechanism that would come close to describing and measuring the risks in a huge and complex portfolio of derivatives. Auditors can’t audit these contracts, and regulators can’t regulate them.”

There’s lots more to the same effect in Buffet’s letter, which you can read in full if you subscribe to the Wall Street Journal’s on-line edition.

The clear implication of this language is that Geithner’s “stress tests” are not enough. They wouldn’t be even if his “worst case” assumptions were still realistic, which they are not. Nothing we can do with these instruments in the short term will make them any less toxic. No one with any brains or caution will buy them, so “bad banks” holding them will be non-starters.

The only rational thing to do with derivatives is to quarantine them, as suggested above, for the duration of the emergency. And the only institution strong and resourceful enough to do that on the scale now required is the U.S. government. Fortunately, the leverage that shaky banks’ low market values now provide should let government do it on the cheap.

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Obama’s Blueprint for Tomorrow

Budgets are to governments as blueprints are to houses, software to computers. They are the plans that make things run. Until today, there was a germ of truth in the claim that we didn’t really have the President’s plans. Now we do.

The Obama Budget is a comprehensive blueprint for our future. It provides for massive investment in energy independence, a slowdown in climate change, universal health care, and an educational system that can meet international twenty-first-century standards. It pays for this investment by increasing taxes on the rich, charging businesses for polluting and heating our planet, stopping payments to big farmers for not growing food, and bringing some economic discipline to health care, government procurement, and the federal government’s own use of energy. It won’t increase taxes on the middle class; they’ll go down. And taxes on the rich won’t increase until 2011, when the Bush tax cuts expire.

Not surprisingly, all this is exactly what the President promised on the campaign trail. But don’t hold your breath waiting for the folks who called him all hot air to apologize.

They’re not going to acknowledge how wrong they were about the President. Instead, they’re going to change the subject. They’re going to moan about deficit spending and higher taxes. They’re going to make up phrases like “generational theft,” which sound scary but have no acquaintance with reality. They’re going resurrect all the lies and “spin” that got us in this mess and that we’ve heard for the last eight years. They’re going to make Bobby Jindal’s flop on TV Tuesday look like opening night in a Vaudeville run.

As you watch this seedy but long-running Vaudeville show, here are three things to keep firmly in mind.

First, no matter what the Republicans tell you, the middle class and poor won’t pay for this investment. The rich will. Taxes on the middle class and poor will go down. And if having to buy carbon credits forces energy and other firms to raise their prices, then tax credits and other benefits—financed by recycling higher taxes on the rich—will help people who need help.

To the extent savings and changed priorities won’t finance these investments, families that make over $250,000 annually will pay. My wife and I are in that category, and you know what? We don’t mind a bit.

Would you rather have a bit more personal cash to spend on big houses, big cars, fancy clothes, and lavish vacations, at the cost of prolonging our national decline? Or would you take a small “haircut” to live in a nation that continues to lead the world in innovation, infrastructure, education, energy, social justice and social cohesion? My wife and I don’t need more than a nanosecond to answer those questions. Nor does Warren Buffet and anyone else, no matter how rich, who has thought them through.

The second thing that Republicans will throw at you is scary claims of “generational theft.” Borrowing heavily now, they claim, is “generational theft” because our children and grandchildren might have to pay back the loans.

But detainees are not the only things Republicans torture. They also torture the English language. “Theft” is taking from someone and giving nothing back. It’s not “theft” to borrow money to invest in your children’s and grandchildren’s future.

Real “generational theft” is something else entirely—something that’s been going on for decades. It’s depriving our children and grandchildren of the same opportunities that our generation had, mostly for free, so we can spend “our own money” on ourselves. That’s generational theft.

Here’s an example. Except for one degree, I got all my education from public schools and public universities. The public high school I went to was one of the top five in the nation. My parents paid not one dime in tuition for it. The university I went to was one of the top two or three in the country, with Nobel Prize winners galore on the faculty. I paid no tuition at all, just a fee of about $100 per semester.

Now students just as smart as I was can’t find public high schools that good anywhere in our nation. They can’t get into the same university. And even if they are admitted, they’ll end up with crushing debt of $100,000 or more when they graduate. They suffer all these disadvantages, apparently, so I can keep more of “my own money” and luxuriate in my old age. Now that’s generational theft.

The third lie Republicans will tell you is that business doesn’t want and won’t make investments like this. I don’t know what kind of businesses they’re talking about, but they’re not talking about the ones that made American great.

Take Intel Corporation, for example. It’s had the lead in microprocessors for decades. Its market share is now about 80%. It just suffered a 90% plunge in profits, and it’s facing a global retrenchment in computers as the world’s economy falls off a cliff.

But is Intel emulating our Republicans, hunkering down and refusing to invest in anything? Is it resting on its laurels, its 80% market share? Not on your life! It’s investing billions in new plants and technology, right on the cusp of recession. Here’s how its CEO, Paul Otellini, explained why:

“We’ve always believed that the best way to successfully emerge from recessions is with tomorrow’s products, not by standing still with today’s.”

I hate to sound like a modern Calvin Coolidge and say that what’s good for Intel is good for the country. But isn’t that precisely the kind of investment we should be making as a nation? Isn’t that just what the Obama Budget calls for?

When you hear Republican politicians claiming to speak for business, you need to think about where they come from. Mitch McConnell, the Senate Minority Leader, hails from Kentucky.

McConnell has a soothing, low key personality, and Kentucky produces some fine horses and whiskey. But it’s hardly an industrial state. It produces about 1.1% of the nation’s gross domestic product and has about 1.5% of the nation’s population. There were almost as many people on the Mall for the President’s Inauguration as voted in the election that put McConnell in the Senate. Do we really want the fraction of Kentucky’s 4.7 million mostly rural people who voted for him telling the other 295.3-plus million of us how to run our economy?

Then take John Boehner, the House Minority Leader. Please. He hails from Ohio, an industrial state. But either he’s an idiot or he thinks his constituents are.

As an example, read the interview he gave Judy Woodruff last June, during the presidential campaign. Boehner was pushing John McCain’s “drill here, drill now” absurdity when Woodruff asked a crucial question: what’s drilling in Alaska going to do for us when all the experts say it won’t produce any oil for about a decade? Here’s how Boehner answered:

“Well, Judy, that’s not really true. I think, if we were to have votes in the House and Senate on opening up the Outer Continental Shelf or issues such as ANWR, we’d send a real clear message to the speculators in the oil market, and it could have a very dramatic affect.”

So Boehner thinks speculators control energy prices. Not only that: he thinks they would immediately overreact to a speculative possibility a decade in the future. All I can say is he could use a good undergraduate course in economics. Maybe he should drop out of the House and take one. We’d all be better off.

When you consider Republicans’ economic prescriptions, think about this. In the presidential election, states representing 72% of our nation’s gross domestic product voted for Obama. Big industrial states like California, Illinois and New York, collectively representing 36% of our GDP—over one third!—preferred Obama by a margin of 20% or more. Those that preferred McCain by a similar margin account for less than 5% of GDP.

The most productive parts of our nation endorsed the President overwhelmingly because they understood and approved the policies and priorities that he outlined in his campaign, which his budget now reflects. Is it possible that maybe our most productive voters know some things that McConnell and Boehner don’t?

So when you hear the same tired old tunes, think. Who got us in this mess? With what ideas? And where do these folks come from? Do they represent the productive heart of our nation, or its rural outback? And who really understands what “generational theft” is and how it’s happening?

If you answer those questions honestly, you’ll take about as long to approve the Obama Budget as my wife and I took to decide whether we want a few more bucks in our personal bank accounts while Rome burns or a country that works again. I’d say about a nanosecond.

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Should Geithner Go?

[For comment on the President’s speech February 24, click here.]

Is Treasury Secretary Tim Geithner the Donald Rumsfeld of our economic recovery? That’s the $ 64 trillion question on which our economic future depends.

After four years of Rumsfeld at the helm, our enterprise in Iraq was collapsing in flames. Things began to turn around when Robert Gates came on board, bringing with him Generals Petraeus and Odierno, Ambassador Crocker, and a change in strategy.

As this recent history proves, in a crisis good people are more important than good ideas. Crises require flexibility, adaptability and speed above all. People who think they have the right ideas because they have never questioned their basic assumptions offer fatal leadership in times of crisis.

Personnel changes are doubly important when the person in charge has an idée fixe. For Rumsfeld, it was the notion that a modern version of German blitzkrieg would let us win a war, occupy a huge country, and change its culture with a small expeditionary force. So enamored was he of this idea that he never considered our failure in Vietnam or the millennial power struggles of Shia and Sunni.

Geithner’s idée fixe is more subtle than Rumsfeld’s. It’s less a particular substantive approach than a philosophy. He believes that the same people who made our economic crisis must fix it because they are indispensable. He also appears to have the same allergy to government intervention in our economy that brought us our first Gilded Age and Great Depression and now seems ready to bring on our second. He has drunk the Cool-Aid of free-market infallibility that, for forty years, has hollowed out our industry and destroyed our economy.

And so we have today’s extraordinary spectacle. The same folks who destroyed our banking system are going to get more money and continued authority to run things, with few or no strings attached. For Citigroup, for example, the taxpayers will give up the protection of their preferred shares (with guaranteed return) without even seeking effective control. And the same folks who ran our auto industry into a ditch seem poised to get new money to squander on the same strategy and tactics that failed for the last half-century.

I don’t know how all this looks from the inside the Beltway or on Wall Street. But I know how it looks from the outside. It looks as if the inmates are running the asylum again.

If you want to know why confidence is collapsing everywhere, you need look no further than that. We, the people—including all the experts who were and are the President’s core constituency—voted for change at the top. We hoped that change would bring a thorough house cleaning, with new, fresh faces everywhere. Now we see the same old, tired faces, mouthing the same old denial and “spin,” running our economy (especially the finance sector!) in much the same old way.

The supreme irony is that we’re talking here about business. Up until a decade or so ago, business and the military were the two remaining institutions in our society where competence and performance mattered. They were meritocracies, or at least they seemed to be.

The marketplace, we were told, imposed “discipline” on business. If you didn’t perform, you were bankrupt or out. “You’re fired!” was supposed to be the response to failure and incompetence. At least that’s what egomaniac Donald Trump used to say with delight before he got his comeuppance.

But off the TV, it hasn’t worked that way for a long time. You can stay on forever if you have the right connections, through failure after failure. You can stay on, apparently, even after you’ve bankrupted your firm and helped destroy the economy. All you need is membership in the right social class and the right subculture in Washington, D.C., New York City or now even Detroit.

If you think this is meritocracy, I’ve got some subprime derivatives I’d like to sell you.

The universal desire for change in personnel is not just a matter of retribution for undeserved salaries and perks. As I have written, the amount spent on unfair perks for executives is utterly negligible compared to the huge sums we have already spent trying to heal our economy, let alone what we still must spend to get it right.

Nor is retribution the principal motivation for cleaning house. No doubt the general public wants a little revenge against the fat cats who cost them their jobs, houses and peace of mind. But the experts just want to see people in charge whose competence and expertise they can trust. Keeping the same folks in place whose abysmal performance created this mess doesn’t seem to satisfy that simple criterion.

And so we have the odd phenomenon of people from the same social class and city, who know each other socially, declining to lend to each other. Even the greedy, incompetent fools who created this mess are that smart.

There are two possible rational explanations for failing to redress this abysmal state of affairs. Seasoned reporters suggest that neither Treasury nor the rest of the federal government is fully staffed as yet. Apparently the President and the Cabinet have been so busy fighting alligators that they haven’t yet had the chance to hire subordinates and fill the ranks.

That’s an opportunity, not a problem. Treasury could, as I’ve suggested, scour the country for bankers of rare competence who actually foresaw and avoided the subprime debacle and ran profitable businesses. Then it could bring them to Washington to help. What an invaluable meritocracy that sort of staffing might make!

The other rational explanation for failing to clean house is that reluctance to do so may be coming from the top, i.e., the President. With his superb political sensitivity, President Obama may believe that the nation is not yet ready to give up its entrancement with economic fairy tales and laissez faire government and impose discipline and competence on our sinking economy.

Denial and reality allergies die hard. A few historians and FDR-haters still think FDR deliberately allowed the attack at Pearl Harbor to happen, believing it would not be so disastrous and knowing that only an event so dramatic could galvanize our isolationist nation for necessary war.

Maybe President Obama believes that we need an economic Pearl Harbor before our collective fixed ideology capitulates at last. Only then, perhaps, can the meritocracy just recently restored to Washington begin to impose some semblance of meritocracy on Wall Street, the executive offices of our financial and automobile sectors, and eventually Main Street.

I’ve learned by experience not to question the President’s political genius or judgment. If this is what indeed he thinks, he may be right.

But that’s a matter of politics, in which the President’s judgment has proven right again and again. As a matter of economic substance, I fear that we are so close to irreversible changes in our national performance and global economic position that an economic Pearl Harbor might be more than we can take.

And as a teacher who believes in merit, excellence and performance above all else, I can only cringe at the thought of another Donald Rumseld in charge of our economy at this critical time. How can we re-establish confidence in our financial system by continuing to rely on the same old boys’ network that destroyed it? How can anyone else trust the folks who are running our financial institutions now, when they—with good reason—don’t even trust each other?

The President’s Speech

When the President gave his “State of the Union speech that wasn’t” last night, there was no question who was in charge. Power and strength emanated from the podium like unseen electromagnetic energy.

The source was wasn’t just the office he holds. Nor was it the majesty of the assembled dignitaries. The power came from his vision and moral clarity and the simplicity of his message. Quoting little Ty’Sheoma Bethea, a young student from a collapsing school in South Carolina, he reminded us that “We are not quitters!”

There was none of Dubya’s happy talk or Billy’s wonky ten-point programs. The message was sober, serious, and simple. We are in a deep hole that we have dug for ourselves over many years, but we are going to dig ourselves out. And, for once in forty years, we are going to do it together, with all of us participating and all of us pulling our weight.

The formula also was simple. Clean energy plus health care plus education equals recovery, he told us. We are going to put ourselves back to work doing things we have neglected for decades. In the process, we are going to renew the promise of America and the American dream.

The vision was so simple and powerful—and so right—that a child could understand it.

For me, the cameras’ brief glimpses of Ty’Sheoma summed up the evening. Small, dark, self-evidently out of her element, she looked overwhelmed and awed by everything around her. Even when the dignitaries clapped for her, she couldn’t manage a smile until Michelle beamed and hugged her.

But she is our future. She studies in a leaky, dilapidated school, with trains rushing by and shaking the rafters. She deserves the same education as any student in Beverly Hills. Though awed and cowed in the Capitol, she had had the guts to write the President and say so.

“Generational theft” is not borrowing to rebuild our city on the hill. It is depriving little Ty’Sheoma and millions like her of the opportunity that we had and that they deserve. As the President so simply explained, we can pick ourselves up by our bootstraps and put ourselves back to work by restoring Ty’Sheoma’s future and, with it, America’s promise.

President Obama’s speech last night marked a stunning reversal from Dubya’s last appearance before Congress. Then our unpopular president seemed like a wayward child pleading his case before a group of disapproving adults. The embarrassment was so overwhelming that I couldn’t finish watching the speech.

Last night, we saw the opposite. An adult reminded squabbling children of all they had left undone.

Members of Congress seemed to absorb his message only dimly. Some jeered and taunted each other across the aisle, applauding and cheering thunderously for their pet ideas, until the President reminded them that all love their country deeply. So do we in the larger audience at home.

After the speech, members of the House flocked for the President’s autograph like groupies at a rock concert. For those of us watching on TV, it was another embarrassing moment, emblematic of the vacuum of sober, sensible leadership we have endured for so long. At times like that, both during and after the speech, the President and our First Lady seemed the only adults in the room.

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Only Shock Therapy Will Do

[For an update on the latest plan, click here.]

A little over a week ago, I posted an essay speculating on how the current global economic catastrophe might produce America’s collapse and China’s rapid rise. I used an unusual device to make my point: a fictional “future history.” Apart from brief introductory and concluding explanations, the post was an excerpt from a fictional “history” of the Great Collapse, written by Chinese scholars in the early 2030s.

Sometimes life mimics art quicker than anyone expects. Today the New York Times reported what may be a trigger to my Great Collapse: massive unemployment and resulting unrest in China.

Why is that a vital bit of news? Because widespread, unemployment-spurred political unrest is one of the few things that might make China divest its $ 1 trillion investment in U.S. Treasuries, plus its second $ 1 trillion in other foreign reserves. If China’s leaders think they can’t trust their foreign counterparts to do the right thing, or to do it quickly enough, they may begin to tend their own garden, divesting their foreign assets for that purpose.

What would happen then? Probably both the dollar and international confidence in America and its economy would collapse.

At the moment, we have a strange economic paradox. With awe-inspiring stupidity and greed, our Masters of the Universe caused the worldwide catastrophe we are now experiencing. Of course our own economy was the worst hit, but it is so big, dominant and globally intertwined with others’ that all thoughts of “decoupling” were short lived.

Everyone is angry at us for starting the snowball rolling down the hill. But paradoxically everyone is still investing in America—or refusing to divest—because everyone still thinks our economy is the world’s safest and strongest.

All that could change if China pulled out. The result would be a plunging dollar, skyrocketing American interest rates, and a deep freeze of credit that would make the current stasis look like a little nip of frost.

How can we avoid this outcome? I think we need to demonstrate the capacity for sudden, bold and dramatic action.

I have praised the President and his new administration repeatedly on this blog for their thoughtful, deliberate and prudent approach to solving problems. But prudence and care have their downside: they take time.

We may not have much time. While recalcitrant on the issue of human rights, China has been remarkably patient with our collective economic mismanagement and malfeasance. Part of the reason is the extent to which China’s and our economies are intertwined.

But domestic unrest has always been the thing that China’s leaders fear most. Disorder in China is the economic equivalent of nuclear war. If it grows, China may divest.

Our own biggest current problem is denial. Our clueless bankers insist that our big banks are just fine, thank you, although they aren’t lending and many economists think they are already insolvent. The markets agree with the economists, as last week’s stock-market meltdown proved. Tim Geithner, in his methodical, careful, thoughtful way, is planning to “stress test” the twenty biggest banks in secret to find out.

Reportedly his testing and response may take weeks. We may not have weeks.

Bankers and others may point to isolated bright spots. But the truth is everything is collapsing at once. Credit, banking, finance, industry, housing, mortgages, employment, consumer sales, auto sales, international trade, and confidence in all of the above—all are collapsing simultaneously. The world is in economic free fall. So far that free fall is in slow motion, but it could accelerate without warning.

If the Great Depression taught us anything, it taught us this: you don’t mess with collapsing banks. You don’t temporize; you act. The first thing FDR did on taking office was declare a bank holiday to sort things out.

I’m not suggesting a bank holiday. But right now, our top bankers are in deep denial. They insist—as they have throughout the crisis—that “the fundamentals are sound.” Even if they are right, no one believes them anymore.

These jokers have to go. So what I am suggesting is a dramatic gesture to prove that our top leaders “get it” and will crush denial whenever and wherever it occurs. We can’t solve this massive accelerating collapse with more denial.

Right now, the market values of Citigroup and Bank of America are so low that our government could buy control of both for a few tens of billions, a pittance compared to what we have already spent.

It should do so. It should make a big show of doing so. Then it should examine their books on a crash basis.

Far from keeping the results secret, it should post every dime of debt and assets on the Internet. Then it should break up these banks, rationalize them, seal off their toxic assets, and sell what’s left back to private investors. It could sweeten the deal for current shareholders and insure fairness to them (in case these banks actually have any net value) by giving existing shareholders warrants to participate in any upside.

This dramatic action would have several salutary effects. First, it would show that our government can act boldly and decisively. Second, it would dissipate some of the global (and justifiable!) anger at our bankers’ stupidity and greed, as well as the world’s debilitating fear of their consequences. Third, it would signal the entire financial community that the days of denial are over and that people will pay for their mistakes, and soon. Fourth, it would let the world know what these banks are worth and how well or poorly they have been managed. Finally—and most important—such a dramatic gesture just might stay China’s divesting hand.


UPDATE (2/23/09 1:10 p.m.) Just about two hours after my post above, the New York Times reported Geithner’s plan to seek voting stakes in big banks—and perhaps even control—after he completes his “stress tests,” which will take several weeks.

The plan doesn’t make much sense to me for three reasons. First, it’s more temporizing, while the markets and the economy demand reassurance now. Second, taking a non-controlling equity stake in a big bank makes no sense at all. Right now the government owns preferred shares in Citigroup, which give taxpayers a guaranteed return. Why exchange those shares for common stock, with minority voting rights but no guaranteed return, unless you also buy control? No rational private investor would make that trade; it’s not an investment but a giveaway.

Finally, keeping current management in place will not restore confidence unless and until the banks pass their stress tests with flying colors. Geithner appears to be banking (pardon the expression) on that result. He’s gambling that the banks won’t fail their tests, or that, even if they pass, the economy won’t collapse irretrievably in the interim.

Geithner’s plan does have one advantage. If a bank fails the “stress test,” its stock will fall dramatically, unless Geithner plans to keep that fact secret, as well as the details of the test. Then the government can buy control at a lower price. If the bank passes the “stress test,” then maybe the government won’t need control after all.

Apparently Geithner has more confidence than the markets or the economy that Citigroup and B of A will pass their exams. He’d better be right. If he’s wrong, we’ll be weeks lower in our free fall with no solution in sight.

Already we are months or a year into this crisis, depending on how you count. I have yet to see convincing evidence that Citigroup or B of A is solvent, let alone ready and able to resume normal lending. I have yet to see any credible assertion, other than bald denial and “spin,” that either bank knows what its toxic assets are worth.

Under these circumstances, delay and secrecy don’t promote confidence. They undermine it. I’m trying hard, but I’m having trouble believing that Geithner is realistically taking the extent of our economic collapse into account, let alone the collapse in confidence that is causing it.

If it were up to me, I’d act more decisively. I’d have Treasury buy control of Citigroup and B of A now, on the open market, at their low current market prices. Then I’d shake them out. If they turned out to be as sound as their management claims, I’d sell the government’s controlling stakes back to private markets at a profit for the taxpayers. If they turned out sour, I’d be in a position to change management, split up the banks, and sell their assets immediately, thereby reassuring markets and the global economy. Whatever happened, the government’s decisive action would boost confidence immediately.


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Obama’s Velvet Glove

President Obama is the iron fist in the velvet glove. When possible, he makes things move without making waves. He doesn’t grandstand, and he doesn’t pick fights. But he moves his agenda forward, often with subtle ploys below the mainstream media’s radar. That approach appears to be his style, and it looks likely to continue throughout his administration.

In less than a month, the velvet glove has made notable progress on several fronts. Not coincidentally, those fronts are vital to our economic recovery and our hope of national renewal.

The first, of course, is the $787 billion stimulus-investment bill that the President signed Tuesday. The media made much of the “failure” of his bipartisan initiatives. But the bill is now law. It provides massive relief to our nearly bankrupt states and suffering workers. Equally important, it makes a down payment on national investment in our decaying infrastructure and a transition to rational energy policy.

Second, the velvet glove has separately advanced the cause of renewable, carbon-free energy. It has revisited waivers for states that wish to require greater fuel efficiency in cars, and it has begun a regulatory process to control greenhouses gases as air pollution. Thus has the President signaled industry that pressure to do the right thing will be relentless.

Up to now, the fossil fuel industries and their apologists have ignored three basic truths. First, the marginal cost of wind and solar power is next to zero. Once you build the windmills, solar arrays and electric grid, there is no additional cost for power but maintenance. No fuel costs. No transportation costs. Zip.

Second, the so-called “lower” costs of fossil fuels neglect the enormous “external costs” of environmental and planetary degradation. When you include those costs, renewables are already cheaper. They will get even cheaper in comparison as the global economy recovers and the highly nonlinear effects of demand inelasticity for fossil fuels work their dark miracles. Finally, many people who run these industries have kids who’ve been taught these truths since kindergarten. They are starting to come home from school and say things like, “Daddy (most of the troglodytes are men), why are you helping destroy our planet? Why aren’t you saving it?”

As this relentless political, legal and social pressure grows, the ocean liner of industrial denial, ignorance and sloth will begin to turn. Even the dumbest business people eventually bow to the inevitable. That’s why nascent carbon-credits markets already exist, although more abroad than at home.

A third example of the velvet glove is the President’s recent announcement of his foreclosure plan. About $75 billion will go for subsidies to prevent and cure foreclosure. That money will mostly help suffering homeowners and their lenders. The rest of the allotted money—some $200 billion—will go to Freddie and Fannie to support new loan-making apparatus, including new, rationalized and standardized securitization packages.

Why is that a velvet glove? Because it avoids talk of “nationalizing” financial institutions—the third rail of financial politics. Unnoticed (or at least unremarked) by virtually everyone, including the mainstream media, Fannie and Freddie are already nationalized. The people who ran them when they nearly failed are gone. Now the government, through its ownership, controls them and can replace management any time it pleases.

By providing government subsidies to these nationalized institutions, Treasury and the Federal Reserve have effectively nationalized the future of the mortgage market and its securitization. Nationalized Freddie and Fannie, not Wall Street, will develop the standardized loans, securitized packages, and other accoutrements of our highly sophisticated housing mortgage markets. As the months roll by, historical experience and more realistic mathematical models (perhaps also promulgated or standardized by civil servants) will help industry price these instruments realistically.

Under present circumstances, this sort of nationalization is vital. Only a rare few heads have rolled in our private financial sector. The management structure that destroyed our economy is still largely in place, often with perverse incentives. It wants to show the world (counterfactually) how it really wasn’t that stupid after all. And it wants to increase its own compensation (through stock and bonuses) by selling toxic assets for more than they are worth. Part of the reason for our present financial stasis is the bluff and bluster of people who created toxic assets and are trying to restore their reputations and wealth by holding out for a higher price. They want to hold our economy hostage to their egos and greed.

By working primarily through nationalized Fannie and Freddie, the Obama Administration will bypass these obstacles to progress. The miscreants will sit on their toxic assets, cooling their heels in their corner offices, while the rest of the world does business. Smarter folk will bow to reality, take the inevitable losses, and sell their toxic assets at reasonable prices or repackage them in standardized form. As the “stress tests” for their institutions approach, the holdouts either will incur further losses from being late, or they soon will be gone.

That, at least, appears to be the plan. Those for whom denial has become a way of life won’t see the iron fist in the velvet glove until they are about to lose everything, including their management perks. Few will cry for them.

With smarter folk like SecDef Gates and Generals Petraeus and Odierno in charge of our military effort, we are committed to using every aspect of our national power in foreign conflicts, including so-called “soft power.” The President is doing the same thing on the civilian side. He is not just relying on legislation like the recovery bill. He is using existing law, executive orders, regulation, economics and social pressure to achieve his ends.

As a “C” graduate of business school, Dubya never “got” law. By and large, his approach to law was to ignore it. A charitable view of his trashing our Constitution might be that he never understood its importance or how it works.

In contrast, President Obama was a top graduate of our nation’s premier law school and a long-time professor of law at another top school. He knows the law, its purposes, effects and limitations better than most of the distinguished lawyers who work for him. He will not likely overreach, but he will use every legal lever to achieve his goals. With his additional understanding of economics (rare among politicians) and his superb command of the public mood, he is a formidable leader.

Most people accept good leadership eventually. The smarter ones just do it sooner. Already in December, a month before the Inauguration, leading innovative businesses formed a battery development consortium, as I had suggested last June. They recognized, as they should, that electric cars and renewable energy are our future and where the President wants to go. They also understood that whittling down the Asian lead in lithium batteries will require a national effort.

Slower learners may take more time. Having been left rudderless and leaderless for most of four decades, they may resist national leadership. But eventually they will recognize that our President is far too clever and capable to ignore, and that anyway his goals are good for our nation and our species and good for business as well. Then our recovery will really start to roll.


Footnote: The recent crash of oil prices illustrates the highly nonlinear relationship between the demand for oil and its price. Since its peak last July, the price of oil dropped by more than a factor of four, from $145 per barrel to about $33. That drop was in response to a decrease in global demand of six percent (no, that’s not a typo). These facts suggest that, if demand grows more than six percent as the global economy recovers, the price of oil will exceed $150 per barrel. If global demand increases further, the sky’s the limit.

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China Rising III: America and China in Crisis

Economic History of the Early Twenty-First Century
Chapter 10: The Collapse of the American Economy (2008 – 2020)
Chapter 12: Rise of the People’s Republic of China
Coda
Brief Update: 10/14/13

This is the third in a series of essays on China’s rise. The first analyzed aspects of China’s political culture that could have beneficial geopolitical effects. The second hypothesized that China’s beautiful but inefficient system of writing might be holding China back. In this essay, I speculate on how the close relationship between America and China might affect the outcome of the current economic crisis and what the world might look like in two or three decades as a result.

Three appalling trends in our own country provoked this speculation. First and foremost was our Senate Republicans stonewalling the economic stimulus package. I understand that, after forty years, Republican economic fairy tales are deeply engrained in our national psyche, let alone the political ideology of so-called “conservatives.” But I had no idea.

How would a petroleum engineer react upon designing a pilot refining plant and seeing it explode in its first test, utterly destroying both the plant and the building surrounding it? Would she recommend using the very same design in a plant of commercial scale? That’s what the Senate Republicans are doing in proposing more tax cuts to remedy our current economic implosion.

The second appalling trend is “conservative” senators’ lack of imagination. Apparently the ones who have not had to campaign recently are oblivious to the widespread pain of job loss, foreclosure, loss of health care, and economic fear. They can’t seem to foresee how these trends will translate, in just a few months, into homelessness, family breakup, vagrancy, crime, disease, suicide, and disorder in our cities and suburbs.

The final appalling trend is ignorance. You don’t need much imagination to foresee social unrest if you know a little history or can read a newspaper. All you have to recall is the riots and labor strife of eighty or so years ago—in which our army and police forces massacred our own protesting citizens. It might also help to recall the “bonus marchers,” World War I veterans who came to Washington to protest denial of bonuses promised them for their service. They built a tent city on our national mall and met repression by our own army and police. But I guess it’s too much to expect people who spend their lives practicing “civics” to know as much about our history as the average college graduate.

What follows is speculation or, if you prefer, fiction. But how improbable is it? There are only two underlying assumptions. The first is that Republicans will continue to obstruct—and Democrats will continue to balk at—the unprecedented measures required to address our unprecedented economic crisis. The second is that, at some point, China’s economic pain will reach the point of provoking significant social unrest. Then China will start withdrawing its massive investments in our collapsing economy before their value erodes entirely. It will use the money to jump-start its own economy with real products, including autos, housing, mass transit, health care, infrastucture, heavy industry and eventually aerospace products. The rest of my “fiction” follows from these two pivotal assumptions.

Economic History of the Early Twenty-First Century
Copyright © 2033, Tsinghua University Faculty of History
(Translated from the Mandarin by Li Hua-Lo, Visiting Scholar, 2032)

Chapter 10: The Collapse of the American Economy (2008 – 2020)

While the People’s Republic achieved its present greatness during the period under study, the United States of America suffered a dramatic decline. Some scholars believe the decline began during the eight-year presidency of George W. Bush (2001 – 2009). Many believe that it became irreversible toward the end of the presidency of Barack Obama (2009 – 2017).

This view has some irony. Mr. Obama—the first African-American president in American history—enjoyed worldwide admiration and great domestic popularity throughout all but the last two years of his presidency. Scholars who think the decline became irreversible during this period attribute it not to Mr. Obama but to the structure of the American government and the ideological persistence of Mr. Obama’s political opponents.

Readers will recall that, unlike the People’s Republic, America was a two-party state. (See Chapter 3: America, Government and Political Structure.) Today, like many European nations, it is a multi-party state. But until about 2020, only two parties dominated American politics.

The two parties were known as the Democratic and Republican Parties. Their approaches to government and the economy differed radically. The Democratic Party endorsed a “mixed” economy based on private markets subject to strong government. It thought strong government leadership essential to guide and regulate markets, build and maintain infrastructure, and protect and support the poor and unemployed masses. The Republican Party pushed for as small and weak a government as possible, with as low taxes as possible. Its consistent recommendations for any economic problem were reducing taxes (except for foreign wars), repealing government regulation, and giving business owners more money and more freedom. Although this party strongly opposed deficit spending in theory, in practice it supported enormous deficit spending for foreign wars, including the early twenty-first century wars in Iraq and Afghanistan. (For the immediate political causes of these wars, see Chapter 5: America and Terrorism.)

The Republican Party had governed America during most of the four decades before Mr. Obama won the presidency in 2008. Mr. Obama’s election marked an important transition in government, but the country was bitterly divided. Only eight years before, the presidential election had been so close and indecisive that the American Supreme Court decided it, giving George W. Bush the presidency. While Mr. Obama won his election by an indisputable margin, the division and discord between the parties and among the people remained.

What followed was an object lesson in the defects of two-party government in times of crisis. Neither Mr. Obama’s decisive election nor his enormous popularity resolved the division and discord between the two parties, especially on economic matters. Furthermore, the peculiar non-parliamentary structure of the American government exaggerated the political power of the Republican Party, which had lost both the presidential election and the previous election for the American Congress decisively. (See Glossary: Great Compromise, Senate, filibuster, Electoral College.) As a result, Mr. Obama, who had received the votes of states representing 72% of America’s productive capacity in his first presidential election, and whose party had a substantial majority of both houses of Congress, had to seek the votes of members of a party with a completely different governing philosophy.

Some scholars believe that paralysis was built into this two-party system and the structure of American government from the very beginning. Others think it was just bad luck that the second Great Depression came precisely at the moment when the government and the people were bitterly divided.

But whatever the reason, the results are now clear. As a strong recession began to turn into what Americans now call the “Second Great Depression” the Democratic Party under President Obama’s leadership tried to implement economic stimuli adequate to the challenge. Although in the minority in both houses of Congress, the Republican party successfully blocked the strongest recovery measures, which most expert economists thought were barely adequate to the task.

For example, in 2009, facing a projected $2.9 trillion dollar shortfall in national productivity, all the Republican Party would allow to pass was a stimulus package of less than $800 billion. And one-third of that package was devoted to tax cuts, not investment. The package included only about $120 billion dollars in infrastructure investment, as against $2.2 trillion that the American Society of Civil Engineers said was required.

By late 2013, after the collapse of its trading partners’ consumer economies, the People’s Republic had lost its export markets almost entirely. It had no alternative but to invest massively in its internal economy, building infrastructure and encouraging domestic production and consumption of goods and services. For that purpose, it sold a trillion dollars of American assets to obtain money to invest.

As the People’s Republic attempted to conduct orderly sales of American assets, the dollar dropped to one-third its former value. Interest rates in America rose to 18% or more. Unemployment, which had reached 20% previously, skyrocketed further. Trillions of dollars of capital fled America, finding their way principally to the People’s Republic, Europe, and Australia. American business and commerce came to a virtual standstill.

In theory, the dollar’s low value was supposed to promote American exports. In practice there was little American industry left to make anything that trading partners wanted. And because the depression was global, there were few buyers for what America still made. The result is now known to Western economists as the Great Collapse. Among many other changes, it motivated replacing the dollar as a global currency with the yuan and the Euro.

Political repercussions within America were equally dramatic. During the Food Riots of 2015, President Obama had to send troops into several large cities to quell violence and looting and to protect lives and property. In some cases, the targets of popular violence were the business owners who had supported the Republican party. Several prominent members of the party, including a few members of Congress, were assassinated or killed in general violence.

Dispirited and derided, the Republican Party split into two fractious camps, extreme capitalists (along with libertarians) and religious fundamentalists. The latter believed that Armageddon and the return of Jesus Christ were near. (See Chapter 6: Role of Religion, Christian Fundamentalism.) What was left of the Republican party was no match for the Democratic Party’s vastly increased strength. The latter party won the presidential election of 2016 decisively, by the biggest margin in over 50 years.

Unfortunately for America, the winning candidate was Victor Cassidy. He was an effective demagogue but not especially thoughtful or well-educated in economics or policy. In an attempt to save American industry from utter destruction, he imposed drastic trade-protectionist measures that only made matters worse. By the end of his single term, America’s economic output had decreased to 45% of its 2007 value.

The American economy has yet to recover fully. Today America is widely perceived as a second-rank industrial and economic power.

A notable consequence of the Great Collapse was the destruction of America’s energy economy. While the People’s Republic, India, Russia and Brazil converted largely to nuclear and renewable energy, America did not have the economic resources to do so. It continued to rely on oil for its transportation needs, even as oil reached $12 per gallon (about $3 per liter) in the early 2020s. It economy was so fractured that, after Wang Ho-Bao invented phytomicrobiotic electricity in 2021 (see Chapter 15: Scientific Revolutions, Wang’s Invention of Photosynthetic Electric Panels and his Nobel Prize), it was unable to afford the cheap panels to produce it. At the present time, America is the world’s largest emitter of greenhouse gases and subject to United Nations sanctions, as climate change continues to erode the world’s coastal cities and displace millions.

Chapter 12: The People’s Republic of China

The collapse of America’s economy mirrored China’s rise. Yet the first decade of the twenty-first century was a difficult one for China. Its economy was almost entirely dependent upon exports, mainly of low-technology items like toys, clothes, shoes and furniture. Its cities and rivers were polluted by coal smoke, industrial effluent and an exploding quantity of car-produced smog. It was one of the world’s two biggest producers of greenhouse gases. Although it had a large, favorable balance of global trade, it had to keep the yuan at a low exchange rate in order to cheapen its exports and maintain export-led growth.

Corruption was rampant, as vestiges of the old Communist guanxi system vied with a new, unrestrained “cowboy” capitalism. The Central Committee’s policies exacerbated all these trends—especially corruption. China’s leaders ignored these evils, believing that only economic growth at any cost could forestall social unrest.

The situation was unsustainable. Events forced change upon China near the end of the first decade.

After the crash of the American stock market and financial system in 2008-2009, China spent trillions of yuan to build domestic infrastructure and promote domestic consumption. But the effort was too little, too late. By 2013, when America finally acknowledged that its economic crisis had become a second Great Depression, Chinese exports had fallen more than 70%, and domestic consumption had not begun to dent the deficit. To avoid economic collapse at home, the Central Committee sold its American assets to raise money for domestic economic support, precipitating the Great Collapse in America.

Unfortunately, even that reluctant initiative by China’s leaders was insufficient. By 2014, over 150 million unemployed migrant workers had returned to the countryside, which could no longer support them. There was widespread social unrest. Disorganized rebellions began in several provinces. The Central Committee sent the People’s Liberation Army to quell the unrest, and an estimated 178,000 citizens and soldiers died in the fighting.

The Great Reform arose out of this turbulent period. Both the Party and the masses felt revulsion at the turmoil, suffering, and loss of life. In extraordinary session, the Central Committee elected Lu Hsiao-Yu Premier and General Secretary of the Party and gave him extraordinary power to address the crisis. Along with that extraordinary power came the title “Chairman,” which until then no one else but Mao Tse-Tung had used.

The Party’s faith in Chairman Lu was not misplaced. He promptly announced the Five Principles as the road to national recovery.

Today every school child knows the Five Principles. But their immediate effect is less well known. Some took longer than others, but in time all contributed to the Great Reform’s success.

The People’s Struggle Against Corruption had the most immediate effect. Chairman Lu traveled about the country, personally setting up tribunals of Party members and ordinary people of good character to root out corruption and try corrupt officials. By 2016, 120,000 corrupt officials had been executed, and over 240,000 had been removed from their posts in government and business. Those driven from office included 74 delegates to the People’s Congress and even two members of the Central Committee. The demonstration that no one was exempt from prosecution did much to earn the people’s trust.

The next most important of the Five Principles was the Principle of Enlightened Democracy. As early as 2014, Chairman Lu instituted popular elections for local officials in the provinces hardest hit by unrest. At first, he screened all the candidates himself, or with the aid of committees of trusted Party members. The requirement for achieving Rank 1 on the Standard State University Entrance Examination came in 2016. It was not until 2019 that screening of candidates for character and fitness by the National Scientific Psychological Committee began.

Although local elections developed slowly and at different rates in different provinces, they, too, were instrumental in reducing unrest. Those provinces that first used these procedures generally experienced the most rapid economic recovery.

Most scholars believe that the third and fourth of the Five Principles—Freedom of Business and State Industrial Guidance—made the greatest contribution to economic recovery. Chairman Lu established the State Industrial Guidance Council in 2015, and the Freedom of Business Manifesto came later in the same year. The former made general, nationwide policy for industry, and the latter made it easy and cheap to form and run businesses complying with state policy.

The Council’s first–five year plan set five goals for state policy: (1) building national infrastructure, (2) developing nuclear, wind and solar energy, (3) providing good jobs in the countryside, (4) reducing pollution in cities, and (5) curbing greenhouse-gas emissions. Spurred by massive state investment in those goals, the growing private sector made even larger investments and effort in achieving them. A decade later, the People’s Republic was a vastly different state.

The last of the Five Principles was the Principle of Excellent Universities. Under Chairman Lu’s leadership, the Party devoted almost half a trillion yuan to this goal. That money underwrote building the New Campuses for the Great Universities of Beijing, Shanghai, Guangdong and (after voluntary accession of Taiwan in 2020) Taipei, with their magnificent architecture, comprehensive libraries, and infinitely expandable laboratories. During the early years, the Party offered to double the salary of any distinguished foreign professor who would relocate to one of these universities, and the offer attracted over 160 educators, including twenty Nobel Prize winners. Chairman Lu also introduced the Standard State University Entrance Examination, which any Chinese citizen is eligible to take.

As a symbol of his commitment to excellence in learning and culture, Chairman Lu changed the Party’s name to its current form: People’s Mandarin Party. It had previously been called the “Communist” Party, after the failed economic ideology of the twentieth century. (See Chapter 1: The Legacy of Communism and Mao Tse-Tung). The change, he said, reflected the Chinese people’s glory under the ancient Mandarin system, with its emphasis on education and excellence, as demonstrated by egalitarian, nationwide examinations that anyone could take. It also reflected the nation’s linguistic unification under the Mandarin language.

The Great Reform took nearly two decades, but its effects are evident everywhere today. Today the People’s Republic is the world’s leading economic power. Its greenhouse emissions are lower than those of India, the European Union, America, Indonesia, and Russia, all of which have lower populations. Just last year, the United Nations Educational, Cultural and Scientific Organization rated the four Great Universities among the top ten in the world, with two (Beijing and Shanghai) ahead of Harvard (the best American university) and Cambridge (the best British university). Over the last ten years, Chinese have won more Nobel Prizes than any other nationality in every field except literature.

Question for Students

1. What caused America to decline dramatically at the same time that China rose? Does this history suggest that one-party states are more decisive and effective in economic crises than two-party or multiparty states? Or does America’s division and discord, at just the wrong time, explain its inadequate response to the economic crises of the second Great Depression? What effect did the peculiar structure of American government have in creating paralysis? the peculiar economic ideology of the American Republican Party?

2. Democracy can be messy and indecisive. Winston Churchill (see Chapter 4: Great Britain, the Legacy of World War II) once said that democracy is the worst form of government except the alternatives. But why did the People’s Republic’s Enlightened Democracy succeed while America’s chaotic and divisive brand of democracy failed? Is the difference China’s one-party system? Or is the difference the wisdom of Chairman Lu, who imposed a Mandarin meritocracy on candidates whom the people might democratically elect?

* * *

Coda. If you think this fictional “historical” textbook is wild fantasy, consider two things. First, remember how you felt on November 1, 2000. That was a few days before the election which (with the Supreme Court’s help) made George W. Bush president. Then ask yourself honestly: in your wildest imagination, could you then have conceived the situation in which we find ourselves today?

Second, consider the Chinese predicament. The “overseas Chinese” that I know here are renowned for “being patient money.” They hold investments for the long term, through good times and bad. That’s one of the secrets of their success. That feature of Chinese culture bodes well for us; the Chinese will not likely sell us out for temporary profit.

But an important feature of Chinese political culture is strong aversion to disorder and unrest. If economic collapse threatens social instability in China, and if the only way to curb it is to sell U.S. assets and invest the money at home, all bets are off.

There is already evidence that the collapse of the U.S. and Western consumer markets has caused China considerable pain. So we don’t have much time. If our own collapse continues while Chinese pain grows, the foregoing scenarios seem much less fictional, apart from the fanciful Chairman Lu. That’s why stonewalling adequate recovery measures is so abysmally stupid.

As for Chairman Lu and the Five Principles, they are just fictional devices to illustrate the success of which China is capable if it gets its act together. At the personal level, Chinese culture has magnificent values, including hard work, pragmatism, discipline, and respect for learning and excellence.

It is China’s political culture—in particular a reluctance to accept some form of democracy and the transparency it needs to thrive—that holds China back. If China’s leaders abandon that reluctance, in whatever unique way they choose, the sky’s the limit for China.

In today’s economic crisis, China has three advantages over the United States. First, it has a huge trade surplus and about $ 2 trillion dollars of foreign reserves. Second, its authoritarian form of government allows it to take drastic steps more quickly and resolutely. Finally, it abandoned its own nonsensical economic ideology thirty years ago. We only began to get rid of ours last November.

Brief Update: 10/14/13

When I wrote the foregoing post, in the first month of President Obama’s first term, our recovery from the so-called “Great Recession” was still very much in doubt. It never occurred to me that, despite the GOP’s stonewalling adequate stimulus, our Fed would save the day by what later came to be known as “quantitative easing.” Sometimes unanticipated events are positive.

But it equally never occurred to me that, 4.5 years later, a small group of House Republicans from the South, masquerading under the historic name “Tea Party,” would cause a national default in an attempt to extort political concessions. Sometimes unanticipated events can be decidedly negative.

Of course much of the “future history” described above never happened. But if you shift the time frame few years forward and think of the decisive event as a national default, rather than a deepening recession due to blocked stimulus, most of that “future history” is still entirely possible. In fact, a real default—even for just a few weeks—would likely cause an international economic collapse far faster and more devastating than slowly worsening unemployment due to inadequate fiscal stimulus might have.

Our nation’s economic future is still quite precarious. It is so not because we don’t have smart people who can make wise policy, but because, except for the Fed, they are no longer in control. We have minority rule in the House and, through routine filibusters and Senate “holds,” minority rule in the Senate. So our future may well depend on the whim of minorities unversed in economics, or even lacking firm contact with reality. Or it may depend on the President taking decisive and correct but constitutionally suspect action to save us from our own worst impulses.

In any event, the future scenario described above remains entirely possible, with the main trigger being a U.S. national default. As much as we consider ourselves “exceptional,” we have no guarantee of continued economic supremacy. We are only four percent of the world’s population, and we are slipping into an historical epoch when minority rule may make our actions and policies unpredictable and even capricious. When national economic policy depends on the whim of pols acting out grudges two centuries old, anything can happen.

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