Senator John Kerry, along with the two other Democratic senators appointed to the "Super Committee", had a column in the Wall Street Journal yesterday on their approach to the committee's work. This piece is infuriating for its empty platitudes and the refusal to acknowledge economic reality. In just 700 words the piece promulgated 3 major economic myths while ignoring the fundamental truths about the economy and the budget.
First, the piece told readers about the confidence fairy: businesses are not investing because they lack confidence in the economy and Congress. The data on investment actually show the opposite. Investment in equipment and software is nearly back at its pre-recession level measured as a share of GDP. This is quite impressive since most sectors of the economy have huge amounts of excess capacity. In other words, tales of business uncertainty might be a clever line to repeat at Washington cocktail parties, but the data show it is not an issue.
The second myth is that we now have to be very very worried because Standard and Poor's downgraded our debt, sending the stock market plummeting. First, Standard and Poor's has a disastrous track record in assessing credit quality. It decided to downgrade based on a $2 trillion arithmetic error and didn't change its decision when the mistake was corrected. Like the decision to go to war in Iraq, the downgrade appears to be a policy that was determined independent of the evidence.
The other problem with this story is that Standard and Poor downgraded U.S. bonds, not U.S. stock. If the markets were responding to the downgrade, then we should have expected bond prices plummet. They didn't. The price of Treasury bonds soared to near record highs in the first trading day following the downgrade.
This suggests that the stock market plunge was a response to something else other than the downgrade. It's easy to find this something else. The debt crisis in Europe had spread from small countries to Italy and Spain; countries that would be difficult to bail out. This raised the prospect of a chain of defaults leading to bank insolvencies. This in turn could produce another financial freeze-up like the one in the fall of 2008 following the Lehman bankruptcy.
That would be enough to shake stock markets even if we were looking at huge government budget surpluses for the next millennium and S&P had added a 4th "A" to the U.S. rating, as Warren Buffet has suggested. It's disturbing that these senators would repeat a scare story that they should know to be false.
The third major myth is that the prosperity and the budget surpluses of the late 90s were the result of the "tough choices" that Congress made in cutting the budget and raising taxes. Actually, if the senators go back and look at the Congressional Budget Office's [CBO] 1996 projections, they would see that it still anticipated a deficit of $244 billion or 2.7 percent of GDP for 2000. This was after the Clinton tax increases and the budget cuts had already been put in place. CBO calculated the tax and spending changes Congress put in place over the next four years added $10 billion to the 2000 deficit.
The reason that we actually had a $240 billion surplus (2.4 percent of GDP) in 2000 was that the United States had a stock bubble propelled boom at the end of the decade. This caused the economy to grow much more rapidly than CBO expected with the unemployment rate falling to 4.0 percent in 2000, rather than the 6.0 percent predicted by CBO. Do the senators not remember the stock bubble?
In addition to promoting these false stories about the economy and the budget, the senators fail to tell the true story. The large deficits the country currently faces are not the result of an ongoing pattern of excessive profligacy. They are the result of the economy's plunge following the collapse of the housing bubble. Even with the cost of the wars, the Medicare drug benefit and the Bush tax cuts, the projected deficits were relatively modest prior to the collapse of the housing bubble.
The true story is that our deficit problem is really an economic problem - we let a huge housing bubble grow, which would inevitably collapse and sink the economy. The deficit is needed now to make up for the $1.2 trillion loss in annual demand from the private sector, which had been generated by the housing bubble. The bubble had led to booms to both construction and consumption that have gone bust now that house prices have crashed.
Senator Kerry deserves special blame in this story because he could never be bothered to pay attention to the housing bubble, even when he was running for president in 2004. I recall urging his campaign staffers to pay attention to the bubble. It was like talking to Barney Frank's dining room table.
Of course Robert Rubin was one of Kerry's top economic advisers. Rubin was making tens of millions of dollars at Citigroup whose profits were derived largely from marketing subprime junk loans. So perhaps it is not surprising that Kerry had little interest in learning anything about the housing bubble.
Still it is more than a bit infuriating that Senator Kerry and his colleagues would now be lecturing the country on the need for hard choices. If they could have been bothered to do their damn jobs just a few years ago, we would not be in this situation today. As a result of their failure, tens of millions of workers are unemployed or underemployed. Yet the senators, who are still drawing their paychecks, want the country to sacrifice even more. Maybe now they can be persuaded to learn a little economics.