Deep truths are often embedded within paradoxes, whether in literature as in Alice in Wonderland or in science; the paradoxes of quantum theory and relativity. At present, an important paradox is lurking that has not yet been identified in the press: We are in the midst of a macroeconomic crisis. Happily, two very distinguished macroeconomists are seated side by side with President Obama, namely Christina Romer (Council of Economic Advisors), and Lawrence Summers (Domestic Economic Council). Nonetheless, neither has had anything interesting to say about today's crisis since assuming their positions. How can this be true of today's Best and Brightest?
The resolution to this paradox is that the solution to today's macroeconomic crisis does not lie within the field of macroeconomics at all, but rather within political theory - a discipline that should be front and center at present, but that regrettably has morphed into the history of political thought in centuries gone by. And with all due respect, neither Romer nor Summers has ever written anything interesting about normative political theory. Just as we should not expect a good oncologist to be a good orthodontist, neither should we expect too much from macroeconomists.
More specifically, the solution to today's economic crisis lies in the realization that what is really at stake is the root political question of how democracy can save itself from itself, and not macroeconomic drivel about what the Fed funds rate should be. How do we impose those constitutional amendments or other procedures whereby Congress is restrained from voting ever-expanding benefits (without raising taxes to pay for them) that could transform the US into a banana republic? What precise form should such amendments take?
The importance of squarely addressing these issues is redoubled when it is realized that two crises are currently in hand, not one. For today's economic and fiscal crisis will increasingly become intertwined with tomorrow's 30 year crisis of unfunded Social Security and Medicare liabilities. This become especially true in the perceptions and concerns of bond market vigilantes being asked to hold trillions of new dollars worth of long-term bonds - not just now during the Obama presidency, but long thereafter.
Accordingly, within the next two or three years, we will enter a new regime in which bond markets become the big story in the world of finance and public policy. Interest rates are likely to rise sharply over time because of new inflation and risk premiums, and in so doing will drive stock markets even more than they did in the dismal 1970s. Additionally, the rising costs of financing the ever-growing stock of debt will constrain policy-making in ways nobody wants. Still worse, such costs will constrain the rate of economic growth itself, the ultimate solvent of most every problem!
We have called this collision of today's crisis with tomorrow's crisis the End Game, and it is indeed drawing nigh. In a way, the story of General Motors offers a striking analogy to this End Game of government: "Sweetheart deals" to pay unpayable benefits were made to GM workers (think US citizens) during the period 1950-1990 when workers were young and when there were very few pensioners drawing benefits (think baby-boomers). When those workers ultimately aged and demanded their benefits (think aging baby-boomers), the till was empty. The delusion that government can transcend GM's fate because it can print money is wrong for the simply matter that "more money" does not equate to "more real wealth" with which to pay the cost of real consumption. The government crisis resembles not only General motors' crisis, but also that of New York City with its overly generous municipal workers benefits packages.
To sum up, pundits need to confront the fact that today's crisis is ultimately not macroeconomic, but political. The game theory concept of a Prisoner's Dilemma game is arguably the best model for analyzing where we are and what must be done. More specifically, what restrictions must be imposed on the strategy sets of the principal players (e.g, deficit ceilings) to resolve the underlying paradox? Additionally, how can the payoff matrix of the game be modified so that it becomes rational for individual players and interest groups to chose strategies that promote a better tomorrow for society as a whole - not a worse tomorrow. History would suggest that democracy itself becomes at risk when citizens perceive the future to be worse than the present.
In a future article, I shall propose concrete policies needed to resolve the problems identified above.