American Thermidor Part II
By Stirling Newberry
t r u t h o u t | Perspective
Sunday 17 April 2005
Why did the "New Economy" fail to create the "long boom" that was promised?
Before I go further, let me say that I have enormous respect for Former Treasury Secretary Robert Rubin - he is a genius in understanding the financial markets, and stands along with Bill Woodin and Alexander Hamilton at the top rank of individuals who have ever held the post. However, history is what happens when one is making other plans, and the economic program of Bill Clinton's presidency is a perfect example of how close one may come to success, and yet fall short.
The "New Economy" is the term applied to the digital economy, and particularly to the use of the internet; as with the phrases "New Politics" and "New Media," it points at the enormous potential of the world of digital communications to change how people live and participate in society. The "New Economy" rose in response to the flow of technology, much of it developed by government, and to an economic program which history will call "Rubinomics." What was Rubinomics, and what contribution did it make to the period of prosperity in the 1990s? And why did it end with a bubble and a radical change in the direction of American politics?
The key to understanding what the Clinton administration did is to remember what the vicious cycle consists of: America must import energy, this causes a trade deficit. The trade deficit, in turn, means that the US must sell assets abroad, this creates an investment deficit. To bring investment in means that one must also cut taxes on the wealthy, so that companies remain under the control of Americans, rather than being bought up by foreigners, particularly those from nations that do not have internal economies. This creates a budget deficit.
The investment deficit and budget deficit together create conditions in which real wages do not increase as quickly and there is less growth in the kind of upwardly mobile employment that people need. This situation also creates incentives for government to tax consumption, both because this reduces the trade deficit, and because the wealthy cannot be taxed. This creates a wages deficit. The wages deficit, in turn, gives people an incentive to borrow more, particularly against their homes. This creates a wealth deficit, with increasing inequality in assets. The solution to the wealth deficit is for people to use gasoline to shop around for better bargains, and to buy homes further from where they work, and in areas that do not have to pay the carrying costs of large metropolitan areas. This means they burn more energy, and this loops back around to the beginning of the cycle. The whole cycle then is:
- Energy deficit creates trade deficit.
- Trade deficit creates investment deficit.
- Investment deficit creates budget deficit.
- Investment deficit and budget deficit creates wages and wealth deficit.
- Wages and wealth deficits create pressure to use energy to generate housing wealth, which starts the cycle over again.
Each stage pushes the next along, because at each stage there is a group of people that can benefit by pushing the problem to the next group of people.
Democratic politics since 1978 has consisted of a series of attempts to find a way to break this cycle. Carter tried direct conservation, to end the energy deficit. Mondale wanted to raise taxes and investment in the US, to break the wages and wealth deficit. By the time Clinton was elected, however, there was a broad consensus that there could not be a direct attack on these problems. Clinton himself tried to attack the problem directly by proposing an energy tax, but this met with tremendous resistance and was dropped. While he was able, because of the high deficits created both by the borrowing Reaganomics had engaged in, and by the collapse of the Savings and Loan System, which was an unintended consequence of lowering energy prices, he did not have the political capital to go farther along this line than he did.
Instead, the solution was to find a different kind of paper to sell abroad for energy: instead of running a chronic budget deficit and selling bonds, Robert Rubin shifted borrowing to short-term borrowing at lower interest rates, easing the budget crunch. This created more money for investment, and the ability of the Federal Reserve to keep interest rates lower than it otherwise would have. And into this environment, with an America looking for a new engine of growth, came the internet, and "The New Economy."
The internet created a whole new class of assets for foreigners to buy; because they began rising so quickly, much of the world's savings poured into the United States. This created a "dollar shortage," and produced a series of financial crisis points around the world, as money that had been flowing to other nations flowed into the US to take advantage of the internet boom. How much of this was intentional is open to question; many of the economics team thought that the Clintonian program of free trade would lead to more investment in developing nations, rather than in the US. Instead, the US became the focus of a global stock market boom.
This dollar shortage continued to push the price of oil down, as demand for dollars went up. The higher demand for dollars, and the increasing size of their circulation, in turn, allowed the Federal Reserve to hold rates slightly below what they would have been, and created what Alan Greenspan called a "virtuous cycle" of investment and growth.
So what happened?
In one sense nothing unusual - all expansions come to an end sooner or later. The New Economy did not repeal the business cycle, and despite, or perhaps because of, the vigorousness of the expansion, the contraction that followed it was almost inevitable. But when historians of economics look back at the 1990s, they will see three factors that made the change in direction afterwards almost inevitable.
The most obvious is the Asian financial crisis that started in 1997 and expanded in 1998. The Clinton program had created a dollar shortage, and in 1997 that shortage became acute, as the "hot money," which is normally invested in high risk growth in developing countries, shifted to the NASDAQ in the US. While there are mechanical details that involve how Russia's economy had been shifted to an economic oligarchy, how Asian nations financed their banking systems, how Europe created a single currency and so on, the essential dynamic was general, and would, in all likelihood, have played out even if financial institutions had been differently structured. This is because money seeks the best mix of risk and reward - why invest in countries that have financial difficulties for high returns, when Intel and Microsoft were putting up double-digit gains every year?
This led to the second problem, that the Federal Reserve had little choice but to flood the world with dollars to prevent illiquidity from causing otherwise healthy companies to collapse, and otherwise strong economies to choke for lack of dollars to pay their creditors. The same dollar shortage that drove oil down to just above $11 a barrel made many economies starved for money to pay their creditors. While many people blame Greenspan for easing so dramatically, there is little doubt that almost any central banker would have done the same thing. Faced with a crisis, he acted. However, this very action meant that the US economy, which had been growing quickly, but not too quickly, kicked into a much higher gear. In 1998, commodity prices, which had been falling for almost 15 years, started to rise. Inflation of basic materials prices entered into the economy.
And this is the real third problem. The United States could have used what economists call "fiscal policy" to offset the forced easing by the Federal Reserve; that is, they could have raised taxes on capital gains, in order to prevent the economy from overheating. But there was no political will for this, certainly not from a Congress that hates taxes the way LBJ hated poverty, but also from a President who had just emerged from a series of political scandals involving his sex life. But this lack of political will is rooted in something deeper, and that is that the New Economy itself had gone in the wrong direction. Instead of producing growth without using more imported energy, as Clinton, Gore, Greenspan and many others, had hoped, it was directed at getting people to consume more, particularly travel, and it created people with enough stock gains to buy new houses farther from where they worked. The New Economy was used to produce a web interface to the old economy. Instead of reducing energy costs of retailing, it went into overnight shipping. While the new economy had lowered the cost of buying and selling stock, the real hope of companies was that it would make people buy more.
This then was the real failure of the Clinton policies, that while they slowed the deficit cycle, and improved real wages, instead of redirecting growth towards information, they made it so that people rushed even faster to create home wealth and use more oil. Because the vicious cycle had been stopped, but not broken, people assumed that this was the best chance in a generation to jump on, not off, the trading of gasoline for land values. To jump on, and not off, the reduction in US savings rates. Even as America poured money into the internet, the new companies saw this as a way of competing with "bricks and mortar" stores, and finding ways of marketing old goods in new packages.
Economic historians will debate what could have been done: what, in an ideal world, needed to happen to ameliorate the effects of the world financial crisis. Doubtless some will find clever solutions that involve changing rules, that would have headed off exactly what did happen. But this, as with the collapse of the gold standard in the late 1920s, ignores that the collapse was driven not by dead numbers, but by living people taking advantage of circumstances, and that different rules would probably have ended in the same place, because that is where people wanted to go: no one wanted the bubble slowed down, because they knew it was a once in a generation chance to make a great deal of money. No politician could have opposed it and survived, because that was what people wanted, one last throw at the crap game before it was raided.
And faced with this, Albert Gore, running for President in 2000, knowing that the clock was against him as a recession came ever closer, could not speak to what needed to be done. He and his major opponent both acted as if there were surpluses to spend, when the handwriting on the wall was quite clear. In American politics, it is often the case that he who tells the truth first, loses. Mondale admitted that taxes would go up, and they did. He was also at the bottom of one of the largest landslides in American history.
Albert Gore could not speak the truth, except obliquely, about the need to end the dependency of transportation on gasoline. He talked about ending the era of the internal combustion engine, but he had to tread softly, lest he convince Americans that he was going to stop them from having a chance to make a great deal of money from selling their homes. After the bubble burst on the market, it was the only road to a comfortable retirement that many people had.
And so America allowed George Bush into the race, and allowed him into the White House, simply because he promised not to break the vicious cycle of energy deficits, and instead reignited it with greater fury by pushing through a series of revenue reductions that made sure that the US was shortly back in the cycle of deficits again. The Clinton economic program - which had woven its way through so many points of danger, and which rested on some of the most brilliant work done by any economic team, was washed away within two years of his leaving the White House.