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Deficit Hawks: Substituting Money for Competence

Monday, 29 November 2010 09:46 By Dean Baker, t r u t h o u t | Op-Ed | name.

Deficit Hawks: Substituting Money for Competence
(Image: Jared Rodriguez / t r u t h o u t; Adapted: benleto, respres)

The Washington Post, National Public Radio (NPR) and everyone else who is respectable in Washington agrees: we must do something about the deficit now. They also agree that this "something" involves major cuts to the Social Security and Medicare, programs that the middle class depends upon.

According to these knowledgeable, respectable types, there is no alternative to painful cuts. The question is whether politicians will have the courage to take a baseball bat to the middle class.

Before we consider their claims about Social Security and Medicare, let's remember what these people were not saying three years ago. Specifically, without exception, these authority figures failed to recognize the largest financial bubble in the history of the world. This failure of the people in power, including the deficit hawks, is responsible for the enormous suffering that the country is now experiencing.

It did not require a crystal ball, tea leaves or brilliant insight to recognize the housing bubble and the risks it posed. It required a knowledge of basic economics and the simple arithmetic that most of us learned in 3rd grade.

There was a 100-year-long trend in which nationwide house prices had just tracked the overall rate of inflation. Beginning in the 1996, with the takeoff of the stock bubble, nationwide house prices began to substantially outpace inflation. At their peak in the summer of 2006, house prices had risen by more than 70 percent in excess of inflation, creating more than $8 trillion in housing bubble wealth.

There was no remotely plausible explanation for this sudden divergence from long-term trends on either the demand or supply side of the markets. The growth in households had slowed markedly from the '70s and '80s, when the baby boomers were first forming their own households. Income growth had been good in the late '90s, but turned negative with the 2001 recession.

There was little holding back the supply side of the housing market, as 2002-2005 was a period of near record construction. Furthermore, we had record vacancy rates as early as 2002. Let’s see, we had record prices and record oversupply; how could anyone not think that this was a bubble waiting to burst?

And how could anyone not realize that the bubble's collapse would devastate the economy and lead to a financial crisis? The record rates of construction would undoubtedly flip to record low rates, in the absence of bubble-driven demand. Similarly, the hundreds of billions of dollars in consumption demand spurred by housing bubble home equity would disappear when the bubble equity evaporated.

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Does anyone know of a quick way to replace more than $1 trillion in annual demand in the economy? This disaster was entirely foreseeable.

Even the financial crisis was an entirely predictable outcome, although the specifics and the timing could not be known. How could anyone have been surprised by large-scale defaults? Many people were buying homes with almost no money down, and sometimes with literally no money down.

Can a serious person really be surprised when a homeowner then defaults on a house that has lost 30 percent, 40 percent or even 50 percent of its value? And, could a serious person really be surprised that highly leveraged financial institutions would face insolvency when these loans started going bad in large numbers?

It was all clear as day to anyone who was prepared to look at the basic economic facts. That is, it was clear to anyone who was prepared to look at the facts and do a little thinking beyond what the elite Washington gang considered acceptable. Unfortunately, among the "experts," original thinking is virtually unknown.

So, when you read a Washington Post editorial demanding action on the deficit, just remember that you are reading recommendations on the economy by a group that could not see that house prices were 70 percent above their long-term trend. When you hear NPR present one-sided stories telling listeners about the urgent need to cut Social Security and Medicare, you are getting news from people who didn’t bother to report on an $8 trillion housing bubble whose collapse was imminent.

All those knowledgeable columnists who tell the public that there is no alternative to cuts in these popular programs failed to see the 200-pound tumor sitting on the economy’s heart back in 2007. And those well-funded and authoritative-sounding deficit commissions don’t include a single person who could see the largest economic storm cloud in the history of the world, even when it was right in front of their eyes.

Before we take any advice from these people, we should demand that they answer one simple question: When did you stop being wrong about the economy? 

Dean Baker

Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University. He is a regular Truthout columnist and a member of Truthout's Board of Advisers.

Last modified on Monday, 29 November 2010 12:07