Can Obama’s policies fix the economy?

April 8, 2009

With unemployment reaching a new quarter-century high, the pressure is on for the Obama administration to deliver help for working people and get the economy on the road to recovery. economics writer Lee Sustar answers your questions about what Obama is proposing, and what the chances of success are.

JUST WHEN there was a discussion of a possible economic recovery, the government's report showed unemployment rising to 8.5 percent and another 650,000 jobs gone. Has the economy bottomed out?

NO ONE really knows. Those who say that the worst is behind us either represent financial institutions trying to sell investments, or they're members of the Obama administration's economic team. Christina Romer, the chair of the White House Council of Economic Advisers, said recently that she's "incredibly confident" the U.S. economy will recover within a year.

It's true that job loss statistics released April 3 weren't as terrible as some economists were predicting. But they're plenty bad: the unemployment rate jumped from 8.1 to 8.5 percent. That figure rises to 15.6 percent when it includes "marginally attached workers"--those who've given up looking for work, or who've had to accept part-time work if they can't get a full-time job.

Some economists anticipate that this broader measure of unemployment could surpass 18 percent in the months ahead. As the Wall Street Journal reported, "For people in this group, comparisons to the Great Depression (when 25 percent of Americans were out of work) may not look so wild, even if overall economic activity is holding up better."

President Barack Obama with Treasury Secretary Tim Geithner
President Barack Obama with Treasury Secretary Tim Geithner

CAN PRESIDENT Obama's economic policies counteract the economy's decline?

THE OBAMA administration's strategy to revive the economy has four interrelated aspects: (1) shore up the private financial system by having the government absorb the banks' toxic assets and providing virtually free credit to Corporate America; (2) revive consumer demand through tax cuts and easier terms for loans, including mortgages; (3) encourage the private sector to preserve or create jobs through stimulus spending and increases in the federal government's budget; and (4) force the restructuring of major industries, like auto, by attaching strict conditions on government loans.

All this constitutes the greatest government intervention in the economy since the Great Depression of the 1930s. Enormous economic powers are being concentrated in the executive branch of government via the U.S. Treasury and the Federal Reserve Bank, which is nominally independent, but in practice subordinate to the White House.

Paradoxically, however, the government is doing its utmost to leave private capitalists in control of financial institutions and government-financed companies, rather than nationalize them outright.

What else to read

The International Socialist Review has published a series of analytical articles on the economic crisis. Recent contributions include Fred Moseley's "The U.S. economic crisis: Causes and solutions" and Joel Geier's "Capitalism's worst crisis since the 1930s."

There are a number of good books on the financial crash, including Dean Baker's Plunder and Blunder: The Rise and Fall of the Bubble Economy and Graham Turner's The Credit Crunch: Housing Bubbles, Globalization and the Worldwide Economic Crisis.

To be sure, the Obama administration forced Rick Wagoner to step down as CEO of General Motors to try and defuse anger over the $165 million bonuses paid to AIG executives. The government may also oust individual Wall Street bosses in the future if the pressure is sufficient.

Yet the Obama administration desperately wants to preserve private property, even when the companies involved couldn't survive without a constant infusion of taxpayer money.

WHY NOT just nationalize the banks and other financial firms, rather than keep spending endless amounts of taxpayer money to keep them going--like the $173 billion given to AIG so far?

DEFENDING PRIVATE property is the default setting of U.S. politics. Nationalization, we're told, is for Europeans and Third World leftists like Hugo Chávez of Venezuela.

But the more important factor is that the bankers have, in the words of economist Simon Johnson, carried out a "silent coup"--they've used their influence in Washington to block any attempt to make them politically accountable, let alone see their companies placed under government ownership.

Johnson should know what he's talking about. He's the former chief economist of the International Monetary Fund (IMF), a job that involved dictating the terms of financial restructuring in several countries. Now, he says, the U.S. financial barons are behaving just like the entrenched business oligarchs in countries like Russia and Indonesia.

So instead of the U.S. government taking over the banks, the bankers have taken even greater control of government policy. Treasury Secretary Tim Geithner, for example, was formerly president of the Federal Reserve Bank of New York. That is, Geithner was the main government overseer of Wall Street even as the big banks drove the economy off the cliff by loading up on mortgage-backed securities and complicated assets known as derivatives.

It was Geithner who negotiated the nationalization of AIG in a meeting that included Lloyd Blankfein, CEO of Goldman Sachs, a major trading partner with AIG. Is it a coincidence that Goldman recently collected $12.9 billion in payment from AIG--or rather, from the U.S. taxpayers, since our money only paused briefly on AIG's books before being funneled into the most powerful company on Wall Street?

But the AIG ripoff is only the beginning of the government's stupendous transfer of wealth from the working class to finance capital. Under Geithner's bank bailout program--the Public-Private Investment Partnership, or PPIP--the government will match private investors' initial investment in mortgages and other toxic assets.

The Federal Deposit Insurance Corp. (FDIC), the government agency that guarantees your checking or savings account, will be pressed into service for the PPIP. Under Geithner's plan, the FDIC will finance up to 85 percent of the money that hedge funds and other firms will use to buy those assets. (This legally dubious maneuver allows Geithner to come up with money for the program without going to Congress.)

If PPIP investments in toxic assets pay off, the government and private investors split the profits. Yet since private investors are required to put up so little of their own money, their gains could be as high as 30 percent. If the assets turn out to be bad, though, the government guarantees investors against losses.

Geithner somehow keeps a straight face when he claims that PPIP will help revive the economy. By assisting Wall Street, the cliché goes, the government will help Main Street through a revival in lending.

In reality, the big banks remain crippled by bad investments and are using the money to cover current and future losses. Even so, with commercial real estate tanking and corporate bankruptcies in the offing, things are likely to get worse for the banks before they get better.

That's why Wall Street was so anxious to get details of Geithner's PPIP. The real aim of the operation is for the government to absorb as much of the banks' losses as politically possible--which means workers will pay the price through higher taxes. In other words, Wall Street has gotten everything it wanted from Geithner, and then some.

And if any more proof is needed between the interpenetration of Wall Street and Washington, consider the career--and income--of Larry Summers, Obama's top economic adviser. A former Treasury Secretary who was later forced out as president of Harvard for making sexist comments, Summers earned $5.2 million as a managing director of D.E. Shaw, a $30 billion hedge fund. He got another $2.77 million for speaking engagements, including $135,000 from Goldman Sachs.

CAN OBAMA'S economic policies work?

THAT DEPENDS on your definition of "work." Then there's the question, "work for who?"

First, the $787 stimulus package will give a modest boost to the U.S. economy. But every serious economist says this amount is too small to compensate for what the Congressional Budget Office estimates will be a $2 trillion shortfall in the U.S. economy over the next two years.

Obama's $3.6 trillion budget for fiscal 2010, which relies heavily on deficit spending, should provide some further lift to the economy--provided that Congress fully appropriates the money later this year.

Even so, the administration's biggest effort to juice the economy may come from the Federal Reserve, which effectively created about $1.3 trillion out of thin air in order to purchase Treasury bonds and securities issued by the government-run mortgage companies, Fannie Mae and Freddie Mac.

By injecting this amount of money into the system while keeping interest rates near zero, the Fed aims to spur lending and economic activity in general.

The Fed is also set to finance another $1 trillion loan program, known as the Term Asset Loan Facility (TALF). Under this program, the Fed will allow banks and other financial institutions to put up bad mortgage-backed securities and other toxic assets as collateral.

Since much of that collateral is worth far less than its value on paper, the Fed will be on the hook for huge potential losses. Thus, some analysts call the TALF a backdoor bailout--a program that, like PPIP, is designed primarily to offload toxic assets onto the federal government.

The Financial Times predicts that once the TALF is fully implemented, the Fed's balance sheet will approach $4 trillion, nearly a third of the size of the U.S. economy. That's uncharted territory.

WON'T ALL this lead to inflation?

THAT'S CERTAINLY possible. But the Fed and the Obama administration are far more worried about deflation--a vicious downward spiral in prices that can set in as an economy shrinks.

Widespread falling prices suppress economic growth--why buy now if prices will be lower later on? Deflation also makes debt burdens even greater. That's because the dollar amount of the debt becomes ever higher in relation to the prices of commodities--which is exactly what happened during the Great Depression.

There's another important dimension to the U.S. efforts to expand the money supply--namely, a drop in value of the dollar in relation to other major currencies, like the euro and the yen. Imports to the U.S. therefore become more expensive, while American exports are cheaper. The economic textbooks call this a "competitive currency devaluation," a tactic that's historically been used by one country to foist the cost of the crisis onto others.

Also, a devalued dollar has the effect of effectively reducing U.S. debts to China, where banks hold upwards of $1 trillion of U.S. government and government-backed bonds. The Chinese government has complained about this, and even raised the idea of creating a new international currency to replace the dollar. But for now, China is stuck with U.S. dollars, which remain the safest form of investment, if only because the alternatives are so much worse.

WILL THE agreements at the Group of 20 (G20) summit in London spur an economic recovery internationally?

THE SLUMPING world economy has put the leaders of the G20 countries under growing political pressure.

The IMF predicts that the global economy will shrink this year by between 0.5 and 1 percent, while the World Bank anticipates a contraction of 1.7 percent. The Organization for Economic Cooperation and Development, the group of leading industrialized countries, predicts the world economy will contract by 2.75 percent.

But rather than drive world leaders toward international cooperation, the crisis has instead brought rivalries into the open. Most notably, the U.S. failed to convince Germany and other major European countries to boost their economies by running up government budget deficits.

Essentially, Germany refuses to allow its economy to bear the cost of bailing out the European Union's weakest economies in Eastern Europe. For its part, the U.S. staved off attempts to create a new system of international financial regulation.

The world's richest countries did agree to boost funding for the IMF to $1 trillion. That money will be used to finance emergency loans to the so-called "emerging economies" in Eastern Europe, Asia, Africa and Latin America. But the IMF will, as usual, use these funds to give the major economic powers leverage over the smaller and weaker countries.

Even if the U.S. does experience an economic revival by the end of 2009 or early 2010--and that's a big "if"--long-term problems remain for the world economy.

That's because the U.S. can no longer use consumer debt to become the world's importer of last resort. This means China, in particular, must transform an economy that's overwhelmingly geared to exports into one with a bigger internal consumer market--a complex, and perhaps impossible, transition.

What international capitalism needs to revive, therefore, is a major reordering of the world economy. That's a process that will take many years--and if capital has its way, the tremendous costs involved will be borne by workers.

The story doesn't end there, however. In a growing number of countries--most dramatically in Greece and France--workers are taking to the streets with widespread strikes and protest. Such resistance is needed in the U.S. as well--both to challenge the bailout to the banks and to force workers' needs into the political agenda.

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