Friday Oct 29 2010
A presidency heading for a fiscal train wreck
By Nouriel Roubini
Published: October 28 2010 20:48 | Last updated: October 28 2010 20:48
What has been the fiscal performance of President Barack Obama? He
inherited the worst economic crisis since the Great Depression, as well
as a budget deficit that – after much needed bail-outs and a series of
reckless tax cuts – was already close to $1,000bn. His stimulus package,
together with a backstop of the financial system, low rates and
quantitative easing from the Federal Reserve, prevented another
depression. Mr Obama also deserves credit that the US, alone among
advanced economies, currently supports a “growth now”, rather than an
“austerity now” path.
But this is but one half of the picture; we must also judge his first
two years on his ability to anticipate what the economy will need
tomorrow. Here the picture is much less positive. Given the likely path
of fiscal policy after next Tuesday’s election – with the expiration of
existing stimulus and transfer payments, and even with most of the
2001-03 tax cuts being kept – the US economy will soon experience
serious fiscal drag just when it needs a further boost. Problematically,
the administration’s failures leave it relying on the Fed, which is bent
on further QE, likely to be announced next Wednesday. But studies show
this will have little effect on US growth in 2011, so fiscal policy
should be doing some of the lifting to prevent a double dip recession.
In an ideal world Mr Obama would also have been able to move towards
reforming and reducing entitlement spending, with commitments to
measures that could be phased in over the next few years, therefore
avoiding short-term fiscal pain. He would also have committed to
increase, gradually over the next few years, less distortionary taxes
such as a VAT and a carbon tax. This would have reduced the fiscal
deficit, and created a climate in which no investor would worry about
additional stimulus.
Sadly, this has not happened. In fact the opposite will now take place.
The term stimulus is already a dirty word, even within the Obama
administration. After the Republicans make significant electoral gains
further stimulus is even less likely. Medium-term consolidation,
meanwhile, will be all but impossible as the 2012 presidential election
begins to loom large.
In truth the only window of opportunity is 2011. Here the president
deserves credit for setting up a bipartisan debt commission, which is
most likely to propose a sensible combination of entitlement spending
cuts and increases in taxes. But sadly the chance that these
recommendations will be implemented in 2011 is close to zero.
Republicans will veto any tax increase, while Democrats will resist
unpopular entitlement reform.
The upshot is that the current gridlock in Congress will soon get much
worse. Of course, Mr Obama cannot entirely be blamed for his limited
progress, when the Republicans take that Leninist approach of “the worse
the better”, and offer no co-operation on any issue. That they now see
Mr Obama as a one-term president will soon mean the worst open warfare
inside the Beltway in 30 years.
The coming stalemate will only be made worse by the lack of a reason to
act on the deficit. The bond vigilantes are asleep, while borrowing
rates remain unusually low. Near zero rates will continue as long as
growth and inflation are low (and getting lower) and repeated bouts of
global risk aversion – as with this spring’s Greek crisis – will push
more investors to safe dollars and US debt. China’s massive
interventions to stop renminbi appreciation will mean purchasing yet
more treasuries too. In short, kicking the can down the road will be the
political path of least resistance.
The risk, however, is that something on the fiscal side will snap, and
the bond vigilantes will wake up. The trigger could be a debt rollover
crisis in a major US state government, or perhaps even the realisation
that congressional gridlock means bipartisan solutions to our
medium-term fiscal crisis is mission impossible. Only then will our
politicians suddenly remember that, on top of our federal debt, the US
suffers from unfunded social security and Medicare liabilities, state
and local government debt, and public pension bills that add up to many
multiples of US GDP.
A bond market shock is thus the only thing likely to break the impasse.
Mr Obama may take some comfort from the fact that the worst of the
coming fiscal train wreck will be prevented by the Fed’s easing. But the
risk is he will then preside not over a bout of inflation but a Japanese
style stagnation, where growth is barely positive, and deflationary
pressures and high unemployment linger.
The Obama administration did the right thing early, and avoided another
depression. He is still doing the right thing now in pointing out the
risks of early austerity. And he is limited by an unco-operative
Republican party trapped in a belief in voodoo economics, the economic
equivalent of creationism. Even so, he and his party have been unwilling
to tackle long-term entitlement spending. Two years in, and this means
the US remains on an unsustainable fiscal course.
The result will soon be the worst of all worlds: neither short-term
stimulus nor medium-term fiscal sustainability. Fiscally the only light
at the end of the tunnel may be that which causes the upcoming crisis.
With two years of gridlock in prospect, it will fall to the next
president in 2013 – whoever he or she may be – to start fixing America’s
fiscal mess. Whether that is Mr Obama or not, that he may leave this
challenge may become the worst of his legacy.
The writer is chairman of Roubini Global Economics, Professor at the
Stern School of Business, NYU and co-author of Crisis Economics
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