Borrowing Our Way into Debt

On September 26, 2011, in economic theory, housing, monetary policy, tax policy, by Jon Lewis

Lost Decades: The Making of America’s Debt Crisis and the Long Recovery. Menzie D. Chinn and Jeffry A. Frieden. W.W. Norton & Company 2011, pp.284, $26.95 The United States is facing a debt crisis that will shape not only American politics, but also American culture for decades to come. Those policymakers tasked with solving this [...]

Lost Decades: The Making of America’s Debt Crisis and the Long Recovery. Menzie D. Chinn and Jeffry A. Frieden. W.W. Norton & Company 2011, pp.284, $26.95

The United States is facing a debt crisis that will shape not only American politics, but also American culture for decades to come. Those policymakers tasked with solving this crisis must do so in a context where the national unemployment rate in August was at 9.1%, many recent college graduates are underemployed and living at home with their parents, and the stock market is exhibiting increased volatility. How did the United States get to the point where the gross debt is about 98% of U.S. GDP and, more importantly, where do we go from here?

In Lost Decades, Menzie D. Chinn (University of Wisconsin-Madison) and Jeffry A. Frieden (Harvard University) argue that our current dire economic situation is, despite its unique attributes, a classic debt crisis, resulting from a capital flow cycle in which foreign capital flooded into the United States, stimulated a boom, and resulted in a subsequent bust. Although they are not hyper-partisan in their writing, Chinn and Frieden contend that flawed and shortsighted government policies are to blame for the current mess in which we find ourselves.

In their formulation, between 2001 and 2007, the United States pursued dangerous policies that, in the past, it had warned other countries against. These included “excessive borrowing, unproductive spending, foolish tax policies, and unwarranted speculation.” Much of the borrowed money from abroad was not utilized productively; rather, much of it was diverted into an unsustainable housing boom made possible by innovations in structured finance. These aforementioned dangerous policies, the authors argue, led to the near meltdown of the financial sector in 2008 and to the United States losing, in economic terms, the first decade of the twenty-first century. Should we collectively fail to respond adequately to the serious challenges facing the American economy, the authors warn, we shall lose another decade.

Due to the authors’ utilization of a comparative and an historical approach to explain America’s dire economic situation, Lost Decades stands out among recent scholarship on the financial crisis. Chinn and Frieden make a strong case for their argument that the American borrowing binge and its resultant debt was, in many ways, not all that different from other countries’ experiences. It was, however, different in its scope. The authors pull no punches; they contend that “there has rarely been a capital flow cycle quite so enormous in its upswing as the American borrowing boom of 2001-2007, and there has rarely been a crash quite so dramatic or so global as the American collapse of 2008.” Indeed, the authors point out that the United States is now the largest international debtor ever in world history. A stark warning of the unsustainability of our current course, if ever there were one.

Readers interested in globalization and the nuances of world trade will find much of value in Lost Decades. Particularly salient is the authors’ discussion of the U.S.-Chinese economic relationship and the need for global rebalancing. American policymakers, we are reminded, have to make their decisions within a global context and with global repercussions. This is notably the case with respect to American concerns regarding the Chinese government’s deliberate policy of keeping their currency, the renminbi, very weak or depreciated. The authors suggest that this conflict over the value of Chinese currency “is emblematic of the domestic and international conflicts the Great Recession will spark and deepen.” One could imagine other scholars taking up this point and conducting a study of how the Great Recession has already affected the American relationship with China and how it will continue to do so in the future.

For ideologues on both sides of the aisle, the most controversial portion of the Lost Decades will be the penultimate chapter. Here, the authors offer their policy recommendations on how the United States should proceed so as to avoid another lost decade. The authors, whose political views could be described as center-left, call for fiscal responsibility and are upfront in their belief that “true fiscal responsibility involves a willingness to raise sufficient tax revenue, over the longer term, to pay for the programs the government implements. Fiscal responsibility should not be equated with a small government, but rather with a commitment to pay for the government services provided.” Whether the American voting public agrees with this particular understanding of fiscal responsibility, of course, will be decided at the ballot box in 2012.

The authors, it should be noted, are not liberal ideologues, either. They rightly acknowledge that entitlement spending, particularly the challenges posed by Medicaid and Medicare, are driving the budget deficit. The only measures likely to make a real difference in countering the deficits and reducing the debt burden, they contend, are to both make substantial reductions in Medicare, Medicaid, and Social Security and to significantly increase taxes. Whether Democrats and Republicans will be able to put together such a deal, one that would anger both their political bases, remains to be seen.

While the authors are not without merit in criticizing the Bush Administration for creating the Medicaid prescription drug program without proper funding, they fail to take seriously the increasing probability that the Obama Administration’s signature health care reform legislation will have a deleterious effect on the American economy and job creation. In addition, for a work on the financial crisis of 2008, Lost Decades does not adequately address the impact that the Community Reinvestment Act had on aiding and abetting the housing bubble. Likewise, it could be argued that the authors let Fannie Mae and Freddie Mac off the hook a little too easily.

Despite these shortcomings, Lost Decades is a highly informative analysis of the American debt crisis. The authors explain difficult economic and financial concepts with great clarity. Even if one does not agree with all of the authors’ arguments, their work is one of most comprehensive on the financial crisis. To that extent, it is worth ample consideration by those interested in moving beyond platitudes and toward a workable solution to America’s economic woes.

Jon Lewis (c) 2011

Tagged with:  

Comments are closed.