Wednesday, March 19, 2008

Establishing Discipline: Over Fundamentals or Over Ideology

The United States is facing a very difficult situation currently due to the economic policies the Bush Administration has followed over the past seven years or so. To begin with, the Bush Administration came into office with the Federal budget in surplus and with the Federal Reserve following a relatively disciplined monetary policy. In a sense, the fiscal and monetary house of the United States government was in order.

Basically, the new administration decided to go it alone. That is, it would conduct its economic policy independently of the rest of the world. This was not inconsistent with what the administration was doing in other areas, such as foreign policy. Its first major economic policy action was to construct and then get Congress to pass a substantial tax cut. This, of course, would throw the Federal budget into a deficit, but, the feeling was that this tax cut would stimulate the economy and create sufficient revenues in the future to reduce the deficit and make it manageable. Also, there was some talk about slowing down the growth, or even eliminating some expenditure programs and this would further help to eliminate the deficit. The tax bill was passed.

In devising its fiscal plans, the administration did not anticipate the events of September 11, 2001 and its aftermath. Not only did these events precipitate a ‘war of terror’, they also resulted in one war in Afghanistan and another in Iraq. The expenditure side of the budget grew very rapidly. Furthermore, all three ‘wars’ left open a future commitment to an unpaid bill that was enormous. Occurring at about the same time all this was happening, the Federal Reserve was setting its operating target for the Federal Funds rate at 2% or below for a period of over 3 years. Given the rate of inflation during this time, this meant that the real rate of interest on these short term loans was negative.

The value of the United States dollar began to drop in 2002. World markets were concerned about how the Bush Administration was acting independently of the rest of the world and that they were not playing by the ‘rules’ of international finance. The most basic rule of international finance is that one country cannot ‘inflate’ its economy for its own purposes without a consequent decline in the value of its own currency in foreign exchange markets. This is just a fundamental result of how markets work. But, in the past, the United States being as big and powerful as it was, could get away from acting independently of these rules. This is no longer the case.

As the value of the dollar declined in foreign exchange markets, the Bush Administration gave lip service to the fact that the dollar was falling in value, but did nothing about it. As a consequence, the dollar continued to decline, falling by about 7% a year against the Euro between 2001 and 2007. It also fell by over 5.5% per year against the British Pound. The day of reckoning has finally appeared.

Historically, all countries that once had significant economic and financial positions in the world, except the United States, faced a transition from being able to act relatively independently of the rest of the world and having to abide by the workings of international markets. As countries moved from the former position of relative independence to disciplined cooperation, they went through a period of learning. During this period, the country in question would find that as it attempted to act independently of world markets through the creation of budget deficits that were eventually monetized by its central bank, ‘international bankers,’ an ambiguous and anonymous clandestine group of money managers, would start selling their currency until the drop in value became significant enough that the government had to back off its fiscal and monetary policies and establish a sound and disciplined program going forward.

The United States now seems to be in this transition position. The world has changed and it is no longer the world power it used to be. Yes, it is still powerful and important but due to globalization and the reliance of the world on oil it is not as important as it once was. As a consequence, the rest of the world is now showing the United States that it must join the club, it must humble itself enough to be realize that it must work with others and not just act as it wishes.

This is the background of the point I would like to make about the working of governments. The Bush Administration constructed its economic policy on the basis of an ideology. This ideology came from the presidential administration of Ronald Reagan. It is founded upon the premise that it is always good to cut taxes. In the past, this premise was presented along with the idea that programs should be cut as well in order to maintain fiscal discipline and reduce the size of the government. However, this latter component fell to the wayside when the proponents of ‘small government’ found that it was not practical or feasible to cut programs from the budget. Thus, only the first part of the ideology remained. Cutting taxes is good!

‘Conservatives’ and the Bush Administration stuck to the ideology. It brought in people to work in the administration that were loyal to the ideology. And, they enacted their tax cut and everybody was happy…on the ‘conservative’ side of the aisle. Discipline was rampant, but the discipline was to enforce adherence to the ideology regardless of the consequences of the impact of its execution. Furthermore, we see this imposed discipline carrying through to the campaign to become the Republican nominee for President in the 2008 election. Candidates went through unbelievable loops to sound convincing that they would continue the Reagan policy of cutting taxes if they were elected President. All seemed intent on becoming the next Ronald Reagan and they fought over who was the most representative of the Reagan tradition.

The problem is that the times have changed. The fundamentals are different now than they were 15 years ago let alone 28 years ago. The United States is not in the position it once was and must respond to the new fundamentals. The market imposes discipline upon those that operate within the market system. There is now enough wealth and power held outside the United States so that the United States must respond to this discipline and impose the discipline upon itself. This is all a part of being just one among many. One must pay attention to the wishes and needs of others. Within such an environment one must conform to the rules and become a good citizen.

This insight applies more than just to the ‘most powerful nation in the world.’ It also applies to those who hold power locally or regionally. Yes, the United States has been arrogant in attempting to impose its will on the world, but others have also been arrogant in attempting to impose their will on their ‘limited’ worlds. The attempt to impose an ‘ideology’ on others and the discipline that is applied to establish or maintain an ‘ideology’ on others is doomed to failure over the longer run. The problem is that the attempt to enforce the ‘ideology’ in the short run can have many dire consequences. The ‘ideology’ of the Bush Administration was related to tax cuts. The ‘ideology’ of others relates to ‘political correctness.’ The ‘ideology’ of others relates to Islamic fundamentalism. And, we can go on, if needed, to identify many more ‘ideologies’ that are alive in the world today.

What I am more interested in is the discipline that is necessary to be aware of and respond to the ‘fundamentals’ that exist in the world. I am not a post modernist. I do not believe that any worldview works and it is just a matter of who is in power. In the case of the economic policy of the United States and the decline in the value of the dollar…markets do work, some better than others, but, they do work. As a consequence, people, governments, and other organizations must operate within the boundaries and limits of being in a world with other people, governments and other organizations. This takes discipline, but it is a discipline that responds to and operates within the ‘fundamentals’ of the world. Some things, some models, some worldviews do work better than others. We must discipline ourselves to achieve the goals and objectives that are dear to us but we must do this in concert with the way the world works.

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