An Inheritance of Ashes

by Karl Reiner

The Congressional
Budget Office estimates the federal budget deficit for the fiscal
year ending September 30, 2009 at $1.2 trillion. That amounts to
$4,000 for every man, woman and child in the United States. The
rapidly soaring deficit is one of the many unresolved issues the
Obama administration has inherited from the group leaving the White
House.

President Obama will no
doubt end the outlandish policy of launching understaffed military
actions. He also sees the folly of ignoring the need to raise taxes
to cover costs once the military has been committed. Although
conditions are improving in Iraq, they appear to be going the other
way in Afghanistan. President Obama faces a dilemma in extraditing
the military from these ineptly managed interventions. He has to
ensure that functioning and survivable governments are in place in
these countries so the troop exit can be permanent.

Unfortunately,
America’s enemies know an opportunity when they see it; they
will do what they can to prolong U.S. involvement. Until a
resolution is reached, the drain on the government’s financial
resources will continue. The affairs in Iraq and Afghanistan cost
the government over $12 billion per month.

The financial crisis
triggered by the sub-prime mortgage mess continues to take its toll.
The total number of questionable mortgages in the system is a
staggering 25 million. The home foreclosure rate is at an all time
high, with 2.3 million homeowners facing foreclosure. As a
consequence, the value of the nation’s housing stock continues
to slide. In some areas, housing prices could fall by an additional
20% before the situation turns around.

Nervous banks have
tightened their lending requirements, resulting in a credit shortage
that is slowing the economy. It has become apparent that a
combination of government policies, lack of oversight and
deregulation contributed to the problem. The use of credit was
allowed to go nearly unchecked; it ran virtually out of control. How
our national housing policy evolved from one originally designed to
help provide a necessity of life into an item of rabid speculation is
a question that needs to be addressed by the administration and
Congress.

The rapid decline in
the housing market has set off a huge chain reaction. Retail sales
are slumping as worried consumers cut spending. Business investment
is declining. Jobs are disappearing at an alarming pace; the
unemployment rate is expected by some analysts to go to 10%. The
income of the states has been clobbered. Surpluses have evaporated;
the majority of states are in financial trouble. California leads
the pack with a $41 billion gap in its budget.

Alan Greenspan, the
former Federal Reserve Chairman, says we are in the worst economic
crisis since WWII. Other observers believe we have stumbled into an
economic morass that could, if not contained, end up being as
damaging as the Great Depression. The policy of getting government
off of the backs of the American people may have been carried to a
perilous extreme. The visible rewards of deregulation came with an
unseen price; they carried with them a growing degree of economic
insecurity.

Deregulation removed
many of the safety nets. As part of the free market conversion, the
gradual change from pensions to the 401(k) shifted the responsibility
for providing the safety net from business and government to the
individual. The concept worked fine as long as housing and stock
prices climbed; now many individuals are finding their home value and
retirement savings decimated.

After more than a
trillion dollars in wealth dissolved one day on the stock market, a
worried Congress, pushed by the Treasury and Federal Reserve, hastily
enacted a $700 billion program to buttress the sagging financial
system. Thus far, it has unsteadily managed to head off a complete
collapse on Wall Street and financial panic on the nation’s
Main Streets.

With the U.S. projected
to slide deeper into recession this year, the focus of the
administration will be on restoring the nation’s economy to
health. As it tackles the job, its experts face many unknowns.
Developing policies that will turn things around will be difficult
because there is a degree of uncertainty as to what will work.
Monitoring the results of the previous salvage effort and getting the
new $800 billion stimulus program that President Obama wants
implemented will dominate the agenda for months to come.

The consequences of our
mortgage muddle have reverberated around the globe. The shock wave
set loose in the U.S. has affected China, India, Japan, Latin America
and Europe. As banks collapse around the world, America’s once
highly rated commercial paper has lost much of its luster. It may be
some time before foreigners are willing to put a high degree of trust
in our financial products.

As the current
recession deepens there have been comparisons made between the
present state of disarray and the Great Depression. Although the
economy is troubled, the situation is not anywhere near as bad as it
was during the infamous depression. During that time, stocks lost
80% of their value. Over 10,000 banks failed. The economy shrank by
31%. By 1932, the unemployment rate had reached 25%. Industrial
production dropped over 46%. As the depression spread world-wide,
international trade fell by two-thirds.

The Great Depression
also caused massive political dislocations. Around the world, 25
countries became dictatorships between 1929 and 1939. The depression
crushed recovery in Germany, helping to destroy the Weimar Republic.

In 1928, Germany was
beginning to recover from the effects of defeat in World War I.
Hyperinflation had been brought under control, and unemployment was
beginning to dip. In the May elections, the National Socialist
German Workers Party (Nazi) won just 12 seats in the Reichstag,
getting less than 3% of the national vote. The onset of the Great
Depression ended the recovery. As conditions worsened in September
1930, the Nazis’ vote share climbed to over 18%.

As political collations
disintegrated under the strain of the economic breakdown, Germany’s
citizenry became demoralized. The unemployment rate climbed to 30%.
In the July 1932 elections, the Nazis received 37% of the vote. As
faith in democracy continued to splinter, the Nazi party became the
country’s largest political party. Its leader, Adolph Hitler,
became chancellor in January 1933. Once in power, he quickly
demolished the last vestiges of democracy. His malevolent policies
made war a certainty.

In pre-depression
Japan, shipments to the U.S. provided two-fifths of export income.
The intensity of the downturn, along with popular discontent
regarding limitations on the size of the navy, reinforced the appeal
of the militarists. After the military gained control of the
government in 1931, Japan expanded plans to secure raw materials and
markets by force. It was a policy that led to Pearl Harbor.

The impact of the
current economic crisis could generate its own host of bedeviling
political problems. Approximately 200 million people, about 3% of
the world’s population, live outside their home countries. The
global economic slump will force many of them back to countries with
little to offer. With expectations dashed, resentment could fuel a
rise in radicalism.

As the recession
deepens, millions of workers in China and India, many of them recent
migrants from the countryside, are in danger of losing their jobs.
Remittances to Mexico are falling, down by over 4%. With a
substantial part of the population dependent on these payments, the
government will be hard pressed to fill the gap.

The political
ramifications of economic events are not easily predicted, but they
should be expected. History has shown that people’s fears and
the human desire for improvement can be easily manipulated by
authoritarian leaders. The worsening state of international economic
affairs may result in some unwelcome new political challenges the
Obama administration will have to deal with. These are difficult
times, and due to the depth and complexity of the interrelated
problems, improvement will come later than most people expect.

Karl managed international trade and economic policy analysis at
the U.S. Department of Commerce. He served as an
acting deputy assistant secretary during the first Bush and Clinton
administrations.