In my recent letter to the editor to the Albany Times Union, “Defaulting on debt a national disaster” (here), I argued that the budget and debt limit crises are the result of the massive growth of inequality, in particular the concentration of wealth in the top 0.01%, 0.1%, and 1% of American households. The top 1% has gained well over $20 trillion of wealth (net worth) since 1980, in constant dollars, and much of that has been financed by federal tax cuts that resulted in the more than $16.7 trillion national debt we face today. I observed that both the amount of the wealth that has transferred to the top, and scope of the catastrophe that will follow defaulting on the debt, are “unimaginable.” My accompanying blog post, “Inequality and the National Debt” (here) provides the details of the wealth transfer, but does not explain what would happen following a default and how catastrophic it would be. It’s a matter of great speculation, but I want to try to do that here.
First, we have to be in touch with the macroeconomic implications of income and wealth redistribution. Here are the points I think we need to consider, which have been explored in earlier posts on this blog:
1. The distribution of wealth and incomes is by far the most significant determinant of prosperity or stagnation in a modern market economy. Economic science never comprehended this reality, because data demonstrating it has only become available in the last decade or so. Concentration of income and wealth depresses economic activity and growth. Adam Smith sensed this (1776), a brilliant insight for his time; perhaps the relationship was easier to spot back then, with the overwhelming poverty, unemployment and idleness of his day. I have found no similar suspicion before Simon Kuznets (1955), an equally brilliant insight in a time of rising prosperity. (Yes, I’ve been doing my homework.) Now we know for sure, because that’s what the data show;
2. Wealth concentration causes depression. This is easy enough to understand, now that we have the data: When wealth siphons up to the top 1% from the bottom 99%, the bottom 99% is poorer, and at some point it falls into depression. That is where we are now. Several economists have tried to explain the depressions of their days unaided by this understanding. John Maynard Keynes thought income and wealth distribution was “arbitrary,” and pretty much resolved at full employment. During the depression preceding the Great Depression, in the mid-19th Century, Karl Marx blamed repression of labor by capitalists, and Henry George blamed the collection of economic rent by landlords. Each had found a kernel of the truth, but none had sensed the full devastating truth of the power of redistribution. Now we know better, because we have the data;
3. Ignoring distribution has been the fatal mistake of economics. In the famous debates between Keynes and the Austrian, Frederich Hayek, for example, Hayek maintained that the government couldn’t stimulate an economy by spending, because the new money would lead to inflation, devouring any gains. Hayek had a good point, assuming the money went to consumers so they could actually bid up prices. But Keynes objected, in effect, that if consumers already had enough money to clear the market, there was no need to stimulate the economy; new money could be injected to a point, he said, without causing inflation. They both had valid arguments, but neither of them took wealth and income redistribution into account. When income and wealth become more concentrated, that’s deflationary, because there is less money bidding for consumer goods. Unemployment rises, investment falls, and the economy shrinks;
4. This is what has slowly happened in the U.S. economy over 3o years. There has been no inflationary spiral from the addition of $16.7 trillion into the economy, because that new money was destined for the coffers of the top 1%, 0.1%, and 0.01%, not the hands of the vast bulk of consumers. Keynes’s plan to stimulate the economy with such expansionary spending can’t succeed today, with new money increasingly going right to the top. (In the last three years, Piketty and Saez report, 95% of new income has gone to the top 1%.) Borrowing more money so far, instead of stimulating growth, has just increased inequality and stagnation. But there has been no hyper-inflation either, because the economy has constricted into depression. I call this effect “conflation.” In these circumstances, monetary policy can’t work either. There has been an abundance of what Keynes called “liquidity preference,” leading as Paul Krugman has emphasized to a near perpetual “liquidity trap,” a condition Polly Cleveland has aptly renamed the “inequality trap;”
5. Thus, the only path to recovery is to reverse the inequality spiral, reestablishing progressive taxation. The $16.7 trillion was not raised with stimulus in mind; it financed the tax reductions for the wealthy elite that commenced in the Reagan administration. The top marginal income tax rate was reduced in the Reagan/Bush years from 70% to 28%, and remains far too low at 35%, and other taxes are regressive as well, including capital gains, at 15%. Incidentally, all of this debt was incurred during the Republican Administrations that implemented these tax cuts, except for interest on Reagan/Bush debt during the Clinton Administration, and stimulus/bailout payments made to avoid an immediate depression after the Crash of 2008 and subsequent huge interest payments (nearly $400 billion projected in 2013), during the Obama Administration. The Obama Administration has reduced spending, not increased it, and now reports the deficit has been shrinking (a trend I regard, under the circumstances, as temporary). In short, it has been entirely Republican “big spending,” not Democratic, that got us here.
Thus, we have $16.7 trillion of national debt that financed tax cuts for the rich, and resulted in unimaginable increases in top 1% wealth, now reaching the point of no return – a potential default on October 17, 2013 if the debt limit is not raised. As I write this, House Republicans vociferously complain that Democrats are refusing to work out a “compromise.”
Such blackmail is morally reprehensible, and it is more than commendable that President Obama is unwilling to submit to it. Compromising on more austerity is just bad economics. The effects of default will be much harsher than ordinary austerity, however, as the dollar would be gravely weakened: With the proceeds of all that debt known to be firmly in top 0.01% hands, and their henchmen known to be precipitating the default, the dollar will likely quickly plummet in value, and cease to be the international currency of last resort. It can no longer be the foundation of global economic “stability.” Only very blind overseas observers will fail to see why and how this avoidable default happened, and the U.S. government, presumed to be under plutocratic control, will have lost most or all of its creditworthiness.
It’s not clear how much inflation the domestic 99% economy will see, but there will certainly be a market crash and a severe deepening of the depression. We’ll be in Great Depression II. At that point, to be sure, the 30-year suppression of growth through redistribution may become academic: When your house burns to the ground, it makes little difference whether the foundation was totally consumed – you still must rebuild.
Beyond that, it seems to me we are only beginning to think about the possibilities. Rebuilding the bottom 99% economy will be difficult, but I am lining up behind those like Gar Alperovitz who favor growing small businesses and local cooperatives. A whole new round of anti-monopoly regulation will be in order.
Whatever else the bottom 99% does, should it somehow regain control of the national government, it will have to reform Congress and thoroughly reform Wall Street’s investment banking operations. The U.S. would do well to nationalize the Federal Reserve system, and start printing its own money rather than borrowing from banks, a practice that has greatly increased inequality and instability.
A constitutional amendment reversing Citizens United will certainly be essential. The artificial idea of corporate “personhood” has been a tragic mistake: From the beginning of “political economy,” Adam Smith was among the many who emphasized the anti-competitive behavior and socially destructive character of big corporations.
Above all, we must reestablish progressive taxation. We now know how tragedies like this are initiated and how they can be avoided. The plutocracy will threaten to leave, but they have substantially left already. If there is a silver lining to the dark cloud of Great Depression II, it may be that the American people will finally rise up and stop the drain of American wealth and resources into the coffers of the world’s wealthy elite.
JMH – 10/3/2013 (ed. 10/4/2013, 10/15/2013)