Slick Willie's Surpluses - the Real Story

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People in Washington have incredibly bad memories. The last time that the United States balanced its budget was just a decade ago. Even though this is not distant history, almost no one in a policymaking position or in the media seems able to remember how the United States managed to go from large deficits at the start of the decade to large surpluses at the end of the decade.

There are two often-told tales about the budget surpluses of the late 1990s: a Democratic story and a Republican story. President Clinton is the hero of the Democratic story. In this account, his decision to raise taxes in 1993, along with restraint on spending, was the key to balancing the budget.

The hero in the Republican story is News Gingrich. In this story, the Republican Congress that took power in 1995 demanded serious spending constraints. These constraints were ultimately the main factor in balancing the budget.

Fortunately, we can go behind this "he said/she said" to find the real cause of the switch from large budget deficits to large surpluses. This one is actually easy.

In the spring of 1996, the non-partisan Congressional Budget Office (CBO), whose numbers are taken as being authoritative in Washington, projected that the government would have a deficit of $244bn in 2000, or 2.7% of GDP (pdf). Instead, the government actually ran a budget surplus in 2000 of almost the same size. This amounted to a shift from deficit to surplus of more than 5.0 percentage points of GDP; an amount that is equal to $750bn given the current size of the economy.

The reason for picking the spring of 1996 as the starting point is that this is after President Clinton's tax increases and spending restraints were all in place. It was also after all the spending restrictions put in place by Gingrich Congress had already been passed into law. In other words, the CBO knew about all of the deficit reduction measures touted by both political parties and it still projected a $244bn budget deficit for 2000. Furthermore, the changes to the budget in the subsequent years went the wrong way. According to CBO's assessment, the legislated changes between 1996 and 2000 actually added $10bn to the budget deficit.

The trick that got us from the large deficit projected for 2000 to the surplus that we actually experienced in that year was, in fact, much stronger than projected growth. CBO projected that growth would average just 2.1%. It actually averaged almost 4.3%. Instead of ending the period with an unemployment rate of 6.0%, unemployment averaged just 4.0% in 2000.

It would be helpful if policymakers paid more attention to this history, since it should remind them that even if their primary concern is the deficit, and not economic growth and low unemployment, economic growth may still be the best way to reach their deficit targets. It is all but impossible to balance the budget when the unemployment rate is above 8.0%. By contrast, if we got the unemployment rate back down below 5.0% (where it was before the onset of the recession), we would get most of the way back to a balanced budget – even with no additional changes to the budget.

Many people look back with fondness on Clinton years and there is good cause. The economy grew at an annual rate of almost 4.5 percent during his second term. The unemployment rate fell to a 4.0 percent as a year-round average in 2000. And the country saw strong real wage growth up and down the income ladder for the first time since the early '70s.

This was all good news. However, it was unsustainable and Clinton's economic team should have known it at the time. The immediate cause of the prosperity was the demand created by a $10 trillion stock bubble. While this gave some boost to investment, its main impact was on consumption. People spent based on their newly created stock wealth, causing the saving rate to fall below 2.0 percent, which at the time was the lowest level of the post-war era.

Of course bubbles burst, and when this one did, it gave the country a severe downturn in 2001. While the official recession was short and relatively mild, ending in just seven months, the economy didn't start to generate jobs again until September of 2003.

It is not easy to recover from a recession caused by a collapsed asset bubble, as is becoming more evident every day. The country did not regain the jobs lost in the 2001 downturn until 2005, and even then it was only due to growth driven by the housing bubble.

One of the factors that made it harder to recover from the 2001 downturn was the sharp increase in the country's trade deficit. Demand was diverted abroad from domestically produced goods and services. This was, in turn, a direct result of the high-dollar policy that was put in place by Robert Rubin when he became Treasury secretary.

Rubin put muscle behind his high-dollar policy when he oversaw the International Monetary Fund bailout of East Asia from its financial crisis in 1997. The harsh conditions led the countries of the region to sharply devalue their currency against the dollar in order to accumulate enormous reserves of foreign exchange. Other developing countries also followed this path in order to avoid ever being put in the same spot as the East Asian countries.

As a result of this policy, the U.S. trade deficit soared, eventually reaching 6 percent of gross domestic product in 2006. This was the fundamental imbalance in the U.S. economy. By definition, a trade deficit of this size requires either large budget deficits or negative private savings. We saw the latter in a big way as housing bubble wealth led to another consumption boom that pushed the household saving rate to near zero from 2004-2006.

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Balanced budgets are 180 degrees the wrong answer in today's economy. We desperately need government deficits in order to make up the lost demand from the private sector. For the near-term future, the private sector is not going to spend enough to bring the economy back to full employment.

But balanced budgets were also the wrong answer in the Clinton years. Clinton's spending cuts and tax increases helped get the deficit down in his first term, but the main reason that the deficit continued to shrink and turn to a surplus was the growth driven by the stock bubble. The Congressional Budget Office's projections showed that even with the Clinton administration's tax increase and spending cuts, we still would have been looking at a substantial deficit in 2000 had it not been for the stock bubble.

In short, President Clinton did not balance the budget; the stock bubble balanced the budget. There is no doubt that excessive deficits can harm the economy, but we are not looking at such a situation now or any time in the near future. Over the longer term, we are projected to run large deficits, but this is entirely because our health care system is broken. If our health care system was as efficient as that of any other wealthy country, we would be looking at surpluses, not deficits.

Please, President Clinton, save some trees. Don't give a half-baked lecture on the virtues of deficit reduction. It is not what the country needs.

Thanks for that. Very interesting.

So, does our economy require another bubble to get us going?

While I've found crediting Clinton with the surplus to be a fun way to tweak Republicans who like to use those types of arguments, I've also said the truth is "none of the above."

The reality is that a president can make it all worse (as I believe Bush, Jr. did with his tax cuts designed to return a surplus that had vanished by the time they took effect), but has very few tools to make it all better.

Economic cycles are their own beast. Until someone invents a way to accurately predict the future and all human behavior associated with future events, economic cycles will continue with minimal abatement.

And, no, let's not create a bubble to get a surplus. Because all bubbles are, by definition, destined to pop.

The housing market has supported the economy both directly--through construction of new homes and purchases of existing homes--and indirectly, by allowing families to borrow against the increased value of their homes. Housing construction is up more than 17 percent from its level at the end of the recession. Purchases of existing homes hit a record of 6.1 million in 2003, more than 500,000 above the previous record set in 2002. Each home purchase is accompanied by thousands of dollars of closing costs, plus thousands more spent on furniture and remodeling.

The indirect impact of the housing bubble is at least as important. Mortgage debt rose by an incredible $2.3 trillion between 2000 and 2003. This borrowing has sustained consumption growth in an environment in which firms have been shedding jobs and cutting back hours, and real wage growth has fallen to zero, although the gains from this elixir are starting to fade with a recent rise in mortgage rates and many families are running out of equity to tap.

The red-hot housing market has forced up home prices nationwide by 35 percent after adjusting for inflation. There is no precedent for this sort of increase in home prices. Historically, home prices have moved at roughly the same pace as the overall rate of inflation. While the bubble has not affected every housing market--in large parts of the country home prices have remained pretty much even with inflation--in the bubble areas, primarily on the two coasts, home prices have exceeded the overall rate of inflation by 60 percentage points or more.

The housing enthusiasts, led by Alan Greenspan, insist that the run-up is not a bubble, but rather reflects fundamental factors in the demand for housing. They cite several factors that could explain the price surge: a limited supply of urban land, immigration increasing the demand for housing, environmental restrictions on building, and rising family income leading to increased demand for housing.

A quick examination shows that none of these explanations holds water. Land is always in limited supply; that fact never led to such a widespread run-up in home prices in the past. Immigration didn't just begin in the late nineties. Also, most recent immigrants are low-wage workers. They are not in the market for the $500,000 homes that middle-class families now occupy in bubble-inflated markets. Furthermore, the demographic impact of recent immigration rates pales compared to the impact of baby boomers first forming their first households in the late seventies and eighties. And that did not lead to a comparable boom in home prices.

Environmental restrictions on building, moreover, didn't begin in the late nineties. In fact, in light of the election of the Gingrich Congress in 1994 and subsequent Republican dominance of many state houses, it's unlikely that these restrictions suddenly became more severe at the end of the decade. And the income growth at the end of the nineties, while healthy, was only mediocre compared to the growth seen over the period from 1951 to 1973. In any event, this income growth has petered out in the last two years.

The final blow to the argument of the housing enthusiasts is the recent trend in rents. Rental prices did originally follow sale prices upward, although not nearly as fast. However, in the last two years, the pace of rental price increases has slowed under the pressure of record high vacancy rates. In some bubble areas, like Seattle and San Francisco, rents are actually falling. No one can produce an explanation as to how fundamental factors can lead to a run-up in home sale prices, but not rents.

At the end of the day, housing can be viewed like Internet stocks on the NASDAQ. A run-up in prices eventually attracts more supply. This takes the form of IPOs on the NASDAQ, and new homes in the housing market. Eventually, there are not enough people to sustain demand, and prices plunge.

The crash of the housing market will not be pretty. It is virtually certain to lead to a second dip to the recession. Even worse, millions of families will see the bulk of their savings disappear as homes in some of the bubble areas lose 30 percent, or more, of their value. Foreclosures, which are already at near record highs, will almost certainly soar to new peaks. This has happened before in regional markets that had severe housing bubbles, most notably in Colorado and Texas after the collapse of oil prices in the early eighties. However, this time the bubble markets are more the rule than the exception, infecting most of real estate markets on both coasts, as well as many local markets in the center of the country.

In this context, it's especially disturbing that the Bush administration has announced that it is cutting back Section 8 housing vouchers, which provide rental assistance to low income families, while easing restrictions on mortgage loans. Low-income families will now be able to get subsidized mortgage loans through the Federal Housing Administration that are equal to 103 percent of the purchase price of a home. Home ownership can sometimes be a ticket to the middle class, but buying homes at bubble-inflated prices may saddle hundreds of thousands of poor families with an unmanageable debt burden.

Most people who sanely observed housing prices should've been able to see a bubble.

http://www.lesjones.com/2008/11/25/infl ... 1975-2008/



http://www.thenation.com/article/bushs-house-cards

The Economy was going into the tank even before the 2000 elections. The subsequent disaster cannot be laid entirely upon the Bush administration. Which is not to say that the Bush administration is blameless. It most certainly is NOT. Bush and his unnecessary wars have put us deeper into the tank than Slick Willy could.

I'd blame the housing bubble's inevitable burst a lot more for the meltdown than the Iraq War or any element of fiscal policy. A few seeds of the bubble economy were laid in the late Carter administration, dug into the ground during the Reagan era, and firmly cemented with each successive presidency.

That simply illustrates the risk of having a Republic. When the electorate fails to separate the sheep from the goats we have going on 4 decades of goat sh*t on the ground.

I rate Jimmy Carter as the worst of the lot. If Bush had not be in thrall to Rumsfeld and Cheney I think he might have done much better. But Carter is totally hopeless. What a looser!

ruveyn

Baker's argument is that a large stimulus is necessary in the near-term while bringing manufacturing back the the US via lowering the dollar's value is the long-term solution.

I'd blame the housing bubble's inevitable burst a lot more for the meltdown than the Iraq War or any element of fiscal policy. A few seeds of the bubble economy were laid in the late Carter administration, dug into the ground during the Reagan era, and firmly cemented with each successive presidency.