The high priests of the bubble economy
If Barack Obama really wants things to change, he shouldn't be seeking economic advice from Clinton-era officials
by Dean Baker
THOSE FOLLOWING THE meeting of Barack Obama's economic advisory committee could not have been very reassured by the presence of Robert Rubin and Larry Summers, both former Treasury secretaries in the Clinton administration. Along with former Federal Reserve Board chairman Alan Greenspan, Rubin and Summers compose the high priesthood of the bubble economy. Their policy of one-sided financial deregulation is responsible for the current economic catastrophe.
It is important to separate Clinton-era mythology from the real economic record. In the mythology, Clinton's decision to raise taxes and cut spending led to an investment boom. This boom led to a surge in productivity growth. Soaring productivity growth led to the low unemployment of the late 1990s and wage gains for workers at all points along the wage distribution.
At the end of the administration, there was a huge surplus, and we set target dates for paying off the national debt. The moral of the myth is that all good things came from deficit reduction.
The reality was quite different. There was nothing resembling an investment boom until the dot-com bubble at the end of the decade funnelled vast sums of capital into crazy internet schemes. There was a surge in productivity growth beginning in 1995, but this preceded any substantial upturn in investment. Clinton had the good fortune to be sitting in the White House at the point where the economy finally enjoyed the long-predicted dividend from the information technology revolution.
Rather than investment driving growth during the Clinton boom, the main source of demand growth was consumption. Consumption soared during the Clinton years because the stock market bubble created $10tn of wealth. Stockholders consumed based on their bubble wealth, pushing the saving rate to record lows, and the consumption share of GDP to a record high.
The other key part of the story is the high dollar policy initiated by Rubin when he took over as Treasury secretary. In the first years of the Clinton administration, the dollar actually fell in value against other currencies. This is the predicted result of the deficit reduction. Lower deficits are supposed to lead to lower interest rates, which will in turn lower the value of the dollar.
A lowered dollar value will reduce the trade deficit, by making US exports cheaper to foreigners and imports more expensive for people living in the US. The falling dollar and lower trade deficit is supposed to be one of the main dividends of deficit reduction. In fact, the lower dollar and lower trade deficit were often touted by economists as the primary benefit of deficit reduction until they decided to change their story to fit the Clinton mythology.
The high dollar of the late 1990s reversed this logic. The dollar was pushed upward by a combination of Treasury cheerleading, worldwide financial instability beginning with the East Asian financial crisis and the irrational exuberance propelling the stock bubble, which also infected foreign investors.
In the short-run, the over-valued dollar led to cheap imports and lower inflation. It incidentally all also led to the loss of millions of manufacturing jobs, putting downward pressure on the wages of non-college educated workers.
Like the stock bubble, the high dollar is also unsustainable as a long-run policy. It led to a large and growing trade deficit. This deficit eventually forced a decline in the value of the dollar, although the process has been temporarily reversed by the current financial crisis.
Rather than handing George Bush a booming economy, Clinton handed over an economy that was propelled by an unsustainable stock bubble and distorted by a hugely over-valued dollar.
The 2001 recession was relatively short, but the economy continued to shed jobs for almost two years after the recession ended. Because President Bush refused to abandon the high dollar policy, the only tool available to boost the economy was the housing bubble. In addition to the growth created directly by the housing sector, the wealth created by this bubble led to an even sharper decline in saving than the stock bubble.
Of course, the housing bubble is now in the process of deflating. The resulting tidal wave of bad debt has created the greatest financial crisis since the second world war. With the loss of $8tn in housing wealth, consumption has seized up, throwing the economy into a severe recession.
While the Bush administration must take responsibility for the current crisis (they have been in power the last eight years), the stage was set during the Clinton years. The Clinton team set the economy on the path of one-sided financial deregulation and bubble driven growth that brought us where we are today. (The deregulation was one-sided, because they did not take away the "too big to fail" security blanket of the Wall Street big boys.)
For this reason, it was very discouraging to see top Clinton administration officials standing centre stage at Obama's meeting on the economy. This is not change, and certainly not policies that we can believe in.