Staving Off Another Great Depression

The Washington policy debates of
the last week would almost make a casual observer believe that the
nation's political leadership is in fact nostalgic for the good old
days of the Great Depression when the country suffered double-digit
unemployment for a decade.

The two big news items last week were a batch of absolutely horrible economic reports and the release of President Barack Obama's
budget. The media almost completely ignored the former and focused its
attention primarily on the latter. So, let's start with the bad news.

As
can be expected, much of the bad news centred on housing. The National
Association of Realtors reported that existing home sales fell below 4.5 million for the first time since the mid-90s. They also reported that the median house price dropped another $5,400 in January or 3.1%.

Since
July, this series shows a drop in the median home price of 18.9%. Other
data also showed house prices in a free fall, most notable the commerce department's series on new home sales,
which showed a drop of 10% in the median price between December and
January. With vacant housing units at record levels, and many potential
home buyers no longer having the equity in their current homes for a
down payment, it is difficult to see how this free fall stops any time
soon.

Housing isn't the only sector that's plummeting. Investment fell at a 28% rate in the fourth quarter, the sharpest rate of decline in more than 50 years. New orders have fallen more than 5% in each of the last two months.

Along with the collapse of these sectors, the number of new unemployment claims just keeps rising. Last week, it was 667,000 new claims.
February may show more than 700,000 jobs lost for the month in the
report released on Friday. The unemployment rate is likely to hit 8%
for the month, and it could well be over 9% by the summer.

While this bad news was flowing, President Obama released the first budget
of his presidency. It is an ambitious document. The proposal calls for
directly confronting powerful interest groups in order to eliminate
important sources of waste in the budget. For example, the budget
eliminates subsidies to private insurers in Medicare and drug companies
in Medicaid. The saving will go toward financing healthcare reform.

He
also proposes to eliminate the fund managers' tax break that allowed
managers of hedge and equity funds (some of the richest people in the
country) to pay tax at just a 15% rate. Obama proposes to have these
Wall Street tycoons subject to the same tax rates as everyone else.

There
are many other areas where the budget turns to long-neglected areas,
most importantly a proposal to establish a cap and trade system to
provide incentives to reduce greenhouse gas emissions. It is not clear
that Obama can accomplish the full agenda laid out in his budget, but
there is no doubt that he hopes to accomplish a great deal in his term
in office.

Remarkably, much of the discussion of the budget did
not focus on Obama's agenda, but rather his deficit targets. In
particular, many commentators questioned whether he would reach his
deficit target for 2012 because the economy might be weaker than his
budget assumes.

The pundits' concern on this point should have
caused people to throw their television sets, radios and newspapers out
the window. Let's suppose that the pundits are correct and the economy
sinks farther and later grows more slowly than the Obama administration assumed in planning its budget.

Would
the pundits have Obama therefore cut more spending and raise more
taxes? This would be close to crazy. With the economy plummeting, the
first priority of the administration and Congress must be to boost the
economy.

If the unemployment rate is 12% when Obama's first
term ends, he can forget about getting re-elected, even if the budget
is balanced. On the other hand, if he has managed to bring the
unemployment rate down to a reasonable level, no one other than a few
Washington pundits will be bothered by the deficit that might have been
necessary to achieve this result.

The electorate is well ahead
of the punditry on this issue. The federal government is the only force
capable of turning the economy around in the near future and sustaining
growth. The public recognises this fact and will demand good economic
policy even as the punditry continue to push policies that would throw
the economy into another depression. Even if they have very large
megaphones, the punditry are thankfully still a very small minority and
unlikely to get their dream.