While They Argued Over the Debt Limit

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Dean Baker
The Guardian Unlimited, August 1, 2011

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At this point, no one knows exactly how the debate over the debt limit will be resolved. The Republicans are holding tight with their big-cuts, no-taxes stance. The Democrats continue to insist on limited cuts and that revenues will have to be included in any package with really big cuts.

In spite of these two seemingly irreconcilable positions, it is virtually certain that either a debt ceiling bill will be passed or there will be some sort of presidential workaround, such as the claim that the 14th Amendment overrides the debt limit law and requires the president to make good on the government’s obligations.

The reason that we know that this will happen is that Wall Street is on the front line in this battle. If there is a default on U.S. debt so that it can no longer be held on bank books as being a riskless asset, then most of the major banks will likely be insolvent. It will not be just U.S. debt that must written down, but also debt implicitly guaranteed by the government, such as mortgage-backed securities issued by Fannie Mae and Freddie Mac, as well as a wide range of other assets held by the banks.

The loss of value on a wide range of assets could easily wipe out the capital of the Wall Street banks, putting them on the road to Lehman land. Since J.P. Morgan, Citigroup and the rest have enormous power in Congress, it is a safe bet that they will force their allies to find a way to keep them in business. Therefore, we need not worry much about the default story.

What we should be worrying about is all the news that Washington has ignored while it was doing the debt-ceiling shuffle. Most importantly, the economy has almost stopped growing and unemployment is again on the rise.

On Friday, the Commerce Department released data showing the economy grew just 1.3 percent in the second quarter. Even worse, it revised down the first-quarter growth number from 1.9 percent to just 0.3 percent. This means that the economy was growing at just a 0.8 percent annual rate over the first half of 2011. This is well below the 2.5 percent pace that is necessary just to keep unemployment from rising.

Of course unemployment has been rising, with the June figure hitting 9.2 percent. That is up from a post-recession low of 8.8 percent in March. The unemployment rate does not give the whole story since many of people have lost hope of finding a job and given up looking for work altogether. The employment-to-population ratio (EPOP) – the percentage of the population with jobs – has fallen back almost to its low-point for the downturn. The EPOP for African Americans has hit new lows in each of the last three months.

The revisions also provided other interesting pieces of information. For example, corporate profits were revised sharply higher for both 2009 and 2010. The share of profits in corporate sector output hit a new record high, more than a full percentage point above its previous peak. Finance was the biggest winner within the corporate sector, accounting for 31.7 percent of corporate profits, also a record high.

In short, we now have an economy that is stuck in the doldrums. It is operating well below its potential level of output. Furthermore, instead of catching up, it appears to be falling further behind. We are seeing a growth rate far below the economy’s potential when we should be seeing growth that is far above potential. And, the Wall Street guys are fat and happy.

There was another interesting item in the revised data. It showed that the economy was plunging even more rapidly than we previously recognized in the two quarters following the collapse of Lehman. However, the plunge stopped in the second quarter of 2009, just as the stimulus came on line. This was followed by respectable growth over the next four quarters. Growth then weakened again as the impact of the stimulus began to fade at the end of 2010 and the start of this year.

In other words, the growth pattern shown by the revised data sure makes it appear as though the stimulus worked. The main problem would seem to be that the stimulus was not big enough and it wasn’t left in place long enough to lift the economy anywhere near potential output.

But, none of this was being discussed in Washington. All eyes are on the debt-ceiling negotiations and the default clock that many news organizations now feature on their websites.

Of course if anyone in Washington bothered to pay attention they may have also taken note of the UK’s third consecutive quarter of near stagnation. After all, the UK is showing us what we can expect to happen if the big budget cutters actually get their way.

But in Washington, concerns about matters like growth and unemployment have no place. We just have to keep talking about the debt ceiling.


Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The End of Loser Liberalism: Making Markets Progressive. He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues.