5. How the Keynesian Endpoint Is Changing the Global Political Landscape

The scene: A walkway in a tree-lined park on lovely summer afternoon

The players: A dark-suited man, ostensibly politician Republican Congressman Paul Ryan (who wishes to reform Medicare) and grandma, 80 years old

In a finely appointed dark suit, a man is walking an elderly and frail white-haired woman in her wheelchair through a park on a glorious afternoon, where the sun’s rays can be seen bursting through the park’s leaf-covered skies. The woman is closed-lipped but smiling, turning her head ever so gingerly toward the seemingly kind man, whose smug face seems out of tune with the melody playing both in the background from an unknown source and in the heart of the woman, whose smirk casts an outward glow of the joyful feeling she has inside, no doubt from the memory of a life filled with thousands of similarly blissful days.

In haste, the smug man quickens his steps, but he says nothing to the old woman; she sustaining her smile, although now only with her lips—her eyes opening wider, her knees touching, and her shoulders hunching like a cat at the ready. The melody is still playing, but now only in her ears, her heart sullen with fear.

Faster still go the steps of the man, whose dark hair holds still even as the woman’s flowered apron wrinkles, matching the lines on her face. The stroll darkens as the walkway brightens, where through the trees an opening is ahead. There’s a cliff there. The pair moves toward it. It is the woman’s final glimpse at the sun and the open skies as she is ushered to the cliff where her wheelchair is tipped forward like an applecart, and she tumbles out over the cliff.

What you ask is this horrifying scene? (Don’t worry, the elderly actress is just doing fine; a mannequin was tossed over the cliff). It is a commercial made by a group of “concerned citizens,” better known to some as “liberal attack dogs.” The message in the commercial is obvious, but the attack dogs leave nothing to chance, flashing onto the screen the message, “America can’t be beautiful,” pausing for a moment and then adding, “Without Medicare.” The ad was uploaded to the Internet and could be found on Youtube.com in the spring of 2011. It was meant to alarm senior citizens about proposed cuts to Medicare, in particular to changes in the program proposed by Representative Paul Ryan, the chairman of the U.S. House Budget Committee, who ostensibly is the protagonist in the shocking commercial.

This particular attack ad is an attempt by politicians to summon the powerful dynamics of gerontocracy to gain the support of senior citizens and get re-elected. A less sinister view would be that politicians are attempting to support policies they believe are best for the United States. The latter thesis in a different era would be more believable than the former, but it has become difficult to put blind faith in politicians in recent years, they acting so irresponsibly with public money.

The ad is a sign of the times and indicative of the immensely powerful impact that government indebtedness is having on the political landscape throughout the world and the many dramas that going to continue to play out on the world stage. Protests against cuts to salaries, pensions, and healthcare benefits have already become commonplace in countries worldwide, including in Greece, Spain, Portugal, London, Sri Lanka, Romania, France, as well in the United States, where there have been protests in Wisconsin, New York, Washington, Michigan, and New Jersey, among many other states, cities, and smaller towns.

Public furor over fiscal austerity will make it difficult to implement the austerity needed to rehabilitate the public sector’s poorly situated balance sheet. The scene described here is one example. In the United States, politicians are under pressure to maintain existing entitlement programs and the promises they made over many years with public sector unions. Consider what happened in New York in May 2011 when the state held a special election for an open congressional seat in the 26^th Congressional District in the western part of New York. Astoundingly, a Democrat won in a district widely known to be conservative. Kathy Hochul, the Democratic candidate and a country clerk, beat Republican opponent Jane Corwin, an assemblywoman, by a margin of 47 percent to 43 percent, with the balance of the vote going to independent candidates. Hochul ran openly against Paul Ryan’s plan to slow the growth rate of Medicare. Her victory is widely seen as evidence of the political pressure that politicians face in attempts to control entitlement spending and by extension the U.S. debt problem.

In her victory speech, Hochul shed light on her campaign strategy, which was to focus beyond the cohort of people aged 65 and older, by focusing on those who are not far from senior citizenry. Hochul said sarcastically of her victory that night,

Yes, we are all future seniors, that’s for sure. It’s the future seniors they were going after, and we didn’t like that did we?¹

Hochul added a specific reference to Medicare, as many others did that night and in its aftermath:

The voters of this district have sent me to Washington because I said I’m willing to fight for them on Medicare, make sure the lobbyists pay for their fair share and get our budget under control. The question is: Did I have the confidence and faith of Republicans, Democrats and independents who listened to our message loud and clear? We’re going to protect seniors, we’re going to protect the middle class and small businesses.²

Nancy Pelosi, the former Speaker of the House in the U.S. House of Representatives and widely cast as a liberal, said,

Kathy Hochul’s victory tonight is a tribute to Democrats’ commitment to preserve and strengthen Medicare, create jobs, and grow our economy, and it sends a clear message that will echo nationwide: Republicans will be held accountable for their vote to end Medicare.³

Oh, the pressure today’s politicians must bear for having to be the ones who have to shrink the scope of entitlement programs after their predecessors for 50 years did nothing but expand them! Never mind that entitlement spending accounts for close to 60 percent of all U.S. spending—the U.S. can solve its debt problem by cutting everything else! Not! The fact is, it will be exceedingly difficult if not impossible to trim the budget deficit without cutting spending on entitlements because there is no meat on the bone to cut from these other areas. For example, the one area presidents often say they are going to cut or “freeze” is nondefense discretionary spending. This is one of the few areas they can exert any control over. The problem is nondefense discretionary spending represents a very small slice of the overall spending pie, totaling just $689 billion in 2010 compared to overall spending of about $3.5 trillion.⁴ The meat is on the entitlement spending bone, so any politician that says he or she can reduce the U.S. budget deficit as much as is necessary to stabilize the U.S. fiscal situation is either lying or a magician.

No Grand Bargain on the U.S. Deficit Problem Until After the 2012 Election

Saddled with worry over how the public will respond to any proposals that would reduce the growth rate of entitlement spending (as opposed to reducing the actual amount of entitlement spending, which is extremely unlikely owing to factors related to demographics and inflation), politicians are likely to sit on their hands and do very little ahead of the 2012 election. In other words, there will be no grand bargain between Republicans and Democrats that strikes a balance between the Ryan plan or any other Republican plan and any plan the Democrats might put forth. Instead, both parties are likely to continue to kick the can down the road, content that by having raised the debt ceiling for about the eightieth time in U.S. history, that they will have again staved off a problem—for themselves at least.

Failure to do more than agree to an outline for future deficit reduction constitutes another in a series of abuses of the U.S. reserve status privilege. It is another step in the eventual loss of the U.S. reserve status of the U.S. dollar—it will be a process, not an event. The process has actually been underway for quite some time, with the U.S. dollar falling from 71 percent of the world’s reserve assets at the start of the millennium to 61 percent in early 2011.⁵

The world, in other words, is already diversifying out of U.S. dollars, a process that is likely to continue for two reasons. First, the U.S. is likely to experience a slower rate of economic growth than many other parts of the world, in particular the emerging markets, owing to its massive debts, poor demographics, large current account deficit, and poorly comprised public spending. (Compared to nations with healthier balance sheets, the U.S. spends very little on infrastructure, R&D, and education, allocating a large share of national income toward healthcare.) As the U.S. economy shrinks as a share of global trade, so will use of the dollar, which is currently the world’s medium of exchange. Second, the inattentiveness of U.S. policymakers to address the structural factors that are worsening the fiscal position of the United States will compel foreign investors to behave as any good banker would by derisking their reserve portfolios, increasingly allocating money away from the United States toward countries whose balance sheets are improving rather than deteriorating. This will further reduce the proportion of the world’s reserve assets that are held in U.S. dollars.

The diversification process will be sped up by continued recklessness toward budgetary matters, such as what was seen in 2011 when policymakers took a battle over the debt ceiling to the brink, with Democrats and Republicans playing a dangerous game of chicken over whether deficit reduction should be comprised of spending cuts, tax increases, or some combination of the two. This oft-repeated game of Russian roulette occurring at a time when the world has tapped the last balance sheet is the height of recklessness. Foreign central banks will not be party to this sort of fiscal irresponsibility and will use it as a wakeup call to the tail risks they face in holding vast amounts of sovereign money in U.S. dollars.

Certain events have a way of waking people up to risk, and it changes their behavior for years afterward. September 11^th of course woke up the United States and other nations to glaring security lapses that previously went undetected. And it resulted in widespread changes in security measures on a variety fronts, including efforts to protect borders, airports, and buildings, as well as intelligence collection. In a far different vein, but one that speaks to how certain events act as markers for changes in the way things are done, the devastating earthquake that occurred off the coast of Sendai, Japan, on March 11, 2011, illuminated the heavy dependence that much of the world has on Japan for supplies in major industries such as the automotive industry and the technology sector. In fact, economic data throughout the world showed a very significant impact on industrial output from cutbacks in the production of automobiles and high-tech equipment in the aftermath of the earthquake. It is felt that in the aftermath of “3/11” (in the same way that many refer to the tragic events of September 11, 2001 as “9/11,” many in Japan refer to the tragic events of March 11, 2011 as “3/11,” or “three-one-one”) many global companies that depend on Japan for supplies will diversify and add new suppliers to reduce the risk of future disruptions to their production schedules.

Although the battle over the U.S. debt ceiling can hardly be called a seminal moment in the evolution of the U.S. dollar as the world’s reserve currency, it will reinforce and perhaps hasten slightly the diversification of the world’s reserve assets away from U.S. dollars toward alternative currencies by alerting investors to the folly of U.S. policy toward its fiscal situation. Although no individual currency stands ready to take the mantle (Europe is a mess, Japan has too much debt, and China doesn’t have fully convertible currency nor a bond market to house the world’s reserve assets), continued abuse in Washington of the reserve-status privilege of the U.S. dollar will speed the diversification process, which at some point could result in the dollar falling to under 50 percent of the world’s reserve assets, with a plurality of other currencies thereby becoming more dominant.

If a plurality of currencies become the dominant global reserve asset, real interest rates will likely rise in the United States, crimping economic growth and lowering investment returns on riskier assets such as corporate equities. Increases in funding costs will require further austerity, harming economic activity still further. An increase of just a percentage point on the roughly $10 trillion of public debt outstanding in July 2011 amounts to an additional $100 billion of annual interest expense, holding the debt load constant and pushing aside the cost of interest on interest, which of course we can’t because both the debt load and the amount of interest paid on interest will increase as long as the United States has a budget deficit—as it surely will for many, many years to come.

The political pressures Washington will feel ahead of the 2012 election will result in mini bargains containing outlines at best for future deficit reduction. For example, there will be no provision that states Part D of the Medicare program (the prescription drug program begun in 2003) will be reduced because that would scare seniors, and anything that scares seniors politicians will not touch. No meaningful specificity is likely until after the 2012 election. In other words, the U.S. is likely to continue to kick the can down the road on its fiscal dilemma and further abuse its reserve currency privilege, opening the door to further depreciation of the U.S. dollar, higher real interest rates, lowered investment returns, and weaker economic activity. To the politician, these costs do not seem to have resonated much, as is evident by the fiery and consequential battle that took place over the debt ceiling in the summer of 2011, which is why many believe Washington won’t wake up unless or until there is a crisis.

Beyond the Keynesian Endpoint Leaders Must Lead

The political battles playing out on the world stage are therefore a major problem for indebted countries. Politicians are inclined to give in to pressures applied from their constituency on major issues—it is the essence of democracy to do so and to let the will of the people decide, after all, but this a rare time when letting the people decide what is best for a nation may not be what is best for a nation, or a state, or a city, for that matter. Instead, this is a time when policymakers have to make honest assessments of the actions they believe are necessary to right the ship. It is a time for leaders to lead, in other words.

Take Greece, for example. When George Papandreou became Prime Minister of Greece in November 2009, he discovered that his nation’s budget deficit was much greater than he previously believed. Papandreou proclaimed to the world in December 2009 that his predecessor had disguised the size of the deficit, which in 2010 reached 10.5 percent of the nation’s gross domestic product. Combined with an already-high stock of debt, the deficit created an intractable problem for Greece. Recognizing the dilemma, investors saw Greece as a bad credit, forcing Greece to pay high interest rates to investors in order to be compensated for the risk of owning Greek bonds. This worsened the problem because interest rate levels exceeded the growth rate in Greece’s economy. In such a situation where the interest rate on a nation’s debt is higher than the growth rate for its gross domestic product (in nominal terms), its debt-to-GDP ratio will rise in perpetuity.

In 2010 Greece faced a deep crisis that required it to borrow $140 billion from the European Union and the International Monetary Fund in exchange for austerity measures that would stabilize Greece’s finances. It still wasn’t enough, despite the loan package amounting to almost half the size of Greece’s economy about $14,000 per person for each of Greece’s 10.7 million citizens.⁶

In 2011, Greece needed another bailout, but lenders would not agree to one unless Greece took more drastic actions than it did the previous year. Facing political pressures of their own, Germany and France and the rest of the European Union demanded Greece implement additional austerity measures before they were given additional aid because the European Union risked losing support from their constituencies for not just the support package but also for the euro.

Papandreou crafted a $113 billion austerity plan for Greece that would inflict a great amount of pain onto its people, who rose up in objection to the harshness of the plan, defined as much by the change it would impose on its people’s way of life, especially for public sector employees, which accounts for about 25 percent of employment in Greece.

On June 29, 2011, Greek citizens took to the streets by the thousands to protest an impending vote on the austerity plan. Many protestors were dressed ominously in all-black clothing, covered fully except for their hands and above the noses of their face, their menacing eyes peering through their covering. The protestors hailed rocks and bottles, lit fires to cars, and charged at uniformed police with wooden sticks and metal pipes, shouting at them with great passion and verve. All the while the protestors fended off a constant dispersion of tear gas and the risk of serious physical harm, which is a constant risk amid the madness of crowds. The crowd amassed outside of the Hellenic Parliament in Athens, where 300 parliament members were holed up inside to vote on the $113 billion austerity plan that lenders wanted to see Greece approve before divvying out any additional loans. In a fine display of bravery and sense of duty to their nation, the members of parliament were completely undeterred by vociferousness of the crowd and the tear gas that could be seen outside of the parliament building, where the stench of the gas was seeping inside. They voted in favor of the plan by a count of 155 to 138, with a few abstentions.

As part of the $113 billion austerity plan, public sector workers would be asked to pay more into their pension plans, have their pension and health care benefits cut, and retire later in life. Tax rates were increased, the income threshold for paying taxes was lowered to $11,600 from $17,400, and the number of people employed by the public sector was cut. Greece would also privatize about $70 billion of public assets.

Figure 5.1. Protesters fill the rotunda of Wisconsin’s capital, February 2011.

Source: Antenna, University of Wisconsin

Figure 5.2. Protesters at the Hellenic Parliament in Athens, Greece, June 2011

Ironically, Papandreou sought to reverse course on policies begun by his father, Andreas Papandreou, who, following two decades of harsh rule in the 1960s and 1970s, including a dictatorship from 1967 to 1974, was elected prime minister of Greece in a landslide victory in 1981. He was Greece’s first socialist prime minister, and his mandate was to restore the income inequality that had built up in Greece while it dealt with right-wing leadership. Andreas Papandreou immediately began efforts to redistribute income, increasing pensions and wages, and establishing a welfare system that provided substantial increases in coverage for welfare, health care, and retirement. This was a sharp turn from previous policies, and in fact Greece until the 1970s had one of the smallest public sectors of any European country.⁷ The expansion of government services and social programs occurring in the absence of efforts to offset the costs put Greece on a path to indebtedness that Andreas Papandreou’s son is now having to alter.

Beyond the Keynesian Endpoint, entitlement-oriented societies such as Greece can no longer fund their large entitlement programs nor sustain levels of public spending that exceed revenue sources. For George Papandreou, this means he must be a stalwart and do the opposite of his father and reduce the size of government. Leaders such as Papandreou have a calling unlike those of any leaders of recent decades, to formulate and then implement policies that are apt to be extremely unpopular with the very people that voted them into office and which can result in their removal from office. In short, politicians must change their stripes and put the longer-term interests of their respective political jurisdictions before their own, and they must fend off virulent opposition wherever it may lurk, as it surely will.

Power Is Shifting at the IMF and Away from the G-7

In addition to the changes that will be seen in political leadership throughout the world and in every level of government, there will also be major change in the structure of the International Monetary Fund (IMF) and vastly more influence for the G-20—the Group of Twenty nations, which accounts for 90 percent of global gross national product.⁸ The G-20 has now supplanted the outdated G-7 as the world’s most powerful cooperative group of finance ministers and central bank chiefs. G-20 nations that were not part of the G-7, including China, Brazil, Indonesia, Mexico, Russia, Turkey, and South Korea, now have strong voices in shaping policies more consistent with the makeup of the global economy than possible with the G-7.

At the IMF, voting rights have been altered to better reflect this makeup, but the allocation of these rights remain outdated, as evidenced by the voting rights that individual countries have relative to the size of their economies. For example, China’s voting share ranks sixth even though China’s economy is the second largest in the world. Meanwhile, ancient post-WWII voting rights given to relatively small European nations remains stubbornly high. For example, Belgium’s voting share in July 2011 was 1.86 percent of all votes compared to 1.72 percent for Brazil, despite Brazil’s economy being five times larger than Belgium’s.

The declining economic prowess of developed countries and their shrinking share of world economic activity are part of a handoff of power and influence to the developing world that is likely to continue for many years to come owing to the debt burdens the developed world must work through before it can return to faster economic growth rates. Institutions such as the IMF must continue to evolve to reflect the true composition of the global economy if they are to represent their members and therefore the global economy more fairly and in a way that best promotes sustainable economic growth and stable financial conditions.