The Income Statement v. the Balance Sheet: Will the Economic Crisis Unravel the Long Peace?

"This is Worse" from Disaster of War series by GoyaAs the Obama team reels from its dramatic defeat at the polls last week, there is pretty uniform agreement across the spectrum that “it was the economy, stupid.” Workers were convinced that we could not afford a “lavish” entitlement program like health care in the middle of a profound economic crisis. And so as yet another anemic jobs report was released on Friday it makes sense to try to make sense in very basic terms what the crisis is all about.

There is some good news – I think I can paint a pretty simple picture of the crisis, but there is really bad news, too. Nothing in the current form of modern capitalism and politics is likely to get us out of the crisis either.

First, the picture of the crisis. There are really two ways of looking at the current situation. If we take the perspective of the average American worker, it is the income statement that matters. There is no longer sufficient money coming in the door to satisfy debt obligations.

Credit cards, mortgages, student loans, car loans – all of the debt that workers took on board over the last twenty years, aided and abetted on the right by deregulation and on the left by “social justice” pushes for home ownership and access to often useless “higher” education, have now caught up and overwhelmed them.

On the flip side, from the standpoint of the banks and financial institutions that created this world of debt it is a balance sheet problem. They now have piles of debt on the asset side of their balance sheet (debt is in theory an asset for financial institutions since it creates an income stream in the form of interest payments) that must be written down significantly if we were being honest about the actual value of those loans.

Naturally, banks are reluctant to engage in those write downs. And they are equally reluctant to create new assets in the form of new loans to consumers because they know the income statements of those consumers are in very bad shape, overwhelmed as they are by the debt created by these very same banks and financial institutions!

So we have a vicious circle created and no apparent way out. The latest gamble by the Fed, so-called QE2, is pushing on a string, as economists like to say, because the banks are unwilling to lend and workers are unable to borrow. So the money will get sent elsewhere, most likely to emerging economies which will waste it away on fanciful infrastructure projects like China’s bullet trains that only a handful can afford to ride.

There are, in fact, some ways out but they are too threatening to institutional interests in the current political climate.

Obama could have nationalized the banks early in his presidency with the aim of forcing them to write down the loans and then coupled this with a rewriting of the debt principal held by workers more in line with the deflated value of the underlying collateral (home, car, education, etc.) If combined with major government funding of intelligent infrastructure we might have the outlines of a sustainable recovery program.  But the scale of what is needed clearly frightened the mainstream economic advisors around the President and was well over the heads intellectually of the politically correct inner circle in the White House.

(The troglodyte right contends that the minimal interventions made by Obama amount to “socialism” but in fact, as I explained in The Obama Paradox, the President’s long history of a relationship with the politically correct left actually makes him behave far more conservatively in the current crisis than would a typical liberal. See, for example, Dana Milbank’s column yesterday assessing how Hilary Clinton might have responded to the mortgage crisis.)

Several left liberal economists made the call (Krugman on the banks and Galbraith on government investment, for example) for some of this kind of effort but clearly Obama feared the S-word – socialism – and it is not even likely this got serious consideration beyond the op-ed pages of the New York Times.

head_in_the_sandAnd Obama knew that these calls by a handful of intellectuals would never get the backing of serious political forces as organized labor has stuck its head in the sand (spending a quarter billion dollars on the recent drubbing of Democrats, for example) and the politically correct left would continue thinking that breaking the blockade of Gaza would lead to the social revolution.

The only other way to solve the problem is to improve the income statements of the working class. That would require a significant increase in real income, which has stagnated for decades.

But to create the real world economic basis for such an increase would require significant increases in productivity – not just the temporary efficiencies now being created by laying off workers, shutting down unused plants, etc., but something deep and real such as is the result of major new technologies like the steam engine, the assembly line, or the semiconductor.

It is no longer clear to me that the current organizational forms of capitalism are capable of making such technological leaps. The world wide web has been a small example of the potential as it has rendered obsolete layers in the global production and distribution machinery of the economy.  But it now seems mired down in serving as a simpleton social networking and advertising platform with little real impact on overall productivity.

The outlook when capitalism exhausts its options is not pretty. It happened in 1914 and then in 1932 and of course it has never been able to do much at all for Latin America, Africa and much of Asia which suffer continual crisis. That there is greater fear of protectionism, some signs of a rising level of xenophobia here and in Europe, that China is engaged in expanded mercantilist activity, that fundamentalism remains attractive to many – all these signal the possibility of the vicious circle turning downward into a vicious and out of control spiral leading to greater inter-state conflict if not widespread war.

This ongoing battle between banks and workers threatens, in other words, to unravel the long peace – the decades we have enjoyed without widespread global armed conflict. This is not to minimize at all what the Iraqis, Afghans and Pakistanis, among others, have felt over the last decade. But it would be a mistake to underestimate the magnitude of difference between what they are experiencing with the implications of a true downward spiral to world war.

As Goya would say, “this is worse.”