"MILITARY KEYNESIANISM" BLAMED FOR THE GREAT RECESSION
Dr. Thomas Oatley, since 2000 an Associate Professor of Political Science at the University of North Carolina at Chapel Hill, posted the following provocative (if flawed, IMHO) argument on the university's International Political Economy blog:
Military Keynesianism suggests that Operation Iraqi Freedom had such systemic consequences in the form of the global economic and financial crisis of 2007-13. As I know people resist a direct attack, let me back into it with an analogous case: Vietnam.
There is pretty broad scholarly agreement concerning three aspects of the Vietnam War. First, the US financed the war by running large budget deficits. Second, the deficit-financed war buildup sparked an inflationary boom in the US economy, which worsened the balance of payments position and led to a rapid increase in foreign claims on the American gold reserve. Third, the budget deficit-financed economic boom collapsed the Bretton Woods system as individuals, private institutions, and governments lost confidence in the dollar's peg to gold. The collapse began with the first massive speculative attack against the dollar in March of 1968 (an attack which led the Johnson administration to suspend all private dollar convertibility and sharply limit official convertibility). Thus, the US decision to finance the Vietnam War by borrowing rather than by raising taxes had severely negative consequences for the international system: it undermined global monetary stability.
Now consider the Iraqi case. The sharp increase of military spending sparked by 9/11 and Iraq followed a massive tax cut (and coincidentally, we had a massive tax cut in 1964). Like Vietnam, therefore, the US borrowed to pay for the War on Terror. If the Vietnam War experience is any guide, this budget deficit must have had consequences for US macroeconomic and financial performance. The deficit was larger and persisted for longer than the Vietnam case. I argue that the choice to finance the War on Terror by borrowing rather than by raising taxes worsened the US external imbalance and the resulting "capital flow bonanza" triggered the US credit boom. The credit boom generated the asset bubble the deflation of which generated the great global crisis from which we are still recovering. Obviously, it takes a lot of heavy lifting to get from the war-related budget deficit to the global financial and economic crisis. (That's why I am writing a book. I will begin posting chapters in the next week or so here if you are interested).
Here's my rebuttal:
My first impression of the thesis ascribing the Great Recession to “military Keynesianism” is that it gives undue weight to a peripheral and largely coincidental event — a case of the tail wagging the dog. There are much larger forces at work which explain the genesis of the Great Recession to a much more satisfying extent.
In ascertaining the causes of the Great Recession, we must begin with first principles. The precipitating factor behind the Great Recession was excessive mortgage debt — a superabundance of mortgage credit creating a housing bubble, which in popping, dragged down the economy.
How? A significant portion of the expanding mortgage market consisted of loans made at adjustable, unusually low interest rates to unqualified, subprime borrowers. When interest rates subsequently rose, vulnerable borrowers were unable to meet their skyrocketing mortgage payments, leading to cascading defaults, the deflation of the housing bubble, and a liquidity crisis within the banking system prompting lenders to curb private lending. Starved for credit upon which the private economy depended for both consumption and investment, the economy contracted into what has been called the Great Recession. So the bursting of the mortgage-fueled housing bubble is at the core of the explanation for the Panic of 2008 and the accompanying Great Recession. This much Oatley gets right.
Any discussion of the Great Recession’s contributing factors must explain first and foremost how and why the U.S. mortgage market became overextended. The answers to three questions will suffice to explain the housing bubble.
Where did the money come from?
Why were lenders so eager to lend?
Why were homeowners so eager to borrow?
Where did the money come from that fueled the tsunami of mortgages and the housing bubble?
Three primary sources:
Rich Americans, who scooped up 87% of the growth in National Income under Reagan and 98% for the first 7 years of the Bush II administration. (By no coincidence, these ratios are much higher than the 35% share garnered in the postwar period until Reagan came along.) For this largesse the rich are indebted to Reaganomics’ slashing their tax bills by 60% and building up their source of income through corporate profits enhanced by deregulation and military spending. (Here is an aspect of military Keynesianism I don’t believe Oakley includes in his analysis.) Here we see mounting inequality of wealth emerge as a precondition, indeed a cause of the financial and economic meltdown between 2007 and 2009.
A super-accommodative Fed, eager to avoid or ameliorate recessions at all costs. Without periodic, normal business cycle recessions to curb the rise of private borrowing, the expansion of credit continues unabated from 1982 on, pumping up household debt to levels revealed as unmanageable during the S&L crisis in the late 1980s, and again in the recent crisis, beginning in 2007, exploding in September 2008.
Foreign trading partners recycling their trade surpluses back into the U.S. credit markets. Foreigners enjoyed trade surpluses thanks to trade advantages gained by undervaluing their currencies and offering cheap labor and favorable direct investment inducements to stimulate their exports to the U.S. and restraining their domestic consumption by various means (in Asia particularly) to dampen demand for U.S. exports.
Why were lenders so eager to lend?
Rich Americans, unable/unwilling to spend the windfalls of Reaganomics had to put the money to work, so they flooded the banking system with deposits which were promptly loaned to homeowners. Likewise, foreign trading partners, rather than putting their surpluses to work at home, recycled them back into the U.S. economy to provide Americans the wherewithal to keep buying foreign goods as well as increasingly expensive houses.
The flood of money overwhelmed the U.S. banking system, prompting bankers to lower their lending standards in order to be able to put the money on deposit to work. Loans were made to unqualified borrowers and lenders derived false security from the soaring values in the housing market, thought by the conventional wisdom to be impervious to declines.
Why were homeowners so eager to borrow? Two main reasons.
In order to maintain the appearance of the American dream in the face of real wages unchanged since the ‘70s, consumers had no alternative but to borrow. In so doing they filled in the gap between their rising ambitions for consumption and their flat incomes.
There are many reasons for the stagnating wages of the middle class, including outsourcing in a globalized economy, increases in payroll taxes, automation (placing workers in competition with machines), waning power of labor unions. The bottom line is that while productivity soared during the 80s, 90s and 00s, all the fruits of such gains went to corporations’ top management and shareholders, none to the wage earners, exacerbating inequality of income and wealth.
The tidal wave of money flooding the mortgage market pumped up the housing bubble, making it seem to middle-class homeowners that borrowing against their continually appreciating homes was a painless undertaking. Indeed, homeowners treated the swelling equity in their homes like an ATM machine for routine purchases. None other than Fed Chairman Greenspan beatified growing homeowner equity as a valid source of savings for old age, again, based on the mistaken common perception that housing prices would never fall.
Putting it all together: Flush with money to lend, the rich, ruling U.S. elite and prosperous foreign exporters were happy to underwrite stagnating middle class ambitions for the American dream with cheap, readily available funds thanks to the overly accommodative Fed. Reaganomics -- slashing tax rates for the rich, while filling their pockets with profits from deregulation and military spending, to the detriment of the middle class — can be properly seen as the reason the rich were flush and the middle class was forced to borrow, and therefore, the primary cause of the housing bubble, the bursting of which caused the financial panic in 2008 triggering the Great Recession.
This, then, represents the central narrative of the Panic of 2008 and accompanying Great Recession. I find no compelling reason to include military spending as a significant causal factor (other than as previously mentioned source of profits for the rich exacerbating wealth inequality). Given the military-industrial complex’s predilection for long wars, heightened greatly by Reagan and Junior Bush’s predisposition for military spending, it is no accident that bloated military spending has accompanied the events of the past half century. But coincidence is not causation. To link the surge in military spending to the housing bubble and the savings and loan crisis of the 1980s, and later Panic of 2008 is a non-sequitur.
It is “heavy lifting,” indeed to get from the war-related budget deficit to the global financial and economic crisis. (“That's why I am writing a book...." Oatley hastens to add.) He gets his causality all wrong.
Unfunded military spending has certainly pumped up U.S. Government debt during American wars since time immemorial -- Vietnam, Afghanistan and Iraq being no exception. But household debt at the root of the problem. Military spending does not pump up household borrowing; the factors I have described do, deeply intertwined with a governing set of rules (Reaganomics, mostly) making the rich stupendously richer, the poor, desperately poorer and the middle class mark time, impelling the rich to lend and the middle class to borrow.
The connection is illogical linking military spending and the “U.S. External imbalance and resulting ‘capital flow bonanza’” triggering the U.S. credit boom and the credit boom generated the asset bubble the deflation of which generated the great global crisis.” Oakley is grafting the coincident event of increased military spending on to the central narrative of the credit boom and its implosion — giving his account some factual credibility at the end but creating a false chain of causation.
What generated foreign capital inflows into the American credit markets (both government and private sector) were the trade advantages gained by American’s trading partners through currency manipulation, cheap labor made very productive by foreign investment in Asia, and policies calculated to restrain the flow of U.S. goods and services into their markets (by discouraging consumption and impeding the influx of imported goods). To keep their trade surpluses coming, foreign exporters recycled them back into U.S. Credit markets, underwriting the borrow-and-spend Americans demand for foreign goods.
Using their surpluses to buy up U.S. government debt was just one parking place for their surpluses — essentially a portfolio decision as to where to lend. The portfolio decision made possible increased U.S. military spending, not the other way around. Foreigners were not compelled by the fact of increased U.S. military spending to create trade surpluses so they could lend money to the U.S. Government and American households as Oakley seems to be saying. Somebody should clue the man in before he embarrasses himself by publishing his book.
The core of causation of the global financial/economic crisis resides in inequality of wealth created by a rich ruling elite, both within the U.S. and abroad, who have rigged the game in their favor — with low taxes, and corporate profits swollen by deregulation and bloated military spending -- to the detriment of the governed. The acquiescence of the governed to such an arrangement in a democracy is one of the great paradoxes of our time — readily explainable by the domination of the political process by the marriage of Big Money and Corporate Media.
PS: It was Charles de Gaulle who put the nail in the coffin of convertibility of the U.S. Dollar for gold. During the first Nixon Administration, the Fed was creating a flood of new dollars which American corporations used to buy up French companies. The assumption was that those dollars would remain in Europe (Eurodollars) and the American economy would never have to redeem the paper they had issued for valuable French assets, in effect a loan which never need be repaid. So, fed up, de Gaulle said, I will redeem those Eurodollars for gold from Fort Knox. The volume of dollars in Europe was so great, that at the rate de Gaulle was redeeming them for gold, he would soon deplete the entire U.S. Reserves of gold at Fort Knox. Realizing this, Nixon told de Gaulle and the world, the U.S. will redeem no more dollars for gold.
For the full story, read my forthcoming book: The Predicament: How did it happen? How bad is it? The Case for radical change now!" 2nd edition due out in about a month. www.the-predicament.com