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Phony “Fiscal Conservatives” – In The Midterms And Beyond
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By Simon Johnson

Should we take seriously people who, in the current US political
debate, argue that they are “fiscal conservatives”? No.

These self-labeled conservatives are very far from even being willing
to discuss the real issues – let alone make proposals that would have
significant effects. As Peter Boone and I argue on Bloomberg this
morning, US “fiscal hawks” are just pretending. Perhaps this will
prove effective in the midterm elections, but then they will face the
music – what exactly will they put on the table that will make any
difference at all?

Unless and until you are ready to really reform the financial sector,
you cannot be taken seriously in the fiscal space. It’s the big banks
that blew up the economy, caused a devestating recession, andpushed up
debt by 40 (forty) percentage points relative to GDP.

None of today’s “fiscal conservatives” showed up to work hard on
constraining global megabanks over the past 18 months. They have
repeatedly and explicitly earned the right not to be taken seriously.

Here’s the full Bloomberg larticle below


U.S. ‘Fiscal Hawks’ Mimic France: Peter Boone and Simon Johnson
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Commentary by Peter Boone and Simon Johnson

Nov. 1 (Bloomberg) -- The sharp budget cuts announced in the U.K. last
month have people asking: could the U.S. soon take similar steps?

The two countries share some key problems, including the aftermath of
a housing bust, overreliance on high-risk financial services, and
government debt levels approaching the danger zone. Self-proclaimed
fiscal conservatives also are likely to make a strong showing in
midterm elections.

But there is a world of difference between the nations’ fiscal
situations. The British, who are front-loading their cuts and may be
overdoing it, are explicitly recognizing the extreme damage and future
dangers to society inherent in their banks.

In contrast, our fiscal conservatives are much more French- like than
British. Like President Nicolas Sarkozy, we have some politicians
willing to make a fuss about tinkering around the cosmetic edges of
our persistent deficits, but no one is ready to address our core
issue: the U.S. financial system blew itself up, leading debt relative
to gross domestic product to soar by 40 percentage points, and now is
poised to do the exact same thing (or worse) again.

The macroeconomic trajectory in the U.K. is undeniably bad. The budget
deficitwas 11.5 percent of gross domestic product last year, with
general government debt rising from 44 percent of GDP in 2007 to 80
percent in 2010. The heart of the country’s vulnerability lies with
what used to be thought of as an advantage -- London’s status as a
financial center.

Bad Bets

British banks became large relative to the economy, mostly because of
financial globalization, and then collapsed; total assets reached more
than six times GDP and the largest bank, Royal Bank of Scotland, had a
balance sheet that was almost 1.5 times the size of the economy. (In
Iceland, a country completely ruined by its banks, financial sector
assets peaked at around 12 times GDP.)

The bust after their disastrous bets on U.S. and U.K. real estate
pushed the country into deep recession and increased the budget
deficit as tax revenue fell and government spending increased, partly
driven by unemployment insurance payments.

At some level, the electorate and political elite get this. Britain’s
coalition government isn’t just cutting the budget deficit; it is also
conducting a far-reaching review aimed to reform big banks and end the
dangerous boom-bust-bailout cycle. Even the Bank of England seems to
be strongly on the side of centrist reformers now in power.

This fiscal adjustment will be painful; a right-leaning cabinet has no
qualms about pushing the costs of fiscal adjustment onto relatively
poor people.

Preemptive Action

But the framing of this choice has been handled with admirable
cynicism. If the British stick with their previous path of budget
deficits and the world doesn’t get better, the continued buildup of
debt will lead to a major calamity. If so, the U.K. would face a
crisis, forcing even more drastic budget cuts at an ugly time. Guess
who would pay for that?

Since the U.K. isn’t facing an immediate fiscal crisis, it is acting
in a preemptive manner.

In contrast, what do we see in the U.S. political debate?
Prevarication. The Obama administration, the Federal Reserve, and the
Republican Party are curiously silent on measures that would really
reduce the political power of our largest banks and ensure that
creditors and shareholders -- not taxpayers -- bear the costs when
global megabanks fail again.

People who call themselves fiscal conservatives propose either raising
taxes or cutting non-security discretionary spending -- actions that
are trivial relative to the scale of deficits. This is no surprise;
the U.S. can borrow at near- record low interest rates.

Parallels With France

Americans like to think of themselves as very un-French, but the U.S.
has exactly the same problem as France: entrenched interests that
block any discussion of real reform.

In France, it’s the unions protesting any adjustment to pensions. In
the U.S., it’s powerful and far less visible corporate interests that
fended off any attempt to make banking sounder -- the financial
industry lobby essentially defeated all attempts to make big banks
smaller or substantially safer.

France suffers from a complete lack of social recognition that tough
measures probably need to be taken. Its budget deficit is 8 percent of
GDP, its debt-to-GDP ratio is 82 percent. Its society is aging,
putting more pressure on the retirement system. The U.S. is in very
similar shape -- with the most ironic difference being that big banks
have less political power and thus pose less danger in France.

Most likely France and the U.S. will muddle through until investors
grow tired of the risk or the banks blow themselves up again -- or
both. Then the question becomes: who bears the cost of the necessary
fiscal adjustment?

(Peter Boone, a research associate at the London School of Economics’
Center for Economic Performance, is a principal in Salute Capital
Management Ltd. Simon Johnson, a professor at Massachusetts Institute
of Technology’s Sloan School of Management and former chief economist
of the International Monetary Fund, is co-author of “13 Bankers: The
Wall Street Takeover and the Next Financial Meltdown.” The opinions
expressed are their own.)

To contact the writer of this column: Simon Johnson at sjohnson@mit.edu

To contact the editor responsible for this column: James Greiff atjgreiff@bloomberg.net
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