Subject: U.S. ‘Fiscal Hawks’ Mimic France: Peter Boone and Simon Johnson _ Baseline Scenario
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Date: Mon, 1 Nov 2010 15:25:44 -0400

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 [email-masked]

To contact the editor responsible for this column: James Greiff [email-masked] 
.