President Obama received his first political victory yesterday when the House passed his fiscal-stimulus package, almost exclusively along party lines. Indeed, if the Senate passes its own version of the bill, it would be difficult to discern a political downside for Obama-in the short to medium term. Regardless of how the economy looks in a year or two or three, the president can always argue that conditions would be worse without a package.
But in economic terms, fiscal outlays of such size pose considerable risks. While a spending initiative of this magnitude should, at some point, trigger an increase in consumer spending and smooth the way towards looser credit conditions, that level of government spending is also unsustainable. The government would be forced some years down the road (possibly during a second Obama term) to begin making painful cuts, which could then trigger a subsequent crisis-at which point America's debt would be larger by well over a trillion dollars .
Though Obama said repeatedly on the campaign trail that a withdrawal from Iraq would pay for the kind of initiatives included in the stimulus package that the House approved, it remains unclear how much his planned "surge" for Afghanistan and Pakistan will claim of those Iraq "savings." And while Obama has invoked the spirit and tenor of FDR, America's 2009 economy is quite different than it was during the New Deal and World War II. Back then, for example, American consumers spent much of their stimulus dollars on U.S.-made goods. And while the New Deal spurred some positive economic activity, it was ultimately World War II that was the real engine for growth. It is unlikely that the country will repeat the long, post-war boom.
Even some of the endorsements of Obama's stimulus package are somewhat sobering. "The package does not arrest the most powerful recessionary force in the U.S. economy, which is the deleveraging of the U.S. consumer," said Stephen Roach of Morgan Stanley in an interview. "But it puts a floor" on economic contraction, he added. "It limits the downside." Roach added that it is "preordained" that economic activity will remain anemic this year, but that by 2010 there could be a 2 percent recovery in the economy.
Roach acknowledged that even some time after a stimulus has been launched, it may be difficult to assess just what its impact has been.
The main risk to a sustainable recovery appears to be continued weakness in the banking sector. If banks continue to have bad assets on their books, despite the government's injection of hundreds of billions of dollars in the system, then it is difficult to see how lending and investment could suitably rebound. But dealing with the banking sector's problems is by far the most complicated part of a recovery plan, politically and technically.
Spending on the country's aging infrastructure, for example, would at least leave the country with modernized roads, bridges, dams, etc. China's stimulus package is heavily weighted in infrastructure spending. But government spending on the U.S. banking sector is not only politically risky-in part because it seems to reward the perpetrators of the crisis-it is also technically challenging, because if it is not done correctly, there is a risk the money could by and large simply disappear, without yielding a restoration of the sector and an increase in lending. The Bush administration's approach, under TARP, was to inject liquidity into the banking system and give itself rights to a share of the banks. But that approach failed to address the main vulnerability in the system. If the banking sector is to recover, banks must begin to sell or write down troubled assets and acknowledge their losses on their books. The Obama administration would have to play a leading role in helping to develop a pricing mechanism for those assets, such as an auction that both federal officials and private investors would participate in. But the government should use taxpayer money to buy assets only at fair prices, perhaps just slightly above market prices. The banks would vigorously challenge such an approach to dealing with the crisis, but a sustainable recovery may well depend on it. At any rate, many banks have hardly been honest about the assets they hold and the value of their books.
Still, even the government's so-called investment in the financial sector appears more promising than the resources the president plans to spend in Afghanistan and Pakistan. There is much at stake in that graveyard of empires, including lives, much-needed funds and the restoration of America's image abroad-as Obama has often noted. If the modest tax cuts and spending on education, alternative energies and infrastructure is to provide the kind of stimulus the administration is hoping for, it should take the lead in organizing auctions for banks' troubled assets and pay fair prices for bad debts. And the president has promised to vigilantly assess the efficacy of his stimulus initiatives and to end those that are not yielding results. He should make a similar promise regarding Afghanistan. Surely, Obama does not want to exit office the way his predecessor has, left with so few achievements he can only ask the public to refrain from judging his legacy for some undefined period of time.
Ximena Ortiz is a senior editor at The National Interest.