Money politics

By today, we should know the outcome of the midterm elections in the US. We should also know the final decision taken by the US Federal Reserve regarding the second quantitative easing program (QE2) that will have tremendous repercussions on the global economy.

The two are not unrelated events. We now know that QE2 substitutes for a second stimulus package that would have been too politically costly for the Obama administration.

QE2 is a program where the Fed basically prints dollars and buys up bonds in the American financial market. Its execution is nearly a certainty even as its wisdom is under heavy debate. The only thing to be answered today is how much dollars will be released to the market.

The program intends to increase liquidity in the US financial market in the hope that this will help reflate companies, encourage investments and create jobs. It is an alternative to a stimulus program where government basically expands spending in order to prop up domestic demand. The hope is that stronger domestic demand will encourage investments that, in turn, will create jobs.

The stimulus program launched by the Obama administration produced only mixed results. There were not enough government projects that were “shovel-ready” and the impact on domestic demand was either muted or delayed.

That stimulus program (whose most visible feature was massive public lending to big banks and large corporations) was eventually criticized for favoring Wall Street and ignoring Main Street. Unemployment continued to rise. The big banks, blamed for the financial mess that produced the recession in the first place, were back to reaping billions of dollars in profits (and millions of dollars in bonuses).

It is arguable that the stimulus program managed to prevent the recession from worsening and returning the US economy to (barely tangible) growth. Some argue, although there is hardly evidence to prove it, that the recession might have blossomed into a full-scale depression had the stimulus package not been rushed into place.

The most politically sensitive metric, however, is the unemployment rate. The number of unemployed people in the US today is larger than what that number was during the depths of the recession. Even as the US economy has now managed to expand by 2%, the higher unemployment level felt deeply at the grassroots leads to the impression that the Obama administration has utterly failed in winning economic relief for his people.

That impression fuels the anger that became a major factor in the recently concluded midterm elections where the Democrats are expected to lose control of the House of Representatives and, possibly, the Senate.

Just two years ago, the Republican Party was considered in a near-death condition, with no major figure to lead it and no clear idea to animate it. Over the past few months, however, social and fiscal conservatives rallied around the Tea Party movement, called for smaller government and lower taxes as the solution to the economic malaise that grips America.

Under the great shadow of a higher unemployment rate and the perception that a government-sponsored stimulus package will never work, it would have been suicidal for the Obama administration to push for a second stimulus package in the heat of a midterm election campaign. But all the numbers showed that some form of support needed to be mobilized by government to reinforce a feeble economic recovery. The price for not doing so could be a double-dip recession.

 With the Obama administration stymied by shrill partisan criticism of its policies, it was up to the Fed to step up to the plate and deliver QE2. It is a program for infusing money into the economy that is significantly shaped by the political dynamics of this time.

Both the stimulus package and QE2 add to the debt stock of the US. As things stand, that debt stock is already immense.

This is the other angle of criticism — not from partisans but from sober economists. The American approach in fighting the recessionary malaise is exactly the opposite of the preferred European approach.

Last month, the British Prime minister outraged the unions and shocked his people by unveiling a brutal austerity program. The program is so comprehensive and far-reaching, it even involved sharing military capacity with France to cut costs.

Through most of the European continent, governments are brutally cutting back on spending, sparking protests from Bulgaria to Greece. While Europe is saving more to climb out of financial difficulty, the Americans prefer to spend more to accomplish the same.

Over the long run, of course, what will happen is that public spending in the US will be curtailed by a large debt overhang while the Europeans will tend to have more resources for public intervention by keeping their deficits — and therefore their debt overhang — low.

Large deficit spending by the Americans will undermine the dollar’s strength and cause the euro to appreciate. That gives American exports a price advantage over European competitors — a likely prospect that is angering the Europeans.

In the near term, Washington will be trying to appease public discontent by pumping money into their domestic economy. During the same time, European governments are trying very hard to manage public anger by enforcing austerity.

Over the longer term, however, the Europeans will have a more stable (albeit low) growth and a manageable public debt. The US economy could spurt ahead in the short term but will be saddled for a very long time with an immense public debt.

Economic strategies are always shaped by the expectation of specific publics. The American public, it is clear, is predisposed to instant gratification. It is, after all, a public with a zero savings rate.