Premature Virtue

Published on Project Syndicate, by George Soros, Oct. 5, 2010.

NEW YORK – The Obama administration’s insistence on fiscal rectitude is dictated not by financial necessity, but by political considerations. The United States is not one of Europe’s heavily indebted countries, which must pay hefty premiums over the price at which Germany can borrow. Interest rates on US government bonds have been falling and are near record lows, which means that financial markets anticipate deflation, not inflation.

Nevertheless, Obama is under political pressure. The US public is deeply troubled by the accumulation of public debt, and the Republican opposition has been extremely successful in blaming the Crash of 2008 – and the subsequent recession and high unemployment – on government ineptitude, as well as in claiming that the stimulus package was largely wasted. 

There is an element of truth in this, but it is one-sided. The Crash of 2008 was primarily a market failure, for which US (and other) regulators should be faulted for failing to regulate.

But, without a bailout, the financial system would have remained paralyzed, making the subsequent recession much deeper and longer. True, the US stimulus package was largely wasted, but that was because most of it went to sustaining consumption rather than to correcting the underlying imbalances.

Where the Obama administration went wrong was in how it bailed out the banking system: it helped banks earn their way out of a hole by purchasing some of their bad assets and supplying them with cheap money. This, too, was guided by political considerations: it would have been more efficient to inject new equity into the banks, but Obama feared accusations of nationalization and socialism.

That decision backfired, with serious political repercussions. The public, facing a jump in credit card charges from 8% to nearly 30%, saw banks earning bumper profits and paying large bonuses. The Tea Party movement exploited this resentment, and Obama is now on the defensive. The Republicans campaign against any further stimulus, and the administration now pays lip service to fiscal rectitude, even if it recognizes that deficit reduction may be premature … (full text).

(George Soros is Chairman of Soros Fund Management).

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