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Obama and the House can produce Economic Growth
Howard Richman, 11/22/2010

Ironically, divided government gives the United States an excellent chance to solve its economic problems. Although the Democrats may be unable to balance budgets and the Republicans may be unable to balance trade, together they may be able to do both. All that is needed is for each party to do what it has the power to do.

Republicans Can Balance the Budget

In the last election, the American people spoke. The Republicans were given the House with a mandate to move the federal budget into balance. The American people will no longer put up with reckless borrowing from our children.

The Republican House has the power to balance the budget, without any cooperation needed from the Democratic Senate or President. They can do so simply by refusing to raise the debt ceiling. That would force serious negotiations about where to cut federal spending.

But doing so could cause even higher unemployment than we have now. In his commentary that appeared in TheStreet (Chinese Mercantilism is Making a Mess), U. of Maryland economist Peter Morici predicts that moving the budget toward balance would cause 15% unemployment, unless direct action is taken at the same time to move trade into balance. Morici calculates:

If the United States cut its budget deficit in half and raised domestic interest rates two percentage points, U.S. consumption and imports would crash, unemployment would rocket to 15%, and a global depression would result whose horrors we all thought were long ago buried in history books.

If China and Germany won't be reasonable, the United States is really left with no option but to take direct action to balance its trade.

Democrats Can Balance Trade

Just as the Republican House has the power to refuse to raise the debt ceiling without Presidential approval, the Democratic President has the power to impose tariffs without congressional approval. The G-20 summit just made it clear that America's budget deficits cannot be solved through diplomacy. Action is required.

Obama could balance trade through the WTO-legal scaled tariff, a tariff which forces mercantilist countries to take down their barriers to American exports. Its rate goes up when our trade deficit with a mercantilist country goes up, down when the trade deficit goes down, and disappears when trade is balanced.

In the short-run. Balanced budgets and trade cancel each other out. The economics is simple. Aggregate Demand for American products is the sum of Consumption, Fixed Investment, and Government Purchases, after subtracting the Trade Deficit. If government spending is reduced, Consumption (due to transfer payments) and Government Purchases decline, hurting demand. But if trade is brought toward balance Fixed Investment (mostly new factories) and the Trade Deficit both improve, helping demand.

Balanced trade and balanced budgets also work together in the long-run. Balancing trade reduces the loans coming into the United States from the trade surplus countries, which raises real long-term interest rates unless the government moves its budget toward balance. Moreover, the combination is especially good for economic growth since both high government spending and high trade deficits retard long-term growth.

Events have given the United States an excellent opportunity to solve its economic problems. If both the President and Congress take advantage of their power, America will be the big winner. Otherwise, the future looks bleak indeed. We just don't yet know whether the crash will be precipitated by a loss of government credit (caused to the budget deficits) or a dollar collapse (caused by the trade deficits).