Belmont Club

Deficits both political and economic

Nouriel Roubini predicts that the worst economic news is still to come. Writing in Forbes he argues that optimists who have declared the crisis past have been proven wrong six times in a row. More likely is a two year recession followed by a recovery so weak it will seem the recession had never ended.

Obama will inherit an economic and financial mess worse than anything the U.S. has faced in decades: the most severe recession in 50 years; the worst financial and banking crisis since the Great Depression; a ballooning fiscal deficit that may be as high as a trillion dollars in 2009 and 2010; a huge current account deficit; a financial system that is in a severe crisis and where deleveraging is still occurring at a very rapid pace, thus causing a worsening of the credit crunch; a household sector where millions of households are insolvent, into negative equity territory and on the verge of losing their homes; a serious risk of deflation as the slack in goods, labor and commodity markets becomes deeper; the risk that we will end in a deflationary liquidity trap as the Fed is fast approaching the zero-bound constraint for the Fed funds rate; the risk of a severe debt deflation as the real value of nominal liabilities will rise, given price deflation, while the value of financial assets is still plunging.

What’s missing from Roubini’s scenario is any consideration of what would happen to the economic situation if a significant political or military crisis happens over the next four years. Because as he points out, the economic woes will be global in character many regions, already wracked by instability and misery, will be even more so. The traditional palliatives — foreign aid, peacekeeping, bribery — will be available in far smaller quantities. The combination of greater stresses on unstable region combined with a reduced means to cope with them means that Obama will be facing a greater security risk on top of an economic risk.

Moreover, Obama may have inadvertently generated another source of risk for himself: unrealistically high expectations. Austin Bay notes that disputants in regions as remote as the Southern Sudan are counting on Obama to bail them out.

The 2005 CPA created a “national unity” government in Khartoum, but North and South Sudan are increasingly appropriate names. The SPLA has become the GOSS — Government of South Sudan, which regards Kenya as an ally. Recall the Somali pirates who hijacked a freighter loaded with tanks and other weapons. The bill of lading said Kenya. The likely destination? The GOSS.

Now back to President-elect Obama. After his election, a GOSS spokesman requested a U.S.-led peacekeeping force in south Sudan. Why? Perhaps expectations spurred Kenya’s holidays as much as pride. Kenya and GOSS may assume they will have a great deal of influence on U.S. policy in the region.

Obama rhetorically promised hope and change, and seeded great expectations.

As 2005’s fragile peace frays, more war threatens Sudan. Of course, war threatens Ethiopia, Eritrea and Djibouti, and war rages in Somalia, in Chad, in Congo … and the daunting list goes on.

Beware this irony: Great expectations unmet seed grand disappointments — and add new bitterness to devilishly complex conflicts.

“Hope” and “change” are like political credit instruments which a politician floats through his campaign promises and political programs. When people take them seriously enough it is natural for them to present them for encashment. Once they see the check bounce then image of the Messiah can be quickly transformed by disappointment into the likeness of a confidence man. This idea is captured in the phrase, ‘never let your mouth write a check that your ass can’t cash’.

The likelihood is that over the next four years there will be many checks and precious little cash.

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