This Is No Way to Run an Economy

The world looks to America to be a leader, but instead it's a dysfunctional mess.

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The currently dysfunctional U.S. political system is causing some worry for the rest of the world. No one could have expected such a situation in the aftermath of the worst financial crisis in 80 years. The political and economic instability that seems to pervade the U.S. is, in reality, a series of artificial crises generated by a series of artificial deadlines. Is this really what we need from the largest and most influential economy in the world during a post-recovery phase?

The view from the outside world is that the Republican tea party is holding the Obama administration up for ransom. And as much as the U.S. government shutdown significantly damages and stalls the U.S. post-recovery, it is still relatively small global event. On the other hand, a U.S. debt default would be a significantly larger global event because U.S. Treasury bonds are a critical asset in global financial markets.

Currently, the U.S. government has approximately $17 trillion in outstanding debt. This money allows for liquidity and provides the basis for short-term borrowing for U.S. banks and U.S. non-bank financial institutions (i.e. investment banks). If there was indeed a government default, it would immediately freeze the U.S. credit market. As a consequence, banks would once again begin to collapse. There is no doubt that this domestic crisis would spread globally within 72 hours. Most doomsday scenarios estimate a 3.5 to 4 percent drop in U.S. GDP if this occurred, with a global stock market and money market funds collapse preceding a global recession.

[See a collection of political cartoons on the economy.]

Global governance failure is the highest risk facing Western governments today; it could not be truer for America. Financial markets are losing their patience with the dysfunction in Washington and are beginning to punish the artificial crisis with large dips in the stock market, eroding the average American’s wealth.

The recent budgetary deal in Congress funds the government to January 15th and suspends the debt ceiling until February 7th, which then becomes a new artificial deadline. It is widely expected that if a similar public display of political dysfunction occurs again in January, the markets will react even more aggressively, causing larger drops in the stock market. I anticipate a more volatile roller coaster in the financial markets, in particular the stock markets, in early February, as there seems to be no real commitment in Washington to become more politically effective and functional.

How volatile and damaging does the financial market reaction have to become so that Washington has to pay attention? This is clearly not the optimal way to run the largest and most sophisticated economy in the world. Americans need to demand a better system of governance or, among other things, the division between the rich and poor will continue to widen at a much more rapid pace as the average American’s wealth erosion continues.

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