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Farewell to Bill

Clinton’s political skills shouldn’t prevent us from understanding the track record of his economic policies.

The mythology of Clintonomics is that Clinton cut spending and raised taxes, thus shifting from large deficits to large surpluses and a booming economy. There was in fact much to celebrate. However the reality is quite different from the mythology.

Bill Clinton is clearly the most talented politician of our era. It is difficult to imagine Clinton losing an election to any of the people who have run for office in the last two decades. But his skills as a politician should not prevent us from understanding the track record of his economic policies. In fact, until we get a clear understanding of these policies, it unlikely that we will be able to restore the economy to a path of sound economic growth.

The mythology of Clintonomics is that Clinton took the hard steps to bring the deficit down. He cut spending and raised taxes. This supposedly shifted the budget from large deficits to large surpluses and led to a booming economy.

In the late 90s, we had the lowest unemployment in three decades, and we saw real wage growth up and down the income ladder for the first time since the early 70s. There was in fact much here to celebrate.

However the reality is quite different from the mythology. The reduction in the deficit was supposed to lead to an increase in investment and a fall in the trade deficit. These are the two components of the Gross Domestic Product (GDP) that increase our wealth for the long-term: the former by increasing our productive capacity and the latter by giving us ownership of more foreign assets.

It turns out that the investment components of GDP actually did not increase in the Clinton boom. After we adjust for a technical issue associated with a surge in car leasing in the 90s (leased cars count as investment in the national accounts, purchased cars are treated as consumption), investment as a share of GDP increased by just 1.2 percentage points from their late 80s level.

However this was more than offset by a 2.2 percentage-point-increase in the size of the trade deficit. As a result, at the height of the Clinton boom in 2000, these wealth-increasing components of GDP were 1 percentage point smaller as a share of GDP than in the high-deficit 1980s.

Instead, the component driving the economy in the late 1990s was consumption. The stock bubble led to a surge in consumption, which rose by 3 percentage points as a share of GDP, while savings hit what was at the time a record low.

The problem with this stock bubble boom was that it was destined to go bust. There are a limited number of fools with money. At some point there was no one left to pay billions of dollars for shares of Internet start-ups that didn’t even know how they could make a profit.

This reversed the irrational exuberance that had sent the market soaring. The market tanked and the economy and the budget surpluses went with it. The recession of 2001 was officially short and mild, ending just seven months after it started. However the picture was much worse for most people in the country. The economy did not start to create jobs again until September of 2003, almost two years after the official end of the recession.

The 2001 recession was hard to recover from because it was the result of the collapse of an asset bubble, just like current recession. It is easier to recover from a normal recession, because a typical recession is brought on by the Federal Reserve Board raising interest rates to slow the economy.

Higher interest rates lead people to delay buying homes and cars. This means that when the Fed wants to get the economy going again it can just lower interest rates and spark a surge in home and car buying. That sort of boost isn’t possible when the downturn is caused by the collapse of an asset bubble.

When the economy did finally start creating jobs again following the 2001 recession, it was on the back of the housing bubble, which drove growth in the last decade. In effect, we used the growth of one bubble to overcome the wreckage created by the collapse of another bubble, just as an alcoholic seeks to cure one hangover by starting on the next.

There is another important part of the Clinton legacy that is impeding growth. When Robert Rubin became Treasury Secretary in 1995, he pushed a high dollar policy. He put muscle behind this policy with his control of the International Monetary Fund (IMF) in setting the ground rules for the bailout from the East Asian financial crisis.

The harsh terms of the bailout led countries throughout the developing world to demand massive amounts of dollars. Their reserves of dollars were an insurance policy to keep them from ever being in the same position as the East Asian countries. This increased demand for dollars pushed up the value of the dollar and led to the massive trade deficits that we have seen in the last dozen years.

We will not be able to get to a sustainable growth path until we reverse the high dollar policy. The dollar has to be pushed down to a level where US goods are again competitive in international markets. This is a central part of the adjustment from the period of bubble-driven growth.

In short, the Clinton era policies sent the US economy on a seriously wrong path. They created an absurd obsession with budget deficits, a pattern of bubble-driven growth, an incredibly bloated financial sector and an unsustainable trade deficit.

The next time he has occasion to address the country it would be great if President Clinton could explain these facts to the American people. Now that would be a speech worth watching.