Tuesday, February 3, 2015

Fiscal Union and the US

Paul Krugman likes to point out the benefits of fiscal union, and the dangers of monetary union without it, by comparing Europe's financial crisis to our Savings and Loan crisis.  A few things should be taken into account here.  First of all, compared to the total size of our economy, the savings and loans failing were quite manageable.  Second, the crisis was nation-wide, with old style bank runs taking place in Ohio and Maryland.  But third, although failing thrifts occurred nation-wide, they were not equally distributed nationwide.  Texas, fueled by oil money, had about half of the total, both in terms of failed thrifts and in the volume of losses.  As a result, about half of the total funding spent cleaning up the mess went to Texas.  Furthermore, Krugman points out, this amounted to about a quarter of Texas' GDP, an amount Texas could never have raised left to itself.

A few point are worth emphasizing here.

First, the Savings and Loan cleanup was much less controversial than the 2008 bank bailout because we had a longstanding statutory and contractual obligation to insure depositors and an established mechanism for doing so.  Besides, honest citizens who put their money in the wrong bank are a lot more sympathetic than Wall Street high flyers. Most people look at people losing their savings when a bank fails and think, that could be me.  Most people look at Wall Street high flyers losing money and think, serves 'em right.

Second, there was nonetheless controversy surrounding it.  People criticized the expense, how it was done, and even whether we should continue to insure deposits at all.  But, Krugman emphasizes, one thing that was never a subject of controversy was that Texas was benefiting disproportionately. Certainly, along with a lot of gallows humor about banks and savings and loans in general at the time, someone might occasionally throw in a dig about Texas Savings and Loans being particularly unreliable. But no one ever suggested that those improvident Texans were getting an unfair break.  It was the Savings and Loans being cleaned up.  Texans were our fellow Americans and not regarded as a special or separate category.

Third, for anyone worried about moral hazard, relax.  Texas did not avoid suffering the consequences of its bad decisions.  Texas fell into recession even as the rest of the country prospered.  But if Texas had been forced to handle the mess with only its own resources, it would undoubtedly have been a lot worse.  And to be quite fair to Texas, they learned their lesson from the experience and enacted strict banking regulations that have served the state well.  During the 2000's housing bubble, Texas, though in the middle of the Sun Belt, got off relatively lightly, thanks to a combination of lots of land, light land use regulations, and strict financial regulations.  High oil prices helped lift Texas early out of the recession.  But this time Texas was able to keep oil money from fueling a financial bubble.  Texas is hurting now from falling oil prices, but not as badly as if there had been a bubble.

But here is another point worth thinking about.  If you look at the US circa 1865-1933, you may very well see another example of the dangers of monetary but not fiscal union.  Before the Civil War, the US did not have a national currency in any meaningful sense.  Yes, the U.S. government made gold and silver coins, but there were not enough such coins to finance the economy.  So each bank issued its own notes.  Many states had their own central banks that issued state bank notes.  The U.S. government tried its hand at a central bank a few times, but Andrew Jackson pulled the plug in 1836 and it wasn't tried again until 1913.  During the Civil War, the US began issuing paper money -- the greenback.  And it held.  After the war, the U.S. imposed a prohibitive tax on notes issued by all other banks, and the greenback became the single national currency.

Also following the Civil War, the South fell into a serious economic decline.  The reasons for the decline are controversial.  It is generally agreed that it was not wartime damage because recovery from such things is usually remarkably fast.  The end of slavery is often offered, though morally troubling.  Another answer is most certainly that the 1850's had been a time of unusually high cotton prices and so a time of abnormal prosperity in the South to begin with.  Furthermore, with the US taken out of cotton production, many other countries started growing and exporting cotton instead, bringing about a permanent decline in prices.*

But another explanation may be monetary.  Simply put, the US then had a problem rather like what Europe has now.  Monetary policy that was/is appropriate for the North was/is too tight for the South and caused/s serious damage to its economy.**  And, of course, the thought of fiscal union had never so much as occurred to anyone at the time.  If this is true, then the economy of the Southern US was being treated much as the economy of Southern Europe is being treated now.  And it went on for almost 70 years!  No wonder the South was one of the strongest proponents of fiscal union when the opportunity came along with the New Deal!  This also means (as Krugman has also pointed out), that and Republican/Tea Party attempt to move away from fiscal union would be moving us right back to where we were for those 70 years, and where Europe is now.

*That was one thing I was surprised to learn doing economic research in college -- how many countries that are major cotton exporters to this day got started during the US Civil War. 
**Actually, both in the 1870's and today, monetary policy was probably too tight for the North and hurt its economy as well.  But the South was hurt even more.

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