Despite hand-wringing, we aren't in danger of a Debt Super-Cycle and stimulus spending will have a real economic impact.

Recently, some progressives have argued that further short-term economic stimulus is unlikely to be effective because consumer spending -- which was running at almost 70% of GDP pre-crisis -- has been artificially inflated for many years (perhaps decades) and is simply unsustainable. So, even if renewed consumption could be stimulated, it would never return to pre-crisis levels or levels necessary to achieve full employment. Moreover, given the outsourcing of the US manufacturing base over the last 30 years, stimulating consumption would simply create jobs in China and elsewhere. Accordingly, a large stimulus in the short-run that requires significant additional deficit spending (and borrowing to finance it) is not worth it. Worse, it could be self-defeating and, even if successful, permit avoiding more critical long-term economic problems.

Obviously, both the public policy and political stakes of these views are particularly high and amount to saying that, without addressing long-term structural economic problems, the economy will never emerge from recession or approach full employment. While I sympathize with many of these sentiments and, indeed, have argued some of them myself, I do not agree with the ultimate conclusion. Indeed, it seems to classically confound the short-run cyclical condition of the economy with its long-run structural problems. Although short-run and long-run economic effects have interacted, they need to be kept separate to understand what needs to be done about unemployment now.

It is true that, starting 30 years ago with Reagan's election, household incomes for the vast majority of US households stagnated because of the economic philosophy (and policies) of the Republican Party and its devotion to the wealthy elite in this country. Most household income growth during this period accrued to the top 2% with the vast majority of that in the top ½ of 1%. In order to maintain their standard of living, most households below the top 2% borrowed extensively, particularly in the last 10 years during the housing boom, causing a sharp build-up of household debt. And because of abnormally low interest rates in the last 10 years, there was also a significant build-up of corporate debt. Together, private sector debt experienced significant above trend growth in the last 10 years and reached record levels as a percentage of GDP. Spending beyond the means of most consumers and the subsequent build-up of private sector debt represent classic long-term structural features of the economy.

At the same time, on a short-run cyclical basis, the economy experienced a horrendous financial crisis that resulted from a short-run boom-bust credit cycle. The crisis produced a sharp contraction of credit in the economy that in turn caused households to cut consumption and businesses to cut production. Spending cuts by consumers and business triggered the current punishing recession (which almost became a depression) and mass unemployment. These near catastrophic events were short-term cyclical in nature.

Certainly one of the effects of the unprecedented disparity in wealth that has built up over the last 30 years has been to impair the purchasing power of the middle class and the poor. It has also undermined government economic stabilization policy by making it harder to reflate the economy in the short-run and to avoid a Japanese-style deflation or even a catastrophic depression. However, if handled properly, I do not see the current situation in the US approaching these extremes at this time.

Here's why. Following the Depression of the 1930s, policy makers were determined to avoid repeating its central financial problem: catastrophic debt-deflation. Looking at the business cycle from a pure money and banking perspective, the traditional view was that economic downturns (like the Depression) were caused by credit cycles. An extreme contraction of credit could result (like in the Depression) in a system-wide debt-deflation in which all private debt in the economy was liquidated before the next cycle began. The "liquidation" view of the business cycle has subsequently been referred to as that of the "Austrian School" of business cycle theory.

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The problem with the Austrian School approach is that the liquidation of private sector debt (i.e. the default, foreclosure and forced sale of all debt) as the "stabilizing" mechanism for the business cycle is tremendously destructive economically. The authorities realized that it could be avoided by restarting -- or "reflating" -- the credit cycle before a debt-deflation took hold. Reflation could be achieved by the central government providing adequate liquidity to the financial sector so that it could restart lending and stimulate aggregate demand in the real economy so that borrowers could resume carrying their debt. This approach combines expansionary monetary and fiscal policy and is known as the Keynesian approach to the business cycle.

So far, so good. Policy reflation has worked in every recession in the post-World War II period and the destructive effects of wide-spread deflation of existing debt -- with the associated collapse of business and household spending -- have largely been avoided. However, there is a little-known caveat to the Keynesian approach: By stopping the debt liquidation process and reflating existing private debt, private sector debt builds up from business cycle to business cycle. This is known as the Debt Super-Cycle. The Debt Super-Cycle is characterized by rising levels of private debt and growing balance sheet illiquidity (i.e. greater levels of debt) of corporations and households, which makes them (and the larger economy) increasingly vulnerable to downward fluctuations in the short-run business cycle.

The problem is that at some point the Debt Super-Cycle will come to an end. This will happen when businesses and households are unable to borrow any further to roll over existing debt and restart spending -- even with public sector support. The idea that short-run fiscal stimulus will not work or is not worth it because the effect will be too limited is really saying that the Debt Super-Cycle is now at an end and that the authorities cannot achieve reflation.

But we are nowhere near that point. The corporate sector's balance sheets are currently flush and corporations are spending on everything other than expanding business and generating new jobs. It is true that households are not in a position to increase borrowing or spending, as their balance sheets are tapped out and they are busy raising their savings rates and deleveraging. Consumer spending growth is lower than in any recovery since World War II. No doubt we have a long way to go and the recovery is only modest.

However, what we are lacking is adequate fiscal stimulus to get more spending rolling in the short-run. Increased short-run stimulus will increase demand for goods and services from businesses and assist deleveraging and stimulate spending among households. And, since the corporate sector is flush, all that is needed to increase spending and employment now is a surge of demand for goods and services -- which can be supplied by direct public spending on such things as infrastructure, R&D, alternative energy projects, etc.

Meanwhile, fears relating to the deficit and the concomitant national debt associated with additional short-run stimulus, while real, are only long-term structural problems. They do not represent a realistic threat for at least another 3-5 years, depending on the strength of the current recovery.

It is clear from the level of interest rates for Treasury obligations that the government is presently more than able to carry its debt. Moreover, the credit worthiness of the US -- according to stringent analytical tests applied by credit rating agencies and others -- is still sound. Indeed, it is triple "A". These are true despite a disturbing increase in the public debt-to-GDP ratio that is primarily due to the Bush tax cuts, Bush era wars and deficit spending caused by the recession (which will evaporate once the recovery becomes fully self-sustaining). In fact, the rating on US debt is above that of the vast majority of other economically advanced nations. The European sovereign debt crises roiling several small countries has no relevance to the US.

Based, in part, on the rebound of the savings rate in the US, there are also more than enough available funds to finance renewed fiscal stimulus for the foreseeable future. After that, the only issue is whether, on a longer-term basis (about 3-5 years), current and foreseeable deficits will adversely affect interest rates as a result of the crowding out phenomenon. Whatever that risk, the only realistic way to control public sector debt involves, first and foremost, a resumption of much more rapid economic growth in the short-run which will permit the economy to grow at or above its long-run potential growth rate of 2-2.5% in real terms. Realizing this type of growth in the short-run will require greater stimulus now.

Daniel Berger is an attorney in the field of complex litigation, including securities and anti-trust litigation, and has a broad-based knowledge concerning the structure and functioning of the US economy and US financial markets. He practices in Philadelphia.

Republican ideology and policies created this mess. So how did Democrats squander the opportunity? In the first post of a two-part series, Daniel Berger explains how we got where we are.

Regardless of the outcome of the 2010 elections, the Democratic Party urgently needs a fundamental re-evaluation of its political strategy. The 2008 election of Barack Obama could have been a watershed event in U.S. politics -- not unlike Reagan's election in 1980, which initiated the 30-year political dominance of the Republican Party. It still could be.

Obama won a substantial majority based on a strong showing among young people, minorities, and other voter groups far outside the Republican political base and ambit of influence. Together with a narrow plurality among independents, Obama's vote -- if replicated in future elections -- could represent a durable, long-term majority. Moreover, as a result of Obama's election, the Republican Party has splintered into two factions: an extreme mainstream and the ultra-extremist Tea Party. This opens up the possibility of a complete marginalization of the Republican Party to permanent minority status if the Democrats can co-opt its moderate element and demonize its extremes.

But Democrats have had difficulty capitalizing on an apparent fundamental shift in the political landscape. They are actually struggling to maintain political control, even though the major problems facing the nation are directly attributable to 30 years of Republican neglect and misrule. Despite legitimate efforts by the Administration to begin to address these problems, Obama and his allies on Capitol Hill are being blamed for them.

Notwithstanding the role of the Republican Party and its destructive policies, which are directly responsible for current conditions, any rebuke which the Democrats receive in the elections would also be a direct product of the Party's own ineffective political strategy and that of the entire progressive political movement.

It is almost inconceivable that, during the worst economic conditions in 80 years, a conservative populism has arisen which, among other things, calls for the abolition of the national government. This comes after a recent collapse of private sector economic activity that caused mass unemployment. It required the national government to be the spender of last resort to stave off an economic catastrophe and support a slowly recovering economy. Eighty years ago, parallel conditions (which, left unchecked by the national government, spiraled out of control into the Great Depression) ushered in a progressive political movement responsible for the greatest era of political, social and economic reform in the history of the country. The 20th Century became the American Century and the U.S. was admired, even revered in the world.

Yet where is progressive populism now? Why haven't masses of workers; members of the middle class who are unemployed, underemployed and underpaid; and their allies staged mass rallies to protest the behavior of Wall Street? Where are protests against the business sector for overdoing layoffs, or at least against the Tea Party, the intellectual and political successors of the Ku Klux Klan?

At the very moment of recent political triumph for the Democratic Party and its progressive allies, at a moment in which the nation, for the first time in 30 years, has begun to take action to address its fundamental problems, all progress could be quickly lost in the 2010 elections.

The nature and intensity of the opposition make clear that differences between the two parties now do not reflect competing visions of the future, but rather represent the future versus the past and reasonable change versus the entrenched, and often corrupt, status quo. Normally -- particularly in a moment of crisis -- the political argument in any rational political system would be resolved (as it was here during the Depression years) in favor of the future. So why are we now deeply worried that the argument will be resolved in favor of the past?

The Limits of Current Strategies of Democrats/Progressives

The Democrats seem currently to be following these discrete -- sometimes overlapping -- political strategies. First, apparently both the White House  and the Democratic Congress believe that decades of ideological warfare between liberalism and conservatism has sickened the voting public to this type of conflict and has opened the door to a non-ideological political appeal. Such an appeal could presumably identify a set of problems requiring the collective attention of the country and develop a corresponding set of policy solutions based on the best available information and ideas, whatever their ideological origin. This could be called "policy approach" to politics.

While a policy approach is a good approach to governance, its effectiveness as a political strategy is questionable. The problems facing the country are complex. Unfortunately, issues that are poorly understood -- or even inaccessible to the public -- are easy targets of demagoguery and outright falsification (as the recent "debate" over health care showed).

This is particularly true in the current 24/7 media environment, where any proposed idea is intensively scrutinized -- and inevitably distorted -- by the media. As a result, public support for any policy proposal must be established at the very outset of its consideration and at every step along the way. But this is impossible in the current environment, where the Republican Party isn't committed to a good faith discussion and resolution of differences. Thus, any policy proposal can be effectively derailed (or even demonized) if it is not shielded by an aggressive countervailing public relations campaign.

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A second strategy which the Democrats seemed to have adopted has been referred to as "centrist." Until recently, conventional wisdom has held that any political party must move to the center to establish and maintain political support. The Democratic Party represents 25-40% of the electorate. The liberal base is even smaller. So the leadership reasons that it must appeal to moderates and independents to win elections. While liberals, moderates, and independents largely agree on social issues, they disagree -- sometimes sharply -- on many other issues. As a result, Democrats have to straddle the fence between these factions. On policy issues they have had to settle for the most modest form out of fear of losing support among "moderates." They can never address the fundamental causes of a problem without worrying about alienating a group, nor can they articulate a general guiding principle. Thus, Democrats can never adequately explain the true nature of a problem and why action is necessary, so they seem to act out of political opportunism rather than principle.

All this creates profound unease with the largest faction of the Democratic Party, the liberal base. For these reasons, Democrats wind up rarely appealing to them and almost appear to be running away from them.

The President has a related, but discrete, problem. He was elected in large part by young people and minorities, who not only provided votes but also idealism, energy, and grassroots organization. Obama has seemingly deserted this base by not focusing, at least rhetorically, on issues that are important to it. The best example is immigration. The Republican Party's political agitation served up the issue on a silver platter to the Democrats. Their inability to capitalize on it among Latinos and other minority groups is truly mystifying.

The Republicans, on the other hand, never pursue a "centrist" political strategy and always follow a "base" strategy. This causes the Republican Party to adopt extreme rhetoric and policy positions while allowing it to maintain a degree of coherence in its positions, as it is constantly pointing out that it acts "out of principle."

Although Republicans do not try to expand their base by compromising their "core" beliefs, they have tried to move the political center to the right. The conservative movement has constructed an effective network of think tanks, front groups, and media assets that have virtually unlimited resources. This "Right-Wing Message Machine" has been winning the war of ideas, despite the progression of political and social ideas over the last 100 years and social scientific evidence, all of which overwhelmingly favor progressive policies.

One example of the success of the conservative movement in moving the conventional wisdom to the right should suffice: public spending to stabilize the economy. Richard Nixon famously asserted early in his first term, "We are all Keynesians now." This statement reflected not only his Administration's embrace of Keynesian policy, but a consensus in both parties over modern macroeconomic theory. Nonetheless, 40 years later, conventional wisdom explicitly rejects the role of fiscal policy and, in particular, temporary government spending to make up for a collapse of private sector demand. This can only reflect the triumph of right wing ideology over all experience and reason.

In a third strategy, it is also possible that Democrats are specifically appealing not so much to the general public, but to the business and professional elites in this country. These elites have a remarkable degree of influence at all levels of American society -- not only by influencing political decision makers, but by acting as decision makers themselves. Our government, particularly at the national level, consists of a revolving door between the business and public sectors. In effect, they form a class of permanent technocrats and are as close as it gets to a ruling class in the U.S. For this reason, to get anything done politically in the U.S. it is necessary to have their support.

This latter point represents a double-edged sword for the Democratic Party. On the one hand, these elites follow a simplified form of the policy approach seemingly favored by the Democratic Party. Moreover, they are fairly well informed about the context in which policy decision-making takes place. So, unlike the public, it would be possible to make a serious appeal on policy grounds to the elites. Also, to their credit, they are almost all liberal on social issues.

However, at this particular moment, an all-out appeal by the Democratic Party to the elites is treacherous both policy-wise and politically. They tend to be reasonably well informed about business, their professions, and the state of the country, but they are not particularly knowledgeable about specific policy issues. They can be easily misled about -- or willingly distort -- policy issues, particularly on subjects that are counter-intuitive.

Worse, they also exhibit serious policy biases -- acting to protect their industries, professions, and permanent employers, and exhibiting biases reflecting the tension between private sector and collective action. The elites are devotees of the market and neo-liberalism. As a result, the elites have a general bias against government intervention in the market and policies designed to level the playing field or re-distribute wealth.

A good example of elite bias is their tendency to support "Free Trade." Arguments in favor of free trade never take into account labor protections such as prohibitions against child labor; wage and hour standards; occupational safety and health protections; the right to organize; or prohibitions against work place discrimination. Nevertheless, free trade is an article of faith among the business and professional elites in the U.S. It is also an open secret that the private sector -- in particular, the large multinational corporations headquartered or operating in the U.S. -- has openly advocated free trade as a way to end-run government work place regulations, lower their labor costs, and increase their profitability.

Thomas Frank makes an important point in "What's the Matter with Kansas." In his book, Frank addresses the following seeming paradox: Why would average working people in Kansas  -- home of staunch early 20th century progressive political populism -- vote against their economic interests and overwhelmingly support the Republican Party, the acknowledged party of Big Business that has systematically dismantled manufacturing and blue collar work in Kansas? Frank, a sociologist, found that on the key issue of jobs and overseas outsourcing, the Democrats were no better than the Republicans. Since there was no alternative on this issue, people in Kansas went with the Republicans, who they favored on some social issues. Frank's conclusion -- and his book -- are a devastating indictment of the Democratic Party on this critical issue.

The irony is also too palpable not to note. Historically, the Democratic Party has been the party of labor and the working class and the Republican Party of business and the elites. But, as we have just seen, the Democratic Party now has tilted strongly toward the business and professional elites on a key issue of outsourcing (and many other issues) as its progressive populism has been hollowed out with the passage of time. Meanwhile, the emergence of conservative populism has been bought and paid for by Big Business to pave the way for the Republican Party to regain power, so as to avoid regulations favored by the Democrats and abhorred by the Republicans. The degree of political bad faith is astonishing. You just have to love politics in this country.

Daniel Berger is an attorney in the field of complex litigation, including securities and anti-trust litigation, and has a broad-based knowledge concerning the structure and functioning of the US economy and US financial markets. He practices in Philadelphia.