Obama's federal pay freeze may not be a blunder but a deliberate move to align himself with the banks.

In case you haven't seen it, Brian Buetler has a roundup of reactions to President Obama's two-year federal pay freeze. Ezra Klein has three ways of looking at the freeze, which are not mutually exclusive: 1) This is more unwise, unilateral bipartisanship, 2) This is a smart way to protect the federal workforce, 3) This is bad economics and bad policy.

I think we should discuss a fourth option: President Obama thinks this is a really good idea and wants to spend political capital and energy to carry it out.  Rather than a piece of strategy to force concessions from the other side, this is instead something he wants his administration associated with and wants to take the lead in making a reality.  He's asking for the middle class to suffer first, before bankers and before the richest, without asking for anything in return.

When people refer to this as self-defeating or a political miscalculation, they are assuming that Obama isn't weak on core liberal values, or that his version of liberalism isn't far different than what was expected, or that he doesn't think this is worth fighting for. This is precisely what needs to be interrogated and challenged. The reality might simply be that his administration has different goals much more aligned with traditional centrist Democratic positions, prioritizes fighting for different objectives, and views the world through a different lens. They put bondholders over unions and public workers.

I see this with Treasury issues. The people I've met at Treasury are quite brilliant. I think they are wrong about a lot of what just happened, about what they prioritize and what they isolate or obscure, but I do not think it is because of ignorance. Obama is a smart person, smarter than me and probably smarter than you.  If your reading of this situation requires the assumption, "Obama is consistently making the wrong choice and is misled," you should rethink your position without assuming that and see where it leads you.

It would be one thing if this was an ambiguous part of Maritime law or something, but this gets at a core debate. Liberals think that the work government does is both worthwhile and crucial to the functioning of our country. Conservatives think it is not. Conservatives want to sow discord between factions of middle-class people to distract from lowering taxes and providing goodies for the rich, and this is precisely one avenue for doing that.

I talked about state and local government not being overpaid here. They are definitely not overpaid in their salaries. What closes the gap partially -- but not entirely -- is that health care costs have spiraled out of control for many middle-class people and retirement risk has been shifted more aggressively to working-class people. There is a failure to provide adequate benefits for private workers, and Republicans and now Obama want to convince you that this is normal. It isn't.

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Larry Mishel brings up the important point that Federal workers are clustered in major cities where their pay lags city workers. When I first worked in the private sector in San Francisco, I received a pay bump that was clearly targeted for the higher cost of living there. I wouldn't have if I had decided to work for a regulator. Here's how shocking it is (table 4):

Again, benefits close that gap, but that is a failure of providing benefits by the private market. This failure is anxiety producing for middle-class voters.  It isn't surprising that it works as an effective lever against government.

Meanwhile, here's the President of Third Way, Jonathan Cowan, sounding just like Obama:

As the former chief of staff of HUD, I’ve seen how crucial and committed the federal work force can be. But a pay freeze is the right thing to do. It shouldn’t be seen as a critique of their hard work, and federal employees should get behind it. We have a long-term structural deficit crisis and either everyone is going to contribute to spending cuts, or the United States will cease to be the number one global economic power. Federal employees can lead by example, showing the American people that they place the financial health of the country above a pay increase these next few years. If we’re going to trim Social Security and Medicare -- which are essential steps to balancing the budget -- we’re also going to have to show that we can bring the costs of running the federal government in line as well.

What's the difference here?

So much for Ed Kane's vision of stronger financial market regulators who are more talented and more public-minded.   You simply won't get that without being willing to invest in the people you hire.

Mike Konczal is a Fellow at the Roosevelt Institute.

"America's First Citizen" knew a recession is no excuse to ignore the rights of working Americans.

The latest blow to the Roosevelt legacy was reported in this weekend's NYTimes: "Even at manufacturing companies that are profitable, union workers are reluctantly agreeing to tiered contracts that create two levels of pay." Tactics like these have been used before, but almost always at financially troubled companies and with the assurance that the changes were temporary. This time, however, companies like Harley-Davidson -- usually an emblem of the working men it employs -- are making the two-tier system permanent, against the threat of pulling out of communities and taking jobs with them.

No better time than now to pick up a copy of Brigid O'Farrell's new book, "She Was One Of Us: Eleanor Roosevelt and the American Worker". O'Farrell goes back before ER ever set foot in the White House and takes us all the way to her death in 1962, pointing out along the way the passion she brought to the fight for workers' rights and the expansion of unions' influence. Throughout her life, ER was an ambassador between unions and minorities, the president, and the world at large. She was a card-carrying member until her death and never stopped fighting for labor rights.

But ER didn't grow up in a working-class environment. She was raised as a New York debutante in one of the city's oldest families, attending a finishing school and fancy balls. But at the age of 18 she became involved in the settlement house movement, volunteering to provide necessities to the less well off. It was through this work that she introduced FDR to the squalid life in New York City's tenements and both became involved in social justice. That passion never faltered. She then got involved in union work when her friend Rose Schneiderman introduced her to the Women's Trade Union League. And in 1936, in celebration of the first anniversary of her "My Day" column, she joined the American Newspaper Guild, a union for journalists. She stayed active in that organization until the end.

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As O'Farrell explains: "She practiced what she preached." She surprised the country by going into a coal mine in 1935 to see the conditions for herself and to talk to the miners about their needs. As Heywood Broun, a prominent labor leader, put it, "It seems to me, at the moment Eleanor Roosevelt has a deeper and closer understanding of the needs and aspirations of millions of Americans than any other person in public life." In a pamphlet for a memorial fund set up in her honor by the AFL-CIO in 1963, the unions declared, "she was one of us." That sentiment wasn't just felt by the unions, however. A woman that Glenn Beck would be quick to call an "elite" today, she was beloved by average Americans of all groups, racial minorities and women included, for her work on their behalf. Martin Luther King, Jr. called her "America's First Citizen." Her whole life she worked to make sure that African Americans and women were included in union organizing efforts.

And while today the recession is used as an excuse to damage unions' influence and workers' rights, both ER and her husband ensured that an economic recovery from the Great Depression included improved living standards for the poorest citizens. While she wasn't shy about acknowledging some of the corruption, internal strife and power grabbing that would go on in the unions, she always felt that they held the key to improving the lives of working Americans and thus were vital to protect. She constantly questioned attacks on labor, even after her husband's death. In response to the passage of the anti-labor Taft-Hartley Act, she wrote, "Perhaps [Congress] hope[s] to establish an economy which will keep up large incomes for certain great business corporations but cut down on small business, gradually reducing the living standard for the average individual while keeping it high for the few favored people. This is not a democratic theory." And no matter what other challenges the country faced, she never felt that workers' rights should be ignored. O'Farrell says it well: "In the face of difficulties both domestic and foreign, from the Great Depression through World War II and the cold war to the economic challenges posed by automation and globalization, Eleanor Roosevelt allied herself with workers who sought to advance economic and social justice."

ER also knew that workers' rights didn't just matter at home, but had echoes in the global arena. While she watched squabbles over alleged communism in unions' ranks and attacks on their power, she lamented, "Sometimes, when I see how inadequate we are at settling these disputes among ourselves reasonably, I despair about a peaceful world... If we can't do this in labor disputes at home, how on earth do we expect to do it when the people concerned belong to different nations?" She strived for the US to set an example of democracy and freedom for all of its citizens on the global stage. As we fight two wars and try to make economic deals with other countries, those might be good words to remember.

Her work is far from over; in fact, the torch is in need of relighting. Walter Reuther, a labor leader and dear friend, once said that ER had "the rare combination of courage, integrity, intelligence and charm blended into human kindness and understanding that entitles her to a place in history as the greatest woman in modern times." We can all find a little of her in ourselves and in our fight for social justice.

Bryce Covert is Assistant Editor at New Deal 2.0.

Obama should heed Keynes's warning to FDR: You can't get reform until you have recovery, which means, in a word, JOBS.

After the "shellacking" the Democrats and Obama took in November's election, it is clear that the old time religion of classical economics will come back into fashion. The result is likely to be further economic disaster.

I am not surprised by the Obama administration's failure to win over the American people to a progressive economic program. On pages 13 to 18 of my book "The Keynes Solution: The Path to Global Economic Prosperity," I compared what I expected of Obama vis-à-vis what Roosevelt did in the first few years of his administration. I cited a letter written by Keynes and published in December 1933 in the New York Times in which Keynes warned the president that there were two goals -- recovery and overdue social reforms. But Keynes warned that if one goes for the social reforms before full economic recovery was achieved, then they "will upset the confidence of business... And it will confuse thought." Instead, Keynes recommended concentrating on policies for recovery. Once the president succeeds at achieving that goal, reforms will come much more easily. I suggested that if Obama followed the "jump start" advice of his economic advisors for a small stimulus program just to get the private economy turned around, then the nation would not get the full recovery we needed. All reform, as well as full recovery, would be jeopardized.

Given the current politics of austerity, we face maybe a decade more of economic disaster. Progressive economists must get out in front with Keynes-style economic thinking -- for Keynes' analytical framework is the only complete one that is not just a variant of classical theory. Keynes' theory of liquidity can deal with achieving full employment, correcting international trade imbalances, preventing inflation and deflation, and understanding of the role of financial markets in a money using entrepreneurial economy (in other words, an economy where entrepreneurs organize production and exchange transactions via monetary contracts for performance and payment in the future).

It is necessary to immediately put forth a consistent plan for not only the domestic economy, but also internationally in order to end huge trade imbalances. Mr. Geithner's call for devaluing the dollar relative to the Chinese yuan will not do it. Nor will relying on Old or New Keynesian variants of classical economics, such as Stiglitz's asymmetric information or some other MIT or Harvard New Keynesianism. All of these mislabeled "Keynesian" models assume that the economic system is classical except for some presumed ad hoc restraint on the flexibility of prices or on obtaining complete information about the future as determined by today's market fundamentals. In the long run, all these mainstream "Keynesian" models will create full employment when price and wage fixities are removed and full information about the future is provided. These theories state that it is only the ad hoc constraints that prevent short-run optimal results. Therefore, the implication is to get government out of the way and the market, in the long run, will prove to be optimal. Keynes's response to these classical theory's long run conclusions was, "In the long run we are all dead."

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My book provides a complete alternative to the various classical models that are going to dominate Washington in the next few years as Obama tries to compromise with the conservatives and Tea Party people.

The American people's votes in the midterms are being interpreted as saying no to more deficits -- but what they really want is prosperity and jobs for all who are willing to work. So we must show them why these goals require government deficits. We have to get the kind of progressive programs of the Roosevelt tradition into the public forum and create an economic foundation that provides a good future for years to come.

Until we can provide a single, consistent program for economic prosperity, all the other progressive goals will remain in the dustbin. The conservatives and their classical theories will dominate, even though they are wrong -- because, as they say in politics, "You cannot beat Somebody with Nobody." The only body of economic thinking available that can beat classical thinking is Keynes' original analytical foundation -- not Samuelson's Keynesianism or Stiglitz's New Keynesianism.

The original Keynes analysis stated that the economic future is always uncertain in the sense that it cannot be reliably predicted on the basis of current and past market data. Thus, consumers and entrepreneurs "know" that they do not know the future. All classical theories, on the other hand, presume the future can be reliably known by analyzing existing market data.

In Keynes' analysis, when people are optimistic about the future they believe they will always have enough contractual cash inflows to match their contractual cash outflows, so they are wiling to contract to buy more goods and services. The more people fear an uncertain future, on the other hand, the more liquidity they will demand, for liquidity means one has or can obtain enough cash to meet all known and possible future contractual cash outflow obligations. In other words, when people fear uncertainty they demand more liquidity, rather than goods and services. And given all the cash bankers and businesses are sitting on, no one can doubt that the problem is one of too much uncertainty and private demands for liquidity, with the resulting lack of aggregate demand for goods and services.

Paul Davidson is the Editor of the Journal of Post Keynesian Economics and the author of The Keynes Solution: The Path to Global Economic Prosperity.

A disastrous trade war may be coming our way.

There has been a considerable amount of discussion about current account imbalances in light of last weekend's failed G20 summit. For the most part, the meetings focused less on currency levels per se and more on the underlying trade imbalances. In particular, they discussed the threshold at which both surplus and deficit nations should work to mitigate the extremes implied by deficits/surpluses in excess of 4% of GDP.

Of course, one could argue that the focus on current account imbalances, rather than exchange rates per se, was simply a means by which the Americans could discuss China's pegged rate regime so that Beijing didn't appear to succumb to US pressure and "lose face". But fundamentally, the US dollar/Chinese yuan exchange rate has long constituted a huge source of financial instability in the global financial architecture. Although today's focus on China tends to highlight its huge and growing bilateral trade surpluses with the US (and to a lesser extent, the Euro bloc), less appreciated is the degree to which its exchange rate policies have historically impacted its Asian neighbors and continue to do so to this day. As recently as 1994, Beijing precipitously devalued the renminbi against the greenback, taking it from 5 to 8.4, a 60%+ devaluation. Even this action understates the magnitude of the change, since it was preceded by a period during which the country's monetary and financial authorities embraced a policy in which the yuan declined some 60 percent against the dollar.

So much for the need for policy incrementalism, as the Chinese persistently respond today when confronted with calls for a substantial yuan revaluation! In the late 1990s, Beijing's earlier policy of "beggar thy neighbor" might have engendered comparatively minimal disruption domestically, but it exported the economic dislocation to East Asia and Japan. The cost advantage of these devaluations, conferred on China's exporters, significantly eroded the trade competitiveness of other East Asian and Japanese exporters. They therefore threw their collective current accounts into substantial deficit by the mid-1990s and set the stage for the Asian financial crisis of 1997 and Japan's "lost decade." (It also set the stage for Japan's implementation of a zero-interest-rate policy, which ultimately provided the foundation for the so-called "yen carry trade" -- another grave source of future financial instability.)

I have already argued that QE2 has minimal impact on the amount of new net dollars in existence. But the viscerally hostile Chinese response to the Fed's policy suggests that they see in it echoes of their own policy of the early 1990s (in spite of the fact that the US has a freely floating exchange rate, not a currency peg).

Most defenders of Beijing justify the pegged rate regime on the grounds that it has helped to move the country up the technological curve and thereby enhance living standards. Perhaps, but India has done it without adopting a similarly mercantilist policy. In any event, the improvements of living standards facilitated by rapid export growth and income gains in China are still heavily skewed toward the exterior regions, rather than the interior of the country.

There could have been better ways for China to improve the living standards of its people. It is perfectly understandable why Beijing adopted the Asian mercantilist model, as it worked so well for the nations of Northeast and Southeast Asia. But it makes no sense for a country of 1.5 billion people with a huge domestic market that its manufacturers could potentially supply for decades. India also seems to have improved the living standards of its people, but it has adopted a much more balanced economic model (and correspondingly less trade friction with the US and EU).

Although Beijing no longer explicitly pegs its currency against the greenback, it does so against a basket of currencies of which the dollar is still the largest component. It therefore remains a pegged rate regime in all but name. This type of currency regime is generally not the best institutional structure for an economy because it entails a surrender of monetary/fiscal sovereignty and builds in an inherent financial fragility. In China's case, the fragility has been somewhat masked by the fact that it continues to run trade surpluses but, as noted above, it has effectively "exported" the financial destabilization associated with currency pegs to its trading partners.

So what is the problem with a currency peg? A nation with a currency peg can run external deficits (on the current account) for a time, as long as there are sufficient foreign reserves so that the central bank does not need to contract the monetary base (its liabilities). In particular, if investment is targeted at productive ventures that build extra export capacity and if the nation has enough foreign reserves, then a current account deficit for a time can be beneficial in the longer term.

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But persistent current account deficits become particularly problematic for a nation running a currency board. The nation faces the continual drain of its foreign reserves, which has two impacts. First, the peg comes under pressure. Second, the central bank has to contract the monetary base, which has a negative impact on aggregate demand. A sharp deterioration in the current account can quickly create a crisis because the economy has engineered a sharp domestic contraction (normally, by sharply raising interest rates) to reduce imports, but also risks running out of reserves and occasionally has to default on foreign currency debt (either public or private).

While the higher rates may attract foreign capital inflow, they are also deflationary. Proponents of this arrangement argue that deflation starts a process of internal devaluation (wages and prices fall) and increases the competitiveness of the export sector. But it is clear that currency peg arrangements, which eliminate the capacity of the central bank to run discretionary monetary policy, lead to pro-cyclical policy outcomes. So in boom times, with exports strong, the monetary base expands and interest rates fall. Monetary policy reinforces the demand boom.

But if exports fall and thus aggregate demand weakens and/or foreign capital outflow occurs, then the monetary base contracts and interest rates rise, causing a further contraction. Moreover, when times are bad, the treasury may not be able to fund its current budget position (if in deficit). So fiscal policy has to contract, which worsens the situation.

Clearly this is not a problem for Beijing today, as it runs a huge current account surplus. But if it were to revalue its currency and retain the peg (rather than let it float), a future major collapse in export growth would be highly problematic because it would engender a loss of capacity to build foreign currency reserves and support local demand.

Needless to say, China's peg has NOT been particularly helpful to the US as a whole, either. In general the dollar-yuan peg has helped to perpetuate a weirdly destructive symbiotic relationship between China's military, which seems to be making lots of money from the speculative enterprises that persistently pop up in the US, and Wall Street, which has become a major beneficiary as the agent that recycles these capital flows back to the US. In the meantime, the peg displaces US workers via low-cost Chinese labor facilitated by technological advances, which drives further outsourcing by US corporations. To offset the impact, the US government has consciously built up its "FIRE" (finance, insurance and real estate) sector, which has "leveraged" the rest of the economy as its employment and profits grew at a faster pace (it received 40% of the nation's profits before the bust). Leaving aside the issue of "productive" versus "unproductive" labor, it certainly appears in retrospect that the FIRE sector has played an outsized role in the US economy, in effect offsetting the loss of manufacturing capacity. The "market" is now trying to downsize the FIRE sector, but current policy seems designed to resist that. All efforts are aimed at keeping leverage high as the Fed and Treasury try to get banks to lend again -- as if another private debt bubble is the cure for what ails the economy.

That all might begin to change. After observing the latest G20 fiasco, it is conceivable that American government will feel that it has no choice but to move toward tariffs, especially as fiscal policy is likely to remain constrained by a hostile GOP-dominated Congress. The numerical targets on current account imbalances were the last warning shot to forestall the protectionist option. This has now failed.

Domestic US political considerations for the President and his party might well mandate a more radical tack. Consider the recent midterm election results. The Democrats sustained huge losses in the rust belt. These states have been traditionally Democratic. True, some went for Reagan in the 1980s, but Obama got them back in 2008 and thereby won the election. He needs this region. He can forget about the South: there, we have all kinds of constituencies that voted against him. He'll never win over the Christian right, the plutocrats who narrowly vote their pocketbooks, and so forth. Obama needs to win back members of his disaffected base, especially younger voters who didn't show up because they face a hopeless employment situation. But he won't get this group back to the polls unless he focuses on jobs. The independents will also be hard to get back without this, because they too are disgusted by the government's cronyism. But even if the President wins back a large number of disaffected independents and the youth vote, he still needs the rust belt. He therefore has to attack China, the outsourcing of jobs, and focus on Beijing's currency (which he has recently called "undervalued", potentially setting the stage to name China as a "currency manipulator" with the World Trade Organization). If Obama doesn't do this, the Democrats should just wave a white flag in the next election and not waste money campaigning. This is the US political reality as long as the unemployment rate is above seven percent and Corporate America is nuts about cutting costs by moving to low wage platforms abroad. A trade war, complete with tariffs, could well prove inevitable.

Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.