The economic quake that is starting to rattle Washington

An earthquake registering 9.1 on the political Richter scale rattled the White House today. It was the latest unemployment rate, and combined with this week’s bad news elsewhere in the global economy — from the stock market to housing markets, from Greece’s downgrade to food price inflation predictions — it may not have leveled the president’s reelection prospects, but it certainly has begun to level the political playing field in the United States.

That’s too bad because the people most likely to gain from economic shocks that batter the president are actually the people least likely to be able to help the United States deal with the consequences of those shocks. On the other hand, people whose economic advice I have always been somewhat wary of because they are often a bit too ideological for my taste — Paul Krugman and Robert Reich — have published pieces this week that have me thinking they get it in a way that neither President Obama nor his arithmetically challenged Republican opponents do.

Reich’s piece, published in the Financial Times, and Krugman’s, appearing in his usual column at the New York Times, coolly and accurately assess the problem the United States is facing right now. Both are worth a careful read.

Essentially, the point of both is that the U.S. is having the wrong debate about the wrong problem right now. First, the battle over raising the debt ceiling a complete fraud that will be resolved shortly because no politician in his right mind … nor even all the rest of them … would ever want to be accused of lighting the fuse that led to blowing up the United States’ credit rating. Next, however, and more importantly, as Krugman argues especially effectively, the most critical issue is not the deficit at all. It is jobs and related issues associated with restoring growth to the U.S. and hope to average Americans.

Nonetheless, as Krugman writes, "somehow an overwhelming consensus emerged among policy makers and pundits that nothing more should be done to create jobs, that, on the contrary, there should be a turn toward fiscal austerity.… Somehow it became conventional wisdom that the deficit, not unemployment, was Public Enemy No. 1."

Krugman makes the analogy with a similar misread of the United States’ core challenges that led to a mistake that prolonged the Great Depression. Here, I think he may even ben inadvertently understating the threat. The "mistake of 1937" to which he referred undercut the recovery from the depression. This mistake might well deepen the current crisis and leave the U.S. more exposed to shocks from elsewhere in the world. In other words, its net negative impact might be considerably worse. For example, he doesn’t even really deal with how higher unemployment and sluggish growth might impact housing markets that currently have an astonishing 28 percent of U.S. homes underwater in terms of their mortgages with the number potentially rising past a third next year.

Homes are not just where Americans live. It’s where they keep their savings — not in their mattresses (although who could blame them, given what these numbers suggest about the health of U.S. banks?), but in the value of their properties. While one out of 11 Americans is unemployed, and maybe twice that is unemployed or underemployed, the remaining 80 percent are seeing the most important asset they have crushed. We can debate Medicare all we want. More damage will be done to more retired Americans by the flattening of the U.S. home market than by anything even Paul Ryan could cook up.

And don’t expect a rebound to fix things. With Americans aging, boomers rocked by the devaluation of their principal assets are going to sell and move into something smaller, often renting. There is no guarantee that U.S. housing prices will rebound anytime soon … if they ever do.

Reich, in his brief but thoughtful list of possible ways to deal with the United States’ situation, includes a provocative idea: change bankruptcy laws so that first homes are protected, thus giving homeowners more leverage against lenders. But the bigger issue is that both Reich and Krugman understand what the president and the Republicans seem not to: that the core challenge for the U.S. is restoring growth and creating jobs, and that old formulas aren’t going to work as U.S. and the global economy have changed dramatically over the past decade.

We need to be fiscally responsible (as I noted yesterday). But of the three ways to fix the deficit, cutting spending may be not only the least useful approach, it may be counterproductive to the extent it undercuts growth. Increasing revenue, done properly, should not impeded growth (fairer tax laws would actually attract new investment and eliminate unnecessary drag), and it also would provide the funds for the infrastructure, research and development, education, and other spending that are pre-requisites to the third and most important approach to fiscal rebalancing: generating sustainable growth.

That needs to be project one in the United States. And it only provides slim solace to think that the political class that is ignoring this most critical issue will almost certainly turn to it one way or another — either by waking up and thinking about creating new jobs for all Americans or by continuing to sleep walk until they are forced to think about how to create new jobs for themselves.