The "Third American Revolution" and Its International Consequences

*As per the author's request, this summary is not for quotation.

Since 2002 I have been pessimistic regarding the future of the financial sphere in the United States, where according to American executives and interlocutors everything was under control and running well. However, I am optimistic about the ability of the American people and society to react. There are two major factors to be explained regarding the current crisis: first, the European view of the crisis; and second, the basis and consequences of a new U.S. administration.

The current crisis is severe and its effects are being felt around the world. There are many interpretations of the current crisis, with disagreement among academics, politicians and professionals on its major factors. It should be emphasized that there are both microeconomic and macroeconomic causes for the crisis. It is useful to distinguish between major causes and secondary yet amplifying factors.

Debates are currently ongoing regarding the role of economic policies in this context, and it seems that monetary policy is, without a doubt, the major factor of the current crisis. This includes monetary policy that was too lax and interest rates that were too low for too long. Such policies were made possible by global imbalances, a secondary factor that enabled the longstanding lax monetary policies and low interest rates.

Regarding microeconomic causes, the major factor was unchecked financial innovation. Financial innovation is a good thing in itself, as it is in the manufacturing sector. But there must be safety rules with financial innovation as there are in industrial innovation. The problem is that this potential for financial innovation was used with incredible recklessness by investment banks, which was made possible by lax supervision. For example, the capital ratio rule that was elevated in 2004 by a decision of the SEC was the beginning of the incredibly high leverage operations undertaken by investment banks with the idea of fusing financial innovation to transfer risk to other financial institutions, in particular those in Europe.

There are further secondary or amplifying causes. These include rating agencies who rated companies appropriately, but were not well-prepared to rate complex financial products. These rating agencies facilitated the unregulated use of financial investments. Accounting standards also played a pro-cyclical role by allowing continuously improving results from capital gains.

The previous points give the crisis a sense of being an American-rooted financial crisis. This is how the crisis started, but it is now also a worldwide crisis affecting the real economy. The real economy does move cyclically, but economics teaches us that there are three types of cycles: long-, medium- and short-term. In the beginning of the 21st century, all three of these cycles were in trouble. A long-term cycle of economic growth, innovation and progress began after World War II with mass production simultaneously increasing productivity and allowing the distribution of higher wages, stimulating highway construction, and improving suburban life. This cycle peaked in the late-1970s at the time of the oil crisis. The 1970s and 1980s saw the weakening of this regime.

A medium-term cycle began with the "new economy". The "new economy" was a story of innovation in the production process, improving productivity and products available to consumers. This caused an upsurge in growth during the 1990s that came to an end with the dot-com bubble collapse. The short-term cycle was fueled by aggressive economic and tax policies, and a lax monetary policy. This combination of macroeconomic policies fueled a short-term cycle that seemed very artificial, yet would ultimately have an effect on the financial sphere.

Housing and consumption were the resulting engines of growth in America. New engines of growth need to be discovered, as has been done in the past. Possible fields for future growth include energy markets, commodities, innovation, income distribution, productivity gains, and financial sector stability. This is true for the U.S., Europe and Japan.

Last year, the most recurrent theme of presentations made by investment bankers was that Asia's, emerging economies' and Europe's growth engines could decouple from the U.S. crisis's epicenter. This argument did not hold true because economies have become increasingly global, thus integrated, over the years. Major exporters could not escape from the consequences of a severe downturn in the U.S. Though I am generally optimistic about Europe, it is extremely unlikely that Europe's economic outlook can be positive while the economic outlook of the U.S. remains negative.

What was most surprising about 2008 was the resilience of many economies already facing financial crisis. This includes American consumers who remained active until the summer of 2008, Asian economies which were stimulated by China's energy lasting through the Olympic Games, and emerging economies that were most likely propelled by high commodity prices in the first half of 2008. However, resilience gave way to collapse with the closing of Lehman Brothers The synchronization of all markets and economies became thus apparent by the end of 2008.

It is clear that the economic and social insecurity which was perceived by U.S. voters in the summer of 2008 played a role in the election. At that time, Barack Obama was more aligned with the immediate preoccupations of the voters than was John McCain. It would be inaccurate speculation, however, to limit the interpretation of the U.S. presidential election to a short-term reaction to economic determinants. While some economists build statistics on elections and the economic situation, other references can be used to show that the election was "a Third American Revolution", with precedents in the elections of Franklin Delano Roosevelt in 1932 and Ronald Reagan in 1980.

Apart from the fact that America elected its first African-American president, this election remains revolutionary for other reasons. Under the Bush administration, the U.S. came progressively closer to a political realignment. U.S. institutions are extremely stable, which is not the case in many countries, including developed countries like France. Political scientists use the term "transformational election" to differentiate a small number of elections that have broader consequences than most other elections. In transformational elections there are large movements in public opinion, social forces, changes in the vision the rest of the world can have of America. Also, the understanding of the relationship between the market and the state, which makes the center of gravity of American politics, swings from one side to the other.

The election of Roosevelt started a 35-year period of Democratic rule from the New Deal to the civil rights movement. By the 1960s, the conservative flank was maturing after failure with Nixon, but the election of Regan solidified the place of conservatives. Approximately 30 years of conservative leadership ended up with an attempt by the Bush-Cheney administration to move American politics away from the center and toward the extreme right. This was demonstrated in the Bush administration's policies regarding religion, the environment or foreign relations, to name a few.

During this period, the American public became frustrated with three issues. The first one was the increasing difficulties of day-to-day life. Living in debt was a more and more rooted into reality for those in lower-income brackets. Moral frustrations emerged with many debates on the role of religion, limits to freedom amid the Iraq War, actions contrary to American ideals, and corruption in Congress due to long periods of Republican control. Finally, the political change in the 2006 election turned the Congressional leadership over to the Democrats and signaled a new political direction for American voters.

Beyond the political crises that have been described, there is the idea of new aspirations. There are three elements that could be the basis of this American Revolution. First, the U.S.'s focus on free-market economics has produced good economic results but increased social unfairness. While Americans are comfortable with the idea that some are rich and others are not, the American dream is that everyone who works hard and makes good choices may access a secured place in the middle class with a god job and thus security for his family that includes health insurance, children's education, and a pension.

However, following the last decade of job insecurity, decreasing healthcare benefits, increasing education costs and growing pension concerns, this axiom of American life is now being threatened. The problem is more a concern of social equity than envy and jealousy towards those "who made it". The economy must, indeed, deliver even for those who are not rich. A required element of the Third American Revolution is the creation of a system that provides people with access to a middle class lifestyle that includes jobs, healthcare, education and pensions.

Second, the environment is another area of importance which the Bush administration was hostile to any related concerns. The U.S. is a diverse country with many different forms of government ranging from national to state to local and municipal. Many city and state governments pursued measures to satisfy people's desires for a better environment. What is striking is that the business community also became more environmentally friendly when it realized that clear rules of the game were needed to prepare for the future of industry. Developing green capitalism is currently emerging as an important priority in the U.S.

Third, the U.S. manufacturing sector has been strongly affected by external competition, and the share of manufacturing employment has decreased in the U.S. This becomes an economic and political problem when Americans on both sides of the aisle believe foreign competition is causing the loss of good jobs for American workers. Middle-class workers harbor protectionist more and more insecure while the elite fear that the technological superiority of the U.S. to be threatened. The latter belief holds that the U.S. must return to technological superiority, if only for security reasons, and develop a new series of industrial innovations to take leadership in promising industrial sectors.

In sum, the new American Revolution could firstly encompass changes in the country's social fabric, secondly, make its businesses and financial sector more environmentally friendly and thirdly encourage its industries to embrace green capitalism, and integrate a more innovative industrial orientation. It is difficult to gauge whether President Obama will deal with these medium-term issues since there are huge short-term challenges to be tackled. The new administration seems to be attempting to fulfill two goals: fighting the recession and establishing a foundation for this new American Revolution. This can be seen in significant signals including budget choices that give high priority to healthcare, education, innovation and the environment. This is not by chance; it is a structural choice but only the first element. This move clearly indicates to Americans that their country will recover from the crisis, and this president is already trying to show the country its future economy and growth potential.

In domestic policy, the major theme is pragmatism. President Obama and those around him are convinced that the situation is extremely severe. They are not inspired by an ideology, but have in mind solutions that they need to sell to the American public only, and not to Europeans. The situation is extremely difficult, but they will have to act in the coming quarters to decide of the relevance of adding to the deficit, to take new fiscal, budgetary and financial measures, and possibly to nationalize the financial industry. Knowing this, they are still going step-by-step as they reach the policy effectiveness. . They do not want to rely too heavily on ideology, responding instead with pragmatism to any new developments in the situation.

In terms of international policy, the keyword is leadership. It was made clear at the recent meetings in Europe that, in some sense, American leadership is back, though weaker. The roots of American weaknesses will not be surmounted with a few good decisions by the White House. America's ability to exercise efficient leadership is not what it had previously been. Thus, we enter a better international situation than under the Bush administration as the U.S. is playing its role in a way that rings with global public opinion, but it cannot exercise this leadership in the same efficient way it did after World War II. The world is entering a more unstable economic situation, but hope is possible for a better future. However, there are still many economic risks that are linked either to excess liquidity that can create inflation, or deflation risks that come with reduction in employment, consumption, production and exports.

Q: Regarding Europe, the disparity between the finances of EU countries is growing and some are experiencing hardship maintaining the value of the euro. Such countries would like to enlarge financial expenditures. There are ongoing talks regarding the difficulties maintaining the euro as a unified currency. Please relate your opinions on this matter.

Jacques MISTRAL
The coming of the euro has been a European Revolution. The idea of a weakening or collapsing euro is still a premature notion. First of all, the euro has been extremely effective in protecting Europe in the current situation. It must be kept in mind what the previous currency regime was like in order to imagine that without the euro, there would have been three monetary crises in Europe since August 2007. Many currency fluctuations would have occurred and they would have been compounded by European finance ministers being preoccupied solely with preparing for the next devaluation or taking care of the previous one. The euro has thus protected good management, employment and purchasing power. The idea of Spain or Italy abandoning the euro is a highly unadvisable one.

Second, there is a difference between the European policymaking process and the American one. Europe has been frequently criticized in the media regarding the irrational decision-making process in Brussels. The Washington process, however, has been much more cultish than in Europe. The divisions in American policies on what to do to face the crisis prove this point. By comparison, the process was reasonably well-managed in Europe with meetings of heads of state at appropriate moments moving in the right direction to adopt successive measures both regarding budget policies and bank rescues. Additionally, the behavior of the central bank is a prime example of good central bank behavior, especially when compared to the erratic behavior of the Federal Reserve.

It is correct that some European countries are facing difficult adjustment processes. These issues are well-known in the economic history of Europe and tools, that may appear unpleasant to populations, exist to deal with .And this holds true for financial adjustments anywhere. When those having difficulties compare the costs of adjusting within the Euro-zone or going at it alone, they will choose to adjust. There are security measures in place to make the adjustment less costly than what it would be if the countries had to face individual devaluations and adjustment plans.

Europe's difficulties are different than those of the U.S. Europe's financial sector is in a much stronger position than the U.S. financial industry, but there are some countries with issues similar to the budget problems in California. U.S. states have problems that rank with those faced by countries, though this is not mentioned because California has the federal government to rely on. In the same vein, if a European state were to default, there would be European solutions to deal with it similar to the possibilities available to California. The default of a European state could be an opportunity to reinforce the institutions of the Euro-zone.

Q: What is the difference between the Obama and Clinton administrations? You characterized the Obama administration as a third revolution, and the first since the continuation of center-right government that began in the 1980s. However, the eight Clinton years fall in this period. Please explain this discrepancy.

Jacques MISTRAL
In political and economic terms, the Clinton administration took place by accident. Bill Clinton is a very talented politician, but the 1980s was a period where the American mood was toward the center-right. Clinton defeated George Bush Sr. because of the candidacy of Ross Perot. The Republican votes were divided between Bush and Perot because Perot campaigned on the single issue of fiscal conservatism. Clinton was able to win because the other two candidates split the conservative vote. At this time, Congress was Republican and Clinton did not have much room to maneuver. He wisely adopted a policy of playing to the center or center-right. For example, Clinton's signing of a law to reform welfare distribution that was adopted by a Republican majority was seen as a tendency of Clinton to go too far to the right.

The Obama administration stands to the center-left. This can be seen from the criticism Obama has received from many quarters of the Democratic Party. For example, Obama has been criticized by Nobel-Prize winning New York Times columnist Paul Krugman, who said that the fiscal stimulus is not enough and the financial rescue is ill-conceived. There were high hopes that Obama would reverse many of the decisions of the Bush administration, and though he did reverse some, he has not answered every request for reversal.

Barack Obama is extremely pragmatic and does not want to go so far to the left that he repulses centrist voters. It must be kept in mind that U.S. elections occur every two years, so members of the House of Representatives will be campaigning as soon as one year after entering office. The administration needs to demonstrate results that sufficiently prove a new way of governing is underway and that it can lead the U.S. out of the recession. However, the Obama administration should not go so far as to threaten the centrist voters who do not want a leftist agenda.

The administration will adopt whatever measure is needed, but will not do so through ideology or by trying to persuade the people that it has the best solutions. For example, the Geithner plan has received criticism from the left because it is seen as too close to Wall Street interests. This plan is the last opportunity for the financial industry to prove that it can rise out of the mess that it has created. If it fails, a new Obama plan will come forward, and this plan could go as far as nationalization if nothing else works. This will not, however, be done because of ideology.

Q: The use of the word "revolution" seems inappropriate. It seems that the real revolution was under Bush in terms of foreign policy and the appropriation of a large part of national income by the politically connected elites. Obama is heralding a counter-revolution to return to a more normal environment. The word revolution implies a large portion of popular support. While Bush won 50% of the vote in 2000, Obama did not win a much larger share. It seems as though a political revolution is not being met by a revolution of public will, much like what happened in the United Kingdom under Thatcher. What does this mean in terms of the legitimacy of the process and the durability of the changes?

Jacques MISTRAL
Many authors have published books on the mandate of the Bush administration in its first term, explaining that this was a neo-conservative revolution. Taking this view, it is correct to say that Obama is bringing in a counter-revolution.

Looking at the second Bush term, the idea of a revolution disappears as lasting results must be forged in a true revolution. There are hardly any lasting impressions on the public mood from Bush's second term. The Bush Doctrine, Bush's foreign policy and internal measures, have all been strongly criticized. On the other hand, regarding the economic sphere in particular, many Americans see the origins of crisis as the excess of government rather than the lack of it, pointing the finger at Clinton rather than Bush. The distinguished Professor Taylor wrote on this theme.

It is my view that the choices Bush made in his first term were the endgame of what started with Reagan. This is why my interpretation is not based on circumstantial factors. The idea of political realignment every few decades is what I relied upon.

Regarding the effect of the revolution on public will, the dissatisfaction with Bush and neo-conservative orientations was extremely widespread in Bush's second term. There were many events which progressively amplified this public reaction. Hurricane Katrina, the chaos in Iraq, corruption between the Republican Party and Washington lobbyists, and the excessive weight of religion in public life have all been prominent factors in this dissatisfaction. Successive events have anchored the resulting perception of the public's will for the need to change.

This grants limited legitimacy to the Obama administration, not going much beyond winning him the election. Obama is pragmatic because voters can change their minds very quickly. The Bush years have been forgotten and if the Obama administration makes errors like Bill Clinton did, it will be punished next year. Legitimacy is built between elections. The next test is in 2010.

This is also the answer to curability. If Obama succeeds, he can start a process like Roosevelt did with multiple election wins and decades of Democratic rule. But if he fails, it will be like Clinton.

Q: What would be the implication of the third revolution on the rest of the world? The outlook seems optimistic.

Jacques MISTRAL
Naturally, as seen during all of Obama's foreign trips, he has succeeded in stimulating high expectations everywhere, particularly in Europe. At a conference in Paris, the U.S. Ambassador tried to lower expectations because hopes were so high for Obama, explaining that the U.S. president is not the president of the world and will instead work towards American interests.

There are reasons for optimism in comparison to previous doctrines. The Bush administration was excessively standoffish and stubborn regarding foreign policy. For example, the push to install rockets and radars in Poland and the Czech Republic was decided without consultation with European governments. This situation has ended and in itself is a reason for cautious optimism, though this is by no means set in stone.

In economic terms, it is possible to summarize the difficulty of the task to say that the American president has to both fulfill his American goals and exercise international leadership. American power has diminished since the immediate post-war period, so a more difficult balance will have to be struck by this administration in pursuing American interests and exercising global leadership.