Gloom Deepens

The great clunking fist has struck again, or almost. This time it was aimed at the chin of John McCain, who just might be the next president of America. Fortunately, McCain has proved he can take such a blow, so his staff confined its reaction to polite enquiries of Britain’s ambassador, Sir Nigel Sheinwald, asking: “What the devil is the British prime minister doing endorsing the economic programme of Barack Obama?”

Not that it much matters. The McCain team knows that Brown is largely responsible for the mess in which the British economy finds itself. That makes his support for Obama’s economic plans about as useful as feathers on a fish, to borrow a phrase coined by congressman John Dingell in another connection.

The differences between Obama-Brown and McCain are far from trivial. Obama wants to raise taxes on families earning more than $250,000 a year, and on their dividends and capital gains, to support a redistributionist cheque of $1,000 to each of the 95% of Americans not in the top bracket. He would take the tax rate on high earners to about the UK level of 40%. Brown naturally leans more towards Obama than a tax-cutter like McCain.

Otherwise, it is difficult to understand the attractiveness of Obama’s economic programme to the prime minister, with the possible exception of the Illinois senator’s proposal — since withdrawn — to provide relief for some hard-pressed homeowners. Brown famously stole the Tories’ clothes by proposing reductions in inheritance tax; Obama proposes to raise it. Brown believes union members should be protected from their leaders by being entitled to a secret ballot; Obama favours stripping America’s union members of that protection. Brown has remained true to his free-trade beliefs; Obama is wooing trade-union support by promising a variety of protectionist measures, including the renegotiation of the North American Free Trade Agreement (Nafta) and an end to further such trade-opening agreements. Brown has realised that it would be bad policy to impose another windfall profits tax on energy companies; Obama favours just such a tax on oil companies.

So it must be that for Brown higher taxes and redistribution trump all other policy differences.

All of which, it must be admitted, is of less relevance to American voters than whether Obama had Sarah Palin in mind when he said that you can put lipstick on a pig, but it would still be a pig.

Meanwhile, the important question of the nation’s finances goes unremarked upon by both Obama and McCain. Treasury secretary Hank Paulson’s decision to have the government take over the mortgage banks Freddie Mac (a consulting client of mine) and Fannie Mae was aimed at reassuring foreigners who hold billions in those agencies’ IOUs that their investments are explicitly backed by the American government. Paulson, a successful private-sector investment banker, thus ends his career presiding over a de facto nationalisation so large — the two enterprises have $5.4 trillion in liabilities, equal to the entire debt of the American government — that even Lenin might have hesitated to make such a move.

The alternative would have been to let these government-sponsored enterprises, or GSEs as they are called, become unable to borrow to continue to fund about 80% of all the mortgages written in America. So Paulson was probably — not certainly, but probably — right to do what he did. But the Congressional Budget Office has ruled that the GSEs’ liabilities must now go on to the federal government’s books.

Those are already bedecked with ample quantities of red ink. With receipts from corporate taxes down, expenses up as a result of the recent stimulus package, and Freddie and Fannie likely to impose further costs on the government, more red ink is on the way. Estimates of future deficits are notoriously changeable, but we do know a few things with some certainty.

Although the deficit is headed up, in relation to the size of the economy it will be manageable for a few years. But in the longer term the entitlements programmes, mostly Medicare and Medicaid, if unchanged will drive the deficit to levels that will make Italy look like a fiscally prudent country.

We know, too, that several of the foreigners who have been financing our deficit by buying American government bonds are so unsure about the ability of Uncle Sam to take more debt on his broad shoulders that they are paying more and more for insurance against a default by our government.

Finally, we know that neither presidential candidate has the vaguest idea how to get the budget under control. Obama’s taxes on wealthier families will surely discourage the investment we need to get the economy rolling again. McCain says he will cut ineffective programmes, but he won’t identify the programmes he would axe.

Ronald Reagan solved that problem by putting in a figure for such cuts, followed by an asterisk, guiding the budget reader to a footnote advising that the programmes to be cut would be named at an unspecified future date. McCain might have to dust off that old dodge, while Obama would have to persuade his Democratic colleagues to reduce entitlement spending. Neither prospect is sufficiently bright to relieve the budgetary gloom that has been deepened by the Freddie and Fannie takeovers.

Nothing in sight is likely to offset the downdraught that is ripping through the economy right now. But if the housing market bottoms out at the end of the year or early in 2009, as Alan Greenspan says he expects and as falling mortgage rates suggest is possible; if the easing of commodity prices enables the Federal Reserve to keep interest rates stimulatingly low; if exports continue to boom despite the strengthening dollar; and if productivity keeps rising, we should see a recovery sometime next year.

Then, tax receipts would rise, and the flood of red ink might slow to a trickle.

Without that, we will have to rely on the wisdom of our political class, and its willingness to cut the cost of the entitlments programmes. If you believe such wisdom and courage exist, I have a bridge in Brooklyn I would like to sell to you.