America is in shock. It is not because of the unusual sight of the first black president taking up residence in the White House. Barack Obama's profile, after all, is more familiar to the diverse population of today's ethnically and racially hybrid America than the fast-disappearing WASP identity of George W. Bush. Sooner or later, but always, politics codifies cultural change, not the other way around. America is in shock because our economic and financial landscape is suddenly unrecognizable.
In the space of a few short months, we have morphed from the citadel of free-market capitalism and freewheeling consumerism -- from a land of high-flying hedge funds, Hummers and homes that doubled as ATMs -- to a system in which the banks, insurance companies, mortgage industry and auto manufacturers are quasi-socialized. Adding to that shock is the fact that middle-class investors have seen their portfolios, upon which they depended for retirement, diminished nearly by half.
The tax-and-spend epithet that defined America's partisan politics for decades has been replaced overnight with a bipartisan mantra calling for a nearly trillion-dollar fiscal stimulus. No sooner had Milton Friedman been laid to rest (he died in 2006) than John Maynard Keynes was resurrected. Amazingly, even the historical aversion to state-guided industrial policy in the United States has yielded to urgent demands for political oversight of private enterprise, starting with the Big Three automakers in Detroit.
The year 2008 is thus likely to go down in American history as an even more pivotal one than 2001, when the 9/11 terrorist attacks occurred, because the life of the average American is going to be shaped far more by the consequences. We're not talking about the inconvenience of lining up to go through metal detectors at the airport. We're talking about the transformation of the American model itself. Nobel Prize-winning economist Joseph Stiglitz was not exaggerating when he quipped to me earlier this year that "the fall of Wall Street is to market fundamentalism what the fall of the Berlin Wall was to communism." Just like that, we're in a different era.
In this circumstance, Barack Obama will not be judged by the color of his skin, or even the content of his character. He will be judged by the quality of his leadership and the success of his policies in staving off depression and putting America back on the path to prosperity.
A lot depends now on how deep the recession bites. The harder you fall, the harder you come back. Given the continually mounting bankruptcies, foreclosures and unemployment levels, there seems little question that the years ahead will see such a vastly expanded government role that the New Deal will look modest in comparison.
If the wise vision articulated so far by Obama and his team pans out in practice, we'll come out on the other side of the avalanche of new laws and the billions spent with a disciplined financial sector constrained by the public hand, a refurbished and greener infrastructure, fuel-efficient cars, a radical expansion of broadband penetration, universal health care and a reawakened housing market.
In the meantime, it will be no easy task to de-leverage the American Dream. Since the 1950s, when Nixon bested Khrushchev in the famous "kitchen debate," our answer to the equalized deprivation of socialism has been consumer plenitude beyond compare. Khrushchev may have emptily blustered in those years about burying us, but it was the Communist Chinese, in the end, who gave us enough credit to hang ourselves when our consumer society desired more than we could pay for with our own savings.
"Unlike other times of turmoil in the market, the current stress wasn't precipitated by problems in the real economy," Treasury Secretary Henry Paulson told me at the outset of this crisis in 2007. "The current problems were precipitated by excesses in the form of undisciplined lending practices which came about, in part, because of great liquidity available from Chinese savings and other sources, such as the Gulf states, as well as a strong American economy. In a number of markets, lenders reached for yield at a time when risk premiums and interest rates were at historic lows."
This was particularly true in the sub-prime mortgage market. It was the flow of Chinese dollar reserves earned from trade back into U.S. Treasury bills and mortgage-backed securities that held down long-term interest rates in the U.S. and enabled and sustained the asset bubble.
Widespread single-family home ownership has long been proof of the superiority of our ideology, the brick-and-mortar realization of the American Dream itself. Thanks to innovative finance and the easy credit Paulson talked about, no dream need be deferred if it could be mortgaged. That is where the problem began, though not where it has ended.
In a conversation with me in November, financier George Soros filled out the picture. "The current situation is not just about the housing bubble," he said. "The housing bubble was merely the trigger that detonated a much larger bubble. That super-bubble, created by the ever-increasing use of credit and debt leverage across the economy, combined with convictions that markets are self-correcting, took more than 25 years to grow. Now it is exploding."
As a result, according to Soros, we are now witnessing a power shift from the deeply indebted American superpower to Asian creditors flush with cash, "a consequence," he says, "of the sins of the last 25 years." (Already as I write this, waves of Chinese investors are scouring Southern California in search of real-estate deals.)
Whatever else is on his immediate plate, Obama's overarching challenge is to figure out the conundrum of how to unwind this global imbalance, particularly with China, while at the same time re-igniting American growth. Inevitably, as China shifts the investment of its vast reserves to stimulate its own lagging economy instead of purchasing U.S. Treasury bills, the dollar will start to plummet. If Americans are in shock today over how rapidly their fortunes can turn on the domestic front, they will be no less stunned tomorrow when they realize the high costs on the global stage of putting the house of the American dream back in order.
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