Argument

When Democrats Became Doves

With the GOP candidates eager to call Obama weak-willed on foreign policy, it's worth looking at how Democrats got stuck with this tag.

Forty-four years ago this week, the senior senator from the state of Minnesota, Eugene McCarthy, stepped to a podium in the Senate Caucus Room and transformed the Democratic Party. Angered by the war in Vietnam and his belief that President Lyndon Johnson would "set no limit to the price" he was "willing to pay for a military victory," there McCarthy announced his intention to challenge the incumbent president of his own party in four presidential primaries.

McCarthy didn't even bother to declare he was seeking his party's nomination -- after all, in the fall of 1967 everyone knew that Johnson was practically a shoo-in to be the Democratic presidential nominee in 1968.

But a funny thing happened on the way to the Democratic Convention in Chicago. McCarthy didn't end the war, but he ended Johnson's political career and in the process heralded the shift of the Democratic Party from Cold War hawks to anti-war doves. By creating a political opportunity for Democrats, opposed to the war in Vietnam, to directly engage in the electoral process McCarthy helped change the way that all political leaders -- Democrats and Republicans -- talk about national security policy. No longer could national Democrats ignore liberals skeptical of American power; and Republicans were given a renewed opportunity to cast Democrats as a party beholden to their anti-war base. Quite simply, McCarthy's quixotic presidential bid is the gift that keeps on giving.

Eugene McCarthy was perhaps the single unlikeliest person to launch an insurgent presidential campaign, topple an incumbent president, and spark a year of cataclysmic political change. Aloof, haughty, and frankly a bit lazy, McCarthy was given little chance of having a political impact when he announced his candidacy. He would be, said his fellow Minnesotan and Agriculture Secretary Orville Freeman, a "small footnote" to history.

Two events would ensure that McCarthy's run would be far more than that. First the Tet Offensive on Jan. 30, 1968 -- ironically and prophetically the same day Robert F. Kennedy announced he would not challenge the president and would acquiesce to his re-nomination. After months of being told that the proverbial light at the end of the tunnel was visible in Vietnam, the surprise Tet attack, which struck at every provincial capital in the country as well as the U.S. embassy in Saigon, shattered the illusion of progress. In the process it exposed Johnson and the members of his administration as serial liars about the war.

Tet set the stage, but it was the "Clean for Gene," anti-war activists that sealed the deal. Trudging through the snows of New Hampshire for the country's first presidential primary, McCarthy's army of well-scrubbed volunteers (no beards or long hair for this crew) spoke to two-thirds of all New Hampshire Democrats in just a six-week period. They were aided by a candidate who downplayed his anti-war views and depicted his candidacy as an opportunity to send a message to Johnson. It didn't much matter that some voters thought they were voting for the notorious former Wisconsin Sen. Joe McCarthy or were angry at LBJ for not prosecuting the war in Vietnam more aggressively; yet McCarthy's strategy worked beautifully. Even though he lost the final vote, McCarthy's 42 percent showing shocked the political world, brought Bobby back into the race, and ushered Johnson out less than three weeks later. This wholly unexpected turn of events earned McCarthy something far larger than a footnote in the history books.

Of course, the presidential race hardly ended when Johnson dropped out. Before the era of open primaries and caucuses (another reform that ironically came out of the McCarthy campaign) delegates to the national convention were largely chosen by state conventions dominated by party bosses and apparatchiks. When Vice President Hubert Humphrey threw his hat in the presidential ring in April 1968, most of these votes went to him. Still, McCarthy and Kennedy, in an effort to build public support -- and convince delegates that they would be a better choice for November -- continued to battle it out across the country in the nation's few presidential primaries. In the process, McCarthy offered Democrats his unique take on foreign policy and national security.

Kennedy attacked the war in Vietnam with great and laudable venom; but McCarthy became the first presidential candidate to take on the very conceits of American foreign policy. In perhaps his best speech of the campaign, at San Francisco's Cow Palace in May 1968, McCarthy aimed his verbal assaults at the assumptions underpinning the bipartisan consensus that had shaped America's view of the world since the dawn of the Cold War.

"Involvement in Vietnam," McCarthy said, "was no accident. It did not happen overnight. It was a direct result of America's conception of itself as the world's judge and the world's policeman." He ridiculed the beliefs held dear by both Humphrey and Kennedy: "America's moral mission in the world; the great threat from China; the theory of monolithic Communist conspiracy; the susceptibility of political problems to military solutions; the duty to impose American idealism upon foreign cultures" calling them "myths and misconceptions, so damaging in their consequences."

McCarthy was attacking the very heart of American global power -- its over-ambition, its pretensions of global leadership, and its hyper-inflated view of American strength, interests, and capabilities. On the campaign trail, he spoke of recognizing Communist China; he called the Cold War "a concept . . . which has outlived its usefulness," and he even took on the "huge, powerful, and somewhat autonomous military establishment whose influence reaches into almost every aspect of our national life."

In the end, his words that year fell on deaf ears. Though he beat Kennedy in Oregon before narrowly losing to him in the California primary, the Democratic prize went to Humphrey -- whose inability to separate himself from Johnson on the war in Vietnam would seal his fate in November.

To be sure, McCarthy was hardly the first liberal to question America's Cold War foreign policy. That territory had been well-blazed by Wayne Morse from Oregon, Ernest Gruening from Alaska, Frank Church from Idaho, J. William Fulbright from Arkansas, and the torch was carried on with far greater vigor by George McGovern of South Dakota. But by the very fact that he ran in the first place -- and challenged Johnson and the Democratic hawks -- McCarthy took the anti-war activists out of the streets and college campuses and into the political process. He gave them a legitimate outlet to ensure their voices were heard.

Although the hawks won the battle in 1968, they would in short order lose the war, as a new generation of Democrats inspired by the campaign -- and its model of grass-roots anti-war activism -- would re-shape the party's views on foreign policy. In 1972, they nominated the dovish McGovern, who was as suspicious of American power as McCarthy. In 1977, a Democratic president -- Jimmy Carter -- focused on human rights as an overarching national security priority would take office; in the nearly two decades that followed the doves would maintain a tight hold on the foreign policy direction of the party, opposing the arms build up of the 1980s and the proxy wars fought by the Reagan administration in Central America. Their influence was so pervasive that the party's remaining hawkish wing would abandon the Democrats for Reagan's GOP.

That direction would begin to be reversed in the early 1990s by centrist Democrats who believed that the party had veered too far to the left on national security; but the anti-war wing of the party would remain a powerful force, providing a boost to the 2007 candidacy of Barack Obama -- who, unlike his opponent in the primaries, Hillary Clinton, opposed the Iraq War.

With this political shift by national Democrats, the foreign policy divide that appeared in the late 1960s has oddly grown wider over the years. The liberal wing of the party still views Democratic elites and party leaders who supported the war in Iraq with contempt and suspicion (not unrightfully so). For many, it was the ultimate betrayal of the movement that emerged out of the tumult of 1968 and re-opened a wound first gashed by McCarthy in that Senate Caucus Room, 44 years ago. To this day, Democrats continue to be a party defined at its grassroots by reluctance to use military force, support for multilateral institutions, and opposition to the more aggressive elements of the war on terror. There is perhaps no policy issue where the divide between party and president is more acute -- from civil liberties to the war in Afghanistan.

Of course, from a political perspective, foreign policy and national security have traditionally been the one area of public policy where national Democrats are far more responsive to potential brickbats from Republicans than their own followers. Indeed, the foreign policy shift that began in 1968 has consistently provided a political opening of its own for Republicans. It became an opportunity to tar Democrats with the broad brush of weakness and fecklessness on national security (a recurrent GOP political attack since the "Who Lost China" debate of the 1950s). This week came word that the Obama administration is reluctant to apologize for a recent cross-border raid that killed 24 Pakistani soldiers, for fear of being portrayed by Republican presidential contenders as soft.

Even today, when Democrats debate national security -- torn between anti-war liberals and hawkish centrists, and reluctant to be cast as wimps and weaklings by Republicans -- they are arguing on a battlefield seeded by Gene McCarthy. Footnote to history? Not by a long shot.

 

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Argument

Compounding the Meltdown

No, fear is not the main thing to fear in Europe. It's misguided decisions.

In early November, a European academic, speaking at my central bank seminar, assured a very skeptical group of Peking University undergraduates that no country in Europe would need to leave the euro or restructure its debt (except Greece, which had already restructured). The main problem facing the crisis countries, he said, was a short-term financing gap, and this had become urgent only because of a wave of irrational fear in the financial markets (encouraged, he hinted darkly, by interested foreigners). As this fear subsides, he argued, Europe, with the right set of domestic reforms, could work its way successfully out of the crisis.

My students were right to be skeptical. Peripheral Europe faces more than a financing gap, and irrational fear is not the main problem. Unfortunately, too many policymakers make the same mistake as the European academic, which only shows how little they understand the balance sheet dynamics that lead to crisis. The recent request by newly elected Spanish Prime Minister Mariano Rajoy -- that financial markets give him a little time, "more than half an hour," to resolve the crisis -- indicates just how confused they are.

This is also the same mistake made a week later by the Hungarian Ministry for National Economy when Moody's downgraded that government's debt to junk status. "Obviously, the forint's weakening is not justified by either the performance of the Hungarian economy, or the shape of the budget," the ministry said. "Therefore, it can be driven only by a speculative attack against Hungary." 

Like Rajoy, the Hungarian ministry has missed the point. Hungary's economy will certainly weaken, and the government's budget will deteriorate -- but not because of speculators. What is in fact happening is that many actors, from bondholders to labor unions to entrepreneurs to politicians, will protect themselves from the crisis by responding in ways that unfortunately worsen the crisis, and this worsening of the crisis will put all the more pressure on them to respond further.

There is nothing mysterious about the process. It is widely understood in economic theory that financial-distress costs for overly indebted businesses are actually incurred not at bankruptcy but long before, when weakening credit forces stakeholders to behave in ways that undermine growth and reinforce credit deterioration. This explains why crises tend to move slowly at first and then suddenly spin out of control.

The same thing happens to overly indebted sovereign borrowers. When do they have too much debt? The short answer: They have too much debt when the market believes they have too much. This may seem a trite and even meaningless answer, and the European academic who spoke to my class certainly thought so; but, in fact, understanding this is key to understanding the process of financial collapse.

It works in a straightforward way. As the government's fiscal credibility declines, the behavior of major sectors in the economy must automatically change, and this change forces further decline in fiscal credibility. The decline is slow at first, but because it is self-reinforcing it can suddenly accelerate.

The most obvious behavioral changes are in the actions of creditors, who of course raise lending rates, shorten maturities, and push more risk onto the borrower. This raises default probabilities by increasing the cost of servicing the debt and, more importantly, by making the balance sheet ever more fragile.

Unfortunately, it doesn't stop there. Households know that fiscal crises are often resolved by eroding the value of savings through inflation or depreciation, and they react accordingly. The threat that the government will freeze bank deposits and devalue the currency causes them to cash in their deposits and take the money out of the country, as they are already doing in several peripheral European countries, where bank deposits are declining at an alarming rate. In Greece, bank deposits have dropped by one-fifth since the beginning of 2010. This constrains lending sharply and slows growth, while eliminating what is normally a very stable funding base.

What's more, because governments have taxing authority and businesses are easy political targets in a crisis, declining government credibility automatically changes private business behavior. Instead of funding the investment that will generate future economic activity -- especially given weaker growth prospects and higher interest rates -- businesses disinvest and entrepreneurs leave. As they do, workers lose jobs, growth is reduced further, and so debt-servicing capacity drops. By November, investment in the eurozone had contracted for four consecutive months. "The fastest rates of contraction," the Financial Times reported, "were in Greece, Spain and Italy." This is exactly what we would expect, and of course it will continue.

Workers, too, must respond to the crisis. Unions get stronger, workers are radicalized, and labor agitation increases. This further weakens growth by raising both business and political uncertainty.

Finally -- and the historical precedents are very clear here -- policymakers themselves respond in ways that reinforce the crisis. As politically instability rises, extremist parties become more powerful, and political time horizons contract sharply. In response, politicians promote self-serving policies aimed at staying in power by addressing short-term problems, even if these hurt longer-term growth prospects.

A case in point was the desperate requests over the past three months by eurozone politicians that Asian central banks, led by China, provide financing to peripheral Europe. The purpose of Asian help was to forestall the short-term financing crisis, but of course any increase in Asian capital flows to Europe must automatically be accompanied by larger European trade deficits as the euro strengthens on the back of these inflows. Simply put, Europe wanted a short-term bailout even though it would worsen medium-term growth prospects.

These predictable adverse changes in behavior are already happening in much of Europe. A rising probability of default, in other words, has forced most of the major sectors of the economy into behavior that is causing balance sheets systematically to weaken and economic growth prospects systematically to decline. Riskier debt and slower growth, of course, increase the probability of default further, so these sectors are forced even more urgently into accelerating their behavior.

The options facing much of Europe now are either a slow and then suddenly rapid spiral into collapse, or a resolution of the crisis. The prescient English economist Walter Bagehot explained 140 years ago one way in which the latter could occur: Only a massive and fully credible loan guarantee will reverse the self-reinforcing process of balance sheet deterioration. Germany, worried perhaps a bit quixotically about its own debt credibility (which is anyway threatened by a European collapse), is adamant that it will not assume the risk.

The second way is to acknowledge the problem immediately before the economy is further damaged, in which case the afflicted counties must freeze deposits, devalue the currency, and quickly restructure the debt. The third way is immediate fiscal union, though the longer it takes to engineer so radical a solution in such a poisoned atmosphere, the harder it will be to pull it off.

Without a resolution, national balance sheets will simply deteriorate quickly, and economic weakness will increase, along with the ultimate cost of the crisis. Pretending that Europe suffers only from a financing gap and irrational fear, and that with the right set of policies it will eventually work its way through the crisis -- the same option mistakenly chosen in nearly every previous sovereign debt crisis -- is the worst possible policy option.

History and economic theory suggest that it is not fear we have to fear. It is the failure of policymakers to understand how a crisis evolves.

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