The economy has been in bad shape for years. Polls indicating that Americans are unhappy with the economy have emanated from the press for the last six years like a steady drumbeat.

Facts

America's real growth rate over the past five years ranks near the top of all 15 countries on The Economist's list of developed nations. Two of the countries ahead of the U.S.--Australia and Sweden--are large commodity exporters and benefited from significant growth through price increases.

• Unemployment has been near historic lows--a little above half that of most European countries--for years.
• New job creation has been strong. In November, 2007 a new record was set for the longest string of uninterrupted job growth months in U.S. history.
• Productivity growth has averaged 20% higher than Europe.¹

The U.S. economy performed well or extremely well on all the most important measures from 2002 through 2007. Low unemployment and new job creation are important for obvious reasons. However, growth of the nation's Gross Domestic Product is generally considered the most important measure of economic health, because in the long run it correlates perfectly with prosperity.

If you would like to learn more about GDP, scroll to the bottom of this page.

Assessment

While soft spots exist in any economy, one can not suggest with intellectual integrity that the U.S. economy was a disaster under the Bush administration. In fact, the truth is just the opposite. Since informing the public about the economy is an important part of the press's responsibility, repeatedly broadcasting polls about Americans' disappointment with the economy amounts to publishing their own failing report card.

Yes, in 2008 the combination of credit issues related to a real-estate bubble and crippling oil shock did finally manage to slow the strong economy. Another criticism is that real wage growth has not kept pace with real GDP growth. This is true to some extent, but real wages have grown, and the growth rate will catch up over the long-run: it always has, in the U.S., and other free enterprise systems.

For most people low unemployment trumps real wage growth. The most important thing a country can do for its people is make sure that those who want a job can get one. If you doubt that, you may want to contact someone in Germany or France and ask whether they would prefer their economy or ours. Unemployment in the Euro Zone countries, however, averaged 60% higher than U.S. household unemployment rate from 2001 to 2007.

The individual years provide a time-lapse lesson in economic stimulus policy. In 2002, the year after the Bush administration cut tax rates, the U.S. grew +1.5, which placed it in the top third of the pack in a year that the U.S was recovering from the 9/11 induced recession. In 2003, growth increased to 2.5%, making it fourth on the list of 15.

In 2004, the U.S. economy grew by 3.6%. You may remember the mantra from some of the political candidates during that election year: This is the "worst economy since Herbert Hoover." If you put that in quotes and Google the phrase, you'll get more than 1,300 results. But, once again, that sort of rhetoric is so far from the facts it's almost laughable. As the year 2004 closed, the IMF and the Economist magazine actually showed the U.S. growing faster than all other developed countries. The figure was later revised downward.

Take a look at the charts on these pages. The press was reporting on polls saying that the American people are dissatisfied with the economy, so when candidates repeated the same doom and gloom scenario over and over, somehow it seemed to be true. Yet, the fact is, in 2004 the economy was strong and getting stronger despite political predictions of doom. If one doesn't see the potential danger in this particular perception/reality gap, then it ought to at least be clear that the mere possibility that such an incredible discrepancy could exist between public opinion and truth, is in itself dangerous. Such a huge and widespread public misconception could obviously lead to grossly misguided national policy decisions.

In 2006 and 2007, the U.S. economy grew at the fairly healthy growth rates of +2.9% and +2.2%. But the pace of growth of a number of European countries moved ahead of the U.S. What happened? Europe, taking cues from U.S. success, cut taxes throughout most of Europe!.

As this book goes to press in mid-2008, we are again hearing similar predictions of doom, while the underlying economy continues to be resilient. "Mortgages for everyone" clearly hasn't worked. It is causing problems for Wall Street, but "main street," or mainstream corporate America, continues to move forward. The US has historically emerged from changing conditions faster and stronger than most developed countries.

Since there are developing countries with faster growth rates than the ones shown in these charts, we need to take a moment to explain how the countries on this list were chosen. The financial publication, The Economist, has for many years published economic statistics for two groups of countries--developed countries and emerging countries. The list shown here is the complete list of developed countries for which a year-to-year comparison is shown.

Comparing the growth rates of developing economies like, for example, India or Singapore, each of which grew 8% in 2007, but are a small fraction (8% and 1% respectively) of the size of the U.S. economy, would not give useful comparisons. These countries are able to grow faster because they are, for the first time, becoming a part of world trade. Thus they are able to grow more rapidly because they are simply allocating their resources more efficiently than before, and they are able to borrow on the technology and business process innovations of the developed countries that have paved the way for them. We're quick to say, however, that China is a special case, and we will deal with that country's remarkable growth in more detail in section 2.

Assessment: When Perception Becomes Reality

One thing that politics and the financial markets have in common is that "the perception of reality" tends to become reality. In 1996, Alan Greenspan, then chairman of the Federal Reserve Bank and the nominal guardian of the U.S. banking system, said in a speech on central banking that the equity markets were "irrationally exuberant" and had separated themselves from reality.

Despite that observation, the markets continued even higher for nearly five more years before eventually dropping. Literally hundreds of billions of dollar were made by those who stayed "irrationally exuberant" until the third quarter of 2001. In 2002, under intense pressure from current events and other factors, the market finally collapsed.

When Greenspan made those remarks in 1996, the NASDAQ index of stocks was at 880.In 1999 the NASDAQ had traded as high as 4700, which was a gain of 430%. The momentum was strong, and perception was reality. By October 2001, the NASDAQ was trading down, at 790, a five year drop of 10%. The market psychology was based largely on hype; however, it remained real and very strong for a while. But eventually the reality shifted, and the facts had to rule.

In politics, if enough people believe in a politician or a political theory they can make that belief a reality by putting those people or ideas into positions of power. Whether that belief gives you Adolf Hitler, Soviet-style communism, or Richard Nixon does affect the reality. But if the facts are that the perception is wrong, the reality they've created will eventually adjust to truth. In that case, a dictator like Adolf Hitler will self destruct, communism will fall on its own sword of economic inadequacy, and Richard Nixon's inability to play by the rules will eventually destroy him.

In early 2008, Bear Stearns, an investment bank that had been around since 1923, was put out of business by fear of what might happen. Jimmy Cayne, the company's chairman, saw his $1 billion of stock fall to a value of $20 million. Alan Schwarz, who had become president in 2007, watched his company simply disappear. What happened was a typical "run on the bank." Banks and investment banks have hundreds of billions in securities on their balance sheets that are funded on a day-to-day basis. They are secure but highly leveraged entities. Even with plenty of equity, careful risk controls, and a solid record of profitable business dealings, the day the bank can't finance their daily position in securities markets is the day they are effectively out of business.

I know that personally. In 1991 when I was a managing director for the investment bank Salomon Brothers and running one of their European businesses, the company endured a near-death experience. A group of Salomon Brothers traders in New York had conducted illegal activities to profit from a U.S. Treasury Bond auction. They had successfully made dozens of millions of dollars by the activity, but were eventually caught.

An indictment of the firm would have shut down the entire multi-billion dollar company. The market responded immediately and, because of the potential risk involved, funding for the company dried up. Quick action and support encouraged by the Treasury and the U.S. Federal Reserve saved the company. But, because of just a few people in one location, a global, multi-business American financial standard bearer almost disappeared. Once again, the perception of weakness became reality.

Markets go up and down, and the business cycle continues. Dynamic, growing capitalism creates what the Austrian economist Joseph Schumpeter called "creative destruction." The markets become overly enthusiastic and over commit capital during optimistic cycles. Then they become overly negative and destroy good businesses during the down cycles. The good news is that this sort of volatility creates dynamism, with new winners and better opportunities in each cycle. As the old joke goes, the stock market has completely and accurately discounted six of the last three recessions--meaning that the market often mystifies the naysayers. Despite the prophets of doom on Wall Street and beyond, the economy in the first decade of the twenty-first century remains stronger than many people think, and with some perspective we can see that fact. Whatever the current emotional state of the financial wizards and the 24/7 financial news analysts, the economy remains strong, and America is still number one.

If Joseph Schumpeter was right and the cyclical nature of the markets creates positive momentum, we will see this positive long term impact eventually in the mortgage markets as well. The explosion of sub-prime lending over the past several years has put many homeowners at risk as they stretched to buy homes that were expensive compared to their income. News of a larger than normal number mortgages going into default as these homeowners ran into financial difficulties led predictably to the perception of accelerating weakness. The "creative destruction" that hit the markets at that point led to the destruction of a lot of bank capital; but after all was said and done, many people who could never have bought a home without a sub-prime boom ended up owning a home.

Even in the midst of the turmoil, it's a safe bet that America will continue to move toward a higher ratio of home ownership in the months and years ahead. We don't know that for a fact just yet, but we can see that the underlying economy is strong, and that's a good sign. And what we do know is that, whatever the current weakness, over time American resilience will prevail. During the last seven years the American economy has outperformed the majority of developed countries, and that momentum is a sure sign of strength.

--Dennis Keegan, author

Gross Domestic Product (GDP) is simply the total value of all goods and services produced in the nation's economy. It is by far the most common measure of a country's economic growth. This is because over the long run the material standard-of-living correlates closely with the value of goods and services that a society produces.

Gross Domestic Product is the most important measure of economic activity, and real (inflation adjusted) long-term growth in GDP is the clearest signal of strength. For individuals to improve their income and wealth over time, the whole community must produce and earn more. As productivity increases, income and wealth increase for individuals as well.

In most countries, the real increase in GDP generally comes from two sources; population growth and productivity growth. However, if GDP increases with population growth alone, the nation may get richer while the average citizen maintains essentially the same level of income and wealth. This means that GDP growth must exceed population growth for individuals to increase their own incomes.

For a country to maintain GDP growth above population growth, the productivity of each hour worked must increase. When this happens, employers can afford to pay more for that hour of work. The increased value added, then, generally comes from one of three sources:

• Innovation: An idea that uses the same amount of labor to make a better product can increase productivity significantly. An obvious example of innovation is computer power where, for example, a single Microsoft Excel spreadsheet can produce, in a moment, the work that would have required hours of clerical manpower twenty years ago.
• Capital Investment: The second major source of productivity growth involves an investment of both physical and mental resources. One man with proper training and skill in the use of an agricultural harvester can manage thousands of acres of farmland, producing many tons of grain. Fifty years ago, the same task would have required dozens of farmers and hundreds of laborers, to produce many fewer bushels of grain.
• Comparative Advantage: What comparative advantage means is that two countries by reallocating work between them can, in aggregate, produce more goods with less labor, meaning higher of productivity.

A good example of this would be a situation in which the U.S. focuses more labor on making Boeing aircraft and Caterpillar tractors to sell to China. China, in turn, makes more Power Ranger and Star Trek action figures. The U.S., with a higher level of education and capital resources, makes investment-intensive goods, while China, with less investment in intellectual and physical capital, makes products that are genEerally more labor-intensive but less-intellectually intensive. This is, in fact, what's actually happening today.

For example, if something grows +2 units from 100 to 102, this represents an increase of +2%. If something grows from 10 units to 12, the same growth of +2 represents a +20% increase. The U.S. starts from a base that is already many times the size of most of the other economies on this list, so a small percentage growth actually represents a massive increase in actual wealth.

Source: [1] OECD Compendium of Productivity indicators 2005 Gap in GDP per hour worked (p27).

China's economic growth threatens the U.S. economy and its global economic lead.

Facts
The growth of the U. S. economy since the beginning of the Bush administration is about equal to the entire economy of China. Go ahead, read that sentence again. Yes, it's true. Said another way, the amount of GDP added to the U.S. economy in just the past six years equals the entire Gross Domestic Product of China.

      Keep in mind, the population of China is four times that of the U.S. So, if this chart were drawn on a per capita basis, the bar on the right would actually be one quarter of the height shown in this chart. The average American worker earns 22 times as much as the average Chinese worker.

Assessment

Is it not hard to believe that Americans feel economically threatened by a country where the average worker earns less than 5% of the average American? The idea that Americans are "unhappy with the economy" is beyond belief. Stop by Wal-Mart any day of the week and watch the shopping carts, loaded with products made in Asia. Americans who complain about the disappointing economy are buying such quantities of electronics, toys, sporting goods, clothing, and gadgets that they can hardly fit them into their ever expanding houses. They're able to buy all these goods because they just happened to be born on a piece of real estate called the United States where the advances made by three centuries of productive workers and free enterprise created a huge disparity between U.S. wages and that of China where the goods are made. So Asian workers get to make all these goods, and Americans get to buy them at a fraction of what they would cost if they had to make them themselves. Imagine what these goods would cost if they were made by U.S. companies paying 22 times the labor rate, not to mention the fact that with U.S. unemployment averaging 5.2% over the last 8 and 16 years, even if we wanted to make these products in the U.S., there would be not be enough workers to do it!

      The astonishing bounty available to the people of this nation should be a source of perpetual thanksgiving, not whining and dissatisfaction. Yet, according to a report from the Bloomberg financial news service, the growing size and affluence of Chinese manufacturing is seen by many, both in this country and abroad, as a major threat. The writer says that, "China's emergence as a world trade powerhouse, blamed in the U.S. and Western Europe for the loss of thousands of factory jobs, is having an even more severe impact on developing nations." As a result of these concerns, market watchers tell us, support for free trade is dwindling in developing countries around the world, as manufacturers, labor unions, and regional governments begin seeking trade protection against Chinese competition.⁷

Reality Check explains some of the enablers of China's amazing growth, how its per capita income compares to the U.S. in purchasing power parity. The non-obvious costs of China's growth are significant. As they begin to rear their ugly heads over the next decade, the juggernaut's rapid growth is likely to slow.

Sources:

[6] Helen Murphy, Christopher Swann and Mark Drajem, "China's Power Erodes Free-Trade Support in Developing Nations," Bloomberg.com, April 2, 2007. [http://www.bloomberg.com/apps/news?pid=20601087&sid=ar_m7AGPgNlA&refer=home] (accessed April 2, 2007).

[7] Editorial, "Pursuing Sustainable Growth," China Daily, Mar. 30, 2004. [http://www.china.org.cn/english/China/91699.htm] (accessed Apr. 3, 2008).
   
The Economist, "2008 Pocket World in Figures"

Conventional Wisdom

Bush's tax cuts and military spending have created an astronomical U.S. budget deficit.

Typical Headlines

"Bush Deficit Cut Seen as Flawed"

--New York Times, Sep. 8, 2004

"Cost of Iraq War Could Surpass $1 Trillion"

--MSNBC, Mar. 17, 2006

"U.S. Government Debt Soars"

--CNN, Dec. 3, 2007

Facts

      The average federal budget deficit over the past six years is 1.8% of GDP. This is below the average of the 1970's (2.1%), 1980's (3.0%), and 1990's (2.2%). By the end of 2007 the deficit had dropped to 1.2%.

    Source: http://www.irs.gov/taxstats/indtaxstats/article/0,,id=96679,00.html

Facts
Defense spending averaged 3.8% of GDP from 2002 to 2007, which is below the averages of the 1940's, 1950's, 1960's, 1970's, 1980's, and 1990's. 

We're often reminded by the press of the enormous amounts being spent in Iraq and Afghanistan. The overall impression can be misleading, though, because congressional votes each year on "supplemental appropriations" bring extra attention to the spending even though much of it would be incurred whether the wars were going on or not. For perspective, there are 2.8 million men and women in the U.S. military today. The number of servicemen in Iraq is approximately 150 thousand. (That's 5% of the total of uniformed personnel.) If these soldiers were not in Iraq, they would be somewhere else. They would be clothed, fed, and using fuel and ammunition in training and preparedness exercises. The total costs involved would be less, but certainly not zero. Thus "war spending" sounds like it is all extra when it's really not.

Bush unfairly cut taxes only for the rich.

Typical Headlines

Bush Priorities Will Swell Deficit

--Forbes, Jan. 10, 2006

"Tax Cuts Offer Most for Very Rich, Study Says"

--New York Times, Jan. 8, 2007

"Democrats in Debate Urge Taxes on Rich"

--AP, Dec. 14, 2007

Facts

The fact is, just 1% of taxpayers pay 40% of federal income taxes in this country. This is an all time high and it is up from 34% in 2002, and 26% in 1986. An all time high 86% of taxes are paid by the top 25% of income earners. This is up from 83% in 2001, and 76% in 1986. And it's equally impressive to note that an all time high 97% of taxes are paid by the top 50% of earners. This is up from 94% in 2002 and 93.5% in 1986.

       Obviously, taxes cannot be reduced without a disproportionate reduction--in absolute dollars--for top earners, since they pay a massively disproportionate amount of the dollars to start with. Since most taxes are paid by the wealthy, even a tax cut that would result in a more progressive schedule has a higher dollar savings for high-income taxpayers than for low-income taxpayers. A more progressive tax rate is one that proposes to cut tax rates for low-income taxpayers by more than the reduction for high-income taxpayers.

       Federal taxes, as a percent of total income, have increased during the Bush administration compared with the end of the Clinton administration.  

      How is this possible? We have heard endlessly about Bush's tax cuts. While it's true that tax rates were reduced for the top earners, from 39% to 35%, the good news is that lots of people benefited from the healthy economy and moved up into the top 35% bracket--so many, in fact, that tax revenues have gone up significantly. Additionally, significant increases in U.S. corporate profits have led to increases in the taxes paid by corporations.

      From 2000 to 2007, tax receipts from individuals increased by $164 billion. The tax amount paid by the top 25% of earners increased by $167 billion, while the remaining 75% of taxpayers paid $3 billion less in 2007 than in 2000.

Any way you slice it, these are not "huge tax cuts for the rich."

Assessment

The principle is simple:

1.  With lower tax rates, more money goes into the economy. Money is spent; people are hired; money is invested; salaries go up. Things work.

2.  With higher tax rates, more money goes to the government--a graveyard of bureaucracy and inefficiency.

The evidence has never been clearer. The U.S. economy grew by $3.8 trillion in six years. The federal government takes in about 20% of that increase, or $760 billion per year. If spending had been held constant, the deficit, which peaked at $412 billion, would never have appeared.

      The amount of money being taken in by the U.S. government is insane. It is much more than what is needed to do what a federal government ought to be doing. There is, therefore, no good reason for today's large budget deficit. It can and should be fixed simply by curbing spending rather than economy damaging tax increases. The line-item veto would be one important step to help achieve that objective by cutting pork-barrel spending from the federal budget, and reducing wasted time, energy, and money. In our view, more Americans should be pushing for these spending reforms.

      The national debt is a disgrace given America's prosperity. There is no way a country this rich should be in debt. The problem should be fixed. Nevertheless, it is not the cause for alarm that many would have us believe.

Sources

SOI Bulletin, Individual Income Tax Rates and Tax Shares (1986-2005) ⁶

GAO: Federal and State and local government current receipts and expenditures, national income and product accounts (NIPA), by major type (1959-2007) [http://www.gpoaccess.gov/eop/tables08.html]. Note also that the data shown here reflect 2005 Census data with 2007 tax amounts. 

The middle class has not benefited from the recent growth in the economy.

Facts

1. Real after-tax per capita personal income rose by 12.1%--an average of more than $3,700 per person during the past seven years.¹²

2. Real wages (pre-tax) have risen by 3.6 percent.¹³

3. Non-salaried wages increased more than salaried earnings (+24.0%. Vs +22.1%) over the past seven years.¹⁴

4. The unemployment rate has averaged 5.2% since 2000, below the averages for the past three decades.

5. The U.S. economy added more than 8.3 million jobs from August 2003 through the end of 2007.

      The most important way that middle income Americans benefit from economic strength is by jobs being available if they want them. Low unemployment trumps income growth. Clearly, with nearly record low unemployment, this requirement has been met.

      What do we know about "middle-class income?" This simple question seems like it should be easy to answer, but it is the subject of many widely reported fallacies. When you see claims that household income has been stagnant, this is because the average household size has been declining. The fact that the average real household income rose by only 6 percent from 1969 to 1996 sounds like stagnation to most. But in the same time real income per person rose by 51%.¹⁵

When you see claims that the American middle class is vanishing, to a degree this is true but the statement is designed for its political spin not to enlighten people. The middle class is shrinking because many in the range that would have been considered middle class have moved up to a higher income level, leaving fewer in the lower income range.

       Further, true wage advances tend to be understated because they do not include the value of health insurance and retirement benefits which have been increasing rapidly, and because the number of part-timers has been increasing and their wages are lumped in with the totals.¹⁶ For an excellent review of these and other fallacies about middle class income and income stagnation, see Thomas Sowell's Economic Facts and Fallacies.

The truth is, most people are making more money today and they're better off than ever before. Real median household income in the United States reached an all-time high of $48,200 in 2006, median household family income, which averages in multi income families, is up to $60,000 and for most Americans the trend continues upward. While definitions of poverty rate tend to be somewhat specious, the nation's official poverty rate declined for the first time this decade, from 12.6% in 2005 to 12.3% in 2006.¹⁷

Assessment

Next time you hear someone say its harder for the average family to make ends meet than it was thirty years ago, ask them how they're doing with their flat panel TV, 96 cable channels, personal computer and high speed internet, iPod, and air conditioning, all of which are good examples of the many, many things that have been added to the inventory of a typical household over and above what was there thirty years ago. The claim is emotive and cries out to the ever increasing wealth of the American Dream but it does not reflect economic reality.

Sources:

[12] This is from www.whitehouse.gov - we should try and get this from the primary source.

[13] ditto

[14] US Dept of Labor - Bureau of Labor Statistics - Tables B-3 and 1 - April 2008 vs April 2001. Note, this is not inflation adjusted like the figure immediately above it.

[15] Thomas Sowell, Economic Facts and Fallacies, p 125.

[16] Ibid. p130.

[17] U.S. Census Bureau, "Income, Poverty, and Health Insurance Coverage in the United States: 2006 Report, Aug. 28, 2007. [http://www.census.gov/prod/2007pubs/p60-233.pdf] (accessed Apr. 4, 2008).

Tax cuts for the rich have pushed income inequality up rapidly to record levels.

Facts

The most common measure of income inequality is the Gini Index, a calculation that captures in one number the difference between actual income distribution and perfectly even income distribution. The Gini Index summarizes the dispersion of income and ranges from 0, or perfect equality, to 1, or perfect inequality.

       Perfect equality would correspond to a Gini index of 0. In this scenario, the top 1% of income earners in a population would receive 1% of total income and the bottom 1% of the population would also get 1% of the income. A Gini index near 1 would be extreme inequality where, for example, the top 1% of the population receives 99% of the income and the remaining 99% of the people have to share out the remaining 1% of the income. A more complete explanation of the Gini index concept is shown in an appendix.¹⁸

      After increasing for 25 years, income inequality in the U.S. as measured by the Gini index was essentially stable from 2001 - 2005, the latest year for which information is available. The Gini Index had increased from .386 to .466 between 1969 and 2001 indicating increased inequality. Since then it has averaged .466, with the latest figure being .470 (+.004 over four years). What this tells us that the increase in income disparity in four years was so small it is not visible on a chart showing the Gini index for the two years..

The questions remain though, what caused the long-term increase in income inequality, and is it reason for concern? Former Federal Reserve Chairman Alan Greenspan writes in his book, The Age of Turbulence: Adventures in a New World, that the increase in income disparity from 1980 to 2003 is troublesome. This comment was widely reported in the press, but his explanation for the increase and the reason for his concern were not.

       Greenspan's explanation is very different from the conventional wisdom that tax cuts for the rich caused the increase in disparity. (It should be evident from our analysis in Chapter 2 that this could not mathematically be the case.) Rather he points to differences in educational standards between rich and poor as the cause and his recommended solution is to improve the quality of education for all Americans in order to provide advancement through educational opportunities for the poor. The reason for Greenspan's concern about increasing disparity is that lower income earners would pressure legislators to implement misguided policies purely out of their resentment for the rich.

      The International Monetary Fund, looking at income inequality on a more global scale points to a different but related cause for increasing disparity. According to a lengthy study by the IMF, "per capita incomes have also risen across virtually all regions for even the poorest segments of the world's population, indicating that the poor are better off in an absolute sense ... although incomes for the relatively well off have increased at a faster pace."¹⁹ They observed that income disparity has been on the rise everywhere, not just in the U.S., and they trace the increase to differences in the availability of technology. Quite simply, the more education and technical skill a person possesses, the better off financially he or she is likely to be.

Assessment

Blaming increases in income disparity on recent tax policies is false and leads to misguided solutions. The solution is to address the causes and improve education and technology availability among the poor.

Conventional Wisdom  (this is a continuation of section 6)

Poor people are doomed to stay poor while the rich get richer.

Facts

Income and social-class mobility are alive and well in the United States, as indicated by several recent studies. A 2007 Report from the Department of the Treasury, based on the examination of federal income tax returns from 1987 and 1996, reported that more than half of U.S. households (56% by one measure and 57% by another) moved to a higher or lower income quintile between 1987 and 1996. Approximately half of households initially in the bottom 20% of the population moved to a higher quintile within ten years. The largest percentage increases in real incomes were, in fact, earned by those who started out in the lowest income groups.²⁰

      A separate study by the U.S. Census Bureau published in 1998 reported that, on average, more than 41% of Americans increased their inflation-adjusted income by 5% or more per year from 1984 to 1994. The primary reasons for the change in income from year to year was either a change in marital status, a change in the number of workers in the household, or moving into or out of full-time year-round employment.²¹ A study by the Economic Policy Institute in 2000 showed that almost 60% of Americans in the lowest income quintile in 1969 were in a higher quintile in 1996, while over 61% in the highest income quintile had moved down into a lower income quintile during the same period.²²

Assessment:

Is there a substantial difference in income between rich and poor in this and all countries? Yes, but that's the wrong question. The correct question is: "Can the poor improve their lot? And, are they doing it now?" That is, can the poor move up the income ladder?

   Here's one way to look at it. Imagine that you have a choice between being in the bottom income quintile in two different countries. In Economy A (as shown in the diagram) the bottom quintile earns an average of $10,000 a year and the middle quintile earns $30,000. In Economy B, the bottom and middle quintiles earn averages of $10,000 and $50,000 respectively. So which one would you choose?

      If you can move up the quintile ladder, certainly Economy B is the better choice. If you can't move up, Economy B is still better because when the higher quintiles spend money, it fuels the economy and the rung you're on is likely to go up more than it will in Economy A. The only reason you might prefer Economy A is if envy is more important to you than opportunity.

      The U.S. is the land of opportunity and everyone has a chance to move up, so long as they demonstrate the capacity to learn and improve. Most people begin on the first rung. They are likely to move up over time. And in time some individuals or their children will make it to the level of Donald Trump or possibly even Bill Gates, and that's a good thing. Individuals at that level of income spend a lot of money to build the economy, and people like Bill Gates give away a lot of their money to help other people achieve wonderful things. Why would anyone want that to change?

Inequality: No Cause for Alarm

       Here's one more look at the Gini Index and how it measures income inequality. After increasing for 25 years, income inequality in this country has been essentially stable since 2001. The Gini Index is the most common measure of income inequality. It's simply a way of capturing the amount of inequality in a single number. A real world income distribution might look like the one below, where the lowest-earning fifth of the population earns 7% of the total income. In this graph, when you move right to 20% of the population, you only move up to 7% of cumulative income.

      The next fifth (or quintile) might earn 12%, and so on. When you get to 100% of the population, you of course reach 100% of the cumulative income. In the curve below. the straight line represents a "perfectly even" income distribution; the lower one, known as the Lorenz curve, is a more typical distribution. The Gini index is a measure of the area between the two curves, in the shaded area. The larger the area, the greater the income disparity.

Gini Explained

The Gini index is a way of capturing inequality in a single number. Since inequality is, by definition, a comparison of actual income distribution against perfectly equal distribution, the starting point for the Gini is a graph of "equality." If you plot the cumulative income of the five quintiles (fifths) of a population in which everyone has the same income, it looks like this:

This means simply that if you start with those earning least, on the left, and move up until you've reached 20% of the population--shown below.

 ...you will also have reached 20% of the cumulative income...

Since everyone earns the same amount in this scenario, 20% of the population = 20% of the income. 40% of the population = 40% of income, and so on.

 A real world income distribution might look like this one, where the lowest-earning fifth earns 7% of total income. In this graph, when you move right to 20% of the population, you only move up to 7% of cumulative income, not 20%.

The next fifth might earn 12%, and so on. When you get to 100% of the population you are of course always up to 100% of the cumulative income.

Take a look at the two curves below. The first (actually a straight line) is the "perfectly even" income distribution. The lower one, known as the Lorenz curve, is a more typical distribution. The Gini index is simply a measure of the area between the two curves, the shaded area. A larger area means income inequality is greater.

Here is what the U.S. Lorenz curve looked like in 2000 and 2005.

The chart below shows the curves for 1986, 2000, and 2005.

      The U.S.'s federal debt is $9 trillion. This is the largest debt of any nation by far and is a result of many years of budget deficits. It means that 10% of the U.S. budget goes to pay interest on the debt owed by the U.S. government to others.

However ...

      As a percent of GDP, the debt is lower today (65.5%) than in 1996 (67.3%). The debt to GDP ratio is relevant because the size of the economy is what determines the country's ability to pay the interest on its debt.

      The U.S. debt is also lower than many developed countries and most developing countries as a percentage of annual income. According to the IMF World Economic Outlook 2007, the US debt is lower than the chart above--and most headlines--indicate. The IMF reports "net debt," subtracting a nation's liquid assets on hand from its debt. By this measure, the U.S. debt is just 44% of GDP. That compares to Japan at 90%, Italy at 100%, Germany at 57%, and France at 54%. Great Britain was at 38% and Canada, benefiting from the commodity boom, has dropped its debt down to just 25% of its GDP. (The IMF does not report comparable information for other countries.)

       Budget Deficit: When the government takes in less money through taxes than it spends, this is a deficit. A budget surplus occurs when the government takes in more than it spends.

       Federal Debt: The cumulative effect of budget deficits or surpluses. After a deficit of $1 billion per year for five years, the federal debt would be $5 billion.

       Trade Deficit: When the people of a country buy more than they sell, this results in a trade deficit. Adam Smith argued that a trade deficit is not bad because when currency is exchanged for, for example, pots, by definition the trade are balanced. Each party got what it considered a fair deal.

       Supplemental Appropriation: Large temporary expenses must go through a separate approval process so they do not become part of the base budget. This spending still becomes part of the official budget and is tracked in total spending figures like other expenses.

Economic decline has accelerated as a result of failed economic policies.

A Critical Assessment

The End of Affluence: The Causes and Consequences of America's Economic Decline, by Jeffrey Madrick. In this 1995 book, the author says American productivity is in irreversible decline, and he predicts that disputes over affirmative action, immigration, welfare reform, Social Security, environmental policy, and health care will lead to social chaos.

Facts

The U.S.'s share of global GDP is higher today than 12 years ago. After declining from an estimated level of 75% of the world's GDP at the end of the Second World War to 25.1% in 1995, it--amazingly--increased to over 27% in 2006. What's so amazing about this small increase?  The U.S. was--against the odds--defying the trend experienced by other developed nations which lost almost a full ten share points during this time period, from 53.2% to 43.9%. Developing economies increased from 21.7% to 28.9%. The biggest share losers were Japan, France, and Italy.⁵

      The U.S. is also ranked number one in competitiveness by the World Economic Forum, a Switzerland based think tank that grades 131 countries in 12 categories, including the quality of institutions, infrastructure, innovation, and macroeconomic stability. America's number one ranking is due, they said, to innovative companies, efficient capital markets, and a flexible workforce.

Assessment: When Perception Becomes Reality

One thing that politics and the financial markets have in common is that "the perception of reality" tends to become reality. In 1996, Alan Greenspan, then chairman of the Federal Reserve Bank and the nominal guardian of the U.S. banking system, said in a speech on central banking that the equity markets were "irrationally exuberant" and had separated themselves from reality.

       Despite that observation, the markets continued even higher for nearly five more years before eventually dropping. Literally hundreds of billions of dollar were made by those who stayed "irrationally exuberant" until the third quarter of 2001. In 2002, under intense pressure from current events and other factors, the market finally collapsed.

      When Greenspan made those remarks in 1996, the NASDAQ index of stocks was at 880.In 1999 the NASDAQ had traded as high as 4700, which was a gain of 430%. The momentum was strong, and perception was reality. By October 2001, the NASDAQ was trading down, at 790, a five year drop of 10%. The market psychology was based largely on hype; however, it remained real and very strong for a while. But eventually the reality shifted, and the facts had to rule.

      In politics, if enough people believe in a politician or a political theory they can make that belief a reality by putting those people or ideas into positions of power. Whether that belief gives you Adolf Hitler, Soviet-style communism, or Richard Nixon does affect the reality. But if the facts are that the perception is wrong, the reality they've created will eventually adjust to truth. In that case, a dictator like Adolf Hitler will self destruct, communism will fall on its own sword of economic inadequacy, and Richard Nixon's inability to play by the rules will eventually destroy him.

      In early 2008, Bear Stearns, an investment bank that had been around since 1923, was put out of business by fear of what might happen. Jimmy Cayne, the company's chairman, saw his $1 billion of stock fall to a value of $20 million. Alan Schwarz, who had become president in 2007, watched his company simply disappear. What happened was a typical "run on the bank." Banks and investment banks have hundreds of billions in securities on their balance sheets that are funded on a day-to-day basis. They are secure but highly leveraged entities. Even with plenty of equity, careful risk controls, and a solid record of profitable business dealings, the day the bank can't finance their daily position in securities markets is the day they are effectively out of business.

      I know that personally. In 1991 when I was a managing director for the investment bank Salomon Brothers and running one of their European businesses, the company endured a near-death experience. A group of Salomon Brothers traders in New York had conducted illegal activities to profit from a U.S. Treasury Bond auction. They had successfully made dozens of millions of dollars by the activity, but were eventually caught.

      An indictment of the firm would have shut down the entire multi-billion dollar company. The market responded immediately and, because of the potential risk involved, funding for the company dried up. Quick action and support encouraged by the Treasury and the U.S. Federal Reserve saved the company. But, because of just a few people in one location, a global, multi-business American financial standard bearer almost disappeared. Once again, the perception of weakness became reality.

       Markets go up and down, and the business cycle continues. Dynamic, growing capitalism creates what the Austrian economist Joseph Schumpeter called "creative destruction." The markets become overly enthusiastic and over commit capital during optimistic cycles. Then they become overly negative and destroy good businesses during the down cycles. The good news is that this sort of volatility creates dynamism, with new winners and better opportunities in each cycle. As the old joke goes, the stock market has completely and accurately discounted six of the last three recessions--meaning that the market often mystifies the naysayers. Despite the prophets of doom on Wall Street and beyond, the economy in the first decade of the twenty-first century remains stronger than many people think, and with some perspective we can see that fact. Whatever the current emotional state of the financial wizards and the 24/7 financial news analysts, the economy remains strong, and America is still number one.

      If Joseph Schumpeter was right and the cyclical nature of the markets creates positive momentum, we will see this positive long term impact eventually in the mortgage markets as well. The explosion of sub-prime lending over the past several years has put many homeowners at risk as they stretched to buy homes that were expensive compared to their income. News of a larger than normal number mortgages going into default as these homeowners ran into financial difficulties led predictably to the perception of accelerating weakness. The "creative destruction" that hit the markets at that point led to the destruction of a lot of bank capital; but after all was said and done, many people who could never have bought a home without a sub-prime boom ended up owning a home.

      Even in the midst of the turmoil, it's a safe bet that America will continue to move toward a higher ratio of home ownership in the months and years ahead. We don't know that for a fact just yet, but we can see that the underlying economy is strong, and that's a good sign. And what we do know is that, whatever the current weakness, over time American resilience will prevail. During the last seven years the American economy has outperformed the majority of developed countries, and that momentum is a sure sign of strength.

       --Dennis Keegan, author 
 

Facts

Contrary to the common view, the U.S. is still the largest producer of industrial goods in the world. The U.S.'s $2.73 trillion in industrial output is double that of number two Japan's $1.36 trillion. The U.S. has a manufacturing output of $1.73 trillion, compared to Japan's $953 billion and China's $760 billion. If agriculture, services, and government are included, total U.S. production is $12.4 trillion, and no other nation comes close.⁸ The U.S. exports to many countries, most notably Canada and Mexico, both of which are partners in the North American Free Trade Agreement (NAFTA).

       Reality Check shows the industries in which the U.S. has a strong manufacturing presence. In many of these sectors, the U.S. is dominant. The book also shows how the balance of trade is trending quite differently with its various trading partner blocks.   

Assessment

      Yes, the number of manufacturing jobs has declined. But the value of U.S. manufactured goods has increased--significantly. We've produced more goods with fewer laborers (thus increased productivity), and the resulting money has gone into the economy to hire people in other jobs which are more interesting and create even more value. We know this is true since unemployment has been near historic lows. And you might find a few people who would rather be working on an assembly line all day than what they currently do, but that would be an isolated exception, not the rule. The aggregate view is most important as we consider the overall direction of the country. This positive scenario is VERY different from the one often portrayed by gloom and doomers who want to paint the economy as a failure by pointing to losses in manufacturing jobs. The cycle explained here is closely related to the concept explained in the next section about why outsourcing is good for America.

Key Terms

Manufacturing Output: Manufacturing output is the money value of goods produced in factories

Industrial Output: Industrial output is the money value of goods produced in factories plus mining, including oil and gas.

Balance of Trade: The balance of trade is the difference between the money value of exports and the money value of imports in the economy over a specific period of time. Trade deficit is a negative balance which results from a country's importing more goods and services than it exports. Trade surplus is the reverse. The surplus is the result of a country's exporting more goods and services than it imports.

Balance of Payments: The balance of payments is the overall sum of the flow of payments from an individual country with the rest of the world. In simpler terms, if an individual buys more goods and services than he can sell and accumulates a trade deficit, he will have to balance the deficit with a capital inflow. In balance of payments, the capital inflow is known as the "current account" or "capital account surplus"--which would be the equivalent of covering your deficit by borrowing from the bank or running up your credit card balance. The only other alternative is to spend money from your savings. For national accounts, the equivalent of running down savings is drawing on official central bank reserves.

Capital Account: The capital account is one of the two major components of the "balance of payments." It includes all transactions between a country and other countries. It deals with both direct investment, such as the purchasing of real estate or goods, or the changes in investment in stocks, bonds, and the like. A foreign investor buying assets domestically is considered a capital inflow, and the opposite is a capital outflow.

Current Account (Financial Account): A nation's current account is the difference between a nation's total exports of goods, services, and transfers, and its imports of the same things. Current account balances depend on the net foreign assets of a country, positive or negative, determining the balance.

The North American Free Trade Alliance (NAFTA) has allowed Mexico and Canada to drive down U.S. wages and destroy U.S. jobs

Facts

Since the NAFTA trade and tariff agreements went into effect on January 1, 1994, replacing the U.S.-Canada Free Trade Agreement implemented in 1989, real average hourly earnings in the U.S. business sector have risen by 9.5% from $7.55 in January 1994 to $8.27 in December 2007.  By contrast, in the 14 years prior to NAFTA, real wages actually dropped by -8.3% from $8.23 in December 1979 to $7.55 in January 1994. ⁹⁵ There is therefore clearly no evidence that NAFTA put downward pressure on U.S. wages.

       Rather than hurting jobs in this country, NAFTA has, in fact, boosted the rate of new job creation. Between December 1993 and December 2006, U.S. employment rose from 112.2 million to 137.2 million jobs, a 22% increase, with a total of 25 million new jobs. On the other hand, the average rate of unemployment during the same period was 5.1%, compared to 7.1% during the period 1981-1993.

      In addition, NAFTA has boosted manufacturing as well, with output increasing by 63% between 1993 and 2006, topping the 37% increase in manufacturing between 1980 and 1993.⁹⁶ And wages for manufacturing workers have gone up. Average real compensation grew at an average annual rate of 1.6% from 1993 to 2006, compared to 0.9% between 1980 and 1993.

Conventional Wisdom

Lowering tariffs and throwing open the borders to U.S. markets for Canada and Mexico hurt business in this country.

Facts

Again, since NAFTA went into effect, both trade and investment have increased substantially in this country and across the borders with Mexico and Canada. From 1993 to 2006, trade among the three NAFTA partners has climbed 198%, from $297 billion to $883 billion. During this period of time, exports of U.S. goods to those countries grew even faster than imports. While exports to all other countries grew at a rate of 108%, trade with Mexico and Canada grew at a rate of 157%. The net result is that business has boomed since the NAFTA accords were put in place.

Boosting North-American Investment

       According to the most recent U.S. Department of Agriculture (USDA) figures, Mexico and Canada have become two of the top three U.S. poultry markets in the world. In 2004, U.S. poultry exports to Mexico were valued at $331.1 million, while Canada reached $330.3 million (the Russian Federation came in at $530.5 million). Exports to Mexico increased 61.5%, and increased 100% to Canada since 1993. Export increases from 2003 are especially remarkable, at 27.6% for Mexico and 22.8% for Canada.

      At the same time, U.S. pork producers credit NAFTA with their gains in market share in Mexico for pork products, which increased 3.5 times to $430.7 million between 1993 and 2004, and more than seven-fold to $259.8 million to Canada during the same period. One-year increases from 2003 to 2004 are striking, as well, as exports to Mexico and Canada surged 93.6% and 49% respectively.

       Exports of U.S. fresh fruits and vegetables to Canada, our top market, reached $1.9 billion in 2004. This is an increase of 45.5% since 1993, and 5% since 2003. Mexico's growth as a market for these products is even more impressive, according to the USDA, rising from America's fifth largest market in 1993 to the third largest in 2004. Exports to Mexico surged 98%, from $134 million in 1993 to $265.8 million in 2004. Changes between 2003 and 2004 were mixed, as exports to Canada rose 5% while exports to Mexico declined by 0.5%.⁹⁷

      In addition, investment in business, which is important for maintaining a high standard of living in the NAFTA countries, has increased substantially. Excluding housing, U.S. non-residential business investment has increased by 107% since 1993, compared to 45% between 1980 and 1993. The result is that U.S. economic growth over this same period has been remarkably strong, and the cooperation between these North American partners continues to bring opportunities for new growth opportunities.

      As of 2007 Canada was the largest market for U.S. exports. The American trade deficit with Canada decreased by $5.7 billion in 2006, and it continued to decrease in 2007 as exports to Canada increased even faster than US demand for Canadian oil and gas.

      U.S. exports of private commercial services to Canada, excluding military and government-related trade, were $32.5 billion in 2005 (latest data available), and U.S. imports were $22.0 billion. Sales of services in Canada by majority U.S.-owned affiliates were $46.9 billion in 2004 (latest data available), while sales of services in the United States by majority Canada-owned firms were $36.6 billion. Meanwhile, the stock of U.S. Foreign Direct Investment (FDI) in Canada in 2005 was $234.8 billion, up from $212.8 billion in 2004. U.S. FDI activity in Canada is concentrated primarily in the manufacturing, finance, and mining sectors.

Conventional Wisdom

NAFTA destroyed American jobs.

Facts

The primary fear, repeated in many political venues and by many in the mainstream media, is that NAFTA destroys jobs. That fear is neatly encapsulated by the following statement from the Public Citizen website:

Here are the more relevant numbers: U.S. manufacturing employment declined from 16.8 million people in 1993 to 13.9 million people in 2007, a decrease of nearly 3 million manufacturing jobs, and nearly 20% of the total. Moreover, the $190 billion U.S. trade deficit with NAFTA countries--as a simple accounting matter--corresponds to manufacturing jobs that could have been here. The Economic Policy Institute estimates that the United States could have had over one million additional manufacturing jobs had there been trade balance between NAFTA countries alone. This figure subtracts from the NAFTA trade deficit our oil and gas trade deficit, which has always been significant, although it has shrunk 40% as a share of our total deficit since the deal went into effect.⁹⁸

      It's hard to believe that all job losses in the U.S. manufacturing sector are related to NAFTA, since the U.S. goods deficit with its NAFTA partners, excluding oil import/export, is about $45 billion annually, or about 0.3% of GDP. Trade with NAFTA is huge and valuable allowing the US to focus on what it does best and allowing our partners to do the same. The net of the buys and sells is just .3% of GDP. Even if one were to believe that 0.3% of GDP may have a measurable impact on jobs and wages, there are other larger trends to be considered. Total industrial production jobs peaked at around 25 million in 1974, long before NAFTA. Since then, production jobs, which include manufacturing, have trended down to near 20 million.

      At the same time, as industrial production jobs have dropped about 5 million total, U.S. industrial output since 1974 has more than doubled. Clearly U.S. industrial output and employment has primarily been responding to productivity changes. The clearest way of tracking NAFTA related job losses is the number of claims filed under the Trade Adjustment Assistance Act. Since 1994, 1.8 million claims have been accepted for reimbursement under this act, which covers many areas, including manufacturing.

      There are limitations to this number, since not all claims are accepted, and it's not simple to qualify. However, even if you assume the correct number is not 1.8 million but triple that (or 5.4 million), that is still only 105,000 jobs per quarter over 13 years. The government's JOLTS Survey, which reports on job losses and gains, indicates that the U.S. creates and eliminates millions of jobs each quarter. An extra 105,000 job, plus or minus, is not likely to create a major shift in overall employment patterns.

      Since the 1970s, as industrial jobs have dropped, the average unemployment rate has also dropped. In the 1970s, 6% was considered full employment, but since 1992 the U.S. unemployment rate has averaged 5.2%. The broad indicators clearly do not support the argument that the job market as a whole has been hurt by NAFTA, even if some jobs were lost in some areas.

An Accurate Picture

      If you believe everything the political candidates are saying, you would have to believe that NAFTA is responsible for the loss of some 3 million jobs in the manufacturing sector, or that outsourcing production to Mexico and Canada has led to an "exploding trade deficit." Unfortunately, such claims may be long on drama, but they're short on facts. An insightful commentary in the Wall Street Journal by former Michigan Governor John Engler points out that the trade imbalance has nothing to do with NAFTA, but instead is primarily due to the high volume of oil imports.

      As discussed in Chapter 10, Canada and Mexico are the number-one and number-two suppliers of crude oil to the United States. In September 2007, the U.S. imported more than 75 billion barrels of oil from Canada, which was 18.3% of total oil imports. At the same time, we imported 43.6 billion barrels from Mexico, for 10.65% of the total. More recently, in January 2008, the U.S. imported 71.4 billion barrels from Canada, or 19.5% of the total, and 38.5 billion barrels from Mexico, which was 10.5% of all crude oil imports.

Insert Chart 17_C (Oil Accounts for More ...)

       Petroleum imports accounted for 55% of the entire U.S. trade deficit in the fourth quarter of 2007. Outside of oil and gas imports, the U.S. trade deficit has narrowed by 40% over the past 

      three years and now, at 2.3% of GDP, is at the lowest level since 1999. As Gov. Engler points out, the trade deficit has almost doubled between 2000 and 2007, from $77 billion at the turn of the century to $140 billion in 2007. Nevertheless, the problem was not in manufactured goods but in energy imports. Of the $62 billion increase in trade deficits since NAFTA began, $58 billion (95% of the total) is energy related. Except for energy, the trade deficit with our NAFTA partners has grown by just $3.5 billion since 2000, less than .03% of GDP while sales of agricultural and manufactured goods to Canada and Mexico have almost kept pace with imports.

Insert Table 17_D (US Imports of Crude by Selected ...)

Assessment

      NAFTA helped the U.S. economy far more than it hurt. If over the past seven years, U.S. trade with the rest of the world had performed as well as with NAFTA countries, the U.S.'s non-energy trade deficit would only have grown by $25 billion, instead of the actual growth of $155 billion. Our thinking about NAFTA should be similar to that about outsourcing explained in Chapter 5.

       Lastly, since free trade is an absolute necessity for the progress of third world countries, the U.S. must set an example by eliminating trade barriers. There is an enormous global value created when the U.S. continues to show the way.

    Bureau of Labor Statistics www.bls.gov

    Office of the U.S. Trade Representative, "Policy Brief: NAFTA Facts," Oct. 2007. [http://www.export.gov/fta/nafta/nafta_benefits.pdf] (accessed Apr. 15, 2008).

    USDA: Foreign Agricultural Service. Backgrounder: "Benefits of NAFTA," May 2005. [http://www.fas.usda.gov/itp/policy/nafta/nafta_backgrounder.htm] (accessed Apr. 20, 2008).

    "Debunking USTR Claims in Defense of NAFTA: The Real NAFTA Score 2008," PublicCitizen.org. 2007. [http://www.citizen.org/trade/nafta/articles.cfm?ID=17640] (accessed Mar. 21, 2008).

   ⁴ John Engler, "What Nafta Trade Deficit," Wall Street Journal, Apr. 21, 2008. A15. [Available at: http://online.wsj.com/article/SB120873451908929781.html]

Good U.S. jobs are being outsourced to other countries, putting America's economic future at risk. 

Background

      In 2004, opponents of the move toward offshore alliances were saying that one of every ten jobs in the U.S. computer, software, and information technology industries would be going overseas in the near future. One in four IT jobs was predicted to go offshore by 2010. A report from Forrester Research concluded that, "at least 3.3 million white-collar jobs and $136 billion in wages will shift from the U.S. to low-cost countries like India, China, and Russia" by 2015.⁹ Other analysts predicted that a large number of the 57 million white-collar and professional jobs in this country would suddenly be lost to overseas suppliers if the outsourcing trend continued.

       Evidence of what could happen, they said, could be seen in the examples of Japan, Germany, and the United Kingdom, which were bleeding white-collar and technical jobs to lower-cost Asian nations. The UK alone was expected to send as many as 25,000 high-tech jobs, and 30,000 banking and finance jobs to India and other developing countries over the next five- to ten-years. By some estimates, Europe would lose more than a million such jobs to India and China by the year 2015.

      Aware that job losses were real, as were concerns about the trade deficit, public discourse about outsourcing and trade became major campaign issues. Business Week reported in 2004 that not everyone was happy with the numbers coming from Washington. "The link between strong growth and job creation appears to be broken," the writer observed, "and we don't know what's wrong with it. Profits are soaring, yet no one is hiring. Angry voices are blaming Benedict Arnold CEOs who send jobs to India and China. If highly educated 'knowledge' workers in Silicon Valley are losing their jobs," he added, "who is really safe?"¹⁰

      It sounded like a rebellion in the making. This fear came at the height of the political season despite the fact that the GDP was growing at a rate above what the Federal Reserve Bank thinks is a sustainable rate of growth; it was advancing at a rate of 3.4%. The unemployment rate was dropping and was already down to 5.5% from a high of over 6% during the recession. The transition from 2004 to today tells much the same story. Politicians campaigning in Ohio, Michigan, and Illinois have blamed job losses on outsourcing and bad trade deals. Outsourcing is feared and heart-rending stories about families devastated by lost jobs remain common in the press. Those who have lost jobs in Michigan or Indiana won't necessarily appreciate the job gains in Louisiana and Arkansas, but markets and marketplace conditions have been changing for as long as there has been industry itself. And while these changes will bring about some job redistribution, in total, the job market in this country is still strong and growing.

Facts:

      The simple fact that from 2000 to the end of 2007 there were 8.3 million new jobs created and unemployment was very low, while many jobs (good estimates are not readily available) were outsourced to India and other countries, should be sufficient evidence to demonstrate that outsourcing is not necessarily bad for the U.S. To understand this seeming paradox, consider the following extreme but analogous situation where the U.S. lost 82% of its jobs ... and it turned out to be a good thing. In 1820, 85% of the U.S. jobs were in farming. As a result of efficiency improvements, today that number is just 3%¹¹, meaning that approximately 82% of American jobs went away. Why was this good? Because the U.S. now gets all the food it needs from the just 3% of its workers, plus it gets all the additional things created by the 82% who would have been farming, but who are now making automobiles, golf clubs, fitness machines, household products, medicines, and countless other goods and services that make our lives better.

      While this is undeniably good in the long run, it must be acknowledged that some people experienced hardships as farming jobs declined during the long shrinkage from 85% to 3%. Those hardships however, were generally short term, as the individuals made the transition from one sector of the economy to another, and those hardships must be weighed against the greater good. Between 1860 and 1920, the number of factory workers went from 1.3 million to nearly 10 million, and output grew from $854 million to $24 billion. By the 1890s the manufacturing sector in this country had surpassed agriculture as the primary source of income for American workers. And by 1920, manufacturing productivity was more than twice that of the farm-based economy.

Assessment

Outsourcing seems bad only if we think of jobs in a narrow sense as work in exchange for money. This leads to a simplistic notion that there is a limited amount of money to go around, so work done by a foreigner must be at the expense of work done by an American. But to understand the big picture, we must think of work as being part of the process of creating something of value, some of which goes to the worker when the product or service is sold. If the work can be done for less by someone in another country, freeing up American time to do other things of greater value, the total amount of value to be enjoyed by Americans is increased.

       Reality Check provides additional evidence that productivity advances enabled by offshore outsourcing have not led to job losses in the aggregate, and explains further why this is true.

Key Terms  

Insourcing: Insourcing is defined as the movement, by a non-U.S. company, of operations that provide goods and services from outside the U.S. into the U.S.

The declining value of the dollar is the result of government mismanagement. It's more evidence of America's decline.

Facts

The dollar is, in fact, weak against the Euro and some major currencies. This is helping the U.S. increase exports, which added 1% to the U.S. GDP in 2007 over 2006. However, the dollar is still strong against the Asian countries which export significant amounts of goods to the U.S. and other countries.

      To keep the dollar expensive and their own currencies weak, these exporting countries have bought over $4 trillion of U.S. dollars in recent years. This purchase of dollars keeps their products cheap, and thus their exports strong. But such large dollar purchases represent huge sums for these countries, both on an absolute basis and relative to the size of their economies. The resulting enormous dollar holdings represent a significant risk for them; if the dollar continues to decline to what the IMF considers to be a fair value against their currencies, the cost to them would be high.

      The dollar is so expensive against the Asian currencies by the IMF Purchasing Power Parity (PPP) measure that, despite the dollar being weak against Europe, the dollar still remains strong against the world, on average. The IMF 2008 "World Economic Outlook," published in April 2008 says, "The analysis of the Consultative Group on Exchange Rate Issues (CGER) of the IMF suggests that the U.S. dollar has now moved closer to its medium-term equilibrium level but still remains somewhat on the strong side."

      The dollar has weakened dramatically since 2001. This is mostly the result of an overvaluation in 2001 when the dollar was expensive on every measure against most currencies. An in depth analysis of the IMF Purchasing Power Parity (PPP) demonstrated the dollar's overvaluation in 2000;²³ it has gone from a 15% overvaluation against European countries like Germany in 2000 to a 15% undervaluation in early 2008. The dollar is down 30% since 2000, but from an expensive starting point. When the dollar was overly expensive, it contributed to the growth of the U.S. trade deficit by making U.S. exports expensive everywhere in the world and by encouraging U.S. businesses such as Wal-Mart to buy foreign products that looked amazingly cheap compared with comparable products in the U.S.

      The broadest perspective indicates that the dollar has merely returned to the level it held in 1994-95, before the massive rise in the dollar and resulting increase in the U.S. trade deficit. The dollar has even adjusted downward by a small amount against Asian currencies in recent years, though not enough. A bigger decline against Asian currencies would help U.S. businesses increase exports to Asia. As measured by the IMF's PPP, the dollar is still overvalued versus India at 170% of the PPP price today, but that's down from a 2000 overvaluation of 217%.

       According to the IMF's calculation of how much goods and services a currency can purchase, an overvaluation of 217% means that a dollar in 2000 could buy more than twice the value of goods internationally as the equivalent amount of the Indian currency at the then prevailing rate of exchange. On a trade weighted basis, we are back to the 1994-95 level of the dollar. This can be seen on the chart of the Trade Weighted Dollar below, which evaluates the dollar against currencies, weighed according to each country's flow of trade with the U.S.²⁴

      Trade activity often responds to changes in exchange rates with a lag of many years. Changing trading partners can start with a long selling process, then it takes time to set up new contractual relationships followed by the work of increasing production to meet demand. Lastly, end user demand can take years to develop and grow. In 1994-95, the U.S. current account deficit was 1.5% of GDP. As the dollar appreciated 40% over the next seven years, the current account deficit expanded to 4% of GDP. We are now seeing the inverse trends.

      At this moment, trade is shifting back to favor U.S. products. In 2005 the Ex-Oil (excluding oil) Trade Deficit started to decline after increasing for years. It is responding to the weakening dollar. The weaker dollar adds to U.S. GDP growth by encouraging U.S. importers to substitute U.S. made products for foreign merchandise, and it encourages foreign companies to buy U.S. goods instead of buying products from outside the U.S. This is extremely good for U.S. GDP growth and jobs. The risk is that a weaker dollar can create inflation.

Assessment

A weak, or inexpensive, currency isn't necessarily bad. If it were, why would the Asian countries be buying trillions of U.S. dollars to keep their own currencies weak? While the dollar has dropped considerably from 2001, its extremely overvalued level at that time was unsustainable and contributed directly to the increase in the U.S. trade deficit.

      The recent weakening of the dollar has just returned it to the average exchange rates of the early 1990's. This makes U.S. merchandise less costly in world markets, which leads to increased exports. The last time exchange rates were at current levels, the result was a reduction of the U.S. trade deficit to only 1.5% of GDP. It is likely a return of the dollar to this more sustainable level will, as it did before, continue to lower the trade deficit and help keep U.S. GDP growth strong. The dollar is definitely not at an extreme level of weakness. There certainly is no dollar crisis. The U.S. dollar has simply returned to a sustainable level, closer to its long-term fair value, according to the IMF.

Weak Currencies and Inflation

       Reality Check explains how a weak currency and inflation work together and under what no idle plants to produce more goods, a weak currency will provide companies the opportunity to raise prices. A weaker currency at home makes domestic goods and assets appear cheap to circumstances a weak currency can cause problems. The book shows what the effect would be on other countries if the dollar declined further against the currencies of major trading partners.  Reality Check also makes predictions about the U.S. balance of trade, inflation, and the relative strength of the dollar, as well as explaining why foreign governments intervene in currency markets to control the value of their currencies relative to the U.S. dollar, and the costs/risks associated with doing so. An analysis is offered of serious ripple effect problems that this intervention caused in many asian countries in the 1990's.  

       Stabilizing Iraq's government, law enforcement, military, and civilian infrastructure so that U.S. forces can leave with confidence is obviously the main focus now. But eliminating false perceptions about the war is important as well. If the shallow view of the world held by the most cynical people were accurate, fears about a global superpower run amok as a result of failed checks and balances would be justified. We think more complete information reveals that this fear is unfounded. If this chapter helps to cause some readers to reconsider their cynicism and hate, and to restore some faith in the American process, it will have served its purpose.

Conventional Wisdom

The U.S. is at war in Iraq because Bush and Cheney lied. False claims about WMD got us into an unwinnable quagmire that was really about oil.

Facts

      Let's first keep in mind that the U.S. was already at war in Iraq prior to the invasion, a fact amazingly few Americans seem to remember. The U.S. and U.K. flew 280,000 sorties and dropped over 1,650 bombs on 385 Iraqi military sites during the Clinton administration.²⁵ Just two days before 9/11, U.S. fighter aircraft were firing at military targets and being fired upon in the skies above Iraq. Six Iraqi casualties were inflicted on that day.²⁶ In the early 1990's, well after the end of the first gulf war, U.S. troops engaged Iraqi government troops--within Iraq--and pushed them back from Iraq's northern mountains to prevent the slaughter of thousands of Kurds.²⁷

      We should also not forget that "regime change" in Iraq became a stated goal of United States foreign policy when the "Iraq Liberation Act" was signed into law by Bill Clinton in January, 1998. The act directed that:

           "It should be the policy of the United States to support efforts to remove the regime headed by Saddam Hussein from power in Iraq and to promote the emergence of a democratic government to replace that regime."

      In the end, Saddam Hussein's government was removed because it failed to comply with (a) the treaty that ended the First Gulf War in 1990, and then (b) the demands of eighteen U.N. Security Council resolutions.²⁸ One can not understand the case made for war and the related widely-publicized intelligence failures without some knowledge of the events that took place and the actions taken by the United Nations after the First Gulf War.

       Working backward, the last U.N. Security Council resolution prior to invasion, Resolution 1441, was passed unanimously by all fifteen member nations, including France, Germany, Russia, and China, as well as Arab countries such as Syria. This was described at the time as the "final ultimatum" demanding that Iraq comply with the international mandates or face serious consequences.

      The terms of the resolution declared this as "a final opportunity to comply with its disarmament obligations." Saddam Hussein understood the potential repercussions but did not comply. He thumbed his nose at the world community, and most of the delegates on the Security Council believed the time had come for "serious consequences." ²⁹

      By that time the most severe of sanctions had already been applied to Iraq. There's no doubt they were causing serious hardships for Iraqis, but the Hussein regime refused to cooperate. Prior to the next U.N. vote--to actually commit to war under the U.N. banner--France and Russia signaled that they would not vote to invade. The reader can judge, after the facts are provided in Chapter 11, whether the U.N.'s Oil-for-Food scandal played a role in that decision. However, the U.S. and 48 other countries agreed that the time had come for action.

      Here are the important sections from Resolution 1441, passed November 8, 2002, four and a half months prior to the coalition invasion of Iraq:

Acting under Chapter VII of the Charter of the United Nations:

1.  Decides that Iraq has been and remains in material breach of its obligations under relevant resolutions, including resolution 687 (1991), in particular through Iraq's failure to cooperate with United Nations inspectors and the IAEA [International Atomic Energy Agency], and to complete the actions required under paragraphs 8 to 13 of resolution 687 (1991) ...

3. Decides that, in order to begin to comply with its disarmament obligations, in addition to submitting the required biannual declarations, the Government of Iraq shall provide to UNMOVIC [United Nations Monitoring, Verification, and Inspection Commission], the IAEA, and the Council, not later than 30 days from the date of this resolution, a currently accurate, full, and complete declaration of all aspects of its programmes to develop chemical, biological, and nuclear weapons, ballistic missiles, and other delivery systems such as unmanned aerial vehicles and dispersal systems designed for use on aircraft, including any holdings and precise locations of such weapons, components, sub-components, stocks of agents, and related material and equipment, the locations and work of its research, development and production facilities, as well as all other chemical, biological, and nuclear programmes, including any which it claims are for purposes not related to weapon production or material³⁰

       Saddam Hussein's government did not comply with this United Nations ultimatum. Instead, the Iraqi ambassador provided a 1,200 page document in December 2002 that simply repeated previous incomplete declarations. U.N. weapons inspectors concluded that Iraq failed to account for substantial chemical and biological stockpiles which UNMOVIC had confirmed as existing as late as 1998.

      In March of 2002, the chairman of the independent WMD Commission, Hans Blix, said that, "Iraq appears not to have come to a genuine acceptance--not even today--of the disarmament, which was demanded of it and which it needs to carry out to win the confidence of the world and to live in peace." Blix reported further that the Iraqi regime had allegedly misplaced 1,000 tons of VX nerve agent--one of the most toxic chemical agents ever developed.³¹ Subsequent reports showed that an astonishing array of chemical and biological components, as well as armed munitions and SCUD missiles, had simply vanished and remained "unaccounted for."

      There had never been any question that Saddam had WMD. He had used them repeatedly in the past, killing more than 5,000 Kurds in the brutal massacre at Halabja in 1988, and at least 182,000 murdered at Anfal the same year. Dozens of stories have been published in books and magazines detailing Iraq's use of these weapons.³² There are videos on the Internet with heartrending pictures and testimony of how Saddam's thugs massacred innocent civilians with poisonous gasses.³³ You can also find videos of Saddam's opponents being thrown off the tops of buildings.

      After the fall of Baghdad in 2003, more than 275 mass graves were discovered, each containing from fifty to several thousand bodies. Remains uncovered from those sites showed that many had been victims of chemical or biological weapons. Yet, when the search for WMD began in earnest at the end of the war, Saddam's stockpiles were nowhere to be found.

Key Terms

First Gulf War--The world was shocked when, on August 2, 1990, Iraqi tanks, aircraft, and infantry, on orders from Saddam Hussein, invaded and brutalized the tiny nation of Kuwait. Following the invasion, the U.N. Security Council passed 12 resolutions condemning the assault and giving Iraq until January 15, 1991 to withdraw. When Saddam defiantly refused, a 30-nation coalition led by the U.S. entered the region to expel Iraq's forces, destroying most of that country's military with high-precision weapons delivered by aircraft, missiles, and rockets.³⁴ Television coverage of Operation Desert Storm gave the world an unprecedented view of the aerial war in real time.

      The ground war, which began February 23, lasted exactly 100 hours. The rape and devastation Saddam's military had perpetrated on their Arab neighbors was tragic. Thousands of civilians were dead or gravely injured, the Kuwaiti countryside was littered with land mines, and more than 700 oil wells had been deliberately set ablaze on Saddam's orders, massively destroying animal and plant life in the region. Kuwaiti citizens praised their deliverers, but the stories of massacres and atrocities were chilling. The U S. Corps of Engineers and foreign contractors actively assisted in the reconstruction of Kuwait, the cost of which, according to Kuwaiti sources, would top $700 billion.

      IAEA--The International Atomic Energy Agency is a United Nations commission headquartered in Vienna. The IAEA sets standards for acquisition and use of nuclear materials and conducts inspections to ensure the peaceful use of nuclear power and safeguard public health. The agency administers the Treaty on the Non-Proliferation of Nuclear Weapons (NPT), which requires international cooperation and a system for monitoring energy development plans. IAEA inspectors are authorized to monitor transport of weapons-grade nuclear fuel to ensure that none is diverted for military use.

       UNMOVIC--The United Nations Monitoring, Verification, and Inspection Commission was created in December 1999 by U.N. Resolution 1284. UNMOVIC, the successor of the U.N. Special Commission, UNSCOM, was authorized to verify destruction of Iraq's chemical and biological weapons, and missiles with a range of more than 150 kilometers. Under order from Saddam, Iraqi scientists and engineers successfully hid munitions and other WMD from inspectors, which ultimately became the real reason for the invasion of Iraq in 2003. UNMOVIC inspectors left Iraq in March 2003, but the commission continued to operate outside the country with a roster of more than 300 experts in weapons detection. The commission's mandate was eventually terminated in June 2007 by Security Council Resolution 1762.

       WMD--Weapons of Mass Destruction (WMD) are those which can kill large numbers of humans and cause large-scale damage to buildings and infrastructure. The most commons types are nuclear, biological, and chemical weapons, but WMD may also include other types of non-conventional weapons. In military shorthand, the term ABC refers to atomic, biological, and chemical weapons; NBC refers to nuclear, biological, and chemical weapons, and CBRN refers to chemical, biological, radiological, and nuclear weapons.

       Oil-for-Food Program--Under the UN sanctions imposed during the early-nineties, the international community agreed not to buy oil from Iraq until the country complied with U.N. resolution requirements. The Oil-for-Food program was established in April 1995 by Security Council Resolution 986. The purpose was to allow Iraq to sell oil to bona fide traders in exchange for food and other humanitarian necessities, to soften the impact of U.N. sanctions on Iraqi citizens. Between 1997 and 2002, until revelations of the scope of Saddam's double-dealing erupted in a major scandal, Iraq sold more than $67 billion in oil and issued $38 billion in letters of credit to purchase goods and commodities.³⁵

      Much of that revenue, unfortunately, ended up in Saddam's possession or was transferred to private bank accounts in Europe and the Middle East. The program ended in November 2003 with Security Council Resolution 1483, which lifted civilian sanctions on Iraq and provided for termination of the program. Oversight was then transferred to the Coalition Provisional Authority and any remaining funds were given to the Iraqi Development Fund. We offer a fuller treatment of this issue in Chapter 11.

Assessment

Many around the world are passionately opposed to the war in Iraq without even knowing what led to it. While some downplay the importance of resolution 1441--or ignore it--one can NOT understand the rationale for war without it. Since under this resolution Saddam could have avoided an impending disaster by simply telling the U.N. what had been done with his WMD, it was almost universally assumed that the reason he was not doing so was that he still had them. This universal assumption established the context for those assessing--and reporting on--Iraq's WMD capabilities over the following 4-plus months leading up to the invasion. The claims of WMD were bold because those making them had what they believed was irrefutable logic on their side.

   Much has been made of the failure of the intelligence community and also the failure of the press to push back on the bold claims being made about the existence of WMD. Whether you believe that Saddam actually had WMD or not, whether or not you view resolution 1441 as an important geopolitical event or not, you must acknowledge that it affected the context importantly, paving the way for reporters and policymakers to make assertions that were unusually bold given the relative lack of complete information. Apparently it's easy to forget an old context when things get heated.

      Some might think that requiring Saddam Hussein to provide evidence that he had destroyed something that had been destroyed is doubletalk. This lacks an understanding of the nature of the weapons he had. There were large confirmed stockpiles of lethal, horribly dangerous weapons, some of which were used against Iran and on Iraqi citizens. These weapons could not have been destroyed without leaving many memories of the destruction process and probably many written records. If the WMD were, in fact, destroyed, a few conversations with those responsible for their destruction or disarmament could have settled the matter and avoided the mess.

       Saddam apologists have explained this by saying that he actually believed he still had WMD because his officers were afraid to tell him that the weapons had all been used, destroyed, or perhaps never existed. Those with this line of thinking typically also hold that the world leaders and press are at fault for not knowing something that Saddam didn't know himself, and something that also contradicted statements made by the CIA and intelligence agencies around the world.

Conventional Wisdom:

George Bush made the case for war solely on the WMD claim and then changed it later to spreading freedom through a democratic Iraq.

Facts

During his address to the nation one week prior to full-scale invasion of Iraq, President Bush made it clear that the U.S. was acting in concert with the wishes of the world community. In the first paragraph of that address, Mr. Bush confirmed that the emphasis had shifted from international concerns about the physical presence of WMD in Iraq to the Iraqi government's failure to report on the disposition of WMD. He says in his opening remarks:

"My fellow citizens, events in Iraq have now reached the final days of decision. For more than a decade, the United States and other nations have pursued patient and honorable efforts to disarm the Iraqi regime without war. That regime pledged to reveal and destroy all of its weapons of mass destruction as a condition for ending the Persian Gulf War in 1991.

  "Since then, the world has engaged in twelve years of diplomacy. We have passed more than a dozen resolutions in the United Nations Security Council. We have sent hundreds of weapons inspectors to oversee the disarmament of Iraq.

  "Our good faith has not been returned. The Iraqi regime has used diplomacy as a ploy to gain time and advantage. It has uniformly defied Security Council resolutions ... (emphasis added)."

Near the end of his remarks, the President laid out the vision for democracy:

  "Unlike Saddam Hussein, we believe the Iraqi people are deserving and capable of human liberty, and when the dictator has departed, they can set an example to all the Middle East of a vital and peaceful and self-governing nation.

  "The United States, with other countries, will work to advance liberty and peace in that region."

Related to the specific claim that "Bush lied," consider the following. The three most frequently cited events are:

1.  George Tenet, head of the CIA, told George Bush two weeks prior to invasion that it was a "slam dunk case" that Saddam Hussein had WMD.

2.  Colin Powell delivered a speech to the U.N. in February 2002 in which many claims were made that turned out to be false. Before going before the U.N. with this information, however, Powell sat face to face with George Tenet and asked for assurance that all of the facts he would present were unassailable. It turned out that many could not be proven after the invasion.

3.  George W. Bush, in his January 2003 State of the Union Address, made the now famous sixteen-word claim: "The British Government has learned that Saddam Hussein recently sought significant quantities of uranium from Africa." This claim was supposedly discredited by former Ambassador Joe Wilson after a trip to Niger to investigate the claim for the CIA. Later investigation by the CIA and the media showed that Wilson's report did not dispel a false rumor but actually tended to confirm that agents of Saddam Hussein had, in fact, traveled to meet with industry officials in Niger in 1999, where they undoubtedly discussed the country's only valuable export, yellowcake uranium, which is a low-grade precursor of nuclear fuel.³⁶

       Regarding points 1 and 2: George Tenet was appointed to his position as head of the CIA by Bill Clinton, not George Bush. His claims were possibly false, but the source was not the Bush administration. Regarding point 3: While the Bush administration later said the infamous sixteen words should not have been included in the State of the Union speech, it is nevertheless true that (a) the British did inform the CIA of the meeting in Niger between agents of that country's government and emissaries from Iraq; (b) the British government later issued a statement affirming that they stood by the claim; and (c) a special panel investigation by the U.S. Senate also confirmed that the sixteen-word statement was probably true.

      The fact that Resolution 1441 went to a unanimous vote of its fifteen members is sufficient evidence to prove that the Bush administration was not acting alone in the belief that Iraq had WMD. Without such a belief, the resolution would have been absurd. Further, the following quotes indicate that almost all world leaders at the time believed that Iraq had WMD:

Public Statements about Saddam's WMDs

The following public officials, many of whom now claim the war in Iraq is illegitimate, made public statements during the run-up to war indicating that they believed that Iraq had chemical and biological weapons, and an active program of nuclear weapons development:

"People can quarrel with whether we should have more troops in Afghanistan or internationalize Iraq, or whatever, but it is incontestable that on the day I left office, there were unaccounted for stocks of biological and chemical weapons."

--President Bill Clinton, July, 22, 2003 ³⁷

"Iraq is a long way from [here], but what happens there matters a great deal here. For the risks that the leaders of a rogue state will use nuclear, chemical or biological weapons against us or our allies is the greatest security threat we face."

--Secretary of State Madeline Albright, Feb 18, 1998.

"Saddam Hussein has been engaged in the development of weapons of mass destruction technology which is a threat to countries in the region and he has made a mockery of the weapons inspection process."

--Rep. Nancy Pelosi (D, CA), Dec. 16, 1998.

"We know that he has stored secret supplies of biological and chemical weapons throughout his country."

--Vice President Al Gore, Sept. 23, 2002.

"I will be voting to give the President of the United States the authority to use force--if necessary--to disarm Saddam Hussein because I believe that a deadly arsenal of weapons of mass destruction in his hands is a real and grave threat to our security."

--Sen. John F. Kerry (D, MA), Oct. 9, 2002.

"In the four years since the inspectors left, intelligence reports show that Saddam Hussein has worked to rebuild his chemical and biological weapons stock, his missile delivery capability, and his nuclear program. He has also given aid, comfort, and sanctuary to terrorists, including al-Qaeda members. It is clear, however, that if left unchecked, Saddam Hussein will continue to increase his capacity to wage biological and chemical warfare, and will keep trying to develop nuclear weapons."

--Sen. Hillary Clinton (D, NY), Oct 10, 2002

      In an article, in the Wall Street Journal, former Clinton CIA director James Woolsey made several points--that Saddam possibly intentionally misled the world into thinking he still possessed WMD to keep his status as a power player in the region; that stockpiles of WMD possibly remained only to be destroyed at the last minute; that WMD-related material "probably" entered Syria months before the war; that Iraq admitted making 8,500 liters (8.5 tons) of anthrax, which if reduced to powder, could fill a dozen easily portable suitcases; and that "Iraq's ties with terrorist groups in the '90s are clear," with a decade worth of connections between Iraq and al-Qaida, "including training in poisons, gases, and explosives."

       Weapons hunter David Kay, testifying before the Senate Armed Services Committee, said that based on the pre-war intelligence, Saddam Hussein posed "a gathering, serious threat to the world." Hussein's scientists possibly misled the former dictator into believing Iraq possessed WMD, with the scientists possibly misappropriating funds. Though he also said "we were all wrong" regarding WMD in Iraq, which was widely publicized, he also said that, based on his investigation, Iraq was "far more dangerous than even we anticipated."

      The bipartisan Silberman-Robb commission and Senate Intelligence Committees both scrutinized the claims made by the intelligence community and the justification for war. Both concluded that "every intelligence agency believed that Saddam's regime had weapons of mass destruction." They concluded that no one lied.³⁸

      The post invasion Duelfer report concluded the following: "Hussein maintained the capability to produce them [WMD] on short notice. There was abundant evidence of contacts between Saddam's regime and al Qaeda and other terrorist groups. Given Saddam's hostility to the United States and his stonewalling of the United Nations, American leaders had every reason to believe he posed a grave threat. Removing him removed that threat."³⁹

      There was never any question that Saddam Hussein was a brutal tyrant who would stop at nothing to achieve his goals. The record of his atrocities was growing day by day. Right up to the moment coalition forces entered Iraq, the overwhelming majority of world leaders agreed that, whether by diplomacy or by force, the Iraqi dictator had to be removed. When the U.S.-led coalition invaded, in March 2003, the potential use of WMD by Iraq against our forces was listed by Defense Secretary Donald Rumsfeld and senior commanders on the ground as their "Number One Concern," and was the focus of much of the military preparations. Who will forget the images of American soldiers, covered head to toe in specialized gear and face masks in the 100-degree heat, because of the presumed risk of a chemical weapons strike by Iraqi forces?

Assessment

Lying, by any reasonable definition, involves the intent to deceive. Clearly President George Bush and General Colin Powell believed that Saddam Hussein had WMD. Their claims were based on information delivered to the administration by others who had no partisan reason to make false claims. Their military plans were based on thoughtful consideration of the context, evidence, and current events, and by the terms of U.N. Resolution 1441.

      Even if some of the facts had later been shown to be incorrect, the president and his advisers did not lie. However, those who continue to repeat the "Bush lied" mantra--knowing the claim is disingenuous--actually do fit the "intent to deceive" requirement.

      The premise of the U.S. and coalition invasion of Iraq was not: "We're going to invade Iraq because we know they have WMD." Rather, it was almost the opposite. The premise was: "We're going to invade because we don't know if they still have WMD, (more precisely, he has been required to tell us what he did with them and has refused) and Saddam Hussein is a tyrant who can't be trusted." We knew without a doubt that Iraq had WMD at one time, that the international weapons inspectors were being blocked by Saddam, and that Saddam's regime refused to provide the accounting of their weapons and weapons-related technologies as required by resolutions of the international community.

WMD: Where Are They Now?

      Since the end of Operation Desert Storm, many credible sources have reported that there are at least three facilities in Syria currently producing chemical weapons, near the cities of Damascus, Hama, and Safira (in the Aleppo area). A senior Syrian journalist has reported that Iraq's WMD were transported to Syria prior to the U.S. invasion, and were hidden in three bunker complexes in that country.⁴⁰ In addition, the testimony of a former high-ranking Iraqi Air Force officer published in this country after the U.S. invasion describes in detail how and when WMD were ferried out of Iraq and into Syria, in 56 sorties using retrofitted 747 and 727 aircraft, by civilian commercial pilots carrying out Saddam's direct orders.⁴¹

       Additional support for these reports comes from former members of the Iraq Study Group (ISG) who found evidence of hidden stockpiles in Southern Iraq but were rebuffed by their superiors, who refused to authorize recovery operations. Former ISG inspector Bill Tierney, who speaks and reads Arabic fluently, made headlines in 2005 and 2006 when he translated 12 hours of conversation from audio tapes of General Staff meetings, in which Saddam and top-level aides (including Ambassador Tariq Aziz) discussed Iraq's use of chemical weapons and how the Iraqis had successfully misled U.N. weapons inspectors.

Assessment--The Courage to Act

Did the U.S. government really assemble a 30-nation coalition and commit its military and diplomatic resources to war in Iraq because Bush lied? The assumption is unreasonable, but if you believe it's true, ask yourself this question: Should the U.S. and the UK--after eighteen United Nations resolutions and twelve years of arrogant defiance by Saddam Hussein--have pushed for the "final ultimatum" requiring Iraq to provide an accounting of their WMD programs? Or should the U.N. have said, "Never mind. Let's just continue with this costly containment, punishing Iraqi civilians with sanctions and a corrupt Oil-for-Food program."? And all those previous resolutions? Should we simply have ignored them as well?

      If Resolution 1441 had passed and no serious actions were taken, the U.N. Security Council might as well have shut down, having completely destroyed the credibility of the U.S., the UK, and the Security Council itself. On the other hand, by taking action the coalition ensured that when the U.N. votes similarly in the future, there will be a credible threat of action, not empty resolutions that will drag on forever with no real threat of force behind them.

      A leader's job often involves making decisions with imperfect or incomplete information, and then advocating for the action required. Waiting for perfect information is almost always a recipe for disaster, and leaders worth their salt don't put things in motion by saying, "Well, we think he's dangerous, but we're not totally sure about that, and maybe we should just wait and see."

      By the same token, the idea that the Iraq War was only about oil is disingenuous and ill-informed. The decision to invade Iraq was "about oil" only to the extent that it was the vast supply of oil in that country that enabled the Tyrant of Baghdad to pursue his maniacal lust for power for more than three decades.

   Suzann Chapman, "The War Before the War," Air Force Magazine: Vol. 87, No. 2, Feb. 2004. [http://www.afa.org/magazine/Feb2004/0204war.asp] (accessed May 20, 2008). See also: David Usborne, "The West's Forgotten Conflict: US & UK Have Flown 280,000 'Sorties' Bombing Iraqis," The Independent, June 23, 2000. [Available at: http://commondreams.org/views/062300-102.htm] (accessed May 10, 2008).

    Hassan Hafidh, "Iraq Says Civilians Killed," The Washington Post, Sepember 11, 2001. and Julian Borger, "Democrats lash Bush 'lunacy' on missiles," The Guardian, Tuesday Sept. 11, 2001 http://www.guardian.co.uk/world/2001/sep/11/usa.julianborger1  < needs formatting

    Stephen Zunes, "The United States and the Kurds: A Brief History," Foreign Policy in Focus, Oct. 25, 2007. [http://www.fpif.org/fpiftxt/4670] (accessed May 10, 2008). See also: Carl Rochelle, "U.S. readies forces in response to Iraqi attack on Kurds," CNN Interactive (inlcues AP and Reuters reports), Aug. 31, 1996. [http://www.cnn.com/WORLD/9608/31/iraq.forces/] (accessed May 10, 2008).

    The text of United Nations Security Council Resolution 1441 is available at: http://www.worldpress.org/specials/iraq/unscr1441.htm. The text of Security Council Resolution 686, affirming the continued relevance of the twelve previous resolutions demanding Iraqi compliance is available at: http://www.worldpress.org/specials/iraq/unscr686.htmresolutions, but Resolution 686

    News of the U.N. decision to demand compliance and President Bush's final offer of a peaceful settlement to Saddam Hussein were broadcast on both sides of the Atlantic. Transcript of the President's national address, "Bush: 'Leave Iraq within 48 hours,'" CNN, Mar. 17, 2003. [http://www.cnn.com/2003/WORLD/meast/03/17/sprj.irq.bush.transcript/]. See also: "Bush sets deadline on Iraq," BBC, Mar. 17, 2003. [http://news.bbc.co.uk/2/hi/middle_east/2855461.stm]

    The complete text of Resolution 1441 with precedents and documentation, is available in PDF format at the United Nations website: www.un.org/depts/unmovic/documents/1441.pdf.

    A partial list of the WMD that went missing from Saddam's stockpiles, according to official U.N. reports, included: 3.9 tons of VX nerve agent, 6,526 aerial chemical bombs, 550 mustard gas shells, 2,062 tons of mustard precursors, 15,000 chemical munitions, 8,445 liters of Anthrax, 11,000 liters of botulinum toxin, as well as SCUD missiles and rockets armed with chemicals. Inspectors of the Iraq Study Group have suggested that these and other munitiions were transferred illegally to underground storage sites in Syria, Jordan, and Iran prior to the U.S.-led invasion in March 2003.

    See for example: Brian Kraiker, "A Tyrant's Life," Newsweek, Dec. 14, 2006. [http://216.109.125.130/search/cache?ei=UTF-8&p=WMD+%228%2C000+Kurds%22&fr=yfp-t-501&

   u=] (accessed Apr. 9, 2008). A detailed report on the Anfal massacre can be found on the Internet: Andrew Whitley, George Black, et al., "Genocide in Iraq: The Anfal Campaign Against the Kurds." a Special Report. New York: Human Rights Watch, 1993. [http://hrw.org/reports/1993/iraqanfal/] (accessed Apr. 9, 2008).

    For those with the courage and a strong stomach, a heartrending Youtube video on the Anfal massacre and memorial is available, powerful even in Kurdish, at:http://www.youtube.com/watch?v=dBX2_byWYgc .

    The military coalition included Argentina, Australia, Bahrain, Bangladesh, Belgium, Canada, Czechoslovakia, Denmark, Egypt, France, Greece, Hungary, Italy, Kuwait, Morocco, the Netherlands, New Zealand, Niger, Norway, Oman, Pakistan, Poland, Qatar, Saudi Arabia, Senegal, South Korea, Spain, Syria, the United Arab Emirates, the United Kingdom, and the United States.

    "Bill Clinton on Bush uranium line: 'Everybody makes mistakes': Former president accepts explanation on

   State of the Union," CNN.com, July 23, 2003. [http://www.cnn.com/2003/ALLPOLITICS/07/23/clinton.iraq.sotu/] (accessed Apr. 1, 2008).

    U.S. News and World Report, May 19, 2008, Rethinking the Iraq Critics, by Michael Barone,

    Ibid.

    For those interested in more details on the production and concealment of WMD in Syria, check out these websites: http://www.2la.org/syria/wmd.html, andhttp://www.2la.org/syria/iraq-wmd.php.

    General Georges Sada, Saddam's Secrets: How an Iraqi General Defied and Survived Saddam Hussein. Nashville: Integrity, 2006. A review and discussion of the generals' testimony and the book can be found at http://www.cnsnews.com/ViewSpecialReports.asp?Page=/SpecialReports/archive/200602/SPE20060202a.html.

 Mohammed Daraghmeh, "Saddam Hussein raises reward Iraq will pay for suicide bombings," The Associated Press, April 3, 2002.

    Trudy Rubin, "Northern Iraq is a region on edge," Knight Ridder Newspapers, Feb 25, 2003 http://www.accessmylibrary.com/coms2/summary_0286-6034109_ITM

    CNN, "Iraqi Council Member: Saddam hid $40 billion," Tuesday, December 30, 2003.

    Con Coughlin, "Saddam's WMD hidden in Syria, says Iraq survey chief," London Daily Telegraph, Jan. 24, 2004. [http://www.telegraph.co.uk/news/main.jhtml?xml=/news/2004/01/25/wirq25.xml&sSheet=/news/2004/01/25/ixnewstop.html] (accessed Nov. 12, 2005).

    "Ex-agent says U.S. ignored WMD sites: Waged 3-year battle to conduct searches, but politics, fear got in way," WorldNetDaily.com, Aug. 5, 2006. [http://www.worldnetdaily.com/news/article.asp?ARTICLE_ID=51394] (accessed Nov. 11, 2006).

    An eye-opening interview with Mr. Tierney can be found at: Jamie Glazov, "Where the WMDs Went: An Interview with Bill Tierney," FrontPage magazine, Nov. 16, 2005. [http://www.frontpagemag.com/Articles/Read.aspx?GUID=D47C7304-B454-4294-8A21-DBEC5E2AACBE] (accessed Nov. 30, 2005).

    Jim Geraghty, "The WMD Road to Damascus," National Review, Jan. 12, 2004. [http://article.nationalreview.com/?q=NmEwNzY3MjRiNzA4YTc1YTk0MWNiYzgxMjcwMDU3YTg=] (accessed Nov. 11, 2005).

    Ira Stoll, "Saddam's WMD Moved to Syria, An Israeli Says," New York Sun, Dec. 15, 2005. [http://www2.nysun.com/article/24480] (accessed Mar. 8, 2007).

    See Hayden Peake, The CIA Review of: Mahdi Obeidi and Kurt Pitzer, The Bomb in My Garden: The Secrets of Saddam's Nuclear Mastermind. Hoboken, NJ: John Wiley & Sons, 2004. [https://www.cia.gov/library/center-for-the-study-of-intelligence/csi-publications/csi-studies/studies/vol48no4/bombs_in_garden.html] (accessed Aug. 30, 2005).

    Iraqi General Georges Sada offers the following accounting of casualties in the book, Saddam's Secrets, cited above: "Of the approximately 360,000 Iraqi soldiers on the field of battle, 28% of them (or nearly 100,000 men and boys) were killed in action, and as many as 200,000 sustained serious injuries. In addition, coalition forces captured 60,000 prisoners, and by some estimates there may have been as many as 150,000 deserters. As for casualties on the other side, 390 American soldiers, sailors, and airmen died in combat, while 458 were wounded in action. Among coalition forces, there was a total of 510 casualties. The financial cost to America was approximately $80 billion, of which coalition nations contributed $54 billion. In the end, it's clear that Saddam had underestimated the resolve of the American forces, and he completely misjudged the unity and determination of the coalition." (Saddam's Secrets, pp. 189-190).

    "Major Military Operation since World War II," Ask the Editors: Fact Monster. Pearson Education online. [http://www.factmonster.com/timelines/militaryoperations.html] (accessed Apr. 9, 2008).

    L. Paul Bremer with Malcolm McConnell. My Year in Iraq: The Struggle to Build a Future of Hope. New York: Simon & Schuster, 2006.

Facts

The leading Shiite cleric in Iraq, Grand Ayatollah Ali al-Sistani, believes Islam and democracy are compatible.⁴² More than 70% of the mostly Muslim citizens of Iraq voted in their first elections, in January 2005, despite significant risk to life and limb, indicating that they believe they are compatible. Here's how they expressed their views in the new Iraqi constitution:

1st--Islam is the official religion of the state and is a basic source of legislation:

(a)  No law can be passed that contradicts the undisputed rules of Islam.

(b)  No law can be passed that contradicts the principles of Democracy.

(c)  No law can be passed that contradicts the rights and basic freedoms outlined in this Constitution.

Assessment

Those who think Islam and democracy are incompatible are at odds with some important stakeholders. These people are (a) Muslims, and (b) citizens of Iraq. We believe their opinions carry more weight than those of the American media elite or the public intellectuals. There are, in fact, many intellectuals who do recognize the importance of a winning strategy in that country.

       Kenneth M. Pollack, a Middle East scholar at the liberal Brookings Institution in Washington, wrote in a 2005 editorial in the New York Times that, "critics of the president who make parallels between Iraq and Vietnam are equally wrong. Iraq is far more important. Because of its oil wealth, its location in the most politically fragile region of the world, and its importance in the eyes of Arab nations that wonder if democracy is possible for them too, Iraq is critical to American interests in a way that Vietnam never was."⁴³

       Pollack's criticism of the Defense Department strategy in Iraq was the lack of an effective counterinsurgency plan, a reality that was eventually resolved in 2007 with the military Surge directed by General David Petraeus. But the belief that democracy can survive and thrive in that ancient country is a gamble well worth taking. 

       Reality Check offers an assessment of whether Iraq really posed a threat to the U.S. and other countries, or whether things would probably have been OK if the world had simply continued to "manage" Saddam.  The book reflects on the somewhat valid acusations that the plan to win the peace was inadequate, explains what had to be done to respond to situations on the ground, and offers suggestions for further reading on the subject. An assessment is offered of reasons for diminished popular support--globally--of the difficult endeavor in Iraq, and the likelihood that such a series of events could happen again. Also offered are some facts about whether the Iraqi people actually wanted an invasion and democracy, and an analysis of the effect of the war in Iraq on the credibility of the U.N. and the U.S.

      Facts are given about the number of successful U.S. military actions that have taken place on foreign soil since WWII--without declarations of war--along with an assessment of the importance of stabilizing Iraq before withdrawing all troops. 
 

 Ed Finn, "Grand Ayatollah Sayyid Ali Husaini Sistani: Why we'd better listen to Iraq's influential cleric," Slate.com, Feb. 4, 2004. [http://www.slate.com/id/2094814/0 (accessed Apr. 3, 2008).

    Kenneth M. Pollack, "Five Ways to Win Back Iraq," New York Times, July 1, 2005. [http://www.nytimes.com/2005/07/01/opinion/01pollack.html] (accessed Apr. 7, 2008).