Archive for October 13th, 2008
One thing a blog allows one to do is to make bold and admittedly arrogant statements about politics and history. Know only that I realize I’m on a limb here, and I hope I’m wrong. But I believe we have lost a 63 year old friend and comrade: the post-WWII economic boom. Instead, we’re in for, if not a true depression, at least a lengthy recession, followed by a global economy where the US and the West no longer run the show.
In a touch of irony, the boom ends when the first “boomers,” that post-war generation from 1945 – 1960, start retiring. Officially I am a boomer too, though barely — I was born in 1960, at the tail end of the boom, the last year of the Eisenhower administration. Assuming my job doesn’t disappear, I don’t plan to retire for 25 more years. But some early boomers are retiring, having lived their entire lives during a time when the US economy has experienced an unprecedented growth in material prosperity compared to any time in history.
And I don’t mean unprecedented in US history. I mean unprecedented for any time in written history EVER. The amount of material wealth and prosperity created in the industrialized West from the end of WWII to the present is phenomenal. Even the lower middle class live lives of convenience and comfort unimaginable in the past. Better to be an average American worker than even a member of the aristocracy 200 years ago. We have soft beds, safe, tasty food, good health care, entertainment that surpasses anything imaginable in the past, and power at our fingertips.
Conservative Senator Jesse Helms once induced scorn when he said that “our poor people are fat,” but he had a point. Being poor in the industrialized West is often much, much better than being average in much of the Third World. Some of the inner cities and slums are horrific, but for the most part, we in the industrialized West have a truly prosperous existence.
The boom took place for a variety of reasons. Perhaps most important was free trade. After WWII the US was in a position to create a free trade regime, which loosened trade restrictions world wide, widening the production possibilities frontier and expanding global output. Trade has never been truly free, of course, but compared with the pre-war era, the destruction of barriers to trade have been phenomenal. Similarly important was the ability to create a sound investment regime. Unlike the speculative bubble that defined the 1920s, investment during the boom was, until the final years, generally stable and rational. This was due to sound regulations, rational policy from central banks, and in general the fact that one did not need to delve into the realm of irrationality to do very well.
However, something happened around 1985. The world of prosperity created after WWII was one based primarily on sovereign states trading and interacting. They would regulate themselves internally (especially investment regimes and credit markets), and then trade and cooperate internationally. After 1985 the watch word became globalization, and soon intra-state regulations ceased to function. The US found it could sustain current accounts (primarily trade) deficits and finance two speculative bubbles in a row by borrowing from the world — in particular China and Saudi Arabia. Those two states benefited because we bought their goods and oil, and they relied on a strong US economy to drive demand.
As in 1929, some saw this coming, but most did not. The conventional wisdom that “the system is sound” was too strong, and thus everyone found reason to believe. But as in 1929, these speculative bubbles, particularly the housing bubble recently punctured, were built on a credit bubble. The dirty secret of capitalism is that the hidden hand works poorly in credit markets. There greed combines with very imperfect intelligence to create an incentive for quick short term profits at the long term expense of the economy. Simply, credit markets need regulation.
Yet, as any true capitalist will tell you, the regulators are not necessarily better than the market at understanding and controlling events. Indeed, that’s the Hayek-inspired view that the market is always better, numerous small decisions based on the pooling of individual information will trump imperfect bureaucratic decisions, based on information surmised by a small group of inadequately informed officials. Yet in credit markets often those individual choices are so warped by short term greed and a fundamentally misunderstanding of the situation that a long term protective regulatory scheme is better. That must, however, be learned. The Great Depression was a object lesson for regulators during the time of the sovereign state, and they learned the lesson reasonably well.
The era of globalization, however, has altered the nature of the game. Governments have learned they can borrow tremendous amounts of money to fund short term programs, rationalizing the long term impact by pointing to future growth. This isn’t just a creation of the left; the Reagan Administration, which saw American budget deficits balloon from 30 to over 60% of GDP, infamously proclaimed budget deficits irrelevant. Banks quickly discovered the benefits of private debt too. It padded the asset side of their books, and appeared relatively safe — so long as economic growth and prosperity continued onward and upward. The only thing that could threaten this state of affairs would be a deep recession. Normal recessions aren’t deep, they are corrections to an overheated economy. Economists and politicians thought they had this all figured out, hence the recurring recessions of the boom era were minor and, while sometimes feeling intense (the 1974, 1981 and 1991 recessions all caused alarm), were ultimately meer bumps on the road to increased prosperity.
Yet a recession can become deep, even a depression, if it comes on the heals of a speculative bubble that threatens credit markets and the nature of the banking system. That’s what is happening now. Despite words proclaiming that “things will be better soon,” there is reason to believe the “Great Boom” is now over. The question is not if things will get tight, it’s more “how tight will things get?”
The government intervention to save credit markets by covering bad debt is designed to make sure that credit, the lubricant of a capitalist economy, doesn’t dry up. It’s the equivalent of adding new oil to an overheated engine. The question is whether or not damage to the engine is so great as to make this new oil irrelevant. Moreover, given high government debt and bureaucratic inefficiencies — not to mention a penchant for corruption — a socialized credit system is unlikely to prove effective. At best it’s a short term solution; at worst it’s an illusion. “Something is being done.” Great — but if that “something” is really as bad if not worse than “nothing,” it’s not too comforting.
Moreover, we haven’t learned the lessons from this crisis yet. What does it mean that the US relies so much on Chinese largesse and Saudi petrodollars? Does the US current accounts deficit need to be brought into balance, and if so, how can that be done? Does the global nature of the world economy mean that the pain of these imbalances will be shared, also meaning that there is no “national” solution? Will these problems kill globalization, and bring back stronger, inward looking nation-states? Is that even possible, given global business and finance? Can a regulatory regime be created in an era of globalization to try to control credit markets without bringing the stifling choke hold of over regulation and bureaucratization?
The good news is that the answer to the last question is probably yes. The bad news is that it may take a global depression, and possibly political unrest and even war, before we learn that lesson. Get ready for a bumpy ride!