Archive for November 20th, 2008
Last month I proclaimed the “boom” of 1945-2008 to be dead. That was an admittedly bold statement, in that recessions have come and gone for over sixty years, without a fundamental halt to the economic progress of the post-war era. Now, as the stock market dips below 8000, jobless claims grew at a rate surprising even bearish economists, and the US is forced to consider whether or not to rescue the big three automakers, once the foundation of the US industrial base, people are dizzy from the array of bad news.
In other sectors as well, cuts are intense. Universities, both private and public, are making painful cuts. Hospitals are in crisis. Here in Maine the state is seven years behind it’s medicare/medicaid payments, leaving hospitals to eat loses. At some point, this becomes unsustainable. Citbank is laying off over 50,000 workers, and companies around the country are shedding jobs as both profit and credit become hard to obtain. Where will this all end?
Many people are hopeful that this is simply an adjustment to the popping of the property bubble and the wild speculation of the last decade. To them, the problem is that Wall Street went on a binge, and that has to be fixed. Others hope that Barack Obama will undertake fundamental changes to a system where deregulation and an unwarranted faith in the free market allowed business elites to run wild. I think both of those camps are overly optimistic. This crisis is worse than most people realize, and it is the result of long term policies by the United States which set up an unsustainable world economy.
It started after the Carter Administration’s “malaise” led to stagflation and economic recession. In a desire to reassert the US economy the Reagan Administration began a strategy of lower taxes, higher spending, and persistent and growing trade deficits financed first by Japan, then countries like China and Saudi Arabia. This meant that the US could consume more than it produced, and the government could spend more than it brought in. Such a mix of budget and trade deficits would usually cause a currency to buckle and force economic adjustment. The willingness of foreigners to finance this through investment in bonds, stocks, and other aspects of the American economy allowed us to escape that plight.
Thus we partied in the 80s, 90s and through this year, with only short, relatively mild recessions. During this time the trade deficit grew and grew, as did both governmental and private debt. Moreover, Americans stopped saving — as our country became a debtor state, we became a debtor society. This seemed to the experts to be OK. First, foreign financing of the debt/trade deficit was called good — it’s great foreigners want to invest in America! Wording it as a sign of confidence that future growth was assured, the imbalance this was causing could be ignored. Second, people pointed to wealth creation — whether in the stock market, retirement accounts, or property values — as enough to easily overcome the problem of personal debt. Sure, we have credit cards debt, but overall wealth was up. It was ignored that this was paper wealth, able to disappear as quickly as it grew — and, in fact, it has done just that.
And what about this “foreign investment” in the US? The reason Japan and China were so willing to finance our trade deficit is that we were giving the money back to them to purchase the goods they were producing. It was a net win for them — they got the money back, and they got American assets. Everyone seemed to benefit — we could have low taxes, high spending, cheap consumer goods and live above our means, while China, Japan and Saudi Arabia were funding our debt so we could buy their products and oil. Everyone wins!
Some imbalances grew from this, however. The dollar was kept artificially weak for much of this era, meaning that the US essentially de-industrialized, losing manufacturing jobs and replacing them with lower paying service sector jobs. The result was the gap between the rich and the poor, narrowing until about 1980, has been widening for almost three decades, so that now the gap is as large as in the 19th century — the middle class has been disappearing. Workers in China were hurt as well — because profits from Chinese export led growth were invested in the US rather than shared with Chinese workers, there hasn’t been the devleopment of a larger working middle class in China.
Ultimately, this was a bubble destined to burst. High debt and cheap credit made speculation intense, with a stock market bubble followed by a property bubble. As long as cheap credit could help fuel consumer spending, this illusion of wealth creation could continue. As long as speculation continued, foreign money would still flow to the US. Once it burst, the house of cards tumbled, financial companies saw their values collapse, credit tightened, and the ripple has unleashed a major economic crisis which, due to the size and importance of the US economy, is global in scale.
There is no way to fix this. Repeat: there is no way to fix this. There will not be a return to “business as usual” after a year or two long recession. The old system does not work, it has collapsed. With debt of $10 trillion we cannot spend our way out of the recession. The good news is that with proper action we can create a stable global economy for the future — but not without feeling intense pain during the transition.
The system that can’t be fixed is the one where the US could live off foreign money while enjoying ongoing budget and trade deficits. We have to get our economic house in order. The key to doing this is to recognize that we need to have a manufacturing sector that can export, and we need to rebuild a middle class. Yet we can’t do this by simply spending government money; with debt out of control, we need to actually spend less. Yet we’re in a recession, spending less only intensifies a recession according to conventional economic wisdom. Spending more only increases the debt and interest rates could start climbing, especially as foreign economies slow and money does not continue to get invested in the US.
Therefore, there is no solution to this that can be achieved at the national level. There needs to be a global effort to create a new economic regime to replace the remnants of the old Bretton Woods system. Questions of debt, currency valuation, regulations on finance and investment need to be addressed, and some radical changes might have to be made. It won’t be easy. The US will have to recognize that our old position as the dominant world economy is over. We’re still the biggest and most important economy, but we can no longer call the shots.
One can’t fall for simplistic solutions like “let the market fix it.” The market is not magic, and markets can fail. The “true believers” in free markets are operating on undeserved faith. We will need supranational and governmental intervention at all levels to reconstruct the global economy. That said, the goal has to be to create conditions for markets to operate effectively. Markets do operate better than planned economies, and governmental intervention to set up a system is different than intervention to run/control a system. The former is needed, not the latter. We don’t need a ‘new new deal,’ we need a ‘new Bretton Woods’ — a new approach to facilitating market driven economics at the global level.
Yet that is a vague solution, and it probably won’t be seriously considered until it becomes clear to everyone that the economic pain is not going to go away soon. Once the credit rating on US bonds is cut, or governmental bailouts fail, or the US potentially defaults on its debt, then it will become clear that we need to fundamentally rethink the very nature of the global economic system. One problem is that globalization has been taking place in a world economy defined by national regulatory and policy orientations. This has created a loophole for international finance, and allowed the US to “enjoy” it’s credit and debt driven free ride. Now that this has collapsed, it’s time to work for a regulatory system that is global, rather than national.