Archive for January 25th, 2009

Spiraling vortex of doom

A student in one of my classes asked how I would describe the current economic state.   The title of the post was my admittedly flippant answer.  The economy is in a spiral downward, and nobody knows when it will stop, if and how it will turn around, and what the future will bring.

I’ve blogged ad nauseum about the economy: the general state, worries about future inflation, our societal error of wanting something for nothing, and have even attempted a “best case scenario.”  And those are only a few of my economic posts, to write more about this crisis is to risk being redundant.  So I’ll repeat the core, and try to approach this differently.  The core: We’ve been living beyond our means for nearly three decades and now are in for a period of painful rebalancing.  Read the posts linked above for details.

To many people the details aren’t as important as the questions: 1) Are we seeing the worst; 2) when will things finally bottom out; 3) how will things turn around; and 4) when will things get back to ‘normal?  Alas, the answers to those questions are not easy.

Back during the intense recession of 1980-82 the US did not make the structural adjustments to the economy that were necessary to remain competitive.   Instead we let the manufacturing sector start a slow death, led by a steel industry that was decimated by that recession (the Billy Joel song “Allentown” speaks to that, as more generally Bruce Springsteen’s “Born in the USA,” each from the early eighties).   What we need to do to get out of this is make the adjustments we should have made nearly thirty years ago.  By living beyond our means through budget and trade deficits for so long we’ve made those adjustments far more difficult and costly than they would have been if we’d done them back then, and that means that this spiraling vortex of doom is likely to keep spiraling downward for the foreseeable future.  So the answer to question one:  things are going to get much, much worse before they get better.

One can only speculate on question two.   Bottoming out will occur.  I think given the stimulus plans in play it’ll be a weird bottoming out.  So much money is being pumped into the economy that things may start to seem to be improving (or the spiral downward slowing) for awhile.  But then we’ll probably shift to a period of stagflation (so lock in low mortgage rates now while you can!) where inflation alongside a continuing recession creates a “worst of all possible worlds.”   Only after that will we hit bottom, and the sign of that will be an increase in manufacturing jobs as we shift away from a service-sector driven economy.   My guess: six years, as long as terrorism, war, oil shortages, global warming, famine, or some other crisis doesn’t intervene.

How will things turn around?   Ultimately I think the government can’t do it, it’ll be market driven — the fundamentals of the economy will have to come into balance, we’ll have to produce as much as we consume.   Markets are not magic, and can malfunction either on their own or through government intervention.  Yet they do operate under economic laws based on supply and demand that cannot be ignored or avoided forever — sooner or later the system cracks.  The US has avoided the power of the market to force corrections thanks to our status as a global superpower and the world’s largest economy.  We were able to run outlandish capital account surpluses and large budget deficits without weakening the currency too much or causing capital flight.  The Iraq war was probably the straw that broke the camel’s back on our ability to do so; but at some point reality was going to bite back.

Does this mean I oppose the stimulus?  Not necessarily.  I believe it is likely to cause inflation (though stagflation is likely in any event, in my opinion — since I think the dollar is overvalued), but it depends on how it is spent.  Giving money to states and focusing on building productive infrastructure does set up a post-recession (depression?) boom in a way that just handing out checks and tax cuts does not.  So I don’t think the stimulus is a fix, I worry about creating more debt, but if done properly it might be part of a longer term improvement.

When will things get back to normal?   That’s a tricky question.  I’d argue that the hyer-consumer society of the 90s and 00s was not normal.  For students born in 1990, I would say that they’ve experienced an American lifestyle that was built on illusions.   If by normal one means the wild consumer oriented prosperity seems eternal mood of the last 25 years the answer is never.  That kind of hyperconsumer society was unsustainable and destructive on psychological and sociological levels.

But if by normal one simply means back to lower unemployment, the possibility of home ownership for most, educational opportunity and the idea that hard work can bring success — the America before 1981 — the answer is probably again not for six or seven years.   And frankly, that’s a somewhat optimistic assessment, I could see scenarios where this spiraling vortex of doom continues downward for ten to twenty years, especially if oil shortages, global unrest, global warming, terrorism and other factors start forcing their way back on the scene.

Still, most of us will have jobs.  Most families will survive.  We’ll still have lots of flat screen TVs, Ipods, Wii games, and other conveniences of the modern world.  The malls will still have shoppers, and we’ll get through this.  It’s still better than living in many other parts of the world.  But we’re in for a tumultuous ride, and it won’t be fun.