Life is full of lessons, and clearly one is the persistence of delusions. People have trouble breaking from clearly failed beliefs or ideologies, even when it’s clear that their beliefs are being contradicted by reality. As noted in my blogs last week, many in this country had a belief that the stock and property bubbles of the past decade were not dangerous (and maybe not really bubbles). The “fundamentals” of the economy were sound, and that was proven by the willingness of foreigners to invest, and the extremely high level of “wealth” in the US. Our lack of savings didn’t matter because our wealth was in property and other assets — things actually more dynamic than savings accounts. Thirty years having the “gloom and doomers” proven wrong gave the eternal bulls a sense of cockiness and arrogance. Doubters in the strength and resilience of the American economy just didn’t understand how strong it is, they argued, and may even have some kind of desire to see America fail.
But now people are realizing they need to take a very different perspective on things, and are trying to figure out just what this all means. So let’s take our breath and take stock of the lessons learned so far — and the uncertainties still out there.
1. Fundamentals matter. Ultimately if you consume more than you produce, and you expect ‘something for nothing’ – money to roll on in just because you put it in stocks, bonds, or property – you’ll be disappointed. Look at the current account, especially the trade deficit. Look at private and public debt. Look at the level of investment — is it sane productive investment, or is it just a speculative bubble? The latter occurs when the scope of investment is overwhelming, and it appears a cheap way to wealth that all can get in on. All of these fundamentals were deeply out of balance last year, and have been for some time.
2. The economy takes its time. Due to human dynamics, people can sustain bubbles and imbalances for quite awhile. Frankly, I thought a crisis of this magnitude was possible in 1999 — and if it had come then, it would have been less severe. Yet we found ways to increase cheap credit, borrow at insane levels, and keep the party going another decade. That also means that the rebalancing can take a long time too, especially if humans put obstacles in the way of change rather than assist it.
3. Regulation and rule of law are needed. Humans, including dyed in the wool free market capitalists, will break rules and behave dishonestly if it brings them benefit. Not all of them, but many. And if its in the context of a “game” — the fast paced world of wall street or the business board room — it’ll be easy to rationalize or even turn into a virtue such practices. And, since “markets” aren’t magical entities, but just a result of the actions of other people, smart, powerful people with inside information can find ways to circumvent the rules of the market. To keep people in line you need regulations to protect the market, and work with it to try to minimize such abuse. As the stories unravel of the practices of even respected big time banks (and don’t forget the self-regulating accounting industry, and how the big Arthur Anderson fell due to the Enron scandal) this is painfully obvious, even to those most skeptical of regulations.
4. Don’t rely on ideology. Governments are inherently less able to function efficiently than markets because, as Hayek noted, they are not able to automatically process diffuse information like the market can. But markets aren’t perfect either. Moreover, governments are part of the whole market mechanism because they are one of many corporate institutions involved. Thus they can abuse power, or be part of oversight and effective action. So throw out the anti-capitalist reliance on bureaucracy, that doesn’t work. But also reject the “market is magic” mantra. Throw out class war that either embraces lower taxes on the rich and “trickle down” or mass transfers of wealth to the poor and “redistribution.” The reality is that either extreme brings its own ills to society. Practically do our best to give everyone an opportunity to do their best — that’s all we can hope for.
5. Humans easily delude themselves. They believe what they want, either in terms of economic theory, or nationalist rhetoric. The Soviets were convinced they had a great power, a workers’ paradise that would prevail. They collapsed. Americans got heady after the Cold War and believed we were the unipolar powerhouse able to shape the world, that’s collapsed. Realistic thinking means taking a hard look at core beliefs, especially when those beliefs are self-serving. We have to ask ourselves hard questions about our country, it’s values, and how it functions. We can’t be afraid to admit we’ve been making some real fundamental errors.
Uncertainties: Open questions we do not yet know the answer to:
1. Can one have use debt to stimulate economic growth and reinvest in the economy? Or will that debt just set up a more painful adjustment as it pushes an economy to stagflation or even hyperinflation. Right now with the dollar remaining strong and the stock market recently recovering, there is a sense of optimism that since everyone else in the world is also doing poorly, we’ll avoid inflation. But unless Obama matches his increased borrowing with cuts to other places in the budget — unless he spends smartly rather than just spending more — the Democrats will learn the hard way that you can’t simply spend your way to prosperity. Indeed, the Republicans want a pain free “let’s lower taxes and that will make everything better” while many Democrats want a pain free “let’s spend our way out of this.”
Remember fundamentals! There is no such thing as “something for nothing.” Obama says he’ll cut the deficit in half and promises cuts in “non-productive” programs. It’s imperative he pull that off; if not, we could be looking at inflation around the corner.
2. How long does a recession keep oil prices low? Right now we’re enjoying cheap oil. After the summer of ’08, that is a very welcome respite. But even if the $150 a barrel price was more than what it reasonably should have been, a price inelastic commodity like oil can spike very high or very low on relatively small changes in demand. Moreover, with production at a peak and perhaps declining, even a long recession may not guarantee low oil prices. At this point, we just don’t know.
3. Will the recession stave off global warming? Some optimists believe that a mix in lower economic activity plus an active push for more ecologically friendly “green” technologies will help buy time to make a dent in the global warming process. Others decry how the economic collapse has taken the environment off the front page (even as today high flood and severe weather levels in the Northeast are predicted to increase dramatically over the next few years). Is this actually a good thing in helping us with that fight — one that is far more important in the long term?
4. Will this lead to the actual collapse of the United States as a major power, if not at the level of Soviet collapse, at least something analogous to Britain after WWII.? Are we seeing a transition of global power to other parts of the world, or perhaps a move towards intense multipolarity? Given the growth of terrorism and extremism, we could be entering a new, more ominous global era. That’s a bit scary — and we don’t know.
5. Finally, does the United States have the capacity to again adjust to changes and maintain its democratic character, and its success on the world stage, despite the tough times. Can we let go of old illusions, make major policy shifts, and give up our hyper-consumerist culture for a return to the fundamentals? Will we learn to again embrace people rather than “stuff,” and to treat even our political adversaries with respect, trying to learn from each other rather than “flame” or attack in the Limbaughesque fashion?
We live in interesting times.