Archive for May 11th, 2009

It’s Not Over Yet

Lately people have seemed a bit less pessimistic about the economy.  The pundits report that things seem to be bottoming out.   To be sure, when it is reported that there were fewer new jobless claims last week, or that job loses in April were less than in March, it can create a false impression that things are getting better.  Ongoing jobless claims are at record highs; things aren’t getting better, they are just getting worse at a slower pace.  The hope is that this slower pace of worsening means we’re closer to a point where things will turn around and start to go in the other direction.  That would be recovery, and I’ve not seen anyone claim we’re in recovery mode yet.

The story line for the recession nearing an end seems compelling.  Faced with conditions similar to 1929 and 1930 the US avoided the mistakes made by Hoover and Roosevelt (neither of whom really figured out what was going on) and instead worked hard to rejuvinate the life blood of capitalism: credit.   Credit even trumps hard work and innovation as a necessity for a capitalist economy — you can have a great idea but without credit it doesn’t get far off the ground.   Money was injected into the finance market, banks were given unprecedented assistance and the risk of global financial markets collapsing into stagnation and failure seems to have been avoided.

The other part of the story line is less compelling, though popular.    The so-called stimulus, the American Reinvestment and Recovery Act (ARRA), was not really about a direct stimulation of the economy — only a small portion of that bill was focused on getting money in consumers hands.   Most of the money will go to address other structural faults in the economy such as a lack of investment in infrastructure (think of the I-35W bridge in Minneapolis for a dramatic example) and helping states handle a crisis in education and health care spending.   Education is seen as a key to economic growth, necessary to maintain a well educated and innovative work force.  Health care costs have been dramatically rising, harming both states and business, dragging the economy down.    In that sense the ARRA is a first step in addressing long term problems — a step, not a solution.  But there are dangers on the horizon.

The first and most obvious danger is inflation.  Already bonds to finance the deficit are selling poorly (the US has to offer higher interest rates than expected to find buyers) and the influx of money into the system has people worried that the dollar may be overvalued.  At this point there has not been a run on the dollar, in part because no other currency is trusted as much, and in part because the increase in the money supply has not led to much of an increase in demand.   Still, the danger is real.   Once inflation begins, it’s hard to control, sometimes requiring putting breaks on economic activity in a way that could nip any recovery in the bud.   That’s a real gamble of Obama’s strategy — can he pull his off and avoid inflation?

Second, and even more difficult, is how to deal with the economic restructuring that must take place in any event.    We cannot simply recover and go back to the life style of 2006.   We cannot return to current accounts deficits of 6% of GDP, and an unholy arrangement of China buying US currency and bonds with the knowledge that this will finance a trade deficit benefiting China.  That’s not a sustainable situation, and China realizes that if the money they invest in the US simply finances consumption it’s not really a safe investment.  If you invest in a company and the company uses your money to buy company cars and cool office furniture, rather than to improve its performance, you’ll likely lose in that investment.

Long term the US will have to get used to higher structural unemployment rates, a permanent loss of service sector jobs, a need to reindustrialize parts of the country, lower tax revenues, and lower rates of economic growth.  The US will have to improve its savings rate and make some hard choices about government spending.   Can we keep entitlements as they are?   Should we maintain a massive military spending half the world’s military budget?   How much can we invest in education, infrastructure and health care without increasing debt and deficits in the long run?

Moreover, what happens if the credit card industry goes the way of the mortgage industry?  New rules on credit card companies, increased bad credit card debt, and a decreased public will to go into debt could be a perfect storm for the credit card industry.    The mortgage crisis could be followed by a credit card  crisis. This could cause a further erosion before recovery begins, and we might look back at early 2009 as being defined by unwarranted optimism; we might be seeing a false bottom.

Perhaps we’re out of the spiraling vortex of doom.   But if I’m right that the great boom of 1945 to 2008 is over, then we need to think about how to handle a new era in the global political economy, one where we enter a  phase of rebalancing and restructuring.  This requires not just a change in policy, but a cultural shift away from consumerism towards a sustainable economy.  Government and business cannot do this for us, we as citizens have to change our behaviors.

So, sure, feel a bit hopeful.  But be wary, stay frugal, and recognize that it’s definitely not over yet!