Archive for October 28th, 2011
The stock market broke 12,000 for the first time in a long time on news that Europe had reached a deal on the Greek debt crisis, the US economy grew by 2.5% last quarter, and first time unemployment claims fell slightly. It’s possible the economy may be turning around and we’ll avoid the dreaded “double dip” recession.
If true, this is the best news President Obama could receive. If next year there is a palpable sense that things have turned around, Obama’s chances of re-election grow considerably. Still, The recession currently is in its fourth year. Yes, there has been growth so it’s not technically a recession, but in terms of high unemployment and a tough economy things have been in the dumps since 2007, even before the September 2008 crisis.
President Bush and Obama get little credit for how they mitigated the worst of the crisis. President Bush’s “bailout” of Wall Street was necessary in order to prevent a further credit squeeze, perhaps pushing us into the Great Depression. The banks also paid it back, meaning it turned out to be “cost free.” President Obama’s stimulus package also turned around the bleeding of jobs and prevented states from becoming insolvent in 2009. Since we never experienced the reality that would have happened without the stimulus it’s easy to dismiss it since it didn’t “fix” the economy and make everything better. But in 2009 nothing was going to do that.
There is a good chance this spurt of growth will cause economic tailwinds to push the economy forward in 2012. But while this may save the President’s job, it doesn’t mean the economy is “returning to normal” or that the problems are solved. It does suggest that we may be able to handle the crisis without total collapse.
Here’s the deal. Global debt is still way to high, and that’s going to hinder economic growth. Moreover, states like the US have been consuming more than we’ve been producing, thinking this is OK because we lured in outside investment (the capital account surplus balanced our current account deficit).
At a national level, the US needs to expand its productive capacity and reduce consumption to the point that it more or less balances production. The trade deficit needs to drop, either through currency devaluation (inflation) or less consumption. At a global level the issue gets murkier. Total debt (public and private — one can’t blame governments alone for this) is over 300% of GDP for the industrialized West. High debt levels have funded a sustained period of living beyond our means.
The good news is that the year to year deficits (how much we’re living beyond our means) have not been dramatically high. But if you earn $50,000 a year and spend $52,000 a year, in 20 years your debt is probably near $30,000 (thanks to interest). Small deficits repeated yields high debt, both for governments and for the private sector. Because yearly deficits were relatively small, and the economy seemed to be growing thanks to the bubbles, people had the illusion that growth would solve the debt problem. In the US a brief surplus in the federal budget at end of the 90s made it seem like a solution was easy. The high federal budget deficits in the last decade got rationalized by the aftermath of 9-11.
The brief budget surpluses were thanks to the bubble economy, and did not extend to the private sector — private debt kept growing, in part because no one identified it as a problem. High debt and cheap credit created this crisis. It’s different than the classic Great Depression crisis of over production. Yes, easy credit was a factor there (margin calls, etc.), but the level of pervasive debt was nowhere near what it is now. That makes this crisis unique and difficult to solve with traditional means.
Obviously it’s important to de-leverage — to pay down debt. That’s been happening, especially in the private sector. Governments have not paid down a lot of debt yet, in part because of macroeconomic pressure to stimulate recession weary economies.
Another lesson is the need to reform and re-regulate the financial sector. The bubble and the extent of the collapse in 2008 was completely avoidable. If over the counter derivatives had been subject to regulations of reporting and transparency, the big financial institutions could have never packaged dubious mortgages into bonds that confused ratings agencies stamped “triple A”. That in and of itself would have done a lot to prevent the crisis since it was demand for mortgages to be packaged as bonds that created the intense increase in real estate prices.
Beyond that, incentives matter. In the past lenders had incentive to be careful about who they lent money to. If someone can’t pay their mortgage the bank stood to lose a chunk of money. But when the demand for mortgages was high and brokers did not bear any of the risk, then there was an incentive to just provide the mortgage no matter what — even if it meant lying and arranging absurd loans to people who had no means to pay it back. That also was engineered by the big banks, who then did all they could to try to decrease their risk (thereby creating systemic risk).
So three things need to be done: pay back debt (de-leveraging), increase production, and create a functioning regulatory regime for the financial sector to prevent future credit orgies. Increasing productive capacity usually involves investment, which works against paying back debt. However, at a global level if the economies of export led growth countries like China start switching towards more internal consumption and less reliance on trade (something the recession is forcing them to do — bankruptcies are growing in China), then rebalancing is possible. Things won’t be as cheap in the US so consumption will decline, but domestic production will grow, as will jobs.
Regulating Wall Street is a tougher nut to crack, thanks to the intense lobbying power of the big financial institutions. Public pressure like “Occupy Wall Street” helps, and President Obama’s new found populism could give him support to push effective reform in a second term. One can understand his coziness with Wall Street in the depths of a recession — you don’t want to scare the big economic actors. But if the economy starts growing so too does the governments independence from big money.
So far my worst fears about this recession/depression have not been realized. It’s not been the quick recession many predicted back in 2008. It’s not just another business cycle recession. There still is a long way to go. But perhaps we’re turning a corner and it’s possible to see a way out of this that avoids catastrophe, even if there will be no return to the heady consumerism of 2006. And just maybe we’re relearning the importance of virtue — focusing on the importance of work, family and values rather than material consumption.