Why is this happening?
Short answer: Because we never really fixed underlying structural problems in the U.S. and global economies that had been building for decades and caused the financial and economic crisis in 2008.
Steven Pearlstein is a Pulitzer Prize-winning business and economics columnist at The Washington Post.
Investors concerned about another recession in the U.S. and the global economy, took part in a massive stock sell-off, sending the the Dow Jones industrial Average down 512 points. The Dow has now given back all of its gains for the year and then some.
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Those problems included a U.S. economy that was living well beyond its means, consuming more than it produced. They included an Asian economic boom that relied on intentionally undervalued currencies that led to massive buildup of dollar reserves and a massive credit bubble in the United States. And they included a new European system with a single currency and a single monetary policy but not the single economy that is needed to go along with it.
Since the crash in 2008, the strategy of economic policymakers has been to flood the global economy with monetary and fiscal stimulus, with governments ramping up deficit spending and central banks printing money and injecting it into the financial system.
The stimulus accomplished its short-term objective of ending the panic and stabilizing the global economy.
What it failed to create, however, was the kind of virtuous cycle of growing sales, growing profits and growing employment, all feeding off of one another, to keep the economy growing even as the stimulus wears off — “escape velocity,” to borrow a term from aerodynamics. The hope was that such self-sustaining growth would give the country the economic and political head room to finally fix the underlying imbalances with a minimum of pain.
Unfortunately, we never reached that escape velocity and have now pretty much exhausted our policy ammunition. As a result, we are now going to have to make the rest of those painful structural adjustments — eliminating jobs, closing companies, lowering incomes, reducing government services — in the context of a stagnant economy. And its not just the United States. Similar adjustments will be required in Europe, Japan, China and much of the rest of the world as well.
That said, there are some things governments can do right now to stabilize markets and provide some needed support under the economy.
As long as the rest of the world is fleeing to the safety of U.S. Treasury bonds, driving down U.S. interest rates in the process, the Federal Reserve should take this opportunity to sell some of its enormous pile of T-bills into the market. There is nothing positive about having panicked investors pull their money out of productive investments, increase the value of the dollar and drive down bond yields below the inflation rate. And by selling into the panic, the Fed will give itself more maneuvering room should it need to provide additional monetary stimulus in the future.
At the same time, the European Central Bank has to finally shed its reluctance to print money and buy up some of those sovereign bonds that are being dumped on the market by anxious banks and investors. The Fed, the Bank of Japan and the Central Bank of China should all lend a hand by agreeing to temporarily swap some of the U.S. Treasuries in their vault for some European bonds as well.
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