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.
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.
That should provide some temporary relief for European debt markets. By the end of the year, European leaders will have to figure out a political mechanism for replacing Italian, Spanish, Dutch or Irish bonds with more reliable euro bonds.
There’s also an urgent need for President Obama and Congress to get involved, even if it does ruin their August vacation.
Over the next decade, the federal government is slated to spend hundreds of billions of dollars building roads, schools, airports, trolley lines and airport terminals, modernizing the air traffic control system, replacing computer systems and buying planes, ships, tanks, trucks and cars. Moving up some of that spending from years 8, 9 and 10 to years 1,2 and 3 won’t cost any more in the long run, or increase the long-term deficit any more, but could sure help put a floor under the economy in the short run. For those worried about pork, the actual spending decisions could be left to an independent Infrastructure Bank.
To spur private investment in equipment and research, the government could immediately allow companies of all sizes to deduct 100 percent of such expenses made in the next three years, rather than “depreciating” them over many years. That incentive to invest now will increase the deficit in the short run but have little or no impact on the long-term deficit.
While such actions would be helpful, we shouldn’t kid ourselves about how much government can do. Only markets can right-size companies and industries, find the market-clearing price for houses and shopping centers or bring wages in line with global competitive realities. Only markets can wring the speculative premium out of the price of stocks and commodities. And only markets can move workers from where they live to where they are needed, and create a match between the skills workers offer and the skills that companies require. Unfortunately, markets don’t always move as quickly as we’d like, and as we learned Thursday, they often overshoot.
The truth is we’re in something of a trap. Until imbalances are corrected, the U.S. and global economies are unlikely to return to robust and sustainable growth. And yet to the extent that we address these imbalances, the correction process will inevitably be a short-term drag on an already weak economy.
It’s a good thing, for example, that China is moving to slow its export-led growth, reduce its trade surplus and take some of the steam out of its overheated real estate and stock markets. But the immediate effect is to slow imports of European and U.S. machinery, just when we really need the sales.
It’s surely a good thing that American households, which at the height of the bubble were saving almost nothing, are now setting aside 5 percent of their income for savings and paying down debt. But for the moment, that’s a drag on retail sales and job creation. And the same goes for those hard-won reductions in the federal deficit, which will soon translate into pink slips for teachers, social workers and employees of government contractors.
In order to revive U.S. real estate markets, regulators are going to have to finally force banks to stop the game of “extend and pretend” and write off residential and commercial real estate loans that are unlikely to ever be repaid in full. Doing so, however, will surely roil financial markets, discourage bank lending and delay the revival of markets in mortgage-backed securities.
Here’s a little metaphor: Earlier this summer, Volkswagen opened a big new manufacturing plant in Tennessee to make cars not just for the U.S. market, but also for export. That’s the good news. For manufacturing workers and those with similar skills, the bad news is that the wage rate at the plant is half that of unionized auto workers. That’s an extreme case, perhaps, but an example nonetheless of the kind of painful downward adjustment of living standards that will be necessary for the U.S. economy to reach full employment again and for the global economy to be put back into balance.
After decades of putting off the inevitable, we’ve finally nearing the end of our string. There are no easy or painless solutions. The only real question now is how, as a society, we are going to apportion the pain.
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