Summary: We are on the brink of an economic disaster like nothing since the 1930’s. Here is a sketches (nothing more), of guesses as to what we can look forward to. While the past guesses on this site have proven accurate, these might prove too pessimistic. Or too optimistic.
On March 11 “The US economy at Defcon 2” said “The deleveraging of the US economy is putting “torque” on the US financial system. This is a process which cannot be stopped prior to completion, although the government will try. The US economy resembles a rock balanced at the top of a cliff. It was stable hanging on the top; it will be more stable at the bottom. Hence the need for Defcon 2 — defense condition 2, one level below the maximum. ”
On October 3 “The last opportunity for effective action before disaster strikes” said “The financial system has had a cardiac arrest. … Restarting the necessary flows through the business credit system must be done immediately, and will require drastic measures.” Such as “Massive fiscal stimulus” since “The full effects of the recession will hit in the next few quarters”.
Now the effects ripple from the virtual economy (financial markets) to the real economy. Americans have reduced their spending. Hundreds of companies around the world have announced falling revenue — and responded with cutbacks in employment and capital expenditures. Tens of thousands are doing the same, but outside the media spotlight. Most of this will hit in the early months of 2009. We must move the US to Defcon One, a war-like mobilization of resources.
Update: As the terrible economic data comes in, some major economists are joining me in the “go to Defcon 1” camp. For example, Paul Krugman: “Depression Economics Returns“, op-ed in the NY Times, 14 November 2008.
The unmentionable history
Before looking ahead, we must put these events in a historical context. Two aspects of our situation are unmentionable, upon pain of becoming an outcast among respectable people.
First, US government’s response has mirrored that of 1929-1932 (although current events cannot be closely mapped onto that timeline). Bernanke, whose reputation was built on his criticism of the Hoover Administration’s handing of the crisis, must find that baffling. These things probably seemed so simple when writing about them at Princeton.
Phase I: Worrying about inflation during the early stages of the debt deflationary collapse.
Phase II: A slow, inadequate response to the collapse of the financial system. Then it was the banks; now it is the “shadow” financial system — a complex network of banks, brokers, leasors, credit insurers, mortgage brokers, hedge funds, and private investors. The results are pervasive and serious, as seen in the collapse of the corporate bond market (esp for bonds over 1 year), and shippers’ difficulty in obtaining letters of credit.
Phase III, now in progress: A late, slow, and small fiscal stimulus to offset the collapse of credit.
Second, that the US economy might be less stable than that of 1929, and our knowledge of economics as inadequate vs. the situation as it was then. That is, we know much more — such as how to prevent the mistakes of 1929 – 1938 — but not necessarily more vs. the more complex global economy of today.
Note others share this fear, such as former Goldman Sachs chairman John Whitehead at the Wednesday’s Reuters Finance Summit: “Whitehead sees slump worse than Depression“, Reuters, 12 November 2008.
What might happen in 2009?
- Rapidly rising unemployment
- More household bankruptcies
- More business bankruptcies
- Result: a collapse of business and consumer spending
1. Rapidly rising unemployment
Businesses cannot all improve their financial condition by cutting costs. Your expense — spending on vendors and wages — is somebody else’s income. Simultaneous cutbacks just ratchet the economy to a lower level of activity, with almost nobody better off.
2. More household Bankruptcies
Much of the most important economic research predicting this downcycle was done by the Levy Institute. Perhaps the single most important was Asset Poverty in the United States, Asena Caner and Edward N. Wolff, Levy Institute, April 2004. It showed that roughly 40% of US households are 3 months or less from bankruptcy. That is, their high debts and low savings mean they cannot withstand even brief periods of unemployment.
Consider an average blue collar (3rd quintile of income) family in 1980. Husband working full-time; no debt except for the mortgage (30 year fixed, 20% downpayment) and car loan (2 year term). Plastic meant a Esso or Texaco card to buy gas. A savings rate of 15% or more, with 6 months cash in the bank. Unemployment meant tough times, but unemployment insurance and savings — plus sustenance spending — could get them through 6 – 12 months.
Their 2008 equivalent has both spouses working, revolving credit greater than savings (excluding retirement accounts), and far larger home and car loans vs. their income. One spouse losing a job means bankruptcy in 3 to 6 months. Esp if that person is a one of the new entrepreneur class, perhaps an independent contractor — not covered by unemployment insurance.
What about economists’ assurance (often with graphs!) that US household balance sheets are in fine shape? True, in aggregate. So long as Bill Gates shares his wealth with the newly unemployed. Aggregate data tells us nothing in a society like ours with such concentrated wealth and income.
3. More business Bankruptcies
Businesses are in just a fine condition as households. That is a small number have sound balance sheets, while most are dangerously levered. The bankruptcies have all ready started, and will accelerate in 2009. Developers and construction companies. Retailors, esp if the Christmas season is a bust. Auto companies and their suppliers. It will be a long list.
4. Result: a collapse of business and consumer spending and investment
The resulting collapse of aggregate demand might initiate positive feedback. A collapse of economic activity, feeding on itself and spreading throughout the economy. It will eventually burn itself out, the economy restored to equilibrium. This equilibrium might be at a substantially lower level of national income.
Unfortunately that leaves the government as the only entity both willing and able to borrow and invest during the next year or two. The necessary government action must be on a scale seen in the US only during of wars — and the 1930’s.
The governmen’s response
So far our strategy is deny and pretend. We are like children playing on the beach while a tsunami approaches. “Look at the giant wave. Cool!”
The government has responded with twenty complex and small programs, all doomed to fail, with an emphasis on manipulation of public opinion. At all costs they avoid telling the truth about the situation (and the cost will be high). The current fight to reveal the objects of Fed’s largess (source) is symptomatic of an upside-down strategy. While it might alarm the public to reveal that so many of America’s top corporations require emergency aid to avoid defaults, keeping it secret diminishes public trust and cohesion that we absolutely require to survive the coming crisis.
Worst of all is the government’s obvious lack of a plan — or even a coherent strategy. Without that even measures on an adequate scale would have failed.
Time is not our friend. Not only is this a bad thing, but Martin van Creveld says is symptomatic of a fundamentally flawed strategic posture.
There is no point repeating what I and others have said about the necessary measures. To mention two of the most obvious:
- An large-scale fiscal stimulus program is needed Stat. A big one in November, giving local governments money to spend right now. Pay contractors to fill in potholes, build playgrounds, paint buildings. Small projects that can be started now, with a minimum of time-consuming paperwork. A much larger program will be needed in February to fund large-scale infrastructure projects.
- Immediate cash-out of OTC derivatives, esp equity, commodity, and credit default swaps (interest-rate swaps are by far the largest segment, but probably have the least risk). This might be legally difficult to do, and perhaps operationally complex. But it is imperative, as these are burning fuses to very large bombs.
Unseen obstacles lie ahead
While economists express confidence in fiscal and monetary policy to mitigate the downturn — they have always worked for us — there are possible obstacles ahead.
First, theory and experience say that the government can borrow any necessary sums during a recession. Other parts of the economy either do not need to borrow — or cannot borrow. Savings rates rise, as do risk premia (a fancy way of saying that people only want to lend to the government). The US government is about to test this belief, attempting to borrow many trillions of dollars during the next two years.
Second, moral hazard might make large-scale bailouts impossible. How does one limit government aid? For example, if we say households with incomes under $50,000 can get cheap new mortgages if they need them — need shown by defaulting on their current mortgage — what stops everyone eligible from defaulting? It’s like a government-run intelligence test, with free money as the prize. Once people realize this — as I think they will — the cost of the bailouts will quickly become infeasible.
And not just households. Now the line forms behind the banks for government handouts to corporations. Even the government cannot bailout everybody.
The situation is complex, the appropriate remedies uncertain, the consequence of failure perhaps horrific. Interesting times, indeed.
Afterword
If you are new to this site, please glance at the archives below. You may find answers to your questions in these.
Please share your comments by posting below. Per the FM site’s Comment Policy, please make them brief (250 words max), civil, and relevant to this post. Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).
For more information from the FM site
To read other articles about these things, see the FM reference page on the right side menu bar. Of esp relevance to this topic:
- about the Financial crisis – what’s happening? how will this end?
- about the End of the post-WWII geopolitical regime
- some Good News about America!
Some solutions
- A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
- Slow steps to nationalizing the US financial sector, 7 April 2008 — How this will change our society.
- Slowly a few voices are raised about the pending theft of taxpayer money, 21 September 2008
- How should we respond to the crisis?, 24 September 2008
- A solution to our financial crisis, 25 September 2008
- A quick guide to the “Emergency Economic Stabilization Act of 2008″, 29 September 2008
- The Paulson Plan will buy assets cheap, just as all good cons offer easy money to the marks, 30 September 2008
- The last opportunity for effective action before disaster strikes, 3 October 2008
- Prof Roubini prescribes first aid for America’s economy, 4 October 2008
- Effective treatment for this crisis will come with “The Master Settlement of 2009″, 5 October 2008
- Dr. Bush, stabilize the economy – stat!, 7 October 2008
- The new President will need new solutions for the economic crisis, 9 October 2008
- Results from the IMF meeting – just thin gruel, 12 October 2008
- The G-7 meeting was the last chance for action before the global recession, 12 October 2008
- A brief note about our financial system: Intermediation, disintermediation, and soon re-intermediation, 16 October 2008
- New recommendations to solve our financial crisis (and I admit that I was wrong), 23 October 2008
- A look ahead to the end of this financial crisis, 30 October 2008
“Second, moral hazard might make large-scale bailouts impossible. How does one limit government aid? For example, if we say households with incomes under $50,000 can get cheap new mortgages if they need them — need shown by defaulting on their current mortgage — what stops everyone eligible from defaulting?”
Indeed, government aid to households will have to start with those least able to survive, in the bottom quintile of income. That means unemployment payments should be the first to ramp up in the short term. Make-work projects are next.
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Fabius Maximus replies: Agreed! But the homeowner bailout bills and business aid programs will find it difficult to either control costs or avoid arousing widespread public anger.
Rumblings:
Valley Potentially Losing $18 Million — “Interstate 70 is a major artery in the Valley but Belmont County commissioners said Wednesday that part of it’s future is unclear. Near the Ohio Valley Mall, Commissioner Gordy Longshaw said the federal government promised millions of dollars on I-70 to add entrance and exit ramps that would ease traffic and encourage business. However, Wednesday Longshaw said he’s hearing that the dollars may no longer be available.”
Highlands For Sale? — “The Highlands [economic development project] in Ohio County may be run by the county government, but leaders said they’ve been looking into the sale of the land for quite some time. County Administrator Greg Stewart said with the sagging economy taking it’s toll on the shopping center, now might be a better time than ever. “With where we were in the development, the addition of the credit crunch and the economic hard times, we’ve definitely felt it there,” said Stewart.”
Ohio Running Low on Unemployment Money — “With unemployment rising, state officials warn that Ohio’s fund for paying jobless benefits is dwindling and could be empty by December. When that happens, the state will be forced to take out a federal loan to keep the unemployment checks flowing, for the first time in 26 years.”
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Fabius Maximus replies: This is another important factor. State and local budgets will be going deep into the red. Most are not allowed to run deficits, so they should cut expenses. For many the cuts will be so large as to be impractical. Also, with the private sector cutting jobs the government should not be adding to the problem. Massive Federal aid — another set of big checks — is the only solution.
If this is a recession like 1973-75 or 1980-82, the Federal deficits will be awesome. If it is worse, the worst since the 1930’s, the deficits will be beyond anything most people can imagine today.
More rumblings: “Law Firms Feel Strain of Layoffs and Cutbacks”
This differs from Fabius’ thesis in that the legal mania afflicting American society is more of a post-1965 than post-1945 phenomenon. Still people aren’t rushing to the courts – part of the government – to get things fixed.
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Fabius Maximus replies: This is part of a common larger phenomenon. Often social conflict declines during periods of economic stress, as people do not have the energy to fight over social issues — which look less important when concentrating on putting food on the table and a roof over the family.
“The US government is about to test this belief, attempting to borrow many trillions of dollars during the next two years.”
The odds of success in raising those amounts would increase if there where a long term strategy for repayment over the next 30-40 years.
No potential lender would believe in a long term strategy if US policy could change over night depending on what party got the best election result. So political differences between the Republicans & Democrats should be tone down massively on economic policy etc, etc.
Co-operation should be the new slogan.
Are the Democrats & Republicans up to the task?
My worry is wheater the money will be there to borrow. The Oil rich Arab states and China are going to have a heap of there own problems, that global glut of savings is going to get used up very quickly.
The UK’s ability to borrow is really going to be tested, the pound is on the slide big time, we could be seeing a large western economy defaulting within the next year.
Fabius Maximus replies: This is part of a common larger phenomenon. Often social conflict declines during periods of economic stress, as people do not have the energy to fight over social issues — which look less important when concentrating on putting food on the table and a roof over the family.
Quite often, when a business is about to go under, it’s accounts receivables go up.
This is a brilliant post, one of your best! I’m floored — there’s nothing I can quibble with.
On Whitehead’s remarks — I always look for the hidden agenda, the coded message. Here, believe it not, it seems to be about raising taxes. It’s usually taken for granted that taxes can’t be raised, because of popular opposition, but it seems that BO is moving toward at least a shift in tax burdens away from the middle class, which would be a priori politically palatable. I can hear the chorus of howls about discouraging business investment, but heck, these are unusual times. A collapse of the US credit rating would really put a crimp on business investment!
What are the consequences of the massive amount of worldwide government printing/borrowing that you advocate?
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Fabius Maximus replies: Nobody knows, as it depends on too many factors in the months — perhaps even years — ahead. We have traveled beyond the borders of the map of the known.
(1) Debt deflation is a rare beast among developed nations. The major example is Japan: fighting deflation during two decades of near-zero growth. Of course, Japan’s circumstances then differ substantially from ours. Also the current recession is global — not just us.
(2) Our response is without precedent. The Bank of Japan grew from roughly 9% of GDP to 29% over the 10-year period from 1994 to 2004, as it pursued “quantitative easing.” The Fed has expanded its balance sheet by 11% of GDP in 6 weeks — from roughly $900 B on September 3rd to $2.2 Trillion. Paul Schulte said “It makes the New Deal look like a bake sale.”
Cut the social security tax rate in half and remove the cap. Everyone who makes under $100,000 gets a tax cut and revenue is increased. Add a temporary 10% tax on income over $1,000,000 until we are off of Defcon 1.
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Fabius Maximus replies: Just from a quick glance at the IRS website (a 2002 study), we have the following (I think this is right, but I am not familar with these numbers — corrections welcomed!):
* the top 5% of American households reporting taxable income made roughly $100,000+,
* this top 5% reported aprox 1/3 of all reported cash income.
So cutting FICA tax in half on 2/3 of the US personal income stream AND adding in a tax (at the new low rate) on the remaining 1/3 => looks like a net loss of very-needed FICA revenue.
I don’t know the effect of a tax increase on incomes > a million when made during a severe recession. It might reduce the inevitable drop in tax revenue. Unless offset by other revenue we’re repeating Hoover’s 1932 mistake. As Japan proved again, raising taxes during recessions just depresses the economy and generates no net revenue.
Thanks for an excellent article. If indeed the main thrust will genuinely turn to the real economy, this will prove a great blessing in disguise despite the many hardships that will be suffered along the way. It is time to get real. And by doing so a far more genuine society might emerge, that oft-aspired-to ‘more perfect union’.
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Fabius Maximus replies: One of the valuable aspects of Paul Krugman’s (now Nobel laureate Krugman’s) work was the time he spent examining popular views of economics. Despite it being one of the most common undergraduate majors for several decades, Americans’ ideas of economics tend to run from false to bizarre. Here we have an example of the “no pain, no gain” school of economic management. Krugman wrote about this many times; here is one snippet. From “No Pain, No Gain?“, Slate, 15 January 1999 — “The case against recession, past and present.” Excerpt:
More of your unflappable optimism, Fabius? How do you survive with such head-in-the-sand cheerfulness?
Seriously though, how do you think our fiat money system will play into the above concerns? Will not having a gold standard this time ’round make a major difference in how issue plays out or is resolved?
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Fabius Maximus replies: Fortunately we no longer have a gold standard, which caused so much unnecessary pain during the 1930’s. Nations that quickly dropped the gold standard has a mild depression; ones that waited (like the US and UK) had a long, hard depression. See this post for details: “Government policy errors as a cause of the Great Depession.” Or go to the IMF’s World Economic Outlook of April 2002 — Chapter III, box 3.2: “The Great Depression”, by Michael Bordo.
Instead of Defcon One, we’re getting party time.
No one anywhere seems to understand what’s going to happen the American economy in 2009. We still have people arguing about whether we face a recession in 2009 or a mild recovery. The scenario of a mild recovery is obviously delusional, yet we’re still hearing lots of people propound this fairytale — a clear indication of massive denial.
Most worrisome: the prospect of the ignorant incompetent fool Larry Summers getting appointed as Treasury Secretary. This guy is a hard-core fringe lunatic deregulating laissez faire free marketeer no different from the other kooks like Greenspan (ex-buiddy of Ayn Rand) who got us into this mess in the first place. Recall that Larry Summers forcefully advocated and oversaw Russia’s disastrous “shock therapy” privatization, which effectively destroyed Russia’s economy and created a country where essentially all the wealth got concentrated in the hands of 7 oligarchs and a few ex-KGB apparatchiks turned politicos. Since 1992, the life expectency of Russia’s population has plummeted, incomes have collapsed by 40% since 1991, industrial capacity dropped by 26% between 1991 and 1995, and 80% of the population now lives in abject poverty.
Given his track record, Larry Summers would probably do for America in 2009 what he did for Russia between 1991 and 2001. And this< is our next treasury secretary…?
I’d like to think otherwise, but it sounds like we’re doomed.
an ‘outside (the current) box’ proposal from old China hand Francesco Sisci: “US’s road to recovery runs through Beijing“, Asia Times, 15 November 2008
“# The United States should offer China a general reduction in restrictions on imports of American technology and acquisition of American companies, in return for a treaty linking Chinese and American security interests. The treaty would include:
# A system of royalties for technology transfers and guarantees against pirating.
# Freedom for Chinese companies to acquire American companies, including financial institutions.
# Agreement on a common stance towards rogue states, nuclear arms proliferation, terrorism and other issues of mutual concern, covering such issues as Pakistan, Sudan, Iran and other areas of past diplomatic conflict.
# An agreement on strategic arms deployment in Asia.
# A roadmap for China’s democratization.
# Environmental and energy-efficiency goals.
# Stabilization of China’s yuan against the dollar to support free capital flows between the US and China.
There are close to 2 billion people in China and the countries in its immediate periphery, and a further 1.1 billion people in India. Half the world’s population lives in emerging Asia, and its productivity could triple in a generation. Out of the present crisis, the world might enjoy one of the longest and fastest economic booms in history – or it might remain in an economic mire for a decade. The incoming American administration might be remembered as one of the worst, or one of the best, in American history.
David P Goldman was global head of fixed-income research for Banc of America Securities and global head of credit strategy at Credit Suisse. Francesco Sisci, Asia Editor of La Stampa.”
There are ways to turn this around. Will we take them?
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Fabius Maximus replies: WHoever they are, this is absurd. A collection of random ideas from a discussion over drinks, mostly silly.
(1) They want a lot from China and gives little. I doubt there are many barriers remaining to technology transfer (and even that assumes that the US has much unique tech left, which I doubt). Ditto with trade barriers (our trade deficit is almost entirely China imports and oil).
(2) They omit from the list the only major thing China wants from us: removing our security umbrella from Taiwan.
(3) “A roadmap for China’s democratization”
There is zero evidence that China will sign a treaty with a foreign nation committing itself to changes in its political regime. Nor is it clear what those would do for us? What if China says we should go to a multi-party system (perhaps figuring that this would make the US government less stable, more like Italy)?
(4) “Stabilization of China’s yuan against the dollar ”
Stabilazation? The Yuan/USD is far too high, which is shown by the large US trade deficit with China — and astonishing growth in China’s foreign reserves (two sides of the same coin). Most calculations show that it must come down 1/4 to 1/2 to restore balance.
(5) “to support free capital flows between the US and China.”
What free capital flows? We are the world largest debtor, consistently running a large current account deficit. The only way we can get capital to invest in foreign nations is borrow it from another foreign nation.
Update: As the terrible economic data comes in, some major economists are joining me in the “go to Defcon 1” camp.
For example, Paul Krugman: “Depression Economics Returns“, op-ed in the NY Times, 14 November 2008. He advocates a massive fiscal program, as I did in my post of October 7. Excerpt:
I think a full-scale public works project starting this month would be a bit premature. The sky is dark with storm clouds, and my hair is prickling from all the static, but I don’t see the massive unemployment you’re talking about. Yet. Maybe it’s in the government figures, but I can tell when there’s unemployment by looking at the job adverts in my field (if there are no jobs, there are no ads), and right now things seem to be fine. I haven’t heard of any massive chain of layoffs. Yet. So starting up the WPA right now would mean importing workers from south of the border to fill those potholes and build those playgrounds. Who else would do that work anyway, come to think of it? What have you been smoking, Fabius? We Americans expect to have our government checks directly deposited into our accounts, and no crazy talk about grunt work, ok?
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Fabius Maximus replies: Employment is a lagging indicator, among the last economic indicators to show a recession — since employers are reluctant to make large-scale firings. The government waiting until you see mass unemployment would like waiting to treat a cut until you develop gangrene. Delay would be esp foolish as most indicators have been at recessionary levels for many months, and all are signaling a downturn now.
The broadest measure of unemployment has been increasing since December 2006. The U-6 measure, which includes total unemployed, plus all marginally attached workers plus total employed part time for economic reasons, as a percent of all civilian labor force plus all marginally attached workers), peaked at 10.3% in September 2003, hit its low at 7.9% in Dec 2006, and was 11.8% in October. That it has also risen past the peak of the previous recession is a bad sign.
Since so many companies announced “layoffs” in October and November, that number will steeply increase during the next few months. And increase again as the effects of the recession appear.
Our valve supplier is going bankrupt. The problem with bankrupt companies is right before they go under, they lie a lot. Unable to buy steel, they nevertheless told us our order would ship on time, hoping for a miracle. When the parts didn’t show up, after patiently waiting 16 weeks, we find out they lied. So a huge refinery expansion isn’t going to start up on time because one of the large process systems we build isn’t ready. “I got lied to by my now bankrupt vendor”, is about to become the new really good excuse for non performance. Another difference between a recession and a depression. In a recession, you still have to worry about your reputation, in a depression, survival trumps everything.
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Fabius Maximus replies: Powerful testimony of how the effects of defaults ripple though a society, causing not just economic dispuptions but also eroding the mutual trust necessary for the proper functioning of our society.
“Bailout Backfire and the Ticking Debt Time Bomb“, Matt Blackman, Seeking Alpha, 5 October 2008
This debt to GDP chart says it all. The problem is not sub prime, it is not even just all mortgages or just real estate. The entire US and world economy is tangled in debt and insolvent. What good can it do to bailout banks and car companies if consumers can not and should not borrow or buy a new car? The total debt is the US is 350% of GDP in the range of $50Trillion. At least $30Trillion will never be repaid – period. Even if all $12Trillion in US mortgages were somehow magically erased, the US is still insolvent. Part of the Problem is Retirement funds were pooled and handed to the Shadow banking System and expected to earn 15%. That is really funny – we give our retirement savings to “investors” so they can lend it back to us for Mortgages on 5 million houses we did not need and are now empty or in foreclosure.
The world economy is now undergoing a train wreck to erase the US debt along with all similar debt around the world. Someone needs to figure out who owes what to who and see if there is not some logical way to unwind this in a more controlled fashion. Otherwise we will end up with homeless families (that includes your family) and empty houses, empty factories and unemployed workers, and food rotting in the fields with starving and angry people in the cities.
Are the people running our country so dumb they don’t understand something so simple?????????
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Fabius Maximus replies: (1) We’re in the dreamtime. Or rather, we’re waking up from it. Fun while it lasted.
(2) For better graphs showing our accumuation of debt see “A picture of the post-WWII debt supercycle.”
(3) “Are the people running our country so dumb they don’t understand something so simple?”
From their perspective everything has been and is just fine. Wealth will concentrate in fewer hands during the recession, as it always does. Government power (i.e., their power) will increase. What’s the problem?
Perhaps you should ask “Are the people
runningof our country so dumb they don’t understand something so simple?”All current proposals for stimulus are doomed to fail because they are aimed at preserving something that cannot be preserved: i.e. the excessive and unsupported consumption economy in the United States. It’s quite clear that our desire to consume has exceeded our ability to produce for some time, likely by somewhere between five and ten percent of GDP. Until this imbalance is fixed, increases in consumption will not solve our problem.
The political culture is dominated by a desire to push consumption to the highest levels possible as evidenced by Pres. Bush’s “go out and shop” following 9-11 and the current focus on saving an outmoded automobile industry.
Instead of subsidizing unaffordable consumption, fiscal policy must be reoriented to investments that will restore national productivity and prepare the U. S. to compete in the 21st Century global economy, including:
(1) Creation on a modern transportation infrastructure structured to minimize energy use. This will likely entail a significant move to urbanism and a recognition that the current long-distance commuter culture is not sustainable in the long term.
(2) Development of a sustainable energy infrastructure.
(3) Massive investments in workforce retraining and a reorientation of the failing primary and secondary educational systems.
(4) Creation of an efficient digitally based health care system and creation of a national system of preventive care.
(5) A significant increase in the current level of investment in basic scientific research.
(6) Aggressive build out of broadband infrastructure to provide utility-like universal access to a minimum of 40 megs at the household level.
(7) Infrastructure investments to support all of these efforts, not a blind focus on rebuilding around the current automobile/long haul over-the-road-truck focus of the current transportation system.
In order to offset the deflationary forces built into the long term downward adjustment in consumption expenditures, the scope of these programs must be set at a level more often association with a national war mobilization.
This will take a major realignment of political priorities and real leadership from the top, including a new-found willingness to “tell it like it is”. I’m not sure from FM’s posts that he/she would be overly optimistic that such leadership will be forthcoming, but it has before at critical times in the history of the Republic.
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Fabius Maximus replies: While I broadly agree with this comment, there is one vital point of confusion. Large-scale government projects are needed to maintain employment and aggregate demand until the economy heals. That might take several years (perhaps longer, as in 1990’s Japan and 1930’s US). We should avoid Japan’s mistakes — allowing politically powerfull interests to channel government money into construction of largely useless projects. As Slater suggests, let’s spend the money on useful things. But let’s not kid ourselves.
(1) A big checkbook does make the President or Congress smarter. Many of our problems are structural, requiring changes in the way we do things (i.e., processes). Reforming these areas (i.e., education) will consume massive amounts of political capital — and are unlikely tasks for an Administration to address in the midst of an economic crisis.
(2) Some big projects have economic impacts (e.g., transportation). Others affect quality of life, but have few economic effects (or the promised economic effects probably are illusions). Such as fast internet and healthcare reforms. Reasonable expectations are vital, so let’s not confuse the two.
(3) An economic crisis makes us poorer — not richer. It’s a recession, not Christmas. We will borrow the money for these programs. I suggest that we focus on programs that will generate some revenue, to help pay the debt incurred.
Much of the difficulty we are in comes from a greater readiness to spend than to think. The U. S. is facing a societal competitiveness problem. My primary point is that no amount of stimulus is going to provide a quick fix to a problem that can only be solved by rebalancing consumption and production. If we don’t want all of the rebalancing to come a lower standard of living, it becomes critical that we spend on things that increase productivity either long term or short term. If we don’t, we will become Great Britain in the 1950’s.
I strongly agree that I have raised several issues that require changes in process for the investment to be productive. This is especially true of health care reform. Setting the issue of societal equity, health care costs have become a major economic issue that is leaching away our productivity and standard of living. Ask any small business person in America what are the three biggest problems in her business and health care will invariably be one of them (unless she has solved it by not offering any). The system as it exists today is grossly inefficient, because it fails to utilize state of the art information sharing technologies and because it focuses on sick care, not well care.
Similarly transportation cannot be solved with money or technology alone. The land use patterns we have chosen as a society guarantee an energy inefficient transportation system. Throwing money at transportation infrastructure without dealing with these systemic issues will be counterproductive to addressing greenhouse issues and energy independence. I’m tired of political “leaders” who refuse to address the interdependent nature of these problems because they are hard.
Your comment about revenue generation seems unrealistic. Government is terrible at revenue generating activities other than taxes and tolls. The revenue payoff will come as the infrastructure improvements lead to greater national productivity, increased incomes and ergo greater future tax revenue. On the other hand if the expenditures are targeted to increasing consumer expenditures (e.g. tax rebates, payroll tax moratoria, tax deductibility of interest on car loans or construction of bridges to nowhere) none of these future benefits will arise.
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Fabius Maximus replies: Who is unrealistic? Let’s check what I said.
FM: “I suggest that we focus on programs that will generate some revenue, to help pay the debt incurred.”
What are the major infrastructure projects that governments build? Housing, power, water, sewage, hospitals, and transportation (roads, rail, ports, airports). All of these generate revenues, often (not always) sufficient to fund repayment of the bonds which fund construction. The entire vast municipal revenue bond industry is built upon this fact. I recommended a much lower bar — that they at least generate some revenue.
Slater: ” The revenue payoff will come as the infrastructure improvements lead to greater national productivity, increased incomes and ergo greater future tax revenue.”
That is grossly unrealistic. I am moderately familar with the literature on the subject, and it is quite clear that almost no projects improve productivity so as to increase general taxes in an amount sufficient to pay for the projects (i.e., without direct revenue from selling its product, direct taxes, or tolls). Since WWII the calculations showing such returns on infrastructure projects even with direct revenue (such as the Army Corps of Engineers developed to a fine art) have usually proved to be fiction.
Some of the great 19th century infrastructure projects may have done so even after calculating the time value of money (aka return on investment), but usually only over long periods of time. Opening virgin frontier to exploitation (e.g., minerals, agriculture) sometimes has returns on investment greater than most modern infrastructure projects. Note however that these were risky ventures even in terms of direct (let alone indirect) revenue generation; the bankruptcy rate was high.
I think what is most disturbing about the lack of immediate governmental spending packages you advocate is the timing of the transition from the Bush administration to the Obama team. I think that Obama and his advisors are likely on board in executing these policies asap but the ideological rigidity and incompetence of Bush and Paulson will mean a minimum 2-month delay in anything substantive being done. By the time the Obama administration formally takes power, it’s very possible that we may be too late from going over the cliff no matter what they attempt to do at that time.
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Fabius Maximus replies: Agreed. I discussed this in my October 7th post “Dr. Bush, stabilize the economy – stat!“
Large-scale fiscal programs take at least 6 months to generate paychecks. In November Congress should pass a multi-hundred billion spending bill designed for fast effect. For example, almost unconditional block grants to municipal governments to fund small new projects — like hiring contractors to fill potholes, paint buildings, anything not requiring much time for paperwork.
Instead we have this: “Chances Are Slim for Stimulus, Auto Aid Till ’09”, Wall Street Journal, 14 November 2008 — “Stiff Republican Resistance Could Force Democrats to Wait for Obama and Their Party’s Enlarged Majority to Take Office.” Let’s hope Congress acts, and soon.
Excellent post FM, and interesting comments section…
There is no doubt that too much debt, funding too much consumption, has created the fall into deflation that the US is in. Most of the world has followed the US into a too much debt situation, including (or leading?) Japan, which is in recession despite some $500 bil reserves.
FM: Your statement to #1 is so true: “Businesses cannot all improve their financial condition by cutting costs. “
But this inevitably leads to the conclusion that, to fight the deflation we’re facing due to over-consumption in the recent past, the gov’t must support MORE consumption, now.
Bernake will soon be advocating more helicopter dropping of printed cash. And now, I think, this would be wise. $6 000 (or 50% of reported income, whichever is less) to all who filed IRS tax forms for 2007. Much would be spent, much would go to pay down personal debt/ increase savings. Both seem good to me, and inflation is not to be feared.
If one wants ‘out of the box’ — make a BIG deal with Mexico.
Loan all Mexicans in Mexico some $2 000 from a US credit card, at current Fed rates (about 1%, almost free money), to buy US exports (their imports). The Mexican gov’t would guarantee the loans with Oil based cash, but individuals would be using the credit as they best see fit, but all would be helping the US export industries.
Loan, not grant.
In fact, all ‘bailouts’ should be essentially replaced with loans, that are expected to be repaid by those who benefit, even in the US.
Most of the people have an easy going life where they have a tendency to spend more than their pockets. If this is controlled, to a certain extent people would not be hit so badly of financial crisis.