Donald Vandergriff recommended speculating about what should be done by the new President. I avoid “if I were President” articles, but any advice by Vandergriff deserves serious attention. This is part of a series answering his question, describing a scenario under which the new President might take office –- a severe global recession — and the preparations he should initiate immediately after November 4. Part two discusses what the new President should do first, to establish moral leadership.
Before asking what the President should do, we must first sketch out the situation in January 2009 — or least, one scenario of the many possibles. This following is IMO a worst likely case (as in the standard presentation of 3 scenarios), and hence useful to illustrate what must be done.
- US real GDP for 2009: down 4%, tied for 5th place with 1933 (bad, but nothing remotely like a depression).
- World real GDP for 2009: down 1% (although we have only poor data, this is probably the worst since WWII).
- Oil prices: crashing hard, causing severe financial problems for many oil-exporting nations (esp Mexico).
Overall, the downcycle has continued the pattern since it began in December 2006: a sequence of surprises, weak links breaking in the global economic machinery (a network, not a china). Each unexpected, each snap increasing the stress on the remaining components.
Note: my forecast for the election is for an overwhelming win by the Democratic Party; see here for details.
Contents
- Causes of the recession
- Goals of the new President
- Preparing to win
1. Causes
We can look at this on two levels.
First, the big picture. This macroeconomic shock is not a Black Swan event. I list here a few dozen of the hundreds of warnings that our course was certain to end on the rocks. That we ignore warnings and are astonished at the inevitable does make it a Black Swan event.
The primary cause is too much debt, as described here, and in pictures here. For centuries it has been common sense that taking on too much debt was imprudent and risks collapse and bankruptcy — for both individuals and nations. That people repeat such mistakes is one factor making history so dark.
To go one step deeper, this is a Thomas Kuhn-type paradigm crisis in economics. Aggregate debt levels are not considered a significant factor in Keynesian economics, so the massive rise in debt was not a concern of mainstream economists. “Austrian School” economists warned this was unwise, but they are a irrelevant minority in the profession. Some mainstream economists gave warnings, such as Maria Fiorini Ramirez in the mid-1980’s — but were ignored.
If we go deeper, there are reasons why we fecklessly accumulated so much debt. Weaknesses in our society, our patterns of thought. This downturn will fix some of these — an education for American, but an expensive one.
Second, what happened to the financial sector. While the event — long, painful deleveraging — was predicted, its effects have astonished even most of those who saw it coming. We have experienced at most a slight recession so far, yet our financial institutions have suffered damage in many ways like during the 1930’s. The organization and regulation of our financial sector was fundamentally flawed. Both will be radically changed. There are many alternatives. All we can say now is that the new system will be different, almost certainly with far greater government control in the allocation of capital within our society.
2. Goals for the new President
Realistic goals are a key to success.
- Mitigate the suffering of Americans and other nations (through IMF aid) during the downturn.
- Help the economy recover in 2010.
- Prepare the foundation for a powerful recovery.
- Manage the transition to a post-Empire world order.
Attempting to hold back the tide — remain a hegemonic power — guarantees failure, perhaps catastrophic failure. This downturn will shift power from the major nations of the post-WWII era (US, EU, Japan) to the rising states of Asia. Esp China. The transition from a hegemonic power — esp the US dollar as the reserve currency — to just another great power will require skill and wisdom. Success will benefit not just America but the entire world.
3. Preparing to win
The new President takes office with the clock running. A slow start might put his Administration behind the flow of events, as the Bush Jr. administration has been.
The President elect must select his team ASAP, and put them to work immediately. Planning and shaking down into a functional group takes time that they cannot afford after taking office.
The new President should learn from the example of Batman, rather than following the example of the Best and the Brightest in Vietnam as has the Bush Jr. team. Officials in the Johnson Administration were slow and reactive, always seeking to keep their options open (the very opposite of boldness), as have Paulson and Bernanke (see here for a discussion of this). Batman goes into a situation not with one plan, but with 12. A wide range of scenarios are considered and planned for. In the real world the actuals will be none of these, but the act of full-spectrum planning will better prepare them to react. Even more important, preparing for 12 scenarios forces openness to the possibility of extreme outcomes — a key to achieving a rapid OODA look in the face of unexpected events.
Afterword
If you are new to this site, please glance at the archives below. You may find answers to your questions in these, such as the causes of the present crisis. I have been writing about these events for several years; since November 2007 on this site. As you will see explained in these posts, the magnitude of the events now happening is beyond what most Americans have — or can — imagine.
Please share your comments by posting below. 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).
The basis for this forecast
“Systemic Banking Crises: A New Database“, Luc Laeven and Fabian Valencia, IMF, 1 September 2008 — Abstract:
This paper introduces and describes a new dataset on banking crises, with detailed information about the type of policy responses employed to resolve crises in different countries. The emphasis is on policy responses to restore the banking system to health. … The database covers all systemically important banking crises for the period 1970 to 2007, and has detailed information on crisis management strategies for 42 systemic banking crises from 37 countries.
Governments have employed a broad range of policies to deal with financial crises. Central to identifying sound policy approaches to financial crises is the recognition that policy responses that reallocate wealth toward banks and debtors and away from taxpayers face a key trade-off. Such reallocations of wealth can help to restart productive investment, but they have large costs. These costs include taxpayers’ wealth that is spent on financial assistance and indirect costs from misallocations of capital and distortions to incentives that may result from encouraging banks and firms to abuse government protections. Those distortions may worsen capital allocation and risk management after the resolution of the crisis.
Institutional weaknesses typically aggravate the crisis and complicate crisis resolution. Bankruptcy and restructuring frameworks are often deficient. Disclosure and accounting rules for financial institutions and corporations may be weak. Equity and creditor rights may be poorly defined or weakly enforced. And the judiciary system is often inefficient.
… Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.
Cross-country analysis to date also shows that accommodative policy measures (such as substantial liquidity support, explicit government guarantee on financial institutions’ liabilities and forbearance from prudential regulations) tend to be fiscally costly and that these particular policies do not necessarily accelerate the speed of economic recovery. Of course, the caveat to these findings is that a counterfactual to the crisis resolution cannot be observed and therefore it is difficult to speculate how a crisis would unfold in absence of such policies.
… Fiscal costs, net of recoveries, associated with crisis management can be substantial, averaging about 13.3% of GDP on average, and can be as high as 55.1%of GDP.
… This paper presents a new database on the timing and resolution of banking crises. The data show that fiscal costs associated with banking crises can be substantial and that output losses are large. While countries have adopted a variety of crisis management strategies, we observe that emergency liquidity support and blanket guarantees have frequently been used to contain crises and restore confidence, though not always with success.
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 interest these days:
- about the Financial crisis – what’s happening? how will this end?.
- about The End of the Post-WWII Geopolitical Regime.
- A solution to our financial crisis (follow the links for more detail about each recommendation)
Key posts about the financial crisis
-
A solution to our financial crisis, 25 September 2008
-
A picture of the post-WWII debt supercycle, 26 September 2008
- America has changed. Why do so many foreigners see this, but so few Americans?, 1 October 2008
- A sitrep on the financial crisis: why has the treatment been so slow, so small?, 8 October 2008
- Forecasting the results of this financial crisis – part I, about politics, 13 October 2008
