Hidden truths about the state of the US economy

Summary: What I recommended in Sept 2008. What the government did. Results, and how the stimulus has been poorly described to the public. Where we’re going. This is the first in a series. The next chapers are What lies ahead for the US economy? the global economy? and Some thoughts on the political implications of a long recession.

Contents

Recap and introduction
Results
What comes next?
Other posts about solutions
Afterward and contact information

(1) Recap and introduction

After a year of writing warnings, in September 2008 I proposed a package of solutions for the cataclysm about to occur:

A solution to our financial crisis — summary
Stabilize the financial system — Guarantee and lending to banks (nationalize insolvent ones); loans to large and small businesses
Stabilize the economy — fiscal and monetary stimulus
Arrange long-term financing for steps #1 and #2 with our foreign creditors — long-term cures to global imbalances

The government waited too long to stabilize the financial system, acting only after the bankruptcy of Lehman Brothers in September 2008, and months later to help large corporations — and never helping small businesses (one cause of the jobless recovery).

Although the Fed quickly applied monetary stimulus, the government waited far too long to apply large-scale fiscal stimulus — doing so only in February 2009 — and then on too-small a scale, in an ineffective manner.

These measures stabilized the economy after a drop in economic activity broadly similar to that of 1929-30, averting a depression. But economists have misrepresented these measures to the public. These measures do not “stimulate” the economy, they stabilize it. They are first aid, not a cure. First aid in the sense of stopping the bleeding and muting the pain — buying time for treatment (for more on this see Government economic stimulus is financial heroin). But at a cost in added government debt.

Sidenote: faux economics says that there are immediate or short-term costs to the debt, which is nonsense. But the debt is a burden, hence the need for the spending to be some combination of…

effective in terms of humanitarian benefit and spurring economic activity (e.g., food stamps and unemployment insurance)
generating long-term benefits, such as useful infrastructure (parks, sewage treatment plants, power/transporation/communication systems).

(2) Results

After first aid comes a bounce in economic activity, largely due to inventory restocking (after panic-driven liquidations) and restored confidence. It is not “artificial”, nor does it signal recovery. The great recession has different causes than the shorter and milder business cycle downturns since WWII, driven by inventory cycles and the Fed’s efforts to control inflation. See the posts listed at the end for more about this.

This brings us to the great policy failure of the great global recession: no nation has used this crisis to effect structural reforms, with one exception. The European Union, which has put into effect a combination of stabilization measures an austerity measures — which almost ignore the underlying causes of the EU’s problems. But at least they have tried.

As for the rest of the developed nations and China, our fecklessness will become legend. As I said in May Never waste a crisis. That just makes the next one inevitable and probably worse. As usual in 21st century American, Rahm Emanuel spoke the truth and has been brutally criticized for it. We prefer lies and folly.

(3) What comes next?

The distinguishing characteristic of this cycle is its unpredictability. Naturally so. This marks the end of the post-WWII era, and the previous rules and patterns no longer apply. We have sailed off the map into the dark. With no moon or stars to guide us.

The next big question: will there be a second dip to this downturn? As I said (with more detail) in February, a second dip might be worse than the first (we’re weaker 3 years into this event).

What are the odds of another downturn? It’s not a useful question. The current state of economic theory does not allow reliable forecasts, esp in the midst of regime change ( for more this process see A look at the future of the world’s political and economic order). But the odds are substantial. My guess is 1 in 3, perhaps even 1 in 2.

What would happen in a second downturn? We can make some useful guesses. Turn in next week for more about this.

(4) Other posts discussing solutions

For links to all posts about the downturn see the FM reference page Financial crisis – what’s happening? how will this end?