In a recent poll, 60% of U.S. respondents said they believed an imminent economic depression was “likely.” Retirement accounts lost more than $2 trillion in value over the past year, and as of November 2008, the Dow Jones Industrial Average was down more than 30% from its apex in the fall of 2007.
The causes of the current financial crisis are numerous and complex, says Martin Wolf, chief economics commentator of the Financial Times and author of the recently released book Fixing Global Finance, but the real problem is not just too much borrowing, but also not enough. The world, says Wolf, has run out of big debtors.
To stave off a depression, developed countries will need to spend beyond even the stimulus packages already approved by governments such as the United States and the United Kingdom as of this writing, he says.
“We can expect a deep and selffulfilling recession prevented from becoming a depression by enormous increases in fiscal deficits to levels like 10% of GDP or more,” he told THE FUTURIST. To finance this additional spending, the United States may resort to selling more treasury notes to well-capitalized countries like China, or it may simply print the money. There are dangers to both, says Wolf.
“If a country with a large current account deficit prints money like this, maybe the currency will be dumped. It would be better, therefore, if everyone does [stimulus spending] at once. But in a deflationary situation, I think the United States, perhaps a bit less the United Kingdom, can get away with substantial increases in domestic liquidity, because I don’t think other countries would dump U.S. currency, as doing so would destroy their own competitiveness. It would force them to destroy their own money supply.”
Protecting the patient (namely the global economy) from the side effects of the cure (stimulus spending) means understanding the true pathology of the illness. One of the most significant – but least remarked- upon – contributing factors in the current financial crisis, says Wolf, was the pervasive belief that the United States could be both consumer of the world’s goods and borrower of the world’s money.
Small, export-driven countries lent large sums to U.S. consumers through Wall Street, financing creditcard loans and subprime mortgages. But the developing-nation governments in question were less willing to accept direct investment from Wall Street in their own economies, fearing that U.S. investors would pull their money out precipitously and to disastrous effect, as happened when foreign investors pulled millions of dollars out of the Mexican economy in 1994, resulting in an economic collapse.
Too much money flooding into the U.S. consumer market through Wall Street, and the promise of more to come, resulted in over-leveraged investing on the part of firms like Lehman Brothers, too much borrowing on behalf of U.S. consumers, and a housing asset bubble.
“The U.S. Federal Reserve, not totally consciously, chose to offset the deflationary pressure [of the 2002 recession] by greatly expanding domestic demand,” says Wolf. “It was purely accidental. The same thing followed from the Bush tax cuts in the early part of his administration…. In the end, a large part of the domestic U.S. counterpart of this developing- world lending turned out to be borrowing by fundamentally insolvent households, using as collateral assets that were overpriced, and intermediated by a financial system that turned out to be undercapitalized.”
The results have been disastrous.
“Nearly all serious professional economists – there are exceptions – would agree completely with me,” says Wolf, “yet this is seen as a controversial view.”
Perhaps the provocative aspect of Wolf ‘s diagnosis is his proposed course of treatment. If the short-term solution to the crisis is a U.S. government stimulus splurge, then the long-term fix is fasting. Eventually, the United States will have to move away from deficit spending toward running modest surpluses.
Other nations, says Wolf, must embrace a contrasting strategy, lend less money to the United States, move away from exports as the sole engines of growth, invest more in themselves, and open their markets to greater private capital inflows from the United States in the form of loans.
The lenders, in other words, must become borrowers.
“What has really happened here is the world has run out of large-scale, willing, and solvent debtors,” says Wolf. “Because it’s run out of them, except governments, there has to be adjustment everywhere. What’s not clear is that people around the world – in China, Japan, Germany – fully understand this. There’s a danger they won’t do enough. (United States consumers) will be reducing demand anyway. We’ll have a vicious downward spiral … which could push us to a very deep and long recession or even a depression.? If you don’t get a more balanced world economy, it may prove impossible to sustain a world with open capital flows. Then we will go back to the more self-sufficient financial systems and economies of 50 or 60 years ago.”
– Patrick Tucker
Originally published in THE FUTURIST, September-October 2009