GLOBAL FINANCIAL CRISIS: by Colin TeeseNews Weekly
Has the United States finally run out of tricks?
, October 2, 2010
The debate still rages (and "rages" is no hyperbole in this case) over how the United States should treat the malaise in which it finds itself following the global financial crisis of three years ago.
Unlike discussion on this issue in Australia, the US debate is deadly serious and driven by more than politics.
Protagonists are advancing four different points of view.
Not necessarily in order of merit they are as follows:1)
Nobel prize-winning economist Paul Krugman champions financial stimulus (that is, by pumping public money into the economy) as the only way to restore output and employment levels in the US.2)
A directly opposite view is that austerity (that is, slashing debt and bringing the economy back into financial balance immediately by cutting spending in all areas and forcing down wages) is the way out.3)
Harvard economist Kenneth Rogoff has put forward the rather curious proposal that "Americans will have to be patient for many years as the financial sector regains its health and the economy climbs slowly out of it hole".4)
New York University Professor Nouriel Roubini says simply that the US has "run out of bullets". In other words, nothing further can be done.
Let's have a look at each of the proposals in turn.
Take the second one on austerity first, because it is easiest to handle. Cutting government spending as a remedy for faltering economies is a hardly annual for the solid right. The trouble is that it has never succeeded in overcoming the problem of market failure.
It can, however, be useful in getting economies back into balance once a stimulus package has had the desired effect. Germany is in the process of doing just that right now. Having taken a number of measures to head off the possibility of recession (including, it should be noted, encouraging companies not to retrench workers), it now sees a justification for belt-tightening to keep its recovering economy from overheating.
Whether or not this is going to work we shall have to wait and see. The Germans, since the end of World War II, have built their prosperity on strong export growth by the tried and true means of good manufacturing practices and - until the replacement of the Deutsche Mark by the euro in 2002 - holding down the value of their currency.
That formula certainly worked while the US was a major source of export income. Unfortunately, that is no longer the case, nor is it likely to be again any time soon. These days, Germany's exports are a bit of an illusion. Mostly, they are bought by other members-states of the EU, of which Germany of course is a member. Can these genuinely be called "exports"?
Moreover, as we all know, many of the EU member-states that were important markets for Germany have themselves been compelled to impose austerity measures in order to repay their profligate overspending. Their consumers, hit by falling wages and dearer services, are in no position to keep buying from Germany.
As to Professor Kenneth Rogoff's hope that ordinary Americans will just have to put up with many years of grinding poverty with stoic patience until things get better, the most that can be said is that he cannot possibly believe this will be endured in this way.
In many ways, the financial stimulus ideas of Professor Paul Krugman have been seen, on the face of it, to be the most plausible. Both he and his academic colleague Joseph Stiglitz (who, like Krugman, is also a Nobel prize-winning economist) agree that the stimuli packages so far passed into law by the US Congress have been too small.
Stiglitz also insists, and British financial writer Ambrose Evans-Pritchard appears to agree, that the measures have been too badly targeted to have good effect.
Krugman insists on the merits of properly-targeted stimulus packages based upon what he believes worked in the 1930s Great Depression. He also is convinced that the stimuli have to be very large and sustained to be of any use.
For this he draws on the experience of Franklin D. Roosevelt, who apparently imposed a stimulus in the form of New Deal policies in the early 1930s, but in 1939, after they seemed to have worked, succumbed to pressure to withdraw them in favour of balanced budgets.
The US economy immediately fell back into depression and, as Krugman recounts, Roosevelt's personal standing with his electorate plummeted. By 1940 his popularity had fallen in much the same way and for the same reasons as President Obama's.
As much as anything else, this probably explains Roosevelt's reluctance to draw his country into any kind of alliance with the British against Nazi Germany.
This is somewhat paradoxical, because, as Krugman insists, no doubt accurately, it was the war economy which finally lifted the US out of the Great Depression and restored President Roosevelt's popularity and prestige.
Krugman believes, justifiably, that the kind of Keynesian stimulus that World War II gave to the US economy in 1940 was precisely what was needed, and that the same medicine, injected in the same way now, will have the same beneficial effect.
Incidentally, Krugman has calculated that the value of the stimulus package World War II injected into the US economy all those years ago was the equivalent in today's money of US$30 trillion, and the US had no trouble paying it back. By comparison, President Obama's stimulus package of the past couple of years has amounted to only US$1 trillion.
Much of what Professor Krugman asserts is correct, but unfortunately he overlooks some fundamental points.
Prevailing circumstances in 1940 made the introduction of a gigantic increase in public spending popular and inevitable.
With Britain and Germany already at war, and Japan posing an increasing threat to US interests, the US had to prepare itself for war, whatever the cost. In today's United States, a spending spree of a similar magnitude would be much harder to justify.
There are other important differences. Today, US economic prosperity depends on consumer spending and can only be restarted by a renewal of such spending.
Unfortunately, US consumers are loaded to the hilt with debt from over-consumption. Thus giving them access to more money means that their first priority is to pay down debt. And paying down debt won't create demand for goods and services - or jobs.
Back in 1940, putting the economy on a war footing meant jobs for every-one, but it did not start a consumer spending spree - importantly, because there were no more consumable items to buy. The increased productive capacity of the economy was devoted to war production.
It was also an era with a much greater tolerance of high taxation, both of persons and of business. Despite the high taxation rates and generous wages paid to workers, businesses remained highly profitable.
Moreover, businesses could do little with most of their profits but invest in still more productive capacity and output. And workers, with only limited opportunities for spending, saved more of their incomes - mostly in government war bonds.
Paul Krugman's hopes for a massive and sustained stimulus package probably cannot be realised today, because our circumstances are so different from those of 1940.
What should, however, be recognised is that the wartime economic recovery generated a better form of capitalism - modern consumer capitalism, which underwrote Western prosperity for 25 years after the war.
It happened like this. Pent-up demand from five years of war plus the savings of both business and workers built the most prosperous form of capitalism ever known.
Some like to say it had run out of steam by the early 1970s. However, it seems more plausible to suggest that fatal rigidities had been allowed to corrupt the system.
Cracks eventually began to appear. As time went on, these gradually opened deeper until, finally, the global financial crisis (GFC) of three years ago came close to destroying the system.
If Nouriel Roubini is right, the US government does not have the means of rebuilding the economy - mostly because it is trying to look backwards for inspiration.
There is no alternative but to look forward. And that includes recognising that the productive "real" economy cannot be reconstructed without overhauling the problems of financial institutions.
On that score, the financial sector's domination over the total economy is a real problem. Martin Wolf of the London Financial Times
tells us that between 1880 and 1970 British banking sector assets, as a percentage of GDP, were worth 50 per cent of the economy. However, from 1970 to 2006 this percentage soared to more than 550 per cent of the economy. (Financial Times
, London, September 14, 2010).
Much the same no doubt happened in Europe and the US.
As banks became more important, they chose to use less and less of their own money. Martin Wolf, in the same article, charts how long-run capital-to-lending ratios for UK and US banks fell from 17 per cent in 1880 to around 3 per cent in 2006.
The more business the banks financed the less of their own money they risked - because governments were always standing behind them to bail them out.
Who would not want to do business on that basis? This needs to be fixed for the future.
As for dealing with our present debt levels, we cannot help the productive sector of the economy by shifting bank debt onto the balance sheets of governments. If bank shareholders don't lose their money when banks make bad loans or bad risk assessments, but can merely palm off their losses onto taxpayers, governments might as well own the banks.
Outside the banks, the US Administration might have solutions forced upon it. Maybe this is already happening. President Obama is already putting duties on imports - that is, re-embracing protectionism.
The US is uniquely placed for self-sufficiency. If the going gets tougher, and in the face of less palatable options, a US retreat into protectionism might seem a more feasible option.Colin Teese is a former deputy secretary of the Department of Trade.