COVER STORY: by Patrick J. ByrneNews Weekly
Political paralysis as markets implode
, August 20, 2011
Standard & Poor’s downgrade of the United States government’s credit rating and the escalating debt crisis in Europe have pushed the financial markets towards Global Financial Crisis Mark II.
Political brinkmanship in Washington took the U.S. to with 24 hours of a sovereign debt crisis, at the same time as the sovereign debt crisis of Greece is set to spread to Italy and Spain.
While the downgrade will have some effect on U.S. government borrowing, of greater concern is the growing awareness around the world that there are no leaders capable of delivering effective policy solutions to this protracted crisis.
Leadership across the Western nations is weak or bitterly divided or both.
After the 2008 financial crisis, political leaders and financial markets believed that unprecedented stimulus packages and bank bailouts would see Western economies bounce back in a V-shaped recovery.
But this is no typical “common cold” recession. This is the world’s second pneumonia-like “Great Contraction”, argues Kenneth Rogoff, former chief economist at the International Monetary Fund. The first was the Great Depression of the 1930s.
What makes great contractions different from recessions, says Rogoff, is “too much debt” that takes many years for an economy to reduce (Project Syndicate, August 2, 2011).
A 2010 McKinsey Global Report measured the level of debt across the major Western economies. Their combined public and private debt levels are between 250 and 470 per cent of their economies (gross domestic product).
The report warns: “Historic deleveraging [debt reduction] episodes have been painful, on average lasting six to seven years and reducing the debt-to-GDP by 25 per cent. …
“If history is a guide, we would expect many years of debt reduction in specific sectors of some of the world’s largest economies, and this process will exert a significant drag on GDP growth” (page 9).
Economists and policy-makers have offered an array of solutions, including inflation of 4-6 per cent to erode the value of debt, or to extend debt repayments for up to 30 years, and so on. Such management policies have various levels of merit.
However, what’s unfolding is a much deeper crisis of structures.
For three decades the doctrine of economic globalism saw the rapid deregulation of financial markets and international trade.
Deregulated financial markets allowed financial institutions to highly leverage debt, to the point where many banks had insufficient assets to cover their debts during the global financial crisis. Hence the historic bank bailouts, which may yet result in government in various countries nationalising their banks.
Despite the failure of deregulation, banks have strongly resisted recent attempts to re-regulate global markets.
Deregulation of world trade through the World Trade Organisation has seen global corporations shift production to low-wage countries to maximise profits. This has caused U.S. manufacturing industry to shrink from 28 to 14 per cent of the economy. Australian manufacturing is below 10 per cent of the economy.
Clyde Prestowitz, in his recent book, The Betrayal of American Prosperity (Free Press, 2010), says that in the U.S. three-quarters of all research and development are done in the manufacturing sector, which pays wages 20 per cent above those of the services sector.
For each manufacturing job, there are four dependent jobs, compared to just one to one-and-a-half dependent jobs for each job in the services sector.
Of workers who lose their job from manufacturing, 52 per cent find jobs within 10 years at substantially lower pay, while only 36 find comparably paid work.
The point is that the U.S. needs to rebuild its industries and invest in major infrastructure to provide high-paying jobs, creating a virtuous cycle of economic growth that enlarges the tax base to repay America’s vast debt.
Germany and Japan have shown that they can maintain large, high-end and tool-making manufacturing industry. Manufacturing is 22 per cent and 18 per cent of their economies respectively.
Providentially, if the U.S adopts new industry policies, China won’t overly complain. China now aims to drive its economic growth by increasing domestic wages and consumption among its 1.2 billion population. It wants to reduce its reliance for economic growth on exports to the U.S.
However, working against sensible policies to rebuild American industry are an array of corporations that have benefited from the decades of deregulation.
From them a plethora of radical free-market think-tanks and pressure-groups, such as the populist Tea Party movement, have been spawned. They are bent on preserving the very policies and structures that have failed.
They recently succeeded in vetoing an attempt by the Obama administration to remove President Reagan’s tax cuts for wealthy Americans.
The power of this lobby, along with political division and weak leadership, threatens to bring about a collapse of confidence not only in major economic institutions but even in democratic government itself.
It’s time we remembered the lessons of the world’s first Great Contraction of the 1930s.
Patrick J. Byrne is vice-president of the National Civic Council.
Kenneth Rogoff, “The Second Great Contraction”, Project Syndicate, August 2, 2001.
Charles Roxburgh et al., Debt and Deleveraging: The Global Credit Bubble and its Economic Consequence (McKinsey Global Institute, January 2010).