In the current issue of Hamburg’s highly respected weekly Die Zeit, economics editor Fabian Lindner takes a look at an important study of the U.S. economic downturn done by Kenneth Rogoff, the International Monetary Fund’s former chief economist who now teaches at Harvard, and Carmen Reinhardt, a well known capital markets expert at the University of Maryland. The Rogoff-Reinhardt study says that what’s happening in the United States right now has been predictable for some time and that the country is facing the real prospect of a long and severe recession, all the result of profligate fiscal practices and a failure to properly police the capital markets. Here’s the essence of the Zeit piece [my transl.] summarizing the Rogoff-Reinhardt study:
Rogoff and Reinhardt demonstrate the pattern behind the emerging economic crisis. The two scientists reach their conclusions on the basis of a study of 18 financial and banking crises in developed countries. They concluded that a crisis caused an average drop in the per-capita economic growth of two per cent. Countries took roughly two years to recover. Among the particularly hard-hit nations they studied were Spain in the late seventies, Norway in the late eighties and Finland, Sweden and Japan in the early nineties. In these states economic growth fell as much as five per cent, and recovery could not even be achieved within three years. And this worst case scenario is what Rogoff and Reinhardt are projecting for the United States over the coming years.
The course followed by each of these crises was the same: Houses and stock prices rose strongly on the back of both private and public debt and driven in part by the presence and participation of foreign investors, creating high current account deficits. If asset prices fall suddenly, then sooner or later, a collapse in growth followed. In the case of the USA in particular, the rise in housing prices and the current accounts deficit are more pronounced than in previous crises, which does not bode well. Still, until recently stock prices held strong. But Rogoff and Reinhart believe that this has more to do with the Fed’s frequent interventions injecting liquidity into the market to maintain artificially high values. This won’t work any longer. Last week, for instance, the S&P 500 index fell by 5.4%.
What has brought this crisis about? On this point the two economists also see parallels with the past. Rogoff and Reinhart stress that of liberalization of financial markets preceded most of the crises they foresaw. There was no legal liberalization in the United States over the last years, but there was liberalization in practice. One has only to think of the many new financial products with nicknames that sound like robots from the “Star Wars” series to understand the considerable problems now facing the financial community. Especially new and unregulated devices, such as the so-called “Special Investment Vehicles” (SIV).
Just how bad will the downturn in the U.S. economy be? Will the country face a loss in growth closer to two or more in the range of five per cent? At the moment this can’t be forecast. But history tells us that it will not be easily avoided by cute fixes.
But the cute fix is just what President Bush has in mind. He wants to mail out checks to a large stratum of the economy in a move designed to bolster consumer spending. Economists are anything but agreed that it will serve this end. Much more likely, it will simply magnify the already devastating treasury deficit, which is a key part of the current problem.
Bush doesn’t really intend to do anything to avoid the recession. He is aiming to push it back a few months in an effort to create the public impression that the recession will be the responsibility of his successor. And how are the Democrats responding to this brazen effort to saddle them with accountability for the mess that Bush made?
It’s hard to find meaningful analytical discussion in America’s mainstream media. How could it hope to compete with the latest Paris Hilton story, or some flub-up by an exhausted presidential candidate out on the hustings? Viewers and readers don’t want to be worried by it, they reason. They’re wrong, of course. The level of anxiety and concern among the public is high, as is concern and coverage in the quality press around the world. The curious standout is the mainstream media in the United States.
However, the Washington Post’s Dan Froomkin serves up an excellent piece yesterday putting the questions in the perspective of social justice:
Democrats and Republicans agreed last week that this would be a good time for the government to give away vast sums of money. And yet the Democratic leadership is considering it a victory that some small portion of the money will actually go to people who need it. The vast majority will go to the middle and upper-middle class. What did Bush give up in the course of these tough negotiations? Well, originally he wanted the super-wealthy to get some of the money. He wanted the poor to get nothing. He also wanted his tax cuts, which heavily favor the rich, to be made permanent. That is what we call a compromise in this day and age.
Because social justice is essentially off the political radar in the Bush era — and because both parties are prone to pandering to the middle class during an election year — Democrats never even tried to get White House agreement on a stimulus package that would significantly help the needy. An option that could have had a hugely positive social impact, while effectively stimulating the economy, never had a chance.
The Washington press corps didn’t seriously consider what $150 billion might have meant to people living in the margins of our society. The closest thing I could find to a serious treatment of that question was in South Dakota. Kevin Woster writes in the Rapid City Journal: “Mari King, a 25-year-old pregnant mother of two, who relies on food stamps and income-based housing, didn’t qualify for the tax rebate of up to $800 per qualifying individual that was initially proposed by President Bush. And it was unclear Thursday whether she would be covered by an expanded assistance plan being negotiated by congressional leaders to give smaller checks, possibly about $300, to virtually anyone who earns a paycheck.
“As an asthmatic with other health issues who is currently out of work, King relies on government assistance to get by. She said she and her children have daily financial needs that could be helped by a few hundred dollars. “‘It would do a lot,’ she said as she selected free food items at the food pantry on North Maple Ave. in Rapid City. ‘There are things I’d like to buy for my kids that I can’t buy. I could do some thing for them that I can’t do now.’ . . . “King hopes she isn’t forgotten in the negotiations. So does her mother, Bridget Defender, who now lives on disability payments and other assistance, including food from the food pantry. Defender hopes federal officials won’t overlook her as they develop the financial-stimulus package.
I get a little nauseous whenever people start talking about using the budgetary process as a means of addressing social inequality and find it difficult to muster sympathy for this approach. The better approach for the country is fiscal reserve–the very simple rules that every household follows, not spending more than it takes in, and borrowing only for prudent and carefully planned purposes. The classic example of bad borrowing would be to place a bet on a 20 to 1 chance at a horserace. And this is exactly what the Bush Administration has done almost from the minute it took office.
But we need to keep in sharp focus that the last seven years have been a dramatic exercise in social welfare budget making–they have seen a massive reallocation of wealth from the middle class to the wealthiest fraction of one per cent of the population. This was the foreseeable consequence of the Bush Administration’s tax policies which granted enormous relief to the true plutocrats at the cost of incurring tremendous debt that future generations will have address. This process need to be reversed and basic norms of fairness need to be brought into play as the country copes with its fiscal dilemmas.
One of the idiocies I see trotted out every day in the financial industry’s press is the suggestion that Adam Smith and other great thinkers of the Scottish Enlightenmen–who furnished the basic framework for our current understanding of industrial and post-industrial economics–had limitless faith in entrepreneurs. It is true that they had confidence in the entrepreneurial spirit as a creative engine. But their Calvinist inclinations were anything but unstinting in praise of entrepreneurs as individuals or as a class. Smith notes that the individual businessman will always seek the expansion of his own wealth and power at the cost of others and of society as a whole. So Smith would have fully aniticpated, and deplored, the consequences of seven years of Bush’s government of by and for the plutocrats. Socialistic experimentation is not the answer for this. But a sound concept of social fairness in the allocation of the burdens of society certainly is. Government should not unduly burden the entrepreneurial class. But neither should it become a vehicle for transfer of wealth to those who already have the most, while leaving a heavy debt to be borne by those who follow in their wake.
