T. S. Eliot was right. Human beings cannot stand very much reality.
As much as I have an appetite for bearish views (I figure the optimist case gets disproportionate air time), the headline of Ambrose Evans-Pritchard’s latest piece, “Our quarter-century penance is just starting,” is grim even by the standards of the bearish faithful.
Evans-Pritchard, as usual, marshals some persuasive information:
“The current financial crisis is unlike any others,” says the Bank for International Settlements. Lasting damage has been done. The “cumulative output loss” is likely to reach 20pc of GDP in the major economies.
The message is the same at the International Monetary Fund. “The world is not in a run of the mill recession. The crisis has left deep scars. In advanced countries, the financial systems are partly dysfunctional,” said Olivier Blanchard, the Fund’s chief economist.
Mr Blanchard said an IMF study of post-War banking crises led to an unpleasant finding. “Output does not go back to its old trend path, but remains permanently below it.”….
All that has happened over this crisis is that huge private losses have been dumped on society: but the losses are still there, smothering the economy…”As long as economic growth relies on the state, you cannot talk about durable recovery,” said European Central Bank member, Yves Mersch…
We know what caused this crisis. The West kept short-term interest rates too low for a quarter century, luring society into debt: and the East held down long-term rates by flooding bond markets as a side-effect of their mercantilist strategy (ie suppressing currencies to gain export share).
The outcome was over-investment, excess capacity, and too much debt among those supposed to buy the goods. Has any of this changed? No. Have we cleared the excess plant? No.
Jeff Wenniger from Harris Private Bank says an army of baby-boomers have seen their old age plans shattered by the housing bust. Their nightmare is here. They will have to spend less, and save more. “Generational destruction of a society’s balance sheet down not rectify itself in a matter of months”.
Evans-Pritchard takes issue with Paul Krugman’s call for more fiscal stimulus. Evans-Pritchard instead recommends quantitative easing, not as a solution per se but to prevent deflation from taking hold.
I’m not keen about either approach, at least in isolation, The idea of pushing more money through the same unreconstituted systems is likely either not to work or if it is done on a sufficient scale, to produce a reversion to the behaviors that led to the crisis, with the similar, or even worse results (since the underlying debt will be even larger).
I am struck by the insistence of looking at complex phenomena like the Great Depression and Japan’s lost two decades and believing that a single remedy can pull us out of this mess (to his credit, Evans-Pritchard does have low expectations for his suggestion). There is too much willingness among some economists to attribute the substantial improvement by 1936 solely to fiscal stimulus. The early years of the Depression also saw substantial debt defaults and writeoffs (even if they are now deemed to have been a policy error, to analyze the Depression without considering their elimination on the trajectory of the upturn is incomplete).
Similarly, the Great Depression also featured substantial banking and securities reforms, other mechanisms to encourage debt restructuring (the HOLC). We have almost the reverse situation now, with no ready way to restructure or renegotiate mortgages owned by securitization vehicle. Thus while a fair number of debts were resolved in the Great Depression, albeit many brutally and at unduly high cost, we have almost the polar opposite, at least as far as mortgages are concerned, with loans that should be renegotiated instead kept in force, banks refusing to foreclose on houses, to avoid recognizing the loss and even in cases to keep the owner as the party liable for property taxes.
The Japanese have warned us that restructuring the financial system and cleaning up bad debts needed to be the top priority. But US economists decided we understood the Japanese malaise better than they did and refused to heed their advice. Right now, the mood among many in the profession seems self-congratulatory, that they successfully steered the economy off the shoals (of course forgetting that that the economy that foundered in the first place had been redesigned in line with orthodox beliefs).
We’ll see in a few months how viable the “green shoots” prove to be.