Guest Post: Krugman Says American Economy Will Not Recover for a Long Time, Johnson Says “Crisis is Just Beginning”

Last week, Pimco’s CEO said that he doesn’t think we’ll have a v-shaped recovery, and that economists, advisors and managers who have been counting on a v-shaped recovery are ignoring the economic fundamentals in our economy.

Now, Paul Krugman is agreeing:

Plunging prices of houses and CDOs … don’t produce any corresponding macroeconomic silver lining. … This suggests that we’re unlikely to see a phoenix-like recovery from the current slump. How long should recovery be expected to take?

Well, there aren’t many useful historical models. But the example that comes closest to the situation facing the United States today is that of Japan after its late-80s bubble burst, leaving serious debt problems behind. And a maximum-likelihood estimate of how long it will take to recover, based on the Japanese example, is … forever. OK, strictly speaking it’s 18 years, since that’s how long it has been since the Japanese bubble burst, and Japan has never really escaped from its deflationary trap.

This line of thought explains why I’m skeptical about the optimism that’s widespread right now about recovery prospects. The main argument behind this optimism seems to be that in the past, big downturns in the world’s major economies have been followed by fast recoveries. But past downturns had very different causes, and there’s no good reason to regard them as good precedents

And today, Simon Johnson said:

The crisis is just beginning [since] we now have a financial system that’s completely based on moral hazard and too big to fail … and crazy things happen when you have a financial system like that.

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  1. alex

    It’s the debt, stupid. Maybe we should follow the advice that we sanctimoniously gave the Japanese. Write off the bad debt and stop propping up the zombies. Steve Keen also has lots of good insights on this: Some sort of debt jubilee may also be necessary.

    Also, following Krugman, since our foreign debt is denominated in our own currency, a devaluation (particularly against the yuan) would have a stimulative effect.

    1. delta

      there is no nobel of economics, it is the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel

  2. Trainwreck

    Globally, there is so much debt that has yet to be resolved. A tough war seems inevitable. Governments globally will confiscate wealth to fund their existence, which factions will win out in the end. Who knows. But financial demons will be exorcised first. Governments will squeeze wealth first from the speculators, and then next from the honest investors, and then from those that have decided not to pay attention how their moneys were being spent.

    Citizen farmers will win in the end, just like they always have. The middle class life is ultimately an illusion.

  3. Tahoe

    There’s that debt jubilee thing mentioned again. I am marveling at the resurgence of the idea, not having heard or learned much about it before a few months ago. In looking it up, it has some rather historical significance. A sorry state of affairs we humans have, and almost no reasonable path to reconciliation, all paths are likely to be painful from hereon. A grand rebalancing on a megalomonstro scale.

  4. Phil

    I don’t watch CNBC and wouldn’t have watched the linked clip if I didn’t like Simon Johnson. That was painful to watch, but kudos to Simon for getting a great point across in such a hostile interview: that TBTF banks with 60% of GDP on their balance sheets should not be written off as the new normal but viewed as a crisis in itself.

  5. Gbear

    Japan may be the closest example, and everyone forgets that it floundered for 15-20 years while the world was in the biggest debt fuelled boom ever seen.

    What’s the chance of caspitulation there now that global trade is in a mess and China is intent on self preservation, come hell or high water? Pretty high I would say.

    Investors are playing Russian roulette with three bullets in the chambers and hits of ecstasy in the other three!

    1. mmckinl

      Paul “Shifty” Krugman is once again being very shifty …

      He knows the SUV, McMansion, McMansion as cash machine economy is never coming back …

      That is what he is leaving out …

      The Old economic model is DEAD …

  6. btraven

    interesting that Johnson points to China as the weak link. actually the current crisis is probably already linked to China – the working class there for the last decade pushed back against low wages with an extensive strike wave. in essence, the global wage race to the bottom hit bottom and started to move off that bottom. that forced global prices up and I think triggered the end of the great US consumption boom.

    with that consumption collapse of course layoffs and wage cuts now become possible in China and maybe that is causing a new flood of investment there in an attempt to start the whole cycle all over again. but that approach rests heavily on a cooperative working class.

  7. mmckinl

    Paul “Shifty” Krugman’s answer to our troubles is MORE DEBT!

    Of course anyone who follows Yves Blog knows the answer is debt write-off and reconciliation … lowering the aggregate debt …

    Shifty is playing the bankers game in creating more debt for even more leverage in the financial system as a tonic to our woes.

    But what can one say about a fella that called the reason for our current crisis “Magneto Trouble” while the wheels were falling off …

  8. Jesse

    The banks must be restrained, the financial system reformed, and the economy brought back into balance before there can be a sustained recovery.

  9. Element

    There are wider factors that have been rarely discussed. The main problem for the US, as odd as this may at first seem, is excess demand. Here’s a comment I posted up today a Bill Mitchell’s MMT site. It seems appropriate here as well, to widen the view of what all economies face, even if they were to recover stongly (or slowly) in 2010-11;

    Australia’s 21.6 mill people bought 985,000 new cars in 2009, while China with around 70 times our population, bought only about 100,000 more new cars in 2009. Only 0.08% of the Chinese population bought a new car in 2009, as compared to Australia, where 4.6% of the population bought a new car. So about 57.5 times more cars were sold in Australia, per head, than in China. Incredibly, our new-car markets are still of comparable size!

    This is a good indication of how far China is still behind developed economies. But this will rapidly change this decade and every commodity supply chain will be over-stressed by it, and intense demand-driven price spikes will grow.

    Sufficient mineral reserves will be in the ground (I’m a Geo), of course, but it will not be possible to match transport supply to exponentially increasing demand within China, India, and also Indonesia.

    That looks fantastic for commodity suppliers, but it’ll touch off global commodities demand-driven inflation shocks in all economies. Some think that has already taken place, but it was just the beginning of something a whole order of magnitude more intense. It will entail repeated cyclic global price-spikes in commodities, then economic shocks to follow within all economies.

    If you look at 2007-2008 you can very clearly see that a pronounced commodity price spike was the major feature of pre-crisis global trade. I think this obvious fact has been far too overlooked and ignored. This was effectively obscured by the subprime and deregulation debacle in the US. But the commodity price spike was obviously a major feature of global economics and affected companies and individuals ability to pay their bills and loans.

    I don’t believe the crisis was just about dodgy US mortgages (and other debts) that caused people to not be able to pay their bills as the interest rose. That was part of it. But rising prices and falling wages (so employers could still compete), also ensured people could no longer pay their bills and debts. I think the two combined are what tipped us into actual global financial crisis.

    I expect that each time we recover from the last spike and shock, we will strongly boom (Australian commodities already are). Then we will crash into another wall of commodity price spikes (which is already beginning), as demand again goes off scale in the developing world. EU and US stagnation only delays the demand spike peak, but as all begin to recover again just watch how fast commodity prices spike, due to supply under capacity.

    The ensuing price shock will ultimately turn into a bust, and unemployment will rise, wages will stagnate or fall, and real economy business and personal loans will tip into default.

    I can’t see how we can with current bulk supply technology and capacity deliver enough commodities in time to meet these demand spikes, to stabilise global prices, economies and finance. Developing economies are likewise going to feel repeated severe economic shock.

    A Chinese economy with 820 million people employed, growing at 8% per year on imported energy and minerals is a demand spike we can’t supply fast enough via infrastructure growth.

    I don’t see how G-20 meetings will change the dynamics of a non-linear growth of demand outstripping the ability to physically deliver enough commodities. So expect more spikes and shocks.

    1. KJMClark

      Absolutely right. It amazes me that more people don’t see the problem. Ah well, maybe after the second commodity price spike they’ll start to realize that the credit bust was triggered by something else. Of course, after each commodity spike, we’ll have fewer resources available to mitigate the problems. I love it when people point out that “we’ll just all drive plug-in hybrid cars!” … And how are you planning to buy that expensive new car? With that shot credit-rating since your house was foreclosed? With that home-equity loan that no longer exists? While 15% of your income is going to energy and other commodity payments? While your job is being pulled out from under you?

    2. Steveb

      Your statement that car sales in China last year were a bit over one million, and less than that of Australia, disagrees with other recent news articles, which claim car sales in China of 10.3 million last year, surpassing even the U.S. Can you please provide a reference for your number?

    3. S Brennan

      It was not understood in the 1970’s, while our initial response under Carter was good, elements in our society [see Friedmanesque, Reaganism] took political advantage to wipe out the reforms enacted earlier in the century. The engorgement by the uppermost class was entirely predictable. The results are their for anybody to see, we confront resource issues with a political-economic system designed for 19th century enrichment of one tiny sliver of humanity.

      Any diatribe that groups all Americans together knows nothing of US consumer consumption patterns by quintile.

  10. Francois T

    I’m not exactly endowed with a deep knowledge base in finance and economics, but one thing is clear to me: there is a need for a solid and competent political leadership to (at least) enable the necessary conditions for an economic recovery from the deep troubles we’re in.

    Well! We can’t claim to have an overabundance of that now, can’t we?

    I happened to stumble upon this remarkable nugget:

    …the United States finds itself on the brink of an unprecedented crisis of competence in government. The maintenance of American power in the world depends on the quality of U.S. government personnel…at all levels. In this light, the declining orientation toward government service as a prestigious career is deeply troubling.

    This is especially troubling when one considers the source of this warning, namely he U.S. Commission on National Security for the 21st Century.

    By the way, this was written in January 2001. In view of how screwed up the response to the financial crisis has been (and don’t get me started on the so-called “War on Terror”, the health care/insurance “reform”) the authors proved to be rather prescient.

    So, I think Krugman and Johnson are on to something here…big time!

  11. MyLessThanPrimeBeef

    I wonder if we had been told before China joined WTO that our competition was such that the manager of a tainted toy factory woult take responsibility with his own life, how many would volunteer to get into the ring?

    That’s taking the competition level to a whole new dimension.

  12. craazyman

    If it sounds like a squawk it might be a fart . . . it doesn’t necessarily have to be a duck.

    The tendency for economic pundits, even Nobel Prize economists, to take two variables and correlate them to death makes me wonder if math can prove that rooster crowing makes the sun rise.

    Japan had a poplulation of 123 million in 1989. In 2009, Japan had a population of 126 million. Virtually no net population growth in 20 years. In 1989, only 11.6% of the population was 65 years or older. In 2009, that was 22%. They are a tribal culture that doesn’t like immigrants or immigration. That may have had something to do with their economic malaise.

    Yes, their debt-ridden, crony-capitalist dysfunctional financial sector is a strong parallel with our own.

    But there are major differences too.

    Macroeconomics is a science just like Scientology is a religion. Can’t wait ’till they start calling it “Political Economy” again . . . plus ça change, plus c’est la meme chose.

    Booowhahah ahahah ahaha aha hah!

  13. Samuel Morales Jr.

    Wait a min…. The same Paul Krugman that said stimulus saved the economy is saying the economy is not recovering? Recovery won’t happen quickly, because the government, and the Federal Reserve don’t let it. They are busy trying to keep dead corporations alive, and dead markets alive. Reflating the housing bubble with people with volatile incomes/cash flows who in reality couldn’t afford such things. Another thing, interest rates, modern thinking is that interest rates need to be low, because of high unemployment, and that for some reason low interest rates stimulate job growth. This is nonsense since there is no strong empirical evidence to support this, and in fact the evidence would prove the opposite more than accepted belief. The banks are zombies, let’s face it. They are hopeless, and the bailouts weren’t much any better than simply letting them to fail if you really think about it.

  14. Conflationist

    Krugman seems to be proving himself to be something of an ideologue. He seems to be in favoring of increased government spending and involvement in commerce despite its poor historical results. Japan has been on a Keynesian binge for decades, yet all they have to show for it is two decades of zero growth and a debt-to-GDP ratio of over 200%. The US fared much better during the Depression, despite greater short-term pain. Krugman admits that the stimulus isn’t going to succeed in the US, but then posits that we should have another stimulus program on top of the current one which is simply not a productive use of capital in the long-term.

    The favorite trick of economists these days (be it Krugman or Bernanke) is to claim that the reason their policies never worked in the past was because they were not applied appropriately. Hence they blame the Japanese or the 1930’s Fed for not being aggressive enough, as opposed to drawing the obvious conclusion that such monetary/fiscal policies are not sufficient during balance sheet recessions following debt-fueled asset bubbles.

    This ideological hypocrisy is further underscored by Krugman’s preference for government spending over tax cuts. He is fine with a steep yield curve that will allow banks to earn their way out of insolvency, but this “economist of the people” doesn’t believe that consumers should be afforded the same privilege. He thinks government spending is better because it gets spent, even though it just worsens the overall debt picture; while tax cuts might not get spent, at least this would allow consumers to improve their balance sheets in a way similar to how a steep yield curve helps banks. I think the only way to work our way out of this crisis is to eliminate debt and improve balance sheets; more government spending is fine if we are making productive long-term investments and simultaneously addressing what ails us. But Krugman seems to be in favor of growing government for the sake of growing government. In other words, he is a partisan–no different than the supply-side charlatans on the Right (only with a higher IQ).

  15. Ishmael

    Once a Krugman fan when he went around bashing Bush for his over the top spending, now I am a Krugman cynic when he goes around say the problem with Obama’s over the top spending is that it is not big enough. The guy has proven to be a party hack and not a man of the people at all.

    Krugman fails to see that Bush inherited a deflating economy and attempted to borrow and spend his way out of it. It then collapsed and is resulting in even a larger borrow and spend exercise.

    Is not the definition of insantity doing the same thing and expecting different results. To misuse a quote from Henry II “Will not some one rid me of this thinking.”

  16. ranman

    Everyone on this blog:

    I, like many of you, have been following this mess as it unwinds for a couple of years now. We all flop around trying to give our two cents about what is wrong or what needs to be done. However, if you approach this from a “total Quality Management” point of view, they instruct people (when fixing problems in business) to identify the root cause(s) of the problem, list them in a pareto diagram and develop action plans to solve them starting with the biggest problem.

    I think most everyone will agree that (at least) one of the biggest problems is that Wall Street has captured Washington DC and controls the purse strings. Nothing is going to have lasting positive effects on our economy if this is not fixed.

    How do you fix a corrupt system like this? I’ve been struggling with this for a long time.

    I think a very good start is what has been proposed by Ariana Huffington (and many people before her, Mish, Denninger,, et al) is for everyone to MOVE YOUR MONEY out of this top banks…….Citi, JPM, GS, Wells Fargo, and Wachovia. This is relatively easy to do. Put the money in local regional banks so th community can benefit.

    If we all did this (( am) it would shift trillion to local banks and help our cause.

    The next step, a multi-million person march on WDC.

    I know the second step is difficult to pull together. However, the first is not and as for me, I’ve already opened my alternative accounts in local banks and have started the transfer.

    Good Luck to all!


  17. david

    Japan’s economy has grown since its crash, though more slowly than before. Their minimal population growth is a factor in addition to the excessive debt.

  18. S Brennan

    I you take “Farms” out and replace with “homes” you’ll the similarity. We returned to 19th century economic behavior, leaving the 20th century reforms of 1906, 1932 behind [See Friedmanesque, Reaganism] we should see similarities in the years prior to reform.

    “The Depression of 1893 can be seen as a watershed event in American history. It was accompanied by violent strikes, the climax of the Populist and free silver political crusades, the creation of a new political balance, the continuing transformation of the country’s economy, major changes in national policy, and far-reaching social and intellectual developments. Business contraction shaped the decade that ushered out the nineteenth century.”

  19. Conflationist

    Statistically speaking, Japan’s nominal GDP is flat over the last 17 years I am paying attention to nominal given that we are discussing a pierced asset bubble and its aftermath which has included massive accumulation of debt. Moreover, the Japanese stock market is still 75% off of its highs–and most of Japan’s collapse took place against a backdrop of a booming world economy.

    The US in the Great Depression shrunk violently almost 50% ( ) in the three years following the peak, but was back to pre-crisis levels in less than a decade; GDP exploded thereafter, but its hard to disaggregate the effects of WW2.

    Given the relative economic and market performance of Japan in the past 20 years, together with the prospects of default in the future from their excessive fiscal activity, should we really conclude that the Japanese route is the best for the US? There is a mindless consensus for pain avoidance that is not necessarily borne out by the factual data.

    1. Ishmael

      Coflationist –

      We are left with the option of taking the pain now and moving forward or socializing the cost of this and buggering everyone except maybe the top .1%.

      Assets are even more over priced than they were before. Due to the government and Fed propping up prices while millions are losing their jobs, having their incomes slashed and losing credit lines. Accordingly, the longer the govt waits the more the adjustment needs to be.

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