No consensus at all about the causes of the Great Recession and regarding a radical reform of the financialization regime to be done. Three analysts in a virtual round table around the globe, from Boston, to Dublin, to Singapore.

A conversation with Economics Editor Marc Coleman, from Dublin, Financial Consultant and author Peter Cohan, from Boston, and David Caploe, Chief Economy Editor from EconomyWatch in Singapore.

© Jorge Nascimento Rodrigues, September 15, 2010

Q: Can we say there’s a consensus about the causes of this Great Recession?
MARC COLEMAN: No, unfortunately. There is too much attention, relatively speaking, on the role of the banks and too little attention on the role of policy makers (central banks maintaining interest rates that were too low, regulators failing and governments building up an overreliance on tax revenues which – due to overly loose monetary policy – were excessively vulnerable to a downturn). Without the encumberance of big government, the leading economies of the world would have been in a position to respond to the crisis with the tax cuts needed to stimulate growth. So although we cannot say the public sector initiated the crisis, its approach to monetary governance made it possible and its approach to fiscal governance hindered the necessary response.
PETER COHAN: Not formally. For example, there’s still a commission [in the US] trying to figure out the causes. But if you ask me, I think there are six: 1) Securitization. Up until about 30 years ago, people took out mortgages from an S&L and paid their loan officer every month until they owned their house. In the 1980s, Wall Street invented securitization — the process of buying up, say, 1,000 mortgages from mortgage companies, creating a security based on those mortgages, paying for a AAA rating, and selling the securities to investors worldwide. Securitization is a problem for reasons I’ll describe below. 2) Too much borrowing. Over the last several years, Financial Institutions (FI) have made some $2 trillion in fees from securitization, according to DealBreaker. One reason for this is that they have been able to buy these securities — of which there are $13 trillion on the market between Mortgage-Backed Securities (MBSs) and Collateralized Debt Obligations (CDOs) — with a sliver of capital, roughly $340 billion. The typical FI had a ratio of assets to capital of 30:1. This meant that a mere 3% decline in the value of these securities would wipe out all the capital. 3) Skewed incentives. Bankers, ratings agencies, and consumers made decisions based on a bad system of incentives. Bankers got paid as a percentage of the size of the deals they brought in — if they brought in a big deal and it later lost money, the bankers got to keep their multi-million bonuses. Ratings agencies competed with each other to win million dollar fees from investment banks depending on whether they would give the junkiest securities their highest, AAA, rating. And consumers — struggling with declining incomes and rising costs — could not resist the lure of borrowing money they could not repay — in the case of the $1.3 trillion in subprime mortgages. 4) Lack of transparency. The MBSs and CDOs were priced by extrapolating historical patterns of mortgage repayments, delinquency rates, and home price changes into the future. When those historical patterns proved to be poor predictors of current behavior as three million borrowers foreclosed and housing prices declined 15%, there was no way to put an accurate value on the securities. In simple terms, pricing those securities would require examining each of the say, 1,000, mortgages in an MBS and identifying which mortgages are current and likely to remain so and which are not. Such basic information is simply not available to investors. 5) Letting managers write their own report cards. Examples abound of the dangers of letting CEOs direct how they report their results to investors. Lehman Brothers used an accounting trick, Repo 105, to deceive investors into thinking it had less debt than it really did. Madoff put together a subservient and largely untrained staff to “generate false and fraudulent documents,” and Madoff “told lies and supplied false records to regulators, and shuffled hundreds of millions of dollars from bank to bank to create the illusion of active trading.” In other words, he wrote his own report card every day. Letting managers write their own report cards was a key source of the financial collapse. 6) Global interconnection of markets. If global financial markets were not so closely intertwined, the collapse of one institution would not have such a terrible impact on the rest of the world. For example, earlier in the week a bank in Hong Kong experienced a run on the bank because of rumors that it was weakened by the collapse of Lehman Brothers. One reason the government bought AIG was that the counter-parties to its Credit Default Swaps (CDSs) were so inter-dependent that AIG’s failure could have placed severe strains on many big players.
DAVID CAPLOE: Absolutely NOT. My basic argument is that the US — and now I would have to include the Eurozone — is in the midst of a structural crisis with SIX different, albeit interrelated aspects: financial / economic / ideological / political / intellectual – academic / media … If you look at the latter two especially, I think it’s clear that MOST conventional economists have learned absolutely NOTHING about the real world, a failure which comes from a general lack of DESIRE to know anything about the real world. So I would say, in fact, that the current crisis has, if anything, EXACERBATED the fault lines among those — supposedly — in the know.

MARC COLEMAN:“I think the real trigger was the collapse of Bear Stearns in March 2008. Given the momentum of the crisis over ensuing months, I believe the collapse of Lehman was inevitable and desirable.”

Q: Lehman was the trigger of the financial panic and the accelerator of the Great Recession? At the time, could secretary Paulson and FED chairman Bernanke acted differently?
MARC: I don’t believe so. I think the real trigger was the collapse of Bear Stearns in March 2008. Given the momentum of the crisis over ensuing months, I believe the collapse of Lehman was inevitable and desirable. The institution’s behavior over the preceding summer – contemplating further real estate based investments in Korea! – clearly marked it out as badly led. The subsequent contraction in world output has been harsh. But it had to happen. And it is better that it happened sooner rather than later. Bernanke was also correct to raise interest rates steeply upon becoming Fed Chairperson. I believe his performance has been exemplary.
PETER: Lehman’s bankruptcy was the peak of terror in the financial markets. Short-term money markets froze up. Two measures of that were the TED spread, which counts the difference between three-month (London Interbank Offered Rate) Libor and the three-month Treasury rate, and the Libor-Overnight Indexed Swap (OIS) spread. As I posted, on September 30, 2008 the TED spread was near a record 3.38% (it was 1.1% in August 2008). And the Libor-OIS spread was a record 2.46% (it was 0.08% in September 2007). Paulson and Bernanke could have arranged a bailout as they did for Bear Stearns and the rest of Wall Street after they saw how bad their decision was to let Lehman collapse. It’s quite possible that Bush did not like the criticism he was getting for not letting the free market work so he decided not to bail out Lehman. Then Paulson and Bernanke – who may well have counseled a bailout – are forever forced to claim that they had no legal authority to do the bailout.
DAVID: I could write a book on this alone — and several people already have , but they could and should have done something at the time of Bear Stearns in March, which they were content to shrug off as “just one of those things” instead of a CLEAR harbinger of structural problems. Both at the time, and in retrospect, it is shocking that they were so relaxed about the potential systemic implications of an investment bank failure, and were consciously un-willing to acknowledge in March how close the global system came to collapse, in precisely the way it ALMOST did, in fact, in September, with Lehman Brothers. There are about a million things they could EASILY have done differently — had they not been so much a part of the Cheney / Bush propaganda effort about the soundness of the financial system — but I would say the main one was not taking Bear Stearns more seriously at the time. In this context, Fuld’s testimony before the so-called Commission — which clearly will NEVER be mentioned in the same breath as the Pecora Commission [in the 1930s] — is intriguing, because he just about said Paulson, as former head of Goldman Sachs, was willing to let Lehman Bros go in order to simplify the playing field for his former company. Of course, Fuld didn’t have any answers for Repo 105, which made clear how structurally weak Lehman was for a long time, so I guess that part of it is, as for so much of this situation, not a victory for ANY of the participants involved.

PETER COHAN: “Banks are taking the nearly free money the government is providing them and investing it in risk-free assets like Treasury bills.”

Q: The brutal deleverage of the banking system particularly of the shadow financial system was an inevitability?
MARC: Yes. Unfortunately it should have started much earlier and this would have happened had interest rates been increased as they should have earlier in the policy cycle. Had this happened the deleveraging would have been less procyclical and far less damaging. Again this underscores the procyclical and dysfunctional nature of global policy cycles.
PETER: It would have been much more extreme if the government had not put $23.7 trillion in cash and guarantees at the industry’s disposal. Banks are taking the nearly free money the government is providing them and investing it in risk-free assets like Treasury bills. According to the Federal Deposit Insurance Corporation (FDIC), in Q1 2010, all FDIC-insured institutions had a total of $9.2 trillion in deposits, up 2.7% from the first quarter of 2009. During that period, banks’ holdings of securities — 61% of which are U.S. government securities — rose 14.7% to $2.5 trillion
DAVID: Here I would say two things: 1) We now clearly have a two-tiered banking system in the US, with the TBTFs knowing they have NO moral hazard, but the rest of the banking system being allowed to collapse like a house of cards — making them all the easier for the TBTFs to pick up for a song, as indicated by the on-going near bankruptcy itself of the FDIC, with which Betsy Bair is trying to do a great job, but, in typical fashion, is not getting a huge amount of help from the Obama regime. 2) I think we have a LOOONG way to go in terms of the deleveraging of the SYSTEM as a whole because the derivatives issue was more or less avoided by the so-called financial reform. While I’m not the St Warren of Buffett worshiper many people are, I do think his description of derivatives as “weapons of financial mass destruction” remains the most accurate — while raising questions about his esteem for / relationship with GS, which clearly has played the derivatives game brilliantly — and, like their correlatives in the physical world, there are going to be both immediate “blast effects” and long-term “fallout” when they finally DO start crashing, an eventuality I think is unavoidable. Given this, I think we are LOOONG way from the “final” deleveraging of the global financial system — don’t forget how involved many big Euro banks got with derivatives as well — so the brutality we’ve seen is only the beginning, I’m afraid, …

DAVID CAPLOE: “If these trends continue, it’s going to be a Chinese-centered world political economy MUCH sooner than even I thought would be the case.”

Q: Two years after, how you evaluate the evolution of this recession?
MARC: It is not just a recession, although there is a clearly cyclical element to it, but also to a large extent the unwinding of a level of excessive economic output that should never have occurred in the first place but which did due to two factors. The first was the illusory belief and denial on stock markets (up until 2007) over the unsustainable trajectory of growth in terms of the growing limitation of fossil fuels availability. The second was a monetary policy regime which, since the late 1990s, was far too loose. Just when the world’s real interest rate should have been rising to counter the limited resources of fossil fuels (and consequent need for a higher hurdle for investment decisions) it actually fell, and for political reasons.
PETER: Things in the money market world have recovered nicely since then. On September 3, 2010, the TED spread was 0.17% and the LIBOR-OIS spread was 0.11%. But fear has not left the building. Instead it has taken the form of investors buying gold on the assumption of massive inflation around the corner. As I wrote on August 17, strangely, investors are also piling into corporate bonds — a bet that will only pay off if deflation is the rule and will decline in value if the gold bugs are right. Meanwhile, the US economy is at a crossroads. The good news is that job losses are way down from the nearly 800,000 lost in January 2009 at the peak of the recession. Corporate profits are high and cash balances at $1.84 trillion are at near record levels. Moreover, the economy has been growing since the summer of 2009. Unfortunately, if left to its own devices the economy appears poised for stagnation. While consumers are borrowing as much as they can from credit cards; business demand for credit appears to be down as their balance sheets strengthen and banks cut lending to them. With 70% of economic growth coming from consumer spending, it is hard to see how that spending will rise enough to get the economy moving again until businesses start to hire enough workers to take up the slack from the 8.4 million who have lost their jobs since the recession began in December 2007.
DAVID: I think all the structural problems in the US / Icelandic / UK / Irish housing markets remain, and have barely been addressed, let alone solved. So I see no relief coming from an improvement in those housing sectors at all. At the financial level, of course, the US and EU are following almost step by step the deeply mistaken Japanese mistake of NOT forcing the banks — ALL the banks, including the TBTF ones like — to write down their bad loans and losses, for fear of hurting the stock price of those banks. Meanwhile, the non-TBTF banks, at least in the US, are collapsing, and the TBTF banks are just sitting on the zero-interest money the Fed has BEGGED them to take, and NOT lending it out, but either letting it sit there, as I said, or using it to profit by buying short-term bonds with higher interest rates. The result of this is the collapse of most of the “real economy”, which is not just damaging on a human scale, but is also disastrous from a long-term “advancing sector” point of view. I am definitely a Schumpeterian, insofar as I think sustainable long-term growth MUST come from innovation of some fundamental sort, whether technological or not — because it means that the financial sector is sucking up WAAAY too much of the society’s resources, and there is little left for the type of long-term / costly, especially at the start / slow to develop invention, and then innovation that will eventually solve the problems. The only society that is NOT losing out on long-term research into the sectors like clean energy — is China, which is very intelligently using its huge hoard of cash to get top-flight researchers from all over the globe to come there and DO that kind of vital R & D. If these trends continue, it’s going to be a Chinese-centered world political economy MUCH sooner than even I thought would be the case, a prospect that has both good and bad potentialities. India is growing well in most areas, but high levels of domestically-held debt, corruption and, even worse, increasing income inequality are potential traps for them, so they’ve got to be careful, as do the Chinese, who DO seem to have come in for the “soft landing” we have long predicted, in terms of lower but more sustainable growth rates, but have a brewing crisis in their non-public-bank “private trust company” sector and, related to that, the finances of many municipalities & provinces, which have borrowed heavily in the last two years, and may not be able to pay back. Fortunately, the Chinese have a lot of cash, so they can avoid some of the otherwise predictable problems of an active “shadow banking system,” but they do have to be careful that everything doesn’t suddenly colapse.

PETER COHAN: “As far as consolidation, the U.S. financed even greater concentration in the financial services industry which does not bode well for the future.”

Q: Two years after, how you evaluate the “cleaning” of the financial system and its rampant consolidation?
PETER: It’s not clean because there are still huge amounts of bad mortgage debt out there and those bad loans were the cause of the collapse. Until those loans are written off, they will hang over the financial system. As far as consolidation, the U.S. financed even greater concentration in the financial services industry which does not bode well for the future. I would give financial reform a B. Bringing light to the derivatives market is a good move. Of course, unless that’s done in a very rigorous way, Wall Street will find a way to cloak it in invisibility again. Unfortunately, the plan preserves Too Big to Fail (TBTF) institutions rather than breaking them into smaller pieces. And the package doesn’t fundamentally change compensation plans that drove Wall Street to make bad bets. It fails to end the securitization process that pretty much set the world on course to the financial meltdown. It doesn’t demand outside, independent third-party accounting scrutiny of Wall Street firms’ books. And it doesn’t create sufficiently strong limits on leverage. Many aspects of the plan are OK but not great. For example, the Volcker Rule might help with some of the concerns regarding leverage and TBTF. Consumer protection could help by making it easier for people to analyze the risks of a financial product. Say-on-pay might help limit problems with pay packages, but since it lacks teeth, it’ll probably be more of a way for frustrated investors to blow off steam.
DAVID: Practically non-existent, and for the reasons cited above: the US & EU following Japan in the political “leadership”‘s un-willingness to force the banks to declare the losses. Not only is this destroying most of the banking sector, but is creating terrible effects in the real economy it is SUPPOSED to service, but is instead starving, in both the short- and, as above, long-terms. The global financial system remains a complete mess & will be so until someone on the political side shows some guts –and it certainly ISN’T Obama — unfortunately for all of us.

David Caploe: “The MAIN thing is the failure of political leadership to force the banks to clean up their books.”

Q: In your opinion what was DONE and what was NOT DONE dealing with the causes of this crisis and the prevention for the future?
MARC: What was done: 1. Bursting the bubble by raising rates in 2005 and 2006 2. Swift and effective response by central banks in September 2008 to inject liquidity into the world banking system 3. Achieving resolve at G8 & G20 to avoid destructive devaluations or trade restrictions. What was not done: 1) Accepting that long term real interest rates must rise, and that central banks must chart a course for recalibrating interest rates 2. Fundamentally re-examining the basis on which global economic growth in the last ten years has been based, i.e. a technology that is going to hit the buffers in terms of fossil fuel resources. 2) Overly loose monetary policy 3) Achieving a clear resolve to radically re-engineering monetary and fiscal governance, making the former much more independent in the US and making the latter leaner and smaller in Europe and 4) Addressing the fundamental causes of global imbalances between east and west – the US economy’s overreliance on consumption and its low savings rate and China’s failure to ease internal imbalances by allowing the renminbi to achieving a more realistic level.
PETER: Not done: 1) End Securitization. securitization is too dangerous to continue. 2) Create transparency of securities’ cash flows. If you keep MBSs and CDOs, make each cash flow completely transparent. 3) Create an indendent government agency to do financial reporting. Partially Done: 1) Put Derivatives on exchanges. Some of this is happening but not enough. 2) Limit borrowing. Bank regulators are raising capital requirements but will they remain high when lending fever resumes?
DAVID: The MAIN thing is the failure of political leadership to force the banks to clean up their books . This is the root cause of the continuing problems, and as long as it remains the case, I see little improvement on the horizon any time soon, except, again, with the possibility of China, which at least TRIES to exercise a modicum of control over its financial sector, unlike the US / EU / Japan, where the most powerful bankers basically tell the political leaders what to do –with sadly predictable results.

Interviews with 5 Economists by Jorge Nascimento Rodrigues ©janelanaweb.com, 2010

Today high unemployment rates in the developed world, Europe’s sovereign debt crisis in a large group of countries, a change of the growth model in China and the risk of a bubble bust in this “engine” of the world growth, growing evidence that the US economy – another “engine” as so many exporting countries depend upon this consumer market and outsourcing dynamo – is running out of steam, the American Dow Jones oscillation around the 10.000 points benchmark and the volatility in the financial derivatives markets rose concerns in the class of analysts and opinion makers and spread a fear behavior inside the world financial ecosystem, around the big institutional investors and professional speculators.

Consider also that trust in governments to resolve such problems – either in a Keynesian mood or in an Austrian hard line fiscal adjustment – has been damaged badly. A crisis of confidence has yet to be overcome.

Other key indicators of global economic health (or lack of) “talk” so hard that it would be unwise do ignore: The Baltic Dry Index, a measure of commodity-shipping rates, fell 2.8 percent this Monday (July 5th) for a 27th consecutive retreat, the longest losing streak since August 2005 and it is now down nearly 50%; gold is tentatively attempting to consolidate this week above $1,200/oz (spot gold hit an all-time nominal high of $1,261.90 an ounce on June 18th), investors traditionally see this precious metal as a safe-way in crises times.

On the other hand, some healthy figures, like a forecast from OECD for a real world GDP growth of 4.6 percent this year and a jump of 9.5 percent in the world trade according to World Trade Organization economists, were engulfed by the pessimism. Also, the money “parking” around the world makes no headlines in the breaking news. OECD figures refer that the private sector of its members is forecast to run a surplus this year of $3,000bn [4.8 percent of world estimated nominal GDP for 2010]. Add $300bn in aggregate surplus in emergent economies (the largest slice generated by China), a figure from the Washington-based Institute for International Finance. Only private equity firms, where corporate takeovers and global raids are planned and plotted, sit atop $500bn – some of this financial capital is like “dry powder”. All these trillions are “sensing” deals worth doing. As economist David Caploe, from Singapore, said this week at EconomyWatch.com: the “fat cats” around the world have literally more money than they know what to do with.

With this contradictory background to the current hot topic, we interviewed a diverse group of experts and analysts in different continents about the double-dip buzz. The opinions are clearly divided. Some would say the double-dip is unlikely – we had a single-dip. Others say it’s a true risk with no precise date already scheduled, but unavoidable. Others even would say the Great Recesssion never stopped so it’s only the same music.

TECHNICAL INFO
Definition of the double dip: When gross domestic product (GDP) growth slides back to negative after a quarter or two of positive growth. A double-dip recession refers to a recession followed by a short-lived recovery, followed by another recession. The National Bureau of Economic Research (NBER) doesn’t define a double dip more than this short sentence: a continuous recession that’s punctuated by a period of growth, then followed by a further decline in the economy. Or in alternative: after a first trough following the recession the economic activity might rise for a period, but not far enough to complete a cycle, then fall again, and finally rise above its original level, only then completing the cycle. Visualy this is a W-shaped movement.

The roots of this W design can be diverse. For some economic historians the fault is to be found in wrong policies. A series of monetary and fiscal blunders drove the countries back into recession. Exit policies from Keynesian stimulus packages at the wrong moment, to early, may stop the recovery. For other analysts and economic historians, Great Depressions are followed by serial default crises and led “naturally” to downturns in the most fragile countries and regions with a risk of world contagion. Only when rent-seeking strategies lost dynamics and the real economy take over the situation, the recovery will consolidate.

Historical case study: The Great Depression was made up of two distinct economic slumps – August 1929 through March 1933 and May 1937 through June 1938. The last period is commonly classified as a “double-dip”. The world GDP downsized softly in 1938 (0.1%) but the world trade contracted dramatically by 12% (more than in 2009). The American stock market S&P composite crashed between October 1937 and May 1938.

INTERVIEWS with Professor CARLOTA PEREZ, Chief Global Economist BILL WITHERELL, researcher MARK J. LUNDEEN, Chief Political Economist DAVID CAPLOE, and consultant and author PETER COHAN.

CARLOTA PEREZ
“If the Chinese manage to avoid the collapse of their housing and commercial real estate bubbles they deserve a medal.”

Carlota Perez, 71, is the renown scholar and expert in technology revolutions, and Professor at Tallinn University of Technology, Tallinn, Estonia, and Visiting Senior Research Fellow at the Centre for Financial Analysis and Policy, University of Cambridge, UK.

Q: World global double-dip is a true risk ahead?
A: Yes, indeed.
Q: Do you forecast a new recession climate for the second half of this year or for next year?
A: Impossible to predict. Too many variables in the game.
Q: The double-dip risk has a higher probability for the developed countries?
A: No. Both developed and emerging. If the Chinese manage to avoid the collapse of their housing and commercial real estate bubbles they deserve a medal.
Q: Can the G20 policies avoid the double-dip?
A: The G20 are no longer recognizing the gravity of the situation. They are back to seeing the crisis as an “accident” to be overcome by monetary policy and some regulation, rather than a structural break that needs the radical re-coupling of the world of finance with the real economy. If you “regulate” a casino, you do not change its nature. We will not be out of the crisis until financial profits come largely from the profits created in the real economy and not from differential asset inflation.

BILL WITHERELL
“We think a double dip is unlikely. But except for the highly indebted members of Club Med in the Eurozone, significant near-term fiscal restraint is not desirable with the recovery remaining so weak”

Chief Global Economist of Cumberland Advisors, a global independent, fee-for-service money management firm, based in Florida, since 1973.

Q: Do you forecast an imminent new world recession will all this buzz around a double-dip and the Chinese bubble bust risk?
A: The downside risks for the global economy clearly have increased recently, but we do not see this mid-cycle slowdown deteriorating into a recession either later this year or the next. In other words, we think a double-dip is unlikely. Monetary policy in the US and the eurozone and Japan will remain highly “accomodative”. Probably for the next 12 months with short-term rates staying close to zero. Central banks will seek to counter the effects of the ending of one-off fiscal stimulus measures. Inflation will not pose a problem. Corporate profits should remain strong and business investment is picking up. While the global locomotive economy is slowing from its excessively rapid pace in the first quarter, a healthy development in our view, it will still be the most rapidly growing major economy, with the GDP advancing by 10 to 11 % this year and 9-10% in 2011. The pace of the US economy will clearly be slower than is normal for this stage of a recovery, but should remain positive. Both the job market and the housing market will take a long time to recover. Consumers and investors remain very risk adverse and the equity market appears to be pricing in a more adverse future than we are projecting. This implies attractive buying opportunities for stocks may lie ahead in what are likely to be volatile market conditions.
Q: The slowdown is more probable in the developed countries than in the emergent regions?
A: It is the developed economies that face the greatest growth headwinds. But my answer to your first question indicates I do not expect a double-dip for the US economy. Nor is a recession likely for the Eurozone as a whole. It will likely manage a 1+% growth this year and not much better in 2011. Germany, France, and the Netherlands will do better than this while the weaker members of the zone will remain depressed. Spain, for example, will remain in recession this year and probably longer. This is not a double-dip, but rather an inability to recover from the single-dip.
Q: The recent G20 meeting supporting adjustment fiscal programs against the Keynesian mood can upgrade the risks of a double-dip?
A: The G20 pledge to halve fiscal deficits by 2013 and stabilize or reduce debt-to-GDP ratios by 2016 led some to fear that this will make a double-dip more likely, but this call for starting to take well timed steps to bring fiscal finances under control is less restrictive than it appears at first glance. Governments have already announced steps in this direction and most will be phased in over a number of years with little if any effect during the next 12 months. Also, there will be a significant improvement in fiscal finances as the recovery proceeds and from the ending of the one-off fiscal stimulus measures. Clearly, except for the highly indebted members of Club Med in the Eurozone, significant near-term fiscal restraint is not desirable with the recovery remaining so weak. But we regard the G20 action as positive for the long-term growth of the global economy and hope that sooner, rather than later, our own government will demonstrate that it too is starting to prepare to deal with the grim long-term outlook for the nation’s fiscal situation due to the rising costs of health care, pensions and debt interest.

MARK J. LUNDEEN Statement
“A global double-dip is unavoidable”

A private economic researcher has developed what he called ‘Bear’s Eye View’ (BEV) Chart to track the depth and form of the bear market. He is following the market race between the Great Depression of the 1930s and the present Great Recesssion since 2007 at the Gold Eagle website and at the Le Metropole Café.

“A global double-dip is unavoidable. The problem is that we have massive global debt weighing down the world’s economies; economies that are woefully incapable of servicing the debt burden’s placed on them. Debt by itself is not necessarily bad, if used property it has many benefits. Debt financed the industry and commerce that lifted western civilization out of the dark ages. But debt has a dark side too. What it built, it can destroy.

So what distinguished creative debt, from destructive debt? Simple, all debt finances economic activity of some nature. If in the creation of debt, economic activity is stimulated that pays off the debt, and leaves a profit for the lender and borrower that is good debt. Valuable goods and services are produced, jobs are created, and taxes are paid, all thanks to debt.

But this is not what happened in the past 40 years. Credit standards have been relaxed, resulting in massive debt in government, commerce, and individuals, who were encouraged to take on debt to finance economic activity that could never pay off the debt. So now we find ourselves in our current situation. What is our current situation? On a global basis, we have come to a point where our assets have transformed themselves into liabilities. If you correctly understand our problem, you will understand that it’s not a question of whether or not, we will see a global double-dip, but rather how long, and how much pain the world must endure before we start discussing how best to go about the liquidation of uneconomic debt?

I’m in favor of returning to the marking debt to the market. No more bailouts! If a debtor can’t pay his debts as scheduled, his assets are liquidated for whatever the going price is. I understand that this will result in massive deflation. Banks will fail as housing prices drop by 50% to 90%. Governments will fall too. But all this is going to happen anyway. The current policy of bailing out insolvent debtors will in time result in hyper-inflation. And Hyper-inflation is even worse for political careers, the banking system, and lives of private citizens. We need to admit that there is no good solution to our economic problem. But of the two we are confronted with, the solution that results in truly affordable housing, lower taxes, and steady employment in two to three years seems preferable to me.

So there is nothing the G20 can do to avoid a double-dip. To have, or not have a double dip are not the two choices laid before them. These people have brought the world to the brink, and the only choices they can now choose from is either massive deflation, by liquidating the uneconomic debt that their previous policies have created, or continue their program of bailing out bankrupts, which will result in hyper-inflation, and chaos.”

DAVID CAPLOE
“I reject the whole double-dip thesis. I think we’ve been in a consistently negative situation”

Chief Political Economist of EconomyWatch.com, Singapore, and founder and president of the Minerva School Program in Critical Thinking.

Q: A W-shaped recession with a double-dip ahead is a true risk for the global economy?
A: I would have to disagree with your assumption of a “double-dip” as a possibility. In my view, the advanced industrialized world — US / EU / Japan — have ALL been in a fundamentally recessionary condition since BEFORE Black September 2008, and certainly since then in a more or less unbroken line … We were openly skeptical about the fourth quarter numbers in the US in particular, and, in general, are generally so about almost ANY numbers produced by a US government agency. When you analyze all the fundamental “real economic” factors — above all, unemployment and, in the US at least, the inventory of unsold houses, both new and “used” – it’s very difficult to believe the US economy has ever come out of the “first” dip, so the fact that all the current numbers are so negative, for both the present and as leading indicators, says to me that the W idea is much less convincing than the long L_________…
Q: Or the double-dip risk has a higher probability for the developed countries?
A: As I said, I don’t think any of the developed countries ever really got OUT of a recessionary situation, so I reject the whole double-dip thesis. I think we’ve been in a consistently negative situation, and, doctored numbers from the Bureau of Labor Statistics in the US AND the stock market aside, the situation has been, is, and will remain grim for the foreseeable future. In that context, let’s remember something a lot of people often forget: The stock market is NOT the real economy. This may — or, at least, should — seem obvious after everything that led up to Black September 2008, but for whatever reasons, people tend to forget that. So just because SOME stock markets “rallied,” that doesn’t mean the real economy has improved in any significant way. This is especially so when one considers the outsize role that finance sector stocks play in a lot of stock market indexes. Without the finance sector — which in the US is now in almost exactly the same structural situation as its “cousins” in Japan have been since 1989, namely, being propped up by the government with a zero interest rate policy that enables them to borrow VERY cheaply, and then invest in a lot of short-term securities in other markets where rates are even slightly higher — the increases we’ve seen in various indexes would be MUCH less than what they’ve been statistically. In this context, we can see the stock market, sometimes at least, reflects the exact OPPOSITE of what is going on in the real economy, especially when, as now, most indexes are so heavily weighted toward finance stocks, whose numbers are radically inflated by government policies that they themselves have had a major hand in crafting.
Q: Can the G20 avoid the double-dip?
A: The G-20 has quickly become the farce that the G-7 became by the time of its second or third meeting back in the mid-70s. It’s just a big show that is now more inclusive than the G-7 / G-8 was, by including China, India, etc, which is all to the good from a symbolic point of view, but it’s already completely devoid of substance, just as the G-7/8 so quickly became as well. So I don’t even think we can meaningfully speak of G-20 policies — let alone place any hopes on them that they are going to do much of anything about world economic problems. For all the talk — and, to a certain extent, the reality — of “globalization”, as the EU debt crisis makes abundantly clear, the nation-state remains the real locus of economic policy-making, and I don’t see that changing any time soon, even though nothing would make me happier than to see greater political — and hence fiscal — integration in the EU. But both the US and Japan are integrated nation-states, and they are in just as big a mess as the EU, so even an enthusiastic supporter of European integration like myself can’t pretend such a development — as unlikely as it seems with each passing day — is going to be able to solve the very deep / real / structural problems that the advanced industrialized world faces. For that, we would need what I see as the sort of intelligent and far-seeing leadership of China — but it remains to be seen how even a cohesive group like that is going to be able to overcome the long-simmering labor militancy that has erupted there, and has already, in our view, made the previous Chinese model obsolete. But they, at least, seem to have a plan — which is something I’m not seeing from the US, EU or Japan.

PETER COHAN
“I think we will see a slowdown in growth, but it might not be as bad as negative growth.”

Analyst, consultant and author. Peter S. Cohan & Associates, Massachusetts.

Q: Do you expect a double-dip for the second half of this year?
A: I am not sure we ever got out of the first recession so it is wrong to talk about a double-dip. In the U.S., the recession that started in December 2007 persists (at least according to the official dater or recessions, the National Bureau of Economic Research). The NBER dated the beginning of the recession based on job losses and it has not declared the recession over because it is not confident that job losses are over. Having said that, if you define a recession as two consecutive quarters of negative GDP growth, then the first recession ended in the U.S. in the fourth quarter of 2009. I think we will see a slowdown in growth, but it might not be as bad as negative growth.
Q: Can we talk about an asymmetry in the take-off of the world recovery?
A: Part of the reason is that there are some countries like China and India that are still enjoying growth – and in many Latin American countries, the growth is very strong. The growth in China may slow down a bit due to efforts by the government there to let some air out of the bubble. But I would not be at all surprised to see the slowest growth (or possibly economic decline) in Europe due to budget balancing and deficit reduction efforts.
Q: The G20 summits will avoid the double-dip?
A: It might just slow down to very slow growth that will feel like a recession. In general, I find it curious that the political argument for deficit and debt reduction is strong enough to overwhelm the popular benefit of using government spending to keep the economy going forward until the private sector can take over by investing. I suppose the fear of a collapse of the Euro zone is a scary and highly motivating prospect for deficit reduction. But it remains to be seen whether a massive dose of Euro Thatcherism will produce prosperity.

HIGHLIGHTS

The risk of an overlap
“There could be another overlap. In the previous case the overlap was due to (and the cause of ) a changing of the core country from Britain to the US.”

The uniqueness of the recent financial crisis

“But never before as in this [last] surge has the technological revolution been so directly relevant to financial innovation and to its spread across the globe. That is why I think this financial boom is different from the 1907 one. This one was also about innovation, but in financial instruments. All other financial bubbles are about leverage, arbitrage, asset inflation, etc. but not necessarily about financial innovations (although there are always some, of course).”

Globalization

“Full globalization will not happen unless there are measures taken to induce investment across all continents and stop the marginalization that leads people to migrate or adopt violence.”

FRAMEWORK OF THIS CONVERSATION

Carlota Perez developed in her book Technological Revolutions and Financial Capital (2002, Edward Elgar) a hypothesis of the long-term pattern of modern capitalism based in great surges of development driven by technological revolutions: five great surges until now since the beginning of the Industrial Revolution. Each surge represents a process of propagation of a tech revolution across the economies and societies during more than a half a century, from installation phase to deployment and maturity. In each surge we saw boom and bust episodes that constitutes a recurring endogenous capitalist phenomenon, caused by the way the modern market economy absorbs tech revolutions.

Carlota Perez found that the major tech bubbles regularly occurs midway along the process of assimilation of each tech revolution, after a generation of 20-30 years of market experimentation.The collapse of these major bubbles creates the conditions for enabling a Golden Age.

In the case of the fifth surge of capitalist growth – driven by the information and digital communications revolution from the 1970s and the 1980s -, we have seen a double bubble, first the dot.com mania from 1994 until 2000 Nasdaq crash, followed a few years later by a financial boom around new financial vehicles and a crash mid 2007 with a financial panic in 2008 and a world Great Recession.

For people interested in the technical side of this pattern, Carlota Perez published in the Cambridge Journal of Economics (2009, number 33, pp.779-805) an article titled “The Double bubble at the turn of the century: technological roots and structural implications”. Perez hypothesis is different from the notion of Kondratieff long waves that have been applied by several researchers to economic history and forecasting. An article by Tessaleno C. Devezas, Harold Linstone and the late Humberto Santos pictured a similar analysis for the tech bubble and the innovation and consolidation structural cycle of a long wave. “The growth dynamics of the Internet and the long wave theory” was published at the Technological Forecasting and Social Change review (2005, number 72, pp. 913-935).

In this interview we do not develop two other aspects of the long waves of modern capitalism or surges of growth that professor Carlota Perez mentioned directly or indirectly in her paper referred above: a) the financialization waves studied since Hilferding and Hobson and stylized by late Giovanni Arrighi and late Hyman Minsky, and b) the David Harvey’s “switching crisis”.

PROFILE

www.carlotaperez.org

Venezuelan, researcher, lecturer and international consultant, specialized in the social and economic impact of technical change and in the historically changing conditions for growth, development and competitiveness. She is Visiting Senior Research Fellow at CFAP (Centre for Financial Analysis and Policy), Judge Business School, Cambridge University, U.K., Professor of Technology and Socio-economic Development at the Technological University of Tallinn, Estonia, and Honorary Research Fellow at SPRU, Science and Technology Policy Research, University of Sussex, UK.

INTERVIEW by Jorge Nascimento Rodrigues, Janelanaweb.com, 2010 ©

Q: The double bubble and crash patterns of the 1990s and 2000s are unique in modern capitalism’ history or we can visualize the same pattern before in the double bubble and crashes from 1890-93 (a major technology based type) and 1906-1908 (a financial type)?

A: That’s a very interesting point. Apart from the 1907 panic, there was also the “rich-man’s panic” of 1903 and they were both mainly financial. I have always seen them as a manifestation of the fact that the third surge [the third great surge of development] did not really have a Golden Age but only a gilded age (see Chapter 12 of Technological Revolutions and Financial Capital, TRFC). And this is the danger we are running now. Every major technology bubble is unique, among other factors because every technological revolution is unique. In the third surge, which was the first globalization, there were major technology bubbles in most of the emerging countries of the Southern hemisphere and in the USA. In each the frenzy was about the new infrastructure for long distance trade, especially the railway network. In most of those cases the whole funding process was centered in London which was also the center of world trade. But never before as in this surge has the technological revolution been so directly relevant to financial innovation and to its spread across the globe. That is why I think this financial boom is different from the 1907 one. This one was also about innovation, but in financial instruments. All other financial bubbles are about leverage, arbitrage, asset inflation, etc. but not necessarily about financial innovations (although there are always some, of course).

Q: Despite the actions taken and J.P. Morgan leadership in the financial panic of 1907 and after, until the establishment of the Federal Reserve in the US, we assisted 20 years later to a renewed bubble and then to a big crash and the most severe Great Depression so far. Can this pattern repeat in the next 20 years after this Great Recession of 2007-2009?

A: That was already the fourth surge which began in the US with Ford’s model T before the third surge deployment was over in Europe. This is a case of overlap. The real regulation should have happened in the end of the 1890s to enable a proper Golden Age. I do expect another major technology bubble with bio, nanotechnologies, bioelectronics, custom materials or whatever but a couple of decades after some major breakthrough in them comes and after the whole potential of this revolution has reached maturity. But, of course, there could be another overlap. In the previous case the overlap was due to (and the cause of ) a changing of the core country from Britain to the US.

Q: You refer that technology waves, or great surges of development of a new technology platform and subsequent techno-economic paradigm, are the “drivers” of economic growth and society shifts. Toffler referred in the 1970s the so called Third Wave. Despite 20 years of “third industrial revolution”, only after the Nasdaq crash (the cleanup of the infant mess) and the crises of the 2000 decade we are truly entering in an new age? We need always this financial and economic destruction as a bridge to a golden age?

A: Yes, we do, unfortunately.

Q: At the time, when the “irrational exuberance” of the so called “new economy” assets picked, what was your mood, your perception?

A: I was in the middle of writing the TRFC book and was “predicting” the crash. When it happened, I had to rewrite everything in the past tense. But it was good because now the book is timeless. It can be read at any moment of the surge. It explains how the system works across the centuries.

Q:  In the new deployment phase of the present fifth tech wave, which kind of companies will see an asset valuation boom?

A: Every deployment is about shaping the potential that was installed during the previous decades and especially during the boom. The mass production boom was shaped by suburbanization, the Welfare State (through income distribution making it possible for the workers to become middle income consumers) and the Cold War. I believe this potential will be strongly shaped by the environmental imperatives, not only global warming but also the limits to availability of natural resources, oil, water, etc. But that will depend both on market forces (price changes) and on regulation. The other force that could be extremely important in shaping the direction in which the ICT potential transforms products in all the other industries is full globalization. The more countries and people are incorporated into modern consumption the greater the possibility of catering to the “bottom of the pyramid” and to the people that gradually climb up the pyramid, rather than to the top layers, as happens during installation (because of income polarization). But, again, full globalization will not happen unless there are measures taken to induce investment across all continents and stop the marginalization that leads people to migrate or adopt violence.

HIGHLIGHTS

«The sense is that the participants expected each decision to be sufficient to return markets to normalcy; but of course, they were not.  The ad hoc, short-term nature of policy process, as described in the book, carried with it the risk that not all decisions would be good and would carry with them unintended consequences.»

«By now, it is apparent that the crisis was misdiagnosed [by policy makers] as a liquidity problem when in fact it was a solvency crisis.»

«After all, if FOMC participants can freely talk to the press in violation of their own security rules, surely Congress has a right to know what is going on as well.»

«Perhaps in the debate that surrounds regulatory reform of the financial markets, the basic management issues of decision-making process design and planning should become a priority.» 

REVIEW

“David Wessel’s book, In Fed We Trust: Ben Bernanke’s War on the Great Panic, is the definitive chronicle of the 2007-2009 financial crisis, but it is much more.  The book gives us an inside view of how policy making took place in response to the striking events

Wessel provides insights into the key players and decision makers, and conveys a very real sense of what they were thinking as those events unfolded.  In doing so, however, his account triggers serious questions about the Treasury/Federal Reserve decision-making process

Here, we emphasize three serious flaws in the policy-making process that Wessel describes:  a) the consistent lack of a plan and short-time horizon of the decisions, b) the insularity of the decision makers, c) and the apparent disregard for FOMC information-security rules governing meetings and associated documents.

We conclude by noting some oversights in Wessel’s account of the Great Depression [of the 1930s] and the Panic of 1907.

Lack of a Plan

The insider’s view of the policy making is the unabashed strength of this book, and Wessel provides an extensive chronology of how the crisis unfolded.  It is not a pretty picture.  His most telling observation is that the principals seem to have lurched from event to event without a plan, even after it should have been apparent that one was needed.

The discussions among key participants – namely Chairman Bernanke, Secretary Paulson, then-president Geithner, and Governors Kohn and Warsh – seem rushed, from Wessel’s descriptions of them.  The policy discussions tended to focus on short-term problems, pushing off potential longer-run consequences of the policy responses as a matter of expediency

The sense is that the participants expected each decision to be sufficient to return markets to normalcy; but of course, they were not.  The ad hoc, short-term nature of policy process, as described in the book, carried with it the risk that not all decisions would be good and would carry with them unintended consequences.  For example, the problems of exiting from many of the policies are now significant and have yet to be addressed

Wessel alleges that the policy makers continually underestimated the crisis and that there was no long-range planning undertaken from the time that the crisis initially erupted.  This should come as no surprise to anyone reading closely the financial press throughout the crisis, and yet it remains disappointing

It is important to note that not all the decisions had the time constraints that surrounded the issue of the Lehman failure in the fall of 2008.  That event was preceded by almost a year of financial turmoil, serial reports of losses, failures or mortgage related institutions, and market disruptions that should have signaled to policy makers that something serious was at hand and that they weren’t simply facing a short-term liquidity problem

By now, it is apparent that the crisis was misdiagnosed as a liquidity problem when in fact it was a solvency crisis.  Funds didn’t suddenly dry up and markets did not stop functioning because there were no funds available.  Rather, because of the trail of losses and preceding events, financial markets finally became wary of the solvency of key counterparties, as the Bear Stearns episode clearly demonstrated.

This was long before the problems in Lehman Brothers emerged.  Market participants’ concerns, as subsequent events proved, were well-founded.  It took policy makers too long to recognize the capital deficiencies relative to the risk exposures of major primary dealers, which then left them with insufficient time to design resolution plans.  Most of the largest financial institutions – both domestic and international – proved to have inadequate capital.  Some failed, and many were bailed out by their respective governments

Wessel’s description of the decision-making process reminds one of a perpetual Chinese fire drill rather than a considered, analytic approach to the problems as they unfolded over time.  The latter implies a systematic plan, and the former implies a sequence of ad hoc responses to unrelated shocks. Even if an initial plan proved inadequate, the experience would have permitted corrections as events evolved.    And lacking a plan, it is harder to see if and when a decision was wrong.

Delegated and Concentrated Decision Making

The second issue that emerges from Wessel’s account is the insular and concentrated nature of the decision-making process, which excluded many members of the Board of Governors and FOMC. Three governors and the president of the NY Fed apparently took on the decision-making responsibility for the central bank in the midst of the crisis. From the narrative, it seems as if this core group effectively froze out the remaining two members of the Board and FOMC members from both decision making and access to key real-time information.

Why did it happen?  Under what authority did this happen?  One plausible answer is that the core group felt that the existing structure was too cumbersome to effectively coordinate policy among so many principals, and so they simply exploited a loophole in the law governing open and closed meetings of government agencies.

Let us explain.  Normally, there are seven members of the Board of Governors, so that a gathering of four would constitute a majority and could officially make decisions.  According to the 1976 Government in the Sunshine Act, which sets out the rules meetings of federal governmental agencies, official Federal Reserve Board meetings in which policies are considered must be announced in advance and,  at a minimum, an agenda must be provided.  For this reason, only three governors can get together in the same room without it constituting a “meeting” and invoking the provisions of the Sunshine Act.   But during the entire crisis there have only been five governors on the Board, with two vacancies.  (David Kotok has written extensively on this issue in previous commentaries.)

Thus, the gathering of the three governors in the meetings that Wessel describes meant that while not technically meeting the legal requirement for a meeting, the three de facto constituted a majority of the sitting governors and could actually make decisions.  Coordinating policy with the entire FOMC would have been more cumbersome and likely would have also required that a written transcript be prepared.  It could be that the core principals felt that a smaller group would make decisions more quickly, and the sense of such a desire for quick decisions comes across in the narrative.

Nevertheless, one can’t help but feel that it might have been beneficial to have been able to tap the broader experience and expertise of the Federal Reserve Bank presidents, especially since so many of the key principals making the crucial decisions were relatively new to their jobs.

The Sanctity of FOMC Meetings

From the perspective of former senior officials of the Federal Reserve System, the details that Wessel reports about specific material in confidential FOMC documents and discussions that took place during FOMC meetings are especially discomforting.  FOMC security is governed by the FOMC’s Program for Security of FOMC Materials, which is a classified program that defines the security levels and handling of FOMC-classified documents.

The Program also sets out rules for how many people can have access to such documents.  At one time, only 10 people at each reserve bank (with the exception of New York and the Board) could have access to the Bluebooks, which contain the policy options presented by the staff to the FOMC.  The Bluebooks receive the highest level of security classification.  The procedures also require detailed record keeping and govern storage and delivery of both hard-copy and electronic documents.

Most importantly, it is also clear in the Program to every attendee that what goes on in that board room at the Board of Governors stays in that room until the transcripts are made public five years later.  In the past there have been a few leaks.  When that happened, staff who attended the meetings, as well as bank presidents, and presumably Governors, were interviewed under oath by the FBI in one case and by a representative of the Board’s Inspector General in another case in an attempt to smoke out the source of the leaks.  The penalties for divulging classified information are extremely severe and might even include criminal charges.

Against that background, the kinds of candid conversations that Wessel had and divulged in his book are indeed surprising.  There are at least a dozen revelations of what went on at various FOMC meetings, who said what, and even what was substantively covered, that rise to a level of severity far above that which triggered investigations by the FBI and Inspector General during the Greenspan era.

One might deduce by simply examining historical Bluebook documents released on the Board’s website that the staff typically offers three policy options for FOMC consideration at each meeting.  So in describing that process Wessel is merely drawing on public information. However, Wessel indicates that in one meeting during the crisis there were actually four options presented, and he describes what some of those options were.  Either there have been significant revisions in the Program for Security of FOMC Materials in the past couple of years or there is now blatant disregard, for whatever reason, of the rules and sanctity of the meetings.

One could view this as another example of how the rules are now being bent at the Fed.  In the near term, these revelations may further damage the credibility of both the FOMC and the Federal Reserve.  It certainly weakens the Federal Reserve’s arguments against additional Congressional auditing of Federal Reserve activities.  After all, if FOMC participants can freely talk to the press in violation of their own security rules, surely Congress has a right to know what is going on as well.

Prior Financial Crises: 1907

Wessel devotes Chapter 2 to describing what he believes are parallels between financial crises of the past and present.  In the interest of historical accuracy, even if it appears that we are nitpicking, it appropriate to point out a couple of factual oversights.

In the second chapter of the book Wessel mischaracterizes key events during the Panic of 1907.  Specifically, he notes that the suspension of Knickerbocker Trust on October 22, 1907, after several days of depositor withdrawals, was the catalyst for the onset of that crisis. Wessel refers to the Knickerbocker Trust as the “Bear Stearns” of its day, claiming that Knickerbocker had lent heavily to the copper speculators, who failed in an attempt to corner that market and brought that firm down, just as Bear Stearns’ mortgage activities brought it down.

But in fact, such allegations about Knickerbocker have never been substantiated, and Wessel may have drawn upon a flawed analogy.  Bear Sterns’ problems were of its own making and not due to the actions of its borrowers.  In discussing Knickerbocker’s failure, Wessel also suggests that Benjamin Strong, then a Morgan employee who was asked by Morgan to inspect the books of the trust company, said that Knickerbocker Trust was insolvent.  Rather, Strong said that he was unable to determine whether it was solvent or not, a subtle but important difference.  That uncertainty parallels the uncertainty that market participants apparently felt about counterparties during the current crisis.

Finally, in contrast to Bear Stearns, which was rescued, Knickerbocker Trust suspended operations but eventually reopened as a going concern in March of 1908.  Ironically, the corrected analogy is likely a closer parallel than the one Wessel draws.  It is precisely the lack of clarity about financial-market solvency in 1907 that parallels the opacity that existed in 2007-2008.

Regardless of perspective, we do not really know how close the financial market came to collapse in 2008.  Whether letting Lehman Brothers fail was good policy or not, it is clear that timely resolution is critical when systemic issues are of concern.  If policy makers, present and future, draw their insights from past attempts to alleviate crises, they should distinguish the successes from the failures during those episodes.  Allowing Knickerbocker Trust to fail was likely a mistake, and one that arose from the lack of timely information about its solvency to the existing lender of last resort at the time (Morgan).

In another section, Wessel suggests that the Federal Reserve System’s creation was largely based on an earlier plan written by investment banker Paul Warburg.  The statement overlooks the overarching point that the Federal Reserve Act was not the work of one person, but was in fact the outcome of several years of careful research, discussion, and debate.  In particular, the National Monetary Commission and its proposal for banking reform, named the National Reserve Association, did incorporate many of Warburg’s ideas.

But Wicker (2005) emphasizes that the Federal Reserve Act bore a striking resemblance to the National Reserve Association legislation.  More importantly, the process was completed nearly five years after the Aldrich-Vreeland Act created the commission to study the reform of the monetary system.  The larger point about the time taken to appropriately reform the financial and monetary system is especially relevant today, as the Congress seems to be in a great rush to reform our financial regulatory system in response to the current crisis.

The Great Depression vs. Depression 2.0

Wessel’s treatment of the Great Depression era is essentially in accord with the standard views regarding that period.  There are two minor points of difference, however.

First, some of the Reserve Bank presidents (governors, as they were then called), most particularly Eugene Robert Black of Atlanta, were consistently supporting the extension of liquidity, rather than policies to enforce the gold standard.  It was this policy that Friedman and Schwartz document and that resulted in a one third contraction in the U.S. money supply, thereby exacerbating the depression.

Bottom Lines

Wessel’s book confirms that the process of saving the financial system was, to no one’s surprise, ad hoc.  Further, the decisions were imperfectly informed by the principals’ perceptions of what was actually occurring.

Clearly, Chairman Bernanke understood the big risk of a financial meltdown and made bold moves to ensure that we didn’t experience another Great Depression.  President Geithner, now Treasury Secretary Geithner, is described as an interventionist whose main concern was the short run and who was willing to deal with the unintended consequences as they arose. Finally, Secretary Paulson seems to have been solely a markets person, long on the bravado associated with a deal maker and short on the analytics required to formulate good policy.

Whether all the actions taken were necessary we will never know, because we can’t observe what might have been had other policies been followed.  But it is clear that the process of dealing with the crisis might have benefited from additional inputs and analysis by people who held responsible positions within the Federal Reserve, but who, for whatever reasons, were not actively involved in the policy-framing process.

Perhaps in the debate that surrounds regulatory reform of the financial markets, the basic management issues of decision-making process design and planning should become a priority.  If not, then we may in the words of Yogi Berra experience déjà vu all over again.”

Note: We would like to note that we benefited greatly from the comments of Kenneth Kuttner who is the Robert F. White Class of 1952 professor of Economics, Williams College.

The reviewers: Bob Eisenbeis is Cumberland’s Chief Monetary Economist. Prior to joining Cumberland Advisors he was the Executive Vice President and Director of Research at the Federal Reserve Bank of Atlanta. Bob is presently a member of the U.S. Shadow Financial Regulatory Committee and the Financial Economist Roundtable. His bio is found at www.cumber.com.  He may be reached at Bob.Eisenbeis@cumber.com. Ellis Tallman is the Danforth-Lewis Professor of Economics, Oberlin College, and was formerly Vice President, Federal Reserve Bank of Atlanta.

A riqueza mundial cairia nos três anos seguintes ao crash de Outubro de 1929 mais de 6% ao ano e o comércio internacional sofreria os maiores recuos de sempre da história da globalização capitalista depois da Revolução Industrial – em média, de 1930 a 1932, caiu quase 1/3 ao ano.

A mão inglesa

Tudo começou em Inglaterra em Setembro de 1929 com a falência de um grande grupo financeiro global liderado por Clarence Charles Hatry, que seria preso na sequência de um jantar no Hotel Charing Cross, em Londres, e com a decisão do Banco de Inglaterra, liderado pelo governador Montagu Norman, de subir, unilateralmente, a taxa de juro de referência para 6,5%, na tentativa de segurar o papel central da City londrina como pólo de atracção mundial de capitais.

O efeito destes dois acontecimentos foi uma fragilização muito forte da Wall Street nova-iorquina que em meados de Outubro começaria a manifestar nervosismo até que o pânico dominou a partir da célebre quinta-feira negra de 24 de Outubro e depois com as maiores quedas diárias, até então, do índice Dow Jones na segunda e terça-feiras negras de 28 e 29 de Outubro.

A crise financeira despoletada em Wall Street, mas congeminada em Londres, segundo vários historiadores económicos da época, rapidamente se tornou global.

Contudo, o pior ano desta Grande Depressão não ocorreria logo após o choque de 1929. A dificuldade da Reserva Federal (o banco central americano) em ser eficaz até 1932 (apesar de ter injectado na última semana de Outubro de 1929 um aumento de 10% na massa monetária!) e a inabilidade política da Presidência americana (o republicano Herbert Hoover, entre Março de 1929 a Março de 1933) conjugou-se com novo golpe estratégico dado em Londres, num domingo, em 20 de Setembro de 1931, com o abandono do padrão ouro pela libra esterlina, o que iniciou um processo de desintegração do sistema financeiro mundial.

O desastre económico concentrou-se em 1932, quer nos Estados Unidos como à escala global. Agrava-se a quebra do comércio internacional (exportações mundiais caem 29% em 1931 e 32% em 1932). O ano de 1932 é, de facto, o mais negro do PIB americano (quebra de 13%, a maior de sempre nos EUA) e no número de suicídios (17,4 por 100 mil habitantes) em grande parte dos Estados Unidos, com particular destaque para Nova Iorque (21,3). A 8 de Julho de 1932, o Dow Jones Industrial Average atinge, finalmente, o seu ponto mais baixo na crise. O índice havia caído 89,2% desde o pico em 3 de Setembro de 1929 e o PIB mundial contrairia 6,6%, o maior de sempre em tempo de paz.

Em 3 de Março de 1933 Hoover termina o mandato e no dia seguinte entra para a presidência o democrata Franklin D. Roosevelt, que ganhara as eleições em 1932 e escapara a uma tentativa de assassinato um mês antes. Pelo final daquele dia de posse, o número de bancos americanos falidos somava 5504. A herança que o novo presidente recebe não poderia ser pior.

Polémica sobre as causas

As causas da Grande Depressão dos anos 1930 continuam envoltas em polémica. O gatilho da crise financeira teria sido a grande especulação dos anos anteriores e do próprio ano de 1929 particularmente em Wall Street, como o narrou John Kenneth Galbraith no seu clássico sobre este acontecimento, intitulado Crash 1929 (edição em português pela GestãoPlus, 2009; versão em inglês aqui), que, durante anos, levou os quiosques de aeroporto a torcer o nariz à venda de um livro que dava ideia de um monumental acidente aéreo.

Como este economista disse, o capitalismo vivia, naqueles anos vinte, num “mundo de faz-de-conta”, que, mais tarde ou mais cedo, sofreria uma derrocada. Entre 1920 e 1929, a capitalização bolsista em Wall Street multiplicou por cinco, refere Robert Shiller e George Akerlof em Animal Spirits, uma obra publicada este ano.

“O que não era historicamente nada de novo”, frisa Carmen Reinhart e Kenneth Rogoff, em This Time is Different, um livro acabado de publicar. O padrão histórico deste tipo de crises financeiras engendradas por especulação bolsista e imobiliária alimentada por excesso de crédito é conhecido e cíclico.

O frenesim de crédito nos EUA geraria um montante de dívida privada que subiu nos anos 1920 a 184% do PIB americano, sublinha J.-A. Lesourd e C. Gérard, dois historiadores económicos franceses, que recordam sobre os anos 1920 um vício financista, que reconheceremos facilmente nos anos 2000: gerou-se “uma predilecção das empresas por operações de Bolsa, frequentemente artificiais, particularmente intensas nos EUA”. A economia real vivia mais virada para a especulação do que para a produção, ironizam os dois autores de uma História Económica dos séculos XIX e XX.

O que difere na apreciação das crises financeiras é verificar se ocorre uma projecção global (à escala planetária) ou apenas restrita a um grupo de países ou região específica. A Grande Depressão dos anos 1930 acabaria por ser uma crise global, sublinham Reinhart e Rogoff no livro referido. Tal como sucedera com a iniciada pelo pânico financeiro de 1907 (que geraria em 1908 uma quebra de 3,6% do PIB mundial e uma diminuição do comércio internacional de 6%) e agora pelo pânico de 2008.

O elo mais fraco era, de facto, a Wall Street, e, segundo o controverso autor Webster G. Tarpley, a própria onda especulativa americana dos anos 1920 teria sido incentivada pelo governador do Banco de Inglaterra com a conivência do seu amigo Benjamim Strong, do New York Federal Reserve Bank.

Outra interpretação clássica das origens da crise prende-se com o avolumar de uma crise de sobreprodução, provocada pelo duplo crescimento da produção quer nos países desenvolvidos como nos países emergentes de então, alguns deles ainda colónias europeias que iniciaram um processo de industrialização durante a 1ª Guerra Mundial que não parou após o final do conflito. Em Junho de 1929, o índice de produção industrial norte-americano tinha atingido o pico e começado a decair. O mercado bolsista nova-iorquino teria sido um espelho desta crise, com atraso de três meses.

A interpretação menos ortodoxa é a do historiador económico Lee E. Ohanian, da Universidade da Califórnia em Los Angeles, que, num trabalho recente para o National Bureau of Economic Research dos Estados Unidos, argumenta que o fósforo que incendiou o ambiente depressivo foi a política salarial prosseguida pelo presidente Herbert Hoover que obrigou o sector empresarial americano a manter salários nominais altos com vista a domesticar o alastramento do movimento de sindicalização e a conter a influência ideológica e política do socialismo nos meios laborais.

Esta dinâmica criaria uma distorção paradoxal no mercado laboral de progressiva baixa criação de emprego (e aumento do desemprego de longa duração) e de altos salários nominais na indústria de transformação. Segundo Ohanian, a produção e as horas trabalhadas cairiam 20% por meados de 1930 e cerca de 40% pelo Outono de 1931. O emprego industrial cairia, naquele período, de 30%.

O filme: 11 dias que abalaram o mundo

19 de Outubro (sábado)

Queda de 3% no índice Dow Jones Industrial Average (DJIA) em Wall Street nova-iorquina, depois de uma queda de 2,5% no dia anterior. O DJIA manifestava oscilações desde o pico em 3 de Setembro, mas sem clima de desconfiança no trading floor. Acontecimentos além-Atlântico influenciam negativamente Wall Street. A 20 de Setembro tinha falido na City londrina o poderoso grupo de Clarence Hatry e o Banco de Inglaterra, pouco depois, decide aumentar a taxa de juro de 5,5% para 6,5%, na tentativa de captar fluxos de capital de curto prazo dos Estados Unidos e de França para Londres, que era ainda a capital financeira mundial, ainda que em declínio.

20 de Outubro (domingo)

Jornais de Wall Street fazem manchetes com as quedas de sábado. Desconfiança e pessimismo contagiam, pela primeira vez, investidores.

21 de Outubro (segunda-feira)

Pânico começa a apoderar-se dos investidores. Mas os analistas insistem que é “apenas o sacudir das franjas mais lunáticas” (dizia o guru economista da época Irving Fisher, que arrecadaria o prémio de maior asneira do ano). Queda do DJIA é inferior a 1%.

22 de Outubro (terça-feira)

Recuperação bolsista de 1,7%, aparentemente dando razão à desdramatização.

23 de Outubro (quarta-feira negra)

Mas, logo no dia seguinte, milhares de investidores saem do mercado em debandada, desmentindo os optimistas. Queda do DJIA de 6,3%.

24 de Outubro (quinta-feira negra)

Inicia-se a verdadeira onda de Pânico Financeiro no trading floor de Wall Street. Mudam de mãos 13 milhões de acções a preços ridículos – um recorde para a época. Uma multidão desesperada agrupa-se à porta da Bolsa nova-iorquina. Winston Churchill visita Wall Street e assiste em directo ao pânico. Principais banqueiros de Wall Street reúnem à 1 hora da tarde nos escritórios da J.P. Morgan e decidem “segurar” o mercado, assistindo-se a uma contenção das quedas no final da tarde. O DJIA acaba por cair apenas 2%, muito menos do que no dia anterior, mas descendo, pela primeira vez, abaixo dos 300 pontos.

25 de Outubro (sexta-feira)

Efeito da reunião dos banqueiros melhora médias diárias dos preços das acções. DJIA sobre ligeiramente (0,6%).

26 de Outubro (sábado)

Ligeira queda (0,7%), mas a comunidade financeira sente-se tranquila com a intervenção dos grandes bancos. O The New York Times diz que “sentimento de ansiedade diminuiu”.

27 de Outubro (domingo)

Alguma tranquilidade com o efeito das declarações do presidente Hoover de que a situação estrutural estava “em boa forma e numa base de prosperidade”.

28 de Outubro (segunda-feira negra)

Campanha publicitária matinal das correctoras de Wall Street incentiva investidores a comprar acções “com toda a confiança”. Mas a realidade é outra: o pânico financeiro agrava-se. O investidor não acredita no presidente Hoover nem no marketing. Segunda maior queda percentual diária da história do Dow Jones Industrial Average (DJIA): 13%. (A maior queda diária de sempre foi, posterior, no crash de 19 de Outubro de 1987 com 22,6%). Efeito mundial nos mercados é imediato.

29 de Outubro (terça-feira negra)

Agrava-se o Grande Pânico financeiro. 16 milhões de acções mudam de mãos – novo recorde na época. Queda do DJIA é de 12%. A bolsa americana perdeu 14 mil milhões de dólares nesse dia, quase 5 vezes mais que o orçamento federal dos EUA. Efeito mundial nos mercados é imediato. No dia seguinte (30/10), o DJIA recupera 12% e no final do mês (31/10) sobe mais 6%. Wall Street volta ao crash na reabertura a 4 de Novembro (DJIA cai 6%) até dia 13.

Robert Madsen is a senior fellow at the MIT Center for International Studies.

IN BRIEF
- “Deleveraging events are much rarer and more serious, leading in some cases to depressions as well as to bad recessions. In this sense, the early stages of the 1930s Great Depression and Japan’s Lost Decade resemble what has happened globally over the last year. All three were driven by the sudden determination of numerous borrowers to reduce their leverage by a large margin.”

- “American spending was the major engine of global growth.”

- “In summary, the effect of the current deleveraging will make this commercial downturn a deep and long one that in some parts of the world may resemble a depression.”

- “But who holds the leverage right now? Can China pull its dollars out of the US markets without losing vast sums of wealth as American bond prices fall?”

- “The Chinese emergence as a globally important source of credit is important and may well herald a change in the balance of power, but I don’t think that will happen soon. For the duration of the present crisis, at least, excess credit is a weakness and not the advantage it has historically been.”

- “I don’t think Japan did as badly as most people think. It had excess savings and hence excess supply for a very long time.”

- “The answer has to lie in greater spending in the developing world as well as in China, Japan, and Germany.”

- “I do not, however, think that governments are stupid enough to reprise the protectionism of the Interwar Years.”

INTERVIEW by Jorge Nascimento Rodrigues
Q: What were the roots of the present economic depression in the OECD countries: a) the credit crunch engineered by stressed and zombie banks, or b) the crash in stocks and in the house sector shortening liquidity of institutional and private wealthy investors and reducing purchase power from households? Or both are converging for a complex situation?

A: Both factors are responsible, as is a third: the loss of global demand.
a. A typical recession occurs when the private economy overheats and the monetary authorities tighten policy in order to slow things down. Corporations cut back their output, investment, and employment until inflationary pressures abate. At that point the central bank eases monetary policy again and allows commerce to accelerate. The whole process typically takes two-to-four quarters.
b. Deleveraging events are much rarer and more serious, leading in some cases to depressions as well as to bad recessions. They begin when the level of debt in an economy rises far above the normal level, often in a way that causes asset prices to rise dramatically. Then something happens that convinces borrowers-corporations, banks, households, or some combination of them-that they are dangerously indebted and need to pay down much of their obligations. The paying down of that debt through sales of stocks, bonds and real estate even as banks curtail the supply of credit, depresses wealth and, through tighter credit, corporate and household commerce. In this sense, the early stages of the 1930s Great Depression and Japan’s Lost Decade resemble what has happened globally over the last year. All three were driven by the sudden determination of numerous borrowers to reduce their leverage by a large margin.
c. In more detail, over the last fifteen years global leverage (not just the United States, not just banks but also hedge funds and consumer finance companies) rose dramatically. The result was a massive global bubble with pockets of particular excess in a few of the most liberalized real estate markets. Once the subprime market collapsed in the United States, financial institutions in North America and Europe realized they were overextended and started calling in loans and selling assets. One effect was an intense credit crunch, some of whose effects have been mitigated by aggressive central bank action-though the ECB in particular has not done enough in this regard.
d. Meanwhile the asset sales by deleveraging financial institutions started driving down the values of all assets, including stocks and real estate that was not at all subprime. The massive erosion of wealth hurt all investors, corporate and private, with the partial exception of governments that were invested in US or Japanese government bonds. Thus the two factors that you adduced in your question-credit crunch and lost wealth–are different aspects of the same story.
As is a third factor, I would add.

Q: A third factor?

A: The third factor-the one which makes this episode of deleveraging particularly nasty–is its effect on the global imbalances. Over the last decade the United States and a few other countries provided the demand that the world needed, on the margin, to grow. This was financed by people and companies within those economies borrowing against the bubbles in real estate and securities markets. It is tempting to view the global imbalances as a result of this excess spending and the current account deficits it produced. But there is another way of looking at the problem. In fact, the extra demand produced in the US, the UK and some other countries was critical to the world because so many other countries-Japan, China, Germany, the developing world, the oil exporters-were all saving much more than they ideally would have done and needed to import demand to keep their economies growing. The overreliance on US consumption was thus the reflection of excess savings elsewhere. American spending was the major engine of global growth.

Q: In that context, what was the impact of the deleveraging process?

A: The deleveraging process would have been difficult enough if it had occurred alone, but its effect on American consumption complicated the problem badly. The sharp loss of US spending means that other countries have lost much of their export markets and will inevitably see their growth rates decline significantly. Unless consumption suddenly increases in the creditor nations (Japan, China, the developing world, Germany) or the US consumer starts spending irresponsibly again-which is unlikely given the lack of credit-the result will be a sustained deceleration in global growth. Instead of expanding at 5-6% per annum as in 2005-2006 over the next decade, it may grow at just 3.0-3.5% for several years. This is unfortunate not only because it means living standards will not rise as fast but also because it may not be enough to suppress unemployment rates in much of the world. Thus we could have several countries around the world shrink by close to 10% of GDP this year and others enter a protracted period of unemployment at 10% or more-both of which meet alternative definitions of depression. In summary, the effect of the current deleveraging will make this commercial downturn a deep and long one that in some parts of the world may resemble a depression.

Q: The present crisis in the US and in the other OECD countries is “lighter” or worse than the Japanese one of the 1990s?

A: The Great Depression, Japan’s 1990s malaise, and the current debacle all originated in the collapse of bubbles and the ensuing process of aggressive deleverage. Japan’s challenges were aggravated, however, by the ageing of the country’s population, which meant a sustained deficit in consumption (alternatively, elevated savings) and a shrinking labor force for something approaching two decades. In this sense Japan’s stagnation was more firmly entrenched than what happened in the Great Depression or the present global crisis. But the country also benefited from a strong external environment: it was growth in the US and China that caused Japan’s current account surplus to expand, kept its factories busy, and allowed GDP to increase rapidly from 2002 to 2007. Now that that external support has collapsed, so too has Japan’s economy. The world should do better than Japan did, since it does not face the same demographic problem. There will be demand from the developing countries and from some parts of the OECD world, which should enable the rate of worldwide growth to increase after 2010 to 3% or a bit more. There are, however, downside risks: governments could make mistakes, as they did in the 1930s, and consumers in the big creditor nations remain insecure and consequently fail to expand their spending. This would depress the medium-term growth rate a bit further.

Q: It’s difficult to compare Japan of the 1990s with US or some of the European countries of today (probably excluding Germany, another powerhouse of exports). Japan was and is a powerful creditor, unlike US and the Europeans, most of them addicted debtors. So, probably, it’s difficult to extract lessons from Japan for the US and Europe, or not?

A: I think it is a mistake to treat creditor nations as if they are stronger than debtor nations. Creditors look strong if you believe that debt is the problem; excessive consumers look strong if you perceive chronically inadequate demand as the systemic vulnerability. You are right in saying that Germany, Japan and China used to comprise a separate category from the profligate economies like the United States. But the loss of the American consumer has created a global situation that looks a lot like 1990s Japan. Japan lacked adequate demand and was forced to grow through a combination of greater current account surpluses and government spending. The world today is in danger of inadequate demand and, since it can’t export to other planets, has no choice but to expand government spending dramatically until private demand begins to resume somewhere. So the world can learn a lot from 1990s Japan even if the United States, still with excess demand, looks somewhat distinct.

Q: But in geopolitical terms to be a creditor is not an advantage that could be leveraged? We can remember the relationship between the US and the British in the 1940s.

A: Yes, you are right. But who holds the leverage right now? Can China pull its dollars out of the US markets without losing vast sums of wealth as American bond prices fall? Then would come higher bond yields, less investment and consumption within the United States and much weaker demand for foreign goods and services. The world recession would deepen and lengthen, and China’s growth rate would fall. It might be appropriate to recall the old banker’s saying: “if you owe the bank $100, you are in trouble. But if you owe the bank $1 million, it is the bank that is in trouble.”

Q: But there’s a moment when the creditor, even if loosing in the financial side, will act upon the debtor, particularly if it is dealing with the incumbent superpower…

A: I think we are talking about two different things, or at least two different timeframes. Over the longer term China may be able to use its creditor status to displace the United States, but in short term China desperately needs American demand. You’ve probably noticed that over the last week (May 18-22) or so China has distanced itself from the idea of fleeing the dollar, saying fos instance that it will continue to finance the US debt. This is not altruism, but a statement of chinese necessity.

Q: For sure China will act with intelligence and in the long term. The US managed the relationship with the UK from the 1910s till the 1940s…

A: There are also a couple of other complicating factors. One is that a dominant currency has to meet other preconditions besides being based on a massive suplly of credit. One of these is a clearly dominant economy, which China does not yet have. Another is convertibility, which is largely impaired in the case of the renmimbi. Still another is stable and internationally compatible governance, which Beijing again does not yet have. Another factor that accelerated the US displacement of Great Britain was of course the devastion of two world wars. In the absence of such events the transition would have taken decades more.

Q: So, the time has not come yet for China…?

A: The Chinese emergence as a globally important source of credit is important and may well herald a change in the balance of power, but I don’t think that will happen soon – and it almost certainly cannot until the world has found a sustainable alternative to US demand. For the duration of the present crisis, at least, excess credit is a weakness and not the advantage it has historically been.

Q: What was the main policy error from the Japanese between the “Akio Morita shock” in 1991 and the temporary recovery of 2002?

A: I may surprise you, but I don’t think Japan did as badly as most people think. It had excess savings and hence excess supply for a very long time. Singapore, Switzerland and other countries with this problem have run current account surpluses of about a tenth of GDP during these times and no one has complained. Japan was much bigger, so the export of so much capital would have hurt the rest of the world-more deflationary pressure-but, ironically, China has been allowed to do much the same thing. So part of the story is why the world has been so much more patient with China. Domestically, it is hard to see how Japan could have pushed down its savings rate. Structural reforms of the sort that increase supply and lower prices might have made things worse, though that is what the US and other foreign powers demanded of Tokyo. Absent that success, expanding the government deficit to keep GDP growing was a good policy. By default, the rest of the world will now do the same thing. The only alternative, globally and within Japan, would be to encourage consumption to expand sharply-which is empirically difficult to do.

Q: So, Japan´s lost decade was not so “lost” after all? There’s certain hype in the criticism from the West analysts?

A: Japan made lots of errors. It should have been much more aggressive with monetary policy, should have avoided the tax hikes of 1996-7, etc. But given the huge problem of excess savings and inadequate demand, it could easily have undergone a depression. Avoiding that was a significant accomplishment, one that outsiders often underestimate.

Q: You say “ironically, China has been allowed to do much the same thing [as Japan]. So part of the story is why the world has been so much more patient with China. “. Why it happened?

A: That is a very interesting question and I don’t have a completely satisfactory answer. In part, it is probably because China is perceived as being a small economy even though that is no longer the case. Another factor is that the Chinese surplus widened rapidly at a time of fast worldwide GDP growth, when countries were less worried and more tolerant. The middle 1980s, when Japan’s imbalance became problematic may have been a more anxious time with memories of the Reagan recession still fresh. Perhaps politicians were more sensitive then. But politics must surely be part of the story as well. Japan relies on the US and has been in a constant dialogue with it. China is an outsider whom the West would like to draw in. I think that reality translated into more tolerance regarding any number of Chinese policies, from human rights to support for nasty governments around the world and perhaps even to economic policy.

Q: The geopolitical and geo-economic situation is today very different from that of the 1990s when Japan began its “lost decade”. Now we have a group of big world creditors with liquidity and with a geopolitical strategy like China, Brazil, India, and the petro-Arab SWF. How this new situation will impact in the evolution of the present Depression?

A: If the big creditors insist on continuing to run surpluses, this downturn will become deeper and longer than it otherwise would. Ultimately developing countries must become a net source of demand. My feeling is that they will not do this until they are convinced that the IMF or some other organization will help them in times of trouble, thereby obviating the need for precautionary current account surpluses.

Q: Are you expecting a balkanization of the global trading system? What will be the most challenging task for the WTO in the months and years ahead?

A: I exaggerated a bit when I used the word “Balkanization.” [referred at an article at Foreign Affairs magazine]. We are already seeing fiscal stimulus packages that favor domestic interests and discourage international cooperation, and the bank recapitalization efforts have the same effect. So to some extent the global system is weakening somewhat. I do not, however, think that governments are stupid enough to reprise the protectionism of the Interwar Years.

Q: Can we compare the ongoing Depression with the Great Depression of the 1930s? If there’s a public policy “lesson” for nowadays from those Great Depressions, which would be?

A: This downturn could border on a depression in some parts of the world though it will not approach the scale of the 1930s Great Depression. Monetary and fiscal stimulus are so much better understood, and used, now than in the past. The lessons that one could glean, however, include:
a. Countries that depreciate dramatically and early fare better than those that hold their exchange rates constant. Obviously this is a difficult game, but empirically the observation is factual;
b. Monetary and fiscal stimulus must be aggressive, so too bank recapitalization;
c. The late 20th-century preoccupation with excess demand and inflation may no longer be appropriate. In deflationary times, the weakness is inadequate demand. Returning the global economy to long-term health will require finding new sources of demand. This cannot reasonably be the United States, where consumers are already overstretched and scared; and ultimately it cannot be governments, since national debts cannot rise indefinitely. The answer has to lie in greater spending in the developing world as well as in China, Japan, and Germany.