CommUnity of Minds — Daan Joubert writes: It is no longer news that the US economy is in trouble. This essay reviews certain key features of the US economy and how these might influence the outlook for the US over the near to medium term. The conclusions, unfortunately, are gloomy.
The theme for the analysis is set by a quotation from the book, “This time is different: Eight centuries of Financial Folly”, by Ken Rogoff and Carmen Reinhart. Near the end of the book, the following appears:
“The lesson of history, then, is that even as institutions and policy makers improve, there will always be a temptation to stretch the limits. Just as an individual can go bankrupt no matter how rich she starts out, a financial system can collapse under the pressure of greed, politics, and profits no matter how well regulated it seems to be. [Much has changed . . .]
‘Yet the ability of governments and investors to delude themselves, giving rise to periodic bouts of euphoria that usually end in tears, seems to have remained constant. No careful reader of Friedman and Schwartz will be surprised by this lesson about the ability of governments to mismanage financial markets, a key theme of their analysis.
‘As for financial markets, we have come full circle to the concept of financial fragility in economies with massive indebtedness. All too often, periods of heavy borrowing can take place in a bubble and last for a surprisingly long time. But highly leveraged economies, particularly those in which continual rollover of short-term debt is sustained only by confidence in relatively illiquid underlying assets, seldom survive forever, particularly if leverage continues to grow unchecked.
‘This time may seem different, but all too often a deeper look shows it is not. Encouragingly, history does point to warning signs that policy makers can look at to assess risk—if only they do not become too drunk with their credit bubble-fueled success and say, as their predecessors have for centuries, “This time is different.”
One can argue long and hard about the causes of the ongoing financial crisis of the past 3-4 years, but it will be generally admitted a few factors played a key role in fomenting the crisis. Underlying it all is a change in social climate that took root in the US after WWII and subsequently found fertile soil in many other places, predominantly in the western world. There was a change from the old standard where society was rated more important than the individual; it would seem that with the increased rights of the individual came a “me first” attitude that meant one was entitled to break society’s rules and even laws when in pursuit of personal benefit.
Leaving this more philosophical factor aside, it is self evident that reduced or even lack of oversight in financial markets, a too free and easy monetary policy, new and free-flowing sources of credit, a free-spending Federal government, manipulation of official statistics and the free trade climate have all at various times and to different degrees contributed to the complex mess that erupted in 2007 when Bear Stearns announced that their mortgage funds were in deep trouble. Of course, it took the Lehman collapse to bring home the magnitude of the developing crisis.
Despite initial assurances that ‘the mortgage problem is contained’ and later that the ‘green shoots are sprouting all over’, then that ‘economic growth is slow but steady and the end is in sight’, it should be evident that the American economy is not well. The real question now is not so much whether we will see a double dip, but whether the ongoing recession will drag on until the economy can show new growth or if it will deepen into a more severe recession, even depression. If the latter, which is the anticipated future here, the question of how long and how deep becomes relevant. (08/30/11)