Bad ideas spawn Lesser Depression

By Edward Hadas
May 16, 2012

On September 15, 2008 Lehman Brothers collapsed in a heap, a bankruptcy that was followed by a recession in most rich countries. As time goes on, the severity of the disruption becomes both more apparent and more puzzling.

When Lehman failed, it was reasonable to expect the pain to be brief and concentrated. While too many houses had been built in the United States, most of the world’s real economy (comprising factories, offices, retail outlets, construction projects) was doing well. The global financial sector was more distorted, even before investors took fright at the decision to let Lehman go under. But by the middle of 2009, governments and central bankers had agreed to provide bankers and brokers with anything needed to keep them healthy.

Optimism was not justified. Although the countermeasures stopped the deterioration, the rich world now seems stuck in a Lesser Depression – many years of poor economic results and a series of financial crises. In the United States, the euro zone, Japan and the UK, real GDP per person is still lower now than it was four years ago. In all of them, GDP growth is currently either slow or non-existent.

The consumption setback shouldn’t cause too much concern – it wasn’t so bad five or six years ago, when real GDP was last at today’s level. But the enduring recession in the labour market is another matter.

In April 2008 the unemployment rates in the United States, euro zone and UK were respectively 5, 7.3 and 5.3 percent. In April 2012, the corresponding percentages were 8.1, 10.9 and 8.4. More refined indicators – youth unemployment, involuntary part time work and disaffected ex-workers – are even more discouraging. The post-Lehman economy is failing a significant number of people in a fundamental way.

Some economists argue that this real suffering is the necessary price to pay to bring order to the financial world. That’s a dubious argument, since people are more important than money and credit. But the ethical debate isn’t necessary. Despite the real economic pain and the official aid, the financial world looks as ill as ever. On the monetary side, policy remains in shock territory – buyers of safe government debt receive negative real returns. Fiscal positions are equally alarming. Deficits everywhere remain at levels more suitable for wartime mobilisation than for a sputtering economy.

The puzzle is why a relatively small problem in the real economy has led to this Lesser Depression, especially when the authorities have followed expert advice throughout. Surely, if the counsel were sound, the depression would have lifted by now.

The experts offer several excuses. One is that the euro zone’s special problems have delayed recovery. That’s probably true, but European politicians and central bankers are following the best advice on how to compensate. Another is that the authorities should have been even more aggressive in their support for the financial system. Maybe, but even larger fiscal deficits and even easier money would create other distortions. Yet another claim is that governments should have cut back their spending faster. Possibly, but that would hit consumption harder and further increased unemployment.

The problem is actually the experts. Recent history provides a good reason to doubt their competence. Five years ago, economic gurus saw no end to the pre-Lehman “Great Moderation” – steady GDP growth, shrinking unemployment and rising asset prices. They were wrong about that, and they are still making two basic mistakes.

The first concerns the real economy, in particular the highly productive modern economy. Economists underestimate the difficulty of keeping unemployment down. It is much easier to destroy jobs, with labour-saving devices and more efficient procedures, than to create them by starting up enterprises, finding customers for new services or creating new bureaucracies. The employment asymmetry accounts for the persistent pain in the labour market. The jobs shed at the beginning of the Lesser Depression are not easily replaced, nor are the jobs currently being cut by governments searching for austerity.

The second mistake is financial. Economists underestimate the danger of debt. Whether the money is owed by companies, households or governments, the disadvantages of debt financing increase as the ratio of liabilities to income rises. Heavily indebted borrowers are less eager to take economic risks and more likely to default. In a highly leveraged and financially interconnected economy, one default often leads to other bigger collapses. In short, massive debts almost invite economic paralysis. It’s hardly surprising that the increase of debt-financed government spending has done so little good.

So what should be done? New ideas are required – and I’ll offer my contributions over the next few weeks. Without a fundamental change in the thinking, the global economy won’t reach its goal of steady growth and low unemployment.

16 comments

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This is an excellent, thought provoking article. Why it has taken so long for our opinion leaders to acknowledge the blatant failure of public policy I simply do not understand.

Something different needs to be done. The planetary political system cannot survive anti-ethnic, “corporatist” policies aimed at maintaining a global 1% at the expense of the rest of humanity. This is simply a return to 18th century aristocracy, which ended in cataclysm.

Posted by usagadfly | Report as abusive

Mr. Hadas is the only journalist or commentator or editor who has identified September 15, 2008 as the pivotal day when the market crashed world wide.

I have been writing this as an anonymous commentator for years.

Why is this date so significant and remarkable, in advance of the actions of the U.S. Federal regulatory agencies against the banks and investment firms, such as J.P. Morgan?

September 15, 2008 was the day that the use of XBRL, extensible business reporting language, was to be mandatory by Federal law for all publicly traded companies, in the United States.

George Bush, junior, thwarted the mandating of XBRL by the SEC, led by then Chairman Christopher Cox, by installing, if you will 2 persons on a government oversight committee or organization that voted XBRL down.

The SEC is not a politically liberal agency, yet Bush II, was threatened by its attempt to regulate out of control stock market investments and over stating the value of publicly traded stocks. In 2008, the SEC was attempting to get control of the dangerous trading in the US stock market by implementing a computer business language that would allow them, and investors alike, to review and analyze the accuracy of quarterly and annual reports.

JP Morgan in June of 2008 had fired all but one of its paralegals in the NYC office in their legal departments.
I asked why. I was told that the housing market investments had turned south and there were no quarterly or annual reports for them to file with the SEC as in the past, thus, JP Morgan no longer needed the paralegals.
Somewhere in the midst of my questions, JP Morgan admitted that the CDS had run into a wall of no return for them, as in profit.

At the same time in the summer of 2008, retired Wall Street traders exchanged notes about the impending collapse of the market. For them, what was about to happen had been predicted for decades in advance by their stock brokerage firms due to capitalism, and not the computer and not CDS or the housing market, but some elements of the housing market were mixed in.

To me, as an outsider of all of it, trading, compliance with the SEC’s regulations, investments in CDS’s and toxic stocks, and the Bush Administration, there was a complicit understanding of what was going to happen, yet it happened.

It seems that those in power decided that there never has been a solution to what I believe is a depression of a different sort.

The correction that may or can change our present condition is an overall re-engineering of economies from that of acquisition of extreme wealth to that of middle wealth.

Otherwise we will be experience cycles of extreme ups and downs in our economy with companion pain and suffering by most of the population.

Posted by legallyoriented | Report as abusive

Powerful new ideas to extricate ourselves from this mess from a guy who predicted all of this: http://jackworthington.wordpress.com/ or Youtube: http://www.youtube.com/user/jackworthing ton2

We ignore Jack Worthington, his analysis, his proven predictions, and his solutions at our peril. There, I’ve discharged my duty…

Posted by sarkozyrocks | Report as abusive

You leave out that corporations are sitting on huge cash reserves, are making record profits, but still refuse to hire. Without the return of the displaced/laid off workforce, there is insufficient demand for the consumer economy to support. The corporations like having a cowed workforce, where there are 100 people who would take your job at a reduced salary and increased workload.

Posted by Quatermass | Report as abusive

It would literally take a book to answer this casual comment, “The puzzle is why a relatively small problem in the real economy has led to this Lesser Depression, especially when the authorities have followed expert advice throughout. Surely, if the counsel were sound, the depression would have lifted by now.”

It will have to suffice to say it has not been a “relatively small problem” for more than 30 years, due mainly to the continual erosion since then of banking regulations and the concurrent growth of “free trade” — each feeding off of each other until it turned into a full-blown “feeding frenzy”.

After 30+ years of unrestrained wealthy greed, what else would you expect?

Especially since for much of that time our “economic experts” were Alan Greenspan and Ben Bernanke, who managed between them to violate just about every economic principle in the books, plus created some of their own that aren’t even in the books (because no one would ever deliberately choose such a course of action for a country and expect it to survive).

Remember the classic phrase uttered by Greenspan when testifying before Congress about the fact he didn’t understand why the markets were acting with such “irrational exuberance”?

Everyone thought it was a hilarious remark at the time, but frankly I don’t think he — nor Bernanke — ever realized that you simply cannot keep interest rates “at or near zero” for an extended period of time and NOT end up with a financial crash.

In other words, Greenspan didn’t have a clue as to what he was doing. Apparently, neither does Bernanke.

DUH!

Posted by PseudoTurtle | Report as abusive

Some suggestions:

1. Any country that wants access to the USA market must allow their currency to float freely. Too many jobs have been lost to China, because they manipulate their currency to gain an unfair advantage in world trade. If the yuan traded at 2 or 3 times its current level, we would have more jobs here, and the industrialized economies would be much healthier. Consequently, more people could pay off their student loans and buy houses.

2. End the costly, wasteful war on drugs. Legalize marijuana and tax it. Spend the tax revenues on drug education. That alone would save billions.

3. Tell China that if they don’t invade North Korea by Dec 2012 and put an end to the human rights abuses there and stop the nuclear blackmail, we’ll do the job for them. Otherwise, North Korea will inevitably grow stronger, and will become increasingly effective at blackmailing the world with nuclear missiles. That will start to negatively impact our economy, as we must forever accommodate North Korea’s endless demands, and as we are forced to re-militarize for our own defense.

Naturally, we all wish this problem would quietly go away, but it won’t. North Korea is a cancer on the face of the earth. We must not allow their evil ruling dynasty to remain in power generation after generation, for centuries. We might as well take them out now. But give China first crack at it, so they cannot accuse the USA of interfering in their sphere of influence.

4. Stop wasting money trying to police the Middle East. At least Iran is a democracy, of sorts. And they have wealthy, powerful neighbors, such as Saudi Arabia and Israel, who can sort out that mess for themselves.

Posted by DifferentOne | Report as abusive

@DifferentOne: “Otherwise, North Korea will inevitably grow stronger” – Hardly! They may grow “stronger” in absolute terms (all of a sudden, after growing weaker over the last two decades); but a Stalinist near-absolute command economy will never grow as fast as a free market economy with basic social safeguards. North Korea is becoming weaker, relatively speaking; and there is nothing they can do about this except to reform for the better.

Excellent article and comments.

> “It is much easier to destroy jobs, with labour-saving devices and more efficient procedures, than to create them by starting up enterprises, finding customers for new services or creating new bureaucracies. The employment asymmetry accounts for the persistent pain in the labour market.”

Thank you for giving me new terminology for a concept I have been struggling to express concisely. “Employment asymmetry” – I like that.

My concerns for long-term economic growth stem from the fact that the absolute necessities in life are gradually being made to require less and less labour. So, taking into account other factors (such as human greed, “free” market economics etc.); we have three roads to choose between, for the future economy:
1* Increasing differences between rich and poor, with increasing numbers of people working to produce ever more opulent and excessive luxury experiences e.g. electronics, space travel joyrides etc. OR:
2* Increasing involvement of the public sector in economics, with increasing standards of social care e.g. education, health care, support for the disabled etc. (with new technology and paradigms of accountability to improve public-sector efficiency, which might be built on modern communications systems); OR:
3* Increasing exploration, expanding our horizons in space, science, etc.; and thereby forever increasing the domain of competitive entrepreneurial activity (so that employment can keep up with technology) – forever revising our cultural outlook w.r.t. the minimum standard of living that we consider acceptable and dignified for any human being. OR:
4* Some combination of the above.

In any case; it’s clear that the only way to reach any acceptable macroeconomic outcomes (2, 3, 4) involve us SHARING THE WEALTH. In my personal opinion, this will require two things:
#1* Increasing taxation over time, as a proportion of GDP, to counteract the possibility of abusive & undeserved accumulation of “personal” wealth (please note that I would not support confiscatory tax rates; I believe in giving people a chance for #2);
#2* Culturally encourage voluntary giving (kudos to Gates and Buffett for this).

Posted by matthewslyman | Report as abusive

…Addendum…
Solution #1* Increasing taxation over time, as a proportion of GDP… I think this might necessary, on a modest scale; to rebalance the economy for the long-term coming market; in light of the disruptive effects of increasing economies of scale conferred upon ever decreasing numbers of people by ever improving manufacturing & information technology. The winds have changed and we need to collectively change tack…

Posted by matthewslyman | Report as abusive

@matthewslyman

Two factors keep North Korea strong:

1. Our willingness to cave in to their demands.

Consider that North Korea might create a credible nuclear missile force soon, even within a decade. Then, would they be crazy enough to use it? Maybe if they have nothing to lose, which could easily be the case. Then we would be forced to give them whatever resources they demand, helping them continue to survive. Otherwise, we would have call their bluff, at great risk, hoping China would/could intervene. Or we would have to fight them.

2. China’s support.

North Korea is China’s bad boy Frankenstein puppet. And North Korea will continue to behave as it does as long as that suits China’s purposes. No matter how backward North Korea is, it will survive if China wants it to.

And it is certainly a useful bargaining chip. Every time we push China to play fair with their currency, or improve their human rights etc, they can loosen the leash on North Korea as a scary diversion. Then we must beg them to please keep North Korea in control, (and not send nuclear technology to Iran, etc etc.)

So will North Korea collapse any time soon? No way. That would be a disaster for China. Hence, China simply will not allow it.

Here’s another way to think of this: Every time you buy cheap products made in China – and you have very little choice – you support China, which is a dictatorship. And you also support North Korea, because North Korea is China’s puppet.

Many thanks to all the politicians who have gotten us into this mess.

Posted by DifferentOne | Report as abusive

I am intentionally being provocative on this, because we need to think about it now, as the problem will only grow if we do nothing.

Consider the Scarborough Shoal, in the Pacific ocean near the Philippines, where vast oil resources are believed to exist.

China is using our Wal-Mart money to build its military. Why? So that it can claim such resources as the Scarborough Shoal against the will of other claimants, such as the Philippines, which is a USA ally.

Here’s a plausible scenario: China relentlessly bullies its neighbors to intimidate them, climaxing in a naval military standoff. To break the impasse, China unleashes its crazy mad-dog puppet North Korea, who threatens a missile attack on major Pacific cities, including LA, San Francisco, and Seattle.

To avert a disaster – and avoid appearing irresponsible – US negotiators make numerous concessions to China that would otherwise be unthinkable. Victorious, and much richer, China puts North Korea back in its cage. And it starts planning for the next international extortion event, whether for fishing rights, energy resources, or political influence.

This will be enormously profitable for China, and economically disastrous for the other industrialized nations.

So let’s recognize that losing our jobs to China is just the start of a massive transformation of the globe in which totalitarian China become the new imperial master, to our lasting regret.

Welcome to the 21st century, if we let it unfold this way.

Posted by DifferentOne | Report as abusive

We should also ask why Samsung is able to challenge Apple in the cellphone market. Well, Samsung is based in South Korea, and so has benefited enormously from the adversarial politics in that region.

Clearly, many prominent South Korean companies would not be nearly as successful if the USA were not so determined to give South Korea every advantage they need to prove that capitalism is better than communism.

Perhaps if the USA were willing to withdraw from South Korea, we could persuade China to stop supporting the North, and encourage reunification instead, under the leadership of South Korea.

Think of the billions of tax dollars that would save. Think how USA companies could be more competitive if they were not always subsidizing their Korean rivals with USA tax dollars.

Posted by DifferentOne | Report as abusive

To be factually correct, US aid to South Korea ended in the 1960s, and South Korea even pays for the US troops stationed there.

http://www.politifact.com/truth-o-meter/ statements/2011/apr/01/donald-trump/dona ld-trump-says-south-korea-doesnt-pay-us- troop-/

Perhaps the USA really did prove their point that capitalism is better than communism.

On the other hand, some have claimed the won has been artificially undervalued. If true, this is just one more example of how undervalued currencies hurt the USA economy, which is an issue that deserves more attention.

Posted by DifferentOne | Report as abusive

This article keeps referring to unidentified “economists” and “experts”, a habit too easily adopted by financial reporters. Who are these sources of economic punditry? They don’t seem at all like the bona fide economists who would never make such assumptions or make such wild predictions. The analysis and reasoning is interesting, but set against a backdrop of ideologies pushed by pseduo economists and self-proclaimed experts.

The CBOE announced two years ago (without substantiation) their answer to a question debated by economists for four decades: What is the breakeven point in GDP growth that would account for the growth in the labor pool, variously estimated between three to five percent. Their answer: 2.75%. This means that definining a recession as at least two quarters of less than breakeven growth and a depression as at least two years of less than breakeven growth.

This means that the United States (and much of the Euro Zone) has been in a depression for over four years.

Then, there’s the unemployment statistics variously reported by the United States Labor Department’s Bureau of Labor Statistics (BLS). The artificially low official unemployment rate was mandated by Congress years ago to present a more rosy picture of unemployment and most of the media followed like sheep.
But, the BLS also reports the underemployment rate accounting for part-timers and the real unemployment rate that includes the varying labor participation rate – excluded by other measures as “no longer in the labor pool” and “no longer looking for work”, an insulting and blatant lie. The BLS has stated for many years that the real unemployment – laborers who did work, can work and no longer work – as typically 70% higher than the official rate in “good” economic times and 100% or more in bad times. Some estimate that it is currently more than 200% higher. That’s a lot of unemployed people who are “too lazy” to look for work. Let them eat cake.

Posted by ptiffany | Report as abusive

[...] Can we retain privacy in the era of Big Data? Bad ideas spawn Lesser Depression [...]

The lesser world problem:

Too many incompetent people and false elites who want to play God, to be the savior and think they can solve the world problem. False hope, false God.

And the people are always fooled by their charismatic appearance.

Posted by trevorh | Report as abusive

[...] Bad ideas spawn Lesser Depression Should we ditch the idea of privacy? [...]

Hooray for Mr. Hadas for bringing this up for discussion. I propose a corollary to the old adage about insanity: insanity is continuing to follow advice from persons who are essentially batting zero.

Let’s see, we have managed to concoct the following quandary (and this is just a smattering of the ways in which our way of life is nuts):
- a production system capable of producing what everyone needs and what most everyone could reasonably want using only a fraction of our labor capacity. The result should be a society living in plenty with plenty of spare time. Instead, we have a huge labor pool chasing very few productive opportunities.
- so policy makers look at ways to increase our productive capacity thereby creating lots more job opportunities. But we already have a natural world teetering on the brink of collapse due to non-sustainable resource exploitation.
- a crumbling social safety net encourages all who can to squirrel away as much as they possibly can if they want to have any retirement years. This is inefficient — far more retirement savings are needed to insure everyone individually than collectively through social security and/or private pension.
- in the meantime, the world is awash in investment money looking for someplace to invest. It should be clear to all but the most fundamentalist free marketeers that we have long suffered from too much investment money chasing far too few investment opportunities. The housing bubble was but one result (huge demand for those CDOs encouraged dubious mortgage loans, and the rest, as they say , …). The Bush tax cuts can thus be seen as having only exacerbated a bad situation by channeling even more productive output to investments. The dot-com bubble also likely had the same roots.
- our entire way of life is completely dependent on fast dwindling supplies of fossil fuels (yes, there’s plenty more, but it is in increasingly expensive places. Shale oil costs: take the price of Saudi crude and multiply by 100 and that doesn’t even take into account the huge environmental damage).
- so shouldn’t we be developing alternative forms of energy? Well, click your heels and pretend for a moment that we have this alternative energy technology in place. It’ll rely on some combination of natural resources — we can’t build windfarms or solar panels out of thin air, and even thin air is a natural resource. So soon we’ll find ourselves at Peak-New-Energy-Resource, whatever it is.

The idea of infinite growth, both of population and per capita consumption, needs to be put to rest. We should decide to leverage all this productive capacity and use it to distribute output in a sane manner and at the same time free up some of our time. Clearly, this is not the whole answer, but it’ll take us closer.

Posted by Sanity-Monger | Report as abusive

Having voiced some highly speculative theories about South Korea that apparently lacked any basis in fact, and having subsequently eaten my words in public, I am now back from a long, brooding bathroom sulk to ask some questions. I sincerely hope someone knowledgeable will provide a convincing answer:

Given that USA consumer markets have been conquered by one Asian tiger after another in recent decades, with considerable impact on the USA economy, it would clearly be advantageous to understand the Asian Tiger phenomenon in depth.

What puzzles me in particular is how South Korea has recently replaced Japan as the leader in consumer products. For example, Samsung, Hyundai, and LG have come to the fore, while Sony, Panasonic, and Sharp now struggle. This cannot be a mere coincidence.

Is the relatively high value of the Japanese yen the main factor? If so, what is causing the yen value to remain so high? Shouldn’t the Bank of Japan allow some inflation, to devalue the yen and stimulate the economy? And … is the South Korean won undervalued?

No discussion of the western economies can be complete without considering the corrosive impact of currency manipulation by aggressive trading partners who seek an unfair advantage. Some people denigrate the European peripheral nations, calling them PIGGS, but that derogatory term might not even exist if Europe and the USA had not lost so many jobs to China.

Reclaiming some of those jobs would increase EU and USA tax revenues, allowing national debts to be serviced more comfortably. Higher employment would also support the real estate market, and the banks. And it would help students pay off their debts.

Perhaps if we acted decisively to stop currency manipulation now, we could stop worrying altogether about the disintegration of the EU, and the supposed necessity for draconian austerity measures in the USA.

So, what are we waiting for?

Posted by DifferentOne | Report as abusive

[...] Cyprus’ bank bailout may not be the last Bad ideas spawn Lesser Depression [...]