I posed myself the question: have the Greenspan and Bernanke puts since the 1980s combined with fiscal stimulus to avoid the pain of serious recessions caused the economic problems of today? If so, is there a way out of our current economic quagmire of high unemployment and low growth without simply working off all of our excess debt accumulated over that time? Or can there again be economic gain without terrible pain? Is it as simple as true fiscal stimulus as opposed to some of the measures that have been offered recently? Or are we headed to another downturn in a couple of years followed by the inevitable pain of war or some type of military spending that is the only way out of this mess?
To answer these questions let’s compare today’s situation to two other nasty economic periods in modern American history – the 1970s and the 1930s.
The 1970s: America lost much of its opportunity for growth in the years 1973 – 1976 + 1979 – 1982.
Stagflation reigned brought on by a commodity bubble due to an oil price shock.
The 1930s: America lost much of its opportunity for growth in the years 1929 – 1933 + 1937 – 1939.
Deflation reigned brought on by debt fueled financial asset bubbles and monetary tightening.
Today: America lost the opportunity for growth in the years 2007/8 – 2010. The US experienced an Internet/technology bubble and bust due to 9/11 followed by an even bigger real estate bubble and bust. If we expect something similar to either of these prior eras, when is the next downturn going to begin? 2013? 2014? If history is a guide, it is probably not going to occur as early as in 2011, but anything is possible.
Are we experiencing a combination of Disinflation then Stagflation or a taste of the 1930s followed by a meal from the 1970s? I think we may very well be in for such an experience brought on by debt fueled real estate and commodity bubbles. Look at the prices of many commodities and gold today. The interesting distinction about real estate is that it is both a financial asset (the 1930s part of the equation) and a non-financial asset for homeowners. Homeowners use their homes as a personal investment vehicle – as a financial asset – and borrow against it and use it to save and help fund their retirements. Yet they also live in their homes and receive imputed rent benefits from owner occupied facilities. Moreover, real estate is responsible for a good deal of the use and consumption of commodities (along with the real estate and industrial booms in emerging markets, real estate in the US is the 1970s part of the equation) – e.g. copper, steel, wood, concrete, etc. It is real estate’s dual nature that may help explain the period of disinflation that appears to be followed by stagflation today.
Although America has not yet exhausted its borrowing capacity, bills for the US appear to have come due. Since the oil crisis of the 1970s, the US began borrowing heavily from the Middle East and Japan adding to pre-existing European and domestic borrowing. Since that time, the US has augmented its spendthrift ways by adding borrowing from China into the mix in its efforts to maintain an economy fueled by consumer spending and lessen the impact of “normal” business cycles. The right hand of loose monetary policy from the Federal Reserve has enabled the left hand of fiscal policy to continue its profligate ways and allowed consumers to stretch beyond their means and enjoy a lifestyle that they cannot maintain across business cycles whose troughs are too shallow. No one is willing to bear any pain. We can no longer manufacture booms without any gloom. It doesn’t work over the long term.
In the 1970s, it took painful, rising interest rates combined with increased government defense spending on the cold war in order to pull the US out of its stagflation mess. In the 1930s/1940s, the US economy was slowly moving back to health, but it took holding interest rates around the 2 to 3 percent range and a truly massive federal spending effort on WWII to lift the US (and the world) fully out of the Great Depression.
What will it take this time for the US economy to reach escape velocity and avoid the fate of Japan of the 1990s and today? Low interest rates and large amounts of public spending have not worked for Japan. The correct monetary policy will depend on where inflation is. If the US avoids another near term economic downturn, it may only take time to get the economy going again if there is a long term, credible plan for fiscal rectitude along the lines proposed by the bi-partisan commission. That may be sufficient to restore confidence and the animal spirits necessary to reignite private investment. Without such a plan, fiscal stimulus is wasted. And it may indeed take some real fiscal stimulus along the lines of major infrastructure projects (upgrade of US electrical grid, US interstate highway system, universal broadband wireless) to get the private sector moving again. If history is our guide, however, and if US GDP declines in the next couple of years, it is a dire situation and even most fiscal stimulus will not work. In that scenario, it is likely to take substantial defense spending in anticipation of a war to get the US back on track as horrifying as that prospect may be. Perhaps the war against Islamic fundamentalists is closer than we think?
