Fixing the Economy: Of Fences and Futures
A man calls a carpenter and says that his dog has been getting out. He instructs the carpenter to raise the fence in the back yard by a foot. The carpenter does the job.
The next day, the man calls the carpenter back and says that the dog is still getting out. He tells the carpenter to add another foot to the top of the fence. The carpenter does so.
On the third day, the man calls the carpenter back yet again and begins to tell him to add still another foot. But this time the carpenter interrupts him. Pointing to the far corner of the yard, he says, "Sir, I can raise the top of the fence to the sky, but until you fix that hole at the bottom, the dog is going to keep getting out."
So far, all the money aimed at fixing the economy has gone to the top of the fence - the banks - and not at the actual hole in the bottom - insufficient incomes. We can pour money into the banks until the government itself is bankrupt but until we fix the problem at the bottom, with vanishing jobs, declining incomes, and rising foreclosures, the crisis will only deepen.
Giving money to the banks hasn't worked and won't work for three reasons. First, they are insolvent. The financial crisis has destroyed almost $4 trillion in bank-system capital, against a little less than $2 trillion in equity. The banks are literally bankrupt with nothing to lend. Unless the government is willing to give the banks an additional $2 trillion of taxpayer money, they cannot be revived in their current form.
Second, the banks are leery of loaning to each other because they all know this. They all know of their own devastated balance sheets and of the "toxic sludge" that has brought them down. They know all too well that the same toxic sludge infects the balance sheets of all of the other banks. No one wants to lend to someone that is both bankrupt and holding nothing but bogus assets. Would you?
The final reason the top-of-the-fence strategy won't work is that banks know all too well the plight of consumers whose spending makes up over 70% of GDP. They can see better than anybody the collapse of consumer incomes, the overextension of credit card debt, the late payments on car loans, the decimated retirement accounts, the skyrocketing foreclosures, and the imploding home values. There has never been a worse time to lend money, so expecting it to happen from bankrupt banks to collapsing consumers is idiocy.
All of this is made still worse because the collapse is feeding on itself. Every time someone loses a job, the chance of foreclosure skyrockets. And every time a home's value is written down in foreclosure, the balance sheet of the bank that wrote the mortgage is undermined. The losses at the bottom are precisely what continue to erode the balance sheets at the top.
A "banks-first" strategy amounts to trying to fill a bucket with a hole in it by catching the water that's leaking out of the bottom and returning it to the top before it drains out again. You can't get ahead because to raise the level in the bucket, you need ever more water from the hole in the bottom. But more water from the bottom is exactly what lowers the level at the top. It's an exercise in futility, indeed, insanity.
The government needs to plug the hole in the bottom by declaring a moratorium on foreclosures until mortgage debts can be renegotiated, probably with government help - the same government help that would otherwise go to the banks. Only this will stop the drain on bank balance sheets.
But this can only be effective in the context of a revived employment market. The U.S. economy has lost almost 4 million jobs in the past year and the rate of loss is accelerating. In January, 600,000 jobs were lost, an annual rate of over 7 million. This is why the administration's stimulus program is so important.
It is the first attempt since the beginning of the crisis that begins to actually address the core of the problem: that consumers do not have enough income to keep the economy afloat. And there's nothing left they can borrow against to sustain the illusion of prosperity that has been the entirety of the economy's "growth" for the past eight years.
As important as restoring jobs and improving productivity are in the short run, they are even more critical in the long run. The U.S. needs to borrow in excess of $2 trillion this year and perhaps as much again next year. It is an astonishing, almost inconceivable sum, four times the amount the nation borrowed in its first 204 years combined. That is the plight the Republicans have left us with. It cannot be underestimated.
To borrow such sums, the U.S. needs to present a plausible story to its foreign creditors about how it will pay the money back. Until recently, the dollar's status as the world's reserve currency allowed the U.S. to simply print money for the things it wanted to buy. That is what has allowed us to run trade deficits and budget deficits in excess of a trillion a year, essentially borrowing that sum from foreigners on the promise to pay later.
But that era is over. It has become clear to all the world that the U.S. has lived far beyond its means and that it does not begin to earn the funds needed to sustain its lifestyle. After the near collapse of Fannie Mae and Freddy Mac last fall, foreigners have become leery of the "trust us" line that has become Uncle Sam's only story.
If the U.S. cannot show these foreign lenders - think China, Saudi Arabia, and Japan - how it will pay the money back, they will soon stop the lending, as any sensible creditor would. Why throw good money after bad? This was the clear message of Vladimir Putin and Chinese Premier Wen Jiaboa at the recent Davos conference in Switzerland.
If foreigners stop lending, the resulting collapse will make the recent crisis look like a child's game of Monopoly gone awry. Instead of a 5% fall in GDP, it will be closer to 15%. Instead of 7.6% unemployment, think 20%. Asset values, meaning home and stock prices, will plummet even further. Consumer spending will retrench dramatically in fear of still further erosions of wealth and income.
At some point, such a dynamic becomes impossible to reverse. To attract the money to run the government, the Treasury will have to raise interest rates on government bonds to stratospheric levels. This will kill off any possible recovery, consigning the U.S. economy to a self-reinforcing downward spiral of insufficient demand, inadequate investment, crumbling infrastructure, declining productivity, and competitive obsolescence.
Susan Sontag once wrote, "We need the courage to be serious." We need not only a short-term but also a long-term strategy that provides jobs and incomes so that we don't require ever greater doses of borrowed money to keep the lights on. As a nation, we need to begin producing things that other nations want to buy so that we can afford to buy the things they produce without having to write an endless stream of trillion dollar hot checks.
There isn't enough money in the treasury to raise the fence to the sky. Even if there were, it would be fruitless unless we fix the hole at the bottom. And we need to fix it quickly and persuasively while others will still loan us the money to do it. The decades-long sucker's game we've played on other nations and ourselves is over. It's time to grow up.