There is no longer any debate about the U.S. entering a period of a declining economy. Everyone who watches the leading indicators had been expecting a recession since the beginning of the year. Finally, in the third quarter, it came.
Nor is there any debate about the global slowdown. It's not that the United States controls the rest of the world. It's just that the same things that have pushed us into recession are also affecting the rest of the world: overextended credit based on loose credit standards, and a growth spurt based on the loose standards. As is almost always the case, growth spurts go too far, too fast, and have to be brought back to earth and consolidate before taking off again. I think it will be some time before the emerging markets take off again, but they will, eventually. Just not any time soon. This is also true of the United States and Europe. We will resume our growth, eventually. But there is going to be some time before we are ready to sustain more growth.
And therein lies a problem. With everyone declining at the same time, we can go too far to the downside and experience deflation--a spiral to the downside that frightens economists. Depression, which is the companion of deflation, is not something anyone who knows would want to see. There is nothing uplifting about suffering for years, where entire economies collapse under the weight of falling demand, falling employment and falling production. Recessions are a necessary adjustment to a period of excess. Depressions are not necessary, but they can happen if the economy isn't handled well.
A recession could see unemployment in the U.S., for example, reach 7% or 8%. A depression could see 25%. There is no comparison, though, between this set of numbers. The level of suffering under a depression is much more than, say seven multiplied by three or four (7% x 3 = 21%). From depression come revolutions and war, as scape-goats are sought and found. Demagoguery rules when things look hopeless, and those afflicted by unemployment and despair are easily swayed into despotic politics. It happened in post WWI Germany, when the onerous provision of the Treaty of Paris pushed Germany into the arms of Adolph Hitler. It has happened in Argentina where bad conditions led to the fascism of Juan Perón. This specter could easily be duplicated in many of the emerging markets if things get bad. The democracies in South East Asia, for example, are too fragile to handle a period of major deflation.
These conditions make it exceptionally important that the American, Japanese and European economies be handled properly during the downturn. The burden falls on these three regions because it is demand from the large economies that drive production and growth in the smaller ones. During this time we cannot look for strictly balanced budgets. Deficit spending, if done on public projects that are needed and useful (roads, bridges, schools, etc.), can go a long way in reducing the ill effects of unemployment and help keep consumer spending up. Longer unemployment benefits, veteran help for college and home loans are other measures that were especially effective after WWII that saw the return of more than a million soldiers and sailors to the economy.
We will have our hands full for most of 2009. Most of the predictions I see point to a possible end of the recession by the third quarter of next year--if things go well. One thing about deflation: it can be stopped by printing enough money. But, the balance between enough and too much is sometimes hard to find. And that task, in my view, will be the defining test of our next President. Go too far, and we have hyper inflation, which, in its own way, is as bad as deflation. Not go far enough, and we have deflation and depression. It's a thin line between these poles. I hope for a wise President and an equally wise Congress to keep the proper balance on this line.
Even though there will be plenty of skeptics who think "wise President" and "wise Congress" are oxymoron terms, I disagree. There are times when it appears that way, but I think when things get bad, there is a tendency of Americans to pull together. We will certainly have this test to pass in the coming year.
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