Seven days ago, I wrote that Martin Wolf’s urgent warning about the dismal “Bank Bailout II (This Time We Mean It”) made his column a must-read.
Wolf has been one of my very favorite economics writers for a while, but he is doing perhaps his most important work at the moment.
His dispatch this morning is another clarion call. Combine it with his newspaper’s mind-boggling front-page exclusive on Alan Greenspan calling for banks nationalization and its in-depth look at the fall of Spain’s economy, and you’ve got yourself one helluva newspaper. All for only $2.50 on the newsstand (or $11 a month on the FT terrible Web site).
Wolf compares the current state of affairs to Japan’s “Lost Decade” and says we’ll be lucky if that’s all that’s in store for us. He neatly dispatches the New Hoovers who oppose government spending (emphases are mine):
Second, those who argue that the Japanese government’s fiscal expansion failed are, again, mistaken. When the private sector tries to repay debt over many years, a country has three options: let the government do the borrowing; expand net exports; or let the economy collapse in a downward spiral of mass bankruptcy.
Despite a loss in wealth of three times GDP and a shift of 20 per cent of GDP in the financial balance of the corporate sector, from deficits into surpluses,
So, without Japan’s heavy government spending on infrastructure and the like, the country would have likely fallen into a crippling depression rather than the long malaise that became known as the “golden recession.”
Wolf knocks a flawed analogy off the table:
First, comparisons between today and the deep recessions of the early 1980s are utterly misguided. In 1981, US private debt was 123 per cent of gross domestic product; by the third quarter of 2008, it was 290 per cent. In 1981, household debt was 48 per cent of GDP; in 2007, it was 100 per cent. In 1980, the Federal Reserve’s intervention rate reached 19–20 per cent. Today, it is nearly zero.
But he notes that asset prices, believe it or not, were far more inflated in Japan in the early 1990’s than they were in the U.S. and elsewhere two years ago. Remember the infamous belief that the real estate underneath Japan’s Imperial Palace was worth more than all of California?
Okay, enough of that. Back to bad news:
The bad news is that the debate over fiscal policy in the US seems even more neanderthal than in Japan: it cannot be stressed too strongly that in a balance-sheet deflation, with zero official interest rates, fiscal policy is all we have. The big danger is that an attempt will be made to close the fiscal deficit prematurely, with dire results. Again, the US administration’s proposals for a public/private partnership , to purchase toxic assets, look hopeless. Even if it can be made to work operationally, the prices are likely to be too low to encourage banks to sell or to represent a big taxpayer subsidy to buyers, sellers, or both. Far more important, it is unlikely that modestly raising prices of a range of bad assets will recapitalise damaged institutions. In the end, reality will come out. But that may follow a lengthy pretence.
Yet what is happening inside the US is far from the worst news. That is the global reach of the crisis. Japan was able to rely on exports to a buoyant world economy. This crisis is global: the bubbles and associated spending booms spread across much of the western world, as did the financial mania and purchases of bad assets.
Gird your loins.