A Forlorn Conclusion
Joseph E. Stiglitz is University Professor at Columbia University, a Nobel laureate in economics, and the author of “Freefall: Free Markets and the Sinking of the Global Economy”. His December 28th article, “The Book of Jobs”, can be seen in Information Clearing House, but in the meantime we’d like to bring a few of his observations to your attention.
Re-examining the cause of the Great Depression, Professor Stiglitz tells us to forget monetary policy. He argues that the U.S. now must manage a similar shift in the real economy, or risk a tragic replay of 80 years ago.
“We knew the crisis was serious back in 2008,” he begins. “And we thought we knew who the bad guys were – the nation’s big banks, which through cynical lending and reckless gambling had brought the U.S. to the brink of ruin. The Bush and Obama administrations justified a bailout on the grounds that only if the banks were handed money without limit – and without conditions – could the economy recover. We did this not because we loved the banks but because (we were told) we couldn’t do without the lending that they made possible … In the meantime, a short-term stimulus, moderate in size, would suffice to tide the economy over until the banks could be restored to health.
“The banks got their bailout. Some of the money went to bonuses. Little of it went to lending. And the economy didn’t recover … and the job situation is bleak …
“We were told, in effect: ‘Don’t put conditions on the banks to require them to restructure the mortgages or to behave more honestly in their foreclosures. Don’t force them to use the money to lend. Such conditions will upset our delicate markets.’ In the end, bank managers bank managers looked out for themselves and did what they are accustomed to doing …
“But incomes for most working Americans still hadn’t returned to their levels prior to the previous recession. The American standard of living was sustained only by rising debt – debt so large that the U.S. savings rate had dropped to near zero. And ‘zero’ doesn’t really tell the story. Because the rich have always been able to save a significant part of their income, putting them in the positive column, an average close to zero means that everyone else must be in negative numbers.
“(Here’s the reality: in the years leading up to the recession, according to research done by my Columbia University colleague Bruce Greenwald, the bottom 80 percent of the American population had been spending around 110 percent of its income.)
“What made this level of indebtedness possible was the housing bubble, which Alan Greenspan and then Ben Bernanke, chairmen of the Federal Reserve Board, helped to engineer through low interest rates and nonregulation – not even using the regulatory tools they had. As we now know, this enabled banks to lend and households to borrow on the basis of assets whose value was determined in part by mass delusion …
“The trauma we’re experiencing right now resembles the trauma we experienced 80 years ago, during the Great Depression, and it has been brought on by an analogous set of circumstances. Then, as now, we faced a breakdown of the banking system. But then, as now, the breakdown of the banking system was in part a consequence of deeper problems. Even if we correctly respond to the trauma – the failures of the financial sector – it will take a decade or more to achieve full recovery. Under the best of conditions, we will endure a Long Slump. If we respond incorrectly, as we have been, the Long Slump will last even longer, and the parallel with the Depression will take on a tragic new dimension.
“Until now, the Depression was the last time in American history that unemployment exceeded 8 percent four years after the onset of recession. And never in the last 60 years has economic output been barely greater, four years after a recession, than it was before the recession started. The percentage of civilian population at work has fallen by twice as much as in any post-World War II downturn. Not surprisingly, economists have begun to reflect on the similarities and differences between our Long Slump and the Great Depression. Extracting the right lessons is not easy.
“Many have argued that the Depression was caused primarily by excessive tightening of the money supply on the part of the Federal Reserve Board. Ben Bernanke, a scholar of the Depression, has stated publicly that this was the lesson he took away, and the reason he opened the monetary spigots. He opened them very wide. Beginning in 2008, the balance sheet of the Fed doubled and then rose to three times its earlier level. Today it is $ 2.8 trillion. While the Fed, by doing this, may have succeeded in saving the banks, it didn’t succeed in saving the economy.
“Reality has not only discredited the Fed but also raised questions about one of the conventional interpretations of the Great Depression. The argument has been made that the Fed caused the Great Depression by tightening money, and if only the Fed back then had increased the money supply – in other words, had done what the Fed has done today – a full-blown Depression would likely have been diverted … But the inability of the monetary expansion to counteract this current recession should forever lay to rest the idea that monetary policy was the prime culprit in the 1930s. The problem today, as it was then, is something else. The problem today is the so-called real economy. It’s a problem rooted in the kinds of jobs we have, the kind we need, and the kind we’re losing, and rooted as well in the kind of workers we want and the kind we don’t know what to do with. The real economy has been in a state of wrenching transition for decades, and its dislocations have never been squarely faced. A crisis of the real economy lies behind the Long Slump, just as it lay behind the Great Depression …
“The breakdown of the banking system didn’t culminate until 1933, long after the Depression began and long after unemployment had started to soar. By 1931 unemployment was already around 16 percent, and it reached 23 percent in 1932 …
“By 1937, F.D.R., giving way to the deficit hawks, had cut back on stimulus efforts – a disastrous error. Meanwhile, hard-pressed states and localities were being forced to let employees go, just as they are now. The banking crisis undoubtedly compounded all these problems, and extended and deepened the downturn. But any analysis of financial disruption has to begin with what started off the chain reaction …
“But it was not until government spending soared in preparation for global war that America started to emerge from the Depression. It is important to grasp this simple truth: it was government spending – a Keynesian stimulus, not any correction of monetary policy or any revival of the banking system – that brought recovery. The long-run prospects for the economy would, of course, have been even better if more of the money had been spent on investments in education, technology, and infrastructure rather than munitions, but even so, the strong public spending more than offset the weaknesses in private spending.
“Government spending unintentionally solved the economy’s underlying problem: it completed a necessary structural transformation, moving America, and especially the South, decisively from agriculture to manufacturing. Americans tend to be allergic to terms like ‘industrial policy,’ but that’s what war spending was – a policy that permanently changed the nature of the economy. Massive job creation in the urban sector – in manufacturing – succeeded in moving people out of farming … The process had been long and very painful, but the source of economic stress was gone.
“The parallels between the story of the origin of the Great Depression and that of our Long Slump are strong …
“Two conclusions can be drawn from this brief history. The first is that the economy will not bounce back on its own, at least not in a time frame that matters to ordinary people. Yes, all those foreclosed homes will eventually find someone to live in them, or be torn down. Prices will at some point stabilize and even start to rise. Americans will also adjust to a lower standard of living – not just living within their means but living beneath their means as they struggle to pay off a mountain of debt. But the damage will be enormous. America’s conception of itself as a land of opportunity is already badly eroded. Unemployed young people are alienated. It will be harder and harder to get some large proportion of them onto a productive track. They will be scarred for life by what is happening today. Drive through the industrial river valleys of the Midwest or the small towns of the Plains or the factory hubs of the South, and you will see a picture of irreversible decay.
“Monetary policy is not going to help us out of this mess. Ben Bernanke has, belatedly, admitted as much. The Fed played an important role in creating the current conditions – by encouraging the bubble that led to unsustainable consumption – but there is now little it can do to mitigate the consequences. I can understand that its members may feel some degree of guilt. But anyone who believes that monetary policy is going to resuscitate the economy will be sorely disappointed. The idea is a distraction, and a dangerous one.
“What we need to do is instead is embark on a massive investment program – as we did, virtually by accident, 80 years ago – that will increase our productivity for years to come, and will also increase employment now. This public investment, and the resultant restoration in G.D.P., increases the returns to private investment. Public investments could be directed at improving the quality of life and real productivity – unlike the private-sector investments in financial innovations, which turned out to be more akin to financial weapons of mass destruction.
“Can we actually bring ourselves to do this, in the absence of mobilization for a global war?
“Maybe not …
“The private sector by itself won’t, and can’t, undertake structural transformation of the magnitude needed – even if the Fed were tom keep interest rates at zero for years to come. The only way it will happen is through a government stimulus designed not tp preserve the old economy but to focus instead on creating a new one …
“The second conclusion is this: If we expect to maintain any semblance of ‘normality,’ we must fix the financial system. As noted, the implosion of the financial sector may not have been the underlying cause of our current crisis – but it has made it worse, and it’s an obstacle to long-term recovery. Small and medium-size companies, especially new ones, are disproportionately the source of job creation in any economy, and they have been especially hard-hit. What’s needed is to get banks out of the dangerous business of speculating and back into the boring business of lending. But we have not fixed the financial system. Rather, we have poured money into the banks, without restrictions, without conditions, and without a vision of the kind of banking system we want and need. We have, in a phrase, confused ends with means. A banking system is supposed to serve society, not the other way around.
“That we should tolerate such a confusion of ends and means says something deeply disturbing about where our economy and our society have been heading. Americans in general are coming to understand what has happened. Protesters around the country, galvanized by the Occupy Wall Street movement, already know.” –
[Now you know why Professor Stiglitz became a Nobel Laureate in Economics.]
He makes us feel pretty good about ourselves. He’s saying, in a very professional way, what we’ve been saying for the last dozen years: We must create jobs – and the follow up “multiplier effect”.
– “It is important to grasp this simple truth: it was government spending … not any correction of monetary policy or any revival of the banking system – that brought recovery.”
– “Government spending unintentionally solved the economy’s underlying problem: it completed a necessary structural transformation …”
– “Two conclusions can be drawn from this brief history. The first is that the economy will not bounce back on its own …”
– “Monetary policy is not going to help us out of this mess. Ben Bernanke has, belatedly, admitted as much.”
– “What we need to do instead is embark on a massive investment program – as we did, virtually by accident, 80 years ago – that will increase our productivity for years to come, and will also increase employment now.”
– “Can we actually bring ourselves to do this, in the absence of mobilization for a global war? Maybe not …”
Well, yes we can. We “accidentally” ended the Great Depression by building ships for wartime use. We can certainly end the current crisis by building patented container ships for peacetime use.