The Vicious Cycle

If the no drama team is scared, then I'm scared.

It's quite unsettling to talk to members of Barack Obama's transition teams these days, especially those who are helping with the economics portfolio. Without going into details, the sense I get from them is that they are very worried that the economy will get a lot worse before it gets better. Not just worse... a lot worse. As in -- double digit unemployment without the wiggle factors. Huge declines in aggregate demand. Significant, persistent deficits. That's one reason why the Obama administration seems to be open to listening to every economist with an idea and is stocking the staff with the leading lights of the field. In one sense, the general level of concern among Obama advisers and transition staffers is reassuring; they get the magnitude of the problems, and they're not going to assume that, just because the bottom has never dropped out before -- certainly not in the lifetimes of most people doing policy these days, the bottom will never drop out.

Ambinder winds this around to the worry that an unstable nation, like Pakistan, will suffer a total economic collapse and the US won't have the wherewithal to bail them out. But I see a bigger problem - that the worldwide slowdown and drop in demand crashes China's stratospheric growth, which has been an engine for the global economy for the last decade.

BEIJING — Chinese exports registered their largest drop in nearly a decade last month, suggesting that the global recession could be far worse than many economists had previously predicted.

According to statistics released by the Chinese government Wednesday, exports fell 2.2 percent from November 2007 to November 2008 — the largest year-over-year monthly decline since April 1999.

Even at a time of increasingly dour economic news, the Chinese trade numbers stunned many economists. They struck an ominous note for China, where labor unrest has increased markedly as the economy has slowed in the last month.

Many analysts had anticipated that the monthly trade figures would show China's export machine slowing along with the global economy, but few had expected it to slip into reverse. In October, exports surged 19.2 percent year-over-year.

"We were expecting a slowdown, but the magnitude is a bit shocking," said Wang Tao, an analyst at UBS Securities.

China makes stuff that American consumers buy. When American demand drops, China has a lot of surplus labor. And their factories close. Really terrible situation.

We're also seeing extremely stable entities like the NFL and National Public Radio cut jobs and close down parts of their business (the Arena League? Gone).

In these troubled times, it's important to hold people responsible, so that as we drag ourselves out of this ditch, we never put ourselves in the same situation again. Joseph Stiglitz, who isn't on Obama's economic team right now for reasons that are inscrutable, makes the argument in this month's Vanity Fair that the problem was explicitly ideological.

There will come a moment when the most urgent threats posed by the credit crisis have eased and the larger task before us will be to chart a direction for the economic steps ahead. This will be a dangerous moment. Behind the debates over future policy is a debate over history—a debate over the causes of our current situation. The battle for the past will determine the battle for the present. So it’s crucial to get the history straight [...]

Greenspan played a double role. The Fed controls the money spigot, and in the early years of this decade, he turned it on full force. But the Fed is also a regulator. If you appoint an anti-regulator as your enforcer, you know what kind of enforcement you’ll get. A flood of liquidity combined with the failed levees of regulation proved disastrous.

Greenspan presided over not one but two financial bubbles. After the high-tech bubble popped, in 2000–2001, he helped inflate the housing bubble. The first responsibility of a central bank should be to maintain the stability of the financial system. If banks lend on the basis of artificially high asset prices, the result can be a meltdown—as we are seeing now, and as Greenspan should have known.

What we ought to see here is the death of both neoliberalism and free market fundamentalism - the ideas that risk can always be managed, that asset bubbles are good when they're running so they should be encouraged, that investment banks should be unregulated and free to make big bets with other people's money, that credit rating agencies owned by the banks would be independent enough to make judgments on those banks, that tax cuts are an economic panacea, all of it. Stiglitz' final paragraph should be seared into our brains.

The truth is most of the individual mistakes boil down to just one: a belief that markets are self-adjusting and that the role of government should be minimal. Looking back at that belief during hearings this fall on Capitol Hill, Alan Greenspan said out loud, “I have found a flaw.” Congressman Henry Waxman pushed him, responding, “In other words, you found that your view of the world, your ideology, was not right; it was not working.” “Absolutely, precisely,” Greenspan said. The embrace by America—and much of the rest of the world—of this flawed economic philosophy made it inevitable that we would eventually arrive at the place we are today.

What has me worried is that this failure of ideology will result in a very long and deep economic collapse, out of which there isn't much hope for a few years, and that Obama, not his predecessors, will be tarred with the responsibility for the problem because he could not work the country out of it, and in opposition we get the exact same failed solutions (really, Mike Pence is calling for things like a balanced budget amendment), and an American public starving for relief will buy what Republicans are selling again. That's the vicious cycle we have to avoid, and so drastic steps must be taken without worrying about the short-term political consequences.