The idea of a long term global recession has gone mainstream

For a year now we have been getting repeated news of new economic problems, followed by quick responses from financial leaders that the problem is near its low and that early recovery is expected. After each "happy news" response we have gotten a new announcement that there is a new problem -- immediately followed by new happy talk announcements the the economy is strong and flexible, the problem has gotten as bad as it can, and recovery can be expected "soon." For most of this year the "soon" has been either by the end of the year or as the year has worn on, early in 2009.

Since the current recession is caused by a combination of the garbage mortgage loans bankers have been selling at exorbitant prices to investors for years and the fact that the American consumer has run out of both disposable income and savings to spend in consumption and the government is not going to do anything beyond playing with interest rates and the money supply (both financial economy measures to deal with what is now a real economy problem of lack of consumption), there has been no obvious source of recovery any time soon.

Lack of demand means lack of investment and declining sales. The absence of increased consumer income together with the inability of banks to lend even at previous levels shuts off any likelihood of an economic recovery anytime soon. The negative feedback loop here is that the declining economy is leading to increased unemployment and even less money for consumers to spend.

Financial fixes that the Federal Reserve can conduct involve either lowering interest rates or increasing the money supply. Increasing the money supply directly creates inflation. The bond market will react to anticipated increased inflation by increasing interest rates - anticipation of inflation is the reason why long-term mortgages have not dropped in price, for example. In the meantime, the fed lowering short term interest rates (the only rates the fed has much control of are short term) will continue to cause a drop in the price of the dollar and thus increase inflation.

This view has gone mainstream. Read Jon Markham at MSN Money. He reports on the highly respected money manager Mohamed El-Erian's recent report that we face "...a painfully stretched-out global recession over the next couple of years."

El-Erian believes that the solvency issues now challenging big U.S. banks are destined to spread out into a full-blown economic dislocation that engulfs and endangers innocent bystanders the world over.

In an interview this week, he insisted that regional banks and local governments can no longer stomp their feet and claim they are immune from danger because they did not speculate on high-risk real-estate loans or structured finance: Collateral effects are going to crash into every institution that has ever lent a dime as excessive levels of debt are violently wrung out of the global financial system.

"I live in a world where crisis management is the norm, not the exception, and you learn a few things" El-Erian said. "You learn never to underestimate the destructive power of negative feedback loops."

Here is El-Erian's view of how the recession is spreading. Bullet points are added.

The insidious loop now has spun its way from Wall Street to the everyday lives of Americans as a financial crisis has become an economic crisis.

• Damaged money-center banks are lending less, leading to lower levels of production and curtailed expansion at companies.
• That has led to job cuts,
• which in turn have led to cutbacks in consumer cash flow and spending,
• which are feeding back into creating problems for credit card, auto and home loans made by smaller banks.
• Those troubles will in turn lead back to a diminished appetite to lend locally for projects with the slightest whiff of risk.

What makes El-Erian stand out among so many skeptics today is his view of the length of time these loops will need to play out. He argues that current stock and bond valuations are still so lofty, even after recent declines, that they suggest most investors believe solutions will come quickly -- creating a V-shaped recovery.

So according to El-Erian, there is still a stock and bond bubble, with both still greatly overprices. Working those prices out will involve a set of negative feedback loops that are all operating to deepen and extend the recession now. There are no free market possibilities which can stop those feedback loops or even shorten the time they go on.

Clearly the only hope that the recession can be shortened lies in government actions. Here's El-Erian's view of that.

El-Erian thinks U.S. government action has been so slow and timid that the recovery will instead drag out into the shape of an L and that it will curve upward into a U only when regulators and lawmakers worldwide are bludgeoned by losses to coordinate their approach despite dramatic regional differences in growth and indebtedness.

"Policy change in Washington, D.C., has been too little, too late," he said. "In a crisis like this, leaders have to be much bolder." [Snip]

A big part of the problem, he says, is that U.S. financial leaders have failed to communicate the extent of the problem, insisting that everything is fine and thereby creating false expectations. He also believes that the Federal Reserve has erred badly both by taking on too many responsibilities and by not prioritizing them effectively. The Fed, he says, started with this mandate: to guide short-term interest rates in a way that supports U.S. economic growth without causing inflation. In March, it appeared to add another mandate: to promote financial stability by mediating deals to keep faltering broker-dealers from collapsing, as it did by assisting the takeover of Bear Stearns by JP Morgan (JPM, news, msgs). And the Fed then appeared to add one more mandate when Bernanke began to talk up the value of the dollar, which is something no predecessor had done.

These mandates conflict with each other, particularly in an economy in need of radical deleveraging, or the shedding of debt. Unless Bernanke can pare back his obligations and clearly articulate that he will help promote growth as a top priority, it will be difficult to assure investors that the central bank is being guided by policy focused on restoring profitability to banks and companies.

A lot of this, El-Erian believes, is because the western bankers and financial experts do not realize that the world economy is very suddenly shifting.

...the United States and Europe have lost their role at the center of the investment universe. He observes that we are currently at a unique moment in world history when the richest countries on Earth are borrowing heavily from the poorest countries... [Snip]

El-Erian says, the world is "upside down" when you consider the strange turn of events that have led irresponsible New York banks to go hat in hand to Abu Dhabi, Singapore and China's sovereign wealth managers in search of new capital. "Poor countries are recapitalizing the rich countries. It's a complete change," he said.

As a result of this transformation in world finance, emerging economies are buying developed countries' assets on the cheap and thus will be first to benefit when global deleveraging is complete. And even at present, while heavily indebted consumers in the United States, United Kingdom and Australia are cutting back on their purchases, dampening their countries' economic growth, consumers in Eastern Europe, China and India who have never had credit cards or subprime mortgages are actually accelerating their purchasing, helping their local economies power ahead.

Going forward, El-Erian believes we should anticipate a widespread realignment of the U.S. banking system, with dozens of medium-sized and large banks disappearing and a few supersized entities, such as, potentially, JP Morgan, emerging.

So if El-Erian is correct, the global financial world is rapidly shifting away from the current wealthiest countries and towards the less-developed world.

The current economic problems, then, reflect major changes in global finance and economics and massive shifts in control of the world's assets. This rather sounds like the abrupt shift that occurred in global finance as a result of WW I, in which Great Britain, France and Germany entered the war effectively owning or controlling over half the world, and four years later came out of the war as essentially destroyed debtor nations with the U.S. owning most of the debt.

But the global shifts are less clear than the fact that the current recession is gong to get deeper rather they recovering by early 2009. That is no longer insider-information known only by the big money banks and traders. MSN Money has reported it, which means that it is already old news that has gone mainstream.

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Discussing the political problems of the Whigs as the severe recession of 1837 to 1846 ran on, Historian Daniel Feller stated "It was one thing to invite people to thrive on their own, another to tell them to suffer on their own." [From p. 505, "What Hath God Wrought[*]" by Daniel Walker Howe.] It has surprised me to find that American political rhetoric from the period of Andrew Jackson and Thomas Jefferson seems to be recycled by modern politicians.

Today's Republicans have a strong interest is denying that the economic conditions are bad and getting worse with little likelihood of recovery soon, particularly since they base a lot of their appeal to voters keeping government intervention out of both the real and the financial economy. Ex-Senator Phil Gramm's recent statement that the American public is a bunch of whiners is exactly that. He is expressing the conservative view that Americans need to suffer alone.

If El-Erian and I are correct about the depth and length of the current economic problems, the conservative economic message and the Reagan Revolution are dead in the water and will be for a long time.

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[*] Addendum 8/11/2008 11:52 pm CDT Misspelling of "wrought" corrected. I blame my fingers liberated by touch-typing for that error. My typing fingers are convinced I meant "wrote."

Which, if you think about it, is a very interesting piece of psychology. How much conscious control do we really retain over those functions we have learned sufficiently well to relegate to unconscious processes - like driving a car or shifting a manual gearshift, for instance.

Think of a soldier trained to fire at any possible threat before thinking about it. It's the same psychological process.

175 Peaceful Protesters at WTO get $1 million from Seattle.

Consider this story in the light of my previous post.

Why did Americans expand the vote from just property owners to universal manhood suffrage after the Constitution was adopted in 1787? One major reason was that the non-property owners had only one political outlet, and that was rioting. American history includes the Whiskey rebellion and Shay's rebellion, both of which were responses to what appeared to be tyrannical government. Armed uprisings by militias in Maryland led quickly both sharp reductions in property rights to vote and to adding an expansive "Declaration of Rights" to the Maryland Constitution. to get the mule to move, first you must get its attention. When nothing else works, a riot is the necessary 2 by 4.

Then Gandhi and Martin Luther King demonstrated the political power of non-violent demonstrations. This was still a way for an oppressed group to bring their requirements to the notice of a government that was otherwise ignoring their needs. The non-violent demonstration is today clearly a much superior form of pressure on governments and corporations which are ignoring the needs of people who are not represented among the decision-makers.

The power of the demonstration depends on the availability of widespread public news. Before newspapers were widely read, it required deaths and fires to get attention. Gandhi had the advantage of newspapers and radios, and was greatly assisted when the British overreacted. The same was true for Martin Luther King. Pictures of the Sheriff of Selma, Alabama siccing dogs on peaceful protesters who included women and children gave the Civil Rights Movement the attention they greatly needed. So did the KKK killings of the Freedom Riders in Mississippi.

Now we get the news that the Seattle Police badly overreacted to the peaceful Protesters at the WTO meeting. I'm happy to see that they are getting the insurance money, but the really important part is that they are getting (positive) widespread news coverage of their message.

Before we get a decent political-economic theory that explains (and limits) Globalization we will have to get a good description of the many problems the current methods are causing. After that we will get the overarching political-economic theory that I discussed in Are corporations conspiring to take over the world.

Maybe we'll get lucky and find some brilliant individual who builds a theory that cannot be so easily reduced to mathematical equations as Keynsianism has been. Not that the math is a bad thing. It's just that the apparent precision of math conceals the many non-quantifiable variables which are often more important than the quantifiable ones are.

Are corporations conspiring to take over the world?

MSNBC has an interesting article on whether corporations are taking over the planet - which makes "Globalism" the equivalent of a conspiracy to dominate the Earth.

It's an interesting article. A major point the author makes is that it is not a conspiracy. It is a bunch of unregulated international corporations which are each working for their own gain, and spreading across the world. It was a similar situation in America when corporations between the end of the Civil War and the Great Depression were operating under the then prevalent Economic theory of the Free Market. The world wide depression beginning in 1872 and then the Great Depression beginning in 1929 were not the result of conspiracies. They were the result of the inadequacies of Economic knowledge and theory that existed at that time. They resulted in John M. Keynes' great theoretical presentation the "General Theory of Employment, Interest and Money."

Keynesian Theory is not yet full developed. Milton Friedman said in a joint lecture with Paul Samuelson at Texas A&M that he was using Keynesian theory, but disagreed with Keynes about the relative importance of the money supply. The thing is that Keynesian economic theory is that it is applicable primarily to national economies using a single currency and under what is mostly a single set of government regulations. In the meantime, the theory of international economics applies to individual national economies operating in an unregulated space between those economies. Globalism appears to have badly blurred the distinctions between national economies and the theory of international economics.

In short, much like the U.S. economy in 1939, economic events are occurring that are not controlled by existing overall economic theory. The solution has been for corporations to retreat back to unrestricted Free Market ideas as would be expected of corporations operating within the idea of total self-interest. The absence of an accepted overall theory that balances the needs of labor, families, and less developed nations allows the corporations to ignore the problems their actions cause, while competition between global corporation forces them to try to beat each other to the most destructive actions they can take to avoid being left behind.

But the real problem of Globalism is not that it is a conspiracy among the corporations. The real problem is the total absence of an accepted global theory of economics and government agreement on how to deal with the corporations.

Josh Bevins presents an interesting view of future globalization.

Josh Bevins over at TPM Cafe presents an interesting view of Globalization. It is an overview of the central problems of the U.S. Economy in a world of globalized trade and his suggestions of what has to be done to bring the American economy back into balance with the global economy. He presents it as an attempt to lay out the ultimate goals that people discussing globalization would probably agree on.

I hadn't realized that the way the Chinese have pegged the value of their currency to the value of the dollar keeps the dollar from falling to its proper international value. But it is reasonable when it is pointed out. That makes our currency automatically overvalued, so that our production industries which export are priced out of the global markets.

That has left the American overdepending on interest-rate sensitive industries (like Construction) to keep producing. When the dollar does finally reach the proper (lower) level, then Construction will have too much labor and industrial production will not have enough. The shift back will be difficult for both industries, but especially for the labor that must be retrained - if we bother to retrain older laid off workers.

There is a lot there. Go read it.