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' Let's Wish Ourselves The Best Of Luck'
Nobel-Prize Winning Economist Says Bottom Just Fell Out Of The U.S. Economy
By Richard McCormack
The United States economy is in a "steep nosedive" that is proving to be "horrific and awesomely dangerous," according to the most recent recipient of the Nobel Prize for economics. Few of the normal prescriptions for reversing a traditional recession are working to avert a potential depression.
"Right now, the numbers giving you some indication of where the economy is moving are quite frightening," says Princeton economist and New York Times columnist Paul Krugman. "Basically, I fire up my computer every morning, take a look at the economic numbers and generally say something I can't print in the New York Times because it's really, really bad stuff, day after day. The economy is headed downhill very fast right now."
With the economy currently losing more than 500,000 jobs per month, Krugman expects the unemployment rate to reach 10 percent within the year. GDP is currently shrinking by a rate of 6 percent. The downturn is feeding on itself.
"As the economy sinks, businesses scale back their investment plans because why add capacity if you're going to have a sharp drop in demand?" Consumers are scaling back out of fear of losing their jobs, and the downward pressure builds.
"I'm scared to death of [2009]," Krugman told a luncheon of the National Press Club in December. "I'm quite optimistic about the year after that because the stimulus will be coming on line and we will be getting a lot of boost. The team coming into the White House does understand that. I start to get concerned again once you look further out because I take a look and say, 'Well, okay, we do know how to boost the economy. If we do a lot of federal spending, that will boost the economy.' But what I don't know is what the end game looks like. Eventually, you want the private economy to step back in. You want to withdraw the stimulus spending. Eventually we have to start worrying about servicing the debt we've run up in the course of the stimulus program. But I don't have a clear story about which part of the private sector takes up the slack after the federal government's stimulus is done. Hopefully we'll get a better read on that a little bit further out, but that is going to be a big issue."
Krugman is struck by the similarities between the conditions that led to the Great Depression and those that have occurred over the past year. A shadow banking system that grew up outside of the traditional banking regulatory system -- one that includes investment banks, hedge funds, asset-backed commercial paper, money market funds and auction rate securities -- has collapsed and "all hell has broken loose," he says.
This shadow banking system was bigger on the eve of the crisis than the traditional banking system -- the one that is protected against bank runs with deposit insurance and regulations on capital and reserve requirements. The shadow banking system was worth at least $10 trillion.
"It hasn't all disappeared, but it has shrunk massively in what is basically a 21st century version of the bank runs that ushered in the Great Depression," Krugman told the scribes. "What made the Great Depression great was not the stock market crash but the banking failures of the early 1930s and we've essentially replicated that experience....The crisis that we have right now is like everything we've seen before all at once: there is a real kind of sum-of-all-fears quality."
The collapse corresponded with bursting of bubbles all around the globe -- in Eastern European nations like Ukraine and Latvia, and with housing in Spain, the UK and elsewhere.
So far, the Federal Reserve and the federal government have responded "predictably" to the crisis, says Krugman. "If you look at [the] policy responses so far it looks a lot like we're moving down a check list."
The Fed has instituted a zero interest rate policy (ZIRP) to rates below where they were in 1935, "and that's not going to work," says Krugman.
The Fed has been aggressively purchasing assets, increasing its holdings from $850 billion to $2.5 trillion, including the purchase of mortgage-backed securities from Fannie Mae and Freddie Mac, which "is not your normal kind of policy," he says. "They are doing enormous stuff."
Those policies have helped mitigate the damage. Mortgage rates have come down, but nothing is working to reverse the nosedive.
The next item on the checklist is fiscal policy -- a massive government stimulus. But even at $850 billion over the next two years "I will be shocked if the Obama people can stop the unemployment rate before 8 percent," he says. "Everything right now hinges on whether we understand this stuff even as well as I think we do, and whether the tools that are at hand are enough to pull us back from the brink. I think so. Not quite as confident of that as even I would have been a year ago. Professionally there is a part of me that says, 'You know, this is the crisis I always wanted to live through,' because that is what economists study. But of course, as an actual human being, it's horrific. Scary times. Let's wish ourselves the best of luck."
--Richard McCormack
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