June 16, 2009

Our Great Recession Could Be Made Into A Great Recovery (Updated)

I was reading through Brad DeLong's 1997 chapter on the Great Depression, enjoying his detailed writing, when I hit the central question we face now posed in his section "The Persistence of the Great Depression." DeLong offers a consideration of long-term unemployment in his 1997 perspective, but the ultimate cause is missing. We now can say incisively a more fundamental reason the Great Depression persisted.

The reason the Great Depression persisted in such a long slump, instead of simply reversing into a typical recovery is ultimately quite simple -- debts and the necessity to pay them off, and the spread of frugality in response to the conditions. These are not primarily a question of debt service loads or interest rates -- people decide in accordance with their expectations and longer term plans whether they can borrow more or must pay down debts instead. Debts and frugality, which I laid out more fully here, explain the persistence.

The other piece I've read over a couple of times lately is Ambrose Evans-Pritchard's recent column "The depression quietly deepens" which is, of course, about here and now. This is useful for its bracing quality, to focus the mind.

With my description of the Great Depression, these three pieces together suggest a key piece of the way out of this morass.

Debt forgiveness.

In the U.S. we have two primary forms and one minor form which are often used. The two major forms of debt relief are foreclosure, which can deal with the large debts from overpriced housing that has returned to normal values, and bankruptcy, which can deal with the debts from too many (overpriced) purchases driven by the illusion of equity wealth. A minor form of debt relief is to negotiate debt reductions from unsecured creditors, such as credit card companies (which may prefer partial payments over total losses in a bankruptcy). (Update: just saw that CR has a post on this particular form of debt relief - a good sign. NYTimes source article here.)

What we fail to realize in our public discussion is the high virtue of these forms of debt forgiveness for the general economy.

We do much better for each other if we do not insist on the enslavement of many of our fellow citizens in modern debtors' prisons -- walls of debt that cannot be repaid. Debts so large that their attempted payment would ensure another Great Depression, which in turn would make their payment progressively harder and finally impossible.

Debt relief is our chance to get out of this mess by forgiving those who truly did not expect house prices and the economy to go south.

While we don't want to benefit those who knowingly took advantage, we must forgive the majority who were blindsided by forces they did not imagine.

In addition to the debt-overwhelmed group that isn't able to purchase much of anything, we also have the large group I'll call the In-Betweeners -- those who are currently able to make payments on their significant debts, but who are squeezed into sharp consumption cutbacks due to rising credit card interest rates. Their reduced spending also threatens to drag the economy into a long, long slump.

I proposed a specific way to ease the interest burdens of this group here (look for "What might help consumers pay off their non-mortgage debt faster?")

Together, these various forms of debt relief can help revive our economy.

Once the debt load of American consumers is reduced, they will be able to buy more goods and services, supporting a stronger economic recovery. The other key piece for a strong recovery is new American innovation, new American goods and services, new businesses -- and the aid of a helpful climate to allow new business to flourish, including favorable tax conditions and such aids as more economical health care.

At this point we no longer need to fear over-consumption. That trend is well and truly broken. (more here, here, and Mish's version) It was a matter of psychology, and the psychology is changed. It is a new world.

What shape would we like our New World to take? We face either Depression or radical change to escape one.

Our Great Recovery will require either a overwhelming stimulus program like World War II or...widespread debt relief.

The thing is, the faster this debt relief is brought forward, the sooner a friendly and easier economic climate can arrive.

And time is not irrelevant. Years of slump really can add up. Three or four years of a 5% per annum growth difference, for instance, would add up to a very different world. While we think rightly of issues like solvency of medicare and social security, even more drastic consequences are always possible. Imagine for example if the graph of national economies during the Great Depression in DeLong's chapter did not have an turn upward for the U.S. in the 1930s, while the 1930s German and Japanese economies soared.

Real national security comes from economic and technological capacity. The ability to arm. A "defense" plan that puts current defense spending above the economy itself profoundly threatens the nation.

But long-term security isn't the main justification for a better economic plan. We should do it for quality of life.

The thing we understand now, in 2009, that we did not know in 1933-1935, is that the nation pays one way or the other for deflating-asset debts. We will all pay regardless, one way or another. Whether we pay directly, or indirectly through a long slump.

Debt relief is a quicker way to cure this key underlying problem.

We are all in this together regardless of philosophy, and will recuperate, or suffer, together.

Update 6-18

Martin Wolf lays out the big picture for the world economy and our situation to date vs. the Great Depression in his latest article -- whether we might escape another Great Depression.

Martin writes:
The question is whether today’s unprecedented stimulus will offset the effect of financial collapse and unprecedented accumulations of private sector debt in the US and elsewhere. If the former wins, we will soon see a positive deviation from the path of the Great Depression. If the latter wins, we will not. What everybody hopes is clear....

Martin points out the exact question that will determine whether we recover -- exactly what I've addressed above:

[My explanations in dark green]:

We are seeing a race between the repair of private balance sheets [paying down large debts] and global rebalancing of demand [nations with big trade deficits, like the US, importing less], on the one hand, and the sustainability of stimulus [whether deficit stimulus spending can be maintained long enough to allow a sustainable recovery], on the other.... Robust private sector demand [consumer and business spending] will return only once the balance sheets of over-indebted households, overborrowed businesses and undercapitalised financial sectors are repaired or when countries with high savings rates [China, etc.] consume or invest more. None of this is likely to be quick. Indeed, it is far more likely to take years, given the extraordinary debt accumulations of the past decade. Over the past two quarters, for example, US households repaid just 3.1 per cent of their debt. Deleveraging [paying down debts to a lower ratio vs. income] is a lengthy process. Meanwhile, the federal government has become the only significant borrower [household and business borrowing is sharply down, which is why treasury bonds interest rates are still historically rather low]....
Here is the graphic article Martin refers to by Eichengreen and O’Rourke showing our world economic progress to date vs. the Great Depression.


(Readers may wonder if the idea of debt forgiveness was an original piece from the book I've been writing. The answer is no, these thoughts were worked out here in this blog. The book deals with more fundamental economic and life questions, which will help our nation, and ourselves individually, really thrive.)

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