(Update 8/2: see Martin Wolf below)
7/29 -- As the popular American dialogue -- which our media blows into a theatrical crisis of the day/week/month -- tends to obscure reality, I thought it would be useful to remember where we really are.
We are on an economic bridge -- a support of deficit spending/investment on education/infrastructure/unemployment benefits -- over a deep economic chasm. Reality is more dramatic than the popular fiction this time.
Here's the normal outcome from a credit/debt/asset bubble-and-collapse such as the one the U.S. has experienced. From the abstract of Kenneth Rogoff and Carmen Reinhart's paper on the normal aftermath of such bubble-and-collapse:
This paper examines the depth and duration of the slump that invariably follows severe financial crises, which tend to be protracted affairs. We find that asset market collapses are deep and prolonged. On a peak-to-trough basis, real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years. Not surprisingly, banking crises are associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls an average of over 9 percent, although the duration of the downturn is considerably shorter than for unemployment. The real value of government debt tends to explode, rising an average of 86 percent in the major post-World War II episodes. The main cause of debt explosions is usually not the widely cited costs of bailing out and recapitalizing the banking system. The collapse in tax revenues in the wake of deep and prolonged economic contractions is a critical factor in explaining the large budget deficits and increases in debt that follow the crisis. Our estimates of the rise in government debt are likely to be conservative, as these do not include increases in government guarantees, which also expand briskly during these episodes.
And this is the average from bubbles both large and medium sized (big enough to put much of a nation's banking system into real trouble/insolvency). And an average that includes especially the last 100 years where governments acted to mitigate the crises, instead of allowing them to slowly grind out (as the US did in the nineteenth century, such as 1870s-1880s long depression).
Since Ronald Reagan's massive deficits ignited a new debt binge, we have experienced an unusually large credit/debt bubble:
From the wiki on the economy of the US:
We are far from getting out of the aftermath: Total public and private debt in the US is still at higher levels vs total US income (GDP) than at the peak of the Great Depression.
And after the asset bubble bursts (housing prices in our case), then households respond to their high debts by cutting spending for many years, even decades if nothing changes. This reduces or eliminates job growth.
That's where we are.
...
In order to recover from this massive debt overhang that would reduce consumer spending and job growth for decades without intervention, household debt vs income ratios must be sharply improved.
When debts become smaller in ratio to incomes, people will feel safe in purchasing more goods and services (much of which will be new style green goods and services -- economic growth and consumption can be environmentally favorable).
In short, for US recovery, people must have less debt and/or more income, including less mortgage debt.
That can only happen by three, make that four, means:
1) Rising incomes
2) Debt restructuring
3) Debt forgiveness
4) Or a lot of time treading water (if very slow growth is even possible -- if economic collapse doesn't ensue!) and such stagnation means a lot of people suffering for a long time
Since rising incomes can only happen via inflation or economic growth (and growth requires more consumer spending), it is obvious, necessary that we need significant help from restructuring and forgiving debts.
Foreclosures and bankruptcies are the two of the most rapid means of forgiving debt.
For this reason, current foreclosures and bankruptcies are especially beneficial to the US economic future.
Instead of a bad sign for our economy, these are a very good sign. They will help the US economy enormously.
(Yes, it is notable how incompetent so much commentary is -- suggesting that what actually helps us the most is a drag on the economy!)
If we had a lot more bankruptcies and foreclosures, quickly, we would get a quicker return to a good economy.
Economic growth also relies heavily on investment, both public and private.
Economic growth happens in response to new products, rising productivity/wages, and rising consumer spending.
Productivity and new products, key to growth, require investment.
Because the private sector is afraid to invest significantly now, deficit spending for public investments -- education (investment in people), infrastructure, technology, and science -- is indispensable to the future economy of the US.
Public investment will kickstart increasing private investment.
Without such public investment, we won't remain among the world's leading economies.
We should therefore focus federal spending, now, on education, infrastructure, science and technology, and require a level playing field in trade with all trading partners (this requires an end to the Chinese export subsidy/import tariff via currency peg).
For a good future, we must have public investment and fair trade. These are the real priorities.
Instead of the current media melodrama about whether the world's strongest economy is a good credit risk (whether US treasuries are a good investment, as the market clearly thinks).... we need to focus on reality and make good decisions now.
It's time for Obama to step up to the microphone in a more dramatic, clear way.
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8/2: Martin Wolf lays out the big picture succinctly:
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8/23: Paul Krugman and Ken Rogoff on how to get out of this "Great Contraction" (Great Depression) (hat tip to Mark Thoma). Rogoff's idea of mortgage debt relief is one of the most powerful steps we could take to shake off the decades long fallout a credit/debt bubble such as our entails.
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