'May you live in interesting times'. The purported Chinese curse which is not Chinese at all and can be cited no further back than 1950 to British science fiction author Eric Frank Russell, is a perfect distillation of the past two years.
Interesting times, historic times. The collapse of Lehman, the rushed sales of Bear Stearns and Merrill Lynch, Bank of America, TARP and the 2008 financial panic will be analyzed for years. But surprisingly these dramatic events have not left traders, bankers, regulators and politicians with a true sense of the vulnerability of the global financial structure and the political revolution which has taken place.
The operating opinion in Western finance and government seems to be because the world did not end in 2008 it will continue just as it was before. We have a sense of returning normality not of danger, of continuation for our financial system and methods not of their end. The sharp break that took place a little more than a year ago has been concealed by the restoration of economic growth in most countries and the survival of almost all pre-crisis institutions.
Europe and the United States have lost the ability to finance their own governments. Their political systems have refused the budgetary discipline necessary to recoup their fiscal positions preferring to borrow trillions from thriftier nations and they are unable to secure sufficient economic expansion to reduce their exposure. Under these circumstances the retention of past attitudes on the exercise of political power, economic dominance and global leadership are just so many left over mental habits.
The financial crisis revealed the unstable foundation of modern Western economies. Nations cannot fund a burgeoning welfare state on the back of permanently loose credit. No matter how tame inflation appears, the result is always a bubble market and then collapse. Cheap money does not foster economic growth. Consumption without the requisite economic expansion to pay for it is a dead end, as is a state that rewards non-productive activity over work as social policy.
But before we write the end of Western economic dominance let us look at where the United States and Europe are some fifteen months after the great crash.
It has been almost three years since the sub prime housing crisis in the United States catapulted the world into the longest economic crisis in three generations. We have, thus far, escaped the worst that was thought to be imminent in the fall of 2008. The global financial system did not fail; unemployment in most of the developed world while severe is nowhere near the levels of the 1930s. The destruction of GDP has been minimal compared to the Depression and even equities have fared much better than in the fall that followed upon October 1929, when the Dow lost 90 percent of its pre crash value and did not return to the level of the Roaring Twenties for twenty five years.
But for the spendthrift US and European governments any solution to their deficit and debt problems will damage what potential for economic growth remains in their economies. If they continue to amass debt in an effort to spend away the recession they increase the chance for a high interest rate future as investors demand heightened return before taking on more government debt. And if a government cuts benefits and spending enough to dent the deficit, the crash in government expenditures will deepen and prolong the recession. There are no good fiscal and economic choices for either side of the Atlantic.
In Europe and the United States growth has resumed but with little indication that it will be sufficient to reduce the huge burden of unemployment on consumption and economic growth. Nor will world trade provide the engine for economic progress. Exporting nations cannot improve their domestic economy by sending goods overseas if there are few buyers and if export expansion is the goal of all nations at the same time.
The European conception of austerity for Greece, but not for Spain, Italy and Portugal is a pleasant fiction. If Greece receives assistance, if German workers who can retire at 65 are forced to subsidize Greek workers who can retire at 58 then the entire European democratic social construct is bankrupt. The European economies do not generate enough cash to support their own social payments. The choices are stark, cut social spending and reveal to the population that there are few jobs and little chance for economic improvement, or permit sovereign bankruptcy and endure the financial and social chaos that will follow. The austerity prescribed by Germany and France will inflict a deep recession on Greece and any other country that is forced to accept a bailout. In a trading bloc like the EMU austerity for some must damage growth for all.
American economic growth in the fourth quarter, though revised up to 5.9% is far more fragile than apparent. More than half the quarter's expansion was generated by restocking of business inventories. Real final sales, the actual expansion of consumer spending grew by only 1.7% in the fourth quarter. New home sales and existing home sales have plummeted. Government support for the housing market in the form of a tax credit for home buyers only succeeded in pulling future home sales forward not in creating economic activity. Jobless claims have climbed since January and consumer confidence in February was at the lowest point in 30 years barring the extreme lows in the fall of 2008 and the following spring.
Europe or the United States are no longer self-sustaining financial polities. They maintain their governments and social structures at the sufferance of others. The habit of power and their existing military and financial resources will carry them for a few years yet but without economic growth their influence is finite. The financial crisis has revealed the rot at the heart of Western economies.