A Great Description of The Global Crisis and a Plan For Restoring Global Economy

This is the best analysis of the global economic malaise that I have read. It also proposes a plan for recovery that is better than what has been proposed by the Obama administration, because it is based upon a better analysis of the causes. This is not a typical cyclical downturn in the economy.

This recession is different in at least three important ways. The bursting of the housing bubble has created a problem of debt deflation. Households are forced to pay down their debt, or defaulting their debt. This limits consumption and it puts stress on the banks that hold their debt. Banks have responded by limiting credit to households and to small businesses.

Secondly, technology has increased productivity and encouraged the globalization of supply chains. This has resulted in an excess supply of labor, capital and productive capacity relative to demand. It has undermined the role of the US as the consumer and borrower of last resort for the products and capital from emerging market economies that are export based and net savers.

This has shifted the relative power of labor and capital in the developed world. The results have been stagnant wage growth, and an increase in income inequality to the levels that prevailed prior to the Great Depression. The use of government transfer payments has helped to limit the decline in spending but it is not sustainable. The problem is that incomes are not likely to grow under current circumstances with the global glut in labor and capital that exceeds global demand.

They propose a tripartite recovery plan that will take 5-7 years to achieve the needed results. The US government has fallen behind in infrastructure that is needed to compete in the global economy. It can also borrow at very low interest rates. It makes sense to take advantage of the low interest rates to invest in infrastructure that will benefit the private sector. This is better than cutting taxes or increasing transfer payments because the return is not equal to the investment on this kind of stimulus.

Secondly, they recommend a program of debt restructuring. Households and the banking system need to be financially repaired and the only way to accomplish that is to take steps that can reduce the debt overhang and deleveraging that is limiting economic growth.

Since the US and Europe, with the exception of Germany, are running current account deficits, and are deleveraging, the countries that are running current account surpluses need to raise the levels of their spending to compensate. This is not a good time for governments to increase savings and to impose austerity. There needs to be a global rebalancing, particularly in the export based emerging market economies. They need to increase their levels of domestic spending.

This is a short summary of the article which I strongly recommend. It makes a lot of sense to me, but it requires a rational approach to a problem that is much more complex than many are willing to admit. It is also a long term solution that will take several years to produce results. This is one time that I wish that the assumptions made by rational expectation theory would actually apply to reality. We understand the problem and there are solutions, the question is whether we have the capacity to act upon the understanding.