The Great Recession & The Greater Recovery

Economists, politicians & journalists have repeatedly compared the current recession to the Great Depression. There are certainly some similarities between the two business cycles. The Great Depression dramatically impacted people from all walks of life, there were major bank runs & severe panics in the credit markets that brought the economy to a complete halt and there was uncertainty as far as newer regulations were concerned. But we responded with fierce resilience to get ourselves back on the path to recovery. This included enactment of laws such as the Glass Steagall Act of 1933 which strengthened the financial regulatory framework, implementation of programs such as New Deal that improved our infrastructure & ultimately our decision to enter the Second World War that uplifted millions out of poverty & enabled the US to become a super economic power in the world.

The state of our economy was far worse back then compared to what we have today. The unemployment rate was over 25 %, the stock market lost over 90 % in value, over 60 % of Americans were below the poverty line and the GDP decreased by over 30 %. Simply put, the picture was much gloomier than what we see today. However, in spite of the unprecedented actions taken by the Government & the Federal Reserve to rescue our economy from the brink of failure & shore up our financial institutions, we have not been completely successful. There is a renewed interest in the idea that we might enter a double dip recession. Investors & consumers alike are fearful of the prospects of living through a “Lost Decade.”

We need to do more as a country before these grim myths turn into reality. There is a need to reinvigorate the economy & jump start a steady recovery. However, there are some unique challenges we face that need to be considered. Firstly, we are now living in an era of globalization where there are severe trade imbalances. There are some regions that rely on lower domestic consumption and others that rely on higher imports. The United States has had a trade deficit for several years. The last time we had a trade surplus was in 1975. Secondly, we have run out of fiscal & monetary policy tools. The interest rates are at all time lows. In addition, we have a higher than usual debt to GDP ratio (currently at 93 % compared to 45 % in the midst of Great Depression). This strains & limits our ability to provide additional rounds of stimulus for our economy. Thirdly, the credit markets have still not recovered completely. Banks are still carrying mortgage securities that have not been fairly marked to market. There are concerns that the bank supervisors and the Basel Committee will soon require banks to increase their capital ratios & limit how much they can lend. This would further hamper economic growth in the country. There is also enormous amount of uncertainty regarding the laws/regulations after the passage of Wall Street Reform & Consumer Protection Act of 2010.

We might have achieved a technical recovery but we won’t truly recover if the unemployment numbers continue to remain high. Therefore, jobs must be our focus as a country. Employment is usually a lagging indicator. However, we still haven’t seen major improvement in this category. The longer the unemployment numbers stay high, the longer it will take us to completely recover. We witnessed painful jobless recoveries after the 1987 & 2000 recessions.

Our actions need to target the three major challenges that I described above. We need to show our political zeal to push for increased consumption in countries such as China, Australia & Germany. We also need China to revalue the Yuan which would make our goods more competitive internationally. In addition, we should consider more rounds of stimulus measures that provide tax credits, remove capital gains taxes on businesses & increase our infrastructure spending. Some might argue that we cannot afford higher spending right now especially when credit markets are already fearful of sovereign debt defaults. However, the truth is that the higher unemployment rate would continue to be a drag on our economy if we don’t act. Let’s not forget that the debt to GDP ratio was over 130 % after the Second World War, without which we probably would not have recovered from the abnormally high unemployment numbers after the Great Depression. Therefore, instead of being fearful of the higher deficits, we should continue to make major investments in our infrastructure and provide additional tax credits for businesses to increase production & encourage them to look for newer markets for our goods and services. Our response at this stage is extremely crucial. If we continue to worry about our deficit levels, the odds of entering a lost decade might increase enormously. The fear of deflation could also become a daunting challenge in itself.

Therefore, we should collaborate with our global trade partners to reach consensus on solving the issue of trade imbalances, provide additional fiscal stimulus for our economy and at the same time firmly state the time frame for decreasing government’s discretionary spending after we are firmly grounded on the path to recovery. We can only afford increased government spending if we truly commit ourselves to the promise of decreased spending going forward. These measures might be our last best hopes for getting ourselves out of the recession, jump starting our recovery & simultaneously investing in infrastructure projects that would prepare us for the future.

Thanks to Wikimedia for the picture.