Let the Year of the Ox begin!
As the Year of the Ox has just begun (January 26), I hope the anxiety and fear from the Year of the Rat will give way and in its place confidence will re-emerge. In our complex economic world, theories were tested; experiments were made. Some of them failed; some were derailed; some still look for validation. We are traveling in uncharted waters as the magnitude of deleveraging is unprecedented. To avoid an outright liquidity trap now and to protect the economy’s long-term growth viability after a huge run-up in public debt, a new course has to be mapped based on integrated political, economic, and financial analysis, with human behavior as a key element of the risk structure. Because an economic outcome is determined by what we (no one else) do as economic participants, it is important to remember there are always two approaches in difficult times – you either give up and give in, or you actively find a solution and work toward it.
Arguably, half the battle for economic recovery is one of confidence. Negative headlines like those describing the 2.6 million job losses in 2008 as the worst since 1945 without considering six decades of population growth, and others portraying the current economic situation as similar to the 1929-33 Great Depression, work against confidence building. To be sure, the economy is undergoing a painful adjustment process and the current situation is very challenging. But we need to recognize that the unemployment rate is some distance from that of the early ‘70s and early ‘80s; the early ‘80s saw a double-digit rate for 10 consecutive months. December’s 7.2% unemployment rate was still below that registered in 1992 (7.8%), far from that of the Great Depression, when one out of every four people lost their job.
We also need to recognize that, despite the fact that the National Bureau of Economic Research’s Business Cycle Dating Committee has declared that a recession started in December 2007, real GDP actually grew 1.3% in 2008. It was around September when Lehman’s collapse and the subsequent freezing of the credit market translated a year-long financial crisis into a collapse in economy-wide activities. Since then panic has been widespread and reinforcing.
It is equally important to recognize that policy actions have been swift and the intention clearly has been toward stimulating the economy. This has been demonstrated by both the Bush administration and the incoming Obama administration. This is in sharp contrast to the Great Depression when taxes and tariffs were raised and the FDIC was not in existence to protect depositors.
In the next few months, at least, we will continue to see an uphill battle in finding and implementing the right policy measures and a struggle to communicate both the substantive and inspirational messages. The first $350 billion of the TARP money used mainly in shoring up banking sector capital ratio, together with the Federal Reserve’s actions, have led to some tentative signs of stabilization as the TED spread, an indicator of perceived credit risk in the economy, has come down and mortgage rates have also come down noticeably. The second $350 billion, currently awaiting Congressional approval, is intended to be deployed as mixture of tax cuts and federal spending. The size itself is about 2.5% of annual GDP. It is widely expected that more fiscal stimulus will come once the new administration is in office.
On the monetary side, the primary problem we are facing in the economy is a liquidity problem or a money supply problem that directly affects consumption and investment activities. Despite remarkable efforts by the Fed in increasing the monetary base, liquidity dried up in a matter of a few months when the private portion of it collapsed. This portion includes various types of typically liquid assets (e.g., mortgage-backed securities) which have a monetary value assigned to them. When risk aversion increased due to falling home prices, the demand for mortgage-backed securities disappeared and an earlier credit expansion was followed by a credit contraction.
So the question becomes how to lift the total money supply (or loosely speaking “liquidity”) by stabilizing and further revitalizing the availability of private money while, in the meantime, increasing public money. These are precisely what the government and the Fed are working on through their attempts to limit the downside risks of troubled assets – the foundation of many securitized products – through purchases and guarantees of those assets and directly injecting capital into the private sector. It is obvious that we are facing a major crisis on a global scale. It is never a certainty as to how the growth outlook will take shape because no one is in the driver’s seat to change a course, yet everyone is in a driver’s seat to affect a course. Despite periodic confusion, many policy actions with the right ingredients are already in the pipeline. It is important to give them a chance to work.