Summary/rewrite:
A second Great Depression is still possible
October 11, 2009 4:37pm
by FT
By Thomas Palley
In the last year the world economy has been shrinking. On Wall Street, economists see signs of a recovery. Yet, the opposite may be true. A second recession may start soon, followed by a long period of economic stagnation that could be called the Second Great Depression.
In September, there were tremendous US job losses. Recently US automobile sales have dropped after the end of the “cash-for-clunkers” programme.
Despite this bad news, it is not surprising that Wall Street predicts a recovery. Wall Street tends to be optimistic, because it earns fees whenever it manages rising assets, or advises deal makers, or convinces investors to buy stock.
Mainstream economists did not predict this crisis, and they assume that the economy will grow until it reaches full employment. Econometrists also predict continued growth, because crises in the past have ended and the economy has returned to normal.
Unfortunately for these scholars and their predictions, the future is not always like the past. This crisis shows us why our old ideas about economic growth in the US and the world are so wrong. The economy grew because of increased consumption, inflation in asset prices and rising debt. Now the party is over.
This time, the economy will contract again because of deleveraging, which has two steps.
1. Like a car, the economy has an acceleration pedal, which we call borrowing. When the borrowing stops, the foot comes off the pedal and the car slows down. But it is heavier than before; the trunk is stuffed full of new debt which holds the economy back even more.
2. Consumers pay off their debts instead of spending; this is like stepping on the car brakes. Today's rapid deleveraging hits the brakes very hard. It reduces debt, but forces the economy to slow down until it settles into a new average speed, that is much lower than before.
Today the economic car continues to slow down. Spending is falling, jobs are being lost, and businesses are failing. Indeed, our huge debts are breaking down the car motor -- the institutions that keep the economy going, and may lead to an immense crash like the Great Depression. For example,
unemployment insurance is running out for many workers, who must now spend less and may be forced into foreclosure. State governments are cutting spending and jobs in order to balance their budgets, so even the public sector is shrinking. Countless households and businesses have seen their wealth get destroyed, so now they will be forced to save; they won't be able to borrow; and worst of all, large numbers will go bankrupt and lose access to affordable credit.
That isn't all. The US government also has a growing trade deficit. In the cash-for clunkers program, 80% of the top brands sold were foreign. Companies, too, are offshoring jobs and new investment. All this reduces the impact of the stimulus.
The financial crisis shrank financial markets, and deleveraging in finance has shrunk the real economy. That is why a second Great Depression can still happen.
Thomas Palley is former chief economist of the US-China Economic and Security Review Commission and is currently Schwartz Economic Growth Fellow at the New America Foundation