Deflating Assets, Shrinking Global Economies

Sunday, March 1, 2009

As shrinking global economies right-size themselves to match more modest and realistic global demand, meet American life without so much junk (things) and a lower standard of living that is the future. Martin Wolf tells the truth whether U.S. government functionaries like it or not. The $40 trillion that has been lost in world equity proves to have been chimerical wealth after all, quite reflecting our human folly. United States is bereft of adequate leadership. In truth, no human being knows how to fix this economic monster of our own creation. The pain of this economic wipeout cannot be avoided nor forestalled, would only prolong the injury and incapacity of financial markets. We must accept that THERE IS NO SOLUTION OR FIX, and take responsibility for what we as a civilization chose to do in the pursuit of money. Each person with a 401K or IRA is a player who wanted a piece of the action.

So much for the ever-escalating standard of living that each American generation has always wanted to bequeath to the succeeding generation---that level of growth and development is unsusratainable to the earth anyway. Sorry, but this rude financial awakening is also a survival call.

Fareed Zakaria's Interview with Martin Wolf of the Financial Times:

ZAKARIA: It was a week of superlatives -- a historically high budget, a record-breaking deficit, new lows for home sales, new highs for unemployment.

In short, another terribly depressing set of economic news this week -- not just in the United States, but around the world.

I thought long and hard about whom I wanted to talk to about all of this, and there's nobody who knows more than Martin Wolf.

Martin is the chief economics commentator at the "Financial Times." His column is an absolute must-read.

Welcome back, Martin.


ZAKARIA: I've been reading your columns over the last few weeks, and I've been struck by the fact that you've been very critical of the Obama team and their plan.

Explain in a nutshell, what's the problem?

WOLF: Well, first of all, I think we have to recognize this is a very serious problem we're now in. We are in a major, massive global downturn with a real prospect of getting out of hand.

Everything is going very badly. The shrinkage of world output is terrifying. And I think this is an event which can only now be compared with the '30s.

Everything has turned out worse than anybody expected, even the most pessimistic people a year ago. It's important to remember how much worse it is now than even the most pessimistic, like my friend Nouriel Roubini, thought it would be now.

Against that background, we -- I suppose this may have been a fond expectation -- hope that the new team -- very intelligent people, completely free from the taint of the past -- would take hold of the situation and take action so decisive, so comprehensive, so ruthless, that it was clear that, on the worst case scenario, it was going to be turned around.

I think all the segments they've dealt with, the three things they've dealt with -- the stimulus, the financial package, the home situation -- they're the right segments.

But in every case, the policy has been far too cautious, far too politically constrained. And it's not going to shift expectations. And that's absolutely obvious it's what the markets have concluded, and it's what the world's concluded.

And I fear now, that this tremendously important opportunity to turn things around has been lost. And that means we may have a really dreadful situation in the world economy -- and the whole world, therefore, politically, as well -- over the next few years.

So, I think they failed to seize the initiative.

ZAKARIA: All right. Let's start with the stimulus.

The economic stimulus plan, $900 billion. Obama's gotten a lot of criticism from the right, that it's full of pork and things.

But your criticisms are different. Explain exactly what your problem is.

WOLF: Well, the problem with the stimulus package, in my view, is essentially twofold. First, surprisingly, it's too small. I know $900 billion -- or $800 billion -- sounds like a lot of money. But this is a $14 trillion economy. And the private sector is in freefall, in my view.

And that's because the private sector stopped spending, simply, around the world.

ZAKARIA: People and companies have stopped spending.

WOLF: People and companies have just stopped spending.

ZAKARIA: So, the government has to...

WOLF: And so, the government has to spend.

We are in that very rare situation, in my view -- it occurs in the West perhaps once every 70 years. It's a situation described by the famous English economist, John Maynard Keynes. It's a situation of deficient demand.

So, the government must spend. And it must spend in very large quantities.

So, I think, actually, on my calculations, you wanted a stimulus of six or seven percent of GDP, at least -- in the first year. Not...

ZAKARIA: Which is -- explain what that is in layman's (ph) terms (ph)?

WOLF: That would mean about the sums we're talking about. Seven hundred billion dollars or so should be spent at once.

ZAKARIA: In the first year.

WOLF: In the first year.

ZAKARIA: And in fact...

WOLF: Now.

ZAKARIA: ... only $200 billion will be spent...

WOLF: That's right. Now. We want it spent now.

A year from now, in the year -- it could be too late.

ZAKARIA: But you know what? A lot of Obama people say, when you say that is, they didn't have what they call shovel-ready projects. There wasn't -- you couldn't find things to spend on.

You don't -- you're not restricted to just so-called shovel-ready projects. You're not restricted to investment at all. You can just send people checks. And if it's not large enough, send them more.

Even if they save some, that's not so terrible, because you want people to reduce their debt. The crucial thing is, this is a situation in which you need to get money out into the public, to people who will spend. And that can be done, I have no doubt about it, just by borrowing money from the Federal Reserve and sending it.

The trouble is, if everybody decides not to spend in a country where 72 percent of demand was consumption, you know -- and this was a big...

ZAKARIA: (UNINTELLIGIBLE) 72 (ph) percent of the economy...

WOLF: ... the economy was American consumer demand, and they all decide, "Actually, we don't want to spend so much. We want to consume only, perhaps 10 percent less than this," then, of course, you've got very weak demand, and there's nothing in the world, really, to offset this.

The statistic I like to point out, if you look at the world level, is American household spending, consumption, was twice as much -- twice as much -- as the total GDP of China and India together.

This is really a big part of the world economy.

ZAKARIA: So, explain to an average person watching, what is their life -- what is the life of an average family going to look like? If what you're describing as, you know, a bleak outcome, but a quite likely outcome, a year or two into this, what is their life going to look like?

WOLF: What I'm really imagining here is a world in which over- indebted people are trying to pay down their debt. The level of debt in the household sector -- among households in the United States -- has doubled relative to their incomes in the last 10 years or so.

So they spend a lot of time saving. They don't go to the mall. They live more cheaply.

Obviously, we're assuming here they have a job. A lot of people will be without jobs. Certainly, more of them will be without good, well-paying jobs in this situation, for a long period. So they're going to be more frugal.

And I think at the aggregate level, the result is that the sort of huge consumption binge we saw -- I mean, U.S. households were spending more than their incomes for years and years and years, and borrowing and borrowing. That will all be over.


WOLF: And that's what happened in a different way, of course, in Japan.

ZAKARIA: And it means their 401(k)s, their retirement accounts have been -- have dropped in value, so they retire later.

WOLF: Yes. ZAKARIA: It means that...

WOLF: They're poorer.

ZAKARIA: ... no more raises, because companies aren't doing well enough.

WOLF: They're poorer than they thought they were.

I mean, part of that was -- I'm not predicting the stock market, because the stock market can move everywhere, on anywhere.

But, yes. And house prices are certainly not going back to the peaks that we saw two or three years ago, maybe for a generation.

Their wealth loss is trillions and trillions of dollars. So -- and that's true around the world. Around the world, the loss in equity value is about $40 trillion around the world. So, these are monstrous figures.

Now, in this situation, of course, it's inevitable. People are cutting back, so there was no big consumption driver.

Corporations aren't going to go out and invest when they've got no demand. And they can't borrow from the banks, either. We haven't discussed the failure to fix the banks.

So, for all these reasons, you know, for the private sector, it's not at all obvious where the demand will come from.

And meanwhile, as I said, I think the government stimulus here is not too bad, here and around the world. It's just too little.

So, I fear a long period of stagnation, and with a lot of bad news coming out -- very bad economically and very bad politically, and very depressing.

ZAKARIA: Martin, stay right here. After the break, what might be even scarier than what you've already heard -- Martin's opinion of the Obama administration's bank bailout. It isn't good.


ZAKARIA: And we are back with Martin Wolf, the columnist for the "Financial Times," talking about the Obama plan.

Let's talk about the other part of this package, the Obama team's package, which is the bank bailout.

You had been advocating a bank bailout for a long time. The Obama team comes in -- fresh team, smart people, you know them all. And as far as you're concerned, they lay an egg.

WOLF: Yes. I don't really understand -- but I am here in very good company -- what exactly they're trying to do. There is a big debate about how insolvent the banking system is. But I think many people whom I trust would say that, if you understood what's going to happen to the value of the banking sector's assets, the claims they have on the rest of the economy, you look at where we are now, it's going to get worse and worse. So that they are almost certainly grossly undercapitalized -- the big banks -- if not insolvent.

And that's clearly what the market thinks.

ZAKARIA: So, what should Obama do?

WOLF: In this situation -- let's first understand the danger. The danger is, it won't lend. And worse, they're all trying to reduce their loan book. And that will make the economic situation much worse. So, you need soundly capitalized banks.

Now, if that's the case, there are essentially only two ways of doing this. One -- which is quite wrongly called nationalization -- is restructuring under a sort of bankruptcy procedure, which is exactly what the FDIC, the Federal Deposit Insurance Company (sic) does.

ZAKARIA: And the FDIC does this with small banks...

WOLF: Yes.

ZAKARIA: ... every -- is doing this...

WOLF: Yes, yes...

ZAKARIA: ... with small banks every week.

WOLF: Yes.

Now, obviously, the big institutions, it's much more complex. I understand that. And, of course, they're incredibly big and important institutions. So, you have to do it quickly and ruthlessly.

And it is possible that this is where they will end up when they do their so-called stress testing. But nobody's quite clear whether that's what they want to do. And some of the suggestions we've heard from the Federal Reserve chairman, Mr. Bernanke, suggest they're very unwilling to do something so radical.

Now, the alternative thing to do -- which is, I concede, politically very difficult -- is just to put in a vast quantity of public capital. In a sense, they're sort of dripping it in in very small quantities.

But if, of course, the public sector does put in most of the capital -- that means the taxpayer is bearing most of the risk -- it seems completely unreasonable to say this is a private business.

But the crucial point about it is this. The country cannot prosper if its biggest banks are not seen as being utterly sound, utterly solid institutions, which are capable of coping with the crises that will come. Otherwise you have so-called zombie banks.

We saw that in Japan. Zombie banks won't lend, can't lend. They can't write off bad debt, so they keep on -- because they don't have enough capital -- so they keep on relending to bad debtors. They can't start lending to good new customers, and you basically get a frozen economy.

And that is part of the story. I think that a lot of this is that they're not prepared to say -- the people who invested in the banks and the bank management themselves -- the game is over, it's going to have to change.

ZAKARIA: You have to fire the management...

WOLF: It has to be new. These are -- you know, they're incredibly concerned to keep private sector management of these banks. I think that's rather (ph) reasonable. We want private banks, and are utterly against nationalized banks.

But these banks, and these bankers? I mean, with a few exceptions, well, you know, they made the mistakes that got us here.

ZAKARIA: The mortgage proposal, the third part of the Obama plan. What do you think of that?

WOLF: Well, as I understand this -- it's not something I've looked at quite so closely -- the essence of it is to try and reduce, as it were, the cash flow burden for households, lowering interest rates.


ZAKARIA: So, you lower the interest rate, so that the monthly payment that an average household has is less.

WOLF: Even though they have a house which is worth less than their mortgage.

Now, I don't know whether that will work. My own view is that the collapse in housing values here is permanent. It's a long-term loss. That was a huge bubble. We're not going to see those prices again.

So, there are a great many mortgages which are under water. There'll be people -- and they will remain under water.

I think it's very...

ZAKARIA: No matter what you do with that...

WOLF: What you do. And there's nothing you can do about it, because I actually think house prices need to fall. They have to fall to clear -- houses have to become cheap, so people will start buying them again and you've got a normal market. And that's going to have to continue, I think, for a little bit longer while prices get really cheap. So, in this situation, what I worry about is that, actually, this won't solve the problem. It's a bankruptcy situation. And in a bankruptcy situation, you have to reconstruct the debt. In fact, you have to lower the debt below the value of the property.

Now, whether that is very important to do this through a foreclosure process or through -- by keeping people in their homes, that's a sort of big social decision. And you can take that either way.

But it seems to me, the fundamental point to recognize is, there are bankruptcies. And in bankruptcies, it's just like the banking issue. There are real losses. And these losses have to be borne by somebody.

And that means, in some way or other, either the government bears them -- the taxpayer at large -- or the creditors bear them.

ZAKARIA: What grade do you give the Obama team?

WOLF: Well, they're certainly better than the predecessor in terms of dealing with this. And they're much smarter, and they have got all the right subjects and right topics.

But in terms of -- well, I would say probably a B.

ZAKARIA: And you're an English grader, so I'm guessing B would translate in America as a D.

WOLF: I don't know. It's not a very high grade.

And basically, it's disappointment, because I think these are incredibly smart people. They understand the problem. And they had a unique, wonderful opportunity to transform everybody's views of what the U.S. is capable of.

And the U.S., as always, is the only place that can fix this problem, which is now a major global crisis.

ZAKARIA: Martin Wolf, thank you. Very sobering.

[Aired March 1st, 2000, CNN]


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