The economy stinks...everywhere.

Aug 05, 2011

Americans aren't the only people worried about their nation's economy right now. Stock markets plummeted Thursday among fears that the global economy is headed back into recession. Desmond Lachman chatted about why the global economy is suffering, if anything can be done to control it, and how this situation affects our every day lives.

Related: Markets plummet on global economic fears

My name is Desmond Lachman and I am following closely developments in the US and European economies. It is my pleasure to try to answer your questions to try to make sense of the difficult times we are experiencing in the global financial markets.

What stimulative measures does the Fed still have available to it? Barbara

The Fed has relatively limited scope for policy  action now that it has reduced its target interest rate to 0-0.25 percent. What the Fed can do is a third round of quantitative easing. However, it is not clear how effective the previous two rounds of such easing have been. There is also political resistance to the Fed doing this which means that by the time it does so it will be too little too late.

Since the housing and financial markets collapsed in 2008, I think that there has been a tendency to underestimate how bad the situation really is. As a result, no one has put forward solutions that are more than band-aids on gaping wounds. Do you agree with this assessment and if so, do you think that the lights are starting to turn on as a result of the recent news?

I would agree that there is often a tendency for denial in policy circles that makes policymakers reluctant to address the real problems that confront us. This is particualry the case in restoring sustainability to the public finances where the recent Congressional efforts have fallen well short of what is needed.

It would also seem that the adjustment in the housing market is far from complete and we could see another 10 percent decline in US home prices over the next year. That would be a big headwind to the recovery.

If the U.S. were to find itself in a double-dip recession, can we predict how the second dip would compare to the first? Is it likely to be shorter and less intense than the initial recession, or could it be even worse?

A double dip recession were it to occur now would be serious since we have all but exhausted our room for counter-cyclical policy reaction. Unlike in the Great Recession of 2008-2009, there would be little room for monetary and fiscal policy stimulus. This would likely mean that any recession now could be of longer duration than in 2008-2009.

Can you clarify how much of the economic crisis is the US and how much is Europe and other parts of the world? I think the perception is that is simply the US and US controlled.

The severity of the global financial market turmoil stems from the fact that markets correctly perceive that the US could be moving back into recession and that the Eurozone crisis is intensifying with Spain and Italy firmly in the market's sights. Having major economic problems in two major economic blocs at the same time tends to make these crises worse. It does not help that the European policy reaction to the mounting troubles in Spain and Italy has been so weak. It is difficult to separate out th enet effect of the US and the net effect of Europe.

There was a time about 30-40 years ago when economist were warning of dire consequences if the west didn't share their prosperity with under developed countries (we don't hear about this anymore). So open trade developed as a way to quell fears of not helping countries develop. With this in mind do you think the West is suffering from the lack of education in areas where jobs are plentiful, such as engineers, accounting and medical fields to name a few?

There can be little doubt that the West's relative economic importance is declining and that of the East is growing. While many factors can explain this, one of the more important of these has been the West's poor savings performance in general and its poor public finances in particular. Declines in western education standards also plays an important role.

Why is it that Greenspan and later other economists didn't give out a loud warning about a possible bust in the economy especially where the housing market was concerned? I mean houses were doubling in value in some areas. Is it that many, many people were making a bundle from it in other investments connect with the housing market? Didn't Greenspan mention something about "exuberance" during that time? Seems like it was all about greed.

There is no question that policymakers in general and Mr. Greenspan in particular bear huge responsibility for the housing and credit market bubbles. They certainly should have raised their voices and done something to cool the bubble. However, when the party is going on, it seems that nobody had the courage to do th eright thing and point out the high price that woudl be paid for the party. 

I'm in my 40s, in my prime stock-buying years to save for retirement. Why shouldn't I want the price of stocks to go down?

A sharp decline in equity prices would have a bearing on the way in which consumers behave and the economy performs. A big decline in equity could push the US into recession which is something nobody would like.

There are people sending around emails trying to get people to buy gold (through them, of course) warning that the world is headed into a terrible depression and that only gold will survive the crisis. What are your thoughts on this advice?

Gold looks to be a very crowded trade which means its price could very well could correct downwards. However, the major attraction of gold is that all three major currencies--the dollar, the euro, and the Japanese yen --all look dysfunctional. In those circumstances, gold looks like a safe haven

It's my understand that from the time this started in 2008, the American savings rate has grown from approximately zero to six percent. Which is good. But it also implies that we need about a 4-6% smaller labor force. What's the intelligent way to adjust for that? Something along the lines of encourage two-parent families to convert to one part-timer?

It is important that the US improves its savings rate if the US economy is to grow. For this to happen, other countries have to be prepared to reduce their savings rates if we are not to have too little global demand. the obvious candidate for this in the global economy is China which has an exorbitantly high saving rate

Why doesn't the Fed just create money and pay the debt down to 9 trillion or so? If debt is so bad, and Quantitative Easing okay, why not pay off the debt and get lasting benefit for what ever damage the creation of a few extra Trillion Causes?

If the Fed went in that direction we would get a huge spike in inflation. We should have learnt from our experience in the 1970s and 1980s that inflation is not a good idea from an economic or an social point of view.

Has the debt ceiling bill quashed any possibility of fiscal policy? Is this what Wall Street is worried about?

It would seem that the mood of Congress is firmly against  any increase in public spending under any circumstances. This could prove problematic should the US slip back into recession.

How do we know if we are in a Depression or Recession? With the housing crisis and unemployment numbers ("real" unemployed) it sure looks like we are in a Depression. Does no one use the D word because they don't want to cause a panic? Alison

Generally the word Depression conjures up the 1930s when unemployment reached 25 percent. Fortunately we are far from that. However, with unemployment stuck at over 9 percent for a long time we are clearly far from healthy. We now use the word Great Recession to distinguish  this more severe recession from the previous 11 post-war recessions

If the Federal Reserve and the government have little power to do anything about this, what are some other options?

The sad truth is that many years of irresponsible budget policies on both sides of the aisle has left us with little room for policy maneuver. Denying this fact will only make future business cycles worse as we load ourselves with more debt.

How does China's downgrading of American debt affect us?

If China were reluctant to hold our debt it could complicate our lives by raising US long run interest rates and by weakening the dollar. We are fortunate that China's large holdings of US Treasuries makes it unlikely that China will do that as it would not want to impair the value of its holdings. We are also lucky that Europe's very serious and immediate problems do not give the Chinese the option of switching out of US debt into European debt.

Is it true that our recent recession was very different from the Depression, in that while fewer people were without jobs, it was taking longer for people without jobs to find work? Does this appear to continue to be the situation?

Our current job situation is lamentable from many points of view. However, it does not come anywher close to the Great Depression were the unemployment rate reached 25 percent and people were out of work for literally years.

Why won't any politician ackowledge that US politicians have little control over things like, say worst case Greece, Spain, and Italy defaulting, which would have a huge effect on our economy, instead of acting like government officials can directly contol economic growth?

Policvmakers frequently do not want to recognize problems especially when there is little that they can do to address them. There is no question that if European countries start defaulting the US economy would be seriously impacted because of the US financial system's large exposure to the European banking system.

Is "quantitative easing" the same as "just printing more money"? [If so, that seems okay right now, up to a point.] But the last time QE was done, that money went to the banks, which, I believe, just sat on it. No lending, no investment in anything tangible. [Correct?] If QE were tried again, where should that money go? Could it go to infrastructure, education, job training, green industries, etc.? Would that create real improvements/assets without increasing the debt?

If we were to get anothe round of QE it would be similar to the last in the sense that the Fed would buy further large chunks of US Treasuries and mortgage backed securities. You are right in thinking that we have reached a point where monetary policy is ineffective and it is like pushing on a string. If banks do not want to lend and consumers and businesses do not want to borrow, monetary policy becoimes largely ineffective

From what I can read, some of the European countries ( Spain with the Fitch downgrade) can seem to win. If they cut government expenditures heavily then growth is hobbled and they are downgraded anyway. Didn't many of these same austerity strategies destroy several third world economies?

A big problem with European countries is that they are stuck within the Euro. This means that they cannot cut interest rates nor can they devalue to boost exports. Tightening budgets in those circumnstances has already plunged Greece and Ireland into the steepest of recessions

It seems that just about all the central banks have lowered the interest rates to prime the pumps. What can else can they do besides flooding the markets with useless cash?

I agree that the central banks in the US, Europe and Japan have all pretty much exhausted their room for effective policy action. With interest rates at or close to zero, all that they have in their arsenal is quantitative easing, which does not appear to havae been very effective

What keep this currency elevated? They have very limited exports and although their housing bubble has yet to be popped I can't see why their currency is so strong.

The UK pound has already depreciated against the dollar by around 20 percent over the past year. One would expect it to decline further as fiscal consolidation bites. The UK is very much more sensible than member countries in EMU in that they use depreciation to boost the economy

Should we be laughing? Only a couple of days ago there was insane hand wringing about our debt not attracting enough buyers. Now the prices have dropped so low the fed so start dumping its hoard. What do you make of it?

The decline in long run US government interest rates is not a good sign. It indicates that people are selling all risk related product and going into the safe havens of gold, Swiss francs, and US Treasuries. The last time something like this occured was during the Lehman crisis in 2008

Did Greenspan get off easily given his egregious errors?

No question about that. He was the main architect of the US housing and credit market bubbles that have got the US into such deep trouble

Didn't many of these same austerity strategies prescribed for Europe and the US destroy several third world economies?

Those emerging market countries that were on fixed exchange rate systems paid a very heavy price. However, countries like Brazila and Turkey succeeded in doing massive fiscal adjustment by using their exchange rates to boost exports as an offset

Mr. Lachman, I struggle with the seeming political polarization of economists. If one says one thing, another seems to say the opposite. Is there anything you, who I presume is conservative as you are at AEI, would agree upon with someone like Paul Krugman? In other words, are there any facts on the current economy that most sane economists would agree upon. Are there any policy recommendations that most economists would agree upon?

I think  that it is too easy to overstate the polrization between economists. It would seem to me that there are many things upon which reasonable economists can agree, An example of this would be the Bowles-Simpson recommendations on budget reform on which most reasonbale economists could agree.

How can we pay off the debts of Reagan and Bush if we do not raise taxes? Why are the rich getting richer and richer, while the rest of us sink into this conservative economic mire?

My view is that one should certainly not raise tax rate which could impact economic growth. However, we should eliminate tax exemptions or expenditures which are more pernicious than regular government spending.

What would be the effect if the Federal government were to transfer gold to the Federal Reserve Bank?

I do not think that one wants to exaggerate the importance of gold. Even at US$1600 an ounce, the US gold holdings are trivial in realtion to the country's level of public debt.

Whatever happened to the talk of rebuilding the nation's crumbling infrastructure, perhaps in public-private partnerships, such as roads, bridges, rail, fiber, power, water, sewer, which would have the much needed effect right now of putting people to work? The work would last for years since there is so much to do.

The country certainly needs improved infrastructure. However, this form of stimulus operates with very long lags and only puts people to work gradually. it would have been better to focus any stimulus on measures that gave the most bankg for the buck, whichis sadly what the Obama Administration singularly failed to do.

Does the economy stink everywhere, or just in the world's democracies? Are the experiencing the final result of decades of "voting ourselves money"?

I am not sure that I would go so far since there are a bunch of emerging market economies like India and Brazil that are both doing well and are democracies.

If the market declines and is buying less Federal debt, and if foreign countries are buying less Federal debt, might we find ourselves having to limit spending if only because the market for our debt has diminished?

If I had ultimate power the first thing that I would do would be to devise a credible medium term program to address our country's chronic public finance problem. Hopefully that would give me some room to engage in short-term policy support to our ailing economy.

I would like to thank everyone who sent in questions and I want to apologize for not having had the time to answer all the remaining questions that were posed.

In This Chat
Desmond Lachman
Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund's (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and the multilateral lending agencies.
Recent Chats
  • Next: