Global Great Recession

Transcription

1 The Global Great Recession

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3 The Global Great Recession E Ray Canterbery Florida State University, USA World Scientific NEW JERSEY LONDON SINGAPORE BEIJING SHANGHAI HONG KONG TAIPEI CHENNAI

4 Published by World Scientific Publishing Co. Pte. Ltd. 5 Toh Tuck Link, Singapore USA office: 27 Warren Street, Suite , Hackensack, NJ UK office: 57 Shelton Street, Covent Garden, London WC2H 9HE British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library. THE GLOBAL GREAT RECESSION Copyright 2011 by World Scientific Publishing Co. Pte. Ltd. All rights reserved. This book, or parts thereof, may not be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system now known or to be invented, without written permission from the Publisher. For photocopying of material in this volume, please pay a copying fee through the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA. In this case permission to photocopy is not required from the publisher. ISBN ISBN Typeset by Stallion Press enquiries@stallionpress.com Printed in Singapore.

5 To My beautiful daughters, Katie and Jennie, and their husbands, Jay and Scott

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7 CONTENTS Preface Chapter 1. At Inception 1 Chapter 2. The Great Depression 11 The Prelude to Disaster 12 The Speculative Bubble 13 The Great Crash 16 The Aftermath 16 GNP and the Downward Trade Spiral 18 Keynes s Academic Precursors 21 Keynes s Policy Suggestions 23 Chapter 3. Primal Keynesianism and the New Deal 25 The Early New Deal Years 25 The Famous Keynesian Multiplier 28 Illusions and the National Income 30 Money and Uncertainty 32 Money and the Great Depression 36 Keynes, Harvard and the Later New Deal Years 37 Looking Forward 38 xiii Chapter 4. A Post Keynesian Framework 41 The Income Distribution: Sraffa and Kalecki 43 The Vita View of the Personal Income Distribution 56 The Price Markup and Prices 64 vii

8 viii Contents Incomes Policy 68 Money and the Financing of Investment 71 The Global Spectra 76 Whither Economic Growth? 77 Conclusions 81 Chapter 5. The Rise of Casino Capitalism 83 The Federal Reserve s Experiment with Friedman s 84 Monetarism ( ) Supply-Side Economics 86 The Sequel 91 Casino Capitalism 95 The Growing Inequality During the 1980s 106 A Net Worth Perspective: Where the Money Went 109 Clintonomics: Continuity with the Federal Reserve 110 The Clinton Legacy: Ending the Progressive Agenda 115 The Dramatic Shift from Basic Commodities to 116 Nonbasic Services Conclusions 120 Chapter 6. The Housing Bubble Conundrum 123 How the Fed Can Stimulate Housing Construction 124 and Demand Alan Greenspan Acts 124 The Consequences of Asset Inflation 127 Spotting a Housing Bubble 128 Greenspan Gets Smarter as the Bubble Gets Bigger 130 Defining the Bubble 131 Greenspan s Innocent Hypocrisy in His Attack on 133 Fannie and Freddie Summing-Up 135 Chapter 7. The Anatomy of the Subprime Mortgage 139 Bubble and Collapse The CDO 140 The Black-Sholes Model and the Origin of Derivatives 140

9 Contents ix The Role of the Subprime Mortgage 142 The Credit Default Swap 146 The Collapse 149 Collapses Around the World 156 Chapter 8. The Fallout from the Housing Collapse 161 In the Beginning 161 Innovations in Housing 167 The Subprime Mortgage Mess 168 Complications from Derivatives 170 Problems Go Global 175 Chapter 9. The Great Money and Banking Panic 177 Changes in Banking and Finance 178 Increases in the Use of Derivatives 180 More Deregulation 182 How the U.S. Housing Bubble Burst in the 183 Faces of Banks The Banks were Next 186 Fiscal Policy is Invoked 189 Consequences 191 U.S. Bank Credit and the Stock Market 194 Chapter 10. The Unconventional Use of 199 Monetary Policy The Federal Reserve at Inception 199 Ben Bernanke at the Fed 204 The Specter of Deflation 205 Liquidity Traps 209 The Global Dimension 217 Conclusions 218 Chapter 11. The Deep Decline in Output 221 and Employment The Economic Crisis of Summer The Crisis Deepens 223

10 x Contents The Keynesian Fiscal Stimulus 229 The Crisis in the Automotive Industry and Obama s 231 Response The Housing and Banking Crises: The Aftermath 235 Unemployment and Output in the USA: 242 A Summary Unemployment in Other Countries 245 Roubini: A Cassandra Who Became a Prophet 249 Chapter 12. The Unconventional Use of 251 Fiscal Policy The Stimulus Package 252 The Shortfall 255 Global Fiscal Legacies 259 Chapter 13. The Great Inequalities 265 The Unequal Income Distribution of the 265 United States The Forced Dominance of Freddie Mac and 271 Fannie Mae A Glimpse at Global Income Inequalities 273 Wealth Inequalities in the USA 276 The Weak USA Welfare Net 281 Chapter 14. Policies: Old and New 285 The Financial Crisis in the States of America 285 Policies at Mid-Year Prospects for Monetary Policy 292 European Stimulus? 294 Addressing Income Inequalities in the USA 295 Global Consumption Patterns 297 Empowering the IMF 298 Future Income Tax Policies 302

11 Contents xi A Transactions Tax on Wealth 306 Interest-Free Loans for Infrastructure 308 Interest-Free Bonds and the Business Cycle 313 Chapter 15. Prospects 315 Index 335

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13 PREFACE There s no doubt that there is genuine anger, frustration and anxiety in the public at large about the worst financial crisis we ve experienced since the Great Depression. Part of what we have to keep in mind here is this recession is worse than the Ronald Reagan recession of the Eighties, the recession, and the 2001 recession combined. The depths of it have been profound. President Barack Obama, in an interview with Jann S. Wenner, Rolling Stone, October 14, 2010, p. 39. The National Bureau of Economic Research (NBER) has long served a useful purpose as the arbiter of recessions when they begin and when they end. As prestigious as it is, the Bureau erred when it officially declared the end of the recent recession as June Even by this overly conservative ending date, its 18-month duration greatly exceeds the average post-wwii average of ten months. This, despite the fact that the sharp decline of Reagan s first term happened. In this book I remain steadfast in having named the Great Recession. Thus, I will not much detour from the conclusion of an earlier book, when I wrote, As the Dow became more and more volatile, the National Bureau of Economic Research officially declared a recession beginning in December Most likely, the long recession would be named the second Great Recession of the post-wwii era or the Great Recession of , the xiii

14 xiv Preface longest and most worrisome since the Great Depression of the 1930s. Today the 2010 ending date is a provisional one. 1 Since, I have amended the name of the episode to the Global Great Recession. The Great Recession circled the globe. Besides Global, you naturally raise the question of why the Bureau and I are at odds. The short answer is found in the magnitude of the unemployment rate that continued to bedevil policymakers. It remained disturbingly high, reaching 10.2 percent in October 2009, followed by ten percent rates. Dreadful numbers spilled over into 2010 and got stuck at 9.6 percent in August, September, and October. Worse, the possibility of a significant decline remained remote. Economists were referring to the jobless recovery when indeed economic growth was at a snail pace. The economy had stagnated, awaiting more stimulus from monetary policy, as fiscal policy was taken off the table. There is much more to the story. Before continuing with an overview, I want to acknowledge some important sources for many of the details. I must again be self-referential in the first acknowledgments, those for parts of Chapters 1 to 6. I relied on some earlier publications for much of the material. They include The Making of Economics, 4th Edition and A Brief History of Economics, 2nd Edition (2011), both published by World Scientific. Also, there is influence from Economics on a New Frontier (1968), published by Wadsworth as well as Wall Street Capitalism: The Theory of the Bondholding Class (2000) and Alan Greenspan: The Oracle Behind the Curtain (2006), both again published by World Scientific. Beyond these books, I cite a number of articles that were published in scientific journals. For the balance of the book, where the pace picks up, I leaned gently on several sources. These include Carmen M. Reinhart and Kenneth S. Rogoff s This Time is Different (2009), David Wessel s In Fed We Trust (2009), Andrew Sorkin s monumental Too Big to Fail (2009), 1 E. Ray Canterbery, The Making of Economics, Vol. III, 4th Ed. (New Jersey/ London/Singapore/Hong Kong: World Scientific, 2010) pp

15 Preface xv Dean Baker s False Profits (2010), Simon Johnson and James Kwak s 13 Bankers (2010), Nouriel Roubini and Stephen Mihm s Crisis Economics (2010), Michael Lewis s The Big Short (2010), Raghuram G. Rajan s Fault Lines (2010), John Authers The Fearful Rise of Markets (2010), Roger Lowenstein s The End of Wall Street (2010), Charles Gasparino s The Sellout (2010), Sebastian Mallaby s More Money Than Gold (2010), and Maria Bartiromo s The Weekend That Changed Wall Street (2010). These comprised my background reading; where I used material directly, citations follow. Besides a sweeping look at public sources, The Wall Street Journal, The New York Times and other newspapers also proved valuable. Some of my own work, including the aforementioned books and articles, again comes into play. We return to the main story. The Great Recession was preceded by the Great Depression, Reaganomics, the rise of the Casino Economy, and a housing market conumdrum. Until Alan Greenspan altered the landscape, housing needed a healthy stock market to prosper. The conumdrum occurs when house prices are driven by historically low long-term interest rates while other forms of investment flounder. By sometime in 2005 the housing industry and construction became by far the driver of Gross Domestic Product (GDP), the broadest measure of economic activity. At a time when short-term interest rates were at historical lows, long-term rates were dominating the economy via the housing-construction nexus. A bubble was inflated, only to be pricked by Greenspan s reversal. In the meantime the wealth distribution became more lopsided. The George W. Bush administration saw two official downturns, though the Great Recession spilled over officially for six months into the Obama administration. According to the NBER, a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators. By this measure, the Great Recession was already longer than the average post-wwii recession by December There also was the Great Money and Banking Panic of , with 2008 as the year of its greatest intensity. Within this span The Wall Street Journal and Maria Bartiromo have the financial insider s turning point as September 15, 2008, when

16 xvi Preface Lehman Brothers filed for Chapter 11 bankruptcy. But there is much more. Inside the recession came the debacle of the auto industry, which was essentially taken over by the government. Then President Obama, for one among others, did not see the recession ending in If the NBER had used the unemployment rate as the key indicator, the Great Recession would still be devoid of a happy ending. What has happened was predictable. To understand why, we only need to visit our early chapters and the original John Maynard Keynes and his stress on uncertainty as well as the Post Keynesians such as Hyman Minsky and Paul Davidson. We will return to recent events and prospects for the future in the final chapter. But first we pay a visit to the Great Depression. While the reasons why may seem obvious, they nonetheless will be explained. Throughout the Global Great Recession, the Great Depression was on the lips of many policymakers, in the USA and abroad. While many professors of economics and of finance will find much to chew on, this book, written in accessible bites, can be read by laypersons. The only ingredient required is curiosity. As with my books cited above, I write for a broad audience which has, over the years, included undergraduates and graduate students in economics and in finance. As with most of the books I cite, these and others can be supplementary reading for college and university courses. I must keep the Preface as a preface and end it. After all, this is not the main course. The balance of the book is for your pleasure and instruction.