Friday, October 22, 2010

Looking Back and Looking Forward: Assessing the Great Recession

A couple of days ago, Professor Merton Finkler gave a colloquium at my alma mater doing some comparative economics along with economic forecasting regarding the Great Recession. Since the American economy, as well as the overall global economy were analyzed, Finkler's analysis, much like this blog entry, attempts to cover much ground in a small frame.

The Great Depression and Great Recession are similar in the sense that both were triggered by financial crises in which both situations, the American government tried to resolve the issue with unsustainable borrowing and large amounts of bank regulation. There are actually more differences in comparing the two. In the Great Depression, there was a higher rate of declining GDP (13% vs. 4%) from trough to peak and the rate of unemployment was much higher (25% vs. 10%). However, the Great Recession received a greater drop in stock markets and trade, as well as the job deficit in the Great Recession (8 million and counting) was much greater.

Aside from giving the comparative economic history, Finkler mentioned a particularly interesting economic indicator, which I didn't know of until he mentioned it, which was the Baltic Dry Index (BDI). The BDI measures the demand for shipping capacity versus the supply of dry bulk carriers. The reason why this index is so telling is because the supply of such goods changes slowly, thus making it a strong indicator for the demand of these goods. If you look at the BDI over the past couple of years, it plummeted right around the end of 2008, indicating that the trade sector took a heavy hit.

Finkler also mentioned such global economic factors such as the debt-ridden PIIGS (Portugal, Italy, Ireland, Greece, Spain) in the European Union, thereby forecasting potential destabilization of the European Union. He also mentioned that in the global market, China is here to stay.

What I found most captivating about the event, however, was his bottom line. Financial panics reflect deteriorating balance sheet and potential insolvency. Insolvency is not equivalent to a lack of cash flow, and thus cannot be solved by printing more money. Although debt unto itself is not a bad thing [because debt can potentially be paid off in the long-run], we currently have an unsustainable debt service that cannot be corrected by more borrowing. Since the only thing the Federal Reserve can really do is borrow money, they cannot be the solution to the problem, although many would like to think so. Since the credit to GDP ratio is at 357%, we have no choice but to focus on reducing the burden of the debt. Households make up 92% of that 357%, which means that Americans would need a higher marginal propensity to save and have a sense of fiscal responsibility. Interestingly enough, the private and public sectors have racked up roughly the same amount of debt as of date. What is perturbing, however, is the rate at which the government is borrowing and the rate at which business have cut back. This negative trend can only mean that in a matter of time, the percentage of debt that the government will rack up will be considerably higher than it is now.

This is anything but the deleveraging that Finkler had prescribed, especially in light of the unfunded liabilities indicated by the Debt Clock. What do unfunded liabilities exactly mean? It entails programs such as Social Security, Medicare, and Medicaid. Finkler pointed out that the problems with these unfunded liabilities are exacerbated by the fact that the worker to dependant ratio is below two and continuing to drop. Once it reaches below one, which will happen based on the inevitability of age-based demographics, there will be three policy options for Congress: tax more, cut benefits, or extend benefits to fewer people.

Since financial panics cause longer recessions, Finkler used economic indicators to predict that it could very well take until 2015 to get out of this mess. Regardless of the gloomy prediction, the fact that we are not considering long-term implications of our fiscal policies will guarantee that America is going to be in economic upheaval for the long haul.

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