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BW Businessworld

The Fable Of Recovery

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Legend tells of the boy who often cried "wolf" when in fact there was no wolf. It involves the case where the boy cried "wolf" when indeed there was a ferocious wolf, but no one paid attention.

Ever since the global meltdown began in 2007, Wall Street pundits and government officials have proclaimed cheery optimism that meaningful global recovery will occur by the second half of 2009, or the first quarter of 2010. So, they're telling us we have nothing to fear except fear itself.

Well, we have now entered 2009's second half and unemployment is still rising, so are bankruptcies and mortgage foreclosures. Despite the admirable rescue operations of the Obama team, the Bank of England and the European Central Bank, the vicious circle of consumers and investors too scared to spend continues. Unemployment will worsen still, and shortfalls in the GDP growth rate will persist.

It is rational for a rescued bank to be afraid to enter into risky lending. Why can't orthodox central bank operations reverse accelerating recessions? Early on official shortest-term assets are given yields that approximate zero. At zero interest rates, everyone freezes up and becomes a hoarder.

Macroeconomists who taught in the 1970s and 1980s at elite Harvard, Princeton, Stanford and MIT were slow to understand the obvious. When a few of us, as far back as spring of 2007, warned that meaningful recovery might be delayed by years, we were only a lunatic minority.

Yes, Japan could experience a "lost decade" but academic financial engineers had, in the West, allegedly forged new tools to measure risk and enable both the spread and control of it. No "lost decades" for us smart guys.

A pretty fable. Yes, those financial engineering tools, invented at MIT, Chicago and Wharton, could have had useful functions. But in reality, no CEO you will ever meet truly understood these fiendish new tools.

Instead of controlling riskiness, the new tools — swaps, puts and calls, securitized packets of mortgage loans — under President George Bush's form of unregulated financial investment, diminished transparency and led to dangerous hyper-leveraging. Result: an ultra-fragile financial system, prone to a global meltdown of 2007-2008.

President Barack Obama's treasury secretary, Timothy Geithner, claims that rescue is already working and imminent recovery is on its way. He errs. The rescue of new sustained Main Street spending has hardly begun. Without such, as the New Deal learned in the 1930s, recovery is impossible.

But has any member of Barack Obama's crack economic team spoken about the need to send to Main Street money for sustained spending and re-spending? No.

China, a one-party despotic state, by piling on new deficit spending will, paradoxically, beat the rest of us to macro recovery.

Today's macro scholars are poorly prepared to combat post-2006 meltdowns. Their textbooks on macroeconomics did not talk of "liquidity traps" or "paradoxes of thrift" whereby the attempt of people and businesses to save more, only shrank rather than augment Main Street spending.

It is giving sustained funds to ready spenders that counts most. Now, in the second half of 2009, it is too late to spend on shovel-ready projects. States and municipalities need help to meet their budget needs, and analyze how to deal with deficits and spend government stimulus funds. Suffering states will spend whatever they are given. So discount those rosy assurances of meaningful recovery for a few months.

The late Charles Kindleberger, expert on manias and financial crashes, reiterated Walter Bagehot's insistence that every capitalist system needs a "lender of last resort". If alive today, he would insist on a need for a "spender of last resort", that is the government.

Republican members of Congress do not understand these ABC's. Nor do the Democrats in Congress. Time delays are crucially lethal once a recession is becoming self-generating in the chicken-egg-chicken fashion.

Only an Obama has the charisma and popularity to insist on meaningful sustained deficit spending. Yes, deficit spending. It took all of Franklin Roosevelt's guile and eloquence to push things and maintain the New Deal recovery. Abhorent dictator Adolf Hitler used similar deficit spending to restore Germany to full employment by 1939.

May democracies in the 21st century quickly achieve the compromises needed to restore economic sanity.

© 2009 Tribune Media Services

(This story was published in Businessworld Issue Dated 03-08-2009)