The past several weeks on global financial markets has been quite some roller coaster ride.
As the US flirted with the prospect of default and Standard & Poor’s downgraded the country’s credit rating, stock markets and currencies have plunged, risen, plunged and then risen again.
What does it all mean, and when will it all end? To be sure, opining on the direction of the stock market is a fool’s game.
Investment bank JP Morgan recognised as much in responding to questions on the market’s direction by noting only that, “It will fluctuate.”
However, even if one cannot be precisely sure of where we are headed, history offers some insight as to the nature of our current predicament – and the extent to which we are more likely in the middle of a shift in ideas and power than at the end of any downturn.
Perhaps the most important thing to bear in mind about the current downturn is that, as the saying goes, “It’s not your father’s recession.”
Since the end of World War II, most recessions have been “man-made”. They were usually brought on deliberately by policy itself, in order to wring an inflationary psychology out of the system.
What governments engineered by raising interest rates, taxes, and cutting spending, governments could just as easily undo by turning on the printing presses, cutting taxes, and increasing spending.
Similarly, where financial panics happened – as in 1986’s Black Monday or in the aftermath of the 1998 collapse of Long Term Capital Management – policymakers knew what to do: flood the markets with liquidity and wait for the “animal spirits” of the market to turn around.
What makes this downturn so different? Why have the repeated attempts at fiscal stimulus and monetary easing failed to revive demand?
Understanding this requires some historical perspective, and a recognition of the consequences of thirty years of wage stagnation in the United States.
Indeed, consider that in 1978, US average hourly earnings stood at $8.96 in real terms. In 2008, average hourly wages stood at $8.57.
In effect, after thirty years of rising productivity and education levels, American workers had less to show for their efforts.
Where did the extra money go? Economist and New York Times columnist Paul Krugman argued that, for the past thirty years, the US has been mired in a “Great Divergence,” marked not simply by stagnant wages but rising income inequality, as from 1980 to 2005, more than 80% of total increase in income went to the top 1%, and wages as a percentage of GDP have broadly fallen relative to corporate profits.
How did Americans continue to consume at such high levels? They borrowed with increasing frequency into the 21st century.
As former US Federal Reserve chairman Alan Greenspan noted in his memoirs: “Consumer spending carried the economy through the post-9/11 malaise, and what carried consumer spending was housing… Capital gains, especially gains realised in cash, began burning holes in people’s pockets.”
Indeed, as consumer credit became a substitute for rising wages, consumers in 2006 put $51 billion in fast food on their credit cards!
Explaining these changes is, of course, the subject of much debate. I myself attach considerable importance to the erosion of labour power, as brought on by the Federal Reserve-induced recession of 1981, and the firing of striking air traffic controllers by President Ronald Reagan that same year.
Others stress the role of trade, tax policies, and an eroding educational system.
What is not subject to debate is the implications of these trends for demand.
In this light, what has made the global financial crisis different from past recessions is that it ended an era of credit growth, and stagnant wages have failed to make up the slack.
Viewed from this perspective, the recent financial instability stands as an “emperor’s new clothes” moment.
Since early 2009, markets have waited for the “green shoots” of recovery, rationalising their absence as a result of varied ad hoc events, such as Greek troubles, oil price increases, and the Japanese tsunami.
The past few weeks may represent the dawning recognition that demand is not coming back, as flat wages and low consumer confidence foretell a steep road to recovery.
What are the broader implications of these changes for policy and power? From a historical vantage, we are only three years into the Global Financial Crisis.
The Great Depression and Great Stagflation each took more than a decade to resolve.
What the events of the past week suggest is that the current crisis is no “garden variety recession,” and that it may take recurring bouts of instability – as in past crises – for a coherent response and recovery to emerge.