As this economic earthquake continues shaking the world, we can only guess at the results. What effects from this will ripple into the future? This post considers only what might happen, not if these changes are good or bad for America.
This is speculation about the unknowable, to help us understand the magnitude of these events and open our imaginations to the possibility of extreme outcomes. This series considers the following ways in which the crisis will have large and long-reaching effects. (note the links to other chapters in the series)
- Political realignment in the US — dominance of the Democratic Party for a generation or more.
- Economic structure — a massive increase of government power, a slower growing but more stable economy.
- Oil prices and supply — lower prices followed by far higher prices, perhaps government ownership.
This post discusses #2: the changes to the structure of America’s economy. There will be a recession, probably a global one. How will it change America?
- A smaller role for the free markets
- Greater government control over the economy
- Higher taxes
- Less reliance on foreign money
The result: a more stable economy. It will grow more slowly, and have much less social mobility. The rich will find this trade-off quite congenial. Everyone else must accept it.
The changes might be larger than this, but space and time limitations prevent exploring them in this post. Just to mention one: an end to disintermediation, a return to when household investments were channeled into financial institutions which in turn allocated long-term capital to the economy.
1. Less role for the free market
The past two decades have seen one financial crisis after another. The late 1980’s rise and crash of the US dollar. The 1987 stock market crash. The commercial real estate bust in the early 1990’s, the collapse of the S&L industry, and a recession. The tech bust in 2001, collapse of capital spending, and a recession.
And now this, the biggest bust since the 1930’s. Ten years of stock gains vaporized. Public and private pension funds devastated. The financial sector crippled, requiring hundreds of billions of dollars of public money to recharge.
I think people will say “enough.” The risk of relying on free market systems is too great, the resulting volatility more than we can bear. Whether this is correct or not I leave for God to decide; but the American public must decide relying on our own judgment. Brad Delong (Professor of Economics, Berkeley) may have anticipated their decision (source):
I don’t believe that after this the price of risk will ever again become a free-market price, just as after the Great Depression the short-term price of liquidity — the short term interest rate — ever became a free-market price. The federal government, in one form or another, is going to be in the business of insuring debt securities against steep declines in value. Securities that are not so insured will simply not be traded. What Fannie Mae did for “conforming” home loans, the Treasury or some other government agency will do for derivative securities. It will offer insurance, charge for that insurance, and supervise and oversee financiers much more strictly.
2. Greater government control over the economy
This means not just greater regulation of the economy. The government has taken over some of our leading financial institutions, and will take a piece of many more. It will not quickly release what it has taken. Furthermore, the #1 public policy objective of the Democratic Party is to nationalize our health care sector. The opposition to this has already weakened, and their large majority in the next Congress will make this inevitable. So aprox another 20% of the US economy will pass into government control.
This may be a tipping point for the delicate public-private balance of the United States, in which the government becomes not just the dominant actor in the American polity, but the controlling one. After which all other power centers must accommodate themselves to a subservient position, as power centers in France did with respect to the French monarchy during the reign of Louis 14th.
3. Higher taxes
Consider the cost. Our massive military spending, our foreign wars, the bailouts of financial institutions, the massive fiscal stimulus, and national heathcare. How will we pay for this? The Democratic Party is quite clear on this: higher taxes on the rich and those with large capital gains (overlapping but not identical groups).
During the New Deal the top marginal tax bracket for individuals went from 20% to 80%.
4. Less reliance on foreign money
The Latin American debt crisises in the 1980’s. The 1997-98 collapse of the emerging markets and their severe recessions. The many country-specific crisises (e.g., Argentina in 2001). And now, the massive disruption of otherwise health nations by withdrawals of “hot” foreign money after the US and EU financial sector crisis.
The lesson will at last be learned that dependence on liquid flows of foreign capital is perilous. Either do without, or stick to the recipe of the pre-WWI era. America was built with foreign capital, but mostly illiquid investments. It’s difficult for foreigners to repossess and take home railroads, canals, and cattle. Much of the global financial apparatus exists to “recycle” hot flows of money, and will be rendered unnecessary by this change.
If the current events do not spark this change, eventually the greatest casualty of them all will convince everybody of the folly of relying on flows of mobile cash: the United States. Adicted to cheap foreign loans, the withdrawal process will be painful. Already abandoned by foreign private capital, today we rely on the support of a small number of foreign governments. In the next year or two will we ask them to loan us trillions of dollars. The result will might be the Master Settlement of 2009, which will change the shape of the world order.
For other perspectives on this
“The End Of American Capitalism?“, Anthony Faiola, Washington Post, 10 October 2008 — Excerpt:
The worst financial crisis since the Great Depression is claiming another casualty: American-style capitalism. … Given that the United States has held itself up as a global economic model, the change could shift the balance of how governments around the globe conduct free enterprise. Over the past three decades, the United States led the crusade to persuade much of the world, especially developing countries, to lift the heavy hand of government from finance and industry.
But the hands-off brand of capitalism in the United States is now being blamed for the easy credit that sickened the housing market and allowed a freewheeling Wall Street to create a pool of toxic investments that has infected the global financial system. Heavy intervention by the government, critics say, is further robbing Washington of the moral authority to spread the gospel of laissez-faire capitalism.
“The Commodities Market Bubble: Money Manager Capitalism and the Financialization of Commodities“, L. Randall Wray, Levy Institute, October 2008 — Abstract:
Money manager capitalism—characterized by highly leveraged funds seeking maximum returns in an environment that systematically underprices risk — has resulted in a series of boom-and-bust cycles in equities, real estate, and commodities. Because subsequent cycles have been increasingly damaging to the broader economy, we are now at the point where we are experiencing the most severe financial crisis since the Great Depression. Hasty interventions (bailouts) by Congress, the Treasury, and the Federal Reserve are attempting to keep the financial industry solvent, in the belief that government inaction would result in a prolonged recession.
In this new public policy brief, Senior Scholar L. Randall Wray shows how money manager capitalism (financialization) has destabilized one asset class after another. He concludes that policymakers must fundamentally change the structure of our economic system, break the cycle of booms and busts, and reduce the influence of managed money—as well as prevent the next speculative boom in yet another asset class.
Originally publiushed at Fabius Maximus on Oct 14, 2008 and reproduced here with the author’s permission.