Jun 052012

Martin Wolf, much-honored chief economics commentator of the Financial Times, has been my beacon during the financial crisis. So it is especially discouraging to read his June 6, 2012, column, headlined “Panic has become all too rational”.

Wolf argues that the advanced economies are caught in a “contained depression,” that economic conditions will get worse, and that policy-makers are making “huge errors” in not offsetting private-sector deleveraging with sufficient public-sector deficit spending.

Wolf wants governments of advanced economies to go even deeper in the hole to support aggregate demand. Governments could borrow, after all, at some of the lowest interest rates in history.

Low interest rates, money-printing by central banks, and already very high fiscal deficits have managed to contain this depression so far. But they have failed to induce anything better than feeble recoveries, showing how powerful, Wolf asserts, are the forces of deleveraging — the paying down of debt by individuals and companies.

“This is the legacy,” Wolf writes, “of a huge financial crisis preceded by large asset price bubbles and huge expansions in debt.”

In his June 6 column, Wolf reminds us that the failure of Austria’s Kreditanstalt in 1931 led to a wave of bank failures across Europe, setting the stage for (among other miseries and disasters) the second leg of the Great Depression. He sees something akin to that taking shape now.

Wolf worries that “a wave of banking and sovereign failures might cause a similar meltdown inside the eurozone.” The collapse of the eurozone might, in turn, “generate further massive disruption in the European and even global financial systems, possibly even knocking over the walls now containing the depression.”

Is it realistic to worry about such frightening prospects? Wolf asks rhetorically. His response: “Quite realistic. … In a panic, fear has its own power.”

Wolf writes that Europe needs an unshakable lender of last resort with both the resources and the political will “to act on an unlimited scale” — to stop the runs on Europe’s banks and on Europe’s sovereigns. But there is no such lender in sight. Meanwhile, political systems are under enormous stress, exemplified by spring-time rioting in the streets of Athens.

Wolf’s glum closing lines include the following:

How much pain can the countries under stress endure? Nobody knows. What would happen if a country left the eurozone? Nobody knows. Might even Germany consider exit? Nobody knows. What is the long-run strategy for exit from the crises? Nobody knows. Given such uncertainty, panic is, alas, rational.…

Before now, I had never really understood how the 1930s could happen. Now I do. All one needs are fragile economies, a rigid monetary regime, intense debate over what must be done, widespread belief that suffering is good, myopic politicians, an inability to co-operate and failure to stay ahead of events.

The New York Times reports on Page 1 today that the Greek government as soon as July will run out of money to pay salaries and pensions, as well as buy imported food, fuel and pharmaceuticals. It will have exhausted its most recent bailout round, $162 billion. Meanwhile, reports The Times, “a wrenching recession and harsh budget cuts have left businesses and individuals with less and less to give for taxes — and growing incentive to avoid paying what they owe.”

When I used the phrase “contained depression” last summer, I punctuated with a question mark. Guided by Wolf, I say it is time to ditch the question mark. As I wrote last week, though it resembles a September 2008 blockbuster, we really have not seen this movie before. We don’t know how it ends.

Chairman Mao, asked for his assessment of the French Revolution, reportedly replied: “It is too soon to tell.” The same surely must be said today of the “contained depression.” Contained? Good luck with that.



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