Nov 2nd 2008

Boom, Bust, and Recovery in the World Economy

by Jeffrey D. Sachs

Jeffrey D. Sachs is Professor of Economics and Director of the Earth Institute at Columbia University. He is also a Special Adviser to United Nations Secretary-General on the Millennium Development Goals.

NEW YORK - This global economic crisis will go down in history as Greenspan's Folly. This is a crisis made mainly by the United States Federal Reserve Board during the period of easy money and financial deregulation from the mid-1990's until today.

This easy-money policy, backed by regulators who failed to regulate, created unprecedented housing and consumer credit bubbles in the US and other countries, notably those that shared America's policy orientation. The bubble has now burst, and these economies are heading into a steep recession.

At the core of the crisis was the run-up in housing and stock prices, which were way out of line with historical benchmarks. Greenspan stoked two bubbles - the Internet bubble of 1998-2001 and the subsequent housing bubble that is now bursting. In both cases, increases in asset values led US households to think that they had become vastly wealthier, tempting them into a massive increase in their borrowing and spending - for houses, automobiles, and other consumer durables.

Financial markets were eager to lend to these households, in part because the credit markets were deregulated, which served as an invitation to reckless lending. Because of the boom in housing and stock market prices, US household net wealth increased by around $18 trillion during 1996-2006. The rise in consumption based on this wealth in turn raised house prices further, convincing households and lenders to ratchet up the bubble another notch.

This has all come crashing down. Housing prices peaked in 2006, and equity prices peaked in 2007. With the collapse of these bubbles, paper wealth of perhaps $10 trillion, or even as much as $15 trillion, will be wiped out.

Several complex things are now happening simultaneously. First, households are cutting back sharply on consumption, since they feel - and are - vastly poorer than they were a year ago. Second, several highly leveraged institutions, such as Bear Stearns and Lehman Brothers, have gone bankrupt, causing further losses of wealth (of these failed institutions' shareholders and creditors) and a further loss of credit that these firms once supplied.

Third, commercial banks also lost heavily in these dealings, wiping out much of their capital. As their capital declines, so, too, do their future loans. Fourth, and finally, the failure of Lehman Brothers and near failure of the insurance giant AIG, incited a financial panic, in which even healthy firms are unable to obtain short-term bank loans or sell short-term commercial paper.

The challenge for policymakers is to restore enough confidence that companies can once again obtain short-term credit to meet their payrolls and finance their inventories. The next challenge will be to push for a restoration of bank capital, so that commercial banks can once again lend for longer-term investments.

But these steps, urgent as they are, will not prevent a recession in the US and other countries hit by the crisis. The stock and housing markets are unlikely to recover any time soon. Households are poorer as a result, and will cut back sharply on their spending, making a recession inevitable in the short run.

The US will be hardest hit, but other countries with recent housing and consumption booms (and now busts) - particularly the United Kingdom, Ireland, Australia, Canada, and Spain - will be hit as well. Iceland, which privatized and deregulated its banks a few years ago, now faces national bankruptcy, because its banks will not be able to pay off foreign creditors who lent heavily to them. It is no coincidence that, with the exception of Spain, all of these countries explicitly adhered to the US philosophy of "free-market" and under-regulated financial systems.

But, whatever the pain felt in the deregulated Anglo-Saxon-style economies, none of this must inevitably cause a global calamity. I do not see any reason for a global depression, or even a global recession. Yes, the US will experience a decline in income and a sharp rise in unemployment, lowering the rest of the world's exports to the US. But many other parts of the world that still grow. Many large economies, including China, Germany, Japan, and Saudi Arabia, have very large export surpluses, and so have been lending to the rest of the world (especially to the US) rather than borrowing.

These countries are flush with cash, and are not burdened by the collapse of a housing bubble. Although their households have suffered to some extent from the fall in equity prices, they not only can continue to grow, but they can also increase their internal demand to offset the decline in exports to the US. They should now cut taxes, ease domestic credit conditions, and increase government investments in roads, power, and public housing. They have enough foreign-exchange reserves to avoid the risk of financial instability from increasing their domestic spending, as long as they do it prudently.

As for the US, the current undeniable pain for millions of people, which will grow next year as unemployment rises, is an opportunity to rethink the economic model adopted since President Ronald Reagan came to office in 1981. Low taxes and deregulation produced a consumer binge that felt good while it lasted, but also produced vast income inequality, a large underclass, heavy foreign borrowing, neglect of the environment and infrastructure, and now a huge financial mess. The time has come for a new economic strategy - in essence a new New Deal.


Watch below Professor Jeffrey Sachs giving a testimony on the Financial Crisis to the U.S.Senate on November 20, 2008:


Below Fareed Zakaria's interview with Robert Rubin, who was Bill Clinton's Secratary of Treasury and is an adviser for Barack Obama on economic issues. The interview took place on October 3, 2008.

Video part one:




Video part two:




If you wish to comment on this article, you can do so on-line.

Should you wish to publish your own article on the Facts & Arts website, please contact us atinfo@factsandarts.com . Please note that Facts & Arts shares its advertising revenue with those who have contributed material and have signed an agreement with us.


Browse articles by author

More Current Affairs

Dec 14th 2019
EXTRACT: "Conspiracy theories about sinister Jewish power have a long history. The Protocols of the Elders of Zion, a Russian forgery published in 1903, popularized the notion that Jewish bankers and financiers were secretly pulling the strings to dominate the world. Henry Ford was one of the more prominent people who believed this nonsense."
Dec 13th 2019
EXTRACT: "In previous British elections, to say that trust was the main issue would have meant simply that trust is the trump card – whichever leader or party could secure most trust would win. Now, the emerging question about trust is whether it even matters anymore."
Dec 5th 2019
EXTRACT: "Europe must fend for itself for the first time since the end of World War II. Yet after so many years of strategic dependence the US, Europe is unprepared – not just materially but psychologically – for today’s harsh geopolitical realities. Nowhere is this truer than in Germany."
Nov 23rd 2019
Extdact: "The kind of gratitude expressed by Vindman and my grandfather is not something that would naturally occur to a person who can take his or her nationality for granted, or whose nationality is beyond questioning by others. Some who have never felt the sharp end of discrimination might even find it mildly offensive. Why should anyone be grateful for belonging to a particular nation? Pride, perhaps, but gratitude? In fact, patriotism based on gratitude might be the strongest form there is."
Nov 20th 2019
Extract: "Moody’s, one of the big three credit rating agencies, is not upbeat about the prospects for the world’s debt in 2020 – to put it mildly. If we were to try to capture the agency’s view of where we are heading on a palette of colours, we would be pointing at black – pitch black."
Nov 17th 2019
Extract: "Digital money is already a key battleground in finance, with technology firms, payment processing companies, and banks all vying to become the gateway into the burgeoning platform-based economy. The prizes that await the winners could be huge. In China, Alipay and WeChat Pay already control more than 90% of all mobile payments. And in the last three years, the four largest listed payment firms – Visa, Mastercard, Amex, and PayPal – have increased in value by more than the FAANGs (Facebook, Apple, Amazon, Netflix, and Google)."
Nov 14th 2019
Extract: "Trump, who understands almost nothing about governing, made a major mistake in attacking career public officials from the outset of his presidency. He underestimated – or just couldn’t fathom – the honor of people who could earn more in the private sector but believe in public service. And he made matters worse for himself as well as for the government by creating a shadow group – headed by the strangely out-of-control Rudy Giuliani, once a much-admired mayor of New York City, and now a freelance troublemaker serving as Trump’s personal attorney – to impose the president’s Ukraine policy over that of “the bureaucrats.” "
Nov 4th 2019
Extract: "Trump displays repeated and persistent behaviours consistent with narcissistic personality disorder and antisocial personality disorder. These behaviours include craving for adulation, lack of empathy, aggression and vindictiveness towards opponents, addiction to lying, and blatant disregard for rules and conventions, among others." The concern is that leaders with these two disorders may be incapable of putting the interests of the country ahead of their own personal interests. Their compulsive lying may make rational action impossible and their impulsiveness may make them incapable of the forethought and planning necessary to lead the country. They lack empathy and are often motivated by rage and revenge, and could make quick decisions that could have profoundly dangerous consequences for democracy.
Oct 31st 2019
EXTRACT: "......let’s see what happens when we have less money for all the things we want to do as a country and as individuals. Promises and predictions regarding Brexit will soon be tested against reality. When they are, I wouldn’t want to be one of Johnson’s Brexiteers."
Oct 21st 2019
EXTRACT: "Were Israel to be attacked with the same precision and sophistication as the strike on Saudi Arabia, the Middle East would be plunged into war on a scale beyond anything it has experienced so far. Sadly (but happily for Russian President Vladimir Putin), that is the reality of a world in which the US has abandoned any pretense of global leadership."
Oct 20th 2019
EXTRACT: "Europe also stands to lose from Trump’s abandonment of the Kurds. If, in the ongoing chaos, the thousands of ISIS prisoners held by the Kurdish-led Syrian Democratic Forces escape – as some already have – America’s estranged European allies will suffer. Yet Trump is unconcerned. “Well, they are going to be escaping to Europe, that’s where they want to go,” he remarked casually at a press conference. “They want to go back to their homes." "
Oct 15th 2019
EXTRACT: "Assuming the House ultimately votes to impeach Trump, the fact remains that there are far fewer votes in the Senate than will be needed to convict him and remove him from office. But the willingness of Congress – including the Senate – to continue tolerating his dangerous conduct in office, including threats to US national security, is now truly in question."
Oct 7th 2019
EXTRACT: "The problem didn't start with the election of Donald Trump. Nor did it begin with the Democrats launching an impeachment inquiry against Trump. This is a developing crisis that has been growing like a cancer within our polity for at least the past 25 years. Its main symptoms are a lack of civility in our political discourse, a "take no prisoners" mindset, and a denial of the very legitimacy of "the other side." Trump didn't create this crisis; he was the result of it.   When Newt Gingrich took the helm of Congress in 1995, unlike previous Republican leaders, he embarked on a campaign not only to obstruct the efforts of then President Clinton, but to destroy him. Congress launched a series of investigations accusing Clinton of everything from corruption to obstruction of justice – with hints of even more nefarious plots to assassinate those who might pose a problem to his presidency.  "
Oct 4th 2019
EXTRACT: "As the story spreads, it grows darker. Meanwhile, Trump is trying to learn the identity of the whistleblower (who is protected by law), which could expose that person to great danger. And he is accusing some people – including Adam Schiff, the chair of the House Intelligence Committee – of treason. My sense is that Trump fears the tough, focused Schiff. Trump has ominously noted that traitors used to be shot or hanged. And he hasn’t helped himself with members of either party by declaring, in one of his hundreds of febrile tweets, that forcing him from office could lead to a “civil war.” Trump has taken the United States somewhere it’s never been before. His presidency may not survive it."
Sep 24th 2019
EXTRACT: "But regardless of whether the Ukraine scandal remains front-page news, it will haunt the US intelligence community, which has been Trump’s bête noire since the day he took office. Trump has relentlessly attacked US intelligence agencies, cozied up to Russian President Vladimir Putin, and divulged secrets to foreign officials, potentially burning high-value sources. This behavior had already raised serious concerns about whether Trump can be trusted to receive sensitive intelligence at all. Now, intelligence leaders must ask themselves how far they are willing to go in toeing the White House line."
Sep 21st 2019
EXTRACT: "As Lobaczewski pointed out, pathological leaders tend to attract other people with psychological disorders. At the same time, empathetic and fair-minded people gradually fall away. They are either ostracised or step aside voluntarily, appalled by the growing pathology around them.......As a result, over time pathocracies become more entrenched and extreme. You can see this process in the Nazi takeover of the German government in the 1930s, when Germany moved from democracy to pathocracy in less than two years.......In the US, there has clearly been a movement towards pathocracy under Trump. As Lobaczewski’s theory predicts, the old guard of more moderate White House officials – the “adults in the room” – has fallen away. The president is now surrounded by individuals who share his authoritarian tendencies and lack of empathy and morality. Fortunately, to some extent, the democratic institutions of the US have managed to provide some push back."
Sep 16th 2019
EXTRACT: "If the Supreme Court does agree with the Divisional Court that the question is political rather than legal, it will take the UK constitution into quite peculiar territory. Prime ministers will be the new kings and queens. They will be free to suspend parliament at will, and for as long as they wish, without any judicial interference. Parliament will meet not out of constitutional necessity but in the service of the government’s interests – namely, to pass its legislation and to maintain appearances, rather than to hold it to account."
Sep 12th 2019
Extract: "The Republican Party has lashed its fate to an increasingly unhinged leader. Though three other presidential hopefuls for 2020 now stand in Trump’s way, none can defeat him. But they can damage his reelection effort, which is why the Republican Party has been scrapping some primaries and caucuses. How well Trump does in November next year may well depend on how his fragile ego withstands the coming months."
Sep 2nd 2019
EXTRACTS: "Most people think of revolutions as sudden earthquakes or volcanic eruptions that come without warning and sweep away an entire political system. But historians, political scientists, and even the odd politician know that the reality is very different: revolutions happen when systems hollow themselves out, or simply rot from within. Revolutionaries can then brush aside established norms of behavior, or even of truth, as trivialities that should not impede the popular will............ Only time will tell whether we are currently witnessing the hollowing out of British democracy. But Prime Minister Boris Johnson may well have crossed some invisible Rubicon by.......... Whatever happens now, British parliamentary democracy may never be the same again. It will certainly never again be the model that so many people around the world once admired."
Aug 29th 2019
EXTRACT: "Events such as prorogations and dissolutions happen when countries face difficult times. Therefore, because of the disastrous effects of Brexit: sterling in freefall; a recession looming on the horizon and Britain’s international standing at its lowest ebb since Suez, it is no surprise that the country is in this position now. The worrying thing is that using the monarchical power of prorogation does not solve problems – it has a history of turning them into frightening and often violent crises. There is a worrying relationship between the use of such powers and a complete breakdown in government."