Dangerous Territory

I'm not as excited about the Obama presidency as I envisioned. After eight long years, I was primed for true action on restructuring the energy regime, addressing climate change, and tackling a host of other global problems. Unfortunately, these truly urgent issues will take a backseat to crisis, in the form of the United States’ economic collapse. Worse, despite the truly urgent nature of such global issues as climate change, the focus of the Obama administration will be inexorably drawn to the sustained and continued collapse of our nation’s economy.

Non-financial earnings are just beginning to decline, suggesting that the real economy (outside the financial institutions) is just beginning the plunge that the financial market went through. Paraphrasing my friend at Morgan Stanley, rather than the savage beheading the financials and insurance companies had to endure, non-financials seem primed for a death by a thousand paper cuts.

A few quick indicators: Unemployment is steadily rising and looks like it will hit 10%. A GM default appears imminent. Banks are not lending, insurers are not insuring. Personal consumption is less than -1%, savings rates are increasing towards 5%, and consumers are going to use whatever cash they do spend on paying down debt. All of these trends point to more distress.

This collapse is essentially comeuppance for building an unsustainable and fundamentally unsound economy. Take US household as a percentage of net worth: in 1952 it was 5%, in 2000 it was 15%, and in 2008 it was 24.6%. These numbers help suggest that this economic expansion since the pre-tech bubble was little more than a bear market rally created by too much leveraging, both on the consumer and business sides.

The scary but logical conclusion is that since the boom was not predicated on fundamentals, it can all go away as quickly if not quicker than it came. It is difficult to imagine a world bombed back to no credit, but it certainly would look different than today’s. The difficulty is that even if we “fix” the markets by extending credit, we are going to have to delever as a country no matter what. Doing so means asset values will fall, there will be much less spending, and we will find ourselves in a textbook vicious circle.

The X-factor of this economic recession is that it is truly global. Recent numbers from China are pretty ugly, and raise some potentially disturbing questions. What if China continues only single digit growth? What if it discontinues buying US treasuries? What if it actually starts selling them? The dollar would plummet, interest rates would soar, and the economy would become even more ravaged. The realization that Europe seems to be in potentially even more dire straits than the United States throws another wrench into the global equation.

However, while the global nature of this massive economic collapse may raise a host of questions on how to address it, it may also provide an opportunity for more global coordination. Indeed, the transnational links and flows that helped facilitate countries’ collective rise and fall still exist, and some kind of synchronized management should now be on the agenda. Sometimes it takes a crisis to spur action – we can only hope nations work towards action on the same scale as this crisis.