“You can always rely on the US to do the right thing,” quipped former British prime minister Winston Churchill, “once it has exhausted the alternatives.”
That is indeed why Friday’s market euphoria at the US Treasury’s financial rescue plan was justified. Launching a rescue was the right thing to do, and the good thing about the US is that it has done it quickly, about 13 months after the credit crunch began — rather than taking seven or eight years, as Japan did after its own crunch in the 1990s.
Perhaps it takes a free market, wild-west capitalist system to know when the sheriff should be called in. Anyone wishing to see this market turmoil as somehow the denouement of deregulated “finance capitalism,” the end of Thatcher-Reaganism, and proof that regulated systems work better, needs to take account of Japan, the world’s second largest economy and home of the other great 1930s-style financial crash of recent decades.
Japan’s banking system collapsed in the 1990s, and its once-brilliant bureaucrat-regulators failed to act quickly to clean up the mess. So far, the US — helped, no doubt, by the chance to learn from Japan’s example — is doing better.
But the rapture about the US needs some modification. The good news, both about the latest mega-rescue and the earlier nationalization of Fannie Mae, Freddie Mac and AIG, is that the US government has shown that it is willing to assume responsibility for clearing up the bad debts. A safety net is thus now available to prevent more banks thudding into the ground.
The bad news, however, is that preventing any more collapses will be far from easy. The problem is that it is unclear, in such situations, what a “bad debt” really is. In the 1980s, when the US government cleaned up after the collapse of its savings and loans industry, it took over bankrupt firms and sold their debt.
This time, it is promising to buy bad debts from banks that are still active. It will have to set some sort of price, but also haggle over the definition of eligible debts. For when an economy is sliding into recession, as the US will probably now do, a debt that is good today can turn bad tomorrow.
Consequently, no one can know how much money this rescue will cost. Numbers being bandied about range from US$700 billion to US$1 trillion, though generally with a cheery caveat attached that the federal government could even end up making a profit by taking on bad debts and later selling them. In no calculation of the cost of this venture should that be counted upon. After all, if it looked a good bet, other governments presiding over sliding housing markets, including the UK’s, would be rushing to offer their own plans to buy up dud mortgage debt. They aren’t — though probably some will have to before this affair is over.
No doubt the violent mood swings in financial markets we saw last week will return at some point: new black holes will be found or suspected, and more institutions will be brought to the brink of collapse. But the US action does mark a turning point, as long as neither the White House nor Congress decides to renege on the promises to provide a safety net.
From this point, the right questions will center on the consequences for fiscal policy and national debt, rather than on banking as such. Right at the outset of the credit crunch, in August last year, the IMF’s then new boss, Dominique Strauss-Kahn, called for a big fiscal expansion to try to support the global economy. Finally, he is going to get his way — but not in quite the form he expected.
There has been much hyperactive talk about how vast the US rescue plan is, and how earth-shattering will be the extension of government that it represents. This is misleading: the rescue is indeed very large, but so is the US economy. The federal government is already in debt to the tune of US$5.4 trillion, which sounds impossibly large if you don’t realize that the US’ annual GDP is nearly US$14 trillion. This isn’t Italy, in other words: there is room to add another few trillion to the debt.
The annual cost on the budget deficit in the first year could be US$700 billion, larger even than the impact of the Iraq war. But that, too, is misleading if you don’t realize that the US federal deficit currently is less than 3 percent of GDP — smaller than Britain’s (3.8 percent). Similarly, this extra debt is unlikely, of itself, to lead to a new decline in the dollar, as some have predicted: the dollar might fall in value relative to other currencies, but only if the US economy goes into a deep and prolonged recession, which is what the rescue plan meant to avert.
No, the true impact of this expansion of public spending lies in politics, and in what this rescue will now make more difficult or perhaps impossible: the expansion of other areas of public spending, such as healthcare or public programs for alternative energy. If Barack Obama is elected president in November, he will find his fiscal hands tied a lot tighter than he may have hoped, even with a Democratic Congress alongside him — unless, of course, he wants to raise taxes.
Bill Emmott is a former editor of the Economist and the author of Rivals: How the Power Struggle between China, India and Japan Will Shape Our Next Decade.
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