“What, pray, is all the fuss about?” asked a sage columnist on the first anniversary of the credit crunch (“Crisis, what crisis?”, The Guardian, Aug. 12, 2008). In response to claims that this was a great crisis of capitalism, he even deployed the word “phooey.” That sage columnist was of course yours truly; it is safe to say that I will not paste that article into my scrapbook under the title “Most Prescient Pieces.”
My argument was of course correct in that it looked in the rearview mirror rather than at the road ahead. The striking thing about the first year of the crunch was how little impact it had on the wider economy beyond the banks, the City of London and Wall Street.
And any impact that has yet been seen does not make the situation worse than the recession of the early 1990s, or especially the early 1980s, when unemployment was nearly double today’s level. Still, it is no longer possible to be as sanguine as I was in August. We are still far from a “worst since the 30s” situation, but there is no doubt that in the last four months all developed economies, and many developing ones, have frozen up. How bad might it get? We don’t know, because we can’t know.
It is worth dwelling for a moment on why I was proven so wrong. There are, I think, two reasons beyond idiocy or complacency.
First, I may have spent too much time thinking about Japan. It really did have the rich world’s worst financial crisis since 1929, when after 1990, its stock market plunged 75 percent and property prices fell 70 percent. But it never had a severe recession: more a slow squeeze that ended, from 1997 onwards, in deflationary stagnation. A huge public spending program prevented a slump; while using public funds to rescue banks prevented a meltdown.
The collapse of our financial pyramid scheme could be absorbed, I thought, by learning from Japan’s example and improving on it. That is exactly what British Prime Minister Gordon Brown did by recapitalizing Britain’s banks 14 months into the crisis, rather than waiting eight years, as Japan had. It is reflected in the fiscal expansion announced in British Chancellor of the Exchequer Alistair Darling’s pre-budget report in November and the huge spending program being prepared by US president-elect Barack Obama.
However, our drama now feels worse than Japan’s because it is international. Healthy global growth propped up Japan’s economy, whereas now we are all slowing or receding together. It is also worse because of the second factor that I misjudged in August: psychology.
The position I took was in effect an attempt to argue that we risked talking ourselves into recession through media scaremongering and remarks such as Darling’s warning in his Guardian interview on Aug. 29 that the UK faced the worst economic times in 60 years, with more “profound and long-lasting” effects than people were expecting. No doubt he now thinks he has been proven correct, while I still hope that he won’t be, and feel he may have contributed to the panic — even though it would be implausible to argue that he caused it.
Now fear has taken over. Companies, households and banks have decided that cash must be king, to be in debt is to risk death, and new commitments are best avoided. Individually, this is rational. Collectively, it is disastrous. Or, to avoid being a scaremonger, it brings about the thing we are afraid of: a nasty recession.
We can’t predict how deep the recession will be, or how long it will last, because it depends on psychology. Economics is not about models and mathematics; it is about behavior: our reactions to opportunities, risks and fears.
Brown and Darling are right to be trying to counter that deflationary psychology by throwing away the old fiscal rules, cutting VAT and expanding public borrowing. Like in Japan, this will help to mitigate the slump. But whether it can end the slump will depend on companies, households and banks that hold cash being convinced that it is time to start spending again.
Meanwhile, this is not yet a true “crisis of capitalism.” That would arise if confidence never seems likely to return, if unemployment has soared and if hope seems truly to be dead. We cannot rule it out. But let us, as Obama said in his book, have the audacity to hope that it won’t happen, and the sense not to announce it until and unless it does.
Bill Emmott is a former editor of The Economist.
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