America’s economy has grown for nearly six years and with particular vigor over the last six months. By historical standards, we’re due for another recession.
When that downturn comes, it will mark the end of what has been, recent months notwithstanding, a weak recovery. Even though private employers have added nearly 3.6 million jobs since the beginning of last year, the number of American workers is still only roughly where it would have been by the end of 2008 had the financial system not cratered that dark September. Several numbers point up the shortfall: if employers had added jobs after this recession as fast as they did after the short recession that ended in 1991, we’d have nearly 128 million private jobs now, not about 119 million. Then, too, not all jobs are equal. A family with two breadwinners made slightly less money in 2013 than in 2003, inflation-adjusted, census data tell us. A single-earner family fared much worse, taking in less than a family dependent on one worker made back in the mid-1970s. And many part-time workers want full-time jobs, as well as more predictable schedules.
Why has the recovery been so soft? It’s easy for Republicans to blame President Obama or for Democrats to blame President George W. Bush. But the truth is less partisan, and harder.
As three of the best recent accounts of the economic crisis explain, the recovery has disappointed because the economy was fragile long before it broke. For decades now, the United States, like the rest of the West, has depended on massive levels of consumer debt to mask weaknesses in jobs and income.
As American workers made less money competing with Asians and Eastern Europeans for jobs, they borrowed more, until the US economy owed trillions of dollars to the rest of the world. The economy crashed because its debt levels were unsustainable.
Regrettably, President Obama hasn’t used the crash as an opportunity to rebuild with stronger foundations. Instead, we’ve spent seven years doubling down on the mistakes that got us into this mess.
The China effect
Wolf shows that “the once-in-a-century impact of the rise of China” hasn’t gone all that smoothly.
Three decades ago, the two countries had evenly balanced trade — we sold them a small amount of stuff, and they sold us a small amount of stuff. By 2008, however, the US had accumulated a $1.8 trillion trade deficit with its fast-expanding trading partner, government figures show.
In simple terms, that means that we bought nearly $2 trillion more from Chinese producers than we sold back to Chinese purchasers. Such a massive disparity can’t last forever.
In a real free market, the imbalance would have partially fixed itself. As America bought more things from China, the value of China’s yuan would have gone up, making its exports pricier, and thus less competitive. Instead, Wolf observes, China, keen to keep its job growth exploding by maintaining a high level of exports, artificially kept the value of its currency lower than it should have been, thus keeping those exports cheap.
It did this by holding on to the US dollars it received for its exports, instead of converting them into yuan. By 2008, China held $2 trillion in US currency, mostly in Treasury bonds and mortgage bonds. China’s insatiable appetite for US debt allowed Americans to borrow more money more cheaply — temporarily easing the pain for American workers who’d lost jobs and income to global competition.
Wolf doesn’t blame the free market for the cataclysm. China’s monetary policies fall under the category of “state capitalism,” he believes, in which government leaders manipulate markets to achieve desired political outcomes. Indeed, he laments that the crisis has dealt a “blow to the prestige of Western financial capitalism” — and to democracy itself.
The debt explosion
In “The Age of Oversupply: Overcoming the Greatest Challenge to the Global Economy,” Daniel Alpert argues that America and the global economy are struggling with “an oversupply of labor, productive capacity, and capital.” Too many people and too many dollars are chasing after insufficient work and investment opportunities, thinks Alpert, a veteran financier who founded the boutique investment bank Westwood Capital 20 years ago.
The collapse of the Soviet Union and the state-directed opening of China’s economy helped “doubl[e] the global labor supply in the free market in the past two decades,” Alpert writes. “Today, the world has a market labor force of roughly three billion people,” and “nearly half live in China, India, and the former Soviet Union.”
The nation must finally fix the “too-big-to-fail” financial system that has channeled so much bad debt to American borrowers, assuming that it will never pay the consequences of its risky lending.
There are thus more people around the world looking for work — and they push the price of labor (wages) down. Ironically, Alpert says, “the demise of the socialist experiment” in Eastern Europe and Asia “set the stage for the greatest threat yet to the supremacy of the United States and other advanced democracies.”
“Competing against nearly two billion new workers from poor countries” was never going to be easy, Alpert acknowledges. But America made the “worst possible choices” as it tried, or didn’t try, to help beleaguered working-class and middle-class workers. Rather than finding ways, say, to reduce education and health-care costs to ease the burden for people losing ground, the government — via loosened regulatory standards for mortgages, low-interest rates, and other measures making it a cinch to borrow — “pacifi[ed] millions of Americans with easy credit.”
Sixty percent of Americans saw their real incomes fall, but they didn’t complain because the “shower” of easy money “allowed them to make up for lost income and maintain living standards — at least for a while.”
Why has the recovery been so weak? In their 2014 book, “House of Debt: How They (and You) Caused the Great Recession, and How We Can Prevent It from Happening Again,” Princeton economics professor Atif Mian and University of Chicago finance professor Amir Sufi point to household debt as a chief culprit.
Between 2000 and 2007, household debt doubled, to $14 trillion. The debt-to-income ratio rose from 1.4 to 2.1, meaning that people were using debt to buy things that they couldn’t afford — putting them more in need of the wage gains that they weren’t getting to pay for the higher debt.
What we didn’t do
“Principal forgiveness” on mortgages “would have resulted in a more equal sharing of the losses” from the housing crash, the authors argue, because lenders — wealthier people — would have lost as much as their poorer borrowers.
Protecting creditors, but not debtors, is bad market economics, as well as unjust.
Regrettably, Mian and Sufi contend, housing policy during the earliest years of the Obama administration adhered to the view — advocated ceaselessly by banks and government officials close to banks — that reducing mortgage debt would inflict substantial harm on the banks and that this “would be the worst thing for the economy.”
But the most obvious problem with recovery efforts has been government reliance on yet more household debt to ignite growth. As Mian and Sufi acidly put it, the West is “trying to cure a hangover with another binge-drinking episode.”
Since 2008, the Federal Reserve has kept its interest rates at record lows — zero, to be exact — to spur banks to keep lending to people who really can’t afford to borrow any more.
House prices are finally moving up, and people buoyed by that development are borrowing and spending again. Household debt, after falling between 2008 and 2011, is once again mounting. Our trade deficit with China, after shrinking markedly in 2008 and 2009, is reaching new records. There’s zero reason that America should want young people to keep borrowing from our key trading partner to pay more for houses, as well as for imported goods — unless, of course, the point is to keep a broken system grinding away for just a while longer.
The nation must finally fix the “too-big-to-fail” financial system that has channeled so much bad debt to American borrowers, assuming that it will never pay the consequences of its risky lending. The “entire financial system is based on explicit or implicit government guarantees,” say Mian and Sufi, acknowledging the decades-long history of taxpayer bailouts of lenders. “The idea that financial firms should never take losses is indefensible. They are in the business of taking risk.”
But the simplest fix for finance is strictly to cap borrowing, for lenders and borrowers alike.
Authors of all three books accordingly take aim at mortgage financing. Of America, Wolf notes that “in a country supposedly dedicated to the ideals of market economics . . . the most important social function of finance — lending for home purchase — has become almost completely nationalized,” thanks largely to the government takeover of Fannie Mae and Freddie Mac, the nation’s biggest mortgage lenders.
The authors all agree with most economists that America should stop subsidizing mortgages through the tax code, by letting borrowers deduct mortgage interest when they pay their taxes.
Wolf castigates the political and business classes’ failure to level with the public in the strongest terms. “The economics establishment failed,” he says flatly, and their continued failure will have serious consequences, he warns: “Angry and anxious people are not open to the world.”
That is: If elites want to save free global markets, they should do a better job of responsibly governing them. Otherwise, next time will be worse.
Nicole Gelinas is the Searle Freedom Trust Fellow at the Manhattan Institute and the author of “After the Fall: Saving Capitalism from Wall Street — and Washington.” This article is adapted from the Spring 2015 issue of City Journal.