The Plot Thickens

Our thesis is that the U.S. will need help to recover. The assumption was that to get that help, the U.S. will need to be seen to be doing everything it can to help itself. The greatest danger since July 2007 has been that of policy mistakes. While there has been much honest effort on the part of the U.S. and some other governments, it and they have remained behind the curve in both understanding and in action. Obama is now also looking to be behind the curve on both. His Presidency and the inclusive global order so painfully built since 1945 are both at risk. At the end of the day, Obama can only be persuasive at home and abroad if it is clear that the aggressiveness of the cure he offers matches the aggressiveness of the disease.

It is true that leaders require followers. No one would question the assertion that FDR was an exceptional leader on the economy, who also did not get everything right. However, he did not face thirsting liberals on his left with their agendas or intellectually out-of-it ideologues with no credible alternative on offer on his right. After France fell in 1940, Roosevelt understood the strategic stakes, but the followership he needed was eighteen months in coming. Obama has many positives, but he has so far, for the most part, seemed risk averse. That may also have been politically wise. It may still be the only course open to him in the kind of democracy with political checks and balances that is the United States. But it also heightens the risks. At some point, however, Obama’s risk aversion may cease to be sufficient. Only Obama can be the ultimate judge of that moment and how he can best address it. The answer will then come from political, economic and financial markets around the world.

This is the theme of the latest powerful FT column from Martin Wolf … of February 10th, which assesses the new TARP program and finds it severely wanting. The central theme is in his first two paragraphs:

Has Barack Obama’s presidency already failed? In normal times, this would be a ludicrous question. But these are not normal times. They are times of great danger. Today, the new US administration can disown responsibility for its inheritance; tomorrow, it will own it. Today, it can offer solutions; tomorrow it will have become the problem. Today, it is in control of events; tomorrow, events will take control of it. Doing too little is now far riskier than doing too much. If he fails to act decisively, the president risks being overwhelmed, like his predecessor. The costs to the US and the world of another failed presidency do not bear contemplating.

What is needed? The answer is: focus and ferocity. If Mr Obama does not fix this crisis, all he hopes from his presidency will be lost. If he does, he can reshape the agenda. Hoping for the best is foolish. He should expect the worst and act accordingly.

The reasons for those two paragraphs is found in the last two paragraphs:

The correct advice remains the one the US gave the Japanese and others during the 1990s: admit reality, restructure banks and, above all, slay zombie institutions at once. It is an important, but secondary, question whether the right answer is to create new “good banks”, leaving old bad banks to perish, as my colleague, Willem Buiter, recommends, or new “bad banks”, leaving cleansed old banks to survive. I also am inclined to the former, because the culture of the old banks seems so toxic. 

By asking the wrong question, Mr. Obama is taking a huge gamble. He should have resolved to cleanse these Augean banking stables. He needs to rethink, if it is not already too late.

We all hope events and policy actions will prove Wolf’s conclusions to be too pessimistic, but he is clearly right on one very important factor in our current situation. Up until now, hopefulness has triumphed over aggressive responses, and the costs of that have been very high.

The situation for China may become not how to fend off what it sees as an offensive U.S. that screwed up big time telling them what to do. It will become how it can now take the U.S. cure shortfall (if shortfall it proves to be) and show itself a constructive player ready to fill the U.S. shortfall because the stakes for it and for the rest of the world on which it now depends are so high. Things are moving fast. Yesterday’s FT also had a full page on Asia and the crisis “The speed and ferocity of the region’s economic downturn, which have shocked even pessimists, stem from a reliance on trade – once seen as its biggest strength.” 

The situation is becoming increasingly simple. The U.S. consumer will be lost to the global economy for many years as he rebuilds his balance sheet. Even when he returns, it will be as someone who earns what he spends. So the outcome of the current imbalances, which are the originating cause of all today’s troubles, is already quite clear. The export-based model of Japan, Germany and China will come to an end. The only question is how that takes place. There is no question that it will take place. It can take place through the operation of brute political, economic and political forces. This will lead to depression-like conditions and the breakdown of globalization. Or it can take place in an orderly fashion as the key countries agree on how that is to occur over a several year (but firm and limited) period. This would enable the global and U.S. economies to recover and globalization to continue; and would constitute the essential foundational underpinning for the reshaping of the inclusive global order in a way that brings the world a future closer to post-1945 in the Western world than to post-1914.