Top ten economic wishes for 2009
Happy New Year! As the new year begins, I find myself in a fairly optimistic frame of mind. I am thinking that perhaps we can wipe the slate clean and start anew this year.
In that vein, let me share with you what I think needs to be done in order to right a global economy that is suffering its worse recession since the 1930s. If we accomplish these ten steps, the global economy may well recover much sooner from recession than any of us expect. Feel free to add your own assessment in the comments section.
- Fix the financial sector. I started writing on the Internet in large part because I felt a weak financial services sector was going to have a bad knock-on effect for the global economy. (See my post “Why this blog is named Credit Writedowns” for more on that.) The upshot is that my view is skewed toward a necessity to fix the financial services sector first. That means the sector must be right-sized and recapitalized to effectively fill its vital role going forward. To do this, we must end ad hoc solutions and take a more comprehensive approach. I am optimistic that we will see this policy approach in 2009. (One can read more on my ideas here in my September post, “The global economy has crashed: we need a comprehensive credit crisis plan“)
- Return price discovery to global credit markets. The credit crisis has reduced the liquidity of a number of risky asset classes, making price discovery challenging. Basically, no one is trading these depreciating but previously liquid securities. So it becomes difficult to know how much they are worth. This undermines the entire credit market. My hope is that government programs like the TARP (troubled asset relief program) in the U.S. can be used for their intended purposes — making those asset classes more liquid. The mechanics of doing this without the government’s buying assets at inflated prices is going to be a key issue for governments in the G-7.
- Help end the pain in housing. House prices are going to keep going down in 2009. I am not an advocate of propping them up artificially. However, I do want the pain to end. The easiest way to do that is for government to create incentives for lending institutions to accept loan losses. I would imagine that governments will need to guarantee a capital for loan modification scheme in order to get this sorted. By that, I mean that lending institutions will modify mortgage loans to a lower principal amount, incurring losses. In return, the government will use taxpayer money to recapitalize those institutions only when the modifications occur. This would certainly have to be done in conjunction with a comprehensive banking solution that liquidates bankrupt institutions and strips out toxic assets in order to eliminate moral hazard. Again, the devil will be in the details, so should be a key policy issue for 2009.
- Eliminate worst-case economic scenarios. The problem with this recession and its debt deflation is that it leads to a downward spiral where good companies die and new companies don’t get formed. This can only be avoided by preventing the downward spiral in the first place. While I quibble with policy makers’ specific prescriptions, I realize they are on the case trying to prevent the worst-case scenarios.In my view, this can only be done by providing fiscal (and some monetary) stimulus where the private sector is unable to do so. My view here happens to be in contrast with more hawkish policy makers in the Eurozone, particularly in Germany, where fiscal and monetary stimulus have been weak. Time will tell which countries have followed the correct path.
- Cushion the fall for workers. A lot of workers will be displaced by this turbulence – so many in fact that I would expect civil unrest. As a result, policy makers are definitely looking to use the social safety net as a way of cushioning the blow to workers. But, I anticipate more will be done gloally by investing in public goods like education, infrastructure and health care that the private sector has underfunded.
- Depreciate deficit country currencies. The recession offers a perfect opportunity to correct some global imbalances that have been building for a while. My principal concern here is overconsumption and underconsumption. A number of countries have huge current account deficits due to overconsumption. The U.S., the U.K., and many countries in Eastern Europe are prime examples. On the other hand, many Asian countries have relatively low domestic consumption demand. Here, China is the prime example. A devaluation of the U.S. Dollar, the British Pound and Eastern European currencies relative to the Eurozone and China would correct this problem. A weak currency for debtors means high import prices and inflation. While this is an economic burden, it certainly helps avoid debt deflation and it definitely encourages savings and discourages overconsumption. In China, policy makers could look to spur domestic demand by opening the market to foreign competition and by favoring consumption through temporary tax policy changes.
- Get the oil price back to $50-$55 a barrel. It sounds masochistic to want an increase in oil prices. However, oil at $35-$40 a barrel is not particularly good for the budgets of oil rich but potentially unstable countries like Russia, Venezuela, Nigeria, and Saudi Arabia. In my view a slightly higher oil price is worth accepting if it eliminates potential problems in those nations. Moreover, I would also argue that $35-$40 oil is extremely discouraging to investment in alternative energy and oil exploration and development. That would means we would see another oil price shock when the economy recovers — the last thing we need.
- Align pay incentives and compensation. This is a problem throughout the private sector in the G-7. However, in the financial services sector in particular, there has been an increasing misalignment of incentives and pay. In days of old, investment banks were partnerships where senior executives had most of their wealth locked up in their companies for the long-term. Today, senior executives are paid vast sums for recent market performance. It is no coincidence that we have seen major market dislocations after the end of the partnership business model. Present compensation schemes reward risk and short-term profits at the expense of reliability and long-term profitability. This needs to be changed — if necessary by regulatory means.
- Avoid protectionism. We all have heard about the Smoot-Hawley Tariff Act of 1930. It is legendary as a symbol of the every-man-for-himself mentality that economic turmoil and fear breeds. There are many peddling the same visions today (See Pat Buchnan’s take: “George Bush, Protectionist“). This is a recipe for tit-for-tat politics and a downward spiral as free trade becomes a casualty of recession. My hope is that protectionism will NOT become a major factor in 2009.
- Bring more countries into the global system. Rather than stop free trade by turning to protectionism, the G-7 should take the lead in trying to bring former pariah states into the fold. That means countries like Iran, Venezuela and Cuba. How this is to be accomplished is a political question I don’t wish to examine. Nevertheless, it stands to reason that more trade is better than less. And were the U.S. to take the lead here, I am sure it would have a favorable impact n the bottom line of U.S.-based companies which could do business in those three countries.
So, that’s my wish list. As the new year begins, I am hopeful that some of my wishes do actually come true.