Mind Your Value Judgments of the U.S. Economy

In the leadup to government bailouts this year, a number of commentators said that if the U.S. did succumb to some sort of systemic crisis, it would have shown that despite its wealth, it's no better than a banana-republic. But this view is now being challenged by Ken Rogoff and Carmen Reinhart. In a new NBER paper examining crises in 66 advanced and emerging countries since 1800, they find that:

[N]ot only is the frequency and duration of banking crises similar across developed countries and middle-income countries, so too are quantitative measures of both the run-up and the fall-out. Notably, the duration of real housing price declines following financial crises in both groups are often four years or more, while the magnitudes of the crash are comparable. One striking finding is the huge surge in debt most countries experience in the wake of a financial crisis, with real central government debt typically increasing by about 86 percent on average (in real terms) during the three years following the crisis.

There is one big difference between developing- and advanced-country financial meltdowns, though, which is that the former are typically government default-related while advanced economies have been experiencing "serial" banking crises since the the early 1970's with the end of the Bretton-Woods system.

Rogoff and Reinhart also argue that trying to put a dollar value on the cost of bailouts is "misguided and incomplete" because "the fiscal consequences of banking crises reach far beyond the more immediate bailout costs." Government revenues are severely hit for two to three years after a crisis, and again it doesn't much matter if the country is developing or advanced. In the following chart the blue bars show the average percentage change in tax revenues for advanced economies three years before and after a crisis first develops. The red bar shows the average for the five worst cases -- click here for larger image:

The real loser in crises, however is government debt levels. During the average meltdown, government obligations grew by an immense 83 percent three years after the financial shock. (If that happens in the U.S., by 2010 our national debt would be close to $19 trillion.)

The paper is the latest in a growing list of crises retrospectives, which already includes Rogoff and Reinhart's contribution from last year.

Comments

[Moon Kil Woong:]

I agree with you that the financial cost of government stimulus/expenditure is not the major issue here. However, the operating word is bailout. Government mis-allocation of resources is always a bad thing. You could say government stimulus for the Iraq war, it is pouring money into the world. however, we would see it is pouring money that largely goes to other countries economies thus the benefit is squandered and the US citizen barely reaps any stimulus.

Likewise, the government supporting zombie financial institutions merely keeps a weakening wage structure for AIG and other employees that know the end of the road is near. Thus, their incentive to spend their salary diminishes along with their jobs and salaries. Thus you have slow hemorrhaging rather than stimulus. In fact, it is a bailout. To call it a economic stimulus is ill founded.

An economic stimulus would be pumping money and resources to build up a new viable part of our economy that has a lot of future hope. Or aiding good banks to grow and consume all the bad banks. Instead, the US government is choosing just to keep the bad banks around lugging trillions of toxic poisonous derivatives that is coursing through our economy.

The US citizen deserves much better than this. Our patriotism and loyalty and belief in America is not the issue. The issue is merely, the loyalty of our government to follow capitalism and the incentive structure it creates. Let the bad companies and segments of the economy die out and let the strong segments grow and flourish. Currently, I would say the government is strangling the entire US economy in order to save the rotting branches.

If you are going to spend money invest in better wireless service, power supplies, roads, bridges, research labs, internet connectivity, and education. Don't invest in helping banks pay off derivative bets, multi-million defunct banking executive pay, insurance companies gambles with the devil (Goldman Sacs and Paulson derivatives bets), housing speculators, and giant debt holders.

"One of these things has a future, the other does not."

2008 Dec 22 04:52 AM

[headlocal:]

Splendid!

Note that government revenue impairment tracks incomes (especially at the top 10% who provide 70% of the take) and corporate profits, if any.

With the boomer retirement cycle coming within the inferred three-year down cycle of Reinhart and Rogoff, and the end of the Bush 43 tax cuts on capital gains, is there much prognosis for recovery before the FICA and Medicare "Trust" Funds get depleted, precipitating a secular financial crisis that won't go away.

More to the point, is there any residual reason to put venture capital into play in an environment where the risks are magnified and the possible net returns significantly lowered by vengeful theories of "fairness".

Or, are the incessantly repeated "eight years of the 'failed Bush administration'" really the last golden age of American entrepreneurialism, before deep-macro effects align to induce a new dark age of real diminished expectations. Like, say, Japan, but without the communal work ethic or cultural cohesion.

2008 Dec 22 06:00 AM

[Roger Knights:]

Banana republic--No; Mañana republic--Yes.

2008 Dec 22 02:29 PM