The Economy is Slowing Down – Alas, Much as We Expected

Recent polls have left most Democrats discouraged, even if their loss of public confidence reflects economic weaknesses largely beyond their control. Life in politics is often unfair, and today Americans seem to both blame President Obama for economic developments that were not his doing and discount his real accomplishments in other areas. The White House’s misstep here, however, has been its persistent short-term optimism about the economy, since the basic shape and force of the current economic undertow were entirely predictable – and actually predicted by a number of us.  

This is not a case of the partisan hooey bandied about, that the President’s stimulus “failed.” Regardless of what he might have done in early 2009, the U.S. economy could not have avoided a long, deep recession – nor, without heroic action could we have escaped the slow recovery now disappointing many Americans. What we got is the basic shape of recessions triggered by financial meltdowns and the recoveries that eventually follow them. Yes, the crisis grew out of years of regulatory and economic-policy neglect, mainly by the Bush crew. But once it arrived, there was never a realistic prospect that $800 billion of new spending and tax cuts over two years would produce a big, V-shaped bounce back, as it might have if this were just part of a normal business cycle. But all of that fiscal stimulus, on top of even more powerful easy Fed policies, did stop the slide into a Depression and finally pushed us into a slow recovery.  

We also know why the stimulus couldn’t do more than that – or, more precisely, why it’s in the nature of a financial crisis to take years for an economy to recover fully. To begin, financial meltdowns leave most households markedly poorer in ways that ordinary business cycles don’t – what’s your house worth today? – and that makes most people less eager to spend for years. So, as the stimulus has wound down, retail sales have stumbled in both of the last two months – in fact, the only people spending like most Americans used to are the very wealthy, who still have more money than they know what to do with. And most others, even if they are inclined to spend, have a hard time getting credit because a financial meltdown also leaves lenders much weaker. It also shouldn’t surprise anyone that this reluctance to lend extends to most businesses, keeping investment weak.  

Moreover, these developments are unfolding in an economy that had serious problems before the meltdown and everything that followed. The recession has drawn people’s attention to a decade-long problem: American business’ capacity to create new jobs, even when growth is strong, has weakened markedly. In the Bush expansion of 2001-2007, we produced less than half as many new jobs as we did during comparable periods of the 1982-1989 expansion and the 1992-2000 expansion. And when the economy turns down these days, it also sheds jobs at a prodigious rate. More than 3 million jobs were lost in the 2001 recession and its aftermath, which was six times the job losses, relative to the decline in the GDP, seen in previous recessions. Much of the same happened this time, as the recent recession cost nearly 8 million jobs. In fact, the jobs losses have been so large and so persistent that they’ve put independent downward pressure on the economy, eating away further at investment and consumer spending.  

On top of all this, the potential for a second financial crisis, or a second round, is out there. The problem this time begins in Europe, where governments struggling with unproductive economies and large and fast-mounting deficits are having trouble finding global investors to finance their new bonds. It started in Greece and is spreading to Portugal, Spain and perhaps beyond; and while the EU says it will bail them out if the worst comes, the markets continue to bid down the value of their debt. The rub here is that nearly all of that debt is held by financial institutions still weakened from the last crisis, especially French and German banks which, for example, hold $630 billion just in Spanish government bonds. Even if those bonds, along with Greece’s and Portugal’s, skirt a formal default , their declining value is driving some major European banks to the edge – much as the plummeting value of mortgage-backed securities two years ago destroyed Lehman Brothers, Bear Stearns, Merrill Lynch and AIG. And if large European institutions fall, their counterparties on Wall Street will be left holding tens of billions of dollars in obligations no longer worth much. This scenario is still far from likely, but it remains quite possible that we could find ourselves back where we were in late 2008.

The good news is that if another crisis comes, the administration will have more tools to deal with it, as Congress is on the verge of passing some decent financial reforms. They might need those new powers, because congressional Republicans seem committed to blocking anything the President proposes, whatever the cost to the American economy. And whether or not the administration finds itself facing another economic crisis, or merely has to deal with a stagnant job market and meager wage gains, the luxury of large Democratic margins will soon be gone. In either case, President Obama will have to reclaim center stage and mobilize American opinion in ways that force his opponents to concede to sensible measures – much as Bill Clinton did after the Democrats’ 1994 setback and Ronald Reagan did after the big GOP losses in 1982. If the President can pull that off, he can still build a serious and successful economic legacy.