Monday, September 8, 2008

The crisis is here

Today, the real financial crisis is finally here, and it is evidenced by the government take-over of Fannie Mae and Freddie Mac. On Monday morning, stock markets in New York will go up sharply, as investors will try to tell themselves that everything is OK . That is, however, not the case.

The American government and the American people are drowning in debt, and that debt just got a couple of hundred billion dollars bigger. There is little regulation to speak of, and tax revenue is comparatively minimal. In a normal situation, this combination will almost inevitably lead to an economic crisis sooner or later, but in this case things are even worse. The take-over of Freddie Mac and Fannie Mae signals much more than just trouble in the housing market – it signals that debt instruments throughout the economy have lost their credibility. That, in turn, will decrease the values of all kinds of assets, and lead to a vicious cycle of sell-offs and bankruptcies in the financial industry.

Within a few months, we will see a huge downturn in the stock market as assets lose value, while more financial firms fail because they are too highly leveraged (i.e. they have too much debt). A lot of people will lose their savings and retirement money. The economic crisis may go on for about a decade, provided that necessary steps are taken to help the American economy recover. This is not for certain at all, however, because the American political system is set up in such a way that comprehensive economic action for the benefit of society at large is all but impossible. It has happened only once in American history: the implementation of the New Deal. The so-called “checks and balances” guarantee that America will remain a go-it-alone society for the foreseeable future. This crisis will most likely go on for a long time.

This is not to say that the crisis cannot be overcome (although what I am about to suggest will never happen). Very similar economic crises happened in Sweden and Japan about 20 years ago. Japan handled the situation very poorly, and Sweden handled it very well. Japan basically tried to forget about the fact that there was a crisis, and banks and investors were hiding their losses as much as they could. The same thing is happening in America as we speak. Sweden, on the other hand, went through a decade of economic pain, fiscal discipline and investments for the future, which enabled the country to emerge in the 21st century stronger than before.

This is what needs to happen if America is to get out of this crisis:

1. Decrease government spending dramatically, especially spending on the military

2. Increase tax revenue dramatically

3. Pay down government debt dramatically

4. Increase spending on public infrastructure, education and scientific research

5. Create stringent, uniform federal regulation of the banking and financial services industries

6. Raise gas taxes significantly, so that gas costs at least $7 per gallon

This is the rational way to do it, but like I said, it’s not going to happen. What will happen then? Unemployment will go up dramatically and stay high for many years to come. America’s infrastructure will deteriorate further and income disparities will become greater. The financial markets will recover after a couple of years as soon as they have found new ways to make money which are not dependent on the economy at large doing particularly well. If Barack Obama is elected president, we will see a series of band-aid approaches to fixing the crisis. He will not win a second term, and the needed structural changes to the economy will not happen. If John McCain is elected president, he will do nothing to fix the underlying problems in the economy. He will obviously be too old to run for a second term, so whoever takes over the presidency after him will not have a fun job. America will be much worse off than it is now.

The bottom line is, the gridlock that the American political system creates will bring us decades of hardships, now that America has been high on the crack that is debt for 15 years.

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