Time for the economy to get real

In anticipation of the incoming administration, the long-running TARP debates are building up once again. This first few weeks of Obamaworld are an essential period for the new president to establish his intentions and reputation, so we should expect to see dramatic news and dramatic spending, probably before the end of January. We might perhaps even see something to compare to FDR’s first few weeks of office, when he shut down the banks for four days, recapitalized them, and effectively purged the national economy of much of its lingering panic.

In this context, the pundits are out in force lobbying for their own particular solutions to the problem of credit collapse. Paul Krugman in the New York Times explains how many banks are zombies – walking around like they were alive, but in practice dead already. The only solution, he argues, is effective nationalisation modelled on the Resolution Trust Corporation – which, despite its ability to get people quaking in their boots – means relatively little beyond admitting how things already are: the government is the only thing keeping these businesses afloat, anyway, so why not admit that they belong to the government?

Robert Reich, meanwhile, echoes this point in all but name, though with perhaps a slightly more vengeful tone. Without mentioning nationalisation, he demands that any kind of aggregator bank – that is, a state owned bank taking toxic debt off the balance sheet, as Hank Paulson had said he was going to do months back – issue no dividends, strictly control compensation to executives whilst demanding money back from overcompensated execs from 2005 to 2008, and focus on issuing new bank loans to the exclusion of pretty much any other commercial practice.

Pick your favourite prescription from this and others. But don’t expect any solution to be fun. We can’t get out of this mess by reinflating bubbles, and that means that the consequences of low levels of saving and enormous national indebtedness will ultimately feed through to the real economy in one way or another.

In its latest effort to restore good credit conditions over here, the British government has committed another enormous sum of money this week to supporting the banks (several hundred billion; proportionally, an amount that makes the current US commitments seem small; and a very strong indicator that we'll see some crazy numbers coming from the White House this week). The immediate result: bank share prices collapsed across the board as traders realised that the real value of the banks being supported had sunk to an effective level of zero; and rumours spread that the credit rating of government bonds could be downgraded to a level lower than that of many multinational corporations. Essentially this means that people in the know consider it a possibility (not necessarily a likelihood, but a possibility) that the British government could even be forced to default on its debts.

This is a sure-fire case of the real economy telling the strange world of high finance to wake up. These capital injections don’t come from nowhere: they either come from inflationary practices (that is, printing new money), or from debt (which, at this level, means higher and higher interest rates in the long term). And inflation and high interest rates? Although deflation is clearly the worry at the moment, in the longer term this could make the stagflation of the 1970s pale into insignificance.

In the end, we have to get real and apply some basic home economics to the international economy. Things will only get better when we end up with a system where real national wealth bears some relation to our capacity to produce, and our standards of living match up with our ability to save and invest in the future. This means that it’s not just important that Obama spends money, but that he spends it wisely and constructively, in a way that stimulates America’s future productivity without wrecking its future ability to save and pay off its debts.

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