One of more iconic images of the decade just ended was recorded on May 1, 2003, on the deck of the aircraft carrier USS Abraham Lincoln. Wearing a fighter pilot's flight suit, President George W. Bush strode purposefully across the vast deck where he had just landed to address the assembled servicemen and -women. Behind him, a large banner proclaimed, "Mission accomplished." A month earlier Bagdad, and with it Saddam Hussein’s regime, had fallen.
Almost seven years later, US troops are still in Iraq and over 95% of their casualties to date followed this carefully staged event. As an emblem of misplaced optimism, the photo and the moment it captured should serve as a sobering reminder that serenity does not automatically follow a cataclysm.
In the economic arena, a similar appreciation error looms as we attempt to interpret the financial crisis of 2008 and its aftermath. Over a year after Lehman Brothers' bankruptcy, all the big economies around the globe have clawed their way out of recession. Financial markets bottomed out last March, and then staged a rather impressive rally. The media, at least, has declared the mission accomplished. Federal Reserve President Ben Bernanke, considered by many the architect of this recovery, was Time magazine's Person of the Year in 2009. So, why are we keeping our celebratory Champagne firmly corked?
Despite upturns in both the business cycle and the markets, we still cannot rule out two grim scenarios: for one, economic weakness could return with a vengeance, and for another, corrosive inflationary pressure could gather steam.
Regarding the business cycle, we should recall how things developed 1937. After it successfully pulled the US economy out of the Great Depression, Roosevelt’s government shut down its fiscal and monetary programs much too rapidly, as virtually all economic historians today would agree. The result was a renewed and very severe recession, from which the US economy only managed to emerge in the wake of World War II.
Today, most developed economies are heavily burdened by fiscal and monetary policies that, on a relative scale, dwarf those undertaken to combat the Great Depression. Hence, a 1937-style relapse, or even something worse, could well unfold if these stimulative measures are withdrawn too rashly.
On the other hand, the sheer size of the policy interventions that saved the global economy from systemic collapse is mindboggling. And clearly if this life support were continued for too long, the risk of an economic breakdown is very real indeed. Printing money is simply not a sustainable economic remedy.
In the US, the monetary base has more than doubled from a year ago. Moreover, the public debt-to-GDP ratio is poised to cross the 100% threshold, as it already has in many other countries. In Japan, the 200% debt-to-GDP threshold is in sight. These hyperspace levels of liquidity and debt growth are, of course, very conducive to driving up inflation pressures or inflating new speculative bubbles. These conditions are also ripe for sovereign default threats, and Greece could be the canary in the coalmine here.
Governments and central bankers murmur reassuringly in the nightly news that everything is under control. But how can they be so sure? We have never before experienced a comparable global monetary and fiscal expansion, unless we take times of war into account. Wherever we stand today, the mission is certainly not accomplished and photo-ops will not suffice.
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