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‘You can always rely on the United States to do the right thing,” quipped Winston Churchill, “once it has exhausted the alternatives.”
That is indeed why last Friday’s market euphoria at the US treasury’s financial rescue plan was justified: launching a rescue was the right thing to do and the good thing about the US is that it has done it quickly, about 13 months after the credit crunch began—rather than taking seven or eight years, as Japan did after its own crunch in the 1990s. Perhaps it takes a free-market, wild-west capitalist system to know when the sheriff should be called in.
Anyone who wishes to see this market turmoil as somehow the denouement of deregulated “finance capitalism”, the end of Thatcher-Reaganism and proof that regulated systems work better needs to take account of Japan, the world’s second-largest economy and home of the 1930s-style financial crash of recent decades.
Japan’s banking system collapsed in the 1990s and its once-brilliant bureaucrat-regulators failed to act quickly to clean up the mess.
So far the US—helped, no doubt, by the chance to learn from Japan’s example—is doing better.
But the rapture about the US needs some modification.
The bad news, however, is that preventing any more collapses will be far from easy. The problem is that it is unclear in such situations what a “bad debt” really is.
In the 1980s, when the US government cleaned up after the collapse of its savings and loans industry, it took over bankrupt firms and sold their debt. This time it is promising to buy bad debts from banks that are still active. It will have to set some sort of price, but also haggle over the definition of eligible debts. For when an economy is sliding into recession, a debt that is good today can turn bad tomorrow.
Consequently no one can know how much money this rescue will cost. Numbers being bandied about range from $700-billion to one trillion, though generally with a cheery caveat attached that the federal government could even end up making a profit by taking on bad debts and later selling them.
In no calculation of the cost of this venture should that be counted upon. After all, if it looked a good bet, other governments presiding over sliding housing markets, including the UK’s, would be rushing to offer their own plans to buy up dud mortgage debt. They aren’t—though probably some will have to before this affair is over.
No doubt the violent mood swings in financial markets we saw last week will return: new black holes will be found and more institutions will be brought to the brink of collapse.
But the US action does mark a turning point, as long as neither the White House nor Congress decides to renege on the promises to provide a safety net. The right questions now will centre on the consequences for fiscal policy and national debt, rather than on banking.
There has been much talk about how vast the US rescue plan is and how earth-shattering will be the extension of government that it represents. This is misleading: the rescue is indeed large, but so is the US economy.
The federal government is already in debt to the tune of $5,4-trillion, which sounds large if you don’t realise that the US’s annual GDP is nearly $14-trillion. This extra debt is unlikely, of itself, to lead to a new decline in the dollar, as some have predicted: the dollar might fall in value relative to other currencies, but only if the US economy goes into a prolonged recession, which is what the rescue plan meant to avert.
The true impact of this expansion of public spending lies in politics and in what this rescue will now make more difficult or perhaps impossible: the expansion of other areas of public spending, such as healthcare or public programmes for alternative energy. If Barack Obama is elected president in November, he will find his fiscal hands tied a lot tighter than he may have hoped, even with a Democratic Congress alongside him—unless he wants to raise taxes.—
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