How Does Our Economy Compare?

David Wessel’s book In Fed We Trust: Ben Bernanke’s War on the Great Panic is one of the latest additions to the expanding primary literature on the Global Financial Crisis. The editor and journalist collected information first-hand about the desperate efforts of US Federal Reserve Chairman Ben Bernanke to stave off a complete collapse of global financial markets in the dark days of 2008.

I spoke with Wessel during his recent trip to Australia for the Sydney Writers’ Festival.

The first question I asked him was how the Australian economic situation compared with the economy in the US.

"For an American journalist who covers the economy to come to a country which has full employment, which has something that China wants to buy, and where the Reserve Bank of Australia worries that the new rules of banking will require banks to hold a lot of government bonds — and this is a country which because you haven’t run big deficits doesn’t have a lot of government bonds — it’s a little bit like going through the looking glass."

When I spoke to Wessel, global markets had just gone through yet another convulsion in response to concerns about Greek sovereign debt.

"I think that you can see here, as you can see right now in the States, a great deal of angst about what’s going on in Europe and about whether this is the next stage of the crisis. First we had to bail out the banks and now we have to bail out the governments — and who’s big enough to bail out the governments?"

One of the most interesting things about Wessel’s book is what it tells us about how unprepared US policy-makers were for the sub-prime mortgage crisis and the ensuing chaos on the financial markets. I asked Wessel why he thought that was.

"At the beginning they just misdiagnosed it. They didn’t realise how virulent the cancer was, and once they realised that we were in a full-scale financial panic, the kind we only see once or twice a century, they didn’t have time to say, ‘What’s our over-arching strategy?’ because every day almost there seemed to be some new calamity.

"I mean, that week in September 2008, where they had to deal with the near collapse of Merrill Lynch, they had to deal with Lehman Brothers, which of course they allowed to go bankrupt — big ramifications — they have to bail out AIG (American International Group), then they have a global consensus that we have to guarantee the debts of the entire world banking system until this thing passes, and then they need to get $700 billion from the US Congress to recapitalise the banks, and that was all in one week!"

I asked Wessel if the Federal Reserve was now politically unpopular in the United States as a result of the bailouts.

"Yeah the problem that the Fed has is that the best they can really tell us is ‘It could have been worse’. But that’s not very comforting in an economy like the US, where we have 10 per cent unemployment, where 25 per cent of the people that have mortgages have a house that is not worth as much as their mortgage, and so forth.

"The Fed is, as you point out, quite unpopular now, and I think that’s because they filled a vacuum and they did things that they felt were necessary for the good of the economy, but to a lot of Americans it looks like they bailed out Wall Street and they didn’t bail out Main Street, so they are now paying the price for that."

One implication of the Fed’s extraordinary actions, I suggested, is that we are likely to see more regulation of the financial system. Wessel agrees.

"Yes. I think that a lot of people are uncomfortable that the only agency of the US government that could do something was one that is unelected and has the ability to spend huge amounts of money without the consent of the elected representatives of the people. In the future when the Fed wants to exercise its extraordinary power to lend to almost anybody that only it determines to be ‘unusual and exigent’ — those are the words of the law, ‘unusual and exigent’ — they’ll have to get the formal OK of the Treasury Secretary, an appointee of the President, that’s not now the case.

"And the next thing is that the next time there’s a Lehman Brothers or Bear Stearns, there’s some rules and there’s some way to get taxpayer money into the thing that is set up in advance, so it’s not up to the Fed to wing it on a Sunday night."

President Obama’s stimulus has also come in for a lot of criticism, with critics from the right arguing it is wasteful and critics from the left like Paul Krugman and Brad DeLong attacking it for not being big enough. I asked Wessel about the political troubles faced by Obama in light of this.

"On the stimulus I don’t think there’s any argument that we should not have a stimulus, this was the classic Keynesian condition of a very weak economy, no demand and interest rates already at zero, so it was clearly indicated to have a stimulus.

"Obama made a political calculation that in order to get the stimulus through Congress quickly, he kind of had to let Congress fill in the details, and that turned out to have high political costs. People elected Obama because they wanted change; his first act was to do something that looked very much like business as usual. So there’s a lot of criticism about the way stimulus was done; people don’t believe it did any good even though economists tell us it did. People also argue about the exact composition of the stimulus: should more of it have been quick spend money and less of it longterm investment in infrastructure, should more of it have been tax-cuts or less of it have been tax-cuts?"

Wessel went on to point out that "there are people on the left who think they should have done more," but that the Obama administration was constrained by political realities on Capitol Hill. "It’s not an inconsequential amount of money. We used to think that $787 billion was a heck of a lot of money, it’s only in the current context that anybody would say ‘Oh my god, that wasn’t enough.’

"The problem they have now is that even if they decided they needed more stimulus, the politics of this, the concerns about the deficit, the scepticism about the efficacy of government spending would make it very hard for them to do it, and that’s unfortunate, they don’t have complete freedom to do more stimulus even if they think it’s necessary."

If we fast-forward to 2010, governments have had to take on a lot of banking debt. I asked Wessel if he thought that was the main cause of the current sovereign crisis in Europe.

"I don’t think that’s exactly the problem in Europe. It is true, of course, that governments around the world have had to step in and bail out their banks, to take bad assets off the banks, and to recapitalise them or nationalise them in order to get through this thing. But in countries like the US and Greece, one of the problems is that governments also did a lot of borrowing for other purposes too, and they don’t have clear ways to convince markets that they grow fast enough to create enough tax revenue to pay them off. It’s a frightening thing.

"In a way the US benefits from this right now, because even though we have huge debts, everyone wants to put their money in dollars, but in the long run our government and the governments in Europe are going to have to find a way to live within their means or creditors are going off them, and that’s what happened to Greece. Greece got to the point where it had borrowed so much money and its economy was so uncompetitive, that the markets didn’t believe they would be able to pay the money back, so they couldn’t borrow anymore on the private markets. Well, then they had a catastrophe. And the rest of Europe came to their aid, but the problem is — is Spain next? Is Portugal next? And how is Europe going to do this? So it does call attention to a problem that you don’t have in Australia but the rest of the world does, of governments that have made promises to people that they can’t keep with existing tax revenues and they are unwilling or unable to raise taxes sufficiently to meet those problems — so it’s a conundrum."

Next I asked Wessel about the Rudd Government’s controversial Resource Super Profits Tax. Does he think the claims of mining companies are justified?

"I have learned a little bit about that in my four days in Australia. I think that there are some dynamics that any visiting journalist can see. When you have an economy that is so dependent on resources, when resources prices go up and the government needs money, there’s going to be a ripe target in the resources companies. We all know from the study of taxation that the people who get taxed are almost always the people who pay the tax, so the question is where the tax will ultimately lie, will the Chinese end up paying it indirectly or will it affect investment in the mining companies? It’s hardly a surprise that the mining companies are against it, you wouldn’t expect them to be for it."

Wessel tells me that "the rest of the world is watching this."

"If this tax succeeds, I would not be the least bit surprised if we see countries in Africa and South America, Brazil and India imposing similar taxes, because every government around the world is looking for money, and commodity prices are about the only things that are going up, and so it’s a pretty juicy target.

"I’m sure one reason the mining companies are fighting so hard is that they know that if it is imposed here, the chances are it will be imposed somewhere else, and that’s not in their interest."