Why? “V-shaped” recoveries, in which employment comes roaring back, take place only when there’s a lot of pent-up demand. In 1982, for example, housing was crushed by high interest rates, so when the Fed eased up, home sales surged. That’s not what’s going on this time: today, the economy is depressed, loosely speaking, because we ran up too much debt and built too many shopping malls, and nobody is in the mood for a new burst of spending.
Employment will eventually recover — it always does. But it probably won’t happen fast.
So now that I’ve got everyone depressed, what’s the answer? Persistence.
History shows that one of the great policy dangers, in the face of a severe economic slump, is premature optimism. F.D.R. responded to signs of recovery by cutting the Works Progress Administration in half and raising taxes; the Great Depression promptly returned in full force. Japan slackened its efforts halfway through its lost decade, ensuring another five years of stagnation.
The Obama administration’s economists understand this. They say all the right things about staying the course. But there’s a real risk that all the talk of green shoots and glimmers will breed a dangerous complacency.
So here’s my advice, to the public and policy makers alike: Don’t count your recoveries before they’re hatched.
No, says Simon Johnson, a senior fellow at the Peterson Institute, professor at MIT’s Sloan School of Management, and co-founder of the popular economics blog, BaselineScenario. In fact, if we're not careful, we'll find ourselves in another Great Depression.
What it is time to do, says Johnson, is look at the credit markets, which are telling us that the major U.S. financial institutions are being hit with a "speculative attack":
“The view being taken by people who trade credit in the United States is that we’re definitely not out of the woods. And I would say, in fact, there’s something of a run taking place in the credit market. Not a traditional bank run, but a speculative attack on some of the biggest financial players ….”
Specifically, traders are shorting credit of major banks, betting that the government won't protect bondholders forever:
”Basically these people are betting the big banks will be forced into some sort of default. Now, if enough people bet that, and if the banks can’t draw on enough external support, which in their case would be from the U.S. government, then these runs can be self-fulfilling. It’s extremely dangerous and a situation that’s really not been addressed by the U.S. authorities.”
Professor Johnson doesn't believe another Great Depression is likely, but he thinks denying that possibility increases the risk of it. He says he's not trying to exaggerate but instead to urge policymakers address the facts and take corrective action.
Treasury Secretary Timothy Geithner convinced Wall Street to give banks another chance Tuesday.
Geithner's assertion that "the vast majority" of banks have enough capital pulled stocks from a slump that began with a sell-off Monday and spilled over into Tuesday morning. Geithner also told a congressional oversight committee that some banks would be allowed to repay financial bailout funds with the blessing of bank regulators.
The comments signaled that banks might not get poor marks in government "stress tests" designed to determine whether banks have enough capital to survive if the economy turns even worse. The results are due May 4.
"There is the hope that everything will be well after the stress test," said John Nichol, senior portfolio manager at Federated Investors.
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