Maybe it was the utter collapse of Iceland's financial system. Maybe it was the worst week in the history of the Dow Industrial Average since those five trading days in the antique October of 1929, or the worst ever for other indices, or the trillions of dollars lost in the bourses around the world. Perhaps the elegant yet urgent intervention by British PM Gordon Brown and Chancellor of the Exchequer Alistair Browning hit the spot for the other six of the G7. Whatever, by the middle of October the global financial system had avoided disintegration.
But averting a global financial meltdown is not the same thing as averting a steep recession. Indeed, David Levy, chairman of the Jerome Levy Forecasting Center, argues that despite the government's unprecedented intervention into financial markets, we're in for a recession concurrent with a depression. A recession is a cyclical event caused by a spasm of overproduction - e.g., millions of newly built and empty homes - while a depression is a macro event caused by prolonged overinvestment leading to structural imbalances - e.g., $55 trillion in credit default swaps.
We got to this depression point because balance sheets have been growing faster than incomes, private GDP didn't keep pace with debt and the market became increasingly distorted and less and less stable. Here's the good news: This depression won't become Great. Call it a "contained" depression. "Depressions can be contained if you have an effective lender of last resort, and a big enough government," according to Levy. "We believe we have both."
Thanks to the spirit of Bretton Woods, the G7 and G30's resolve, and the central banks' ardor and ability to pump trillions upon trillions of dollars into the world economy, this new millennium depression won't look much like the 1930s. "We'll see changes in the credit market, and a leaner economy, and that's not a bad thing," Levy predicts. "It's a healing process, and we will not be declining all the time." How long? For the U.S., less than 10 years "with a small recovery in 2010 that will be mistaken as the end. It will bring household, corporate debt values down, all asset values down - from collectibles to art to mineral rights." Adjusting will be painful, but not catastrophic.
Timothy A. Canova, associate dean and professor of international economic law at Chapman University School of Law, also subscribes to the contained depression theory, though he is a tad less sanguine. "The sky is falling. There's a big problem with long-term credit. The banks are just not lending, and that will continue to undermine the economies." Canova has been studying the 1941-1951 period for the past five years, a "time when the Fed was not independent, a period of strong regulation of banking and the economy. Money was channeled directly into companies that would use it for real production. We are going to have to spend ourselves out of the current situation [with public works projects], but the political will isn't there yet."
The credit market may not completely thaw for years, contends Dory Wiley, president and CEO of Dallas-based Commerce Street Capital. But he is confident that this depression has been contained. "If you want to avert an all out panic, you have to step up to the plate with a worldwide, unified effort. And that's exactly what you got. In 1998, the collapsing Asian markets were viewed as silos. This time they realized it's all one huge interrelated plumbing system, and probably held it together." But even with all these lenders of last resort pumping away, "things are going to worse before they get better," Wiley believes.
There are no perfect solutions, and the public's aversion to pain will doubtless inspire bouts of great impatience and frustration, but fears of collapse should be allayed by the unanimous determination by the descendents of Bretton Woods to ensure the world avoids an Icelandic financial meltdown. "Governments are guided by complex political animals that work in messy ways," David Levy observes. "They'll throw a lot of energy and effort at the problem, and if it doesn't work they'll try something else and throw money at it."
Sure, fiscal responsibility is a good thing, but without banks there is no economy.