Martin Wolf in the FT makes some points we generally agree with on the shocking economic statistics pictured above — wealth plummeting and liquidity disappearing:

the idea that a quick recession would purge the world of past excesses is ludicrous. The danger is, instead, of a slump, as a mountain of private debt -– in the US, equal to three times GDP –- topples over into mass bankruptcy. The downward spiral would begin with further decay of financial systems and proceed via pervasive mistrust, the vanishing of credit, closure of vast numbers of businesses, soaring unemployment, tumbling commodity prices, cascading declines in asset prices and soaring repossessions. Globalisation would spread the catastrophe everywhere…Everything possible must be done to prevent the inescapable recession from turning into something worse. Many of the needed actions were laid out in an article on the FT’s Comment page this week by Columbia University’s Jeffrey Sachs. I would stress five points.

First, as Oxford university’s John Muellbauer argues, deflation is a real danger. Yet deflation is lethal for indebted economies. Today, short-term interest rates look far too high in the eurozone and the UK. Central banks need to look at their economies afresh and cut rates by at least 1, and ideally 2, percentage points.

Second, the only way to let the private sector deleverage, without mass bankruptcy and huge falls in spending, is by substituting the asset everybody wants: government debt. Contrary to Professor Sachs, I think tax cuts are indeed part of the solution.

Third, it is crucial that lending be sustained both inside and among economies. Having gone to such trouble to recapitalise banks, governments should insist that their money be used to sustain credit lines to those likely to remain solvent. If banks are unwilling to do this, central banks will have to replace them, as the Federal Reserve is now doing.

Fourth, it is in the vital self-interest of the affected high-income countries to keep hard-hit emerging economies afloat through the crisis.

Finally, it is equally evident that the world will not return to equilibrium if countries in strong financial positions do not expand domestic demand. The day of the housing bubbles and huge current account deficits in high-spending high-income countries is gone. Those who rely on current account surpluses to sustain demand must think again.

Decisions made over the next few months may well shape the world for a generation. At stake could be the legitimacy of the open market economy itself. Those who view liquidation of past excesses as the solution fail to understand the risks. The same is true of those dreaming of new global orders. Let us first get through the crisis.

Art Laffer, whose opinions we often agree with, has a very different view as to what the right course of action is in this situation. Maybe he’s right, maybe he’s wrong, and maybe (in part) he’s trying to sell his new book. Based on our study and understanding of banking and the risks unleashed when high leverage meets panic, and we think that Mr. Wolf has the better argument in our current circumstances. Mr Laffer says that opinions such as ours “will be viewed in much the same light as what Herbert Hoover did in the years 1929 through 1932.” We shall see.

This entry was posted on Wednesday, October 29th, 2008 at 5:31 pm and is filed under business, China, Democrats, EU, General, Republicans. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.