How did the road out of recession lead into a cul-de-sac? And why, all of a sudden, is the world economy falling apart? The answer is all about growth and debt.
Is the stock runoff for real?
If you find yourself confused about the market meltdown, you've got company. Dow crashes, like Monday's 600 point plunge, are notorious black boxes. A few thousand investors acting on a hundred indicators rarely reveal a single, shining Truth. But this appears to be more than a one-time crash. The United States and Europe, twin engines of the global economy, are close to falling back into a recession.
What we're seeing is the confluence of two challenges that are both economic and political in nature. There is growth crisis in the United States. There is a debt crisis in Europe. And there isn't a single government that knows how to solve either.
Are we falling into another recession?
What the heck is going on, anyway?
Why didn't we reach escape velocity? Because the housing crisis never ended.
WHAT'S THE MATTER WITH THE U.S.? GROWTH.
The first thing to understand is that the past two weeks didn't tell us that the financial crisis is coming back. They told us that the crisis never ended.
If you can remember, July of 2010 was supposed to be the beginning of a "Recovery Summer." But when unemployment lingered above 9 percent for the next few months, we settled for "Jobless Recovery." For a year, that label stuck. Two weeks ago, we learned that gross domestic product grew less than 1% in the first six months of this year, and we downgraded to "Recoveryless Recovery." Now, after the first-ever credit downgrade and a historically terrible week in the stock market, we've all but dropped the word recovery. After Monday's carnage, all talk is of a possible double-dip recession.
What precipitated the sell-off? The answers are printed all over our front pages. Investors saw jobs growing slower than population. They saw yearly GDP growth revised down by two-thirds in a single report, from 2.5% to 0.8%. They saw multinationals and financial companies with record-high profits sitting on their cash, moving offices overseas, attracting foreign customers -- anything but hiring Americans. And most importantly, they saw a debt ceiling debate that seemed to take place in alternate universe to our growth crisis. A reasonable explanation for the market's collapse is that investors saw an economy too sick to grow and a government too dysfunctional to act on it.
The economy feels sick because we never extracted the poison of the recession. The housing bust still lives with us. The value of the typical home fell by nearly 50% in the last five years. In many cities, values are still falling. This has wiped out the most important source of net worth to most middle income families. We aren't building new homes -- housing starts are down nearly 75% from the peak -- and we're stuck in our old homes -- one fifth of mortgages are in negative equity.
This housing depression creates a negative feedback loop. Families stuck in negative equity homes close their wallets. Businesses react to low revenue by not hiring. High unemployment depresses wages. Low wages delay the purchase of more homes, which would reverse the pernicious cycle. Since pictures often beat words in economics, here's the broad story of our housing bust through graphs:
But wait. It gets worse. "We've run out of options from government," says Barry Bosworth from the Brookings Institution. "Interest rates are zero. Quantitative easing has had a limited impact on the recovery. There is no prospect of consensus about fiscal policy, which will probably become contractionary over the next year."
In short, we're stuck in a world of no growth and no options.
Too much debt, too little growth. That's Europe in a nutshell.
WHAT'S THE MATTER WITH EUROPE? DEBT.
Depressed yet? Let's talk about Europe.
There are five countries dragging down the continent, but you should think of them in two categories. Greece, Portugal and Italy are the profligate sloths. Spain and Ireland are the busted housing kings. All five are facing rising interest rates that could require hundreds of billions of dollars in assistance from the continent's healthy economies.
Greece is the Western world's mascot for fiscal failure. Even with $300 billion in bailout relief, the country is all but certain to default on most, or all, of its debts. Portugal and Italy's troubles are similar but smaller in nature: slow growth and high deficits. Other European countries face crises that resemble our recession on elephant steroids. Ireland's real estate bubble once consumed 25% of its economy, and in 2010 its budget deficit ate a third of GDP. Spain has battled 20 percent unemployment, more than twice our official rate, even after their housing run stopped.
This is another story best told through picture. Since every debt crisis is also a growth crisis, we've put together this second gallery of graphs on Europe's bond yields and unemployment rates:
But wait. It gets worse. Europe is rotting from the outside in. Germany's hot recovery is cooling. French banks face significant exposure to Spain and Italy's troubles. The United Kingdom's experiment in austerity is backfiring. The city of London, which was even more finance-focused than New York City before the crash, is literally burning as austerity and months of negative growth unnerve the city's young unemployed population.
ARE WE DOOMED?
If the U.S. and Europe are at the edge of a cliff today, it is a shorter cliff than in 2007. The good news is that we have less room to fall. The bad news is that nobody expects a soft landing. There will be no more fiscal stimulus. There is less room for monetary stimulus. The only sure antidote to our crises is time.
Europe's fundamental problem is debt in a handful of states. The continent needs to find a way to offer these states access to the broad euro market. If Greece can borrow at closer to the Euro rate rather than the Greek rate, they'll be safer. Three years after Europe's richest government absorbed the risk of private banks, they will have to absorb the risk of smaller governments.
In the U.S., we have all but run out of new ideas. Government is becoming a drag on the economy. Our trade deficit is a huge drain of capital. Washington can't resolve the housing crisis for people who are underwater, and businesses are increasingly looking overseas to invest.
If you're looking for silver linings, best to take the long view. Financial crises can be decade-long affairs, as families, businesses and banks build back to normalcy. But there is every reason to expect full recovery. Unlike Japan, which has lost two decades to a financial bust, we have a young workforce with a steady stream of immigrants and a culture of risk and entrepreneurship. The road out of recession has led us back to the brink of recession. But even in stalled recovery, the United States is the world's leader in education and innovation. In the long run, if you can wait for it, the road leads back to growth.