Government Foiled the Last Recession, But It Might Create the Next One

Three years ago, we faced a crisis with urgency. Today, we face a crisis of urgency.

REUTERS

Here we go again.

The markets tanked Thursday morning and closed down more than 400 on news that ... well, take your pick. Home sales fell. Germany's growth stopped. Europe's dithering continues. Double-dip risks linger in the U.S.

The straw that broke the market's back today might well have been this "catastrophic" manufacturing report from the Philly Federal Reserve. Manufacturing activity plummeted from a slightly positive reading of 3.2 in July to -30.7 in August, its lowest level since March 2009.

No matter what happens for the rest of the day, the morning's nosedive will revive talk about a double dip. For a good but pessimistic summary of why we might already be living in negative growth today, read this.

Here's the upshot. Everybody is slowing down at the same time, and policymakers are too nervous to do something big about it. The U.S. economy bounced in 2010 as businesses replenished their inventories, but it never achieved escape velocity. Total government growth helped the private sector for more than a year. But now total U.S. government is shrinking faster than any industry, and business weakness has been laid bare.* For a year and a half, the U.S. economy was on crutches. Now the crutches are off and the economy isn't strong enough to stand on its feet -- much less withstand the one-two body punch of high gas prices in Q1 and the collapse of Europe.

In Europe, debt is outpacing growth, and as investors flee government debt, it has fallen to the "core" countries to guarantee the payments of the weaker periphery. Trouble is: The strong core isn't looking so strong anymore. Germany's latest growth numbers are under 1%. Pessimism is gnawing at bank stocks, like France's BNP Paribas and Societe Generale. When banks are too stressed to lend and government is too scared to spend, you've got yourself a continental crisis.

The good news is that few people expect the next six months to be a full-on double dip. Even fewer expect a repeat of 2008. The bad news is governments are as timid today as they were brave in 2008, when the U.S. passed a tax credit, TARP, a trillion-dollar monetary easing plan and a 2009 stimulus bill. Stimulus has now been called off. Monetary easing has been frozen. Total government is contracting and Republicans and some Democrats are content to let it be.

Three years ago, the world was falling apart and our leaders acted like it. This week, the president scheduled a speech to address the economy ... in September. There is facing a crisis with urgency and facing a crisis of urgency. We're on the wrong side of that parallelism.

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* Although I blame the Tea Party principally for the enthusiasm for spending cuts, the blame is too wide and complicated to belong to a single party. The stimulus was a PR failure. Voters rejected deficit spending, and welcomed Republicans. Democrats moved to the center to capture the zeitgeist and some demanded spending cuts to go along with the debt ceiling. They were all complicit in this game of turning government into a fiscal drag in 2011. Besides, as the economic numbers show, the private sector had plenty of weakness that has little to do with the size of government and everything to do with the intractability of financial crises.