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By Newsweek Editors
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The great recession began, as so many others crises have, with the bursting of an asset bubble. This bubble was caused by the now notorious slackening of monetary policies and a longstanding disdain for fiscal discipline in the world's richest nations. Despite the alarms sounded over the United States' twin deficits—its gigantic external and internal debts—the U.S. Federal Reserve under its former chairman Alan Greenspan stuck to its policy of loose money. The U.S. Treasury, throughout the George W. Bush administration, sank deeper and deeper into the red. And China deliberately kept its currency undervalued, ensuring that it would run disproportionate financial surpluses.
Behind this inaction lay the belief that markets are intrinsically rational—and, hence, the less they're regulated, the better. For a long period this belief seemed to hold: as housing prices kept rising, it seemed logical for people to keep borrowing money to buy bigger and bigger homes and then flip them. It also seemed rational for lenders to pad mortgage rates a bit and loosen up on granting consumer credit. And everything worked until we collided with the old lesson of the 17th-century tulip bubble: at some point, someone will stop paying and the whole house of cards will collapse.
The only novelty this time was how central banks reacted. Mindful of the lessons of 1929, monetary authorities worldwide flooded the markets with liquidity, and treasuries rescued faltering banks, spreading the losses to prevent many of the most vulnerable institutions from going under (with some notable exceptions). Somewhere down the line, taxpayers will get stuck with the tab, whether through tax increases, the devaluation of the dollar, or inflation. Never mind unemployment, which has already soared and will continue to climb until well after the financial panic is over. The crisis will continue to weigh on families, claiming jobs and dampening consumption.
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So why did we all believe that this crisis would change everything? Be-cause no one imagined that central banks would join forces so quickly to fight the global threat. And because the world economy isn't what it used to be. China and the other emerging markets quickly passed major stimulus packages. Without worrying too much about the long-term consequences, they sought to spark demand through sweeping fiscal incentives. And because these developing economies are collectively stronger than they have ever been, they served as a dike against the catastrophic tide engulfing the highly developed countries.
But herein lies the danger. The rapid relief brought by these bold economic measures has effectively shelved deeper reforms. A new geopolitical order is slowly taking shape, the most visible expression of which is the G20. But this bloc of nations has no secretariat, no institutional framework to translate its agreements into policy. That means we still must depend on the old bureaucracies: the International Monetary Fund, the World Bank, the World Trade Organization, and the Bank of International Settlements. And above all, the world must still rely on governments.
Then there is the larger question of the nature of markets and of capitalism itself. Since the crash, the heirs of Keynes have been arguing that whenever the financial markets turn into a casino, as happened recently, a strong sheriff must step in. But the free-market fundamentalists are already making a comeback, arguing that tighter regulation of the financial system—even of complex derivatives—is un-necessary and undesirable. The U.S. government, for its part, seems to be betting on a compromise: let the markets operate freely, but raise new lookout towers so that we can see the next tsunami early and act before it hits. The emerging nations, with China in the lead, are taking timid steps toward tightening regulation. And Europe, lolling in its splendid berth, wants it both ways: it preaches the traditional gospel of greater regulation but also winks at the sliding dollar and the British pound, whose fall only enhances the value of the lazy euro.
So will the Great Re-cession end in an anti-climax? Not quite. The crisis hit a world that was already in the throes of change. But where that process will lead and whether it will be enough to prevent the next collapse remain open questions.
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