The decade after the financial crisis saw the creation of a vast asset price bubble
Rana Foroohar
© Matt Kenyon
Americans are traditionally the world’s consumers of last resort. But that’s about to change.
Even when what the IMF is calling the Great Lockdown ends and we emerge from the immediate coronavirus crisis, the economic ramifications of this moment will produce a new age of US austerity.
The idea of Americans penny pinching for any prolonged period may seem unlikely, despite currently living through the sharpest downturn since the Depression. Today’s economy, after all, is built on consumption.
Since the 1980s, the US has incentivised debt over savings for both consumers and corporations, and encouraged the growth of a financial sector that has repeatedly brewed up asset bubbles to support the spending that real economic growth could not. In fact, the decade between the 2008 financial crisis and this one saw the creation of a vast asset price bubble in just about everything.
That bubble is now bursting, exacerbating the economic changes that the pandemic has brought, be that a massive increase in public debt, the reshoring of international supply chains or technology-forced shifts in labour markets.
In many ways, the US has been here before. The period leading up to the 1929 market crash and its aftermath closely mirrors our recent past. It also suggests where we may go next: a new era in which Americans must save and produce more — and consume less.
Like the decade leading up to the financial crisis, the Roaring Twenties were marked by technological wonders, easy money (including a 1921 rate cut by the US Federal Reserve that set the stage for a stock market bubble) and massive income inequality. Working-class wages stagnated, while the wealth of the upper class rose, buoyed by rising asset prices.
Then, as now, when people couldn’t afford to buy, they borrowed: in the 1920s, Americans bought more than three-quarters of major household items on credit. They also began investing in securities en masse for the first time.
As Harvard economic historian Edwin Gay put it in a 1932 article in Foreign Affairs: “They were not . . . educated in the use of credit; they simply received a new vision of its possibilities.”
All that ended in tears in 1929.
But the changes in behaviour that grew out of the crash created a generation of people like my grandmother, who would use a tea bag several times before throwing it away. The personal savings rate of Americans soared from around zero in the early 1930s to as high as 28 per cent during the second world war.
This is crucial.
Like today, government spending rose sharply in the 1930s to stave off an even bigger downturn. Federal spending was just above 3 per cent before the Depression.
It rose to 10 per cent afterwards, and kept rising to over 40 per cent by the end of the 1940s.
Then, as now, the budget deficit soared. Unlike today, however, private savings rates were far higher.
Indeed they were positively Chinese, in part because forced rationing limited consumption, while incomes rose amid strong exports and war-related economic expansion.
It will be harder to achieve similar gains today. Reshoring supply chains could benefit parts of the US industrial sector and boost wages, in a win-win for businesses and workers; Germany’s Mittelstand firms may be a model.
But in the short term, deglobalisation will raise prices for everyone.
Companies that survive the lockdown will meanwhile replace as many workers as they can with software, so unemployment will remain high. Public sector spending will also skyrocket, with US federal debt growing from nearly 80 per cent of gross domestic product before the crisis to over 100 per cent by October, and then probably higher still.
This will further hurt economic performance: academic opinions about worrisome debt thresholds vary, but it’s clear that high and rising debt levels do dampen economic growth.
What the US government is doing now isn’t some sort of productive Keynesian spending programme, but a full-scale bailout of everything.
Perhaps some wise fiscal stimulus in areas such as infrastructure will make some of that additional debt load more productive. But it’s hard to see how that will offset the huge economic headwinds that we face.
This isn’t the 1990s and the US economy will struggle to grow out of the situation. The solution, based on history, is clear. Americans are going to have to save a lot more.
In 2010 a prescient McKinsey Global Institute study, of 45 episodes of deleveraging in mature economies since 1930, showed that half involved sustained periods of austerity, slow credit growth and higher savings. This doesn’t mean we don’t need the vast government spending being implemented now.
But it does mean the US needs an honest conversation about where to go from here. Ultimately, debt is a national burden shared by all taxpayers. Policymakers therefore need to think about how to incentivise savings: trimming every unproductive debt and leverage loophole from the tax code is a good place to start.
In time, the Fed will also have explain how it will shrink all that debt off its balance sheet.
And everyone will have to think about thrift.
Enter the new age of American austerity.
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