In America they call it the Great Recession – an apt name for the deepest economic downturn since the Great Depression of the 1930s. The good years before 2008 are sometimes referred to as the Great Moderation – the extended period starting in the late 1980s when fluctuations in the business cycle became notably muted compared to previous decades. It’s now clear that the Great Moderation was only achieved thanks to wholly immoderate levels of debt. By working with banks to pump cheap credit into the public and private sectors, governments were able to defy economic gravity for a while, but that only made the fall much harder when it came. So where are we now? In an article for Reuters, Felix Salmon starts with the financial health of the banking system – which, on the whole, is recapitalising at a rate that exceeds international regulatory requirements:
“The banks achieved this feat in the most painless way possible: they simply retained their earnings, rather than paying them out in dividends. And those earnings weren’t easy to come by, either… The banks [have] had to make money the old-fashioned way, by lending it out at a higher rate than their cost of funds…”
As a result of this new caution, there’s been no return to the debt-fuelled growth of the Great Moderation:
“Total credit was rising at a very steady real pace for the decade running up to the crisis — but then it stopped growing when the crisis hit, and it has never really recovered.”
Felix salmon wonders whether this is the bad news some people think it is:
“If you stipulate that there was too much lending in the economy in 2008, and that we needed to enter a period of slow deleveraging, this is actually exactly what the doctor ordered.
“One way of reading the [situation] is to think of a set of trade-offs between three constituencies: banks, borrowers, and regulators. When the regulators got tough and implemented Basel III [the tougher requirements on capital], the main losers were the banks, which lost a lot of permanent profitability. But borrowers were also hit: they’re paying more for loans, and they’re not being given as many loans as they were in the past. The big winner, meanwhile, was society as a whole, which significantly reduced the amount of systemic risk in the banking system.”
Furthermore, one has to acknowledge that the level of credit in the economy is about demand as well as supply:
“Individuals are more interested in paying down their debts than they are in borrowing more; businesses, too, have learned the hard way that debt has a tendency to bite, hard, at the worst possible moment. If higher lending spreads help to discourage borrowing, at the margin — and maybe conversely encourage businesses to take some kind of equity funding, instead — then possibly they will result in a more resilient economy overall.”
In other words, the banks – with a little friendly persuasion – are doing what they ought to do and so are the rest of us. It’s unlikely that anyone will ever refer to current upturn as the “Great Recovery”, but if we’re truly kicking our addiction to easy credit – and the associated habits of speculation – then the Great Detoxification of the economy may be at hand.