How the U.S. Can Avoid a Lost Decade

Today’s global problems could paralyze the U.S. economy and stock markets for the next 10 years – but that can be prevented.

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Even crises out of our control, like problems in the Eurozone, could trigger a "lost decade" of economic stagnation in the U.S.

The popular buzzwords nowadays, all around the world, are “lost decade.” That’s shorthand for the fear that today’s global financial problems will paralyze economies and stock markets for 10 years or more. It’s a legitimate worry. But addressing the immediate dangers won’t be enough to avert a lost decade in the U.S. It’s just as important to find a way to promote long-term economic growth that isn’t fueled by borrowing.

The term “lost decade” is best known in connection with the prolonged stagnation in Japan that resulted  from the 1989 stock market crash in that country and the bank bailouts that followed. More recently, it has become popular in the U.K. as a way of referring to forecasts of an unparalleled decline in living standards. The American version of a lost decade wouldn’t exactly parallel that of Japan or the U.K., but it’s still a little scary. Consider these three points:

1)  Avoiding another recession is not enough. On Friday, the White House framed the most recent jobs report as part of a narrative of long-term job creation. And certainly, the decline in the unemployment rate to 8.6% – the lowest rate in more than two years – seems heartening. But while there were an estimated 120,000 new jobs in November, more than 300,000 people left the labor force. At that rate we could eliminate all unemployment if everyone just stopped looking for work and stayed home. For genuine improvement, new jobs have to be created at a much faster rate than they have been over the past couple of years. Slow growth is simply a kinder, gentler recession.

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2)  Financial recessions are more damaging than normal recessions. Every unhappy family is unhappy in its own way, according to Tolstoy, but recessions can be broadly divided into two categories. The first is the normal business-cycle recession. Companies over-expand, build up too much inventory, hire too many people and generally get overextended. Then a period of correction comes in which companies cut back and lay off workers. That process takes around 18 months. But the defining factor is that the banking system remains undamaged. In a financial recession, by contrast, it is not only the industrial economy that gets overextended – the banks do too. And correcting the excesses of the financial system takes far longer. Indeed, the current recession has already been much worse than normal. Some economists say that full recoveries from financial recessions take six to 10 years.

3)  An external shock could cause a double-dip recession. Unpredictable events, such as a crash in China caused by the bubble in real estate prices there or conflict in the Middle East triggered by an attack on Iran’s nuclear facilities, could trigger a second recession and start the clock for recovery all over again. So could the collapse of the common euro currency or the breakup of the Eurozone.  And even without such a dramatic event, attempts to straighten out Eurozone economies and shore up European banks could result in less lending and worldwide stagnation.

From all this, two things should be evident. The first is that there is every likelihood that something damaging to the U.S. economy will happen between now and the 2012 election. The second is that the aftermath could easily be a period of prolonged stagnation. Even the most lucid commentary on today’s economy tends to emphasize immediate problems, focus on the deficit or submerge the essential need for growth among a welter of other considerations.

That’s all perfectly understandable. But recessions – even bad ones – end eventually. And they don’t necessarily harm the prospects of long-term investors. Historically, periods of depressed stock prices have been followed by above-average returns, both because investors get to accumulate shares when prices are at bargain levels, and because economies that have gone through a period of correction usually get to play catch-up for a while once growth resumes.

What is essential, however, is that growth resumes. That’s where the spotlight must shine. Short-term global financial threats may be the clear and present danger, but defending against them won’t prevent a lost decade. Even focusing on long-term budget problems – essential as that is – won’t be enough to improve living standards for the majority of the American population. There is no real way to avoid a lost decade without restoring a normal level of  long-term economic growth. That can’t be accomplished by austerity alone or by stimulus plans that rely on borrowed money.

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In one regard, the U.S. has an advantage over the Eurozone. The most troubled countries that use the euro currency may be shrinking their deficits faster than we are, but they already have crushing debts accumulated in past years. By contrast, U.S. debt is still manageable – especially once you consider that a big chunk of it is owed by one part of the government to another.

What that means is that we still have time to fix things. But it is essential that the current discussion be shifted to focus explicitly on the need for pro-growth policies. As we enter the election season, the first question every candidate should be asked is: “What is your plan to encourage healthy rates of economic growth at the same time that you are reducing the deficit?” To avoid a lost decade, it’s every bit as important to focus on reviving growth as on riding out the recession. Survival strategies just aren’t enough.

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