U.S. Economic Recovery? A Long Way to Go

When will U.S. subprime crisis reach the end? When will the U.S. economy step out of the crisis? It seems so far no one can give precise answers. As “bystanders”, including Norbert Walter, chief economist at Deutsche Bank, along with a number of other German experts and scholars believe that the U.S. economy may not be out of the shadow of subprime crisis till at least the year 2010. As the real estate credit will inevitably spread to other financial entities in the economic field, the current U.S. economic crisis has not yet bottomed out. I am afraid U.S. economic recovery will probably last 10 years or even longer.

In the 1970s, because of the involvement in the Vietnam War, the United States economy experienced severe stagflation. In 1990, Japan witnessed the crisis in the real estate and its financial market. In 1995, the German real estate bubble burst. These crises led to more than 10 years of economic downturn and even recession for the top three world economies. However, the present situation of U.S. is different from that of Japan and Germany.

First, whether during the time of real estate or financial crisis, or at the present, Japan and Germany are the two major exporting countries, with a yearly high trade surplus that could serve as important pillars against economic shocks. On the other hand, the United States experiences high trade deficit, weakening consumption and a lack of external demand. Second, Japan and Germany both have a high private savings rate, and their financial systems have a normal operating basis. The consumption is based on a healthy and rational saving level. However, the U.S. savings rate is so low and even negative that its financial industry is lacking a solid operating foundation. Third, in 1995, Germany’s real estate crisis is mainly involved in the banking system and its real estate, with other financial sectors still relatively healthy. But the financial crisis in the United States not only involves subprime mortgage, but also a huge consumer credit along with the credit derivatives market; almost the entire U.S. financial system has been in crisis.

The measures taken by U.S. government are just a drop in the bucket and far from being sufficient. When the bubble outbreak and the crisis occurred in Japan, the Japanese government not only cut interest rates to zero, but also issued treasury bonds to revitalize the economy, given its strong foreign exchange reserves and high savings; Japan injected huge amounts of money to the market, even so, it failed to save the market out of the crisis within a short period of time.

The U.S. government issued a $700 billion rescue package, only the equivalent of 5 percent of its 2007 GDP, while the subprime mortgage in its real estate credit exceeds more than $700 million. Added on this is on-going falling housing prices, driving many loans into default and as a result the credit derivatives market, as a whole will fall into an even larger losses. How much will be the loss and how deep is “the hole”, nobody knows. The capital put to save the market by the United States and Europe is not enough, even though Germany has also launched a €500 billion financial aid plan, a value equivalent to 20 percent of its 2007 GDP.

Some analysts believe that the high cost of the war has been an important factor that the United States is unable to deal with the crisis effectively. Nobel laureate Joseph E. Stiglitz pointed out in his book “3 trillion-dollar war” that by the end of the fiscal year 2008, the U.S. government would be funding $845 million for the Iraq and Afghanistan wars, far more than the Vietnam War. According to the estimate of the U.S. Congressional Budget Office, by 2017, it will cost the United States a total of $1.2 to $1.7 trillion for the wars in Iraq and Afghanistan. Stiglitz argued that this figure should be $1.7 to $2.7 trillion. The latest U.S. government record budget deficit of $455 billion indicates that the United States is not strong enough to rescue the market. As a result, the duration and the severity of this subprime crisis is more than the period of stagflation in the 1970s. Therefore, the economic recovery will be a long process.