Why we’re still headed for a Great Depression

There’s been a lot of talk since the Dow Jones Industrial Averages breached 10,000 about the disconnect between Wall Street and Main Street. Kevin Drum at Mother Jones thinks “the next bubble is already in the works and its collapse will be every bit as bad as this one.”

That assumes there is any connection whatsoever between what’s happening on the markets and the rest of the world. But it looks like the banks have used stimulus money not to resume lending but rather the very practices with the same incentives that led us into the recession in the first place. If that’s the case, then the effects of a cut-off in lending have already been felt.

But banks that are actually in the business of serving the real world are still struggling. Bank of America just posted a $1 billion quarterly loss. The Wall Street Journal points out that the very banks–the smaller ones–that have been doing all the lending are also the ones which are not too big to fail, which is just what they’ve been doing. As for the rest, the Journal says they aren’t lending to consumers or businesses, that they’d have to go into bankruptcy if they recognized all the bad debt they have on their books, and that they “can earn a huge spread by borrowing virtually unlimited amounts for nothing and lending that same money back to the Treasury.”

So big bank profits are a chimera and the rest of the economy remains in the tank. The U.S. goes deeper in debt and opens wider the door to a possible collapse in the dollar.

As the chart above (based on data from the Bank of Canada) shows, the dollar has lately been dropping pretty steadily against the Euro. A huge U.S. budget deficit doesn’t help, leading several countries to prepare “to end dollar dealings for oil.” This report, written by Robert Fisk for the Independent, was hotly denied, as one would expect. One of the countries, China, is already worried about the value of its huge holdings in dollar-denominated assets.

So while Paul Krugman criticizes an “obsessive fear of inflation even in the face of deflation; opposition to easy credit, even when the economy desperately needs it, on the grounds that it would be somehow corrupting; [and] assertions that even if the government can create jobs it shouldn’t, because this would only be an ‘artificial’ recovery,” President Barack Obama’s team insists that “we must live within our means.”

It doesn’t seem to matter who’s right. Even if Obama were to follow the policies advocated by Krugman, the value of the dollar might undermine any gains as import prices rise and the U.S. no longer possesses the capacity to manufacture goods at home. As Obama more likely follows a policy advocated by monetarists, an already illusory economic recovery vanishes, leading to yet larger deficits as revenues decline. And the idea that politicians might somehow hit a middle ground that avoids the adverse consequences of either policy in fact assumes that Krugman is wrong, that the government need not do much more to put workers back to work.

In fact, Krugman is wrong in one respect. He writes, “Yes, the Federal Reserve and the Obama administration have pulled us ‘back from the brink’ — the title of a new paper by Christina Romer, who leads the Council of Economic Advisers. She argues convincingly that expansionary policy saved us from a possible replay of the Great Depression.” But looking at the real economy–as opposed to government misrepresentations–I cannot imagine how he can believe this.

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