The Price of Recovery
Changing economic policies isn’t enough, says Goldman Sachs executive Robert D. Hormats—we also have readjust core American values. The government needs to stop borrowing, start saving, and beef up socioeconomic programs.
Changing economic policies isn’t enough, says Goldman Sachs vice chairman Robert D. Hormats—we also have to readjust core American values. The government needs to stop borrowing, start saving, and beef up socioeconomic programs.
In a widely reported address to the Commonwealth Club in San Francisco in 1932, New York’s Governor Franklin D. Roosevelt, campaigning for the presidency in the midst of the Great Depression, asserted that the crisis “calls for a re-appraisal of values.” Over 70 years later, the same can be said of our current crisis. Changing economic policies without changing values will only lead us back to the same problems we are confronting now. Indeed, policies rest on a foundation of social and economic values, and so if the latter do not change, neither will the policies over any sustainable period of time. But frequently the crisis itself is a “value changer” and this one promises to be just that. One thing is virtually certain: the economy that emerges from this crisis will not be, because it cannot be, the same economy we went in with.
There are encouraging signs here, too. The recently passed stimulus legislation contains billions of dollars for physical infrastructure: from roads to bridges to dams, and an extensive program for better utilizing information technology.
Of all the changes underway, the most obvious is that, for the moment at least, Americans are reassessing the value of saving versus borrowing. In recent years too many of us appear to have forgotten how to save—or why we need to. We have become a short cut society as far as money is concerned. If the government wants to finance a program or fight a war (as vividly illustrated by the case of Iraq), it takes the easy way out: borrowing money, rather than explain to Americans why they should pay higher taxes to finance it.
Large numbers of Americans who want to buy a car or a house have fallen into a pattern of borrowing as much of the price as possible—even, in some cases, if we cannot afford the terms—rather than saving to buy them. (That was not the case with out fathers and grandfathers.) Remember all the ads on TV a couple of years ago telling us how we could get whatever we wanted, particularly mortgages, with “no many down” and “easy credit”? Our financial system was geared toward selling such loans and otherwise engaging in highly leveraged transactions. (What this industry needs to do to change merits much more space than I have here, but suffice it to say significant lessons can and should be learned—and many already have been—that will lead to important improvements.)
There is a pervasive myth that Americans are not good savers. But throughout much of the early (and mid-) post-war period, savings as a portion of disposable income hovered around 8 percent; they were well over 10 percent as late as the early 1980s. In recent times, however, the figure has averaged a paltry one percent—and occasionally has dipped below zero. Not only did people spend all the money they earned, but they also dipped into savings or increased borrowing to finance purchases. And many financial transactions were based on a high degree of debt issuance. Taken as a whole, the private sector (households and businesses combined) ran a financial deficit of nearly three percent of GDP last year. At roughly 300 percent of GDP, private sector debt is nearly double the once-staggering 160 percent of GDP it reached on the eve of the Great Depression (as the result of the excessive borrowing spree of the “Roaring 20s”).
Low or negative household savings removes the cushion families need to get through a sharp economic downturn or cope with emergencies. It ultimately will cause enormous pain to retirees who have small or no nest eggs. In Japan’s decade-long recession the pain for most families was mitigated to a considerable degree because the average savings rate was 20 percent.
The practice of borrowing against the value of one’s house was especially dangerous for the economy and for many American families. Between mid-2005 and mid-2006, Americans withdrew nearly one trillion dollars in mortgage equity from their houses, much of it through home equity loans or mortgage refinancing. About half of the withdrawal went into added savings or paying down other debts. But the other half went into spending of various kinds, helping to fuel a surge in consumption, which rose from an average of around 88 percent of disposable income to over 96 percent. Withdrawal of mortgage equity left many people with much larger debts and greater exposure to drops in home values than in past downturns. Even during the Great Depression the exposure was not as great because large mortgages based on small down payment to those with poor credit were uncommon.
And the government hardly set a good example. Washington has generated large deficits before, but these were generally during major wars (namely, WWI and WWII) or during deep recessions and depressions. In any case, the pattern was to reduce the deficit and pay down the debt when the emergency was over. But in middle part of this decade, during years of relative prosperity and a booming market, the deficit remained high. Federal debt largely rose due to big tax cuts, unchecked domestic spending, and war costs. They eroded a budget surplus inherited from the Clinton administration. Thus, on the eve of this financial crisis the government was burdened with a sizable budget deficit and a considerably larger debt than in 2001, giving it less fiscal flexibility to respond.
For many individuals, this crisis has underscored the importance of saving more and borrowing less. For the country as a whole, it has underscored the point that economic growth and prosperity based on consumption, and government services financed heavily by debt, are not sustainable. Private savings are now rising sharply and Americans are bringing debt down to more manageable levels. Financial markets are doing the same thing. This will put individuals ,companies and financial institutions on a more solid financial footing. (Of course, the drop in consumption also slows economic activity, forcing the government to become the spender of last resort.) Over time a better balance must be found in which the private sector generates a savings surplus and the economy does not have to rely on a borrowing spree for growth.
And the federal government can use this experience to recognize why, after this crisis, it should return to a practice of fiscal discipline, lost for most of the last fifty years. Like average Americans, the government can’t borrow its way out of problems indefinitely. It now needs to a public consensus, and the political will in Washington, required to put Social Security, Medicare and Medicaid on a sound financial footing—to avoid their having to engage in unsustainable levels of borrowing (amounting to multitrillions of dollars) in coming decades. Otherwise, we will be in an even worse financial crisis a generation from now.
To sustain robust growth not based on excessive debt creation, we need to do things the old fashion way, and focus on the fundamentals. And those fundamentals must include constantly upgrading our capabilities in science and technology, making far more productive use of our formidable human resources, funding more research in health care, modernizing our deteriorating public infrastructure, and building a clean energy economy for the twenty-first century.
There are encouraging signs here too. The recently passed stimulus legislation contains billions of dollars for physical infrastructure: from roads to bridges to dams, and an extensive program for better utilizing information technology to digitize medical records, which will save countless lives and enormous sums of money. Both are vital steps that require sustained follow-up. If health care is the greatest single human challenge for our twenty-first century society, and the value of expaanding access to it increases in our country, harnessing modern science and technology is critical. Breakthroughs in genomics, regenerative medicine, as well as personalized drugs and therapies are all within our reach. None of these initiatives need to be put on hold during the recession—as President Obama has frequently emphasized. In fact, more effort is is needed in these areas to ensure a healthier and more productive society now and when recovery resumes.
Stimulus funds for increasing the supply of clean energy, a top item in our emerging set of national values, also represent an important step toward the kind of economy we want after this recession, especially when combined with other government programs already underway and ongoing work in the private sector. The transformation requires sustained effort: one that cannot lapse just because energy prices have collapsed. If the recession is permitted to derail the drive toward clean energy and improved consumption efficiency—which were beginning to get a full head of steam when oil prices were $140 per barrel—then our national energy policy can be counted as one more casualty of this crisis. It is worth noting that even during the Great Depression technology moved forward—one vivid example being the television. It is also worth bearing in mind that if progress is not made in this area, huge amounts of funds that could otherwise go toward investment and job creation in the US will go abroad and we will have to borrow it back.
Finally, funding for education in the stimulus legislation, chiefly to modernize schools and ease the ability of families to send their kids to college, is essential to the kind of society and economy and we need to see after the recession ends and to getting out of the recession as well. In reassessing values, the value of education needs to be elevated at all levels. But lots more money and, more importantly, innovation, will ne needed. The knowledge-driven jobs of this new century will require men and women who possess sophisticated technical skills. And these cannot be just university graduates. The widening gap between the wealthiest Americans and those in lower income groups has largely come from a difference in education and skill levels. And this addresses another value that needs to be reassessed—the importance of narrowing the income gap in this country. Focusing more attention and resources on broadening access to quality education (especially for minorities and immigrants) is an investment not only in national growth and job creation, but also in a less bifurcated socioeconomic structure and improving opportunities for a greater number of Americans to succeed and be productive participants in our economy .The single most important piece of economic legislation in the post-war period was not a stimulus bill but the GI Bill—because it invested in our own talent. It helped to prevent a decline in the U.S. economy after the surge of wartime spending ended and gave an enormous boost to the productivity for decades. That is the best lesson for today.
Bob Hormat is vice chairman of Goldman Sachs (international). His publications include The Price of Liberty: Paying for America's Wars from the Revolution to the War on Terror; Abraham Lincoln and the Global Economy; American Albatross: The Foreign Debt Dilemma; and Reforming the International Monetary System.