the worst downturn since the great depression

Award winning economist says America has bankrupted itself with the Iraq war
Print Email
Australian Broadcasting Corporation

Broadcast: 05/05/2008

Reporter: Tony Jones

One of America's leading economists Joseph Stiglitz joins Lateline to discuss his predictions on the subprime mortgage crisis which
has burst the US housing bubble and fiercely shaken the debt-ridden domestic economy.


Transcript
TONY JONES: Now to our best and Joseph Stiglitz is one of America's leading economists and one of the most pessimistic. He recently predicted that the subprime mortgage crisis which has burst the US housing bubble and fiercely shaken the debt ridden domestic economy would result in the worst downturn since the great depression. On top of that, he says future administrations will struggle to pay off the massive burden of debt used to fund the war in Iraq. In his latest book 'The Three Trillion Dollar War' Stiglitz sets out the hidden costs of George Bush's Middle East adventure. Stiglitz won the Noble Prize in economics in 2001. Before that he was the chief economist at the World Bank and before that, the chairman of President Clinton's council of economic advisers. He's a Professor of economics at the Columbia School of Business and we caught up with him in Rome earlier this evening. Joe Stiglitz, thanks for joining us.

JOE STIGLITZ, ECONOMIST AND AUTHOR: Nice to be here.

TONY JONES: I'll come to your book on the costs of the Iraq war in a moment. I was shocked to hear you say recently that the US is in the worst downturn since the great depression. How did you come to that conclusion?

JOE STIGLITZ: Well, previous downturns in the United States in the post war period have primarily been of two sorts. There have been excess inventory accumulation, firms build excess inventories and take a little time to de cumulate and the economy goes on as if nothing had happened. The other kind of downturn is when there's been a little bit of an inflationary bout, the Fed steps on the brakes a little too hard, the economy stops. The Fed realises it makes a mistake, takes its foot off the brake and the economy starts again. This is different. This is a real problem in the financial system. The financial system is really at the heart of the economy. And so this is a forecast that, in fact, this going to be a very serious downturn. Now the nature of how serious will obviously depend on the kinds of policy responses. Hopefully they'll be better than that for instance in 1981, '82 where the Fed, still wedded to the notion of monetarism kept interest rates tight and unemployment went up to 12, 13 per cent. So one has to see that policy plays a critical role and it could make things, unemployment get to extraordinary high levels. So far, the policy responses have been totally inadequate, in my judgment.

TONY JONES: If it is the worst downturn since the great depression, how can the rest of the world avoid being dragged into the abyss along with the United States?

JOE STIGLITZ: Oh I don't think it can. Right now you are increasingly hearing stories in Europe that it looks like one business person, the skid marks are on the road. It does look like Europe will be affected. One of the things that, one of the reasons that Europe is going to be effected is that their money authorities, the European Central Bank is focusing on inflation. America is focusing on the economic downturn. The result is increasing gap in interest rates. The result of that is an increasingly strong euro. The result of that is very hard for Europe to export, hard for it to compete with American exports.

TONY JONES: The Australian Government is in a similar situation to the Europeans. They're having to raise interest rates progressively to fight inflation, but Australia considers itself to some degree to be sheltered because of the booming economies in China and India. Can we shelter from the storm behind those economies inevitably, or will they be affected, too, by a US downturn of the scale you're talking about?

JOE STIGLITZ: Almost surely they will be affected but they're beginning with a much higher base. The general discussion for instance that China will probably slow down from maybe 11.5, 12 per cent to 9.5 per cent, 9 per cent, 10 per cent, that's still robust growth and those who are in the orbit of China's economy may feel the slowdown, but still will feel that they are doing very well. So I think that those countries who've diversified their markets and are more dependent on China are going to probably weather the storm far better.

TONY JONES: Going back to the US economy, the phrase " fool's paradise" comes to mind when you think of the extent to which American consumers have borrowed on the paper value of their own houses. Now you cite one recent year in which that figure reached more than $900 billion.

JOE STIGLITZ: That's right, it was quite incredible and it is a real example of the regulators being asleep at the wheel, the banks, the ratings agencies. And this is not done with 20 20 hindsight. It was so clear. I was writing about it, a number of other people were writing about the impossibility of what was going on. Just take one aspect or two aspects of this. They were giving mortgages for close to 100 per cent of the value of the house. There was actually some evidence that many of the mortgages were given for 100 per cent of the value of the house. That meant that if the price went down there was an incentive to walk away. If the price went up the owner of the house got to keep it. It was a one way bet and people took out as large a mortgage as possible. What was going on was the banks were in effect giving money away. You had to ask the question, it's not a standard part of American business practice for American banking practice is to give away money, especially giving away money to poor people. Giving away money to CEOs is one thing, but to give away money to these subprime mortgage borrowers who are among lower income Americans just was a very peculiar thing and what was going on? Well, what was going on is pretty clear. They were printing pieces of paper, making pieces of paper that they were selling on to uninformed people who thought they had value.

TONY JONES: Joe, on top of that, of course, a massive splurge on credit card spending, so people getting themselves even further into debt in the United States and that's been mirrored in this country and many other countries as well. It appears to be that it's unsustainable. I want to know, though, since those things were fuelling the growth in the domestic American economy what happens when you turn the tap off?

JOE STIGLITZ: Well, let me just reiterate, in America it was worse than in most other countries. Our savings rates plummeted to zero and that clearly wasn't sustainable. Now when you turn off those taps, the economy gets weaker. For the long run, this is good. Americans must save more. It is a curiosity. It is a peculiarity one might say that the richest country of the world, the United States, was not able to live within its means. It had to borrow $850 billion in one year from poorer countries around the world. Clearly, something was wrong. But in the short run, with Americans not consuming as much, that means that there's less to fuel the American economy. A normal question at this point is, can't we make up for it through either monetary official policy? Well, monetary policy has been working by having low interest rates, encouraging people to take money out of their houses. That game is over. With housing prices falling and people expect their housing prices to fall something like 20, 30 per cent in real terms from the peak to the trough, with housing prices falling, people are not going to want to take out more mortgages, these mortgage equities and banks are going to want to lend. That leaves fiscal policy. Fiscal policy is in a very bad position, room for manoeuvre isn't there, and that goes back to the war. One of the ways that the war is really going to be hurting us is that in the last recession, 2001, we had a two per cent GDP surplus and that gave us room to do something to help the economy grow. Now we have a massive deficit, mainly caused by the war. We expect, in fact, that the deficit this year will be at a record level.

TONY JONES: You obviously don't think that the $150 billion stimulus package signed off on by the Congress and President will have much effect, especially when you set it against the money borrowed against houses in recent years?

JOE STIGLITZ: That's right. Obviously it's better than nothing. But the fact is, there are two flaws with it. First, as I said, it doesn't give as many bang for the buck. Households know it's more difficult in the future to get credit. A lot of them are going to rather than spend the money, put it in the bank and use it to pay back existing debt. It just won't stimulate the economy. The other problem is, the problem with the American economy is not too little consumption, it's too much consumption. So to the extent that it works, it works by protracting the fundamental flaw in the American economy, an excessive level of consumption.

TONY JONES: You've mentioned this yourself, but one of the great economic drivers rarely talked about by most financial commentators is the immense cost to the US economy of the Iraq war. Now your new book 'The Three Trillion Dollar War' makes some controversial calculations to reach that cost. In the past it's been argued that wars actually cause economies to grow. You seem to have shattered that illusion with this book?

JOE STIGLITZ: That's right. The way that illusion came about was World War II, where the view was that World War II got the country out of the great depression, the world out of the great depression. Well since the time over 75 years ago we know how to stimulate the economy in ways that increase at the same time long term living standard. Nobody ever said that wars are really good for living standard. Well, this war's been particularly bad for two reasons. First, money spent to pay for, say, a Nepalese contractor working in Iraq doesn't give the uplift to the economy, that spending the same dollars in America on hospital, roads, schools any of those other kind of things. So in the sense that it's diverted money that might have been spent in America into being spent in Iraq, it's actually dampened the economy. But the more important factor and it was a factor we noticed back in 1991, is that this war has given rise to an increase in oil prices. Prices were about $25 a barrel five years ago, now they're over $115 a barrel and that means that money that America would have been spending at home is being spent to buy oil from Saudi Arabia, Kuwait, other oil exporters.

TONY JONES: Can you say for sure it was the war that caused oil prices to go through the roof? There are other reasons, the peak, the possibility we're running out of oil and, of course, the increasing demand from the economies of China and India which are growing so fast that they are soaking up oil at a tremendous rate?

JOE STIGLITZ: In our book we took a very conservative view. We only attribute 5 to $10 of the $90 or so increase in the price of oil to the war. So yes, there are other factors and we don't claim it is the only factor or even the most important factor. Although I actually think that it is far more important than we ascribe in the book because we didn't want to get into a quibble about that. Let me explain why I think the war was so important. In 2003 when we began the war, futures market s look to increases in demand and increases in supply. Futures markets understood that China, India were growing. That was well known. They were already growing at this unprecedented rate. They may have gotten it wrong a little bit, but overall most people expected that China would continue to grow at the rate that it had grown, which is 10 per cent or so per year. What they thought, though, was that there would be an increase in supply from the low cost providers, the low cost providers in the Middle East and that the war changed that equation. It brought this instability to the Middle East. And then it let forth a kind of dynamic that we've seen before, a kind of what economists call a backward bending supply curve. The countries in the Middle East that control the supply of oil could meet their budgetary needs without producing more oil. With an oil price twice, three times, four times what it had been, what was their incentive to increase the output of oil? It was even worse. Because of the hostility to many of those from the Middle East, the resistance, the sovereign wealth funds, the problem with Dubai ports, they felt if they took their wealth below the ground and try to invest it above the ground in the United States and in other countries they would meet resistance. So the best place to invest their money was to leave their money below the ground and that's what they've been doing.

TONY JONES: Well, here's a fact, we'll leave oil aside now, here's a fact that will astonish many. You claim the direct cost of the military operations in Iraq already exceeds the cost of the 12 year war in Vietnam and is double the cost of the American involvement in the Korean War. How can that be so? Those wars were so much bigger?

JOE STIGLITZ: Well, actually this is now the second longest war in America's history and the second most costly. One of the reasons it's so costly is the cost per troops have gone up, soared. Previous wars, $50,000 per troop, this war is for $400,000. There are a number of factors. One is this is the first war that has been privatised to the extent that it has. We use private contractors rather than military. Private contractors are very costly. All of this stuff about private sector being more efficient, not true when it comes to war. There's a lot of I suspect profiteering, the stock of Albertson has almost tripled since the beginning of the war. Whatever you call it, it's very expensive. There's some other factors also contributing to the war. Modern medicine has meant that more people are surviving, but the cost of keeping them alive is very high. And the ratios are again unbelievable. Previous wars, the ratio of survivals to fatalities is 2.5 to 1. This war it's 15 to 1. So there are a number of distinctive aspects of the war that have really driven up the cost.

TONY JONES: How much of a poison chalice is this going to be for the next administration? As you pointed out earlier, this war has not been funded from American coffers but it's been funded by debt. In order to fund this extraordinarily expensive war, as you say, the most expensive since World War II, the United States has had to borrow money.

JOE STIGLITZ: We've borrowed every dime. It's the first war in American history where we've borrowed everything. Usually you ask your young men and women to go fight for you and there's a sense of shared sacrifice and those who aren't fighting say, "OK, we'll have the shared sacrifice, we'll give up something, we'll raise our taxes at least as a symbolic gesture of unity.” In this war just months after we sent our young men and women to fight, Bush asked for and got a tax cut for rich Americans. It's actually the first war since the revolutionary war where America was created where we've had to turn to foreigners to help finance, 40 per cent of the money has been borrowed from abroad. And that means that all the bills will be paid by future generations.

TONY JONES: And future administrations and that was my point, a poison chalice if an Obama White House or a Clinton White House comes into office, how are they going to run the economy with this burren?

JOE STIGLITZ: It's a difficult problem. The peace dividend is not going to be as great as many people had hoped. Let me give you an example. I was mentioning the injuries and there have been so many injuries and so many bad injuries. The newest numbers coming out suggest that the fraction of those returning, that will be disabled in one way or another is 48 per cent. We actually use 39 per cent but the numbers coming in look much worse than we had anticipated. So our numbers are conservative. We had estimated in our more reasonable estimate that the total unfunded liability to take care of our returning disabled veterans, health care and disability benefits will exceed $600 billion. That's an amazing amount. It's roughly the order of magnitude the President said three years ago that we had a gap in our social security system. It threatened our economy, it threatened our ability to provide old age pensions for our elderly. Well, we've created just for the disabled in this war in the last five years, a gap equal to the gap that we created over decades in the social security system. So there is an enormous set of bills coming to and it's going to tie the hands of a future administration. Let alone the problem of figuring out how to get out of it.

TONY JONES: What you're saying suggests this is without a doubt, the greatest foreign policy folly and it now is sounding like the greatest economic folly that an American administration has got itself into?

JOE STIGLITZ: I think that's right. It's an order of magnitude worse than the Vietnam War. But here we're talking about a region that was already very volatile in the Middle East. A region with one of the world's most important resources, oil. And what we did is we converted a region that was, you might say, unstable into a region that was just highly volatile, where groups that had lived together perhaps not totally in peace but lived together, the Shi'ites and the Sunnis are now fighting each other. We've let forth a set of problems the full nature of which will take I think decades to resolve.

TONY JONES: Joe Stiglitz, we will have to leave you there. It's been fascinating to talk to you, hopefully we'll get the chance to do that again in the future. Thank you very much for taking the time to join us on Lateline.

JOE STIGLITZ: Thank you.