[Viewpoint] Bracing for the worst-case scenario

“Dr. Doom” may have been proven right again. New York University economics professor Nouriel Roubini, who earned his nickname for his nail-on-the-head forewarning of the subprime mortgage market bust back in 2006, has warned of a double-dip recession since two years ago.

His critical prophesy went largely ignored amid signs of recovery in the U.S. and other advanced economies.

We, too, have a number of critics in Korea. Hanshin University economics professor Yoon So-young also has been pointing out alarming signs of a recession in the making since 2009.

The 2008 financial crisis had been spurred on by excessive private-sector debt. Assets of financial institutions, companies and households turned bad. The government stepped in. It printed Treasury notes to bail out and clean up poor private debt and insolvencies.

Private debt was transformed into public debt. The U.S. nevertheless veered away from the worst recession in a century. But the ticking bomb has simply been tossed around. Insolvencies do not suddenly turn around just because they are in the government’s hands.

The government more or less bought time until the economy turns around and the market can afford to consume nonperforming debt. The Korean government used the same prescription after the currency crisis in 1997. It raised funds through debt issuances to clean up bad private loans and redeemed some of the funds by selling the assets back to the market.

But the success of the prescription depends on the economy’s performance. Unfortunately, the outlook for the U.S. economy is poor. If the economy sinks any more, it is headed for a double-dip recession. The culprit this time would be government debt. Treasuries, equity prices, and the value of the U.S. dollar are plummeting as consumer prices soar. By some estimates, the U.S. economy is expected to contract even more than the 2.6 percent decline in 2009.

The shock of recession in 1938 had been greater than in 1929 and will be likely far-reaching this time round. The problem now is that there is no rescue plan. The government came to the rescue in the 2008 private-sector crisis, but now the government’s hands are tied. The European Union is facing the same dilemma.

A lack of political leadership cannot be entirely blamed for the current problems. Standard & Poor’s is not the culprit. It should not be blamed for putting the U.S. economy in the hot seat by downgrading the country’s sovereign credit rating. The U.S. Congress is threatening to call S&P to a hearing to investigate it for jeopardizing the American economy.

Don’t shoot the messenger. S&P may have jumped the gun, yes, but the U.S. economy has been heading for trouble for some time. It has been worsening since the final quarter of last year. The growth forecast for this year has already been shaved several times. The U.S. Federal Reserve announced that it will maintain the key interest rate at near zero for at least the next two years, underscoring the gravity of U.S. economic problems and the lack of options to spur growth.

Washington’s biggest dilemma is that it has run out of ammunition to drive the economy. Since the 2008 crisis, the government has pumped in near $24 trillion to bolster the economy. It spent $10 trillion more than the gross domestic product, yet failed to put the economy back on a solid growth track.

Washington nevertheless cannot stand idly by as the world’s largest economy collapses. It must employ all possible fiscal and monetary tools and deter the bomb from exploding. It may fall short in turning around the economy, but it at least it would prevent a further contraction.

The Federal Reserve is saving the third round of quantitative easing for something worse. The move may not have done any good for now. Its dilemma is understandable, but the Fed could have sent strong signals to save the economy if it renewed a bond-purchase program. It could have given the market more time to recuperate from latest blow. Washington, then, would have had to brace for a long-term battle.

Korea must readjust its strategy and realign its ammunition accordingly. The export-driven economy inevitably will suffer from shock waves from the U.S. and EU, but it must do all it can to lessen the damage. Most imperative is stability in the currency market. Authorities must keep a close watch on the volatility in the foreign exchange market. Once the market regains calm, the government should accelerate reform measures.

Politicians should lay down their arms race over welfare policy ahead of next year’s elections.

The dangers of budget crises have been loud and clear from the U.S. and EU. The legislature should ratify the Korea-U.S. free trade agreement to prepare for a even fiercer trade war amid a slowdown in the global economy. Restructuring problematic housing loans, savings banks and project financing should also be tackled.

*The writer is an editorial writer of the JoongAng Ilbo.

by Kim Young-ook