INTRODUCTION

THE ENDLESS SLUMP

The past twenty years have seen a transformation of the global economy unlike any ever witnessed.

In the time it takes to raise a child and pack her off to college, the world order that existed in the early 1990s has disappeared. Some three billion people who once lived in sleepy or sclerotic statist economies are now part of the global economy. Many compete directly with workers in the United States, Europe, and Japan in a world bound together by lightning-fast communications. Countries that were once poor now find themselves with huge surpluses of wealth. And the rich countries of the world, while still rich, struggle with monumental levels of debt—both private and public—and unsettling questions about whether they can compete globally.

This shift is hardly news. Starting a dozen or so years ago, we began to hear all about globalization and the economic threat that the new, “flat” world poses to developed countries. Yet since 2008, that talk has been overshadowed by the financial crisis and its aftermath—a crisis that eviscerated trillions of dollars in household wealth, created near-record levels of unemployment, and left the United States and Europe in adverse economic straits that persist to the present day (joining Japan, which has been hobbled for two decades). The causes of the crisis, it was said, lay in too much risk taking by the lords of finance, along with too big an appetite for debt among ordinary people. And so for the past five years, we’ve heard less about China and India and more about how to fix the financial systems and economies of the developed countries.

When people think about today’s economic challenges, many of them put the problems facing the United States and Europe in separate baskets: one basket for such thorny issues as how to jump-start growth, reduce unemployment, and control the national debt; and a second basket for how to deal with trade deficits, currency issues, and competitiveness writ large.

This book argues that all these challenges belong in one basket. You can’t understand the housing bubble and the financial crisis without appreciating how the rise of the emerging nations distorted the economies of rich countries. And you can’t chart a course to more growth and stability in the developed world without recognizing that many of these distorting forces are still at work.

In the pages ahead, I argue that the central challenge facing the global economy is an oversupply of labor, productive capacity, and capital relative to the demand for all three.

Beginning in the late 1990s, a tidal wave of cheap money began flooding the global economy, much of it coming from Asia as China and other countries began to run huge trade surpluses and their burgeoning middle classes and thriving corporations socked away savings. Easy credit set the stage for the real estate bubble and the financial crisis. And cheap money also allowed Americans to sustain a high standard of living with low-cost borrowing and to ignore their declining competitiveness amid a growing surplus of global labor. Of course, the party couldn’t last forever.

Yet five years after the financial crisis, many leaders and commentators in the United States and Europe still don’t get what happened. Nor do they seem to realize that the age of oversupply is here to stay and that oversupply is a central obstacle to restarting growth. Many of the standard tools for fueling growth simply don’t work. As I show in the pages ahead, cheaper credit through monetary easing doesn’t yield much in an era when cheap capital already exists in abundance. And policies that seek to stimulate growth run up against the fact that there is a huge oversupply of global labor and productive capacity. Meanwhile, major risks linger in the banking sectors of the United States and Europe, where reforms have not gone nearly far enough. Today, despite the painful lessons of recent years, the global financial system is anything but stable.

Finally, the United States and Europe face a huge overhang of unresolved private debt, a legacy of the credit bubble—debt on a scale no nation has ever before confronted. These debts hold back growth, but asset holders—mostly the banks—have been loath to write these debts off and take the hit they have to take. Few political leaders are ready to force a painful resolution of these debts. And across both the political and financial worlds, hopes abound that growth will resume, inflating the value of “underwater” assets and devaluing outstanding debt.

That is simply unlikely to happen anytime soon. Economic growth won’t rebound in a sustained way until the developed countries confront deep systemic problems in their own economies and the new and profound distortions in the global economy. Even though three billion people and trillions of dollars in wealth have emerged on the world scene, most policy makers are still stuck in denial about the earth-shattering nature of this shift.

Can the United States and Europe get out of this mess? (And what about Japan, which has seemingly been unable to do so for decades?) I believe they can, and this book offers a road map for avoiding a future of economic stagnation and new crises.

We must begin by acknowledging how much everything has changed. Economic troubleshooters—from presidents to central bankers to lawmakers to economists—need a fresh playbook in the age of oversupply. In particular, monetary policy—historically a critical tool for fighting economic downturns—simply doesn’t have, in a world of easy money, the bite it once had. And while fiscal stimulus can help restart growth, I argue that developed nations need to try this approach on a much larger scale than ever before if we are to put the advanced nations’ huge surplus of workers back to work. I suggest major new investments that deal strategically with infrastructure and I detail how such investment would not only help restart growth but also lay the foundation for future prosperity.

At the same time, I propose an aggressive effort to clear away the crushing burden of unresolved debt that is a legacy of the credit bubble. This is a daunting political challenge, because it means taking on creditors who hold trillions in bad debt. But until our advanced economies can emerge from under debt overhang, strong growth will be impossible. The United States, the world’s largest economy, must also confront two major obstacles to its global competitiveness: runaway costs for higher education and health care—and I suggest ways to confront these costs.

My other recommendations include further reforms to the banking sector to reduce risky behaviors and foster more stability. These efforts need to involve leaders and institutions from across the developed world if they are to succeed, given the interconnected nature of today’s global financial system. Likewise, new multilateral cooperation is needed to create a global currency system that will ensure stability and a level economic playing field.

I come to these seminal challenges not as an economist or a policy expert, but as an old-school investment banker. For three decades, I have worked with a range of companies to help them find the capital they need to grow and succeed, and to provide solutions to their problems. At times, I have restructured failed enterprises and those beset by unforeseen challenges.

During my career, I’ve had many dealings in Japan, experiences that strongly color my views and the arguments in this book.

By now it’s become a cliché to say that the United States risks turning into Japan, a country that has experienced two decades in the economic doldrums since the collapse in 1989 of a huge asset bubble of its own. Yet long before the global financial credit bubble imploded, I could see that the United States was on a path similar to Japan’s and that we might someday face comparable stagnation. As it turned out, far more countries than just the United States were to be drawn into crisis.

I vividly recall sitting in a conference room with other bankers and attorneys one sunny, warm day in Tokyo in the summer of 2005. I was involved in the acquisition of a long-defaulted mortgage loan collateralized only by land, a leftover from the late 1980s Japanese bubble era, with an outstanding balance of about $800 million in today’s U.S. dollars. We were in the process of closing the purchase of the loan for the shockingly low price of $50 million. But I was not particularly astounded. My firm had opened our office in Japan in 2000, and by 2005 I guess I was already an old Japan hand. Nothing surprised me. Although I mostly commuted to Asia monthly and did not reside there for long periods of time, I had spent nearly half of my recent years in Japan. This was the country in which the grounds of the Imperial Palace in Tokyo—1.3 square miles of land—were once estimated to have the same value as all of the real estate in California.

I was in that conference room that day as an undertaker of sorts: a small pile of the remaining ashes of the greatest real estate bubble in history were being laid to rest.

It was all very ominous because in 2005, of course, the United States was in the midst of its own property bubble—one already quite apparent to the small number of us who followed the relationship among markets, lending, and global macroeconomic trends—an unusual combination of disciplines. Prices of homes and commercial properties in the United States had already become unmoored from reasonable investment returns, the ability of incomes or rents to support prices paid, and—most ominously in the U.S. residential sector—the ability of most buyers to secure ownership of a home with a conventional mortgage product. The connection between what was occurring in the United States and what I was doing that day in Tokyo did not escape me. Even as Japan’s leaders struggled with the debt overhang of a decades-old real estate bubble, America’s and Western Europe’s leaders were turning a blind eye as an even bigger bubble (in nominal terms) inflated in the United States and Europe.

After a break, I returned to the conference table and listened to the conversation for a while. During a lull, one of the Japanese lawyers turned to me and said:

“Alpert-san, you must think we Japanese were very foolish to lend so much money against just land. You would never do such a thing in the U.S.”

The Japanese, particularly the men, have a customary and somewhat endearing way of sucking wind through their teeth and screwing up their faces during moments of consternation, intense consideration, or confrontation.

I thought for a moment, smiled, and said, “Unfortunately, I think the U.S. is next up in terms of this type of foolishness.”

“What do you mean?” came the reply, accompanied by much sucking of wind and quizzical facial expressions. “In the U.S., businesspeople could never do something like this!”

“I think you might be very surprised,” I said—to even more sucking of wind through teeth.

Today, seven years after home prices in the United States hit peak bubble values in the summer of 2006 and five years after the financial system of the entire developed world nearly ground to a halt, the economies of the United States, Western Europe—and yes, still Japan—remain mired in severe economic dislocation.

The demand for goods and services in the developed world remains muted, relative to potential. Amid this flat demand, even the most profitable companies see little reason to invest in new equipment or hire new workers. And never has there been such bitter disagreement and deep confusion, among politicians and economists alike, about what ails the economies of the developed world and how to fix them.

To combat the ongoing slump, for half a decade despairing policy makers have employed almost every conventional, and many far more heterodox, economic countermeasures—measures that arose from a century of modern economic scholarship and experience. As a result, they have succeeded in avoiding an outright collapse of key institutions and enterprises, while kicking down the road a growing list of unresolved problems.

At this writing, an alarming percentage of the political leadership in the developed countries have flirted with or have outright implemented fiscal austerity policies. Nothing could be more damaging to the interests of the 800 million or so people of the advanced nations. Commenting in March 2013 on the dominance of austerity policies in Europe, Gideon Rachman of the Financial Times of London wrote, “There are many who argue that this prescription is dangerous. But the anti-austerians have failed to come up with a set of alternative policies that is coherent enough to turn the intellectual tide.”1

The Age of Oversupply is intended to answer precisely that type of criticism: to provide a coherent intellectual rationale for why we are where we are, to deliver policy initiatives that focus on the ongoing challenges to the global economy, and, particularly, to chart a way forward toward the renewal of developed-world growth and prosperity.