What's between you and a Second Great Depression?

It's becoming increasingly apparent to a greater number of economists and political figures that the great recession of 2008 could  merely be a foreshock a second Great Depression. The time is now for leaders to act with swift resolve, for just now there is nothing between the people and economic disaster. 

LOS ANGELES, CA (Catholic Online) - Few people outside of financial experts recognize the perilous situation that the world economy is in. Even less care to speak about it publicly, out of concern they might be seen as inciting fear. But somebody has to say something, and something needs to be done, swiftly.

In order to appreciate the situation the world economy is in, one must first understand why our situation is so dangerous. In 2008 world banks and governments had powerful tools at their disposal. They also had the political capital necessary to use them. Now, in 2011 both tools and political will are lacking.

Interest rates have already been slashed to near zero around the world, leaving governments and central banks with very little capacity to do anything that will stimulate spending. Governments have unleashed multiple rounds of stimulus and despite that stimulus, the economies remain stagnant.

Some people charge that the worldwide fiscal stimulus policies of the past couple years haven't worked, and therefore they are unwilling to agree to yet another round. Certainly American politicians are reluctant to suggest stimulus, because they know it could cost them politically.
But what most learned economists agree on, is that the stimulus policies of the past few years have in fact worked. At least if it had not been for those policies, the recession would have been much, much worse. Still popular sentiment remains against it. Most people still believe the political rhetoric that, "the stimulus didn't work."

So, these are the challenges politicians and bankers around the world face. They're out of options, they're out of money, and they're out of political capital. Yet the threat to the world economy now looms larger than ever before.

It is difficult for anyone to call for "one more round of stimulus" when previous rounds have done little to reverse the continual backslide into recession. Worldwide, unemployment remains high and governments are broke. But perhaps counterintuitively, this is precisely the reason why we need "one more round."

Europe as ground zero

It appears increasingly likely that the Greek government is going to default on its obligations to several banks throughout Europe. When that default likely occurs, banks that are holding substantial sums of Greek debt will fail. They won't be able to meet their obligations as banks. This will have a ripple effect throughout the world economy other banks, and possibly even entire governments, could experience financial collapse. Businesses will shut down, unemployment will skyrocket, and human misery will abound.

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The solution is simple, at least in spirit. It is to re-capitalize European banks. Several European leaders and world bankers have recognized this and are calling for immediate re-capitalization. 
Those banks holding the greatest exposure to Greek debt, need financial guarantees to reassure investors that in the event of a great default, they in turn one experience a default. In other words, governments around the world need to pump cash into the euro zone banks, which will contain disaster of a Greek default.

Once recapitalized, investors will be reassured that the banks will not fail when the Greek government does. They can then return to investing in Europe, which will lead to new growth and expansion and hopefully full economic recovery.

Nor does the money have to be spent. It can be reserved, pending a default. And if a default is avoided, then the money can be returned from whence it came, minus the small sum to compensate for its time value, if appropriate. 

The problem of course is political. Most of the Euro zone governments can come up with the cash. However, the political will to do this is greatly diminished. As explained previously, political opposition to stimulus is higher than ever before.

Another part of the problem is education. Political leaders have not done a very good job of educating their people about how stimulus works. Nor do people fully understand the danger posed by defaults. Without these crucial understandings, it is difficult to persuade people to support these critical policies.

In the end, it's going to take an unprecedented level of cooperation between politicians, bankers, and the people themselves, to take the necessary steps to stave off a second Great Depression. But because politicians are more interested in power than economics, and because the people don't understand the economic realities that we face, the likelihood of that happening--remains slim.

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