The Doom Cycle
We have let an unsustainable and crazy 'doomsday cycle' infiltrate our economic system. This cycle has several simple stages. At the start, creditors and depositors provide banks with cheap funding in the expectation that if things go very wrong, our central banks and fiscal authorities will effectively bail them out. This is the "boom" phase - leading inevitably to an overexpansion of credit, a traumatic market, corporate, and household "bust" and, for as long as we can afford it, to huge bailouts roughly along the lines we saw in 2008-09.
This cycle will not run forever. One day soon, we'll have the boom and bust phases, but when we try the usual bailouts, they won't work. The destructive power of the down-cycle will overwhelm the restorative ability of the government, just like it did in 1929-31, when both the financial shock and the government capacity to respond were on a much smaller scale. The result, presumably, will be something that looks and feels very much like a Second Great Depression.
Peter Boone is a research associate in CEP's globalization program and chairman of Effective Intervention (www.effint.org), a charity based in Britain. He is also a principal at Salute Capital Management.
Simon Johnson is a professor at MIT's Sloan School of Management, a senior fellow at the Peterson Institute for International Economics, and a member of the Congressional Budget Office's Panel of Economic Advisers. He is co-author, with James Kwak, of 13 Bankers (Pantheon, March 2010).
Peter and Simon write for The Baseline Scenario, a leading economics blog, and are co-authors of "Our Next Financial Crisis," published in The New Republic in September 2009 and "Shooting Banks," published in The New Republic in February 2010.
The views expressed in this paper are those of the authors and do not necessarily reflect the positions of the Roosevelt Institute, its officers, or its directors.