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The Baseline Scenario: More On The Two-Track Economy – From The WSJ And Others

Posted: 29 Aug 2009 05:43 AM PDT

The notion of a two-track economy seems to be taking hold.  We kicked the concept around pretty well last week -  your 130 comments (as of this morning) helped clarify a great deal of what we know, don’t know, and need to worry about.  The two-track concept overlaps with, and builds on, long-standing issues of inequality in the U.S., but it’s also different.  Within existing income classes, some people find themselves in relatively good shape and others are completely hammered.

New dimensions of differentiation are also taking hold within occupations and within industries – the WSJ this morning has nice illustrations.  The contours of this differentiation begin to shape our recovery or, if you prefer, who recovers and who does not – it’s hard to say how this will play out in conventional aggregate statistics, but these are likely to become increasingly misleading.

For now, I would highlight three points about the two-track future for banks – partly because this matters politically, and partly of the way it impacts
the rest of the process.

1.       The remaining big banks have become bigger and more powerful economically – the Washington Post emphasized deposits yesterday; good point, but only part of the picture.  The Financial Roundtable is tickled pink about the government’s “reform” proposals (except the consumer protection part), with good reason.

2.      Many smaller banks are getting squeezed – as reflected in the latest news on the FDIC’s “danger/sick list“.  The smaller banks really do not seem to
understand how they have been done in by the big banks – if they did get it, they’d be up on Capitol Hill and all over the media arguing strenuously for
much tougher controls on bad big bank behavior.  The lack of leadership among non-large banks is remarkable.

3.      The WSJ today has the data: borrowing costs for large banks are now lower than for small banks.  This is, of course, a direct reflection of the government’s firefighting/firesetting strategy: unlimited cheap resources for large big banks; for small banks, not so much.
So now it’s all about whether you are a preferred client of Goldman Sachs or another big finance house. If you’re on the inside track, this is a great time to buy US assets that are being dumped by people without access to cheap credit, or assets overseas (e.g., Asia, where the “carry” or interest rate differential
relative to the Federal Reserve is already positive and the exchange rate risk is all upside).
If you’re on the outside track, you are experiencing a version of Naomi Klein’s “Shock Doctrine”.  Some (former) members of the elite are in this category – this is another standard feature of emerging market crises and “recoveries”. But mostly, of course, it’s nonelite on the outside track and a more concentrated, reconfigured version of the elite on the inside.

This can lead to short-term growth – the speed of recovery in many emerging markets surprises many, from about 12 months after the crisis breaks.  But
it also leads to repeated crisis, to derailed growth, and to a loss of income, status, and prospects for most of society.

By Simon Johnson

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