No. 1 A new Era Of Volatility

If there is a poem for this moment, it is surely W.B. Yeats’ dark classic “The Second Coming.” Written in 1919, it evokes the darkness and uncertainty of Europe in the aftermath of a horrific war. “Things fall apart; the centre cannot hold,” Yeats writes. “Mere anarchy is loosed upon the world/… The best lack all conviction, while the worst/Are full of passionate intensity.”

It’s hard to imagine a more eloquent description of our own bearish age. The middle class is shrinking, the markets are flailing, U.S. presidential candidates are bickering, and European policymakers are fiddling while Rome (and Athens and London) burns. A global double-dip recession, implausible in spring, is now a distinct possibility come autumn. Most economists believe the U.S. GDP will grow a little less than 2% this year–and they are the optimists. JPMorgan pegs growth at 1.4%; it estimates that in 2012 the U.S. will grow 1.2% and Europe will contract an alarming 0.5%. Investment oracle George Soros frets that the debt problems emanating from Europe have the “potential to be a lot worse than Lehman Brothers.” At the recent International Monetary Fund (IMF) meeting in Washington, policymakers from around the world were as anxious and shell-shocked as they have been since the financial crisis began in 2008.

No wonder. None of the economic rescue missions on either side of the Atlantic over the past three years–from the helicopter dumps of cash in the U.S. and the U.K. to the Germanic austerity plans being advanced in Greece, Italy and Spain–have managed to arrest the downward economic slide and consequent rise in unemployment in the rich world. The crisis is, of course, as much political as economic; in Washington, no one can move beyond small-bore, partisan debates over debt, while in Brussels, the E.U. capital, the political institutions needed to fix things don’t even exist. The West, it seems, is out of ammo, ideas and leadership. In his 20 years of attending IMF meetings, said President Obama’s former chief economic adviser Larry Summers, he had not been at one in which “matters have had more gravity.”

You can almost smell the fear coming from the Federal Reserve. Despite a strident Republican accusation of “treason” for treating the Fed like a printing press, Chairman Ben Bernanke has moved forward with yet another round of monetary stimulus, this time buying up longer-term Treasury bonds in an effort to further drive down already low interest rates. The aim is that the resulting cheaper mortgage rates will stimulate housing sales and lift prices, which will help homeowners get out from being underwater on their existing loans. Operation Twist, its name a reference to the Fed’s hope that it can twist the long-term shape of the bond-market yield curve, provoked only a shout from the markets. Stocks fell, the dollar rose, and consumer confidence remained as flat as ever.

And why not? While the four Republican Senators who sent Bernanke a letter urging him to stop buying bonds were certainly wrong to step on the toes of an independent head of the Federal Reserve, it’s hard to see how pouring more money into an already bloated system will help–after all, it’s not expensive financing that’s keeping companies and consumers from spending money. It’s lack of demand from people who are grappling with stagnating wages, high unemployment, downward mobility and a bifurcated labor market. (For more on this, see our exclusive excerpt from liberal economist Jeffrey D. Sachs’ new book The Price of Civilization.)

While Operation Twist may become another fruitless policy maneuver, it tells us something very important about where we are now. We can no longer paper over the underlying shifts in our economy with easy monetary or fiscal fixes. That’s because globalization has reached a critical mass that is simply impossible to ignore. American companies in sectors exposed to global competition over the past 30 years haven’t created any new net jobs at home. That fact, published in a recent paper by Nobel laureate Michael Spence, is only the most startling representation of the changes around us. There are many others in the headlines every day, from the flameouts of clean-energy companies like Solyndra that can’t compete with Chinese rivals to the pronouncements by executives like Coca-Cola CEO Muhtar Kent that China is a more hospitable place than America to do business.

Of course, it’s easy to overstate or oversimplify the rise of Brazil or India. Emerging markets have their problems. For starters, their governmental systems and civil societies still have a long way to go. (It would be interesting to see how far Kent would get pursuing, say, an intellectual-property case in a Chinese court.) And their continued rise is far from guaranteed. The explosive growth they experienced in the four years preceding the financial crisis was double their historic norm. Now, as the BRIC countries (Brazil, Russia, India and China) grapple with richer populations, higher wages and demands for more democracy, they too are under pressure. Far from stepping up and taking more political and economic leadership, emerging markets are trying to manage rising inflation, higher unemployment and social unrest. In poor countries, as in rich ones, it’s increasingly every man for himself. China is too busy dealing with its real-estate-driven debt bubble to help bail out the euro. Brazilian President Dilma Rousseff recently declared that in the midst of economic crisis, “our principal weapon is to expand and defend our internal market.”

That’s the sort of classically protectionist line that might have been heard in the decade after Yeats wrote “The Second Coming”–years which led to the Great Depression. Then, as now, the risk was that seismic economic and political shifts would lead countries to turn increasingly inward, exacerbating a downward spiral. Amazingly, that didn’t happen right after the financial crisis and Great Recession. But that doesn’t meant it won’t happen now. The signs of polarization and insularity are growing. German Chancellor Angela Merkel is battling anti-E.U. sentiment at home as she tries to save the euro. Obama and French President Nicolas Sarkozy are shifting their focus from global problem solving to their own re-election campaigns. Self-described free-market presidential candidate Mitt Romney is calling for tariffs on China. Currency wars are brewing as nations try to drive down their exchange rates and boost their exports to stimulate growth.

In the U.S., the 2% economy (fingers crossed) is now a foregone conclusion. What would that be like? The only recent point of comparison is Japan, a country that has suffered 20 years of stagnation, its stock market down 60% from its highs two decades ago. Japan has endured not one but two lost decades without political or social chaos. Still, as well-known hedge-fund investor Barton Biggs recently argued in a note to investors, “Americans and Europeans are much less likely to be either patient or tolerant of a comatose economy, wealth destruction, and political mumbling. After all the Great Depression spawned guys named Hitler and Stalin, National Socialism, and Communism.”

Of course, it also spawned FDR and Churchill and de Gaulle. And so the ever more urgent search continues for a way to get the world back on track. What’s clear is that neither the power spenders nor the austerity buffs have all the answers. Yes, the initial doses of Keynesian stimulus that followed the financial crises saved many jobs. But as we continue to struggle with zombie banks and housing markets that won’t heal, there’s a counterargument to be made for the kind of “creative destruction” advocated by Keynes contemporaries such as Joseph Schumpeter and Friedrich Hayek. Institutions and ideas that don’t work anymore, they might have argued, need to be allowed to fail in order to make way for the new. It would certainly behoove global leaders trying to manage the current crisis to move from particular economic orthodoxies to the acknowledgment of some fundamental truths. We can no longer depend on central bankers to ease our pain; debt levels are too high, problems are too big, and they are almost out of ammo. We’re entering what can only be called a new era of volatility.

The cycles of boom and bust will most likely shorten as countries, companies and consumers adjust to a more uncertain world. This is the world we lived in from 1919 to ’45, albeit without the technology that can move markets in seconds. It was a world in which recessions happened on average every three years instead of every six and people who grappled with large global changes saved more for a rainy day. While downturns were more frequent, recoveries were most robust. That, at least, should provide a ray of hope for leaders around the world struggling to move the global economy toward the next era of growth.