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Government Deficit Spending is America's Last Best Hope for Recovery

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It was most amusing for me to see Alan Greenspan explaining on the BBC to an otherwise trusting viewing audience that the world economies would experience severe economic crises every few years as a matter of course, and this was quite 'normal' and inevitable. Although the economies of the world will experience many ups and downs over the years, they are not at all 'normal' but usually the consequence of central bank and government screw-ups. If the government would try to support their average middle- and working-class individuals and not just their rich 'sponsors', future economic crises could be avoided. The government simply must accept the basic realities and paradoxes of capitalism and abstain from following those 'voodoo' economic theories proven time-and-time-again not to have worked as advertised (but profitable to the rich). If they would simply regulate the economy in accordance with sound economic principles the consequence and extent of future crises would be significantly reduced and workers worldwide could experience the high standard of living that they deserve.

The factor of capitalism most misunderstood is that, if people want to get richer in money terms, someone else must take on debt. Capitalism is all about getting richer. Financial assets are obligations assumed by some second party, individual or institution. There is no invisible genie who borrows from the rich and will magically pay them back in the future from some secret funds source. Rich Republican's claim that they don't want the U.S. government to take on more debt is simply a misunderstanding about what has made them rich. The greatest increases in wealth always occur when governments assume large deficits, most commonly during a war or recession. Private individuals and businesses have limits to the amount of debt they can assume. The U.S. government has fouled its own nest by sitting idly by while Americans lose their jobs, savings, and the ability to take on further debt. Businesses likewise have been put in a position in which they no longer wish to take on debt by investing in the U.S., this situation also caused by government mismanagement of the economy. The U.S. government doesn't have these borrowing limitations and, if it is unwilling to take on more debt, capitalism in the U.S. is in serious trouble.

But of course there are non-financial assets to consider. People get wealthier by buying shares in profitable businesses and in the purchase of other assets such as real estate. In the case of real estate, these assets are limited by nature and have values now primarily based upon speculative demand and far in excess of reasonable valuations. In the case of shares in a going business, value depends upon earnings, which in times of recession normally decline. The wealth of U.S. citizens in this case is limited to its share in the value of going businesses. The U.S. has, for some time, been losing ground in this area due to the deindustrialization of the U.S. economy while jobs and production move offshore. The middle- and working-classes possess few assets of this sort, and real estate was their last substantial asset. We all know how that turned out. This loss of capital is evidenced by international balance of payments accounting which shows the U.S. economy is losing around $700 billion per year in assets. That will continue lacking any government action. In this case, capitalism in the U.S. has not only been stopped dead in its tracks, but what capital assets are remaining will soon be taken over by foreigners.

Both Lord Keynes and Milton Friedman were aware of the fundamental facts underlying a capitalist economic system. If the economy in general and stock markets were to survive and prosper, yearly consumer spending had to increase over the previous period. Likewise the GDP. They both knew this would require a greater money supply. Consumption (and GDP) have held a fairly constant relationship to the money supply over the years by a factor called 'V' (the turnover velocity of money) which varies little over time. According to Friedman's basic theory, called 'monetarism', the only thing necessary to increase consumption was to increase the money supply. That is correct as far as it goes. Friedman simply thought an increase in the amount of bank reserves by the FED would in itself be enough to stimulate the banks to increase their loans to businesses and individuals, thereby spurring increases in spending. He did not contemplate a situation in which the banks would not lend it out or that someone would not be willing or able to borrow it. Keynes knew about the importance of the FED's expansion of the money supply some 40 years before Friedman postulated it. He not only was aware of it, but suggested how it could be done. Keynes knew what our current economists have learned the hard way, that the FED alone could not increase the money supply. Almost half of M1 (the simplest measure of our money supply) is money lent by the banks (creating bank deposits), the rest being cash. For every dollar the FED supplies the banks in terms of reserves, the banks can lend anywhere from 7 to 10 times as much to its potential borrowers, namely businesses, individuals, or the federal government. Lately the FED has provided the money but he banks have not lent it out. This brings us back to the basic problem. If the banks will not extend credit to businesses and private individuals, then the money supply and consumption (and production and profits) will not increase unless government itself borrows it. Lacking this, the U.S. money supply would remain constant and the country would remain in recession. So Keynes' solution was that whenever the private sector (businesses and individuals) would or could not go into debt, the only other borrower remaining was the federal government, which would have to assume more debt to keep the economy healthy. The banks are more than happy to lend to the U.S. Government.

The reason that businesses have resisted making substantive investments in the U.S. is two-fold. First and foremost is the fact that the U.S. consumer is plagued by past debts and his job at risk because of the current credit crunch. In addition, actions by the FED under Alan Greenspan, and continued by Ben Bernanke, designed to reduce consumption (and preserve the value of the dollar), had severely damaged the economy. These consisted in successive claims of non-existent inflations 'forcing them' to raise interest rates, which brought on the ever-more-serious recessions leading to the final collapse in the economy. Secondly, foreign competition stimulated by Globalization has made it unprofitable for most businesses to invest in the U.S. U.S. multinationals are borrowing and investing primarily in South- and S.E Asia. Foreign Direct Investments (FDIs) in the U.S. are minimal and pretty well limited (80%) to the purchase of going businesses in the U.S. (i.e., little additional foreign capital investment). With wage rates in these Asian countries 10% of those in the U.S., who wouldn't be setting up shop overseas. Hint, the answer is nobody.

Workers in the U.S. have lost their high-paying industrial jobs and have had to accept service sector jobs at considerable decrease in wages. In order to sustain their lifestyles (generally fixed costs assumed when times were good), they had to take on further debt (credit card as well as real estate) to cover this income shortfall. Many have had to cash their IRA's, Keoghs, and 401-Ks as well as saving previously put aside for their retirement and children's education. Now that the middle- and working-classes are reaching insolvency and can't take on further debt, a further increase in spending by them is highly unlikely. So if the political elites, supported by their major propagandist (Fox News), think we can pull out of this recession without government deficit spending they are living in LaLa Land.

Properly regulated deficit spending can create a positive economic environment in which American businesses and workers will be able to resolve their debts and resume consumption and spending. This must include a solution for the problems caused by Globalization and by limitations on Federal Reserve meddling with interest rates (which should depend solely on market conditions). Lacking these government actions, the economy will be entirely dependent on continuing government deficits. That is, if the rich want to increase their wealth they will have to accept some changes in the way the government does business.

For this reason I hope those chronic carpers on Fox News and their rich paymasters will stop their attacks on government deficit spending and harping on the taxes their children purportedly will be saddled with. If this crisis is not solved, many of their children won't be saddled with high taxes at all. They won't have jobs. The entity previously known as the middle class will likewise be paying little or no income taxes, having had to accept minimal wages in the service sector (or will be a further drag on the economy if unable to find employment at all). Under current tax laws, a family of 4 with a yearly income of $22,000 pays no federal income taxes, and would have little ability to pay for tax increases caused by interest on future government deficits. Unchecked globalization will ultimately result in all those engaged in world commerce to accept wages at this level (or lower). Service sector wages will likewise be adversely affected by the disappearance of previously high-paying jobs in the U.S., in this case producing a valid 'trickle down effect' on incomes. Who then will pay for any and all taxes necessary to run the federal government in the future? The rich, who are resisting increases in current government deficit spending (one of the remedies necessary for recovery), will end up paying for everything! Fox News and their rich patrons will find that they have simply been shooting themselves in the foot with their tirades against current deficits. As the old ad went 'you can pay me now or you can pay me later'. Later may very well be too late.

 

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Richard Backus is a journalist specializing in economics and politics.He has degrees in physics and engineering, and considerable experience in computer systems development. He is single, a good bridge player, and an enthusiastic tennis player.
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The interview with Alan Greenspan and the reaction... by David Chester on Tuesday, Oct 13, 2009 at 11:00:26 AM
Although George's proposal of 1879 may have worked... by Bacchus on Wednesday, Oct 14, 2009 at 5:12:05 AM
This train wreck is going to happen like it or not... by Gallaher on Tuesday, Oct 13, 2009 at 12:45:11 PM
To say that we should be worried about hyperinfla... by Bacchus on Wednesday, Oct 14, 2009 at 5:23:25 AM