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The Market Has Spoken: Austerity Is Bad for Business

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market collapse by Vault 9

It used to be that when the Fed Chairman spoke, the market listened; but the Chairman has lost his mystique.   Now when the market speaks, politicians listen.   Hopefully they heard what the market just said: government cutbacks are bad for business.   The government needs to spend more, not less.   Fortunately, there are viable ways to do this while still balancing the budget.

On Thursday, August 4, the Dow Jones Industrial Average fell 512 points, the biggest stock market drop since the collapse of September 2008.    Why?   Weren't the markets supposed to rebound after the debt ceiling agreement was reached on Monday, avoiding U.S. default and a downgrade of U.S. debt?   So we were told, but the market apparently understands what politicians don't: the debt deal is a death deal for the economy.   Reducing government spending by $2.2 trillion over a decade, as Congress just agreed to do, will kill any hopes of economic recovery.   We're looking at a double-dip recession.   

The figure is actually more than $2.2 trillion.   As Jack Rasmus pointed out on Truthout on August 4th:

"Economists estimate the "multiplier" from government spending at about 1.5. That means for every $1 cut in government spending, about $1.5 dollars are taken out of the economy. The first year of cuts are therefore $375 billion to $400 billion in terms of their economic effect. Ironically, that's about equal to the spending increase from Obama's 2009 initial stimulus package. In other words, we are about to extract from the economy - now showing multiple signs of weakening badly - the original spending stimulus of 2009!

As others have pointed out, that magnitude of spending contraction will result in 1.5 million to 2 million more jobs lost. That's also about all the jobs created since the trough of the recession in June 2009. In other words, the job market will be thrown back two years as well."

We're not moving forward.   We're moving backward.    The hand-wringing is all about the "debt crisis," but the national debt is not what has stalled the economy, and the crisis was not created by Social Security or Medicare, which are being set up to take the fall.   It was created by Wall Street, which has squeezed trillions in bailout money from the government and the taxpayers; and by the military, which has squeezed trillions more for an amorphous and unending "War on Terror."   But the hits are slated to fall on the so-called "entitlements" -- a social safety net that we the people are actually entitled to, because we paid for them with taxes.  

The Problem Is Not Debt But a Shrinking Money Supply

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The markets are not reacting to a "debt crisis."   They do not look at charts ten years out.   They look at present indicators of jobs and sales, which have turned persistently negative.   Jobs and sales are both dependent on "demand," which means getting money into the pockets of consumers; and the money supply today has shrunk.  

We don't see this shrinkage because it is primarily in the "shadow banking system," the thing that collapsed in 2008.     The shadow banking system used to be reflected in M3, but the Fed no longer reports it.   In July 2010, however, the   New York Fed posted on its website a staff report titled "Shadow Banking."   It said that the shadow banking system had shrunk by $5 trillion since its peak in March 2008, when it was valued at about $20 trillion -- actually larger than the traditional banking system.   In July 2010, the shadow system was down to about $15 trillion, compared to $13 trillion for the traditional banking system.  

Only about $2 trillion of this shrinkage has been replaced with the Fed's quantitative easing programs, leaving a $3 trillion hole to be filled; and only the government is in a position to fill it.   We have been sold the idea that there is a "debt crisis" when there is really a liquidity crisis.   Paying down the federal debt when money is already scarce just makes matters worse.   Historically, when the deficit has been reduced, the money supply has been reduced along with it, throwing the economy into recession.

Most of our money now comes into the world as debt, which is created on the books of banks and lent into the economy. If there were no debt, there would be no money to run the economy; and today, private debt has collapsed.   Encouraged by Fed policy, banks have tightened up lending and are sitting on their money, shrinking the circulating money supply and the economy.

Creative Ways to Balance the Budget

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The federal debt has not been paid off since the days of Andrew Jackson, and it does not need to be paid off. It is just rolled over from year to year. The only real danger posed by a growing federal debt is the interest burden, but that has not been a problem yet.   The Congressional Budget Office reported in December 2010:

"[A] sharp drop in interest rates has held down the amount of interest that the government pays on [the national] debt. In 2010, net interest outlays totaled $197 billion, or 1.4 percent of GDP--a smaller share of GDP than they accounted for during most of the past decade."

The interest burden will increase if the federal debt continues to grow, but that problem can be solved by mandating the Federal Reserve to buy the government's debt.   The Fed rebates its profits to the government after deducting its costs, making the money nearly interest-free.   The Fed is already doing this with its quantitative easing programs and now holds nearly $1.7 trillion in federal securities.

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Ellen Brown is an attorney, founder of the Public Banking Institute, and author of twelve books including the best-selling WEB OF DEBT. In THE PUBLIC BANK SOLUTION, her latest book, she explores successful public banking models historically and (more...)

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The S&P downgrade that came after market closi... by Ellen Brown on Sunday, Aug 7, 2011 at 11:48:54 PM
relevance?I imagine there was much national and Ge... by Working-class UK Socialist on Tuesday, Aug 9, 2011 at 4:51:35 AM
Ellen,From Jason Schwartz on Seeking Alpha, A... by Paul from Potomac on Tuesday, Aug 9, 2011 at 9:12:58 AM
Interesting.  I'll follow up on that -- thank... by Ellen Brown on Tuesday, Aug 9, 2011 at 9:58:03 AM
According to the links I provided, you were at the... by Paul from Potomac on Tuesday, Aug 9, 2011 at 1:24:12 PM
Ha!  Don't think so.  I just wrote an ar... by Ellen Brown on Tuesday, Aug 9, 2011 at 1:49:12 PM
This is an optimistic article. There is no debt cr... by Lawrence Worley on Monday, Aug 8, 2011 at 12:43:23 AM
A quick way to fix the economy is to force all tho... by Simple Truth on Monday, Aug 8, 2011 at 6:35:33 AM
Agreed, but making employers pay more is going to ... by Ellen Brown on Monday, Aug 8, 2011 at 7:50:32 AM
This would work but some action would also have to... by Simple Truth on Monday, Aug 8, 2011 at 9:16:15 PM
And that is the rub. We don't have a free market, ... by Robert Bostick on Tuesday, Aug 9, 2011 at 9:29:21 AM
My suspenders could never bear the weight. In view... by John Sanchez Jr. on Monday, Aug 8, 2011 at 7:24:46 AM
Don't worry, you don't have to carry them around. ... by Ellen Brown on Monday, Aug 8, 2011 at 7:53:19 AM
  On Inauguration Day, Americans needed ... by Richard Clark on Monday, Aug 8, 2011 at 7:41:40 AM
but it must be being blocked?... by nativenezperce on Thursday, Aug 11, 2011 at 6:27:11 PM
OUTSTANDING!...Thank You.... by Donald on Monday, Aug 8, 2011 at 8:47:53 AM
I agree! ... by Kathleen Blanchard on Monday, Aug 8, 2011 at 9:34:02 AM
Both economists and politicians keep telling you t... by Reza varjavand on Monday, Aug 8, 2011 at 10:20:23 AM
This conservative outlook has commonsense ap... by Lawrence Worley on Monday, Aug 8, 2011 at 2:14:14 PM
There's no free lunch, but if there are no custome... by Ellen Brown on Monday, Aug 8, 2011 at 2:20:47 PM
Ellen,The Austrian School of Economics has serious... by Paul from Potomac on Monday, Aug 8, 2011 at 4:57:27 PM
It is strange that Von Mises, which is looked upon... by Gary Murphy on Tuesday, Aug 9, 2011 at 10:24:09 AM
Paul from Potomac,I once read where a city commiss... by Robert Bostick on Tuesday, Aug 9, 2011 at 8:24:12 PM
Illegal Federal Reserve act in 1913, follow by fra... by John Smith on Monday, Aug 8, 2011 at 10:20:36 AM
Speaking of Pax Americana, I see that John Bolton ... by Gary Murphy on Tuesday, Aug 9, 2011 at 10:28:52 AM
"Paying down the federal debt when money is alread... by Rixar13 on Monday, Aug 8, 2011 at 11:59:53 AM
'The budget crisis is an artificial one, and the c... by Jill Herendeen on Monday, Aug 8, 2011 at 3:12:52 PM
they don't want to be taxed.  they want to ho... by Lawrence Worley on Monday, Aug 8, 2011 at 4:40:52 PM
And they control the media so a large number of Am... by Gary Murphy on Tuesday, Aug 9, 2011 at 10:36:48 AM
"The government needs to spend more, not less. Fo... by Mari Eliza on Tuesday, Aug 9, 2011 at 6:32:05 AM
Those of us who questioned the motive behind, or ... by Reza varjavand on Tuesday, Aug 9, 2011 at 11:11:40 PM