The Economy

For at least the past 20 years, the US and world economies have been based on borrowing money in order to spend. GDP growth has been based on the consumer class buying enough to keep everyone employed, but that required spending more money than the consumers were earning. Borrowing was done to make up the difference. This meant that the world economy could grow as long as bankers could come up with ways to lend out more and more money to consumers.

But eventually a debt-based economy will collapse. I keep seeing people say that the economy collapsed because of housing. But the housing market isn't the source of this trouble and fixing housing won't help. The housing bubble was created as a means of justifying writing such huge loans to consumers - the loans were considered safe because they were backed by houses. The mortgages didn't go bad because the housing market collapsed. The housing market collapsed because the banks couldn't come up with loans creative enough to push house prices higher while keeping the monthly payments low enough. In other words, the banks had pushed lending as far as it could go and even their insanely low lending standards were too restrictive to allow further lending.

So now we have an economy that relies on consumer spending for growth, but consumers are too scared of the future to spend any more than they have to. You don't want to see what the equilibrium point is for that. It involves everyone learning how to grow their own vegetables. And having enough land to grow their own vegetables. Which doesn't work very well for a society that has many people living in cities and suburbs.

This isn't a problem that can be fixed by getting the banks loaning money again. That is probably necessary in the short-term while the structural problems are fixed. And this isn't a problem that can be fixed with tax cuts. Tax cuts allow people who are earning money to keep more of it. But the problem is the people who aren't currently earning money, and the people who are concerned that sometime soon they won't be earning money. Cutting taxes doesn't help someone who is laid off. And people know that, so it has no psychological benefit of convincing people to continue spending while they still have a job.

If the government spends enough money to get us back towards full employment, then people will go back to spending. But there has been a large psychological shift now. People are not going to load up on debt the way they did before. And even if they were willing to, the banks aren't going to write loans as freely. We need to fix the income distribution problem. It is actually likely that raising taxes (particularly on the wealthy) will help solve the problem, by pulling money away from people who aren't spending it and transferring it to people who will spend it. Raising taxes on the wealthy will almost definitely be part of the long-term solution, but the reasons for that deserve a separate post.

The Senate has removed most of the stimulus from Obama's stimulus bill and replaced it with useless tax cuts. Hopefully the House will have the sense to insist on the stimulus being put back in (the tax cuts aren't terribly relevant right now, just a waste of money).

And for longer term solutions, we need to get to work on the income distribution problem. Which for the most part hasn't even been mentioned yet.