What really drives Americans? Does, “It’s the economy stupid,” ring a bell? Psychologists tell us that people are less fearful and react with less panic when things are going well financially. Well things are not going well financially and have not been for many years. I used to be questioned all the time on where I got the idea that the middle class was losing ground. Now it is common knowledge and most people get it. What most people don’t get is how our economy works and why things aren’t getting better. Well, reality is giving us a big wakeup call and it is hard to ignore. Could this be a turning point?
First let’s explore what most people (policy makers, finance ministers in Europe, policy advisors, Angela Merkel, Chicago School of Economics, most business leaders, and our financial markets) believe. Markets are perfect systems that self correct and must be allowed to self correct. Our economy acts much like our home budgets and if we spend too much we are headed for disaster. Borrowing too much puts pressure on available funds and raises interest rates. It also affects lender’s confidence in the borrower’s (read government’s) ability to pay it back which is reflected in higher risk and drives higher interest rates.
Then there is the conventional wisdom on inflation. If the economy is sagging, pumping money into the economy either through fiscal policy (making government money more available and increasing the money supply) or stimulus spending will cause runaway inflation. They also believe that government spending supplants private spending and does no good in creating jobs. And underpinning all this is the belief that what motivates businesses are low taxes and a favorable business climate. Business will invest and grow where the burden of government is removed.
The trouble is, it is all wrong and it is demonstrably wrong in our current circumstances. Now there is a grain of truth in all of it, but it depends on where the economy is when you apply it. If the economy is booming, employment is very low, some or all might be operative. But when the economy has reached the zero lower bound on interest rates (when the economy is depressed and you can no longer lower interest rates any lower (they are already at effective zero) to encourage borrowing and investment), none of this applies. Then all of the things we need to be doing are counter intuitive to everything we think we know.
Now let’s look around us. We have had a jobless recovery in the stock market. Government has reacted by increasing easy money, and ruaway interest rates and inflation did not happen. The government has cut its spending and is reducing the deficit quicker than any time since WWII and there is little investment. Reality intrudes. This has gone on for six years while all of the above referenced experts scream out of control inflation and rising interest rates, and nothing happened, They have it wrong. Companies are sitting on record amounts of cash and are not investing and creating jobs. But wait, what about the confidence fairy (businesses lack confidence in the economy because of the government debt) and the high tax, bad business environment argument?
Well Europe bought into the confidence fairy hook, line, and sinker (See Germany and misguided Angela Merkel). Austerity rules and debtors need to be punished. We bought into it just hook and some line (sequester, government cuts, no more stimulus), but our Fed pursued expansionary monetary policies to offset some of the pain, hence the screams of the inflation/interest Chicken Littles. So what happened? Europe is crashing and burning. They are facing their third (triple dip) recession and their recovery (when it was positive) was less than after the great depression. Could it be that contracting government contracts the economy by decreasing demand (money available to buy things) and confidence has nothing to do with it? So far that is the lesson in both Europe and here in the United States. With all the austerity and fiscal discipline, businesses are not investing because there aren’t customers with cash to buy their stuff. The confidence fairy does not exist.
Okay, but what about restrictive government in terms of taxes and regulations. Enter Kansas where Governor Brownback brought them the “conservative miracle”. He cut taxes across the board and reduced government regulation, promising the economic miracle of supply side economics and flow down (as business make money, a high tide lifts all boats). It didn’t happen and the economy is one of the worst in the region with major state deficit problems when he slashed taxes and cut funding for schools to pay for the cuts. We could also remind people of the Clinton years (he raised taxes and the economy boomed), but that is ancient history. Supply side economics is a lie. Demand drives the economy.
Now the real wakeup call is happening in the markets where the markets are starting to fall because Europe is heading down again and America is also faltering. They are terrified of deflation. So here is the question for you, should we still be listening to those people who have promised us out of control inflation and rising interest rates for years and it did not happen. Could their ideas be counter productive to what the economy really needs? Another no duh moment. Could only government and government spending solve this crisis since the markets being allowed to “self-correct” made things worse as we pursuits constrictive policies?
Could they be waking up to the fact that we need to be stimulating our economy? That government must act by increasing spending? That deflation is the real fear and they are starting to see it instead of their chicken little imitation of “inflation is coming, inflation is coming”?
This is what you need to know. We have had the wrong idea about how to fix economy and it has not healed us. The rich are getting richer and the pie is getting smaller for the rest of us, and with it, demand is shrinking. And now it is becoming alarmingly clear to the markets that things are bad. It is time to change what we have been doing.
This could start with raising the minimum wage. It immediately puts more money in the economy and those screaming it will decrease jobs are the same ones who have been screaming inflation and interest rates are out of control. We could restore much investment in government including R&D. We could start a real building program to restore our infrastructure by borrowing at record low interest rates. And we could implement fiscal monetary policies that allow some inflation (it reduces our debt load).
Yes, our deficits will increase, but so will our income and spending. If the GDP grows, the growths in deficit spending are reduced by our increased income. When the economy is able to sustain this growth, government spending gets cut back and all that stuff we have wrong then comes back into play. It’s a different economy. We have a whole history in the 30’s we forgot. Those screaming inflation/interest rate morons told us it didn’t matter and those lessons don’t apply. But now with the realization that deflation, not inflation is the real threat they are rethinking it (I hope). All we have to do is do what we already learned how to do and then forgot because the greedy took over and those lessons weren’t convenient anymore.
So the most important thing you need to know today if you are a fiscal conservative is that you have had it all wrong, and reality is flashing red telling you to change directions. Maybe that is what it takes for change these days. Of course Republicans who control our government, won’t allow any of this to happen. Maybe you ought to get out and vote.
Oh, and Paul Krugman, bless his heart, has been hammering away at this for years and nobody has been listening, Does Cassandra come to mind? But now that the world economy may be heading south, they just might start listening, unless of course it inconveniences the wealthy. Then we are screwed.