Feb 10 2009

Stimulate This

I try not to pay too much attention to the news, because, to be honest, most of it doesn’t have anything to do with me.  Severe weather reports, boil orders, local stuff like that, sure; but national and world news usually isn’t relevant enough to my life to get worked up over.

Still, occasionally something gets so much press that it’s hard to avoid hearing about it and forming an opinion, and this “stimulus” package silliness falls into that category.  When President Bush overspent by 1.5 trillion dollars over eight years, everyone rightly recognized that as wasteful spending “on the backs of our grandchildren” and so on.  But now President Obama promises to out-borrow and out-spend Bush in a much shorter time period, and people actually think this is a good idea?

Photo from Flickr.com

Photo from Flickr.com

When did we start believing the idea that we could make ourselves prosperous by spending lots of money—especially money we have to borrow?  And as someone said, if borrowing and spending a trillion dollars is a good idea, why not two trillion?  Why not ten gazillion?  Why not just stimulate us all into great wealth?

I’m not an economist (which may be a good thing) but I read a little, enough to see that the conventional wisdom on this stuff is as messed up as it is on most topics.  Everyone knows the government has a big pile of debt, but no one talks much about private debt.  Since before 1960, when private debt was 25% of GDP, we’ve been borrowing more than we make every year. Imagine some guy (let’s call him Joe) has a job that pays $30,000 per year, but he lives a $35,000/year lifestyle. So the first year he runs up $5000 worth of credit card debt—no big deal.  But now the second year he’s got credit card payments to make, so now his lifestyle (which he sees no need to change) costs $36,000, so by the end of the second year he’s up to $11,000 in credit cards.  The third year, maybe he can’t get his limit raised on his cards, so he gets a second mortgage to cover the $7000 difference between his cost of living and his income.

See how it keeps growing?  If you keep borrowing more each year, debt compounds just like a little kid’s savings account, but not in the good way.  In 1960, when the total debt in the US was 25% of productivity, it was still somewhat manageable.  If you make $40,000 in a year, you could probably tighten your belt and save $10,000 in a couple years if you really wanted to.  Needless to say, America didn’t do that.  Instead, we continued spending more than we made every year, piling up debt—and even inventing new kinds of debt—to cover the difference.  Now private debt in the US, consumer and corporate combined, is over 40 trillion dollars.  That’s almost three times GDP, and it makes the government debt of 10 trillion a secondary issue.

So, back to Joe the spendthrift.  He makes $30K/year, spends $35K on goodies, and he’s been borrowing every way he can think of—mortgages, personal loans, a title loan on his truck, loan sharks—so after many years of this he’s up to $90K in debt (300% of his personal GDP).  Suddenly he can’t find anyone to loan him money anymore, and the loan shark sent a guy named Knuckles by to say hello.  Now, Joe can’t just cut back to living a $30K lifestyle, because he still has to pay the interest on his debt.  Say he’s paying $9K on debt service:  then assuming he doesn’t shoot himself or file bankruptcy, he has to go from spending $35K a year on living to spending $21K (probably mostly on heat and food).  And that’s just to stay afloat; he’d have to cut back even further to ever pay off any principal and get some breathing room again.  Suddenly he’s putting $14K less into the local and national economy, and he’s not buying football tickets or expensive beer or brand new tires for his truck anymore.

That’s the situation our nation is now in.  For a while now, we’ve been spending about 125% of GDP, borrowing to make up the difference.  We’re finally reaching a point now where the loans are drying up.  If we can’t keep borrowing the 25% extra we need for our lifestyle, we’re going to have to cut back that much.  But we also won’t be able to keep borrowing what we need to pay the interest on the debts we already have, so we’ll have to cut back even more than 25%.

Photo from Flickr.com

Photo from Flickr.com

That means at least a 25% reduction in the amount of money being spent on goods and services.  What’s that lead to?  Right, people losing their jobs.  Then those people have less money to spend on things, which means more jobs are lost, and the cycle continues.  Last time we went through this it was called the Great Depression.  (And at that time debt was “only” double GDP, not triple as it is now.)

So, back to our stimulating new president.  The conventional thinking is that if you dump some extra money on the street, people will go spend it on TVs and toasters, and that offsets the drop in spending.  It’s worked before by cutting interest rates: with rates lower, people borrow more money, spend more, and the economy heats up.  There are two differences this time.  One, the numbers are so much bigger than ever before.  An 800-billion-dollar stimulus package is chump change next to $40-trillion in private debt.  The other difference is that in the past, there was no fear that we might run out of money to borrow.  Now that fear is real, so if you dump a trillion dollars out of a plane, people aren’t going to run out and spend it on candy; they’re going to use it to pay off debts.  It won’t be spent and circulated; it’ll disappear to pay for things we bought decades ago.  To have the effect they’re hoping for, it would have to be several trillion, so something would be left after people paid off a big chunk of the debt.

There’s no way anyone is going to loan us several trillion (more) dollars.  We’ll be lucky if we can borrow the 800-billion for this current bill, and not be left holding a bunch of bonds no one wants, like Germany did recently.  The alternative is to just start printing money like crazy, and that’s awfully risky.  How do you know just how many trillions to print before you’ve gone too far and caused hyperinflation?  The other alternative is to simply cancel debts: just say, “Sorry China, sorry senior citizens and everyone with investment accounts; the whole country is bankrupt, so all debts are null and void and we’re all starting over with our wits and whatever we’ve got in our pockets.”  It’s hard to imagine that happening, but it’s not like pleasant solutions are likely when you’ve spent 50 years digging yourself into a hole.

So the most likely thing is that the government will continue to try tweaks like this, and we’ll continue into a deflationary spiral, complete with high unemployment and all the rest.  I think it was Steve Keen who said (and who provided the numbers I’ve used here): look at pictures of people partying in the Roaring 20s, and then look at pictures of people getting by on peanuts in the 30s, and realize that they were the same people.  They didn’t want to stop the party and pack big families into little row houses and eat turnips six days a week and develop penny-pinching habits that would stay with them for decades. They had no choice.  It’s hard to imagine us going through that big a change today, but our debt numbers are even worse than theirs were in 1929.  We think we’ve got it figured out where they didn’t, but do we really?  We’ve kept the party going longer this time, thanks to the tech boom of the mid-1990s, lots of loans from China, and an optimistic attitude; but ultimately, you can’t just borrow forever.  We have to inflate the debt away, default on it, or buckle way down and pay it off.  Right now, we’re trying to avoid any of those options.

By the way, this isn’t a partisan rant.  Obama is only following in Bush’s footsteps here, and McCain would be doing much the same thing.  The only real difference is to whom they want to hand out the money.  Bush scattered his largess on finance companies, big industries, and faith-based organizations—groups that tend to vote Republican.  Obama wants to throw money at unions, grievance lobbying groups, and various left-wing causes—groups that vote Democrat.  What’s fair for the goose…  The former might have used the money somewhat more wisely than the latter, but that’s irrelevant to the central issue of what effect it would have on the economy.  As far as the economy is concerned, the money might as well be scattered across the country with a crop duster.  Either handing out cash will help or it won’t.  Mostly it won’t.

What’s all this mean to me, so that I’m actually paying attention to it?  Well, it means taking on any consumer debt right now wouldn’t be smart.  In inflationary times, your income and the value of the stuff you borrowed money to buy both climb, so a debt gets smaller by comparison as time passes.  In a deflationary period, the opposite happens: the house or car you bought drops in value, and you’re suddenly upside down on your loan.  Your wages may drop too, which doesn’t help either.  It also means don’t run out and buy gold, because that’s a hedge against inflation, not deflation.  Don’t speculate on the stock market or other financial entities; that’s all a mine field right now.  The sensible thing seems to be to live within your means; work for yourself if possible so you don’t get caught in a layoff; and try to develop some extra skills so you don’t have all your income-producing eggs in one basket.  Invest in yourself, your family, your church, and your local community, so those things will be strong if times get tough.  Really, that’s always the sensible way to live, but right now it may be imperative.

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