Alternative Insight

The Economic Crisis
Part 1- Does correct thinking drive the recovery?

Christina Romer, former Chair of the Council of Economic Advisors, addressed the Brookings Institute, March 09. 2009, on the subject: Lessons from the Great Depression. Although Ms. Romer spoke credibly, her reply to two questions indicated a lack of acquaintance with other than conventional views. To the question: "Is the crisis man-made or systemic?" she replied: "Whatever caused it, we must fix it." This vague answer indicates the leaders of the recovery plan haven't critically examined a significant possibilty - the U.S. is dealing with a failed system that needs adjustment and repair. To another question: "Why hadn't administration officials been able to recognize the economic crisis before it unfolded?" the Chairperson responded: "Nobody predicted the downfall."

It's well known that on Sept. 7, 2006, RGE Monitor lead economist
Nouriel Roubini, professor of economics at the Stern School of Business, New York University, predicted to an audience of economists at the International Monetary Fund that a serious economic crisis was brewing. The Conservative American Enterprise Institute (AEI) conducted a series of seminars, beginning in March 2008, which accurately characterized the housing bubble and predicted the consequences. Alternative Insight published a series of articles (War Cometh Before a Fall, Tulips of Stone, The Socialization of America) beginning in April 2005, which also accurately predicted the downfall. Many, many other persons, media, and institutions provided insightful analysis that warned of the oncoming economic catastrophe. And the word analysis is important - a paucity of presented analysis by the Democrats and Republicans makes the public skeptical of the recovery plans. Conservatives in particular cling to slogans that have dubious merit.

Is the Economic Recovery Plan guided by proper dictates and complete analysis or is it subjected to falsehoods and incomplete knowledge that limit recovery? Is the administration only "patching up" a broken structure and not repairing severe defects in a global economic system? Former Treasury Secretary Timothy Geithner has indicated he recognizes systemic failures and is prepared to recommend measures for ameliorating them. His recommendations are still talk, not set into motion, based on observation rather than analysis and framed about the proposition that what is broken is repairable. The administration is permitting a gamble with time to determine if the economic recovery will succeed or if the United States and the global community face a greater disaster?

Conservative economists constantly repeat: "Always cut taxes during economic downturns. It will increase spending." Is this true?
Don't tax cuts only transfer government revenue to private revenue? By this process, there is no new spending; the spending is transferred from the public sector to the private sector and, unless more deficit is created, the overall spending stays the same. It is debatable which spending is more significant during economic downfalls. Government spending is more investment oriented and more targeted while individual spending is more consumer oriented, which means it might not be spent or might be spent on imported goods. Tax cut proponents present a counter argument: "recessions don't need new investment, they need more consumption." Nevertheless, consider that tax cuts benefit those who are already employed and have less need for income while those who are unemployed could use additional government benefits.

A similar argument applies to raising taxes. By raising taxes consumer spending is transferred to government investment, which could be more beneficial in resolving the crisis. Increasing taxes on the more wealthy facilitates a transfer of income from those who already have sufficient resources to those who need more resources. What benefit is there to someone who earns $500,000/year and receives a $5000 tax cut compared to someone who is jobless and receives $10,000 in benefits? The latter person is more likely to spend the funds on vital goods. What is wrong with raising taxes if it provides a more substantial benefit to the community and lessens the government deficit?

The concept that government deficits lead to hyper-inflation is also challenged. Present government borrowing and deficits replace the private borrowing that is declining due to bankruptcies, foreclosures, failures to repay loans and other reasons. The total sum of all debt is not substantially increasing nor is demand for goods increasing. Increased government deficits might signal a dollar decline and a slight inflation increase due to the rise in prices of imported goods. Nevertheless, unless the government deficits greatly increase the sum of the total government and private debt, the inflation rate should be manageable. Despite its huge government deficits, Japan has maintained a strong currency and negligible inflation. Also realize that the government since early 2009 has been borrowing at relatively low interest rates. The interest on total government marketable debt declined from about 5% in January 2007 to about 3.0% in February 2009, a tremendous savings. Rolling over government AAA debt is no problem. Because rolling over public and private debt can be a huge problem, why weren't conservative observers more outspoken when public and private debt escalated to unsupportable values? More ominous are the Federal Reserve printing money and the growing interest in establishing a new reserve currency that replaces the dollar. These schemes could collapse the dollar and greatly increase inflation.

Although it was obvious that both the credit outstanding and trade deficit had been increasing exponentially and could not be sustained, the excuse was always, "the credit increases (which contained some double bookkeeping) as a percentage of the GDP is manageable." Overlooked is that the credit needed to stimulate GDP has been steadily increasing. FX reports that Ned Davis Research, an independent financial research firm concluded it "took $1.35 to generate $1 of GDP in the 1950s, $1.50 in the 1960s, $1.70 in the 1970s, $2.90 in the 1980s, $3.20 in the 1990s, and $5.40 in the latest decade."

Not explored is the argument whether or not the world economic catastrophe would have occurred despite the sub-prime loan crisis. By stimulating housing demand, the extensive sub-prime mortgages maintained growth in the building industry and its subsidiary industries and raised asset values, which allowed huge home equity financing. Did the additional loans to saturated credit markets only extend the economic prosperity before the ultimate downfall?

The bottom line has everything being done to preserve the present economic structure without regard to what actually must be done to protect public welfare. The elements of the Economic Recovery Plan are worthwhile expedients for soothing economic woes but thoughtful analysis must be performed to assure that after the spending is exhausted the patches and fixes are not only temporary expedients. former Secretary of the Treasury Geithner suggested changes within the system but did not propose changes that modify the system. The U.S. Council of Economic Advisors should prove that sufficient economic structural defects don't exist that will impede progress to full recovery - that the present global economic structure won't topple once the recovery funds are exhausted.

A March 2009 worldwide poll made for BBC World Service by Global Scan supported structural changes. According to a "70 per cent of those across the 24 countries polled think 'major changes' are required to the way the global economy is run....Majorities in most countries - on average 68 per cent - also see the need for major changes to their own country's economy."

Why is this being said?
The United States has the perfect combination of resources for a sound and viable economic system - abundant agriculture, wealth of minerals, inexhaustible coal mines, a productive and educated population, valuable seaports on several coasts, excellent transportation, omnipresent communications and several weather zones. It would be difficult to devise an economic system that brings panic and catastrophe to the world's most fruitful nation. Nevertheless the U.S. is constantly subjected to economic downfalls and the current downfall is beyond conception. The Treasury department statements that the failure of one corporation, AIG, could bring down the entire global financial system and that AIG sustainability depends on a handful of managers (who could blackmail the universe) is bewildering. Can any system operate with a single point failure?

What are these structural failures?
Structural analysis should be ongoing task for the U.S. Council of Economic Advisors. Some obvious areas of analysis are:
(1) The free enterprise system has proved to be a free money system. Free enterprise does not exist and constraints on "free" are obviously necessary.
(2) Excessive credit has supported spending and a trade deficit. Purchasing power within the system has to be increased and dependence on credit reduced.
(3) A global trade structure that is only twenty years of life has brought free trade and increased prosperity throughout the globe but has also brought global economic collapse. Can the same structure continue?
(4) The system contains contradictions that confine successful operation to a small margin. We have:
Need to save more for investment at the same time as need to spend more for consumption
Need to have free trade for prosperity, which history shows leads to eventual global dislocations and instability.
Need to have low interest rates to increase credit, which can lead to inflation and dollar decline.
Need to have free market and need for government interference to avoid severe decline.
Need to have government spending to stimulate economy, which leads to eventual higher taxes to reduce deficit.
Need to lower the dollar to stimulate exports, which leads to increased prices of imports.
(5) Still not resolved are forecasted major problems. These are:
A health system whose costs are reaching unsupportable values. Health costs have harmed corporate balance sheets.
A social security system that is headed to bankruptcy. Pension costs have harmed corporate balance sheets.
(6) The government established the Federal Reserve System in 1913 to prevent financial panics. The system has not been successful in application of its charter. Shouldn't the Federal Reserve system be revised?
(7) Growth cannot occur without credit but debt cannot grow forever.
(8) Debt cannot be re-paid without growth but growth cannot occur forever.

Perhaps Ms. Roemer should re-examine her answer to the question: "Is the crisis man-made or systemic?"
Investing in unstable structures might not be the answer to economic recovery.

Go To
The Economic Crisis
Part 2 - New thoughts to the incomplete analyses

alternative insight
april, 2009
slight update september 2014