There are fundamental errors in the conventional analysis of, and approaches to, current macroeconomic problems, the results of which are disappointing or ineffectual outcomes to policy interventions, along with a dangerous loss in public confidence for the US government’s capabilities to intercede effectively. In contrast to economic projections that predict a slow and precarious recovery, by employing some revised understanding of economic dynamics it is possible to craft more targeted measures that are cost-effective and can put us on track towards repairing the global economy in a matter of months, not years. Part 1 of this paper explores the function of a healthy economy and precrisis dynamics; Part 2 looks at the psychology of economic management; Part 3 presents current economic policy approaches; and Part 4 outlines a strategy to address the current economic malaise.
The Activity of Commerce and a Functioning Economy
We’ll start by discussing a few conceptual pieces separately, and then use a model to tie this information together into a coherent system. Parts of this explanation will be fundamental to some, but it is necessary to include so that this thesis will be intellectually self-contained.
What is meant by “A Functioning Economy”?
In this analysis, this term is equated with an economy that feels like it is operating well, in a state which is not recessionary. During these times we may certainly be aware of various economic problems, but overall there is a sense throughout society that things seem to be OK or better, and the outlook is more or less positive.
Most of the important characteristics that contribute to a “functioning” economy are…
- low levels of unemployment
- well-capitalized lower-, middle- and upper-income classes
- confidence in the national currency
- trust in the solvency and honesty of banks and lenders
- acceptable levels of national debt, with balanced budgeting strategies
- manageable personal levels of debt
- rational government regulations simplifying the processes of business creation & destruction
- a solid and profitable business sector
- general balances between buyers and sellers across most markets
- fair and efficient tax policies and collections
- government that functions well politically
- a sensible forward-looking plan for national growth
- a safety net that handles less fortunate citizens
- a well-managed healthcare system
We consider these factors all together, often subconsciously, and if thought to be mostly in good order we have a sense of confidence and certainty, which allows commerce to thrive. Our faith in the essential integrity of this system permeates every crack and crevice of the financial transaction universe. Conversely, without these factors in place that contribute to trust and confidence, the counterparty transactions that normally happen smoothly at all levels of financial activity become strained and the fabric of an economy begins to unravel.
Every transaction can be imagined to have associated with it it’s own a frictional coefficient, different as well for either party in the transaction. In a low-friction environment, the activity flows freely. In turn, when our whole system in aggregate operates with high friction, the processes of financial activity are impeded.
This activity of commerce is the fundamental process necessary to support the health of the system. It causes moderate expansion, and keeps the velocity of money at workable levels, which preserves a flow throughout the system and is a self-replenishing process. When this system is not working, we feel the squeeze of a recession, with collateral damage generated throughout the economy. These collateral downward spirals and reverberations must be recognized and differentiated as symptomatic of, and not at the root of, the systemic breakdown. I’ll discuss this essential point in further detail later.
Explained another way, in a functioning economy the different entities involved—individuals, corporations and nations—are positively aligned and working together uniformly.
Note that perception of economic stability (confidence) is the more relevant driver than actual stability. For example, Lehman Brothers acted as a solvent entity until the moment we realized it wasn’t. It is only at the point where we actually become aware of an excessive structural breakdown in one or more economic factors that a tremor in the economic system is felt. Depending on the dynamics of that shock, we will suffer either a minor or major slowdown in economic activity.
Also, when these processes are working properly and our economy is in this functioning state, various other concerns with problems like tax rates, outsourcing, manufacturing and national debt may be worrisome but are felt to be manageable.
With the events of 2008, the collapse of Lehman Brothers and AIG, we could no longer deny the massive systemic toxicity that had built up within the banking sector, and the associated sense of wealth that accompanied housing ownership quickly evaporated. Perception gave way to reality and suddenly the capitalization of all classes, as well as that of global institutions that had invested in these mortgage-related instruments, acutely came into doubt. The dominoes quickly began to fall, and panic ensued.
The Pre-Recession Economy, 2002-06
For an instructive, comparative example, I quickly consider the state of the US economy in the few years before the recession.
After the dotcom bubble burst in 2000, and amid the traumatic societal aftershocks of 9-11, the economy went through a reactive moderate economic downturn. Fearing that things could slip further, the Federal Reserve under Alan Greenspan implemented an accommodative monetary policy. This, in the context of only moderately traumatized public confidence, helped us bounce quickly out of fiscal malaise and into the period of hyperactive commerce in the few years that followed.
With housing values seeming like an ever-abundant source of credit, the entire workings of the financial system reacted in kind, as money flowed with a sense of irrational abandon and the economy began to overheat. Since businesses were hiring and people were spending, tax revenues were also at very solid levels and there was no particular concern for pragmatic governmental budgeting.
In retrospect we know that a dangerous systemic toxicity had built up which would inevitably lead to catastrophic breakdown. This was due much less to any hyperactivity, but rather deeply pernicious business practices. It is not necessary for the purposes of our specific examination to analyze the details that led up to this breakdown, which have been discussed in great detail by others. What is essential for our discussion to understand is that all during this time, the activity of commerce proceeded, and that our economy functioned, until again the positive self- deceptions could no longer hold in denial of the facts of the negative reality.
The Concept of a Perfect Economy
To achieve a state of economic perfection, all the factors discussed earlier are needed for a functioning economy, and must not only be perceived to be in good order, must be operating at a theoretically maximal efficiency—an abstract ideal.
But note that our “functioning” economy operated at sufficient levels, and yet with a great many imperfections. We often mistakenly think that relative perfection is more important in maintaining a healthy level of activity. In fact, the opposite is true.
The U.S. Financial System and the Automobile Analogy
Imagine a car as representing the entire financial machine of US capitalism.
This car is made up of an enormously complex system of interacting component parts—individuals, small businesses, corporations, banks, state and local governments, etc…—with an intricate dashboard of gauges that act as our economic indicators.
A tachometer monitors the revving of the engine, so that the we have an indication whether the economy is running in a normal, overheated or recessionary state.
The money supply, our fuel, is distributed into the banking system and dispersed throughout the financial machine. It’s quality is assessed by valuations of capital markets.
A timing chain helps unify all the working components, so they function in coordinated unison.
An annual owner’s manual reflects up-to-date understanding of the car’s systems. Road rules exist for regulating both national and international operations.
Maps, GPS and itineraries represent our financial decisions on projects, major expenditures, budgeting, etc…
The final and essential element in this analogy is the driver, with certain abilities behind the wheel, temperament, knowledge of their car’s workings, command of the roads they’ll drive on, facility to handle difficult driving conditions, general common sense and intelligence, and ability to balance elements of speed and risk—driving with confidence, recklessness, or hyperprecaution.
So, how does this model simplify our view of economic dynamics? How can we use this way of looking at the workings of finance to help analyze and make decisions on courses of action?
On the one hand we have all the component parts (banking system, businesses, city and state governments, etc…), fuel quality, maps and itineraries, and the driver’s natural abilities and wisdom. All of these systems affect the maximal operation of the car, and if any one is not operating at optimal efficiency, toxicity builds up and the car will eventually need repairs.
Thinking back to our concept of a Perfect Economy, all of these parts of the financial automobile would be optimized and therefore the entire mechanism would run flawlessly, without toxic buildup. But our economy has always been rife with flaws and yet functioned acceptably well in spite of these imperfections, with the activity of commerce, or our tachometer, reading at normal levels. Toxicities will predictably build up, and occasionally more severe breakdowns will occur. But outside of these breakdowns the car will function smoothly.
On the other hand, we have two other issues affecting the car’s operation which it’s this paper’s intention to highlight…
- The confidence of the driver.
- The harmonious coordination of all the working parts.
Normally these two aspects of the economy settle into a level of comfortable and smooth performance. But if these two variables are significantly negatively impacted, this is when an actual downturn in commercial activity that we recognize as a recession takes place, and an entirely different constellation of systemic problems sets in. Healthy operation of the car is analogous to the activity of driving at proper revving capacity, and when this process is happening it is self-replenishing. When not, it becomes sclerotic.
The priority then must be to return the automobile to this fully running condition, flawed as some systems and components will still be.
Looking back to the financial events of 2008 through this lens, a severe toxicity had built up in at least one of the component parts, the banking system, which caused our economic car to seize up. Before getting back on the road, this part did indeed require some amount of actual repair. This has been reasonably accomplished, although the banking system remains dysfunctional and problems will still foreseeably recur.
But what had become affected and still remains discombobulated is the confidence of the driver and orchestration of the machine. Recognizing this as a root problem, and then considering revised methodologies that take into account and actuate repair of this broken system, is what’s needed to return the economy to a more properly-functioning state.
This view then of economic dynamics should affect our policy decisions, and predictions can be made as to the likely efficacy of various interventions. We should always ask ourselves whether the particular problem of concern is one that actually blocks the resumption of confident and orchestrated financial activity or whether our proposed intervention will aid in achieving that goal.
Budgeting therefore is currently overly attended to. Smart budgeting and the elimination of wasteful spending should always be an area of concentration, but it should not hobble us in our goal of restoring economic activity in the near term. Indeed, this model anticipates that austerity measures are contraindicated.
Similarly, fears of our lowered bond ratings and long-term debt are simply overblown. We must absolutely take care of this problem in the mid- or longer term, but an intelligent fiscal plan and functioning political system that takes decisive steps are more important to avoid spooking global capital markets.
Quantitative easing measures are predictably ineffective, and are analogous to expecting the car’s functioning to improve simply by adding gasoline.
Concerns about the tax code should be secondary.
Banking and business regulations are of great importance, and must be dealt with at the earliest possible time, but are still of secondary concern, provided they do not block the return of the functioning economy.
Healthcare reform, likewise, would have been strategically better to have been tackled later on, during a time when confidence and activity were on a more positive trajectory. Although for now, with whatever progress that has hopefully been made, it would be foolish to backtrack.
On the other hand, it is important to maintain expenditures that ease societal pain, particularly of the unemployed. In general, funding measures that act to buttress and prevent further disintegration of the commercial architecture are of legitimate concern, as they make restoration more attainable.
On a final note here, the consideration to shrink the size of bureaucracy should be made with the understanding that reduced revenues may temporarily compel it. If the economic contraction turns out to be a “new normal,” then we must reduce the size of government on a more permanent scale. Otherwise, this is currently an inappropriate time to be concentrating on concerns about the streaminling of the government’s administration.
Moderate Versus Severe Recessions
Keeping in mind our previous discussions on the composition of a functioning economy, the automobile model, and our absolute priority and emphasis on fixing the broken activity of commerce mechanism, let’s look at some of the real-world dynamics involved with the state of our financial system.
Although economists typically classify recessions according to their lag time of recovery—V—U—W—or—L shaped, for our purposes, we only need to break them down into either of two types—a MODERATE or a SEVERE economic contraction.
A moderate contraction is generally triggered by a modest imbalance in one or more sectors of the economy and so the breadth and severity of it is not especially widespread or extreme. An example often given is the overbuilding of housing supply in one or more cities, which in turn causes the prices in those markets to dip, along with some loss of jobs or income related to real estate. The anticipation among financial analysts is that the effects may be painful to some, but still fairly modest and transient when looked at in reference to the whole system, and so key is the fact that no major changes in the economic architecture are made in reaction to this contraction. This type of recession will usually last a few months and then resolve itself as the excess supply of housing works through the system.
However, triggered by the collapse of Lehman Brothers and AIG in 2008, the breadth and severity of damage to the system was much more profound, and therefore caused a more widespread, intense, and long lasting panic reaction. This in turn induced certain structural changes in the economic architecture that are much more debilitating and less likely to repair themselves.
Again, we are not focusing on the details of what caused the shock, but rather it’s levels of intensity and severity, and the dynamics of the public and private sector’s reaction to it, which create the qualitatively different systemic reaction that are the hallmarks of a severe contraction.
The Three Main Psychological States of an Economy
In the normal functioning of an economy, where the activity of commerce is proceeding smoothly, players are mostly in positive alignment and the aggregate psychological state is of confidence.
In the wake of a severe shock, players become negatively aligned and are characterized by a general state of panic.
Following this phase, we now find ourselves mired in a period unstructured, non-alignment. This state we call “fibrillation.”
Lacking a sufficient underlying force that acts as a systemic orchestrator, the players remain in this unorganized state.
In a normal economy, and even in a moderate contraction, there is a natural gravitational force which aids in self-repair and gradually realigns the players. This gravity is known as greed, or the profit motive, and in this case greed IS good. But in the severe contraction, these counter forces outweigh and prevent the drives toward active commerce from taking hold. Repair might happen unassisted, but this is unsure and still can be expedited with proper aid.
Now, as this intense shock and the accompanied reactions get generated through the economic system, and combine with the associated collapse of aggregate demand, the private sector makes two very important changes, and on a massive scale.
- They let go of a large number of workers.
- They lower operating costs by restructuring their businesses.
Both moves are undertaken as a way to weather what is anticipated to be an enduring and severe collapse in their individual market’s demand.
While both these strategies make imminent sense from the perspective of the singular private—or public—entity, in the holistic view which considers the entire economic system’s integrity, they have disastrous consequences.
Had the dangers of these broad systemic changes been properly understood and mitigated by higher-level oversight at the right time, it is our opinion that the severity of our current recession would have been markedly reduced, and recovery managed at a fraction of the cost. Our current political stances though favor a general non-interventionist policy with respect to free markets, which inhibit government mediation.
Support for this pro-interventionist ideology might be taken from the examples of the more robust German economic recovery, where programs were instituted to minimize job losses. And in the United States, economists generally now agree, in hindsight, that the bailout of the auto industry was an interventionist policy that likely avoided a much greater collapse.
The massive layoffs and downsizing of businesses combine with other factors that happen as additional consequences of the collapse, to create an overall economic environment that becomes a particularly intransigent tangle of factors. Thus it presents a very challenging puzzle to unwind, with many embedded Gordian knots and self-reinforcing negative spirals. Failing to recognize these dynamics, or to crafting solutions that attack them directly, inevitably lead to interventionist strategies with predictably mediocre results.
Overall Structural Changes in a Severe Recession
Now, let’s examine more closely some of the major structural changes involved, and how this creates the problems that prevent repair of the economic engine.
- Massive layoffs lead to a large excess in the supply of labor, and a kind of tipping point is reached where this imbalance gets locked in. Fear of losing one’s job causes acceptance of lower salary and longer work hours, maintaining a class of those who are managing to remain employed, while creating a fairly permanent and atrophying class of unemployed people. Lower salaries cause an even greater loss in worker’s buying power, as well of course the loss in spending among the unemployed.
- The businesses that survive the initial shock period take advantage of the pressures on individual workers, and along with this manage to restructure their operations to lower overall costs and still bring in acceptable profits. Therefore, there is little incentive for them to expand in an atmosphere of low demand. Additionally, an inertia exists, where gearing operations back up is not easily done, so an entrenchment takes place, which in turn inhibits the re-hiring of the workforce and rebalancing the supply of labor. A negative feedback loop is created, where aggregate buying power is reduced, inhibiting the incentives for business growth that would lead to greater employment and, in turn, greater aggregate buying power.
- Government coffers are strained by reduced tax revenues from lower employment via poor spending as well by the greater cost burdens of supporting the general economy and the unemployed. Therefore, there are ever-fewer resources with which to craft possible interventions. Lacking a solid understanding of how to fix these problems, the resources are even further depleted, along with the insufficient reparative results.
- Losses in stock and bond portfolio values reduce buying power primarily among the wealthier classes, governments, institutions, banks, businesses, etc… This pillar of the economy has recovered in large part, softening the overall collapse, but also creating a larger schism and resentment between rich and poor.
- Losses in individual housing wealth. Although this affects buying power across all classes, lower and middle income owners are most affected since the largest share of their personal assets are tied specifically to the values of their homes.
- In an atmosphere of low and enduring loss of economic confidence and certainty, almost all entities flee to investment safety and essentially put their money under the mattress, also known as a liquidity trap. As we know, private business is sitting on trillions of dollars in profits, and in general a large percentage of global capital, both individual and institutional, is tied up in non-growth oriented holdings. This, combined with a low velocity of money, limits the active money supply and inhibits the effective channeling of capital.
- Borrowing on credit becomes more challenging on every level of the economy. Lenders are even more recession-sensitive than businesses, and even less willing to transact in an environment of uncertainty. Thus, the overall flow of capital becomes sclerotic.
- As the contraction wears on, with its continued emotional stresses, a more pervasive loss of confidence becomes the norm. There is a demoralization of the chronically unemployed. This psychological state has many ramifications throughout the system.
All these problems combine and work together to create a system of entanglements and self- reinforcing negative spirals. It is a turtle on its back, and the system is in fibrillation. Proper analysis of these entrenched dynamics, of understanding exactly what is blocking the system from righting itself, as well as designating a proper course of therapy, are the key challenges for the economic doctor.
Sometime a little over a year ago, there had been sufficient fortifications done in solidifying the flailing economy, where the natural gravitational economic forces might have started to take hold as the engine began to spark, however, the onset of strong headwinds from the European sovereign debt crisis added massive uncertainties and undermined this burgeoning process of recovery.
Summarizing the Current Theoretical Approaches to Counteract Economic Contraction
Letting the processes of natural market forces act
This philosophy believes that free markets should be left alone, and that in their nature they work perfectly to cleanse and purify themselves. Additionally, interventions actually hinder these processes from taking their normal course, which prolongs recovery that would otherwise proceed on its own.
However, our earlier analysis of severe recession dynamics postulates entrenched structural changes to the financial architecture, along with its accompanied negative feedback processes and Gordian knots, which block the self-reparative mechanism from righting the system. Therefore, without active interventions, we think that unwinding of this situation is at best ponderous and unpredictable, and more than that, perhaps unlikely.
The argument is sometimes made that because interventions have not so far worked sufficiently, that this should be taken as proof that they are not by their nature effective. But by this logic, if I were similarly to take one medication for an illness that didn’t work, I should take this as evidence that medicine cannot be effective. Of course, this is ridiculous.
Imagine an investor who is considering a particular opportunity. Let’s call it the black box. This box could represent anything from plans for business expansion to the possible purchase of an oil painting.
The first variable will be the investor’s perceived probability of the likelihood of profit return on this box—either high, medium, or low.
Second, we vary the current general economic conditions to be considered as either highly favorable, moderate, or very challenging, in terms of market confidence.
Now, we can pick a situation that mixes any combination of these two factors we’d like, and look at how the investor’s decisions might be affected as we gradually lower the tax rate, from extremely high and then downward.
Since we are particularly interested how things might play out in a recessionary framework, let’s take as an example one in which the black box has a high probability of solid profitable return, but where market conditions are very challenging.
Starting with a very high tax rate, this investor might be near the tipping point of going ahead with the investment but still declines, since even with a reasonably high probability of very good return, the excessive tax burden makes it arguably not worth the time and trouble. As we lower the tax rate, the investment opportunity starts to look decidedly worthwhile, even with a moderately high rate, so the investor would likely go ahead. After all, profit is profit. And obviously, the more tax rates are lowered after this point just makes the investor happier, since he’ll reap greater profits from the business deal he had already decided to make.
Considering every combination of these variable scenarios, the basic story plays out in essentially the same way. There is a certain tipping point that’s crossed where the cost-benefit considerations of the black box investment are assessed as positive, which then affects the decision to go ahead. Again, profit is profit.
It is therefore only within this very small inflection point window where a differential in the tax rate, typically at the mid or higher level of the taxing spectrum, might nudge an investor to go ahead with a deal where he might have not otherwise, where supply siding might be rightfully thought of as stimulative.
And since this inflection point changes in each particular investment consideration, we cannot use this as our model for deciding on specific tax levels anyway.
In addition, as we continue to imagine lowering the tax rate past this inflection point, from the government’s perspective if their sole intent was to garner revenue from the investment decision, they would be losing out on more and more since the investor had already decided to go ahead with the deal. So in actuality, succumbing to supply siding mentality costs the government revenue in most cases.
By this explanation, we are not advocating high governmental taxes on business which we feel would be gouging, but merely contending that supply side stimulus theory seems ungrounded.
A business person makes investment decisions based on considerations of strategic market positioning and likelihood of reasonable profit. Tax rates are in reality always a secondary concern, except when this rate is set so high as to be prohibitive. In general, businesses may not like the rates, but it does not prevent investing.
In light of our analysis of supply side dynamics, we’ll consider the next few interventions, which have some logical commonalities.
And in several of the following cases, we need to consider separately the effects of these stimulus methods on middle and wealthy classes, since they yield different results.
The current atmosphere of lowered confidence and uncertainty, which leads to the liquidity trap or “money under the mattress” dynamic, is a key dynamic to consider in all these scenarios.
Lowering taxes on individuals
This approach utilizes the strategy of allowing people to keep more of their income in the hopes that it will increase commercial activity through increased spending.
Wealthy individuals as a result have more discretionary funds, and are currently somewhat more confident, primarily because of the bounce back of their portfolio wealth. At best they might use the excess funds for some spending and portfolio allocation, but this of course is not guaranteed. Still, this has likely moderately increased the commerce activity and buoyancy of the luxury retail sector. But it is not enough to stimulate in any significant way the expansion that would lead to a significant uptick in jobs, since the general psychological environment of the economy is uncertain. As well these benefits are primarily restricted to one strata of the economy, which ironically needs the least assistance.
Money certainly trickles down, since the wealthy have some more dispensable income to spend. It is doubtful that their spending would increase by significant amounts though. And those who provide services for this sector benefit in turn, and then tend to spend more money. But this economic driver does not vigorously stimulate broad commerce, and is rather filtered and channeled down until it’s stimulative power becomes minimal. As far as bang for the buck incentive, this is likely a poor choice.
As for the lower or middle class person who gets these modest extra funds, the atmosphere of uncertainty simply depresses the chances of the economic liquidity injection hoped for and their discretionary funds are much more sparse, so the stimulus would be very minor.
George W. Bush memorably sent out $600 checks with the urge to spend, but this lacked the desired effect for the same reasons, as fear had begun to overtake the psychology of the consumer.
So, besides the conclusion that this intervention is only minimally stimulative, these tax cuts would also have the adverse effect of depleting government coffers.
Lowering interest rates on individuals
For all individuals, the effects of this measure is to lower borrowing costs, made possible by the Federal Reserve’s aggressive and large amounts of asset purchases, which then lowers rates.
Right out of the starting gate though, any possibly positive effects of this stimulus are hindered by of the current reluctance of banks to lend these funds because of their continued outsized fears of building up additional non-performing loans. They are more recession-sensitive than even the business sector.
In addition, there is simply very little appetite for anyone, wealthy or otherwise, to build up more personal debt, and at this point further asset purchases by the Fed are quite costly for only minimally incremental reductions in borrowing rates, which are anyway at near zero.
The bottom line is, if you are flatly not interested to borrow money at 3%, you are not likely to want to borrow that money at 1%, or even 0%. Debt is debt.
There are also several adverse affects to running this kind of program. First, it ties up a large amount of funds, especially when considering the chance of benefits. Second, a massive portfolio is taken on by the Reserve, which could theoretically end up as large investment losses, although this is unlikely. Third, this is a very visible intervention as far as public awareness is concerned. So if the economy shows little improvement in response, it severely damages confidence in their view that the government actually has any ability to have effect.
One area of public concern though that is well-overblown is the fear that these liquidity injections will result in runaway inflation. It has not at all so far, because the dynamics of the liquidity trap and a low velocity of money keep the active money supply low.
Moderate inflation can be triggered by a variety of factors, like rises in crude oil prices, for example. And if the economy starts to return to functioning levels, ways to combat the onset of inflation are much better understood. The real fear of economists is for the onset of a deflationary spiral. This is much harder to overcome.
Lowering interest rates on corporations
As with individuals, there is simply little appetite for big business to borrow, in this case for expansion. In an atmosphere of collapsed aggregate demand, the businesses that survived have managed to reconfigure and reap adequate profits with little risk.
For new businesses, if they have incentive to borrow, they are again confronted with a challenging credit lending environment from the banks.
Lowering taxes on corporations
The argument against this as a particularly beneficial motivator mostly follows the same rationale that dismisses supply side stimulus, especially in an environment of collapsed confidence. By lowering taxes the government rarely alters business choices that would not otherwise be made, and therefore is simply losing revenue in a race to the bottom. It amounts to giving a gift to corporations.
Keep in mind also as an example worth pondering the situation in Ireland, which has very competitive corporate tax rates, and yet still has an economy in dire straits.
There would likely be some minor benefits in modest funds being repatriated, and a minimal number of white collar jobs created, but this is mostly a dangled carrot. The use of this fear tactic as a way that business tries to influence government to lower tax rates should be considered with circumspection. The costs versus benefits of succumbing to this tax-lowering logic is questionable.
As far as manufacturing jobs, the bottom line for where business decides to move operations depends on a calculation of costs of production, logistics of shipping and time to market. It is rare that considerations of national allegiance are calculated into this equation.
Austerity and budgeting
This approach puts as top priority keeping the national debt from exploding beyond control and getting budgeting in order, for fear of bankrupting the country in the future and keeping balance sheets in control to preserve trust in the solvency of the currency.
This is a particularly disastrous strategy which indeed locks in policy that works counter intuitively towards unwinding the entrenched mechanisms we have delineated.
The only comprehensible way to tackle serious long-term debt issues is to re-ignite the activity of commerce engine and to untangle businesses position of entrenchment so they shift towards expansion and get unemployment under control. Moving in this other direction, government will only find itself in the continuing position of plugging holes in the dyke. A defensive strategy only leads to a slower death.
Moderate and strategically balanced approaches to reign in budgeting may be undertaken, but this is generally a more of a long term concern and not to be taken at the expense of rekindling the engine of commerce.
One can imagine the challenge of defeating a recessionary economy much like that of trying to win a game of speed chess. Our opponent is the ravages of the contracting economy, and the clock is the national debt. We have several minutes to implement our gaming strategy and defeat our nemesis, but if not mindful of the long term enemy of the clock, this will also lead to our defeat. But the only way to actually WIN the game is by executing a successful strategy. In this respect, the clock cannot help us.
This is the most widely accepted model, and is the basis for the Obama administration’s approach, so let’s try to evaluate its efficacy in light of our previous explanations of commerce dynamics as well as examining some new information.
Firstly, the rationale of supplementing severely diminished aggregate demand with increased government driven spending toward employment and expansion, thus supporting the weight of an otherwise more gravely felt societal collapse, seems based in common sense. The hope is that this stimulus acts as an economic Band-aid, giving business time to regain its footing while also propping up employment and general economic activity.
I support the view that the Obama administration has done a very good job of applying measures to these ends, especially considering the challenges of implementing programs while dealing with the contentious atmosphere in Washington. Michael Grunwald’s recently released book, “The New New Deal,” reportedly makes an in-depth, supportive argument for this narrative.
But ultimately, our interpretation of the Keynesian model is that it lacks certain key additional components, and so is akin to giving only two pills of a prescribed seven-pill medication regimen. In this manner of speaking, it only stanches the bleeding in the hopes that it will give the patient time to heal. Our argument is that the economy’s self-repairing mechanism is also broken, which must be addressed. Keynesian stimulus does not deal with this adequately, and rather takes on very costly measures to take carry the increased burden.
To this administration’s further credit, we think they have recognized and tried to introduce certain measures to deal with some of these other broken systems, but in general we feel that their program relies too heavily on costly band aid measures, and as well on carrying the weight of economic expansion with depleted revenues. It also misunderstands certain key dynamics, making it ultimately less effective.
The attempt of the approaches outlined in Part 4 is to significantly improve on these weaknesses.
WWII and The Depression: What Can We Learn?
Finally, before starting on the explanation of our proposals, we think some valuable points can be reviewed and perhaps expanded upon by a brief analysis of how our involvement in WWII most likely propelled us out of the Great Depression. This is a widely held position, and understanding it is relevant to our discussion.
Let’s quickly look at what factors might have facilitated this transition back to a functioning economy. This analysis does add a couple of key points for consideration…
- First, there was an absolute and unifying national cause in the pursuit to defeat Hitler and the Japanese. Therefore, divisive political arguments over the great expense of war were not a hindrance.
- There was a similar, enthusiastic and unanimous public agreement as well. Everyone was fully on board and actively involved.
- We built up a giant industrial machine for the war effort, and the workings of this manufacturing powerhouse were then in place after the war ended.
- Technological advancements were made which drove new post-war industry and innovations.
- Over the course of the war, we had a period of several years of full employment, which freshly funded a middle class.
- When the war ended, we were left with a pent up energy that needed to be channeled. We were winners, and anxious to shake off the miseries of the past. The psychological damages of the Depression years were easily forgotten. We crossed a threshold.
- Industrialists realized all these components were in place, whether subconsciously or not, and there was a government whose policies were accommodative towards growth.
- And finally, since at that time women did not work, and with the unfortunate depletion of manpower due to the war, there was a very favorable supply of jobs for the existing labor force.
For all these reasons, as the war ended, we hit the ground running!
In our current dilemma, in contrast, although our economy is not nearly in the disrepair that it was in the Depression years, and has not had to deal with as damaging a depletion of resources that this full-on war effort required, we seem stuck in the mud.
Why is our recovery process so much more lethargic?
- First, there is currently too much political infighting, which dismantles an effective decision making process.
- There is similarly no national unity of public opinion.
- The administrative machine created during World War 2 fell into place as a coherent and effective fiscal program, without consciously trying to do this. Other organizational methods are always an alternative possibility, but whatever program is followed, it does have to understand the weaknesses of and execute a potent attack against the enemy. In our case, that enemy IS the recession, but we have no precise and singularly-executed strategy.
- Outside of the context of war, the cost of the theoretically-required stimulus is too daunting. This causes a pendulum effect in the decision making process that wastes time and resources. As this kind of program proceeds, the fear of its price tag causes the naysayer’s voices to be heeded, and the pendulum swings the other way.
- Fear of excessive expenditures sometimes inhibits completely following through with even separate and individual components of a larger strategy.
- Results are sometimes falsely construed as failures, causing confusion. For just one example of this, we have the back and forth arguments about the failure of Solyndra. But any large program of research and development will have setbacks, and this we think should have been viewed, as some voices rationally expressed, as part of a successful and necessary larger process that inevitably involves trial and error.
- There is an overall diminishing of confidence, as interventions often seem only mildly effective.
- There are no jolting sparks of enthusiasm, like the reactive phase following WWII that kickstarted the engine. Creating this kind of emotional state aids in catalyzing the return to full commerce activity. Instead we’ve developed a kind of lethargy, and have become somewhat acclimated to the stance of the economy’s intransigence.
- And, as our theories have explained, there is no grand strategy, which highlights the key dynamics of an economic contraction, and therefore the root causes are simply not sufficiently dealt with.
Then … where does this leave us. Certainly we reject the notion of needing a war to put in place and execute an effective stimulus program. Is there then a practical methodology we can use towards fixing the economy? The answer is YES! And it is more directly targeted and less costly to implement.
An Introduction to Different Approaches for Repairing the Global Economy
I start with a theoretical base in Keynesian style stimulus, but expand on these measures because they are more appropriately viewed as palliative Band-aids that do not get at the heart of the entrenched dynamics. Keynesian approaches are also extremely expensive to execute—unnecessarily so—and can lead to loss of faith in public confidence if the private sector does not respond, as our model predicts. When interventions that address the core problems are additionally incorporated into an overall strategy of attack, the whole process of repair can be made vastly more efficient and sure-footed.
As the key, linchpin factors conceivably begin to resolve, the other constellation of problems associated with this negative spiral should also start to even out, optimistically accelerating the pace of improvement. For example, as employment numbers go up, housing foreclosures should start to decline, helping real estate markets stabilize. MBS valuations slowly improve, fortifying investment portfolios and confidence as the overall domino effect reverses. Tax revenues increase. The government’s burden to assist unemployed workers starts to ease. The overall economic improvement should then aid in getting a firmer handle on unwinding the whole of the entangled mortgage investment collapse, as the tide slowly rises.
At the time when we are finishing this paper, there are some signs that economic recovery may be starting to take an improved hold in the United States. Recent statistics have shown an uptick in some key housing numbers, and consumer confidence has been relatively buoyant. While this is welcome news and hopeful signs of a more enduring recovery, we think that in whatever case the information presented here will be of great value now, or during future crises, and as well can still be applied to expedite and solidify the recovery in Europe.
The Breakdown of the Strategy
is ORCHESTRATION. In order to implement this entire program we must first try to achieve a necessary and sufficient level of concurrence among those in charge—of the proper analysis of problems and solutions. We must then rally the necessary forces and implement an associated and well-conceived plan by following through with an effective administrative process.
After concurrence on a plan, the next issue is choosing the head orchestrator in charge. Whether it is Congress, the president or General Patton, some entity should serve as the head conductor, giving the public a focus of leadership.
Following the setup of the head conductor, aligning the orchestra is next. And this orchestra is comprised of, quite literally, everyone—individuals, banks, corporations and state governments. The best results will be achieved if the different members of the orchestra are willing to follow the leader and play in correct time. Thus we get music instead of chaotic noise. An effective public relations program should be implemented. Involvement and comprehension flows from the top-down and the bottom-up, and helps engender a sense of unified inclusion and group purpose.
Because all the elements of our program have an intuitive, common sense appeal whose rationale can be easily understood, this whole process of gathering and banding together a sense of ratification and enthusiasm should be greatly assisted. This is not rocket science, when the pieces are properly explained.
As we mentioned at the beginning of this section, I incorporated a base of traditional Keynesian measures. But now a re-evaluation of this approach is undertaken, with the intent to streamline and eliminate unnecessary, costly and wasteful parts of this program. This approach is most useful for interim measures, there to alleviate the psychosocial stresses of the prolonged economic contraction. We can therefore cut costs and channel these funds in other ways for better and more immediate effect, specifically towards the desired result of restarting the commerce engine, which I’ll soon discuss.
Besides reducing the psychological stressors, these stimulus funds should also be targeted for limited use in helping to reinforce parts of the existing political and economic infrastructure, preventing further disintegration. So, for example, expenditures made to rebuild roads, bridges and schools can help supplant some amount of lost construction jobs, while maintaining basic infrastructure, and luckily capital is still available at our current low borrowing costs.
But government here should not be trying to substantially accomplish any rebuilding of middle class wealth, or assuming its role is in taking on the weight of any prolonged general economic productivity. Rather, its responsibility is simply in smoothing over the effects of contraction as minimally and strategically as possible, until the baton of commerce can be passed back to the private sector.
Current leadership is now taking a kind of “kitchen sink” approach to stimulus, trying to flood so much money towards a variety of programs in the hopes that it might win the battle against the recession with brute force. This has been an understandable course of action, given some widely held views on economic principles. But by seeing a viable alternative and pulling back on this way of thinking, we can prevent a large waste of stimulus weapons and measures that may have better effects later on in the process, or in fact which may not be needed at all if repair gets solidly under way.
A good example of another way to implement a very large pull back in expenditure strategy is to consider curtailing the use of quantitative easing and other tax rate adjustments, which now we think depletes funds that would have much greater effect in an environment of improving confidence. Its use too early in the cycle of repair ends up as a wasted arrow because of timing. It is, as economists aptly describe, “pushing on a string.”
As well, large government investments intended to lay the groundwork for future private sector enterprise, should be carefully considered for their strategic benefits and timing in conducting this war on economic attrition. A well-chosen and planned program of expansionism is absolutely a vital part of, and must be incorporated into the national agenda, but some of these expenditures can be curtailed during this period of economic contraction, and better left for a time when fiscal balance is more solid, and revenues return to proper levels.
And parenthetically—a better use of unemployment and other supportive welfare funds would be in stipulating them as an exchange for participation in some kind of works or education re- training program. Otherwise this is just money being given away, and arguably incentivizes over-reliance on this type of program. By reconfiguring this allocation strategy, which seems to make simple and plain sense, we also remove the stigma of it being a pure entitlement program, and therefore mollify its critics.
The flip side of this coin though presents another issue of even more vital concern. We must also rightfully consider at some point in the near future the mountain of wasted subsidies given to the wealthy, to corporations and to others who get vast amounts of unnecessary government largesse. We have a nation of “the rich on welfare”, and this is as much an entitlement as anything given to the poor. Besides which, the amounts of these expenditures are much greater, and the pathways labyrinthine. The next part is the most vital.
The carefully applied use of spending coupons, replacing a largely wasteful and costly stimulus measure like sending out rebate checks, with a more guaranteed economic injection. Funds sent simply as checks, in an atmosphere of uncertainty, have the predictable tendency to become part of the “stuff under the mattress” economy. There is, therefore, little stimulative effect achieved. With coupons, on the contrary, the use of these exact same funds, exchanges a costly, wasteful and misfired arrow with a highly effective and targeted one.
Because these coupons would act as the equivalent of a cash gift but are, importantly, accompanied with a termination date—in other words, use ’em or lose ’em—a much larger percentage of the expenditure presumably enters the economy, and the injection is therefore nearly guaranteed. And—as any economist knows, consumer spending accounts for nearly 70% of economic activity. The coupons that go unused are also at least not a wasted expense since they would not have been redeemed.
These coupons would specifically be designated for use in the purchasing of discretionary products, not for applying towards necessary procurements like buying groceries or paying bills, which would waste their intent to increase consumer spending activity.
Additionally, delivery costs and logistics can be expedited and streamlined by integrating online redemption systems.
Highly critical to the success of this coupon program is the coupling of it with a several-months- in-advance public relations campaign that informs the public and private sector of its upcoming use. The business sector would then likely, in anticipation of increased sales, ratchet up their workforce to meet the probable demand. This is similar to the effect we see during the December holiday season, and in that regard this coupon program would best be used to bolster a calendar period with typically lackluster sales.
Because of the positive ripple effects, a moderate improvement in unemployment numbers is likely to be seen. Seeking then to lock in these improvements overall, the government should assure the public that it will re-apply this measure with consistency, as needed, which helps instill public confidence. Costs of this program would presumably be offset by the recapturing of some funds via improved tax revenues, as well as the possible multiplier effects and general acceleration of recovery realized, if system inertias begin to break up. The tide indeed does begin to rise.
Spending coupons, in supportive argument for their benefits, utility and cost-effectiveness, can be exquisitely tuned to hit their specific targets, with the ability to be modulated by dollar amount, by sector, by demographic, and other conceivable variables. The timing can also be adjusted to be delivered quarterly, by birth month, or in whatever rhythm considered optimal. Because of these fine tuning properties, fairly minimal waste should also be achievable. For example, their use would be relatively unnecessary during an otherwise normally buoyant shopping season. Or perhaps, since the luxury retail sector is currently already active, these would be unnecessary to distribute above a designated income level, etc…
This measure simply removes the variable of uncertainty or other factors that depress consumer spending levels and puts it under the control of the interventionist. It functions to act reliably in lieu of a well-funded population that is also willing to spend. It is a variation of the Fordism mentality, but the same effect is accomplished in a more simple and direct manner, seeding the economy at some cost now, but with the foreseeable benefits of much greater profits to follow as the market builds on top of it.
This same methodology may even be considered for use by government that wishes to steer industry towards wanted adoption of systemic changes, like stimulating sector-wide assumption of energy technology changes.
The use of spending coupons is not a completely new and novel idea, yet their utility seems to have been widely overlooked. As we understand, a version of this kind of program has been attributed as a possible reason why China’s economic contraction was relatively mild compared to ours.
I heard one lecture given by a very high-profile economist in 2009, who afterward fielded audience questions. When an inquiry about the possibility of the stimulative effects of spending coupons was brought up, this expert shrugged it off. In fact, I believe this one measure can be used, with great effect, in a more severely depressed economy. It may even possibly be used to build up and establish markets literally from ground up. What would have been the differences achieved if Roosevelt had used this instead of the massive expenditures of the New Deal?
We can reasonably expect some small improvements in unemployment numbers being achieved with the advent of our coupon spending program bolstering some baseline economic activity. This is not necessary for success, but will aid in laying some foundation for the next phases.
We now begin the process of attempting to dramatically shift and re-align the supply-demand imbalances of the labor force using several measures.
First, by re-initiating some significant amount of financial support to states, clearly designating these funds to be specifically for the purpose of reversing the government worker cutbacks initiated in response to budget shortfalls. The federal government must determine and communicate to the states that this program of funding support will be carried through with consistency, in as much as is possible.
Most economists agree that funding states has good bang-for-the-buck returns in positive economic results, and as well we hopefully again see some benefits of positive multiplier effects, which would offset some of the costs.
Moderate additional reductions in unemployment statistics also come from government construction programs to make improvements towards necessary infrastructure like roads, bridges and schools.
A re-analyzed and streamlined stimulus program should see significant net savings, as opposed to the originally conceived expenditures. This is not to say that there is not significant cost, but it should be at fractions in comparison. This, plus the logic behind the overall method, makes it much less likely a matter of political contention to pass these spending measures.
Besides these changes, which are made solely within the channels of government, we also move our focus towards the private sector.
If our public relations campaigns have been successful in developing a national collaborative spirit, then appeals to the business community to support these efforts will hopefully also be met with positivity and enthusiasm. Clarifying our goals to the public, with the simple-to-understand logic that some costs and efforts made now towards realigning the oversupply of labor and lowering unemployment numbers will greatly speed recovery, returning in the end much more profit from the expedited resumption of healthful market activity that benefits everyone, is a message which should make clear and common sense.
Again, the intuitive nature of our program’s workings should help a great deal in gathering broad public support. People long for intelligent leadership and will likely fall in line when they recognize it.
In order to get businesses involved with this process, we initiate a program of “employment drives,” with the specific goal of stimulating private sector jobs expansion. So, for example, once each quarter for a period of one week, businesses would be encouraged to aggressively consider how they might expand their hiring practices.
This private-sector collaboration is again a helpful but not necessary element for success. But remember that over $2 trillion of business assets is currently sitting on the sidelines. And those who maintained their jobs have often had little choice but to accept some combination of working longer hours for less pay. So, some suggestive and patriotic appeals to help in the efforts to reverse these damaging negative trends is not out of the realm of comprehension.
Helping towards achieving success with this may come from businesses who potentially foresee the genuine timing opportunity for expansion, sensing that general confidence is already building. They might otherwise choose to hire a few workers in order to alleviate the pressures on existing employees. Or finally, just because they want to assist in the government’s efforts, and have a sense of the overall mission.
What we are trying to accomplish throughout this phase, besides making significant headway in reducing the unemployment trends, is to get the whole stagnant machine of commerce to start shifting course.
Remember that psychologically we had moved from a state of panic to one of fibrillation and inertia, where the mechanisms of finance had downsized and become entrenched. In order to break up this logjam, we must rally our forces and shift from a mentality of collective lethargy to one of united resolve. We are turning to attack. The tide of battle has shifted!
Since we are now shifting specific expenditures with certain straightforward goals in mind, we will start seeing significant positive results, including reduced unemployment, due in most part to government measures, and somewhat to private sector aid.
Confidence then begins to take firmer hold, as real and palpable results are plainly seen. Tax revenues rise, and the costs on government’s shoulders of supporting the real and psychological effects of unemployment and economic contraction dramatically ease.
The administration would be advised at that time to re-double their efforts towards public relations messaging, reinforcing psychologically the successes made, and looking at ways in which progress can be either solidified or improved.
Businesses now would hopefully start seeing the real likelihood that expansion will lead to investment returns, and so this part of the commerce engine begins to spark with more frequency and less encouragement is needed to hire, building on our employment successes.
Capital lending, the most sensitive to these upward or downward trends in confidence, certainty, and likelihood of investment return, starts to flow more freely.
At some point early on in these transitive phases, government should be considering the best timing for making more accommodative moves to lower interest rates via quantitative easing or whatever other methods are available. This measure is enhanced because differential changes in rates are more readily noticed than fixed ones. At the same time, because of the large excesses of liquidity that will start to emerge, the Fed will have to carefully negotiate a balancing act against the threat of significant inflation.
Another stimulative mechanism which can be used is the perceived “window of opportunity”. If there is a feeling that beneficial rates might be withdrawn without warning, there is more urgent incentive to take advantage of them. Both this and the perception of the change of lending rates tactically use simple sales psychology.
It should be noted that all through these phases of recovery, the use of sales psychology is perhaps the most cost-effective measure of stimulus available to the interventionist and can be quite powerfully manipulated, but this tool is relatively ignored. Whole fields of study are devoted to these techniques, and it would be wise policy to ally with experts to discuss areas where these methods might be used to positive effect.
Having made great enough strides toward solidifying the processes of commerce and reigniting this self-sustaining engine, we can consider the process of passing the baton in full, and ceding all normal aspects of control back to the private markets. The ultimate goal is a kind of pressing of the psychological reset button.
The more typical economic concerns of a functioning economy come back into focus, and the sense of these has returned to one of manageability.
As important indicators have now stabilized, we can also look at where housing and student loan debt issues stand. Further collaboration may be needed with lenders to get a proper handle on this overhanging problem, but the better economic outlook should help greatly towards meeting in the middle on solving this problem. In the end, a truly functioning economy cannot be burdened by this weight, which would always add headwinds against this class of debtors to contribute to the economy by being able consumers. Lenders and the government need to accept their responsibility in creating this mass of excess debt and share in the losses in order to regain this systemic balance.
And now, finally, as more of a sense of economic certainty and wellbeing is reached, comes the proper time where we can roll up our sleeves and look at the real and hard choices ahead. There are many challenges. The economic car needs abundant repairs. In more stable economic times, we would be wise to address these problems.