Video
Transcript
The second key challenge is the economy (including finance). The U.S. is involved in an unhealthy, codependent globalization where consumption-led economies like America’s are matched by production-led economies like those of the export-led nations of East Asia. Multinational companies facilitate the production and shipment of goods from the producing to the consuming nations, earning large profits as they sell products made with developing world labor at developed world prices. The producing nations benefit from rapid economic growth and jobs. The consuming nations get inexpensive “stuff”. Something must be done with the excess dollars accumulated by the producing nations in order to manage the value of the U.S. dollar and not let it depreciate against their currency as that would price them out of the U.S. and other markets. They take their excess U.S. dollars and use them to buy assets from America – primarily U.S. Treasuries. This leaves the producing nations with ample foreign exchange reserves and America with a lot of debt. The financial industry benefits from all the deals that have to be made in order to recycle trillions of U.S. dollars back into U.S. dollar-denominated assets. Wall Street makes a profit on every transaction.
For America, the result is an economy of bubbles on top of bubbles. The recycling of U.S. dollars overvalues the currency. This is the dollar bubble. The recycling of U.S. dollars primarily into debt pushes down interest rates, making it more attractive for borrowers to become more indebted. This is the debt bubble. Finally, low interest rates push up the value of assets like stocks and real estate. Of course, the technology revolution and its irrational exuberance produced the stock market bubble. Low interest rates were a minor factor in that bubble but played a key role in fostering the real estate bubble along with lax credit standards. The net worth is the difference between assets and debt. All financial bubbles eventually deflate – sometimes with a bang! When this happens in America, the value of assets will decline much more than the value of debt, resulting in a much smaller net worth.
The housing bubble deserves a closer look because it is the largest single asset most people own. The chart shows home values from 1890. The scale of the housing bubble that topped around 2006 was unprecedented. Financial bubbles tend to deflate until they return to where they started. If so, the housing bubble may ultimately have further to deflate. However, ultra-low interest rates seem to be helping in putting a floor under prices along with other factors. The table shows that the amount of mortgages doubled from 2001 to 2007 – a mere six years. People owned an average of 69% of their homes in 1985 but only 45% in 2008.
Homeowners used their homes like ATM machines in the first few years of the 21st century, maxing out at a rate of about $500 billion per year in equity withdrawals in 2005 and 2006. Altogether, trillions of dollars of home equity were cashed out and spent by Americans eager to keep up their lifestyle even in the face of mounting wage pressures. But this problem had been building ever since the late 1980s when people began to spend in excess of their cash income by cashing out their capital gains and going deeply into debt. This trend bottomed in 2005-8 with people spending about $1 trillion per year more than their cash income. The people’s ability and willingness to continue spending diminished greatly in the aftermath of the 2008 financial crisis so the federal government stepped in with massive deficit spending in order to keep the economy from shrinking. But anyone should be able to see that that is not a permanent fix.
The result of all the borrowing and spending has been a massive build-up of debt in the economy. Debt as a percentage of GDP peaked in the early 1930s and then collapsed. Most of this debt was corporate debt that was wiped out via default as businesses went bankrupt. Government debt expanded during the 1930s as the federal government partially offset the collapse in private sector spending with spending of its own. The total debt-to-GDP ratio reached a nadir in the early 1950s and has expanded ever since. By the time of the 2008 financial crisis, it had surpassed the debt-to-GDP ratio of the early 1930s. Excessive household and government-sponsored enterprise debt sparked the 2008 financial crisis.
The functional difference that sets apart a bank from any other entity is its ability to create new money. Central banks create new money. And so do commercial banks when they extend credit. No one needs to save first. When people borrow money, they don’t borrow it in order to let it sit in their checking account. They spend it! This spending becomes somebody else’s income. Spending and income are taxed, generating revenue for the government. When recession strikes, people borrow less and, therefore, spend less. Less spending and income generates less government tax revenue. Government deficits worsen.
The table shows household and business borrowing from 2000 through 2009. In 2000, household and business borrowing expanded by $1.1 trillion. By 2007, that had doubled to $2.2 trillion. By 2009, that had reversed to shrink by $0.5 trillion, a reversal in the rate of growth of debt of about $2.7 trillion in only two years. Borrowers simply stopped borrowing and either paid down or defaulted on debt. Assume that the federal government collected 20% of the incremental borrowing and spending and state and local governments collected 10%. (The percentages are only a guesstimate.) A reversal of $2.7 trillion would increase the federal deficit by about $530 billion per year and state and local government deficits by about $265 billion per year between 2007 and 2009. Add in additional spending for automatic stabilizers like unemployment insurance, welfare, and Medicaid plus additional money for stimulus spending and the result will be deficits over $1 trillion per year. A key observation is that the private sector is saturated with debt. It’s not going to renew borrowing large amounts of money, so the drop in government revenues is more or less permanent. Solutions will have to be found elsewhere.
Alexis de Tocqueville once said, “The American Republic will endure until the day Congress discovers that it can bribe the public with the public’s money.” John Kennedy said that we should ask what we can do for America, but the reality since the New Deal is that we ask what America will do for us if so-and-so is elected. The result of this is that the Democrats, under the mantra of “we care,” got most of the social spending they wanted. Republicans tended to oppose this expansion of government, but being tagged as the party that doesn’t care didn’t sell well at the polls. By chance during the Reagan years, they happened upon the formula of establishing their national security credentials through heavy military spending along with tax cuts. That combination did sell well at the polls. But the result of Democratic and Republican policies was chronic deficits that blew out in 2008.
There was a theory put forward by a few people in the early 21st century called “starve the beast.” It posited that you could cut the size of government by cutting its revenue. President George W. Bush did cut taxes…and then spent the money anyway. Big spending drives big government. The bar chart shows the steady rise of government spending over the Bush years and the early Obama years. The only deviation was around the financial crisis when spending temporarily rose and then settled back on track. A person gazing at this chart would not be able to tell which political party was in charge during those years – much less that government had switched from a hard right government to a hard left government. Maybe there isn’t a real difference. After all, the right-wing Bush administration and the left-wing Obama administration both wanted to use government power to realize their respective agendas.
The pie chart shows where the money goes. Most money is spent on social programs. Defense spending is relatively small but far from negligible, particularly when other national security-related spending like veterans affairs, civilian intelligence and homeland security are included.
Slides
FixAmericasFuture_Present_No_Audio-compressed-kc-Economy
Cost Estimate
Not applicable.