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Keynes to Success

The Federal Government has thrown its entire weight into preventing a Depression through a program of dedicated spending.  The original bailout/stimulus of $700 billion is being matched by a project budget deficit of $1,100 billion for 2009, plus whatever President Obama proposes and untold amounts of money loaned by the Federal Reserve.  All together, the total debt of $11 trillion is already similar to the size of our total economy, but we have been told that the additional borrowing is necessary to keep the economy running.

One question is rarely asked:  What happens if it doesn’t work?

There is a fundamental assumption in all this activity that “priming the pump” is what governments do best in a downturn.  If money is short, national governments can spend like crazy to get things going again.  This is called a “Keynsian Stimulus” after the man who first proposed it, John Maynard Keynes.  It’s what got us out of the Great Depression and softened the impact of many smaller recessions since.  It’s proven to be more than handy for propping things up.

There’s one huge problem with it, however.  We’ve been pushing money into the economy, both as a federal government and as private borrowers, for years and we still got into trouble.  Try this graph:

image001

The blue line shows inflation-adjusted changes in our Gross Domestic Product (GDP).  We had a little bit of a downturn in 2000, but appear to have bounced back.  The purple line shows what happens if you take out the part of our economy that was financed by our government’s deficit spending – the Keynsian stimulus we’ve been running since 2001.  We’ve already been goosing the economy, even before we ran into trouble.  Things look much worse in the red line, which is the same data after you remove the cash-out of home equity that was as much as 3.4% of our economy but has now evaporated.  Clearly, there was a lot of cash in the form of Treasury Bonds and home values that moved from being an investment to being something we consumed.

For all this newfound wealth, we still wound up in a crisis.  Indeed, if you look at the typical effects of a recession, which include restructuring and re-allocating money to more productive sectors, you would expect that we would have emerged from the recession of 2000-2001 stronger than ever; that’s the typical reaction.  But we didn’t.  We papered over the effects of the downturn with a massive injection of cash and became weaker.

How much weaker did we become?  In a report from the Dallas Fed, we can see that while consumption ran about 62% of the economy from 1980 to 1996, that number crept up to 65% by 1999 and then rocketed to 70% by 2003.  Consumption edged out other economic activities such as investment to become a significantly larger part of what this economy is about.

Is it entirely possible that a Keynsian stimulus, like the one that is costing us upwards of 20% of our entire GDP, won’t work?  It certainly is.  We have had a stimulus of about a third that for the last 8 years and it succeeded only in making things worse over the long haul.  The need is not for simply more cash, but for a fundamental restructuring that directs the stimulus in the right directions.  Consumption is a big part of the problem, but the financial institutions that are “too big to fail” need very much to change how they do business – or fail.

That may sound very harsh, and I certainly intend it to be.  There is a fundamental assumption to the way we do things in the USofA, and it is almost certainly wrong.  It’s wrong because we’ve been over-using the levers that are supposed to save our asses when things do get bad.  That means we have to change, which is to say confront the Five Crises directly.  Spending a lot of money we don’t have may well be a part of the equation, but only with the kind of painful restructuring that should have taken place as long as 8 years ago.

Let’s get started.  Why do people think that a lot of money borrowed against the future will produce a reasonable return if invested in this economy?  Forget all the assumptions; we’ve burned through those.  What’s the return going to be if we invest in the USofA and the good people who reside in it?

17 thoughts on “Keynes to Success

  1. I’m still getting the hang of all this stuff, so this might be a dumb question. I know you like to present an idea that the mainstream hasn’t considered and let the reader make her own mind up. But what if we spend all this money, and it looks like we will, and it really doesn’t work? Aren’t we in a lot more trouble? And if all this spending doesn’t work to turn things around anymore, why not? What else should we do?

    I think this is one time when you really should answer the question. Maybe you will later, but honestly, I can’t dream of what would come next.

  2. That was 4 questions. 🙂

    If we spend this and it doesn’t work, I have no idea what comes next, either. We’ll have shot our ammo and still not have dinner.

    This may not have worked on the recession of 2000 because we used a “trickle down” method of stimulating the economy – upper middle class tax cuts, a war, and so on. I was hoping to quantify that, but I couldn’t – the resulting argument was a lot of hand-waving that looked stupid. But it’s possible that a real New Deal would still work as it did in the 30s. That’s not what we’re doing so far, however.

    My concern is that there is so much restructuring that needs to be done that we might not have a working pump to prime. There’s far too much money going into exercises in pushing money around rather than actually making stuff, for example. We may have to break the economy as we know it down much further before there’s something that deserves the investment of a Keynesian stimulus.

    I admit, I’m really not sure yet. I would like to see this debated, however. Why isn’t it? Why are people so damned sure this will work – because it’s the only idea they have?

  3. Its the only idea folks have, that ensures the status quo in government and the banking industry can remain, or survive albeit with some damage.

    Radical ideas, such as nationalizing the banks for a short term, such as was done in Sweden, are still anathema. Too many equity holders would loose their shirt, and too many would loose a ton of power. Yet, as history shows, short term nationalization seemed to work pretty well, and banks became private firms again after a couple years… but their are severe haircuts given to a few to make that happen. There are a multitude of other radical ideas out there… but they all cause a lot of specific damage to key areas, thus they dont get much airplay.

    I agree, the working pump may go away, as there will likely be tons of hand waving, and pushing money around, and likly few results, short of avoiding equity holders loosing their entire shirt, or bank runs. If this doesnt work, there will be a major redistribution of wealth as the system rebuilds itself, and the economic system as well as government will undergo dramatic restructuring. We’re already seeing this worldwide in offshore shipping, as bartering is replacing letters of credit and cash. That no doubt puts tremendous fear in the hearts of the banks and govt, but alas they have done it to themselves.

  4. Just curious where your graph comes from. Did you put it together yourself (take annual GDP, minus deficit per year, minus home equity cash-outs per year)?

  5. Kady: I do my own graphs, and always have. It goes with the Chemical Engineering degree. The data sources are linked to in the text just below the graph itself.

    Someday, I’ll pull out the state-by-state comparisons I’ve whipped up that are absolutely fascinating. 🙂

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