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Tuesday, February 10, 2009

The Stimulus Fallacy: The Answer to Too Much Leverage...More Leverage

The two government actions that turned the recession of the late 1920's into the depression of the 1930's were 1) the Smoot Hawley Act, which was protectionist and set off a trade war and thus stunted trade, and 2) raising taxes on the highest income earners. We now all recognize that raising taxes is contractionary and so is protectionism. While these two principles are almost economic fact now, they were then the subject of so much debate that they became policy in the middle of an economic recession.

In my opinion, the biggest fallacy of the stimulus is the idea that we resolve a crisis created by too much leverage with more leverage. On the simplest level, we are in this mess because everyone from government, business, banks, and consumers borrowed more than they could handle. The government ran up outrageous deficits all throughout the whole of this decade. Banks didn't merely get involved in far too much sub prime lending, but they began leveraging themselves to take far too great a position in these financial instruments. In fact, no less than the President himself said as much last night. Meanwhile, borrowers took on mortgages, car loans, and credit card debt they also couldn't afford. Once the financial meltdown became apparent we heard that businesses might cease if they didn't get credit lines in order to meet payroll. Once everything unraveled it was clear the entire nation, top to bottom, is far too leveraged. That was always evident. This decade brought about one of the worst borrowing rates ever.

So, what is President Obama's solution. He wants to borrow an unprecedented amount in order to revive the economy that is in the doldrums from a decade of far too much borrowing. It's the equivalent of giving a crack addict even more crack to cure the addiction. Is the cure to too much borrowing even more borrowing? This appears to me to be a fallacy that will one day wind up in history books as an example of what not to do.

In fact, the President alluded to this dichotomy. He said that soon we will all need to re examine our budgets, but before that, the government will borrow in excess of $1 trillion. This is the sort of illogical thinking that turns economic downturns into crises. If out of control borrowing were the answer, we wouldn't be here in the first place. It was out of control borrowing that got us here. To believe it is the solution is to believe in economic fantasy.

Wouldn't the answer to out of control borrow be fiscal discipline?

1 comment:

Anonymous said...

In answer to your last question, of course it would!

I guess that congressmen and congresswomen (it doesn't matter which party) really don't equate government budgeting with personal and business budgeting. They also must not understand the concept of money. They know that money is important to their political careers. They and their staff spend the majority of their time raising campaign funds. This money is sort of free, except that the donors do expect a return on their investment.

Many, if not most, members of Congress are wealthy and can afford most anything they desire. Plus, they get to spend our tax money for their own self interest. Life is good.

Bottom line, the example that politicians set for spending our money is followed by a large part of our society. Their example shows that there are no real consequences for fiscal mismanagement. The re-election rate is, I think, above 90%. That is pretty good for irresponsible behavior. So, why should any of us be responsible?

What is needed are real consequences (punishment, basically) for these politicians that have lost all control of government spending. And I don't think losing an election is sufficient.