Legendary Boston Celtics coach Red Auerbach traditionally lit a cigar to celebrate his team’s victory.
Unfortunately, we cannot smell the scent of victory over our escalating recession despite spending trillions of dollars that have to date left a legacy of ashes.
For the first time since World War II, policymakers warn that declining consumer demand might lead to deflation and higher unemployment. Deflation is described as a decline in the general price level. And since federal policymakers have used up almost all of their monetary tools, officials will rely more on fiscal tools such as the $800 billion stimulus program.
Our current fears about deflation reflect a 180-degree change from our post-World War II inflation worries. Even during the first half of 2008 we focused on the perils of skyrocketing commodity prices, such as oil topping $140 per barrel.
Many modern economists mistakenly believed that we had cured deflation because of the policy prescriptions of John Keynes. Keynes recommended that the government embark on massive spending and reduce taxes in order to rekindle private sector demand. Our World War II experience confirmed the soundness of Keynesian economic doctrines. That is, the government programs of hiring millions of people and spending billions to provision our troops jump started our economy and rebuilt inflationary pressures.
Why were Keynes’ ideas so revolutionary?
Economists before Keynes generally believed in Say’s Law, attributed to French businessman and economist Jean-Baptiste Say, that supply creates its own demand. A decline in prices would increase demand. The market would self-correct; that is, increased demand would raise prices.
What could cause deflation?
The most recent Federal Reserve Survey of Consumer Finances provided disturbing clues. Specifically, the net worth of the average household, adjusted for inflation, is lower now than in 2001. By 2006, many cash-strapped Americans could no longer make mortgage payments on their homes, whose prices had risen to unsupportable levels.
Some have little incentive to make mortgage payments because the amount they owe exceeds the value of their houses.
The Bank Credit Analyst, a financial research journal, reported that U.S. non-federal debt soared from being equal to 100 percent of the nation’s Gross Domestic Product to being equal to 190 percent in 2008.
Debt stands at the highest level since the 1930s.
What caused the spending gas tank to empty?
Over the past two decades, America changed from a nation of savers to spenders.
Nobel laureate Paul Krugman noted in his Feb. 18 New York Times column, “Decade at Bernie’s,” that personal savings rate dropped from 9 percent in the 1980s to just 0.6 percent from 2005 to 2007. Household debt grew much faster than personal income. Mortgage debt alone grew from $2.5 trillion to $10 trillion from 1990 to 2007.
Has America historically suffered from deflation?
We experienced dramatic price declines from 1837-1841, 1873-1896, and 1929-1939.
Why have massive spending programs and stimulus packages not cured our current malaise?
First of all, the $700 billion Troubled Asset Relief Program, or TARP, was insufficient and poorly executed. The banking system needs trillions, not billions, of dollars.
NYU Professor Nouriel Roubini said that the banking system has a $500 billion shortfall. He estimated total loan losses ($1.1 trillion) and securities write downs ($700 billion) could reach $1.8 trillion. This exceeds FDIC-insured banks capitalization of $1.3 trillion.
Secondly, the high default rate on many asset-backed securities frightened investors into avoiding securities backed by auto loans, mortgages and credit cards.
Third of all, Americans no longer shop until we drop.
Lastly, monetary and fiscal policy corrective measures require a lag time of many months to be effective.
New York Times writer David Brooks argued in his Jan. 8 column, “The Confidence Surplus,” that while there is wide support for fiscal stimulus, there is no historical experience to tell us how to do it, how to make it work, or what kind of economic prescription is required.
In a nutshell, we are damned if we do, and damned if we do not.
We do not have the luxury of declaring victory and going home for we can hear the auction gavel.
The nations’ favorite guessing game is when will we see light at the end of the tunnel? Currently we are still feeling our way around the corner.
Originally published in the Sarasota Herald-Tribune
