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Why There Is A Recession Happening You Non-Economic Douchebags; Part One: Debt

August 8, 2011

Okay, I’m onto my second beer on Monday night and am strongly considering making it a third, so let’s quickly explain what the fuck is happening in this stupid world. The article may be a bit long but it’s all easy to read and will actually explain this shit to you nincompoops so it’s worth the five minutes you could be spending posting links on Rafi’s wall.

There are two kinds of debt; public debt and private debt. Public debt is what the government (in all cases here we’re talking federal) borrows. Private debt is the sum (“aggregate” if you’re an economist) of all consumer/household debt. Being indebted in either isn’t a bad thing per se, but this is assuming a rational world in which people pay back their loans. Now, welcome to the Matrix.

1) Most importantly; almost every Western government has been living beyond its means for a very long time.

Most Western economies have drastically cut their taxes since the 1980s due to neoliberal economic policies (we often call it economic rationalism here), which essentially means they distrust government, see market failure as generally preferable to government failure, and believe that if the rich are taxed less then they’ll reinvest more into the economy, create higher growth, so you may have more inequality but everyone will be better off. Now, whether you think that’s a moral call is your lookout, I personally think it’s tripe but that’s another matter for another day. The point is it doesn’t really work. Rich people/entrepreneurs (whatever you want to call them) don’t necessarily reinvest all of their money. The idea is that given the higher rate of profit acts as an incentive, all economic actors being “rational”, but what they fail to realise is that a lot of rich people will just say “thanks for the money” and not invest anymore, because they value their leisure time over increased risk and work time, and when one is pulling in the millions a few millions more aren’t really that big of a deal.

So tax cuts for the rich just make the rich richer and don’t do much for the rest of us. Cool (if you want empirical proof; see the how taxes are much lower now in America than they ever were in the recent past and how much worse their economy is doing).

What’s also important to note is that there’s a general dichotomy in economic thought, between “free-market” classical/neoclassical/new classical/monetarist economists and “government interventionist” Keynesians (there are many types, but that doesn’t matter at the moment because few people/policies are actually Keynesian at the moment). With the rise of neoliberalism (which is a free-market ideology in case you didn’t pick that up), Keynesianism has increasingly been left out of the orthodoxy. Any Keynesian would have said “lowering taxes on the rich does nothing, because the rich aren’t going to spend much of it, and a more equitable distribution of income creates higher growth, which ergo creates higher employment and less bad times for all”. This is because the poor have less income and therefore are more likely to spend it all, whereas rich people save a lot. And under Keynes, saving is bad for the economy (even if it’s good for the individual; it’s a paradox bitches) because it just lowers the amount spent.

So because we reduced taxes for everyone (but especially the rich), many governments found they had less money to spend. Not that this stopped them; they continued spending, spending and spending. Bush invaded two countries, gave old people all the viagra they wanted and lots of businesses in America are given special treatment (known as corporate welfare) anyway, so some of them like General Electric (the 6th or so largest firm in the US) not only didn’t pay any tax but actually got given money from the government. Thus, less and less revenue, accompanied by increasing amounts of spending. A lot of European economies had similar issues, and all face pretty high debt-GDP ratios.

As said, debt isn’t inherently bad. When recessions hit, economies naturally go into debt. Even if the governments don’t spend a cent extra, what happens is that since unemployment rises, less tax is paid, and more people receive unemployment benefits, so revenue decreases and expenditure rises. And generally most Keynesians advocate government spending to stimulate demand in the economy, so it’s natural to go into debt in recessions. The point is that you’re supposed to go back into surplus when you’re not in recession. And as I explained above, through a combination of political and economic incompetence/vested interests, most economies went deeper into debt in boom-times than they should be in recessions. Yeah.

That was a long point 1), but context is important.

2) Private debt has also risen a lot in the last 30 years.

This isn’t as important but still has significant merit. Over the last 30 years, not only has public debt risen greatly, but private debt has too. Essentially, households have been living greatly beyond their means. Blame credit cards, blame whatever you want. The point is that debt has to be paid back at some point (generally during a crisis/recession when people want to reduce their risks, ie: now). Because the economy has been functioning on such high levels of private debt however (I think it was nearing 100% in Australia, but I cannot honestly recall), what has happened has that the economy has restructured itself around higher than normal levels of consumer spending, which by nature of being debt, aren’t really sustainable. We’re seeing the effects of this in Australia already; retailers are complaining about how little people are purchasing because on the whole consumers are now saving more than they once did. We used to save about 10% of our income, then in the 90s we started spending more than we earned, and now that effect is being reversed and we’re going back to our old habits (thanks Ross Gittins for pointing this out a lot).

This is actually going to take a while to explain, even in my condensed fashion. Part Two coming soon.

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3 Comments
  1. Doug permalink

    What is your opinion of the so called “rebirth” of Keynesianism in 2007-2008 and now America falling back into recession after a short bump in growth from the American Stimulus packages? QE1 and 2 have been quite a joke in the US but all us investors pray they have a third one so we can fantasise we’d actually sell on the last part of the bubble.

    The last week seems to support the theory that Keynesianism has just caused a speculative bubble and bought the market another few years of fun. American public debt is also not yet a real issue due to the size of their economy (But it is a political football). European debt is an issue however due to inept governments which couldn’t collect tax or reduce public spending.

    China could be seen as a success but its inflation is getting out of hand and their central bank is pulling back a bit now.

    • urgh I’ll answer this properly when it’s not 1am; even better I was actually planning to address it in the next blog, how most Keynesian responses really aren’t Keynesian per se.

      Indeed, that was the whole cause of the 1970s bust. While I’m no scholar of the stagflation issue, it seemed to me like it was just poor demand injections to the wrong people when the economy had low effective demand. Friedman’s recommendations, while curbing inflation somewhat, massively increased unemployment, so clearly the monetarists were not in the right then (and frankly when monetarists aren’t right in the 1970s-80s then when are they).

      You say European governments are a joke due to not being able to collect tax or reduce public spending, but man oh man I don’t see how that differs from the US.

    • I mean yeah tl;dr: in China and Australia proper Keynesian policies were used and worked very well. They could have been a lot better, more targeted and with less waste/pandering to rich people (which is probably what has caused some inflation in both countries) but on the whole, much better than Obama’s (Geithner’s/Republican’s really) tax cuts which comprised half of his stimulus bill. The stimulus bill should have been double the size. You don’t get anywhere with a weakass recovery injection. Learn from FDR, you plunge that shit in. And FDR was still always concerned with a budget surplus! Imagine how well should would’ve gone had he not had that worry (as it was to me much more the wars than the New Deal in and of itself that rejuvenated the US)

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