Today, we face the prospects of continuing high levels of unemployment, the default of sovereign nations (i.e. Greece, Italy, Spain, etc.), and a repeat collapse of the global financial system. While all this is going on, I don't hear anyone speaking about the real problem, and consequently, a solution that will lead us back from the abyss. For my part, I believe the problem is obvious ...
The World According to Smith
235 years ago, modern economics was born when Adam Smith wrote The Wealth of Nations. Smith gave us a model of national wealth that grows through the efficient use of land, labor and capital. He believed that the best way to achieve this growth was through the "invisible hand" which magically guides free markets.
Smith wrote his book in 1776, the same year as the birth of our nation. It was at a time when Monarchies first started losing to the modern nation-state, and industrialization had just started to ramp. By embracing the free market philosophies of Adam Smith, capitalistic societies were able to rapidly expand throughout the world, growing along with the dramatic changes brought about by industrialization.
As successful as the free market was in expanding capitalism and industry, one nagging little problem kept cropping up. Every once in a while, the invisible hand would break down, and the free market would stop working. This was especially troubling when the result was prolonged unemployment for the new industrial worker -- a worker who needs a job to keep a roof over their head, and food on their table.
The World According to Kondratieff
While many people saw recurring cycles in the economy, most believed the pattern was simply a mild business cycle that recurred every 4 years or so. Some did recognize a longer cycle that lasted around 11 years, but there was no consensus on why this might be the case.
Then, in 1926, three years before the Great Depression, Nickolai Kondratieff wrote a paper titled "Long Waves in Economic Life." He was one of the first to observe that capitalistic economies undergo decades-long cycles of inflation, followed by deflation. Today, his observations are known as the Kondratieff Wave.
The World According to Keynes
While Smith espoused free markets, and Kondratieff recognized and predicted the "long wave" result, John Meynard Keynes decided to study historical panics, recessions and depressions, with a special focus on unemployment. In 1936, he wrote The General Theory of Employment, Interest, and Money, and Keynesian economics was born.
Keynes gave us a model of the economy that, for the first time, included a framework for governments to actively participate in the business cycle. Instead of solely relying on the invisible hand to manage free markets, governments were now empowered with fiscal and monetary policies that they could use to mitigate recessions and depressions. His model worked so well, that by the end of the 1960's, almost every western nation had adopted Keynesian economics.
When I studied economics in the late 70's, the professor was Denslow, the textbook was Samuelson, and the concepts were Keynesian. While Keynes had worked for 30+ years, the Keynesian model seemed to stop working in the high inflation, high unemployment environment at that time. As Keynes lost favor, so called "supply side" economics came on the scene, eventually to be replaced with a return to the free market ideology prevalent under Smith.
It is that free-market ideology that has brought us again to the brink.
The World According to Batra
I first learned of the long wave back in the early 80s, and I'd been expecting what is today known as the Great Recession ever since. Because of this, in the late 80s, I read a book titled The Great Depression of 1990 by Ravi Batra. While his timing was a little off, his insights into the causes of market failures were spot on, and describe perfectly what's going today.
According to Batra, the reason markets break down, is that capital gets accumulated at the top, and ceases to circulate in the economy. When the bottom of the wealth pyramid collapses, those people at the bottom have nothing left to spend, and the low end of the market freezes. Then, when those who sell or otherwise depend on the low end of the market start to lose their income and wealth, they stop spending as well. This leads to a general market failure, as money is taken out of circulation, and the market failures spiral upward.
We can see this today. Recent poverty numbers confirm that many former members of the middle class, have now entered the ranks of the poor. Many people have lost their life savings, their retirement, and their homes. Those who depend on these people (the retailers, the taxing authorities, etc.) have seen their income evaporate as well.
At the same time, those at the top have been hording money. We can see this in the estimated $2 Trillion held by large corporations, that they are not investing in factories or employees. We can see this in the many Trillions more on the books of the big banks, that they are not lending to borrowers. So long as there is not an expanding market for goods and services, they will continue to sit on their holdings. Instead, they will seek the highest returns possible by speculating in commodities and financial products, or by bribing Congress for tax breaks and more corporate welfare.
Public Policy Response
When the housing bubble burst and the markets froze in 2007, our leaders turned to Keynes for a response. That's why the U.S. Government authorized the $900 Billion stimulus plan. That's why the Federal Reserve has injected over $1.5 Trillion into the system. And that's why foreign governments have injected Billions of Euros into their system as well.
Unfortunately, they did all this without acknowledging nor addressing the real reasons for the market failure.
Today, this folly continues. How many times have you heard someone say that Americans must be retrained with new skills to be competitive to find a job? How many times have you heard someone say that we must invest in new industries, to create jobs and be competitive in the world markets? None of these address the real problem -- a lack of demand for goods and services, caused by a lack of capital in the low end of the market.
The Real Way Forward
If we really want to end the Great Recession, the prescription is simple. Stop putting money in at the top of the pyramid, and put it where it will make a difference and start the spending again. Instead of giving $900 Billion to the banks, instead of borrowing $1.5 Trillion from the Fed to support the too big to fail, instead of spending $447 Billion on a jobs program that at best will create 1 million jobs, give it directly to the people, and cut out the middle man.
Consider this. If we conservatively estimate that the entire amount of money spent through fiscal and monetary policy to prop up these too big to fail institutions, it is approximately $3,000,000,000,000. If instead, we issued a check to every man, woman and child in this country, each person would receive approximately $10,000. That's $40,000 for a family of four.
With this type of Keynesian stimulus, our economy would be humming again. And those too big to fail institutions would be gone, and no longer a problem. I know this one will ruffle some feathers, but as always, comments welcome. Until next time.