The Great Contraction: It's Coming... But Can We Ease The Pain?

There is no point in trying to deny reality: After a relatively long period of general and steady economic expansion, thanks primarily to the post war baby boom and Keynesian economics, we are finally starting to overreact to the all too generous reliance on debt and we are entering a period of economic contraction; a contraction which is a natural reaction resulting from our previous all too generous reliance on debt.
Part of the problem we face is simple demographics. As we boomers age it is natural th at we spend a little less and save a little more: With storm clouds building on all horizons, we will finally start saving for the proverbial rainy day. Part of the problem is simple economics: You can over indulge on debt only so long before the piper thrusts out his hand and demands to be paid.
Some level of contraction was, of course, eventually inevitable. But since contractions are so painful it was also only natural that we try and postpone the day of reckoning as long as possible and manage it as efficiently as possible. And, if we keep our wits about us, we can still postpone the depression to a later date or, with a bit of luck and strong management skills, only experience a deep recession. Maybe we shouldn’t. Maybe we should just bite the bullet and let the economy collapse and get it over with. That is just what we will do if we continue to reduce government spending while consumers individually try to save themselves from insolvency and businesses pull in the reins of expansion since they see 22.5% of the productive capacity sitting idle a full two years after the official end of the recent recession.
But Americans, in general, are optimistic- they are not quitters- and if there is a chance of avoiding a total economic collapse we might as well give it a go. And, in all honesty, a major financial and economic collapse is avoidable, just a bit unlikely. I thought the bubble of debt was about to implode in the late 1980’s after eight long years of Reagan’s we can have it all and we can have it all now philosophy of government but we managed to muddle through the massive increase in debt and the insanity of supply side economics. Now it is 2011 and we have managed, so far, to postpone the supposedly inevitable Day of Reckoning. And, if we use common sense instead of ridiculous rhetoric and political propaganda proposed in the pursuit of political power, we just might discover we still have a quite bit of economic growth within reach.
To avoid the Second Great Depression we have to accept and confront the dual problems we face: An aging population sitting atop a mountain of debt.
We can solve the aging population problem with relative ease. At some point in the very near future we need to expand our population with younger, educated workers ready to embark on a life of productivity and consumption instead of having an economy dominated by old fogies ready to embark on a life of semi or total retirement and a dramatically dwindling desire for the latest gadgets and toys while they wistfully pine for their glory days. In other words, we need to change our attitude towards immigration. Forget the financial aspects and focus on this fact: At some point in the not too distant future we will need more workers just to do the actual, physical, work the boomers will no longer be able to do due to age and infirmities.
We also have to change our attitude towards debt. Debt is not an evil. It is merely a financial tool necessary in a system where too much purchasing power is concentrated into too few hands. This is not just an argument about morality and fairness. It is really an economic argument that markets can not clear, we can’t buy all that we are trying to sell, when so much of the wealth from the real production escapes the real economy only to push up asset prices in the investment economy since it is held by those who don’t need it in the real economy. That is the flaw in Say’s Law. Real production is paid for with real production except for the real production which can’t be purchased at true market value because some of the true market value slipped away to purchase paper investments instead of the real production.
We can also attack that mountain of debt and reduce it a bit but we have to use some rare common sense. We have to remember that debt is one of those areas where what is good for the goose is not necessarily good for the gaggle. Sure, it is financially prudent for an individual to escape their personal mountain of debt and invest, rather than spend, their money but if too many try to follow that bit of financial wisdom a depression and financial collapse will be the inevitable result.
To prudently battle the mountain of debt we can accept the fact that bankruptcy is a fairly efficient way to remove excess debt from our system. Bankruptcy purges our economic system of excessive debt. When an individual or business goes bankrupt and their assets are liquidated the assets are not removed from the economy, they are just purchased by another entity in a better financial position to make the payments and make a profit. The same amount of real wealth is still capable of benefiting the economy but less debt remains to burden the economy. Bailing out the financially weakest makes little sense. We do have to be careful of a spiraling financial collapse in real asset prices resulting from too many bankruptcies in any specific sector but if we use bankruptcy prudently and allow the bankrupt a realistic ability to borrow anew, the economy as a whole will benefit.
We can also pay off some of the debt. We do, however, have to remember that paying off debt does not stimulate the economy. Paying off debt does not create jobs. Paying off debt does not increase our GDP. Sure, it is prudent to pay off some of the debt but we can’t forget someone still has to be spending if we want to see economic growth. Paying down debt cannot come at the expense of spending since spending is the only way we can keep the Gross Domestic Product expanding and that is the only way to avoid a recession/depression. Debt reduction is not a viable option for economic expansion.
However, shrinking that mountain of debt through inflation is an option. As our currency loses its value our debt becomes less of a burden since we can pay off the debt with cheaper dollars. We need to get over our irrational fear of inflation. We are a nation mired deeply in debt, as individuals and as a nation, and debtors benefit from an inflated currency.
Finally, we can try to wean ourselves from imports and focus our energies and creativity on exports. This, however, won’t help nearly as much as most assume unless we increase exports dramatically which is extremely unlikely since most of the world has set sail in the same economic boat constructed of debt as the United States. In June 2011 imports less exports were only .35% of our GDP. It is simply not realistic to expect the rest of the world to bail us out of several generations of excess by buying our goods while we close our borders to theirs.
We can avoid another Great Depression. But will we? I don’t think it is likely. Too many will oppose immigration until it is too late because we all know “they” will steal the jobs older Americans won’t want and won’t be able to perform even if they wanted to. Too many will reduce their borrowing and consumption because the financial whiz on TV says it is the only sane course of action for the prudent individual. Too many will see bankruptcy as the proper punishment for moral degenerates rather than a chance for individuals and businesses to start anew and once again be a consuming asset to an economy driven by demand. And too many will continue to snap up the imports since we all know the least expensive to the individual is always the best choice for the society.
Copyright 2011 - J. Peter Van Schaik