With rising unemployment and collapsing economic activity, there is widespread support on this site and others for some sort of stimulus. This is perhaps an understandable reaction, but misguided. Deficits suddenly don't matter, because there is the fear of unemployment.
For years, we have seen the failure of wages to GDP and productivity; the result is that the gains in GDP have been accrued to entities and people who don't make most of their money from wages. But a stimulus is precisely what we don't need at this point and runs the risk of pushing the existing global financial system to the breaking point.
This is not a normal crisis but rather a multi-generational systemic failure of the entire global system of finance and commerce. What we need is far more radical than a stimulus, but a total reformation of our economic system.
Without addressing the fundamental structural flaws within the economy, any such debt-fueled "stimulus" will amount to a bet: that the government can become and borrower and spender of last resort.
We are faced with the following problems.
The financial system is fundamentally broken. The hallmark of a dysfunctional financial system is that it rewards bad decision making, distorts and hides the values of assets, and fails to provide incentives to invest properly. We have that in spades, but what we have now is even worse: a destablized system in which fraud is rampant and all the rules have been tossed out. Corruption in such systems is not only overt, as in cases such as Madoff, but in the very fabric and culture of the system itself. Banks are collectively hide their insolvency, and TARP is being used merely to prop them up. Their level 3 assets (mark to model, hard to value assets) are likely to be tremendously underwater-- but no one really knows, because there is a shroud of secrecy drawn over everything.
We have entered a debt trap. Much is made out of the notion of a liquidity trap, but many observers point also to the fact that we have entered a debt trap: that every dollar of debt incurred has progressively less ability to grow the economy. At some point, we have observed that each dollar of debt has brought less than a dollar of growth in the economy.
Massive total debt. Some have pointed out the federal debt as a percentage of GDP is in the middle of the historical range and that we can therefore afford for the government to run even larger deficits for a while. However, total debt to GDP ratio (public +private) is at the top of the range at greater than 300%, even before the inevitable decline in GDP. Under the guise of various bailouts, the government is "socializing" of private debt through the Fed and the treasury. The situation is very unlike that of the great depression. Note in the chart that total credit market debt exceeds that achieved during the depths of the great depression, but the rise in that debt was largely due to a collapsing GDP.
An unsustainable debt-driven consumer society. For the past couple decades, debt has bee outstripping income. People have been literally mortgaging their future to maintain their lifestyle. To do this, we have run persistent trade deficits. We are the world's dumping ground for goods, which we exchange for treasuries and other debt.
There remains the common sentiment that a massive stimulus must now be the answer. There will be some who say that we have to stabilize the economy first. More of the same stimulus, only really big amounts, will somehow fix things long enough to make real reforms. Yet if there was by some freakish accident a return to the same unsustainble patterns of behavior, where would the impetus for radical reformation come from?
If there is a plan, it must be a truly transformational one for the government and the economy. We do not have too many shots at this; the current system has reached critical mass. Stimulus based on borrowing is precisely the wrong idea, coming as it would be on the tail of a previous binge in borrowing that was totally malinvested. Reformation is the only thing that might shock the system into another state.
These are some of the elements of a real reformation:
- A reset of the entire financial system. Nationalization of banks and other elements of the financial system under the Swedish model or a modern version of the bank holiday. Stock holders get nothing and bond holders take a hit. Banks that are insolvent need to be liquidated, while strong banks need to be recapitalized and spun off. Depositors are backed to $1 M per account. Total transparency for all assets and reinstatement of Glass Steagall protections will be required for the resetting process.
- Global unwind of the unregulated swap markets. Under the financial reset, the unregulated CDS market needs to be unwound. In this process, AIG gets nationalized, its management team fired, and liquidated.
- Massive redistribution of wealth to recapture the transfers of the past two decades. Major increases in the top tax brackets, with top brackets over 50% at the top levels. Capital gains taxes will be brought in line with existing income tax rates.
- A shift in government spending. We must cut defense spending significantly by ending the wars and All funding in new programs will be achieved through diverting spending from defense purposes to domestic infrastructure programs with long term return on investment.
- Enact single payer health care. This will stop the transfer of wealth to the insurance companies and big pharaceuticals and help create real jobs.
- Reverse globalization. Globalization based on wage arbitrage and currency manipulation must be halted, or else we face the eventual resumption of beggar thy neighbor competitive devaluation and protectionism.
As radical as these may seem, these are only some of the first steps that are required. Above all, we must resist the temptation to borrow more, but rather, we must reallocate our national investment along productive lines.
Even with these steps, I believe to be likely that a depressionary period is baked in at this time. Too much of our economy in FIRE (finance, insurance real estate) industries has become fundamentally non-productive. The imbalances of the past are too great, and the number of promises made and booked too great. A borrowed stimulus thrown into this maelstrom will not restore sanity to the current system, and confidence will not be restored unless there is real transparency and accountability. What is needed is not a stimulus plan but a fundamental reformation.