5 Years. $16 Trillion in Debt. 7.8% Unemployment. Why The U.S. Gov. Cannot Seem to Turn Off The Spigot

By Peter Hartwich, M.A.

It was extremely difficult for anyone beyond a handful of government regulators and economic gurus to believe that 2008 would usher in the collapse of financial giants like Lehman Brothers and evaporate trillions of dollars of U.S. household wealth.

Beginning with the Troubled Asset Relief Program (T.A.R.P.) begun under President George W. Bush and continued under Obama the U.S. has kept an incredibly generous monetary policy intact for almost 5 years. During that time interest rates have been kept historically low by the Federal Reserve, troubled banks and industries have either capitulated, been bailed out, or have clambered back into profitability through restructuring and the U.S. government has been paying for it all with what amounts to an enormous blank check.

Yet, some might pause at the mention of all this and ask two interesting questions: first, why does the U.S. government feel it is required to stimulate the economy even if it means incurring trillions in debt? Second, why after 5 years of this kind of policy have we experienced such anemic and lackluster growth?

The complete answers to those questions are incredibly complex and thoroughly debated in political circles as well as economic circles alike, but the short answers may surprise you in their simplicity.

First thing is first. In a recession, government is supposed to spend. Big time. Even if it means a mountain of debt. Why? It is the deeply held Keynesian philosophy that is guiding the U.S. government in avoiding another Great Depression. Essentially, in the calculation of a nation’s Gross Domestic Product (or GDP, which constitutes all the value of goods and services created within a nation in a year), there are four basic components: consumer spending (C), government spending (G), net exports (X), and Business Investment (I). Therefore, GDP (not adjusted for inflation) equates to C + G+ X (+/-) + I. Simple, yes?

Well, the Great Recession of 2008/2009 was brought on by a massive credit crunch caused by excess leveraging in the global bank system as well as rampant consumer spending fueled by property values and mortgages. All the while, manufacturing jobs fled overseas to India and China while the strong U.S. dollar suppressed our net imports, making our nation have an enormous trade deficit. Thus, the things propping up the economic boom from 2003-2006 were largely consumption (which is 70% of the overall GDP) and business investment.

Now, when the bubble burst consumption plummeted due to concerns over people losing their homes. As a result, net retail sales declined and business investment ground to a halt all while our trade deficit continued to grow. Thus, the components of C, I, and X were useless to prevent recession, as is often the case in the business cycle.

Thus, G, or government spending, is the only component that is capable of saving an economy and preventing another Great Depression. That is why whenever there is a major recession the government immediately begins to print and spend money to spur activity. This tends to drive up debt considerably. At the same time, tax breaks passed in good economic times curtail government revenue at the EXACT time they require even more revenue to pay for the increasing amount of people benefiting from government funded social programs. Hence, government spending spirals upward while the economy struggles to regain its footing.

By the definition above, it seems that Obama and Washington have been doing the right things, but again there lies a caveat with this Keynesian notion. The caveat is that more government spending does not necessarily drive robust economic growth. In fact, because of a lack of revenues and spiraling costs the government is able to incur trillions in debt with relatively little effect on the overall economy.

The issue are, in my opinion, three fold: timing, effective distribution, and lack of cost controls. Put simply, the government historically times their aid too early or too late with too much or little support. In short, they almost always time their infusion of cash incorrectly. Secondly, while they keep the interest rate low and spend trillions the threat of inflation looms ever present and could end up sending the economy into a death spiral again if it impacts consumption (gas, food, power, etc.).

Distribution of the wealth is difficult in a country of 320 million people so you often have the net effect of spending billions to “stimulate” consumption only to have those billions translate to a measly $100 per citizen. They are not going to school on that money, Mr. Obama. They’re grabbing a sandwich and going to a movie to distract them from unemployment. Employment is a far better and permanent distraction.

Finally, government spending, while well-meant, often is done with little to no concern about costs or budgeting. Projects go over budget, funds are misused, and overall the programs are not as effective as they could be given the significant costs.

It is for these main reasons that I submit that U.S. government spending will not be the savior of our economy and cannot be until we begin to focus on the other areas of the GDP chain. America does not need more bailouts and quantitative easing…we need the private sector and manufacturing to hum along once more so that robust consumer spending can once again stimulate serious growth. Of course, how we rteach that is another intense debate, but I’l lleave that for another day.

Thank you for you time and I’d also like to thank Kent D. Du for allowing me to post this on his blog.

Source: http://www.anderson.ucla.edu/faculty/edward.leamer/documents/Hw%20Components%20of%20GDP%20Eviews%20Version.pdf