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Maynard contemplates economic theory

The political debate is lately putting a lot of focus on the Bush tax cuts and the unemployment rate. I think these issues are overemphasized. We’re frantic in addressing symptoms, but we ignore the underlying disease.

Consider the simplest economic model (and of course this will be an oversimplification, but we’ve got to start somewhere). There’s consumption and production. Goods can’t be consumed unless they’re produced. Therefore, the world is necessarily balanced in the long run.

In a barter economy, all transactions are balanced immediately. I trade your goods for my goods. There’s no debt because there’s no money. We can only consume what we produce, or what we exchange for items that are of equivalent value.

Money was invented because barter is inefficient. With money comes the abstractions of a banking system and accounting, so now we count our wealth in purchasing power rather than a pile of stuff with value. But who defines and regulates the money? The financial guardians must understand that their most fundamental task is to maintain a stable medium of exchange.

The money structure allows for the creation of a debt structure, and now we’re getting into capitalism. The idea is that the money will flow to where it will do the most good, and the banks will hold savings and will lend money at an interest rate reflecting a realistic risk of having the loan paid back.

There are two types of spending: Investment and consumption. Investment is where the money is spent to allocate resources to a structure that will be a productive tool. For example, building a factory is an investment, and the production that flows from the factory will be used to pay off the expense (presumably borrowed) of construction. The other type of spending is consumption. If you buy a big-screen TV, you’ve spent money but your expense doesn’t enhance your future productivity or income. Buying a home is something of a middle ground, because you’re acquiring an asset that will maintain inherent value (that is to say, it doesn’t get used up the way a tube of toothpaste does), but you’re using it for lifestyle rather than production.

From a strictly economic point of view, the primary reason money is loaned is to enhance productivity. Otherwise, there’s no predictable basis to pay back the loan and service the interest, beyond the hope that the entity that took out the loan will be able to tap other assets in the future.

That’s why capitalism has historically nurtured an upward trend of prosperity. Savings are channeled into the creation of productive assets, which increase the material wealth of the economy.

Our problem is we’ve largely forgotten the fundamental rules of economics. In the recent era, we’ve ignored the enhancement of productivity, and focused entirely on the expansion of consumption.

Nowadays our national consumption regularly outstrips our national production, and our banking system is feeding the imbalance by inventing new ways to go ever-deeper into debt. This is a trend that will destroy us as a sovereign nation.

A generation ago, borrowing didn’t permeate the American lifestyle, or at least not as thoroughly. If you bought a home, you needed 20% down. Credit cards didn’t exist until recently, and they were hard to get and had minimal credit lines. (When I first emerged from Starfleet Academy, I was turned down for several cards, and finally was granted a card with a $300 limit.)

Then somebody decided that opening the spigots of lending was a good idea. If people had more access to money, so the thinking went, then they’d consume, and production would in turn increase to meet demand, resulting in more employment…and so on and so on, resulting in a virtuous circle of ever-increasing prosperity. It sounds really keen, but wiser heads understand that this wonderful theory is too good to be true. Pushing up consumption doesn’t make you rich; it makes you broke. Isn’t this obvious?

But free-flowing money is like the early stages of drug addiction, when the high is still a good one. At first, anyone can get a real estate loan, and real estate prices are rising, so wealth seems within reach of most people. The increase in consumption is being met by an increase in production, and it seems unimportant that the new consumption is domestic but the new production is offshore, because the rise in the value of our houses makes up the difference (and never mind that our houses are owned by the banks). The stores are full and most people are doing okay, and it’s easy to forget that the nation is living beyond its means.

You see how the government and monetary policy becomes the enabler of bad behavior. In a sane world, you tighten your belt when you start to go broke. You cut your consumption to match your income, because you’ve got no choice. But the government merely plays financial games to keep the money machine humming, and so we go down while we’re feeling flush.

Get back to basics: Consumption and production. America is out of balance, and all the shenanigans of the past generation has served to mask our failure to produce.

This is where the politics turns toxic. Politicians don’t want to tell us we can’t afford our lifestyle. No, they want to tell us we deserve more. Sure, they’ll point out some targeted group of bad guys that deserves to get squeezed a bit. A tax on that rich guy. The cost of servicing illegal aliens. Welfare queens. Corporate welfare. We can all point to someone that deserves less. Someone not pulling their weight. Someone else.

By the way, I agree with some of the finger-pointing. But the problem can’t be solved by finger-pointing. The nation, as a whole, must produce more or consume less. It’s that simple. We’re all going to have to look in the mirror.

I’m flashing back to Barbara Holland’s memoir (mentioned in an earlier blog note), When All the World was Young. She describes coming through the Great Depression and World War II, and Americans learned to be thrifty. The motto of the era: “Use it up. Wear it out. Make it do. Or do without.” And this was second nature, and we took it in stride.

Then the war ended, and a new message was heard. Consume! Use more! And it seems to me that we have, to an unfortunate degree, become accustomed to defining ourselves by our material consumption. Modern America consumes, not out of need or even real want, but driven by a sense of grim, programmed necessity.

I mention these thoughts out of a philosophical contemplation of happiness. Are we a more contented people for all of our bling? Doesn’t seem that way to me.

But the philosophy is a diversion. Whether living beyond our means makes us happier or not, it’s a thing that’s got to stop. And it will stop, one way or another. The problem is, our politicians seem intent on precluding a soft landing, and this may doom us to a very hard landing indeed.

That’s why, as I said initially, I’m not much focused on the Bush tax cuts or the unemployment rate. We can abolish taxes and give every citizen and illegal alien a job washing rocks at the beach, and we’ll still come crashing down. Show me how to break the trend of the twin deficits, budget and balance of payments, and I’ll start to feel a glimmer of optimism. Without that, we’re still just suckers in another shell game.