As the talk of stimulus plans gets louder, I worry that the right lessons will not be learnt. A stimulus is needed, for sure, but how it is done matters actually more, in my view, than whether it happens or not.
The current crisis has a simple immediate cause: too much debt, meaning people living beyond their means and now having to retrench. Stimulating demand via more debt may postpone the reckoning yet once more, but only pushes the problem down the road without solving it, while making it yet again bigger.
The question is: why has there been too much debt? The consensus view of the Villagers is that there has been a "savings glut" in countries like China, Japan and Germany, and countries like the US and the UK were "forced" to absorb these savings by running into debt. This is all too convenient.
The more correct reason is that debt has been used to hide the fact that incomes have been stagnant for too long.
The other core reason is that debt looks and behaves like money, just like real income, and can easily act as a substitute. But debt profits, first and foremost those that control it: the financial world, with its hands on the tap. What's been happening is that, thanks to deregulation, the financial world has been left to its own devices and no limit has been put anymore to how much debt it could create. Excessive debt - for which I use another word: counterfeit money - has been injected into the system and has mixed with "real" income.
And the mix has been shared around, with everybody getting equal shares of real money and counterfeit money. Those that put in real work, got paid partly in real money and partly in junk paper; those that printed debt got back real money for a portion, and junk paper for the rest. Unsurprisingly, this amounted to a large scale transfer of wealth to the money printers.
This has real world consequences (collateral damage if you will), in addition to the growing inequality: more and more people moved fro mte productive economy to the money printing side of the business, and those in the real economy were increasingly squeezed to provide actual value for all. For a long time, the illusion worked well enough, and it looked like overall, wealth was created, even as a majority felt it was running increasingly hard just to stay in place.
As the underying real value creation was increasingly struggling to keep pace with the headline numbers, crack appeared, and the whole edifice crumbled. The counterfeit money has been revealed to be just that, and is turning to dust (however, if the assets no longer exist, the debts that they generated are still there). suddenly, the shrinking real economy is all that's left to support macro-economic statistics, and these look terrible. But those that had grabbed a larger share of the pie thanks to their counterfeit paper are not intent on letting that go, and are fully intent for the pain of the elimination of counterfeit money to be shared a lot more equally than its creation was.
Thus the layoffs, shrinking activity, and economic pain all around.
Government spending can solve that problem, by creating new demand - but it needs to be generated by claims on real assets, not by yet more paper value. Conveniently, there is a way to do that: raise taxes, especially the higher marginal rates, to start moving the redistribution pendulum the other way. It is also essential that the spending be focused on things that are useful to people rather than to corporations and their owners: spending should be focused on social services, basic necessities, investment that will benefit all (energy-use transforming infrastructure like public transport and grid networks, healthcare) and core functions like education.
But the core requirement is to admit that the prosperity of the past few years as fake and inexistent. Acknowledging this does not mean shrinking the economy, it just means measuring it properly, and telling the truth about the Bush years. Most people outside the Village kno it already anyway.
Runaway debt, private or public, is not a sustainable path. And there is an alternative - it simply requires that blame be properly allocated, instead of everybody pretending that this crisis 'just happened.'
See also taonow's diary on a parallel topic: It's all China's fault... Really?