An interesting forward we received on the economy.....

Mom and I got this forward from her dad (thanks Greg), it's very informative and unfortunately makes me wish I had paid more attention in those econ classes I just breezed through.

____
Hi.

For those of you who know me, you know I teach economics and statistics at local colleges here in Indiana. Yesterday, as I watched the news on Secretary Paulson’s U turn on what we’re doing with the bail out, I became more and more angry. I decided to do something about it. So, the following is a bit of a “back ground” piece I hope will give you just a little bit of insight into what is going on, and why I have gotten so angry at “the system.”

What you do with it is up to you. I just felt I needed to get this out of my system, because I am One Angry Hoosier.

The Theory Behind the Bail Out

You have no doubt heard of the “stimulus package”. In economics, this is called an “accelerator” that sort of “jump starts” the economy. Once you get it, the idea is that you will spend it and it will spread throughout the economy. When Ronald Reagan applied this theory to cutting taxes, it was derisively called “trickle down economics,” but when John F. Kennedy announced his tax cut plans in 1963, it was called “the multiplier effect.”

Thus, the whole bail out plan is predicated on this idea of economics, first expressed by an economist named John Maynard Keynes in his “General Theory” back in 1935. He wrote that book during the Great Depression. But Keynes had a zinger in his general theory.

Basically, if you and I save that “accelerator” instead of spend it, then the multiplier will be smaller than it should have been. Another economist named Paul Samuelson, authored a text book series that every student who has majored in economics over the last 40 years has read (that would include any Baby Boomer from me to Fed Chairman Ben Bernanke). Samuelson wrote in his 1961 text book edition (which didn’t get changed through successive editions): “By attempting to increase its rate of savings, society may create conditions under which the amount it can actually save is reduced. This phenomenon is called the Paradox of Thrift.”

Now, after following this idea (that savings is bad, spending is good) blindly for decades, the US has a negative 1% savings rate. We have bought into “Keynesian Economics” BIG TIME. The thing is, if you and I don’t save, banks don’t have money to lend. If they don’t have money to lend, businesses can’t create new jobs (because they need to borrow money to build a factory just like we borrow money to buy a house). How do we get money to invest in America to create jobs? We borrow from the Chinese, the Taiwanese, the Japanese – all those “eses” who still think it’s a good idea to save money. We do this by selling them US Treasury bills. That is how we came to owe much of the world trillions and trillions of dollars.

What We’ve Done, And Why It Won’t Work

To deal with the bail out, part of what Secretary Paulson and Ben Bernanke of the Federal Reserve have been doing is to increase the money supply. They hope that by providing money (economists call it “liquidity”), banks will lend, people will borrow, and life will go on as usual. The problem is: Their plan isn’t working and they should have known better. In an economics class I teach in Indiana, the following appears on page 369 of Steven L. Slavin’s 9 th edition of Macroeconomics where he summarizes what Keynes said:

“but during a bad recession perhaps people would just hold their money, waiting for interest rates to rise before they lent it out. … If the money supply were increased during a bad recession, said Keynes, the money would simply be held as idle cash balances by relatively well-to-do people. Nothing would happen to the money until the economy was well on its way toward recovery, interest rates rose, and more investment opportunities became available.” (emphasis added)

Now FED Chairman Bernanke is said to be an expert on the Depression and what Keynes said. Yet, he ignored this piece of economic wisdom. In fact, with the exception of Congressman Mike Pence from Indiana and a handful of others who spoke out against the bail out plan, virtually all the “smart people” in Washington and Wall Street ignored what people like me teach students in Economics 101!!!

This whole mess begins to sound an awful lot like what economists call a liquidity trap. (If this sounds ominous, it is. There’s even something called a “Death Spiral” in economics, sort of like the “Death Star” in Star Wars. For those who aren’t afraid to read more on this, see this article: http://globaleconomicanalysis.blogspot.com/2008/03/liquidity-traps-myth-and-reality.html where the author recommends that we do nothing, and encourage savings. Oops! Sorry, it’s too late to do nothing!

And so, where do we find ourselves? Well, the banks aren’t lending out the money. What’s more, we aren’t going to stop with a bail out of the banks. News reports indicate the auto industry, cities, states like California, home builders and others are lining up to get their bail outs. Those who watch the Student Loan Industry are worried that Sallie Mae will be the next Fannie Mae and Freddie Mac. For more information on this, read “Will the Student Loan Industry be Bailed Out Next?”

Remember that Paradox of Thrift issue I mentioned? I highly recommend “Paradox of Thrift R.I.P.” In that article, you'll find this quote:

"Perhaps the single most destructive tenet of Keynesian economics was its denigration of saving. Keynesianism has been used to justify wasteful spending, massive deficits, and one after another scheme to redistribute wealth from those who would save it to those who would spend it." (emphasis added)

Speaking of “spread the wealth”, I have more to say on that subject in my blog post “Joe the Plumber and the Character of the American People.”

The Bottom Line

All of us are in charge of the decisions we make. If we wait for the government to bail us out, there’s going to be a long line ahead of us. The truth is, for the last ten years we’ve been dismantling “firewalls” put in place after the Great Depression to prevent another one from happening. This is making it harder and harder for those of us who play by the rules, pay our taxes, go to work, volunteer in the community, and generally make it possible for Americans to enjoy the "American Way of Life" to do what we do. To cover their mistake, all the “smart people” pushed through a bail out plan that they knew really wouldn’t fix the problem, because their solution was more of the same stuff that caused the problem in the first place.

Here’s the bottom line. Since Secretary Paulson started talking about totally changing the bail out plan, I’ve become One Angry Hoosier. And with respect to our leaders in Washington who got us into this mess, I’m angry as hell. I’m not sure what, if anything, I can do about it – though I hope sending you this email is a start. I believe that with knowledge comes responsibility. Yes, the stock market will go up and down, on some days quite wildly. Fear, emotion and hype rule at the moment. I’ve told you what I know, trying to explain things that most economist try to make into a bunch of mumbo jumbo as best I can, and giving you a couple of links to other articles that you may find of interest.

I don’t know how all those email chain letters people forward get started, but if you have found this “back ground” piece helpful, consider forwarding it to others you know. I’ve also posted a related article at my blog called “Of Bail Outs, Student Loans and the Paradox of Thrift” you can find at http://wisejargon.wordpress.com/2008/11/13/of-bail-outs-student-loans-and-the-paradox-of-thrift/ If you like, feel free to read and post a comment or two.

Maybe, if nothing else, we can encourage people across the country to send a few more Mike Pences to Congress in 2010!

Ok. I feel better. Thanks for listening.

Keep fighting the good fight.

David Lantz
Indianapolis, IN
http://wisejargon.wordpress.com
www.wisejargon.com
www.findingcommunity.net
www.brotherhoodscroll.net