Sunday, January 4, 2009

Something for Nothing

As the drumbeat for stimulus policy grows louder, following closely behind the recent slew of widely criticized bailout attempts, the majority of analysts and economists still do not seem to understand the root cause of our financial crisis and recession. This was never more evident than in a remark made last week by Janet Yellen, President of the Federal Reserve bank of San Francisco:
Typically, recessions occur when monetary policy is tightened to subdue the inflationary pressures that emerge during a boom. This time, the cause was the eruption of a severe financial crisis.
For anyone with a basic understanding of cause and effect, this statement is painful to read. While the recession might have been the result of the financial crisis (this is disputable), what was the cause of the financial crisis itself? Is it not important? Did it occur magically? Without knowing its cause, how can we be sure that our solution will be equally magical in preventing further financial crisis and resolving the recession?

The solution, as proposed by Janet Yellen and other like-minded economists who have yet to fully understand the cause of our recession, is stimulus. In order to grow the economy, create jobs, and solidify the financial infrastructure, the government will borrow money and spend it. Unfortunately, this idea falls flat at the outset without first understanding how we came to where we are.

The fact is, the root of our current economic troubles and the solution being proposed by Yellen are one in the same: debt. Debt is a wealth destroyer. It enables over-consumption, malinvestment, asset bubbles, and perpetuates non-productive economic behaviors that otherwise would not have been possible. All of these side-effects of debt played a role in creating the current recession, yet as can be seen with Yellen's comment, the ultimate culprit of the recession is noticeably absent from public discussion. Perhaps it is no wonder, considering that the expansion of debt in the US is controlled by the Federal Reserve. But while this might explain Yellen's support for stimulus, it doesn't explain the broad support from so many others.

The idea that stimulus can combat a recession is rooted in the idea the economy can be forced to grow faster than it otherwise would, without excessive side effects. But the very existence of recession, an economic contraction resulting from overcapacity, overspending and malinvestment, seems to indicate that the economy needs to correct itself when such abuses occur. The idea that we can prevent such a correction from occurring via stimulus fails to acknowledge the real cost that economic abuses have. It attempts to defy age old adage that you cannot get something from nothing.

But attempting to get something for nothing sure does sell. The government loves it, Wall Street loves it, economists love it, and Americans sure love it. Ultimately, it is no wonder that we try, futile as it may be, to manipulate the economy into giving us what we want while not giving us what we don't.