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Four and a half years ago, I wrote in this space about the coming economic crisis. I said it could be worse than the Great Depression of the 1930s.
The crisis that unfolded in 2008 was one for the record books, but it differed from that of the 1930s because Federal Reserve Chairman Ben Bernanke, Treasury officials and Congress manufactured several trillion dollars of government money and pumped it directly into the deflating credit system. That action prevented the collapse of economic trust that characterized the worst years of the Great Depression. Americans correctly saw that it was truly a Keynesian moment, named after John Maynard Keynes, the great depression-era economist who explained how government spending could save an economy.
The bailout hasn't been well planned, nor was the money deployed efficiently, but these are quibbles. The bailout saved the banking system from a complete collapse that would have propagated around the world, bringing down trade, commerce and the economic world as we know it.
The bailout rewarded institutions that profited from excesses associated with the crisis. Bankers with seven- or eight-figure salaries being rescued with taxpayer money makes us angry, and for good reason. Rescuing folks from the consequences of their bad or foolish behavior makes them more prone to that kind of behavior in the future, which is what economists call a moral hazard.
Moral hazard is a real issue, but focusing blame on financial institutions is a mistake. Every modern economy has three distinct sectors: household, government and business (which includes banks). The foolish behavior here was consumption beyond the limits of prudence, but it wasn't our nation's businesses that did that. The rate of business net savings in the United States has remained high. The culprits were the other two sectors: government and households.
At the start of the 1990s, American households were saving nearly 7 percent of their income, close to the historical average. By 2007, borrowing increased so much that the net savings rate had fallen close to zero. In China, net household savings are above 20 percent.
Instead of limiting government (particularly our armed services) to what we were willing to tax ourselves to pay for, we financed huge excess government spending by borrowing (mostly from foreigners).
Net household savings inched up to 0.42 percent in 2007 and increased dramatically to almost 2 percent in 2008. Some households are now getting the message.
Government has done the opposite, however. Gross government debt in this country increased by more than $1 trillion in 2008, and will likely grow by $2 trillion in 2009 to a total of about $12 trillion. To put that figure in perspective, consider that the annual output of the entire U.S economy is only worth about $14 trillion.
This is the irony and paradox of our current economic conundrum: to save our economy and bail out the household sector, the government has had to go deeper in debt. It had to do this in part because households are saving more and consuming less, an action that makes sense on an individual household basis, but which hurts the economy and households as a whole. It's called this the paradox of thrift. Increased saving means reduced spending, which begets fears that the economy will get worse. That causes people and institutions to cut further. Then the cycle keeps repeating.
Bernanke and the Treasury saved us from a replay of the Great Depression, but we are far from out of trouble. On one side, we face the risk of exploding inflation when money starts moving again. But too heavy a hand in throttling back unsustainable government outlays risks knocking us back into the economic death spiral from which we so narrowly and recently escaped.
Households have tightened their belts and put their budgets on a more sustainable basis. If we are to have a sustained recovery, government must eventually do the same. The only credible way to make this happen in the long run is by increased taxes, real cuts in defense, or both.
As Desmond Lachman, an economist with the conservative American Enterprise Institute, noted recently, the Obama Administration has yet to spell out in a credible manner how U.S. public finances are to be placed on a more sustainable basis.
I'd say it's because they don't know politically how to do that. I sure don't.
Juneau economic consultant Gregg Erickson is editor-at-large of the Alaska Budget Report, a newsletter covering the state budget and economy. He can be e-mailed at firstname.lastname@example.org.