As many of you know, I have both a Bachelor's and a Master's Degree in Economics. That certainly doesn't make me an expert on the subject, but it does mean there are certain concepts that I can explain and extrapolate with pretty well. And it means I pay attention to the numbers. Here's one thing I'm pretty sure about: the fact that mortgage lending, and consumer lending as well, has gone through a significant and long-lasting contraction in this country has contributed directly to the disappointing performance of our US macroeconomy over the past four years. The fact that fewer dollars are being pumped into the economy than before means that economic activity is less than it was before. The relationship isn't one to one, as I will discuss, but it is obvious to me that it is a major contributor to our recession.
One concept that I'm well-versed in is the money multiplier concept. What this concept says is that if one dollar is spent in the economy, it leads to several more dollars of economic activity. An example is that one dollar spent by a company on a box of pencils goes in part to the company that sells the pencils, part to the employee that sells the pencils. Then that company has to buy the pencil and part goes to the owner(s) and the employee spends his paycheck, let's say on lunch. The pencil producer spends the money again, as does the company owner, as does the restaurant, and so on. This leads to several more dollars of activity in the economy than the original dollar spent.
This concept applies equally well in reverse. If you remove one dollar from the economy, that leads to several dollars fewer in economic activity as those dollars are no longer spent. This is what has happened with the massive reduction in lending. Billions of dollars have been removed from the economy that otherwise would have been spent. And the economy has suffered from the loss.
You can say that this reduction in lending was a long time coming and that it couldn't be avoided. I happen not to agree, I think we reduced lending too much, but that's not important now. Things are as they are. But let's use this as a lesson of what is likely to happen when you remove dollars from the economy. It's not good for the economy as a whole and activity will be reduced. There may be long term benefits to making our system more rational and responsible, but in the short term, reducing dollars going into the economy causes less economic activity.
And thus we come to the subject of massive government budget cuts. Yes, the Feds are contemplating some $60 billion in cuts (with more to come when we discuss entitlements). California is considering $14 billion in cuts. Other states and localities are similarly cutting. Everyone is cutting. And yes, as much as Republicans would claim that you should differentiate the public and private sectors, the government is still part of the overall economy. So if you cut $100 billion a year (more?) out of the spending that is pumped into the economy, what do you think is going to happen given the money multiplier? It's not hard to figure: several hundred billion dollars in reduced economic activity.
So what is the proposal to replace this activity? Just like the mortgage and consumer lending crisis, there is no such proposal. The idea is that somehow businesses will step into the void with their newly improved incentives and increase their activity. But as we've seen with the banks and other corporations over the past four years, that is not guaranteed. If anything, my expectation is that the corporations, many of whom employ their own economists, will come to the same conclusion I have and will project that the reduction in government spending will further reduce the US consumer market for their products and will continue to be very wary about hiring and investing in our economy. And whatever funds are taken out of our economy by these government cuts will not be replaced, leading to further exacerbation of the unemployment problem we've been suffering through for years now.
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