Should the United States try to avoid a financial meltdown?
Appendix to the US edition of Fleeing Vesuvius.
Many Americans believe that the US cannot avoid hyperinflation or a catastrophic financial crash. Tom Konrad‘s position is slightly different. He thinks that while a crash is possible, the system is more likely to end with a whimper rather than a bang and that any progress towards building a more sustainable society will be undermined unless the country undergoes significant cultural change. With the confidence that comes from living on the other side of the Atlantic, however, Richard Douthwaite thinks he’s wrong and that, in Fleeing Vesuvius terms, what he’s saying amounts to “let’s allow this flow of lava to pass over us. Some of our institutions will be burned up and lots of people will have a bad time but, after it’s over, we can rebuild in a more sustainable way”. Here’s how the debate between them went:
I think we agree, Tom, that the United States is trapped in a downward spiral, blocked on one side of its balance sheet by insupportable debts and on the other by unsustainable asset values. When the spiral was running upwards, almost everyone was delighted because the value of their houses and other assets was increasing and enabling them to live well by borrowing more. The increased borrowings injected additional purchasing power into the economy. This increased the price people were able to pay for assets – which, of course, they bought with borrowed money. It was a wonderful flight from reality while it lasted.
But in 2007 and 2008, when the high energy and commodity prices generated by a global boom pushed up the cost of necessities and left the weakest borrowers with too little money to service their debts, many of those flying on borrowed wings came crashed to. down. The sub-prime mortgage crisis set the spiral turning in the other direction, pulling everything down rather than pushing it up.
In this new environment, no-one wishes to borrow to buy assets since their prices are still falling. People are fearful about their financial future and have cut their spending, increased their saving and are trying hard to pay back their loans. This has given the downward spiral an extra twist as the lack of demand has cut national income and increased unemployment, sucking even more families into the debt trap.
The imbalance between asset values and incomes has widened the gap between rich and poor. The US is one of the most unequal countries in the world and the richest 1% of the population enjoy almost 24% of the nation’s income, up from only 9% in 1976. This was the reason for the death of the American Dream. More than 80% of the increase in national income generated by economic growth between 1980 and 2005 went to this group. The heads of companies did particularly well. They earned an average of 42 times as much as the average worker in 1980, but 531 times as much in 2001.
This imbalance is closely linked to the imbalance between asset values and GDP. Whenever the top 1% get a further increase in income, they spend very little of it on American-made goods and services – in other words, in ways which create many jobs for other people. Most is invested in assets and has the effect of driving their prices up or at least limiting further falls.
If conventional policies continue to be followed, the gap between rich and poor makes it very difficult to see how the US economy can avoid a continuing decline, still less how it can ever “recover”. Any pick-up in the economy can only come from a pick-up in demand for US goods and services but the rich aren’t going to consume any more, the poor can’t afford to and the various levels of government are overborrowed as it is. The federal government’s deficit in 2010 was expected to be over 10% and many local governments have had to make extremely painful cuts. The only possible conventional source of extra demand is an increase in exports but that’s going to be difficult to achieve as the manufacturing base has been badly eroded by free trade policies and there is huge competition from the rest of the world.
What all this says to me is that an unconventional policy is needed that gets money into ordinary people’s hands without asking anyone to take on any more debt. Would you agree?
While I agree with your assessment of the situation, I disagree about the proper goal for a long term shift to a sustainable economy. A sustainable economy operates at a much lower level of economic activity and its primary driver of economic activity is not consumer spending. America’s problem is cultural as well as economic. We have an unsustainable culture, where status is equated with material wealth. The race to acquire more material wealth is in its essence unsustainable. The death of the American Dream of universal home ownership is not just a product of inequality: Universal home ownership leads to sprawl, and is incompatible with a sustainable society.
Our most important task is to bring our culture back to one much more like that of our founding fathers, where industry and hard work are the source of status, instead of the possession of material wealth. Benjamin Franklin used to fetch the paper for his printing shop in a wheelbarrow with an intentionally squeeky wheel. His intent was to call attention to the fact that he did this manual labor for himself, raising his reputation as an hard worker. Today, such manual labor is more likely to be seen as a badge of shame, and fit only for immigrants. Our debt-fueled society has led Americans to believe that we are entitled to everything we want, including the luxury of not working for it.
Putting money into people’s hands without requiring anything in return will simply reinforce America’s unsustainable culture. Instead, current debts should only be absolved through the arduous process of bankruptcy. Social inequity should be addressed through high taxes on inheritance and programs such as the Earned Income Tax credit, while the income tax and Social Security payments (which reduce the rewards of work) should be replaced with a large and meaningful carbon tax on energy, including the embodied carbon of imported goods.
These tax changes should help reward sustainable industry, and reduce the incentives to live the lavish, unsustainable lifestyles to which Americans have come to believe we are entitled.
What you are saying, Tom, is that before the people of the United States can rediscover the virtues of thrift and hard work, they need to pass through the fires of Vesuvius in order to be cleansed of their false consumerist values. My view is that there is a better, surer way to achieve this result. The hundreds of thousands of corporate and personal bankruptcies you envisage would destroy incomes, savings, pensions and asset values. People would become fearful, bitter and possibly violent as a result. They would look around for scapegoats (the Jews, perhaps?) or turn to crime.
Consequently, I just can’t see a period of financial turmoil creating a good basis for building a better society. A worse one seems much more probable as extremist leaders are likely to emerge in response to mass unemployment and the rich could well use force to protect themselves and their lifestyle. The positive things you want like a carbon tax would be much harder to introduce (“What, you want to tax the energy that makes me so productive?”) and Dan Sullivan’s land-value tax ideas was would be rejected outright because people would realise that such a tax would prevent their property values from ever recovering to whatever they were at their peak.
The choice before the US is either to increase incomes by enough to support the current level of debts and asset values, or to write down debts and asset values until they correspond with current income levels. In essence, I’m proposing increasing incomes by enabling more people to work while you, although not exactly wanting a massive deflation, think that one is necessary and would ultimately prove beneficial.
The main reason you seem to reject my job creation route is that it would involve giving everyone some money “for nothing” for a few years while enough jobs were being created to raise the national income by enough to enable it to support the country’s massive public and private sector debts. Let’s go through my proposal carefully to see if your objections really hold.
In November 2010 the Federal Reserve said that the recovery was “disappointingly slow” and it would inject money it had created out of nothing into the economy by buying $600bn-worth of long-term Treasury bonds from their holders before July 2011. As it had already announced it would buy $250bn to $300bn worth of bonds over that period, the announcement meant that between December 2010 and June 2011, the Fed will be handing over about $3,000 for every person resident in the United State to investors in exchange for their bonds. It hopes that the investors will spend the money in ways which boost the economy but it seems unlikely that they will.
Instead of the $3,000 per head being passed to investors, I would like to see some of it being given as a gift to state and county governments so that they can restore local services and rehire the folk they have sacked. I would like the remainder to go on an equal per capita basis to every US resident in a form which prevented them from using it in any other way than to pay down their loans. This would strengthen the banking system, People with no debt would be required to invest it in, say, community facilities or the transition to renewable energy.
It would not be necessary to give this money away for nothing. It could be part of a package involving, say, the introduction of a carbon tax although Peter Barnes’ Cap and Dividend, the US equivalent of Feasta’s Cap and Share, would be much better. This puts up the price of fossil fuel according to its carbon content but returns every cent to the public. Everyone gets the same amount, so those people who use less than the average amount of fuel come out better off. What do you think? Would enabling people to clear their debts for three or four years while jobs were being re-created and the financial system was being restored to balance really be demoralizing?
Bankruptcy replaces unsupportable debt with debt which is (barely) supportable. The losses are borne by the lenders foolish enough to extend unsupportable credit. Inflation destroys incomes and asset values by cheapening them, and the losses are borne by savers who have tried to do all the right things to prepare for their futures.
I certainly see your “solution” would feel much better in the short term but I don’t see how it will do anything to help with the cultural problems I think are the root cause of our current and future crises. Americans are not going to scale back their lifestyles (a must in a sustainable world) without some pain. As long as we pursue strategies that avoid pain, no lessons will be learned and we will simply be setting the stage for the next crisis.
I agree my solutions are not politically feasible, while yours are fairly close to the current policies of deficit spending and quantitative easing (printing money.) Americans are not ready for the necessary painful adjustments, and they would no doubt look around for someone to blame besides themselves.
Just because we’re not ready for it does not mean it’s not the right thing to do.
I don’t think we can avoid pain whatever we do. As Chris Vernon’s article shows, fossil energy supplies are likely to contract very rapidly over the next 40 years. The economy will contract with them, turning everyone’s lives upside down. That will be very painful. My proposal is an attempt to minimise the pain by ensuring that we have a functioning monetary system to help us through a wrenching transition to a low-carbon economy. What’s your alternative strategy to get families and communities through the next forty years? Can you protect savers whose money has been invested in activities which are based on cheap energy from taking hefty losses? I can’t, but an inflation would mean their losses were gradual rather than near-total and overnight.
I believe that your course is a well-intentioned attempt to treat symptoms but may actually worsen the disease, and you believe that my course may kill the patient.
I agree the proper goal is to minimize the pain of the transition to a low carbon economy, but I believe much of that pain is necessary to avoid future bubbles caused by excess stimulus in the face of declining energy supplies. A root cause of the last (housing and debt) bubble was the Fed’s stimulus in response to the dot-com crash, with the money driving up asset values to unsustainable levels. Too much stimulus now, whether it takes the form of giving money directly to households or the Federal Reserve buying Treasury bonds will simply lead to new bubbles and new crises.
In order to reduce the pain today, we should focus on enabling debt renegotiation in the place of bankruptcies. Yet the remaining debt not only needs to be supportable on the reduced incomes that come with lower economic activity, it needs to be large enough that Americans do not just learn the lesson that we can borrow as much as we want and there will be no consequences.
Savers who invested in cheap-energy supporting businesses, like heavy debtors, should take losses. They also have a lesson to learn, and that lesson is that investments in sustainable businesses are sustainable assets, while investments in unsustainable businesses will decline. Investors who invested in sustainable businesses such as energy efficiency, resource conservation, alternative transportation, and sustainable agriculture, are already doing their part to shift our economy in a more sustainable direction, and the fruits of their wise investing should not be appropriated through inflation.
Investors have ways to protect themselves from inflation (by buying commodities or inflation-indexed bonds, for instance) or from declining energy supplies (by buying the securities that are aiding the transition.) If investors must protect themselves against inflation as well, they will have fewer resources (both financial and mental) to dedicate to the transition to a sustainable economy.
Just as the attitudes of ordinary households are important in helping them adjust to a sustainable economy which is not based on debt-fueled consumerism, the attitudes of investors are important in deploying the capital we need for the transition. Cultural attitudes are not changed by pretty speeches; cultural attitudes are formed by real world experiences.
The only way I see to change the American culture to one that is compatible with a sustainable economy is to make both households and investors who have lived and invested unsustainably bear much of the consequences of their actions.
Yes, we must let the lava of Vesuvius wash over us, because it will wash over the most unsustainable parts of our economy and culture. We should not build dams in a vain attempt to stop the lava, especially when those dams are piled on the foundations of a sustainable future economy.
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