by Moe Kinney
Occasionally, the world changes in such a profound way that old modes of thinking, “conventional wisdom” and popular opinion are rendered irrelevant. There is always a certain inertia and even active resistance to such tectonic shifts, but once the new reality is in place, the question of adaptation is only a matter of how and when. The fascinating aspect of these sorts of shifts is that the trends leading up to them, which seem so obvious in retrospect, nevertheless go unnoticed while the old mode of thinking prevails. The frustrating aspect is that many people cling to the old model when the new reality is well established. Such a shift took place in the U.S. Economy in 2008.
The conventional wisdom, which has held true for 20-30 years, is that consumer spending is what powers the U.S. Economy and is therefore the essential element of growth and prosperity. Such “wisdom” also conforms loosely to the economic theories of John Maynard Keynes who argued that “aggregate demand” was the fundamental driver of economic activity, employment and growth. From a public policy standpoint, this has manifested itself in the idea of government “stimulus” spending to combat recession. i.e. creating government demand during time periods when private sector demand has lagged. The assumption being that government spending will smooth out the recession and that private sector demand will eventually recover. What’s often omitted in the discussion of Keynes is that he advocated government savings in times of prosperity and expenditure of surplus during economic downturns. Somehow, the savings part of the theory got lost and the perverted version of the theory promotes the idea that government MUST increase spending during any recession, even when the spending is financed by debt rather than surplus. Again, based on the assumption that private sector demand will at some point recover.
Since the mid 1980s, the U.S. has indeed been surviving with a demand-driven economy. We’ve seen some periods of strong GDP growth and some recessions, but this economic model has remained the “conventional wisdom” and public policy has been implemented accordingly. Anything to get the consumer spending money is good for the economy. The mall is open. What has been lurking under the surface of this consumer demand based economy however is the relentless accumulation of debt. Individual debt, business debt and government debt. When a borrowed dollar is spent on consumption it contributes directly to demand and therefore directly to GDP, just as if it was a saved dollar. From the mid 1980s, to 2008, outstanding debt was on a steady upward trend, thus providing a steady demand and steady contribution to GDP. What’s worse is that the amount of debt accumulation regularly exceeded the observed increases in GDP. The trend should have been clear and the end game of this economic model entirely predictable. Obviously some individuals never joined the borrowing party and a few isolated voices tried to ring the alarm bell, but conventional wisdom prevailed amongst the bulk of the citizenry and in the halls of government and central banks. In fact, public policy, the most obvious of which being the government’s own borrowing binge, only served to reinforce this model.
The consumer demand driven economy suffered it’s first heart attack in 2008. With the collapse of the housing bubble, the mortgage debt component of demand was cut off. The loss of home equity essentially put an end to the HELOC loan frenzy, further reducing demand. The resulting blow to employment and consumer confidence sharply curtailed the ability and willingness of people to borrow and spend, thereby crippling the consumer demand driven economy. The housing bubble collapse is widely seen as the “cause” of the current recession, which is an understandable conclusion. What the collapse really did however was to reveal the fundamental sickness in the U.S. economy, namely, its addiction to debt. In 2008, the economy hit a “debt saturation point”. Consumers had finally, after more than 20 years, exhausted their capacity to take on additional debt. Therefore, the debt component of consumer spending disappeared. With it, should have come the realization that an economy based on debt-driven consumption is unsustainable. This is the new reality. Unfortunately, inertia, denial and active resistance prevail in the population, in public policy discussions and even among so-called “mainstream” economists.
In a reactionary move, the federal government increased spending by $535B (18%) between 2008 and 2009 to “stimulate” demand. They have gone on to borrow and spend over $5T in the last four years, also fueling aggregate demand. The so-called “recovery” was essentially a spike in government borrowing which was done to fill the gap left by the decrease in consumer borrowing and spending. In essence, there has been no underlying economic recovery. It was simply more debt-financed demand, only using the government credit card instead of the consumer credit card. The government and mainstream economists insist that these measures, along with the Federal Reserve’s ZIRP and QE policies are necessary and will eventually “re-start” the demand-driven economy. They are hopelessly clinging to a now defunct economic model.
The nation’s 20+ year borrowing spree , which has included $16T in government debt accumulation and more than $40T in consumer and other private sector borrowing was the only thing that made the consumer demand driven economy possible. With the borrowing capacity of the consumer essentially exhausted, no amount of government “stimulus” and no amount of cheap credit can re-start a new era of debt-financed consumption and resurrect that economy.
The new reality is that demand is dead.