GREAT DEPRESSION IS WRONG MODEL FOR BAILOUT

By Jack H. Swift, Esq.
January 26, 2009
NewsWithViews.com

Pundits are calling our current economic crisis the worst recession yet with a potential of being as bad as the Great Depression. Our leaders are responding with the same tactics we have always used to combat recession, easing credit and increasing government spending to stimulate consumption. These tactics were originally developed by FDR in combating the Great Depression. So far, all they have done is resurrect FDR’s New Deal. At a cost of trillions, it is hoped that will save the day. The difficulty is that this is not the Great Depression. It is far worse.

The Great Depression was triggered by a collapse of the stock market boom wherein the value of stocks and wealth had been artificially increased through the manipulation of leverage
(purchasing with only a portion down). A slowdown in the general economy compromised investors’ capacity to meet their leverage (credit) obligations and their default showed the stocks to have only artificial value.

Our recent boom was brought about by the same sort of leveraging, only this time in the real estate market. Another slowdown in the general economy has once again exposed the artificial character of the value of the assets.

To that extent, our crisis and the Great Depression are the same. But there is a great difference.

After the market crash of 1929, our problem was idled production capacity for which there were no consumers. The country was industrialized. We had enormous production capacity. People simply needed money with which to consume.

FDR’s New Deal addressed the problem of lack of consumption by making the government the great consumer. The government undertook work projects, purchasing products and hiring civil service employees. The government financed all this by credit, deficit spending if you will.

Incrementally, as undertaken during the 1930s, it had very little positive effect other than to dramatically increase the national debt. Finally, World War II came along and necessitated monumental government spending and full time implementation of our production capacity.

That at last allowed a recovery. Thus, based on the historical model, if Obama’s New Deal is to work, we know government spending must be on a scale greater than that of World War II and our production capacity must be fully operational. Arguably, Obama’s plan may be that grandiose. But it still won’t work because the problem is not that simple.

In the Great Depression the country was highly industrialized with an awesome production capacity in a market that was largely closed. The problem then was that our closed market lost its capacity to consume and our production was idled. Our problem today is that we are no longer industrialized and we are no longer a closed economy. We are not a purveyor of goods to the world. Rather we have become the world’s greatest consumer. In our absence of production of goods for the world, we are remarkably ill-equipped to pay for our consumption.

This fundamental problem is obvious in the history of our balance of trade experience over the past decades.

The problem has been masked by two factors: the artificial boom in real estate values over the last two decades and the conversion of our monetary system under the Federal Reserve to credit backed currency. Under today’s system, money is created by the issuance of a loan by a Federal Reserve member institution. A Federal Reserve Note is in reality nothing more than a glorified IOU, backed by the collective payback capacity of the American public. This credit-based currency standard is another great difference between our present crisis and the Great Depression.

Stimulation of consumption by way of easy credit will enhance production in a closed economy suffering from a lack of credit. But the immediate difficulty we are confronting is not a lack of credit. It is purely a lack of additional credit capacity. General Motors and Ford shut down their production lines for the 2008 model year six months early, not because of an absence of credit for that production but because of a lack of orders. This was six months before we ever heard of a credit crunch. Bush’s stimulus plan failed to have any effect on the economy because recipients of the rebate didn’t use it to consume. They used it to pay off debt. This suggests that we as a people are individually maxed out in our credit liabilities. One does not consume and take on new debt when one cannot pay the debts one already has.

In the absence of growing production, credit-based currency is merely a giant Ponzi scheme. New debt for a while can be used to satisfy the obligations on old debt. Particularly this will work during a period of economic boom and inflation of the value of assets. Any downturn however renders the scheme insolvent. That is precisely the insolvency we face today.

The original bailout attempt was to expand credit availability by providing banks and financial institutions with more money. This was simply false analysis of the problem. Banks have an almost infinite capacity under the Federal Reserve to create money. All they need do is write a loan. For the consumption stimulation strategy to work, it is not expanded credit availability that is needed. There must be an expansion of the general public’s capacity to take on new debt. Something they cannot do under the service obligations of their current debt.

Obama’s changed approach is to expand consumption by making the government again the great consumer. This fails utterly to address the key problems: our lack of production capacity for world exchange in a global marketplace and lack of additional credit obligation capacity on the part of the current consumers in the marketplace. All it does is create a monumental debt obligation for future generations of taxpayers, in turn debilitating their capacity to take on their own debt owing to future tax obligations. The approach is not sustainable.

The problem is not altogether lost upon Obama’s financial gurus. There is a movement afoot in the New Deal plan to help with credit obligation reduction for the general public. This is a demand for current mortgage holders to “mark to market.â€