Tuesday, March 17

Should our economy fail?

During the good times, Americans spent, spent and then spent some more. They failed to realize that booms travel alongside busts. And I’m beginning to wonder if we created, with that financial myopia/arrogance, a situation that could only have ended with this ongoing economic failure.

I should preface this with what is probably an obvious statement: I am not an economist. So I can’t get into useful market theory. Then again, I don’t really want to. Theory is all fine and dandy in academia. I’m talking about reality – historical and present-day.

In my admittedly oversimplified view of historical economic trends, I’ve noticed that the economy tends to obey one of the most basic laws of all. I’m referring, of course, to Newton’s third law. For every action, there is an equal but opposite reaction. Put more simply: What goes up, must come down.

What’s ironic, or at least funny in a painful sort of way, is that this law is true mainly because investors refuse to believe it is. If they were more rational, they would realize that a boom is generally followed by a bust. They would take the appropriate measures, and so the “bust” cycle wouldn’t be quite so devastating. Instead, they seem to think they (or perhaps the stock market) are immune to such trends. This means they don’t prepare for bad times. And we all suffer because of it.

And so I’m wondering, if we have all but forced this current situation upon ourselves? Americans rode out the good times, thinking they would never end – and charging as if they never would. So when the inevitable yang to this yin occurred, the results were devastating.

This subject came up in Funny About Money’s post, “Frugality, savings, and the causes of doom.” In it, FAM retorts that frugality is not to blame for the current crisis. I couldn’t agree more. But I’d like to go a step further.

I think we need to turn this accusation around on the accusers. Frugality isn’t creating or worsening the crisis. But the lack of frugality and sensibility are probably what caused it.

The simple fact is that Americans staunchly refused to live within their means. They took advantage of easy, cheap credit. They bought their children (and themselves) lots of toys. When more money came in, such as a salary raise, the spending always managed to rise to claim it (plus a little extra).

If more Americans had focused on the future – not just the boom/bust duality, but also that you cannot live outside your means forever – they might have cut back. They might have sat down sooner and discovered their outlays were more than their income. This might have prompted them to take care of some of the outrageous debt so many had charged up. And so, when the subprime debacle began, they might have had, if not a financial cushion, then at least less debt.

With less debt, they might have been able to better afford the fluctuating interest rates. IF this happened, they might have weathered the rate hikes long enough to finance for a fixed rate. This would have slowed the foreclosure rate, which would have lessened the impact of the subprime mortgages.

Taken a step further, the subprime mortgage debacle might not have occurred. If more people had thought frugally, they would have seen that agreeing to a low rate now for an increasing rate later was a bad idea. They might not have taken their brokers’ assurances that they could “just refinance” down the road. They might have decided to buy less house – or not to buy at all.

And if fewer people had taken out subprime loans, banks would have had lower ratios of these high-risk debts. This might have allowed them to stay in business (without government assistance), as they wouldn’t have had to trade off so many derivatives just to keep their balance sheets clean.

If fewer people took out subprime loans, the craze might not have fed on itself to such a degree. As it was, the pure popularity drove banks to overextend themselves and to be reckless. So if we had been a tad more down-to-earth in our approach to mortgages, there’s every chance that the inevitable “bust” cycle would have been a lot easier to deal with.

Instead, in times of amazing prosperity, America had a negative savings rate. Does anyone else see something horribly wrong about that?

At any rate, we can’t change the past. (At least, not until I finish tinkering with this time machine!) And so we have to accept our present fate as a consequence of our actions – and our inaction.

I guess the problem is simply that economists and financial pundits refuse to do that. They refuse to accept that this is America’s medicine for being so reckless. Instead, they seek a scapegoat. And so they point the finger at frugality.

This is really enraging for those of us who were frugal before, as they say, frugal was cool. We didn’t much participate in the heyday. We have tried to live within our means for ages now. Yet we’re paying the price right along with the people who whooped it up.

But, of course, frugality is becoming a more nationwide trend, so really the finger-pointing isn’t just at the frugal old-timers. Fine. But I still fail to see how it’s a bad thing that Americans are finally living within their means. Really, does that say more about our more rational spending choices, or about the economy as a whole?

We’re told that it’s the lack of spending that’s killing the economy. Perhaps this is mathematically true. But it’s also a chicken-and-egg situation. If we hadn’t spent so recklessly before, the economy wouldn’t be predicated on our continued abandon now.

Essentially, we’re being told to keep up the insanity, so that the asylum doesn’t go under. I’m afraid I just can’t agree with this.

Even if I had money to spend, I wouldn’t want to spend it unnecessarily just to prop up the economy. I’m simply unwilling to help recover an economy that is so dependent on poor choices. I think we can do better. And I think the current pain is part of that process.

Don’t get me wrong: I don’t like to see my fellow humans suffer. Even if their choices led to their problem, which isn’t always the case, I’m troubled by rampant unemployment and foreclosures.

But while we’re all so focused on the human element, we fail to see the bigger picture. Unemployment is high because of the simple business principle: In good times, expand; in bad times, contract.

Companies that increased their reach during the boom can no longer afford to run all the locations. So they close some, which leads to unemployment. Small businesses, which are a gamble in the best economies, suffered financial setbacks, leading to some going out of business.

Seen from one level, it’s random pain created by a faltering economy. But from another, it’s simply the equal but opposite reaction to the boom.

That doesn’t mean I want our economy to fail. But I do want it changed.

We are arguing over how to help the economy, how to keep it from failing. And obviously politicians can’t just stand by while the nation’s finances go into the toilet. But perhaps we’re all focused on the wrong thing.

Instead of saving the economy, why not focus on changing it? Right now it relies on our financial myopia. We need something that’s sustainable, even when consumers are more logical about finance.

But in order to create this kind of change, we may have to wait longer, until the economy is truly at its most vulnerable. More to the point, we have to wait until people are most vulnerable.

Willpower is not exactly in Americans’ lexicon. We’re terrible at it. And so it takes these sorts of epic economic turnarounds to make people understand the value of a life without debt, one of living within their means.

So we may have to wait while Americans slowly learn to make these concepts part of their lives, rather than a temporary fix. If/when that happens, we can begin to rebuild the economy. But, bear in mind, with more rational spending comes fewer booms. If we want a less volatile economy, we may have to accept a more somber economy as a consequence.

In an economy where people spend more rationally, huge surges will be far rarer – and probably a lot less huge than in the past. So while we won’t experience the lows as acutely, neither will we experience the highs as often.

It may mean that a more rational economy looks somewhat similar to what we have today. Unemployment would probably be higher than we’re comfortable with. After all, economic booms are what create large-scale job opportunities. Americans’ net worth would probably be lower than in the last decade. Conversely, it would be a net worth that was more reliable and steady.

Are these trade-offs worth it? Would you rather live in an economically calmer country, or one with a better chance of rapid wealth gain?

We have to ask ourselves whether we prefer to continue with the dubious economy already in place – and just hope people keep their wits about them during the highs – or trade it in for an economy that has citizens with more financial sense, but potentially fewer jobs and raises.

What’s your answer?


Blogger J. Money said...

i wish i were an economic expert so i can give a better answer. but unfortunately you're only going to get this:

I want whatever's necessary to happen in order for my money to grow, and those around me :)

March 18, 2009 at 7:13 PM

Blogger Abby said...

J Money,

Well, at least you're honest. Saying what probably a lot of people are thinking.

Clearly, I have no real economic background. I don't have any hard and fast ideas for keeping the economy from yo-yoing around again like it has always done. Wish I did.

But I think most of us would prefer to just stop seeing it hemorrhage so badly, and stop seeing/hearing about people losing jobs and homes.

I think we're on the right track, as horrified as so many conservatives are by the massive spending. As someone so recently pointed out on Colbert Report: Yes, technically, WWII was what ultimately ended the Great Depression. But if we would have spent the money to continue creating jobs, it would have been the same result. It just so happened that a war came along and made production necessary.

In other words: What ends recessions and depressions seems (at least from the Great Depression) to be increased government help and the creation of jobs. Let's just hope these jobs get created on time.

March 18, 2009 at 7:26 PM

Blogger paranoidasteroid said...

Ugh, finally someone whose making sense! If someone mentions the Paradox of Thrift one more time, I will throttle them.

Everyone just wants to get back to the good times, without acknowledging that those good times are exactly what brought about the bad times! What the US economy was doing was unsustainable.

March 19, 2009 at 10:05 AM


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