As I sit here getting ready to take my economics final exam, I am struck by a comment a friend of mine made the other day about our economy and our economic situation. Essentially, his point was that what we needed to do was save more and spend less. In other words, that it is our consumer-based economy that inevitably led us to at least some point of weakness. His words were not that strong but I am distilling a bit here.
However, a consumption-based economy isn’t a bad thing unto itself. Yes, a low savings rate must be bolstered by some kind of government-based welfare system (Social Security) which does put a strain on earnings, but consumption can help fight off disinflation (which actually is an okay thing) but also certainly helps fight deflation or the threat thereof. Even when our rate of consumption is low, we can still fight deflation (now, massive recession on top of low consumption is a different matter). And high consumption also means payment of taxes, which means money to the government and local municipalities, and a stabilizing effect on the economy (it prevents it from overheating or going into recession for the most part).
The problem is how we fund this consumption. For each person, it’s about whether we are borrowing in order to consume. Are we using all credit card debt? Taking out lines of credit on houses for which we already still have mortgages (and whose value then suddenly drops)? For the government, the same applies – if we have a huge debt to foreign countries by selling bonds to them to fuel our economy, then we have ourselves in a precarious situation.
Selling bonds is a common way of funding deficit spending. Because we have a current and potentially more big stimulus packages coming up (and the future ones will be all government spending, I bet, with little to no tax cuts (which is a good thing for stimulus, actually)), that means we are selling a lot of bonds. When we sell bonds, we go into debt. The biggest buyer of our bonds right now is China. China has sent a “shot across our bow” about devaluing the dollar through the Fed “printing money” by selling even more bonds. This dilutes the market, lowers the price of the bonds, we then have to sell more bonds to get the same amount of money, etc.
So the government is fueling its consumption – which we need – through debt as well. But it was already deep in debt. And just like a person who consumes through debt, already being in debt to start with just makes everything worse.
But…a consumption-based economy isn’t bad unto itself…