Monday, May 11, 2009

Economic Irony?

Let me say at the outset of this that I am not a communist. Keep that in mind, it will be important in a minute.

I spent a good amount of time studying economics before I moved to Birmingham to study theology. I was a pretty strong advocate of the modified classical/monetarist economics employed by the Federal Reserve under Chairman Greenspan and now Bernake. However, the more I have seen about the current economic crisis the more I am questioning the traditional models and ways of viewing economics.

In the classical system, the economy manages itself by money-flow. This is supply and demand at work- if more people demand a good, then more money flows to that market and the supply increases to match the demand. So the greatest way to encourage economic growth is to expand the amount of spending that is going on. This has to be carefully monitored though- we can't just dump money into the system, all that will do is create inflation with little or no growth. To keep this balance, the Fed plays a back and forth game with the money supply by buying and selling bonds to the major banks, thus controlling how much money they have on hand to loan out.

And there lies where the irony begins. Our managing of the economy has been based very largely on the credit industry. We depend on banks to give out loans that stimulate growth. If inflation is getting out of hand, we try and cut back on the amount of loans banks make. If the economy is slowing down, we try to encourage them to make more loans. So our growth is sustained by credit!

What we seem to be realizing now is that this pattern isn't sustainable in the long-run. What has happened in our economy is that we have had a huge "credit bubble" that has collapsed. The bubble was sustained not just by lots of housing loans, but by loans from bank to bank and credit agency to credit agency. Then, to make things really complicated, we turned those loans into "securities" and sold them to other agencies, who bought them using more loans. Now the bubble bursts. My company fails because others can't pay back their loans, which means I can't pay back my loans, which means another company can't pay back theirs, and the cycle goes on. Since all this growth was based on money that no one actually had, the current collapse creates a massive domino effect in the order of a few hundred billion dollars!

So why is this ironic? The very thing that we have been relying on to sustain our economic growth is now the very thing that is causing a massive economic fall-out.

Now, in a sense, that's how a bubble usually works. An industry booms for a while, and then something goes awry and that industry collapses. What makes this especially interesting, though, is that its not a single industry. Its our whole economic system that is being shaken.

Now is where what I said at the beginning is going to be important again. I see basically two options on the "capitalist" system: The first is the classical option- do nothing and let the economy fix itself. The Great Depression is the main counter-example to this method. And, if we did opt for this method, my prediction is the economic collapse would become very wide-spread (remember, this started in the finance sector, which is what the rest of the economy depends on. If it goes, it will take down every other major industry with it), with the end result being a revolution that will probably transform the west into a communist society. In other words, if we do nothing, we will see exactly what Marx predicted come about.

The second option is to try and salvage the economy through a "bail-out" (what we have been doing)- following the New Deal model, in other words. The problem is, in the long run this just perpetuates the problem. This problem exists because our economy is built on credit, which means it can't absorb the shock of a market failure. Dumping more money into the system to try and stimulate more growth is only adding to that problem. So in the long-run, we haven't gotten anywhere. We may temporarily avoid catastrophe, but then we still have the same root problem- an economy built on credit with no shock-absorbers and no way to sustain growth without more credit.

I'm not sure if this second option eventually leads us back into the first. I think that is the worst case-scenario: we get to the point where we literally cannot do anymore, so we have to do nothing. I don't foresee that happening in the major Western powers anytime soon, but there are concerns it might happen (or already be happening) in developing nations that are taking a hit from all of this.

The ultimate solution is going to require some sort of radical change to the underlying economic structure of our system, I think. I'm not sure how we get there (at least without it being a very painful transition). But we have to move away from a dependence on credit and adapt to a more long-term sustainable system. I am not saying we do away with all credit. Credit is important in a lot of ways. People generally buy a house or a car via credit. I (along with most other students I know) am at least partially financing my education through credit. However, what this economic crisis is showing is that we cannot depend on credit, so we have to adapt our system in some way to not be dependent on it (which may mean a fundamental change in the way we manage the economy). What that probably looks like is a much smaller economy on a whole and maybe much more simple life-styles. And for a lot of industries that simply cannot be sustained without credit (for instance, in a lot of ways, the medical industry), there may be a need for socialization.

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