All Cashed Up with Nowhere to Go: What Caused the Depression(s), and What to Do About It

I've been meaning to post about this great two-part article by James Livingston (H/T to Mark Thoma), on the causes of the Great Depression and the current...whatever it is.

Livingston's explanation for both cases (in my words):

• There were oceans of money with not enough productive uses available (like, investments in physical plants and wages--things that would increase productivity and production).

• To get returns, money-holders' only option was gambling (investments not tied or only loosely tied to production).

• Naturally, financial companies' share of GDP and profits skyrocketed.

• Wages became a smaller part of GDP, and profits a larger part.

• Income and wealth inequality increased--more money went to, and stayed with, the wealthiest.

• The wealthy thus had oceans of money with not enough productive uses...

• At the same time, lower wages threatened to kill the golden domestic goose: consumer spending.

• In our current case, government deficit spending and loose Fed policy were gasoline on the fire. It ameliorated--temporarily--the weak consumer spending, but simultaneously exacerbated the more fundamental trends.

Livingston's prescription:

The responsible fiscal policy for the foreseeable future is, then, to raise taxes on the wealthy and to make net contributions to consumer expenditures out of federal deficits if necessary.

His structural analysis is, in my mind, profound. Read his pieces and you'll see that he both adopts the facts of Friedman/Schwartz's Great Contraction narrative, and eviscerates the self-contradictory conclusions that Friedman and Schwartz draw from those facts.

And the first half of his prescription is also dead-on, in my opinion. More below.

But the second half of prescription is far less profound. Some might argue that if we give more money to consumers then they, in their infinite collective wisdom, will find productive uses for it. Without lengthy discussion here, I'll just say that the presumption is somewhat tarnished.

Rather than addressing the fundamentals (productive capacity), Livingston wags the dog: consumer spending. (Because consumer spending constitutes 70% of U.S. GDP--extraordinarily high, BTW, by international standards--it is the big dog. But spending is not production, which is the tail that actually does the wagging.)

If the wealthy can't find productive places to put their money,

1. There's obviously a problem with supply-side theory. Lack of capital was decidedly not a constraint on growth in the 20s, or the 00s (or, once government started pouring money in, in the 30s or 40s). With oceans of cash sloshing around, transfers to the wealthy (by whatever means) do not spur real productivity/production growth.

2. Policy should concentrate on moving money into productive uses.

There are two obvious productive places that pretty much everyone agrees are screaming for money right now: infrastructure, and education. The market provides few or no incentives for individuals to invest in these areas. (I'm not talking about individual spending on education, which obviously has high incentives. I'm talking about building schools, lowering student-teacher ratios, providing class materials, etc.)

So Livingston's right: tax the wealthy--who, pace Grover Norquist, aren't investing their money productively--and put that money into the things that we know will spur long-term productivity and production growth.

As a side-effect, this will spur consumer spending (not as quickly as cash dropped from helicopters, but still...) and create jobs (yes, sorry, a lot of them will be government jobs), which hopefully will tide us over until the payback kicks in from those long-term investments.

Does this make sense? Talk to me. And, I'd love to hear from anyone with time-series statistics on percentage of capital stock invested in productive assets. I've done some digging, but without success so far.

Comments

[tomhagan]

But maybe the problem is more fundamental: our present fractional reserve banking system requires ever increasing levels of debt, and perhaps we have finally reached a level that cannot be further increased. If so, no amount of tinkering will fix the system unless we move to full reserve banking. For more, see http://whatsnotso.blogs.com/whatsnotso/2008/10/will-the-financial-crisis-change-the-game.html

[Steve Roth]

Tomhagan: I'm not clear what you mean when you say it "requires ever increasing levels of debt." As to the 100% deposit-to-debt reserve requirement, I would suggest that you are correct on your site: "The proposal may seem crazy only because I don’t understand it fully." But I certainly agree that reserve requirements for non-bank institutions are in order.

[reason]

I'd like to see more about the trade deficit, terms of trade and a disfunctional international financial system here. The US needs to produce more (good for workers) and export it to the rest of world. They have for too long been consuming more than they produce and giving (overvalued) pieces of paper in exchange. This is the fundamental problem.

[reason]

tomhagen... I wish I had time to think through these ideas more thoroughly. I don't like radical transitions though - it is a way of putting all your eggs in own untried basket. You might want to check out Steve Keen while your at it: http://whatsnotso.blogs.com/whatsnotso/2008/10/will-the-financial-crisis-change-the-game.html

[reason]

P.S. I also think we need fundamental financial reform - not just because of the damage done by casino capitalism, but because I don't think an ecologically sustainable economy is compatible with high levels of debt.

[Steve Roth]

Reason, I'm wondering why you link to the same post that Tom Hagen does. That post doesn't explain Tom Hagen's fractional-reserve assertion, though it does link to a 43-minute video which supposedly does. I'd much prefer a brief, cogent explanation. Searching the web, I haven't found a convincing one--mostly conspiratorial apocalyptica.

[Steve Roth]

And Reason, yes most agree that "The US needs to produce more (good for workers) and export it to the rest of world." One problem is the law of comparative advantage: US companies can't make money (compete) based on low-skilled worker inputs--those inputs are too expensive here. Education and training are obvious answers, but still--not everyone can succeed in a "knowledge economy." A conundrum I continue to ponder.

[reason]

Steve Roth, No you are quoting the law of absolute advantage not the law of (Ricardian) comparitive advantage. The problem is that when Ricardo was writing there was a gold standard and no "hot money" international financial flows. The real rate of exchange doesn't adjust as it should. Perhaps we need to take Warren Buffets "Import Certificate" idea seriously (absent some better international financial reform). Sorry about the link to Steve Keen - should be http://www.debtdeflation.com/blogs/