By Andrew Arends
The stock market is at historical highs. The job numbers are looking good. Everything seems to be the way that it should in the American economy. There is talk throughout the media and the pundits think that we have finally turned everything around. So, time to celebrate and let the good times roll, right?
Well, not exactly. While it is true that the stock market is at its highest ever level, it has barely risen from its previous high in 2007. The last time the stock market took this long to rise was during Carter’s administration. The Great Depression was the only stock market fall that compares to the depth of this recession in recent times. Most of the modern recessions have been about a year long, and this one was significantly longer. All of this points to something very bad.
The usual response from Washington when it is faced with a recession is to raise spending and/or lower taxes. Until 2012, taxes were kept static and spending averaged $3.6 trillion from 2009-2012, spending increased about $600 billion more than 2008 levels. If the economists were correct, that federal spending helps “jump start” the economy, then why did it take so long for the economy to react to this spending?
When the federal government spends money, it doesn’t actually create anything; it just spends lots of money on things the free market doesn’t want. It does this by taking money from the private sector through taxation or through deficit spending (taking from the private sector in the future). One of the reasons the past administrations were able to “brute force” the gross domestic product into growing was due to the low federal debt at the time. Every time that strategy was tried, the debt greatly increased. The biggest problem for the federal government right now is that the debt is already higher than the GDP. This means it really can’t simply spend more, because few people are willing to finance the spending by buying governmental debt (Treasury bonds).
This leaves the government in a quandary. It wants to spend more, but no one is willing to loan it money. The common answer is to simply raise taxes. The problem there is that the historical level of tax revenue has a very difficult time going over 19 percent of GDP and the current spending levels are about 24 percent of GDP. Raising or lowering the tax rates doesn’t really affect government revenues. The government spends more than it takes in. Contrary to what some economists believe, that is as unsustainable for a government as it is for a household.
The debt problem is even worse than a spending issue, however. A massive federal debt is a drain upon our economy. It results in a “crowding out” of private investment by putting upward pressure on interest rates (the cost of borrowing money). The Federal Reserve purposely lowers the interest rate to both fight this and to stimulate the economy during recessions. This creates its own problems. First of all, it reduces all incentive to save. The rates of return on your savings account are lower than the inflation rate, so any money put in there is slowly losing real value. This incentivizes spending money in a very real “eat and drink for tomorrow we die” sort of way. This results in people spending more than they earn which is something that we saw in the years before the recent recession. When the housing crisis hit, the people folded on their mortgages because they hadn’t saved anything.
The second problem here might be even worse. Low interest rates make the returns on investment very low. If you were to buy a bond with a 5 percent annual return, and the inflation were 2 percent, you’ve actually only made a 3 percent return on it. This hits those investing for their retirement very hard (and assumes that the inflation rate is correctly reported). The long-run result of this will be later retirements and another type of “crowding out,” this time out of the job market.
Remember though, I said the Federal Reserve lowers the interest rate to stimulate the economy during recessions and it later raises them after the recession is over. The observant reader will realize that the current interest rate is near zero. This means that when there is another shock to the economy, there is no way the Federal Reserve can lower the interest rate any more than it already has.
The long and short of it is simple. The fundamentals of the economy are broken. In order to get here, the federal government has had to use every trick that it has. It has backed itself into a corner. The next recession that hits will find the federal government unable to do anything about it.
Andrew Arends is an Austrian economist who served in the Marine Corps from 2004-2008.