Bribing Consumers to Save the Economy

The US now has the highest unemployment rate of all major economies. Even France – historically, an economy with high jobless rates – is at 9.5% unemployment, while the US is 10.2%.

As for inflation, the lowest inflation rate among the world’s larger economies is in – you guess it – Japan. After 20 years of on-again, off-again deflation, it’s on again in Japan…with inflation at NEGATIVE 2.2%. But inflation is negative in the US too – at minus 1.3%.

Both Japan and the US claim positive GDP growth, compared to Europe, which is still in recession. But throughout the world – except perhaps for the BRIC nations – growth is weak and hesitant.

The US and the UK are both consumption economies. No consumption; no growth. But how do you get people who’ve consumed too much to consume even more? They know they can’t afford to keep spending. And they know that going further into debt just makes the situation worse. What can you do?

You bribe them!

You give them more money, say, in unemployment assistance. Or, you give them a tax credit when they buy a new house. Or, you give companies a big tax break. In the most recent stimulus bill, for example, the feds do all three – including giving Pulte Homes a $450 million tax refund.

Here at The Daily Reckoning we never met a tax cut we didn’t like. But with the deficit at 13% of GDP, we might make an exception. One way or another, someone’s going to have to pay for the feds’ big spending stimulus efforts. Taxpayers. Bondholders. Dollar holders. All of the above.

President Obama told the crowd in Singapore this weekend that he would make sure Ben Bernanke stayed away from his helicopters. The Chinese are the biggest holder of US bonds in the world. The Japanese are next. Between the two of them they fund a big part of America’s current spending. Naturally, America’s president is eager to keep the cash coming his way. So he has had to reassure the nation’s largest creditor that their loans to the US will be repaid in good order…and good currency.

China alone has $2.3 trillion in reserves…most of it in dollars. Of course, the Chinese want to diversify out of greenbacks. But they’re caught in a trap of their own making. If they turn away from the dollar, they undermine its value…and the value of their own reserves. What’s more, America is still China’s number one customer. They need to sell to America. And for that they need to keep their own currency from rising too much against the greenback. A higher yuan makes their products relatively more expensive compared to other exporters.

So, the infernal system continues…America creates dollars. The foreigners take them as though they had value. And they will have value…as long as they take them.

In the ’90s and ’00s the newspapers were full of stories about what a great place America was. Its economy was so dynamic…its entrepreneurs were so clever…its financial system was so highly evolved and flexible. What could go wrong?

Everything!

And now we’re going to read a lot of claptrap about what an awful place it is.

“The American dream needs repair,” is forerunner of the genre. In today’s Financial Times, it focuses on the rigidities of the US system. The time was when a young American could start at the bottom and work his way up. Luck and pluck was all that it took. But now, according to scholars at the Brookings Institution, people stay put. If you’re born poor in America you’re more likely to stay poor than if you had been born poor in Britain, Denmark, Sweden or dozens of other countries.

What happened? The authors do not say. So we will. Success breeds failure. As a society becomes rich, more and more people find ways to game the system. The elite get tax credits, tariffs, and protective regulations. Every layer of bureaucracy makes it harder for new competitors to get ahead. And every new tax on income makes it harder for upstarts to join the ranks of the rich. The poor get their parasitic benefits too. Welfare, unemployment compensation, child tax credits, medicare, food stamps, social security – all of these programs give the poor an incentive to stay poor.