Why Bother Working?

What Robert Reich and people like him are saying is that working in productive employment is not at all necessary. To follow his logic to the fullest extent, we should just have people save gas and stay home. The government could borrow and/or print money, then send it to foreign countries that are dumb enough to produce goods and services for U.S. consumption.

In the NYTimes financial section former Chair to Obama’s Council of Economic Advisors, Christina Romer, opined on the lessons to be learned from the Great Depression saying, “It would be a mistake to respond by reducing the deficit more sharply in the near term. That would almost surely condemn us to a repeat of the 1937 downturn.”

According to Romer and Reich, what the U.S. needs is an immediate dosage of inflation and debt. These Keynesian “cures” of endless inflation and debt to fix our economic malaise are offered because there is a profound lack of understanding of what causes a depression in the first place.

The cause of the Great Depression in the 1930s, and the Great Recession beginning in December 2007, was one and the same — an overleveraged economy. Easy money provided by banks eventually brings debt in the economy to an unsustainable level. At that point, the only real and viable solution is for the public and private sectors to undergo a protracted period of deleveraging.

The ensuing depression is, in actuality, the healing process at work, which is marked by the selling of assets and the paying down of debt. Unfortunately, our politicians today are focused on fighting the natural healing process of deleveraging by promoting the accumulation of yet more debt.

During this latest economic contraction, the Federal Reserve has taken interest rates to near 0% for the past two and three years and has just promised to keep them there for an additional two years. Meanwhile, the Obama administration is leveraging up the public sector to record levels in an effort to re-leverage the private sector. The government’s philosophy is tantamount to sticking a frostbitten man in the freezer so he won’t have to suffer the pain associated with the thawing of his extremities.

During the Great Depression, real gross domestic product plummeted 32%. The Great Recession, which we are still struggling through, began in December of 2007. But in contrast to the 1930s, GDP during this recession shrank only 3.6% from the fourth quarter of 2007 through its low point in the second quarter of 2009.

Household debt as a percentage of GDP reached nearly 100% in 1929. Between the start of the Great Depression and the end of World War II, household debt fell from 100% to just above 20% of GDP. To put that number in perspective, household debt did not go back above 50% of GDP until 1985. And it was not until the first quarter of 2009 that household debt once again approached the Great Depression level of 99% of GDP.

Debt reduction is a painful process, but such de-leveraging is the only real cure for an economy swimming in debt. Thanks to government efforts to carry on our debt-fueled consumption binge, during today’s Great Recession household debt has barely contracted at all — it has only been reduced to 90% of GDP as of the first quarter 2011.

To make matters even worse, during this current crisis our government’s response has been to dramatically increase its own borrowing. At the start of the Great Depression, gross federal debt was 16% of GDP. It peaked just below 44% when the Depression ended. While the national debt did increase significantly during that period, it was still relatively benign when viewed from a historical perspective. The U.S. entered this current Great Recession with gross national debt equal to 65% of GDP. It has since exploded to 98% of GDP! Comparing the relatively innocuous level of the 1930s with today’s pile of government debt, clearly illustrates the perilous state of the economy.

National debt did rise dramatically during World War II, topping out at 120% of GDP in 1946. But consumer debt plunged concurrently. So while the nation was adding debt to fight and win a global war, households were taking the necessary steps to ensure their balance sheets were well prepared for the aftermath of the battle.

Today, for the first time in our history, gross national debt and household debt are both at least 90% of GDP.

Unfortunately, many in government–like Mr. Reich–believe the government must spend more while consumers rein in their debts. Their strategy is based on the hope that once the economy perks up, the private sector can unwind that debt. But there are two problems with this Keynesian theory. One is that government spending doesn’t increase GDP; it only chokes off private-sector growth and creates inflation. The other is that politicians never regard the present as a good time for the government to pay down its debts.

The result is that the country is left with a massive level of both private and public sector debt, the latter always leading to an increase in taxes, interest rates and inflation — which causes GDP to eventually contract even further and thus the ratio of debt to economic output increases faster.

Since we have yet to address the real cause of this recession, we are moving inexorably closer to causing The Greater Depression. If policymakers and mainstream economists fail to understand that the progenitor of a depression is debt and inflation, they will also be unable to provide a genuine solution. And the “solutions” they do offer are tantamount to seeking the avoidance of a hangover by forcing down a few more drinks.



Michael Pento

Michael Pento is a well-established specialist in the “Austrian School” of economics and a regular guest on CNBC, Bloomberg, Fox Business, and other national media outlets. His market analysis can also be read in most major financial publications, including the Wall Street Journal. He also acts as a Financial Columnist for Forbes and a blogger at the Huffington Post.