Monday, August 22, 2011

Sustainable Economic Growth is the Only Way Forward

The single biggest issue facing us as a nation is achieving sustainable economic growth. For a good refresher of why this must become THE focus of all Americans, A New Strategy for Economic Growth is worthwhile reading.

Try as we may, we simply can't cut or save our way to prosperity. That said, we must reduce wasteful and unnecessary government spending as much and as fast as possible, too. This applies to both the long and short run as well.

First, let's remind ourselves of the completely obvious, because as newscaster Edward R. Murrow once said, "The obscure we see eventually. The completely obvious, it seems, takes longer."

Speaking of the adverse effects of taxation, here's in part what the father of legendary investor Warren Buffett had to say in 1956 (Notable & Quotable), "The part of his production taken from the producer cumulatively increases the power of the federal government proportionately with the increase in its income. This power is not created; it is simply taken away from the people...."

Thus, the "completely obvious" is merely that the private sector provides all the economic growth. Not the public sector. The less the amount of money the government removes from the private sector, the more the economy will grow and the more our citizens will prosper.

Today the private sector has enormous issues to overcome in order to achieve "normal" economic growth. For the good of all Americans, our government officials must stop demonizing the private economy and instead support it in every conceivable way. We all need to get back to the business of business, while encouraging individuals to reduce household debt levels at the same time.

This walk and chew gum approach in the short term will be somewhat difficult, but it is vitally necessary to restore much needed strength to our American economy.

What is referred to as the paradox of thrift means that acting to reduce the excessive household debt levels of today will constrain economic activity in the future. Even though this deleveraging process will take several years, it's imperative that it gets done. When completed, economic growth can then resume at historical or even higher rates. How Far Should Consumers Unwind Debt? is a good discussion of where we are and how far we have to go.

To repeat, the household sector has meaningful future spending constraints due to today's historically large debt burden. This excessive debt is primarily but not exclusively related to real estate. To make a bad situation worse, the debt is often greater than the current value of the house that was purchased with the borrowed money. Thus, underwater mortgages are the new normal for millions of our fellow citizens. But it's even worse than that.

As so many of us have borrowed from the future to spend today, something called "reversion to the mean" is now underway. A simple illustration is that if we assume we earn $100 and spend $80, we will increase savings by $20. But if we earn that same $100 and spend $125, we will need to borrow $25. What that means for future economic growth is profound.

In the first instance, we had acquired $20 to invest in productive assets. In the second, we end up with a debt of $25. In turn that debt needs to be repaid, and that debt will incur interest charges until repaid. That's pretty much where too many of us are today.

In this context, reversion to the mean simply acknowledges that we will spend no more than we earn over time. If we've been spending $80 of our $100 in earnings, we're saving and investing for the future. But if we're spending $125 of our $100 in earnings, we're developing a big problem with respect to future spending capability.

In addition to limiting spending to what we earn going forward, as debtors we would then have to reduce spending much more in order to pay back the money, plus interest, that we borrowed for our past spending spree. The math for our $100 per year earner works thusly; if in year one we spend $125, we need to reduce spending in year two to $75 from $125. That's a year-over-year 40% reduction in spending.

Of course, we won't reduce spending by 40% or more in any one year, but we will need to cumulatively reduce spending by that amount over time. In the interim we have to pay the ongoing interest charges, too.

In simple terms, the foregoing example tells us why consumer spending isn't going to be much help with achieving strong economic growth for several more years at least. Since historically consumer spending accounts for ~70% of our nation's economic activity, that makes the get-more-growth objective even more difficult.

This pretty much summarizes the probable slow to no growth scenario for a long time to come.

We have the effects of many years of bad habits to overcome. The accumulated government debt and deficits will need our attention, but we also need to remind ourselves of one straightforward fact. The only realistic way to solve this debt driven dilemma is to do everything possible to foster economic growth in the private sector.

Since our economy depends largely (much too much, I would argue) on consumer spending, lower than "normal" consumer spending levels will result in a subpar economy for the foreseeable future. This household deleveraging process is necessary, but it will take time. Lots of time.

Accordingly, we'd be well advised to get started right now on this do-all-we-can-to-get-the-private-sector-to-grow-the-economy goal. Time's a wasting.

Thanks. Bob.

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