The Stimulus, The Bailouts, and Trickle Up Economics

Can Obama fix this economy?  Is there any field, other then economics, where the so-called “experts” disagree so profoundly on what’s really happening?

Take stimulus spending. The conservative argument seemed to makes sense: Government spending can’t stimulate the economy because, ultimately, it just takes money away from citizens in the form of taxes and gives it back to them in the form of wages  (A net gain of zero).

But the liberal argument seems to make sense as well: Moving money back and forth is what the economy is: Typically, people pay business for goods, business pays people in wages. When this wheel slows, the government is the only entity big enough to give it another push.

If Obama and the liberals are right, it stands to reason that this push ought to be a wise one, like building infrastructure we actually need and not just throwing money to the wind.

But throwing money to the wind was exactly how we got out of the Great Depression. When WWII began, we borrowed and spent as much as we could and as fast as we could to build tanks and bombs that we never saw again. Our entire economy was focused on churning out products that almost invariably got blown up within a few months.  And somehow, it still worked. It makes our current economic stimulus look quite prudent (at least we’re not blowing things up!).

Still, common sense tells us that this isn’t a sustainable strategy.  If we follow this logic, we’ll just go deeper and deeper into debt. As Hillary Clinton once said looking back on the Reagan years: “Anyone can make things better by writing bad checks”. (I’ve not yet heard her make the same comment about the Obama administration) .

Besides, it’s difficult to swallow the idea that building tanks and sending them overseas to get blown up could help our economy. Surely something else was going on there.

There was.  The middle class was getting richer. And a healthy economy requires a middle class with money in their pockets ready to spend.

As they do spend, the money trickles up (not down) to the business owners providing goods. Yes, some of it trickles back down in the form of wages, but what trickles down is always smaller than what trickles up (otherwise the businesses would

be operating at a loss). This process of the upward movement of money is the engine of the economy.

If we leave the free market alone, the money will continue to trickle up until it invariably pools into the top one to five percent of the population. Obviously, some of this is inevitable. People differ in ability, and the most “able” who extend the most effort will accrue more resources. But, overall, people tend to underestimate just how powerful the tide of money towards the top is. It takes money to make money. Despite our progressive tax system, some estimates suggest the top 10 percent owns 80% of all the wealth. (More info here)  Suddenly “trickle” doesn’t seem like a strong enough word.

The inequalities in wealth today are so great that the majority of people have to borrow money from the wealthy to live. For all those who haven’t thought about it, one of the ways banks make money is by borrowing money from the wealthy (by soliciting investments and paying them a percentage)  and loaning it out to middle class folk (who pay the bank a slightly higher percentage than they pay the rich people). The banks then pocket the difference.

30 years ago our economy was slowing down.  Reagan famously convinced the majority of our population that money trickled down, not up, and if we gave tax cuts to the wealthy, the middle class and poor would prosper. There’s no doubt the nation grew richer.  Average CEO pay went from a few hundred thousand to over 14 million now, but the problem was, the money never trickled down. In fact, the average wage earner in the US (80% of our population) earns only 1 percent more than they did in 1979 (adjusted for inflation). If we look at just the males, we see they actually earn 5 percent less than they used to 30 years ago [pdf].

The conservative argument states that even though the rich earn more, they carry the poor up with them like a rising tide. But this hasn’t been the case. (Many reports suggest that household income has risen by 17 percent. But this is simply due to the fact that more women work. Other reports suggest that since, 1967, income has risen for the poor by $12,000… but all of this gain was from 1967-1981, when the top tax brackets were 70 percent. Once the Reagan tax cuts came into play, earnings grew stagnant for the lower and middle classes.)

So, with wages stagnant, unemployment rising and healthcare costs on a meteoric rise, the middle class is suffering. The gap between the rich and poor is nearly equal to what it was in 1929 – the year that began the Great Depression.  This is of concern because when the middle class doesn’t have cash to buy goods, the economy slows a bit. And when the economy slows a bit, people start getting laid off. And when people start getting laid off, the poor start defaulting on loans. When they default on loans, the rich people’s investments go bad. This is what’s happening right now. And to make things worse, the wealthy play by different rules than most of us. They leverage their investments for massive gain in good times (but massive loss in bad times.)  Each bad loan can quickly turn into 35 bad loans through the magic rules of Wall Street.

This sucking of money out of the middle class and their subsequent inability to pay their debts is exactly the same thing that pushed us into the first great depression. For the years 1924-1928 the upper tax bracket was lowered to 25%.  Industrialization had begun and there was no minimum wage law. The resultant effect was a drastic pooling of money at the top, and a lack of resources in the middle. When the middle ran out of money to pay back the loans, the house of cards the investors had built fell.

Marriner S. Eccles, who served as FDR’s Chairman of the Federal Reserve from 1934 to 1948 detailed it best in his memoir Beckoning Frontiers when he talked about what he believed caused the Great Depression. He states:

As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth — not of existing wealth, but of wealth as it is currently produced — to provide men with buying power equal to the amount of goods and services offered by the nation’s economic machinery. [Emphasis in original.]

Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.

That is what happened to us in the twenties. We sustained high levels of employment in that period with the aid of an exceptional expansion of debt outside of the banking system. This debt was provided by the large growth of business savings as well as savings by individuals, particularly in the upper-income groups where taxes were relatively low. Private debt outside of the banking system increased about fifty per cent. This debt, which was at high interest rates, largely took the form of mortgage debt on housing, office, and hotel structures, consumer installment debt, brokers’ loans, and foreign debt. The stimulation to spend by debt-creation of this sort was short-lived and could not be counted on to sustain high levels of employment for long periods of time. Had there been a better distribution of the current income from the national product — in other words, had there been less savings by business and the higher-income groups and more income in the lower groups — we should have had far greater stability in our economy. Had the six billion dollars, for instance, that were loaned by corporations and wealthy individuals for stock-market speculation been distributed to the public as lower prices or higher wages and with less profits to the corporations and the well-to-do, it would have prevented or greatly moderated the economic collapse that began at the end of 1929.

This then, was my reading of what brought on the depression.

With this in mind, it’s clear the sudden increase in production that WWII provided was not what jump-started the economy (building stuff and blowing it up is not gonna help things), it was the sudden influx of cash that flowed to the middle class. Not only were there suddenly millions of jobs for to work as soldiers (with solid pay) but there were countless jobs for women in factories. All around the country, no-income households were turning into 2 income households. Who paid these wages? Primarily the wealthy people. The top tax bracket soared to 94% .  Add to this the fact that families spent very little during the war years as rationing was in effect. By the time the war ended, we had a massive middle class with money in their pockets ready to burn. It was the largest redistribution of wealth the nation had ever seen, (as indicated in the previous chart here.) Money had come out of the pockets of the oil, car and railroad barons and into the hands of the common man. The tide had come in. The middle class was flush with money and ready to let it “trickle up” to the business owners again, who in turn, let some of it trickle back down. The result was the biggest economic boom in our nation’s history.

So while everyone was up in arms about the stimulus package being “redistributionist”.  I maintain that the only reason the stimulus might work is because it IS redistributionist.  The inequality in wealth we face today is nearly identical to the one we faced in 1929, and without correction, we’ll slip into another depression.

What’s the most effective way to inject money into the lower and middle classes? Surely a tax cut is the is the fastest, most efficient way to do it. This removes government beuacracy from the equation and prevents politicians packing the bill with pet projects. (Dog parks? Really? ) Surely the Federal Gov. has absolutely no business dictating such specificity at local levels.

But there is something the government can do that no private company can do: Invest massive amounts of capital into projects that may not pay off in the immeadiate future: Solar Power, electirc car infrastructure,  education, etc. These are the things that could keep America the super power that it is.

All this brings us to the Bailout. This does not offer any help to the middle class, nor does it invest in our future. It’s a handout to the wealthy and it’s not the way to the fix the economy.  In fact, it’s the absolute worst thing the government could do. There are some that argue that it had no choice. These are typically the former Goldman Sachs executives that orchestrated it. I guess it just goes to show that Wall Street is in charge of Pennsylvania Avenue no matter who sits in the Oval office.

To make matters worse, there’s been only a feeble attempt at paying for the stimulus spending and handouts. This is how toxic the idea of raising taxes has become.

In 1947, the top tax bracket was 91 percent, the US budget was operating from a surplus, and the economy was experiencing the biggest boom the world had ever seen. The Great Depression was a distant memory.

Of course, it’s unlikely the American public will stand for a 91 percent tax bracket these days; we’ll have to find other ways to manage.