By unpopular demand, we're re-running Flip Side's essay of a year ago. — Editor.
My wife wants to understand economics.
Judith: How did the United States get into such economic trouble?
Steve: First, the Federal Reserve Board kept interest rates low. This encouraged people to borrow money and buy houses at inflated prices.
Judith: And second?
Steve: Second, due to the Bush tax cuts and the war in Iraq, the federal government ran up huge deficits.
Judith: And third?
Steve: Third, banks and mortgage brokers loaned money to people who could not pay it back. Then the banks sliced, diced, repackaged, securitized, and re-securitized these mortgages into complex debt instruments that they sold to each other.
Judith: Is that all?
Steve: No. Through the genius of the free market, the banks dug themselves into a deeper hole by selling credit default swaps on worthless debt. You'll be hearing a lot about this soon.
Judith: How could bankers have been so dumb?
Steve: Because they cared only about annual bonuses and quarterly earnings. And they weren't so dumb. In 2006, Stanley Neal of Merrill earned $46 million and Charles Prince of Citigroup $26 million. Last year their shareholders lost tens of billions.
Judith: How will we get out of this mess?
Steve: First, the Federal Reserve will apply monetary stimulus.
Judith: What does that mean?
Steve: It means they will lower interest rates.
Judith: Wasn't that what started the problem?
Steve: You don't understand economics. Second, the Federal government will apply fiscal stimulus.
Judith: What is that?
Steve: They will borrow hundreds of billions, give it to people, and hope they spend it fast.
Judith: But you said deficits were one cause of the present economic problem.
Steve: You don't understand economics. The hope is that fiscal and monetary stimulus will avert a credit crunch. Then lenders will start lending again and borrowers will borrow again.
Judith: But too much borrowing created the problem.
Steve: You don't understand economics. Once we escape a credit crunch, the profit motive and unregulated markets will work their magic.
Judith: I'm confused. You say we got into this mess because federal deficits were too high, interest rates were too low, lenders were lending too much, and borrowers were borrowing too much, and the unregulated free market went crazy pursuing short-term profits. Now you say we will get out of the mess by increasing deficits, reducing interest rates, spurring lenders and borrowers to run up more debts, and leaving everything to the profit motive and unregulated markets. What am I missing?
Steve: You are missing the theory of Homeopathic Economics. It based on the "Hair of the Dog That Bit You" principle. Doing more of what created the problem will cure the problem.
Judith: How does Homeopathic Economics work?
Steve: Consumer spending accounts for more then 70 percent of GDP. The whole economy depends on consumer spending. A Homeopathic stimulus package will keep the consumers spending.
Judith: But aren't consumers already spending too much? Doesn't the country as a whole spend 7 percent more than it makes? Isn't this why we run an $800 billion current account deficit? Shouldn't we be increasing savings and reducing spending?
Steve: You don't understand economics. Cutting consumer spending by 7 percent would create a deep recession. So consumers must keep consumers spending. They can finance their spending by borrowing more.
Judith: Consumer credit card debt and household mortgage debt have both doubled since Bush took office. The average American owes over $8,000 in credit card debt. How much more debt can consumers bear? This sounds like a Ponzi scheme. What happens when the house of cards collapses?
Steve: No one is worried about that because there will be a new president, a new fed chairman, and a new congress before it collapses. It will be someone else's problem.
Judith: Well I'm worried.
Steve: You shouldn't be. We'll be OK.
Judith: How's that?
Steve: With a little bit of luck, we'll be dead first.
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