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A bankrupt country of old men?

By Matthew Jarosinski

Despite return to growth, the economy is far from normal. The main source of the growth is the fiscal and monetary stimulus -- money that government doesn't have. The underlying imbalances remain. Without reforms the economy will have to rely on government for growth for years to come. However, as our society ages, this policy will bankrupt the country. We need reforms so the economy can heal itself.

Most policymakers and the public still do not recognize the systematic nature of the crisis and attribute the crush to ad hoc financial innovation and the temporary housing crisis. They agree with Paul Krugman that "we were the victims of politics." Yet, the outlook for potential growth was darkening long before this crisis. The productivity growth has faded and the rate of labor supply has slowed down. Hence, the rate of economic growth has slowed down and it is now the lowest in American's history. Consumer demand hasn't slowed down because government has reacted by deregulating the banking industry, maintaining low interest rates, and by borrowing more abroad. And consumers borrowed and spent heavily. The crisis was postponed but not avoided. In fact the government created the preconditions for a massive malfunction: trillions in growing debt secured by an inflated asset bubble -- a growth that must end in a seizure.
 
This policy had also other disastrous long-term consequences. The easy money distorted the structure of the economy. Capital and labor were "mislocated." The credit went toward one-time pure consumption. When columnist David Brooks recently suggested that the growing debt reflects a moral decay rather than a short-term policy mistake, his colleagues were unhappy. Paul Krugman pointed out that the surge in debt can largely be attributed to improvised financial deregulation rather than the decline of Calvinist values. "We did not lose our economic morality," concluded Krugman. The world is in better shape than Brooks thinks -- "It's the banks, stupid!"
 
Yet, a brief look at modern U.S. history shows that David Brooks might be right. Prior to the 1960s, a conservative culture dominated. Americans balanced their budgets and believed that government must do the same. The government shared that view. President Eisenhower for example apologized for running the $3 billion deficit. The government spending was only 12 percent of GDP, mostly on defense. State and local taxes were minimal. Following John Kennedy's large tax cut the economy suddenly thrived. Small government and a balanced budget proved to be a recipe for prosperity.
 
The boomer's generation had a different idea. It was breaking with the conservative tradition. Boomers saw nothing wrong with the government running unfunded economic activities and piling up debt. They no longer balanced their budget. They preferred borrowing over saving and the group accounts for 49 percent of consumer demand and for only 7 percent of national savings.

They came to believe that progress was achieved due to the government and through taxation. In the eyes of the boomers the politicians were saviors -- not gangsters. And these "saviors" significantly expanded the Great Society's unfunded programs. They have been running our economic activities by imposing bottomless deficit spending and refusing to accept the consequences. They created debt-induced prosperity. And the boomers celebrated. They've got free lunch and our children and grandchildren will be paying their bill, plus interest.
 
The boomer's generation is approaching retirement now. Demographic forces have a big impact on the economy. The level of retirees to workers is already rising. As the nation ages, the rate of labor supply will continue to fade even further. Consumer demand will decrease. An aging America will have to accept negative GDP growth. It will make the repayment of debt, financing entitlements, and stimulating the economy a sheer impossibility.
 
The U.S. economy has already been struggling to drag itself out of the growing debt as costly old-age benefits are on the rise. According to economic research, every $1 increase in government spending reduces consumer demand by the same amount while each dollar rise in taxes reduces consumer spending by $3. But seniors play a dominant role in the elections and political influence of the elderly is growing. It won't be easy to make cuts in government spending. In fact government spending -- federal, state and local -- has been rising. Overtaxed America is heading for icebergs. And not dealing with the problems or denying that they exist we will create the cataclysm much worse than anything we know.
 
We need reforms. Yet, policymakers stick to Keynesian philosophy and see no need for reforms. Others follow Austrian economist Schumpeter, who declared that a capitalistic system cannot be reformed and will be replaced by socialism. He also once declared that he will be the best horseman, best lover, and the best economist. He admitted he accomplished only two out of the three.
 
Matthew Jarosinski lives in Waitsfield.















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