Is Double A plus enough?

Barack Obama has his own opinion that says, the US is a AAA nation, has always been a AAA nation and will always be a AAA. Well, color me as unimpressed as the stock markets were.

Why did the the downgrade happen in the first place? Well, answering to another comment on an article of the Economist I put it this way:

Ratings agencies don’t rate the potential ability to pay, but the likelihood of default. Given that the US has effectively tied its hands regarding tax increases and austerity measures have proven to be very effective in initiating yet another deep recession (just three examples: USA 1937, Japan 1997, Greece 2010), the likelihood of default is undeniably there.

Basically, it’s all in there. The performance of an economy that is stuck in the kind of situation that the USA is in, depends a lot on state expenditure. Why? Well, in my original comment to this article I explained it thus (with some small corrections):

There is simply not enough demand by the people to justify investments, for a large part because they are still paying off the unreasonably large mortgages that they put on their houses during the days of the housing bubble. Now, the debt is still there and will be there for decades, but the “value” of their houses evaporated in a matter of two years. And while they are paying back debts, they won’t be able to consume as much and the corporations won’t have reason to invest as much as before. Somebody else will have to do the consumption and investment that the economy requires to run (because this is how wages and salaries find their way to the general population).

Unfortunately, the political climate in the USA makes sure that the government won’t intervene on a sufficient scale. The government must provide money to the consumers in some way, if it wants to restore the economy. Simply giving it away might work – but it doesn’t provide the right kind of incentive and in fact there are much more efficient ways to make it work. The government should invest and make sure that the money is not merely lost in corporations but ends up paying employees and creating additional demand.

Why? Because there is a lot of room to invest in the US and investments will not destroy the incentive structure of the economy – as would be the case if the money came for free. US infrastructure is decrepit – be it roads, cellphone networks, levees, electricity supply and on and so forth. There is plenty of need to invest there.

Unfortunately, the blockade of US politics by the Republicans and especially the Tea Party Movement will not allow such investments – because they are not not the kind of policies that corporations are likely to fall in love with. Corporate profits are beside the point here and in a corporate dominated country like the USA, policies that won’t increase corporate profit are nearly impossible to implement.

Hence the danger of US default, that has been obvious for years. If anything, the downgrade from AAA to AA+ is too little, too late – and in fact a step that has long been taken by some smaller rating agencies.

How come I’m so certain about the policies to follow? (Although I’m open to suggestions regarding the precise mechanisms.) Don’t the conservatives of the US say the exact opposite – that the budget should be balanced immediately and taxes be reduced? Well, if we can ascertain the mechanism, it should be easy enough to judge whether the right course is for the government to spend more money or to spend less.

Now I could cite important people, but I don’t like appeals to authority. Because one ends up judging the authority that’s being referred to, instead of the argument itself. So judge my own reasoning:

All economic activity needs supply and demand. Otherwise, well, we wouldn’t be talking about an economy. This creates two obvious ways for an economy to fail. There could be a lack of supply or a lack of demand. That’s obvious. It’s bad for the economy if supply suddenly fails to materialize, e.g. for lack of production facilities or materials. It doesn’t help the economy either, if people suddenly realize they won’t need certain products any more. (E.g. wearing wigs was a bad idea anyway, so why keep making them?)

What’s missing in this picture? Money! Demand must always be backed up with money. A buyer without money (or credit) doesn’t represent demand. A US household savings quota of -0.5% meant that money wasn’t around. With the burst of the housing bubble people ran out of credit and demand plunged. Wages were insufficient, interest rates on mortgages rose, millions lost their jobs when those people curtailed consumption, further aggravating the problem that consumers lack money.

The key factor is lack of money. Supply is not the problem – there is enough excess capacity and unemployed workers to increase it at will, if there is enough money around to pay for it.

Any plan that doesn’t address this problem or makes it worse is bound to fail. The economy is all about transferring goods in exchange for money. For that to work, those who need goods must have money. And those who provide goods must need money. If those conditions don’t apply, you must either proof that there is a mechanism at work that reestablish those conditions or you must provide the mechanism yourself – unless you want to ruin the economy and don’t care about the suffering of people in a depression.

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