'Broad-based mess'

That's how NYT columnist Paul Krugman describes the economy, and he says that the trouble is deeper than most people realize. Here’s the nub of the crisis: the net worth of the average American household, adjusted for inflation, is lower now than it was in 2001. And yet, we've been spending like crazy these last eight years. Judgment day has finally arrived, not just for homeowners who are underwater, but for most everybody who has lived beyond their means.

Everyone talks about the problems of the banks, which are indeed in even worse shape than the rest of the system. But the banks aren’t the only players with too much debt and too few assets; the same description applies to the private sector as a whole. And as the great American economist Irving Fisher pointed out in the 1930s, the things people and companies do when they realize they have too much debt tend to be self-defeating when everyone tries to do them at the same time. Attempts to sell assets and pay off debt deepen the plunge in asset prices, further reducing net worth. Attempts to save more translate into a collapse of consumer demand, deepening the economic slump.

[CUT]

If you want to see what it really takes to boot the economy out of a debt trap, look at the large public works program, otherwise known as World War II, that ended the Great Depression. The war didn’t just lead to full employment. It also led to rapidly rising incomes and substantial inflation, all with virtually no borrowing by the private sector. By 1945 the government’s debt had soared, but the ratio of private-sector debt to G.D.P. was only half what it had been in 1940. And this low level of private debt helped set the stage for the great postwar boom. Since nothing like that is on the table, or seems likely to get on the table any time soon, it will take years for families and firms to work off the debt they ran up so blithely.



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Mark Lacter
Mark Lacter created the LA Biz Observed blog in 2006. He posted until the day before his death on Nov. 13, 2013.
 
Mark Lacter, business writer and editor was 59
The multi-talented Mark Lacter
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