How To Borrow Your Way Out Of Debt

So, what was the cause of the credit crunch? Put simply, people borrowed money they couldn’t afford to repay. So now the government, which is also over-borrowed, and has escalating liabilities in the form of Social Security and Medicare, has a solution to this debt problem. The government is going to borrow more money.

Now, this may seem a little odd. If your problem is too much debt, you can’t solve it by borrowing more money: it is like the gambling addict who wants the one last bet that will solve the problem. Or the drunk who wants to drink himself sober.

The idea is that the “stimulus” will boost the economy. If that were true, perhaps the huge debt would be a price worth paying. Especially as economic growth will ease the size of the debt. But what if that is just wrong? That certainly seems to be the case. It is where the evidence of history lies.

Economists have agreed for a generation that Keynesian “demand management” – the theory that underpins the stimulus just doesn’t work. There is a division between those who believe that the “multiplier” discovered by Keynes is much smaller than had previously been thought and a smaller number who think it doesn’t exist at all.

Supporters of the stimulus cite the 1930s and the Great Depression as being the last time “demand management” worked. Both the causes of the Depression and the recovery from it are still hotly debated. It seems most likely that the 1929 Crash was caused mostly by monetary mismanagement and the Depression itself was caused by the Smoot-Hawley Act which introduced protectionism and wiped out international trade – thereby contributing to the rise of Hitler. Did FDR’s program of “public works” contribute to the recovery from the Depression? It is certainly possible and it is a position maintained by a number of economists. But, if so, why has demand management never worked since?

The experience of the 1930s left Keynesians intellectually dominating economics throughout the early postwar period. But Keynesian policies were not actually pursued at this time. America remained on the Gold Standard which restrained the federal government’s ability to spend, especially in the light of the monstrouspostwar debts. Other countries tied their currencies to the dollar, which meant they were similarly restrained.

In the late sixties the Bretton Woods System of fixed exchange rates broke down. A few years later America left the Gold Standard. From the early seventies governments could manage demand as much as they wanted. If Keynes was right the seventies should have been a decade of international inflation-free boom. Growth rates would have risen. Unemployment would have fallen and inflation would only have been a problem if unemployment had fallen to zero. The last thing you would have expected would be inflation and unemployment at the same time. But that is what happened and Keynes was abandoned.

In the 1990s Japan experimented with Keynes again. It didn’t work again. If demand management really ended the Great Depression, why has it never worked since? And if it hasn’t worked in at least seventy years, why on earth would we expect it to work now?

The economy will recover, but there will be a lot of pain in the meantime. And inflation will follow, possibly before the recovery starts.

Article provided by Quentin Langley
Lecturer in PR and Political Communications,
School of Journalism, Cardiff University

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