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Economists Are Split on Two Primary Views to Revive the Economy, But Politicians Are Only Interested in One

By: Steve Johnson

3/3/2009 - 13 Comments

The funny thing about understanding the economy or how to fix the economy, is that if you ask 10 economists you usually get 10 different answers.

Among those answers, there are two primary views on how to fix the current troubles in the economy.   The difference between these views can be traced back to what the economist believes’ was the root cause that lead up to the current recession. 

What Was The Root Cause of the Recession?

1. Greedy Wall Street

Was it the greedy Wall Street firms that over leveraged there assets until they found themselves insolvent, knowing the government would surely bail them out anyway?   The leverage of Wall Street investment firms packages these home and sold them all over the world, with rating agencies stamping AAA on each package, while home appraisers continued to appraise home values higher and higher. 

2. Expansion of Credit

Or was the root cause of the recession the expansion of credit, which allowed the millions of people to purchase homes that they could not afford and should not have been allowed to purchase them or extra money from?  The expansion of credit was primarily done through the governments influence with mortgage giant Fannie Mae and Freddie Mac and through the reduction of interest rates and lending standards.  This massive credit expansion was the primary driver of all economic growth for the last decade. 

These two root causes lead to two drastically different conclusions on how to fix the economy.  On the one hand, greedy Wall Street firms, points the finger at capitalism and how the economy cannot run without a strong hand of government to protect the people from greed and profit seekers.  On the other hand, the expansion of credit points the finger at government involvement in the market as the primary cause for the entire recession. 

The Solution

The solution that any economist proposes comes from their initial assumption of the root cause, which will undoubtedly lead them to come to different solutions. 

The problem is that the responsible party of the root cause #2, the expansion of credit, is unmistakably the government.  Therefore, how can any economist who has this understanding be involved in the government’s policies to fix the problem, unless the government leaders come to the belief that they are the problem – that they are to blame?  With this in mind, the only economist that the government will counsel about this recession is economist that believe that the root cause could only be #1, greedy Wall Street and capitalism. 

This is not a Republican or Democratic issue as much as it is a failure of our nations’ most powerful leaders to recognize their own failure.  The result of this conundrum is that the root cause of the recession can only be capitalism and therefore any solution can only be targeted at capitalism – as congress and the administration have targeted. 

1. Expansion of Consumption

If the root cause of the recession is greedy Wall Street firms, which has led to the frozen credit market that have brought on a deepening recession, then the solution is without a doubt to expand credit even more by flooding the banking system with more money.  That is the current policy of Fed Chair Ben Bernanke, President Obama and the majority of Congress. 

Furthermore, if capitalism is to blame, than the governments role must expand to control every corner of the economy and keep everything fair so that no one gets paid too much and everyone gets whatever they want regardless of their effort or intellectually ability or their education.  This experience with socialism is like a cancer that is spreading very quickly and without a major dose of chemo, will eventually kill the host.

The expansion of consumption, by flooding the nation with more easy money from the bailout packages will only exacerbate the problem and drain even more wealth out of the economy.  In the end, we will end up poorer than before the bailouts.

2. Increase in Savings

If the root cause of the recession is the expansion of credit, which has led to the bad investments’ in overprices assets that were not worth what they were sold for. Then the solution is to stop expanding credit, raise interest rates and stop bailing out businesses that made bad investments.

The solution is to drastically decrease government spending and lower taxesAs you can tell by now, I am in this group of economist.  But, we have little chance of being heard by the government who is convinced otherwise.

More than anything, the economy is in desperate need for savings to recapitalize the banking system so they can lend to businesses that want to create jobs.  Do to that, we need to reduce consumption – not expand consumption.

In Conclusion

I hope you can see the irony of the situation and understand why the pro-capitalism economists like Peter Schiff, are unlikely to be heard even if they have the answer.

Economic recovery requires greater saving and the accumulation of fresh capital, to make up for the losses caused by credit expansion, bad investments and overconsumption that follow from it.  Yet the proposed solution in the form of "stimulus packages" will only result in a further loss of capital.

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