America’s problem

The world’s biggest economy is in deep trouble. The government and Federal Reserve have effectively tried everything they can to fix the problem but have failed.

That problem is weak consumer demand, which has been caused by the demise of America’s middle class.

Now it seems the question is not whether the American economy will go back into recession, but whether it will be a recession or a depression.

America has the most unequal country in the developed world. The top 1% of people earn more income each year than the bottom 50%, and own more wealth than the bottom 90%.

Between 2000 and 2008 under President Bush, the median family income fell by $2,200, mainly due to weaker union power and because businesses had to reduce worker wages to counter rising healthcare costs (businesses largely pay for health insurance in America).

During the same period, the income of the 400 wealthiest families more than doubled and their effective tax rate halved to 16%.

In 2007, the 400 highest paid individuals had an average income of $345 million.

Their massive savings helped to fund the middle class’s excessive mortgage borrowing. This created the debt problem that now haunts ordinary Americans, who have also seen their property values and incomes decline.

As a result of this financial squeeze, many people have little money each week to spend on items beyond food, clothing and bills.

This lack of spending is America’s real problem.

It is not – as many people have claimed – an issue of credit (bank money). Banks are now well stocked with cash, as are many businesses.

But banks won’t lend money to people in a bad financial situation, and businesses won’t spend money if they don’t foresee reasonable sales.

Numerous surveys have shown that plenty of American businesses are waiting to invest cash in equipment or staff – both of which would grow employment – but don’t have the confidence to do so because of weak consumer demand.

Given the options already tried, it seems there are now only two ways of fixing it.

The first is to introduce a family welfare payment, conditional of employment, of perhaps US$100 a week. Assuming there are approximately 50 million qualifying families in America this would cost about $260 billion a year – expensive but certainly not unaffordable.

This would fuel consumer demand, increase business sales, and grow employment. Confident businesses and banks would start investing and lending more, further increasing employment.

However, its implementation is highly unlikely. It would require an increase in taxes for the wealthiest Americans to help pay for it and the newly-elected Republicans (and most Democrats for that matter) are against that type of wealth redistribution.

The other solution is creating new industries. With its universities, venture capitalist funding and large consumer market, America is one of the best places in the world to foster new business ideas.

Having lost a lot of jobs to China, the US needs to find new things to sell to people in order to create jobs and increase its export sales.

This option is widely supported but the problem is that it will take between 5 and 10 years to develop. The economy will have imploded well before then.

On Wednesday, the Federal Reserve, America’s central bank, announced that it would pump US$600 billion into the economy, by buying government bonds off banks, in a final attempt to fuel demand.

But such a move did little for middle class wealth in 2009 and experts are holding out little hope for it this time round.

As a result, America appears to be out of options. And making matters worse is a broken political system.

Republicans, who now control half the power in Congress, are considered unlikely to give President Obama any legislative victories on the economy in the next two years because they want him out of office in 2012.

Meanwhile, the American public, angry and frustrated at the struggling economy, seem to have lost their sense of reason.

They lapped up the politicians’ recent campaign ads that talked little about their solutions but rather conducted character assassinations on their opponents.

It appears many Americans simply want someone to blame, because making a decision based on economic understanding is just too difficult.

That plays into the hands of politicians who promote vague ideas like small government and freedom without actually specifying how that will improve people’s lives.

Given this culture and political climate, there is little chance that a government-initiated solution can prevent America from going into another recession (two consecutive quarters of negative growth).

The question is whether that recession will turn into a more serious depression. That’s unlikely if they can wear the pain for a few years while they create new industries.

But if the angry voters can’t wait that long, politicians may turn to dreaded protectionist policies for a short-term fix, just as they did with the famous Smoot-Hawley Tariff Act in 1930 which led to the Great Depression.

One would hope America has learned from that mistake. But given the irrational public mood at present, anything is possible.

By The Casual Truth