* By Lounge Lizard
We are now facing a world-wide depression, not just a recession. Governments are in a panic. Never in history has so much money been thrown at a problem. In the US, Obama's proposed stimulus package now totals $US 820 billion, laden with pork for special interest groups and money for causes deemed worthy by the incoming administration. In the UK, Gordon Brown's government is throwing another £200bn to the banks. In Australia, Rudd is now throwing $4bn to the commercial property sector.
All this is in addition to the $US 700bn bank bail-out plan that was signed into law by President Bush on October 3 last year and Gordon Brown's £400bn bank rescue plan unveiled a few days later. When will it end?
Behind all this expenditure is the belief that the only way we can avoid financial disaster and a prolonged economic downturn is to boost consumption. We may already have too much debt but we must take on even more so that we can all continue to buy houses and cars, to consume as before. And political leaders everywhere, in reactions eerily similar to those of the generals on the Western Front during the First World War, insist that economic victory will be achieved by throwing yet more funds into the fight.
But far from achieving victory, this will only make the situation worse. Far from speeding recovery, it will slow it.
To understand why this is so, we must first remember that the current crash is a product of the boom before it. Easy credit helped generate a boom in both stock and real estate markets and as I noted in my earlier post, The Recession We Have To Have, this meant that we didn't need to save to become richer as each year passed. In common with the rest of the Anglosphere, we didn't save much and relied on others to provide much of the funding we needed to maintain our lifestyle.
Sometimes we need to import specialist expertise. We don't currently have people who know how to build and operate nuclear reprocessing and storage facilities should we decide to establish them. However, we should have enough of our own people for most roles in our modern society, enough people for key occupations, such as plumbers, general practitioners, nurses and policemen. If we don't, our society is out of balance.
Similarly, we may need overseas finance for major developments - an aluminium smelter or a major mining project. However, we should be able to finance our houses, our shopping centres and our normal infrastructure from our own domestic resources. If we can't, our economy is out of balance.
It's because our society is out of balance that we must import doctors and nurses. It's because our economy is out of balance that the Australian Government has now decided it must help finance the commercial property sector.
To get the economy into balance will take time. Like the smile on the face of the Cheshire Cat, a huge amount of wealth has just disappeared. The value of business assets has shrunk. When sales of particular items decline, the factory that produces them is worth less, no matter how much it cost, no matter how well it was designed, no matter how modern and sophisticated its plant.
This flows through to individuals and families. Even if only a small minority are actually unemployed, our homes, superannuation accounts, share portfolios and investment properties are no longer as valuable as they once were. And the greater the level of debt, the greater the loss of wealth.
In response, individuals and families together with business enterprises are battening down the hatches and seeking to restore their financial position. Thus consumption will decline and savings will increase.
Only when people feel their personal situation is secure will they return to their old expenditure patterns. That's why the stimulus packages currently being proposed won't significantly affect consumption and therefore won't get the economy moving again. In fact, government packages will generally achieve the opposite, as increases in resources allocated through the public sector will tend to deprive individuals of the resources they need to repair their own financial positions.
So what should governments do?
Government policy should be based on the principle that governments do not exist to promote particular industries or companies but to promote the welfare of the people as a whole. It is not the role of government to bail out particular industries or prevent any particular company from failing. Any government intervention should be for the benefit of individuals and families generally, and be independent of what they happen to do for a living or where they happen to live.
Here are some first suggestions.
Governments should not invest in or promote through subsidies or tax concessions any venture that doesn't have a positive financial rate of return in the absence of government intervention. Enough wealth has been destroyed already without destroying still more.
Governments should recognise that the fundamental problem is the decline in wealth and the need for individuals, families and companies to repair this decline. To help do this, the taxation system should be amended so that realised capital losses (presently offset against realised capital gains and if these are insufficient, carried forward to be offset against future capital gains) are immediately deductible against current income. If current income is insufficient, other things being equal, this implies that previous taxable income was in excess of reality. Thus income tax should be negative and a refund made to the individual or company concerned. Further, to promote flexibility in capital allocation and so speed a recovery, capital gains tax itself should be suspended as from, say 2012, preferably permanently, but at least for the following five years.
Similarly, if a company makes an overall taxable loss, it should be entitled to negative income tax capped at the amount of income tax paid over, say, the previous five years. In this way, help can be directed to where it's most needed while avoiding political pressures from special interest groups.
When sub-prime loans collapsed in the US, many economists and financiers believed that these dodgy loans amounted to less than $US 1 trillion and that the losses could be contained. They forgot about the overall imbalances in the US and throughout the world, imbalances that had developed over many years. The sub-prime fiasco may have been the trigger, but it was only part of the problem. The consequences of the imbalances were inevitable. What could not be foreseen was the timing.
A depression is descending upon the world and we can't avoid tough times for the next few years. It will test our ability to implement rational policies, to avoid the pressures of special interest groups, to escape social chaos and retain national cohesion. In short, it will test our culture. Throughout the world, it will be culture that will determine national success or failure during the tough times ahead.