What Is Happening With the Economy?

The subprime mortgage crisis is only the Sarajevo that caused the financial collapse. The real reason is the massive explosion of debt at all levels and in all forms that has engulfed the world.

Since 1992, the total debt in the world has gone from a level equal to global gross domestic product to a level that is now 3.7 times as much as global GDP. This debt explosion, explained in Charles Morris’ book (no relation) "The Trillion Dollar Meltdown," consists not only of mortgages, but bonds for corporations that can’t repay them, credit cards for consumers who are neck-deep in debt, car loans for drivers who can’t meet the payments, student loans that are swamping young couples and default insurance sold by companies that can’t make good on their commitments. This massive debt has to be sweated out of our global economic system like a heroin addiction.

But we won’t have to go cold turkey. Governments around the world are committed to mitigating the pain. They are not about to ask us to go through the agony of another Great Depression. They have learned the lessons of the ’30s. So government will ease our pain with stimulus packages and corporate bailouts to protect us and the companies that sustain our employment base.

These bailouts and stimuli will not solve the problem. They are simply painkillers — methadone — designed to mitigate our suffering. It is only the private sector shakeout, "creative destruction" in the words of Joseph Shumpeter, that can eradicate the bad debt and bring the economy back to health. To fail to go through this process would put us in the same situation as Japan, which evaded a reckoning with its bad-debt crisis and has suffered with 20 years of stagnation as a result. But to go through withdrawal, even with methadone, will be a long and painful process.

Liberals — demand-siders — and conservatives — supply-siders — disagree on the remedies for the crisis. The demand-siders feel that we need to stimulate demand by passing out checks and cutting middle-class taxes. The right points out that this will only be a drop in the ocean of global demand and that much of the money will be used for debt reduction and to buy Chinese products. The supply-siders plead for a cut in corporate taxes and capital gains levies. Critics say that the current lack of confidence in the economy inhibits investment no matter how much the tax code incentivizes it. Both solutions and both criticisms are correct. The proper medication — the right methadone — is a balance between the two.

But, conceptually, what is happening is the end of the consensus around free market economics engendered by the fall of communism. The era of free market consensus lasted from 1989 through 2008. It is now over. George W. Bush and Barack Obama will leave us with a legacy of government regulation, at a minimum, and control, at the maximum, over the economy.

When the Republican version of the bailout, calling for loans and insurance instead of outright grants of money to corporations, was rejected (thanks to John McCain), the fate of the free market era was sealed. With the bailout cash came the reasonable demand for "equity for the taxpayers" in return. Enter the government.

Now the federal government is the major shareholder in most of our important financial and insurance companies, and in many of our manufacturing corporations. Now we hear this leverage articulated in reasonable demands for limits on corporate executive bonuses and compensation. But soon it will metastasize into calls for a public voice in lending policies and government management and control. Obama and a top-heavy Democratic Congress will accelerate this trend, and there is nothing the Republican Party will be able to do about it.

In the meantime, Obama will pass his entire radical agenda by dressing up the expansion of health insurance and his other schemes as part of a "stimulus package." Already, he includes a grab bag of items from his campaign agenda in his characterizations of the legislation. He wants wind energy, solar panels, infrastructure construction, school buildings and anything else he can think of. Thus sanitized, the most massive pork barrel in history will be rubber-stamped in a matter of days by the new Democratic Congress.

Obama will be freed from the discipline of the balanced budget. With a bipartisan consensus that deficits are vital in fighting the crisis (or mitigating the pain), there is no constraint on Obama and his party. The sky is the limit on spending. Indeed, spending is now a national duty.

The inevitable result will be massive inflation. You cannot run a deficit of a trillion dollars as some suggest and not have double-digit inflation. The Fed will be powerless to stop it because it will not bite the bullet and raise interest rates, for that would truly bring on the mother of all depressions. And since the deficit spending will have been simply to reduce the pain of the depression and not to cure its cause, it will be a stagflation beyond anything we have ever known. A depressflation.

Then the question will be: When will we realize that government controls are magnifying, not solving, the problems that caused the depression? When will the patience of the public with Obama’s remedies run out? When will we realize that the inflation the deficits are causing are more painful than the unemployment they are mitigating? Eventually, all this will come to pass. Our guess is 2010. But maybe it won’t be until 2012 or after. In the meantime, the era of big government is back!