Common Sense in Economics, Not Gimmicks

Fareed Zakaria talks about common sense in our approach to the economic crisis:

The background noise in the wonk world these days is of furious debates over economic theory and policy. The foreground is the American economy, which appears strikingly unresponsive. The Federal Reserve's much-debated quantitative easing ("QEII") appears, so far, to have had the opposite of its intended effect: It was conceived as a way to push down long-term interest rates so that people would borrow more, but those rates have risen considerably since the Fed switched on its presses. To a non-economist, this is the latest example suggesting the limits of macroeconomic policy and the need for some common sense.

Everyone is haunted by the crisis of 2008. Consumers are paying down debts, preserving cash, hoping that they keep their jobs and that their houses stop sinking in value. Businesses, having come from a near-death experience, are being conservative in an atmosphere of uncertainty. With little fresh demand in sight in the United States, why would they hire workers or build factories? And if they do invest, they will do so in emerging markets, where consumer spending is growing by double digits and nearly 50 percent of the S&P 500's profits come from anyway.

Unfortunately, the government's efforts to resolve the crisis amount to giving the country the hair of the dog that bit it. Washington is asking consumers to stop saving and start spending, while the government issues more debt and the Fed lowers rates - all measures designed to increase debt. In other words, we are fighting a crisis caused by excessive debt by encouraging excessive debt. Is that really the best way to get growth?

The investment manager and guru Jeremy Grantham says no. In his latest quarterly letter, he points out that over the last generation, American government has created conditions that encouraged everyone to keep accumulating debt. But far from getting a bang, the country's growth rate actually slowed down over that period. In fact, the effect of all this government-subsidized debt has been deeply destructive. It created asset bubbles in stocks, bonds, commodities and more. One stunning chart in his letter underscores the extent to which the Fed created what he calls "the first housing bubble in history," meaning the first time that U.S. house prices rose dramatically across the board - and are now falling just as dramatically.

Debt-fueled growth "is, in an important sense, not the real world," Grantham writes. "In the real world, growth depends on real factors: the quality and quantity of education, work ethic, population profile, the quality and quantity of existing plant and equipment, business organization, the quality of public leadership (especially from the Fed in the U.S.), and the quality (not quantity) of existing regulations and the degree of enforcement."

This strikes me as the common-sense view of economics. We can push and pull fiscal and monetary policy all we want, but long-term growth depends on these broader and deeper factors.