A Talking Paper on Economics Basics
By Sam Huntington
Introduction
While there are some of us who find history interesting, its only real value is that it teaches us valuable lessons from the past. We know from history that there are causes and effects; we understand that there are very often unintended consequences to causes, and that over time, one effect may in turn cause yet another. Often, causes and effects are not readily apparent, so we must rely on critical thinking to sort them out. In my opinion, we Americans don’t do so well in our critical thinking skills; if we were a nation of critical thinkers, our country would not be in its present financial mess.
Economics is both an art, and a science. There are two essential parts to this topic: theoretical economics, and practical economics. The people who deal in theoretical applications are mostly university professors who have never worked in the real world, so they are prone to argue the kind of nonsense promoted by Karl Marx. Practical economists, on the other hand, have had to sink or swim in the real world of financial management; they generally know what they are talking about, but even then, it is difficult to find economists who agree on either the causes or effects of economic decisions.
It is not the intent of this essay to restate the economic development of the United States; it would take too long and few people are even interested. Rather, I will attempt to illustrate important developments that produced our present economic situation.
Background
First, understand that money is a medium of exchange. Until recently, money had a value based on standardized weights and measures. Gold and silver coins, for example, contained a certain amount of this precious metal, often certified; its weight in gold or silver gave the coin its value. The problem with heavy coins, however, is that they are heavy and somewhat inconvenient to carry around, In early America, bankers sought to create paper money, gold or silver certificates; that way, gold and silver could be retained safely in banks while allowing people to exchange these certificates for goods and services. We called this paper money certificates because it was possible to present them to a bank, and receive gold or silver upon demand.
Not everyone was in favor of paper money, however. Thomas Jefferson, for example, warned us that “Paper is poverty . . . it is only the ghost of money, and not money itself.” Over time, the US government removed currency from the gold and silver certificate standard; today, our money is simply paper. The point is that there is no longer a psychological attachment to money because it has no intrinsic value except that we can exchange this paper for some quantity of goods. If we still used twenty-dollar gold pieces, we would be less likely to exchange them for Chinese made goods at Wal-Mart. Mr. Jefferson continued: “The trifling economy of paper, as a cheaper medium, or its convenience for transmission, weighs nothing in opposition to the advantages of the precious metals . . . it is liable to be abused, has been, is, and forever will be abused, in every country in which it is permitted.” Mr. Jefferson was right.
About Debt
Individual (consumer) debt has been with us for a very long time. It might have started with one neighbor borrowing a shovel from another and then giving it back later. If the borrower failed to give it back, ancient societies might have placed the borrower into bondage until “interest” to the lender was satisfied. Modern lending began in Italy during the 1300s; bankers loaned money, but demanded the payment of some amount of interest in addition to the amount borrowed. It was a penalty for borrowing . . . and it still is. Even so, consumer debt in the United States is a relatively new phenomenon, simply because until the 1920s, banks refused to loan money to middle class or poor people. When these people bought things, they had to pay cash for them; this means they had to save up their money first, and then make high-cost purchases.
But then merchants realized that they could expand sales by extending “credit” for the purchase expensive goods. Combined with exceptionally smart marketing techniques, merchants offered “time saving” conveniences, such as appliances: washing machines, refrigerators, gas or electric stoves and ovens, and electric irons. It was possible to buy them “over time.” Consumers had two options: they could put the product on interest free “lay-away,” or they could take the product home, make regular payments, and pay a surcharge for credit (interest).
Credit purchases involved some risk, however. By spending future income on purchases made in the present, there was always the possibility that a worker might lose his job and have no future income. It was a risk many people were willing to take, however. And under credit arrangements with local banks, car dealers could sell more vehicles. Under this system, car dealers profited, and so did banks. Interest rates were usually high (12% in 1928), but no one seemed to notice “over time.” During the Great Depression (1929-1941), the US government encouraged banks to increase loans for cars and homes, and in order to encourage more spending, government began to guarantee these loans.
Following World War II, with a massive increase of consumer goods, government backed loans helped to propel the United States into a consumer-based society. Veterans received government guaranteed loans and by the 1970s, there were six government agencies in the loan guarantee business. By 1989, the US government backed more than 40% of all home loans; they also guaranteed education loans, farms, and small businesses. But even that was nothing compared to the invention of the credit card. It began with Frank McNamara’s Hamilton Credit Corporation (The Diner’s Card, 1950), and rapidly expanded to American Express cards (1958) and Bank of America. Since federal banking law limited interest charges equal to that allowed by state law, bankers made deals with South Dakota and Delaware, permitting unlimited interest charges. And then credit card companies realized that they could charge less interest and make more money by increasing their debt — smaller interest charges on higher amounts, compounded over a longer period. They also made money by charging fees . . . late payment fees times the number of irresponsible borrowers equated to millions of dollars in pure profit.
Discussion
We must now confront two psychological factors: paper money with no intrinsic value, and plastic money, which is no more than an obligation to pay. Most people do not think much about this—they simply go through the motion of working for some number of dollar bills, which they in turn exchange for goods and services . . . most of which they don’t really need. And they use their credit cards regularly, which means, “debt accumulation.” Because it is convenient to use a credit card, people give no thought to accumulating more debt than they can pay off over several years.
Most credit card debt comes from large consumer purchases: televisions, cell phones, cell phone bills, iPods, and computers. People use their credit cards for gasoline purchases, groceries, medical needs, and even sending packages through the Post Office. Every time someone uses a credit card, they incur debt against future income. There are two glitches to this process however. People not only use one credit card to its maximum limit, they often have between six and ten credit cards, and each of those is used to maximum limit as well. The second problem is people do lose their jobs; when that happens, they no longer have the ability to pay off a mountain of debt.
Psychologically, using a credit card isn’t the same thing as pulling out a twenty-dollar bill to pay for purchases, and even that is very different from giving away a twenty-dollar gold piece. Plastic and paper is easy to dispense because we subconsciously know it has no intrinsic value. It is merely a utility. And even when we pay our bills, whether we do that using online services, or writing checks — it is only key strokes or valueless paper. Either process is only a utility to transfer earned income from one account to another. Again, the system appears to work very well up until there is no more income; or when the amount of debt exceeds income potential.
Monkey See, Monkey Do
Government has been acting exactly this way since the administration of Woodrow Wilson. One administration after the other has attempted to expand “services” through debt . . . spending future revenue (income) on government programs today. But now it’s much worse; we are spending so much money not even our great grandchildren will be able to pay it off. Like most Americans who have collectively incurred 1-trillion dollars of personal debt, our government is technically bankrupt. Note that government doesn’t create wealth, people do. What government does is tax people a portion of their income in order to spend money on a wide range of programs (most of which the federal government has no business being involved with in the first place).
What are the likely consequences to government’s inability to tax people who are no longer working? Like the errant hedonist consumer, our government increases spending even in the face of diminished revenues, and they do this by going into debt. Like consumers, government must pay interest on its debt, but rather than 20% of say, $10,000.00 . . . the government is paying 10% on $10 Trillion. This obligates the American taxpayer to pay the principle and interest, of course . . . but even worse, the amount is so large that our great-grandchildren will be paying it off. It also means, eventually, much higher taxes for everyone. Our government is currently borrowing money from foreign governments to sustain outrageous spending. How can the United States maintain its internal security and national sovereignty when it is so close to outright bankruptcy?
Tying up Lose Ends
When people aren’t working, they aren’t spending. When they aren’t spending, there is a decrease in the demand for goods. When people no longer demand products, companies who make those products start laying-off their workers. An increase in unemployment means a substantial (exponential) decrease in spending and a concomitant decrease in tax revenues. Recently, Congress announced that since gasoline has dropped to less than $2.00/gallon, it would increase its federal excise tax by forty-cents per gallon. Don’t worry though . . . this is the hope and change everyone voted for.
This country is well on its way to economic collapse. I wonder what people will do with all of their expensive high-definition television sets when they have no place to live because they lost their jobs, when they can no longer afford to make their mortgage or rental payments. I wonder what people intend to do with their Lexus or GM Tahoe vehicles that carry upside-down balances: where people owe more than their toys are worth. I wonder how people will react when they finally realize that the federal government is no longer standing there with a safety net.
The number one rule of good government should be, “First, do no harm.” It may also be fitting to consider the saying, “The road to hell is paved with good intentions.” Government does great harm when, in attempting to provide a wide range of human services to the American people, it tramples on the Constitution of the United States. As we have seen, the road to hell in this case is extraordinary debt and the loss of national sovereignty to foreign creditors.
If this realization finally takes hold, people will understand that it isn’t the purpose of government to provide safety nets. People would not be losing their jobs right now if government had not intruded in areas that are not the business of the federal government. Similarly, people might also realize that had they not spent themselves into oblivion, they would have real savings to sustain them through periods of economic recession.
Recommendations
It is time to learn the lessons of history, even if only recent history. Federal spending on programs that clearly fall outside the purview of constitutional intent of federal government must stop. But there are only three options to stop that wasteful, meddlesome spending: (1) States must tell the federal government to “butt out” of areas that our founders intended to be within the realm of states’ rights. (2) American voters must demand that their elected officials focus more on reduced spending than increasing taxes; enough is enough. We do not need a federal department of education, or Indian affairs, or any number of other programs that do little more than spend our money, and (3) the federal government must acknowledge that they do not have all the answers to the problems that confront us.
Presently, there are more than 26 major federal departments . . . all of them arguing for a percentage of your hard-earned income. These huge bureaucracies employ hundreds of employees who do little more than gobble up our tax dollars. They are very much like the charity organizations that spend enormous sums of money on everything but the charity they advertise. Every dollar collected by the government represents a dollar less available for spending, saving, or investing. Beyond the budget, your federal government has spent $2.7 Trillion on “bail out” provisions; and half of that is money borrowed from foreign governments.
The cost of our consumerism is at hand. Your debt is about to catch up with you. And so too is government debt . . . only it will plague you for the rest of your life, your children’s lives, and for two generations beyond that. There is a long-term solution, though . . . but it must start today with a reorientation in the way we think about money and our economy: Debt is bad even when necessary (such as mortgage loans). High debt places people in a bondage situation: they must work for n years in order to pay off their loans. And because of our artificial monetary system, over-use of plastic credit cards, and uncontrolled government and consumer spending, we are no longer in control of our economic destiny.
Cross-post: Conservative Convictions
