by John Brian Shannon
Quick, think fast! Why is there a huge liquidity trap in America?
If you can answer that question, then you’re not ‘looking through the wrong end of the telescope’ blaming the symptoms, instead of the root causes of the present American economic problem. Which, some other people (not you and me) are probably doing right now.
Let’s call some of those people 2012 Republican politicians.
The present excess-liquidity situation has come about as a result of some economic policies of the United States, which gained traction during President Reagan’s first term in office. It was a different world then and the 40th President acted swiftly and responsibly to restart the U.S. economy. I quote the New York Times reportage of President Reagan’s inauguration speech.
He said “progress may be slow,” but his “first priorities” would be to “get government back within its means, and to lighten out punitive tax burden,” a reference to his campaign pledge to balance the Federal budget and cut personal taxes to 30 percent in three years. – The New York Times, quoting President Ronald Reagan’s inaugural speech of January 20, 1981.
Personal and corporate tax rates have dramatically fallen since then and the plan to cut the tax rates and add unprecedented billions of dollars of stimulus spending to the economy (much of it went to U.S. defense contractors) worked to grow the American economy and the economies of other Western nations, such as the UK, Canada and Spain. Yes, it was that much stimulus.
Cold War allies such as Canada, received generous NASA and U.S. defense-related contracts from the administration, which in turn helped to boost the economies of Western allies — thereby helping the U.S. economy.
During Ronald Reagan’s terms in office, most cars and trucks registered in Canada were manufactured by U.S. corporations and the same held true for so-called ‘white goods’ (refrigerators, stoves, dishwashers, etc.) and large volumes of many other products — especially construction industry products and materials. Not to mention Canada’s purchase of 110 F-18’s in 1981.
When your allies have money, they place orders with U.S. corporations. When your allies don’t have enough money to purchase American goods and services, sales fall off dramatically.
Of course, there was much more to it than that. America was deep in the economic doldrums in 1980/81 and the American psyche was still reeling from the Vietnam War, a recession and a loss of American prestige following the dual shocks of the Arab Oil Embargo and the American hostages in Iran.
President Reagan stepped up and hit a ‘home-run’ every day for the U.S.A and got America to believe in itself again. The President authorized the Chrysler bailout, other bailouts and some exceptional mergers so that companies would not be forced to shut their doors and take all those middle-class jobs with them.
Economically speaking, by adding significant hundreds of billions of stimulus dollars to the U.S. economy (perhaps as much as 1 trillion dollars, depending on who is doing the counting) and lowering personal and corporate tax rates, the Reagan administration employed a two-pronged approach to foster growth in the American economy. And it worked.
Fast-forward to 2012. Trying to employ those same policies now when we have reached a state of diminishing returns on them (as there isn’t much left to cut without shutting down America) can only be called tinkering with the economy. Back in the 1980’s huge cuts in tax rates were possible and allowed a decade-long spending spree by American citizens and corporations.
Now that personal and corporate taxes are so low and have been for some time, there is no longer room for huge tax cuts of 10% or more. All the juice has been squeezed out of that lemon.
The policies which allowed huge growth in the 1980’s (mega-stimulus and tax cuts) were financed by running massive deficits which were never paid off — as President Reagan had responsibly promised would eventually happen.
When governments run obscene deficits designed to stimulate the economy during times of economic crisis it is an utterly logical thing to do. When successive governments don’t return to balanced budgets and don’t paydown the accumulated government debt during the ‘good times’ as John Maynard Keynes suggested, governments ability to assist in subsequent recessions are constrained (for a telling article on that, read here) – but this time around the constraint is the liquidity trap.
Now we have people writing to members of Congress, to the media and to each other, asking for fixes to the symptoms of the economic problem, instead of the cause. It gets worse, we now have candidates for high office blaming the symptoms instead of the cause.
Why are we in a liquidity trap? The answer my friend, is right below.
A liquidity trap is a situation described in Keynesian economics in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence fail to stimulate economic growth.
A liquidity trap is caused when people [or corporations] hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war. Signature characteristics of a liquidity trap are short-term interest rates that are near zero and fluctuations in the monetary base that fail to translate into fluctuations in general price levels. – Wikipedia
How can injections of cash into the private banking system by a central bank lower the interest rates when the interest rates are effectively zero?
What we are left with; The banks are full to the top with deposited money from individuals and corporations. There is low demand for goods and services. There is little demand for money to loan. There is little incentive for banks to loan money as there is presently such a small ‘spread’ between prime rate and mortgage rates. There is little room for personal and corporate tax rate cuts — as the largest cuts have already taken place over the past 30 years.
What all of this means is the government has little in the way of actual controls over the economy. When both major levers (monetary and fiscal) don’t work, all that is left is minor tinkering.
When two of the most important economic levers are temporarily out of order, we just can’t stand around blaming the symptoms or wishing for a better day. It is now the time to bring in other levers to spur the economy like a reasonable (export) tariff of say, 5-8% on all raw resource exports, such as petroleum (the U.S. is a net exporter of petroleum) coal, minerals and metals.
This would begin to add cash to the federal coffers from day one and every penny should be used to stimulate actual jobs.
The U.S. could hire 100,000 additional police as President Clinton once did – many of whom are still paying taxes and contributing to their local economies, by the way.
Also, more teachers, or teachers with higher credentials could be educating a better future workforce.
‘Shovel-ready’ national infrastructure programs could create jobs for out-of-work and under-employed labourers.
Want to create demand in the economy? Give a few million Americans jobs! Watch how much tax revenue is generated. Watch the sales of everything from work-appropriate clothing, to cars, gasoline, home appliances and so much more, skyrocket in less than a year and continue to contribute to the economy.
People don’t want food stamps if they have a good-paying job. People don’t want welfare if they have a decent job. And people don’t want to burden social agencies when they can afford to live independently.
Looking through the right end of the telescope, there’s nothing but solutions in all directions. A moderate tariff on raw resource exports is a good place to start.
John Brian Shannon
ABOUT JOHN BRIAN SHANNON
I write about green energy, sustainable development and economics. My blogs appear in the Arabian Gazette, EcoPoint, EnergyBoom, Huffington Post, United Nations Development Programme, WACSI — and other quality publications.
“It is important to assist all levels of government and the business community to find sustainable ways forward for industry and consumers.”