The Root of Our Economic Crisis And the Path To Prosperity

If we are to fix our economic problems here in the US, we are going to have to answer one basic question:

How do we create economic value in the United States in the 21st century?

How we create economic value is more important than our deficit, our debt, or even the question of jobs. It is the fundamental question, but the one question that doesn’t get asked, especially in the partisan foodfight of politics. Without economic value, there are no ‘jobs’ worth working for, and no retirement from those jobs for which you can save. The forces of economic creative destruction have made the answer to that question trickier than in the past. Do we manufacture more, even in the face of offshoring? Where is our competitive advantage, in a world where talent is on tap globally via an internet connection? What’s our labor advantage when our education system ranks lower than dozens of other countries and India produces engineers willing to work for less?

While those questions go unanswered our elites fiddle with the worst sort of financial engineering. It has been a source of frustration to me that all the elites, even up to our Fed chairman, seem to lack an understanding of the roots of the financial instability that has beset us in recent years. We face a continued danger.  Perusing the bearish ZeroHedge website, I found this pertinent comment:

All this financial innovation and shadow banking was not created in a vacuum. Keynesian monetary fiat central banking and policies of promoting growth by fixing the price and availability of credit has drowned the system with liquidity. Demand for capital is what should determine credit growth. Policies promoting uneconomic credit compress credit profitability. Banking capital is forced to reach for a satisfactory return in ever more risky ways as the core economic function of banking is destroyed by government sponsored excess lending capacity. All the eggheads quoted fault a lack of regulation and a failure of free markets. What they should conclude is a failure of Keynesian credit schemes that interfere with a free market for capital.


What has been the source and cause of that excess liquidity? A surplus of savings, combined with a desire of elites to control and mitigate economic pain. Ironically, by holding down risk-free interest rates, and by monetizing credit, we have created bubble after bubble. This is not new. In 1998, the Asian crisis, fomented by stock market and currency booms that went bust, took down economies and Governments. In the wake of that and due to fears of impending Y2K problems, the Fed help inflate the internet bubble. When that went bust, the Fed again decided to ‘go easy’ and fomented the next bubble – housing. Government fiscal, monetary and regulatory actions combined to prop up the sub-prime housing bubble.

Since the bursting of that bubble, the Fed under Bernanke has been desperately using the hair of the dog that bit us, more and more monetary ease, to push the economy forward. That effort is now looking like pushing a rope. Like an addict who is strung out too much, there are no ‘highs’ left, just the dependency on monetary ease that has us hooked on low interest money, large government deficits, and pathetic growth. If we want to know how that goes, look at Japan, 20 years since their bubble burst, and their economy is still trapped.

The world now is grappling with the Last Big Bubble – the mother of all bubbles in fact – the Big Government Debt Bubble. Like the internet bubble, housing bubble and prior bubbles, this one is a false prosperity built on unsustainable debt, debt accumulated when credit was (too) easy. The European Sovereign Debt crisis, one of the causes of recent stock market tumbles, is all about the potential default on debt of Greece, Portugal, and other European nations, all mired in the combination of high debt and low growth.

The Obama policy of Keynesianism-on-crack, creating $1.4 trillion deficits, adding $5 trillion in debt in 3 short years, with long-term projections in his budget to send our debt/GDP ratio past 200%, has all been about feeding that Government bubble in order to ‘help’ the economy. That bubble-nomics doesn’t work, and it’s not hard to see why. Just as mal-investment in the internet or housing bubble just created economic pain when the bill came due, so too it happens that when you pay for non-economic behavior with Government money created out of thin air or via debt, you are not creating wealth. Rather, you are stealing wealth from one taxpayer, either now or in the future, to consume wealth. The process is inefficient enough that on balance more wealth is destroyed than transferred.

Once we realize that the roots of our current economic malaise are in fact the same as the roots of the crisis in 2008, we must realize that nothing that has been done since 2008 has actually addressed the root problem. What we have been doing in the United States, and the true root of our economic crisis, has been we have attempted to use financial engineering to solve our problems and create prosperity.  Bernanke’s QE1 and QE2 are financial engineering. As was TARP. As is the artifice of ‘stimulus’ through fiscal deficits, dollar dilution, and a number of other conjuring tricks to try to squeeze some increase in spending and investing out of a populace skittish of uncertainty in a country that continues to tax, borrow, spend and regulate our private sector to death.

Why have we done this? Like a company that forgets its core business of creating value, we have done this because our elites are failing to ask the fundamental question and get the right fundamental answer. The question is NOT  “How do we avoid a negative GDP number in Q4?” or “How do we get 1 millions created before my re-election?” They are asking the wrong questions because attempting to answer the right question is so hard:

How do we create economic value in the United States in the 21st century?

The elites, befuddled by pleas for band-aids and bedazzled by the quick-fix of ‘free money’,  have led us to adopt noxious, counterproductive economic quackery. Continuing down the Keynes-on-crack approach, we are saddled with green boondoggles, corporate welfare,  an unaffordable welfare state, and debts that will yield bankruptcy.

Yet all is not doom-and-gloom. For the same forces of economic creative destruction are forces of economic salvation for those who adapt. After all, any system, production process, idea, method or company that seeks to usurp an incumbent must meet the challenge of being better – faster, cheaper, higher quality. And despite the tumult of financial crises and a slow economy, innovation marches on.

The world has 4 billion cell phones, 10 times more than a decade ago. The size of the  internet and the capability of computer chips continues to double every 18 months.  In his essay, “Software is Eating the World”, Marc Andreeson remarks on the creative destruction wrought by software technologies. And he notes a particular bright spot for the US. The landmark names in the new economy, the software makers –  Microsoft, Google, Zynga, Amazon, Apple, Facebook, Salesforce – are predominantly (but not exclusively) American.

The elites at the Commanding Heights of the economy have been asking the wrong questions to arrive at the wrong answer. Their attempts to avert short-term economic pain have blown up the very bubbles that are the root of our economic crises. They were and are over-focussed with our economic consumption, comfort and under-concerned with the real economic value our economy creates. The correct answer to the correct question of creating economic value is apparent when considering how America has moved forward in the past 30 years – technology and innovation applied to market goods and services.

For America to succeed economically it needs to: Be the world’s hub of innovation and the knowledge-based economy. Be the hub of new company formation and new economy value creation. Make all sectors of the economy as efficient and productive as possible through new technology. As a society, we will have to wean ourselves off of financial engineering and the false promises of spending money we don’t have and return to real engineering and real value creation. We face some serious questions and challenges, to keep our innovation edge, to increase high-value manufacturing in the USA, to keep the pipeline of entrepreneurial innovation going.

If we focus on answering the RIGHT question, we are far more likely to find a way out of our crisis and back on the path to prosperity.