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Jon Markman

SuperModels3/4/2009 12:01 AM ET

How savers could doom the economy

Continued from page 1

Le freak, c'est chic

A key difference between the theories animating the work of Obama's economists and the theories behind the Levy-Kalecki formula are that the former assume people will act rationally in accordance with government prodding and the latter consider the possibility that people will freak out. Contrary to mainstream economics beliefs that people operate with perfect knowledge, Levy-Kalecki assumes that economic participants -- families, officials, workers, investors and executives -- grope about their lives in an atmosphere of uncertainty, develop false beliefs and make mistakes, especially when surprised.

While mainstream economics argues that markets and people tend toward a harmonious equilibrium that can be guided by didactic government action, Levy-Kalecki suggests behavior instead tends toward disequilibrium. The difference in policy that must be developed in each case is profound, for the former tends to rely on inflexible formulas while the latter would seek to constantly adjust.

The rubber meets the road now in two views of how individuals will react to incentives embedded in the stimulus package. The Obama team apparently believes enough dollars are being applied via government credits, direct spending and state grants to overcome the deep erosion of individual Americans' consumption. Yet Wall Street practitioners who follow Levy-Kalecki tell me that the package falls short by a whopping $1 trillion.

Without directly creating private jobs via public-works projects to give laid-off workers new income streams -- and thus help people stop obsessing about a bleak future -- the Levy-Kalecki model forecasts the next year will feature a steep climb in saving, plunge in spending, wipeout in corporate earnings and disintegration of the stock market.

Anticipating a collapse

One Levy-Kalecki adherent who runs a credit portfolio at a New York investment bank told me he believes that complacent policymakers don't seem to realize the nation faces a grave financial crisis on par with war. If people react to weakening job prospects by stiffing their credit card and mortgage lenders in order to save at a level that will let them survive a financial meltdown, he sees the potential for $6 trillion in lost spending over the next two years.

"This is what commodity, bond and stock markets are trying to price in right now," said the manager, who asked not to be identified. "Investors gave up waiting for the government to act effectively and are taking down the value of everything in anticipation of collapse."

If we were dealing with only a global banking crisis, current policy might have been effective. But the credit drought has sparked what economists call a Fisher debt-deflation spiral, in which companies' long-term cost of funds is too high to provide a reasonable rate of return, so they cut both their borrowing and their investments. The less big companies borrow, the worse banks perform, the less they can lend to smaller companies and the less can be invested in expansion. Rinse and repeat until total implosion in a cycle already beset with individuals similarly disinclined to borrow and spend, as happened in the Great Depression.

Levy-Kalecki followers believe the answer to this is massive direct government public-works spending totaling up to 30% of gross domestic product, even if the national debt rises to greater than 100% of GDP from 60% today -- something along the lines that British economist John Maynard Keynes recommended in the Depression.

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Great Depression © The National Archives/Corbis
The prospects for a depression
Jon Markman shares his definition of a depression and why he thinks the US may be entering one. (Feb. 7)

Since the Obama team has shunned that path, the fear now is that only an event similar to the one that bailed out the United States from the Great Depression will vanquish the six-headed beast of rising unemployment and savings rates, falling spending and earnings, debt deflation and corporate dis-investment. That was the intense manufacturing demands of World War II.

Hopefully a saner alternative will emerge.

Fine print

To learn about other families that are cutting back on their spending, click here. . . . To find out more about the Levy-Kalecki formula, check out the Jerome Levy Forecasting Center at this site, especially this page. Also check out the Levy Economics Institute of Bard College. To learn more about the views of Minsky, check out this article in The New Yorker.

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