Borrowing & Spending Our Way To Prosperity

The Lehmann Letter ©

Today’s San Francisco Chronicle reported (http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2009/01/15/MNRN15B56R.DTL&type=politics)
that the University of California’s Christina Romer, President-elect Obama’s nominee to head the Council of Economic Advisors, endorsed the House of Representative’s $825 billion stimulus package. Testifying at her confirmation hearing before the Senate Banking Committee, Prof. Romer said that her chief task will be to “ensure that the tragedy of the 1930s is not repeated.”

House Republicans were not so sure, as the Chronicle article reported:

"’Oh, my God,’ said House Republican leader John Boehner, R-Ohio. ‘It appears my Democratic colleagues think they can borrow and spend their way back to prosperity.’"

As a matter of fact, they do. And they are correct.

Our economy depends upon rising borrowing and spending for its health. Try to imagine residential construction without mortgage borrowing or auto sales without consumer credit. You know that’s grim because housing and autos’ decline are at the heart of today’s problem. Consumer demand grew robustly from 2002 through 2007 because households borrowed liberally to build new homes and buy new cars. Now that their borrowing and spending has waned, who will pick up the slack?

We can’t reasonably expect business to fill the breach. Why should industry borrow to build new facilities or buy new equipment when demand for its products is falling?

That leaves the federal government. Not even state and local government can help since most state constitutions prohibit deficit spending. So Uncle Sam must pick up the slack and borrow and spend our way out of the slump.

WWII proved the point. Massive borrowing and spending lifted us completely out of the Great Depression and into full employment. It doesn’t matter upon what we spend the funds. Even if it’s war goods that have no peacetime purpose; it’s spending that counts.

Some erroneously contend that this approach was tried during the New Deal and found wanting because unemployment remained substantial throughout the 1930s. We had to wait, this red herring continues, for WWII to pull us out of the ditch.

Not true. New Deal deficit spending would have worked had it been larger: $10 billion annually of government spending supported by $2 billion of borrowing during the 1930s paled in comparison to $100 billion annually of government spending buttressed by $50 billion of borrowing during WWII. Had New Deal borrowing and spending reached WWII levels, the Great Depression might have ended in 1934. Unfortunately, only wartime justified the requisite effort.

We see something similar today. Over a trillion dollars will be spent on the war in Iraq. So far the stimulus package is short of that.

© 2009 Michael B. Lehmann