The Dangers of Debt

The central theory of Keynesian economics is that markets can be stabilized by borrowing and spending heavily during recessions and paying it off during boom periods. However, one of the major problems with this idea is that it completely ignores the risk associated with credit.

According to a new analysis of the Great Recession, the countries that were hit the hardest were those with the most aggregate debt (private + public debt).

Maybe this should be obvious, considering how this economic crash was termed a “credit crisis,” but now we have a definitive picture linking the collapse of the mortgage market (which I’ve already explained in great detail, countless times) to the collapse of the rest of the economy.

Basically, the CRA created a housing and mortgage bubble, which was popped by the Federal Reserve spiking lending interest rates. Normally, such a pop would be dissipated by the strength of the rest of the economy, and this is what Alan Greenspan has admitted he was counting on when he deliberately popped that bubble. However, it turns out there was another, more pervasive weakness in the economy: excessive debt due to at least 7 years of Keynesian stimulus. During the 2001 recession, Bush started a comprehensive Keynesian stimulus plan, including tax credits, stimulus spending, and lowered Fed rates. Even though actual economic recovery didn’t begin until the 2003 tax cuts were implemented, the debt-feeding Keynesian machine continued until 2006.

This is important, because it’s an example of Keynesian policy being implemented exactly as Keynes intended: inflationary stimulus during recessions, with deflationary debt-paying during bubbles. But rather than leveling out the booms and the busts, this policy merely resulted in a new bust being primed by excessive debt, hitting us even harder and faster than the last one.

Suppose you’re trying to walk while holding a glass of water. Keynesian stimulus is like trying to run exactly as fast as the oscillation of the water, so that you can move faster while your rhythm cancels out the waves in your cup. It doesn’t work. You just end up with water all over you.

With this in mind, we should be very worried about the economy in the near future. We’ve now racked up more debt than ever before with the latest round of unprecedentedly large Keynesian stimulus. We even bailed out a lot of the companies that failed last time, so that they’ll be around to fail next time too. It is absolute insanity that we’ve set ourselves up for yet another major recession like this.

Tinkering around with the economy through debt the way Keynes suggested is never safe, and therefore not a responsible approach for a national economy. We need to undo the damage that has been done and reduce our spending and debt levels, or suffer further economic collapse in the very near future.