Understanding the state of our economy
© HSLDA/HEATHER GRAY
J. Michael Smith, President of Home School Legal Defense Association, at the 2010 National Leaders Conference in Chicago, Illinois
I’m taking a different approach in this issue’s column. Because the state of the American economy is affecting all of us so significantly, I wanted to try to explain what is going on and what we might see in the future. I’m not equipped to do that myself, but I know someone who is. In order to better understand our economic situation, I interviewed my friend and financial expert Vic Thompson.
Vic graduated from Pacific Lutheran University with a major in finance and a minor in economics. He is a chartered financial analyst. Prior to coming to Patrick Henry College as the executive vice president in 2003, he was the senior vice president of State Street Global Advisors, where he was responsible for managing over 80 investment professionals in seven offices with over 400 billion dollars in fixed income assets invested, as well as hundreds of portfolios, including mutual funds, commingled trusts, and separately managed accounts. Vic currently serves as president and founder of Bulwark Capital Corporation in Round Hill, Virginia. He and his wife, Sandy, have four children and a strong Christian testimony.
MIKE SMITH: Before we get into more detailed questions, what is the study of economics and why might parents want to teach it to their children?
VIC THOMPSON: Economics is the study of how we produce, distribute, and consume the products and services we use to live our lives. Economics is often referred to as the “dismal science,” and I think the Bible explains why. Genesis 3:17 announces part of the result of man’s fall into sin: “Cursed is the ground because of you; through painful toil you will eat of it all the days of your life” (New International Version). Economics gives us many competing frameworks to understand this toil; some frameworks use assumptions that are consistent with a Christian worldview and some do not. Our children need to understand economics because much of their lives will be spent toiling. Our children also need to know that through their future vocation, God will bless their toiling if it is aligned with His will.
MIKE: We hear a lot about our economy being in trouble. Is there an economic term that defines what state we are in now?
VIC: Deleveraging. Americans want to consume more than they produce and have been willing to borrow money in order to do it. Unfortunately, one has to pay back the lender. Now it’s payback time. If your income is falling and your assets are depreciating, you have a strong incentive to reduce your debt if you want to avoid default.
MIKE: We see interest rates that are the lowest of our lifetime. Why are they so low? If this becomes a long-term thing, is it good or bad for America?
WANT TO COMSUME
MORE THAN THEY
PRODUCE AND HAVE
BEEN WILLING TO
BORROW MONEY IN
ORDER TO DO IT.”
VIC: Interest rates are influenced by Federal Reserve policy and the supply of and demand for money. The Fed is trying to keep rates low. The demand for money is weak since people are trying to pay down their old debt and are unwilling to take on new debt given the uncertainty of the times. Weak demand for consumer loans keeps pressure off of rates, helping to keep them low. Foreigners are also willing to hold dollar-denominated debt, especially when they are worried, which bids up bond prices and thus lowers interest rates.
Rates are probably too low and we may be better off with higher short-term interest rates. Low rates can cause asset bubbles when cheap money propels prices somewhere in the world to unreasonable levels. Senior citizens rely on interest income to support their consumption, so while low rates ease the funding of government consumption, they also retard the consumption of retirees. We are punishing people who did the right thing and saved for their retirement, while enabling more reckless government spending.
MIKE: We know about the housing market plummeting and many people losing their homes because they can’t afford them. What caused the problem? Is there a way out?
VIC: The problem was caused by mortgages that were too easy to get. It is being corrected through falling home prices, defaults, and mortgage restructurings. Government should neither incentivize nor retard the private activity of adults seeking to acquire shelter, and the Fed should not artificially lower mortgage interest rates to try and manipulate home prices and home ownership rates. These activities create distortions that misallocate resources. In this case we are over-housed and underinvested in other types of infrastructure that could have been more useful.
MIKE: How does the Federal Reserve impact our economy?
Vic Thompson is president and founder of Bulwark Capital Corporation in Round Hill, Virginia.
VIC: The dollar is a fiat currency which has value through the force of law, as opposed to being backed by an asset such as gold. The Federal Reserve has the ability to strongly influence prices by buying government debt issued by the Treasury with dollars it creates out of thin air.
Intuitively, we know that increasing the supply of dollars faster than the supply of goods should result in higher prices for those goods. So why is U.S. inflation flat when the Fed is printing money at a furious rate? The Fed’s money creation can affect prices across the street and across the world, since the dollar is widely held by foreigners and many foreign currencies are directly tied to it. Because America has an open economy that is highly integrated through trade and finance with the rest of the world, it is possible for our monetary and fiscal policy stimulus efforts to leak out of the country. Thus, food costs are rising in India, land prices are rising in China, our trading partners are exporting more to us, and many globally traded commodities are rising in price. In a world with open economic borders, the stimulus can flow to the countries that are more competitive and in better financial health than ours.
MIKE: How does the tax policy of our government impact the economy?
VIC: Much of economic theory deals with the question of how incentives affect outcomes. Taxes have a huge impact on incentives. If the combined taxes on your pay were raised to 100%, would you work? Taxes also enable government spending. Much of this spending allows people to become less reliant on themselves, their families, and their churches. Our leaders create class warfare through tax policy. They divide Americans into smaller groups defined by their income and turn one group against the other. Thus, higher taxes retard the incentive to work and invest and they enable the government to spend more. I don't think this can be good for the economy.
MIKE: What’s the theory behind stimulus packages? Does it really work?
VIC: The stimulus idea basically says that the government can spend your money better than you can. With the unemployment rate holding steady near 10%, I think there is scant evidence that the stimulus is working. A permanent tax cut, especially on employment and corporate taxes, would have been much more effective. The private sector drives the economy and lower taxes and reduced regulation would have incentivized firms to hire and invest, while giving consumers more money to spend. The U.S. has some of the highest corporate tax rates in the world. In a global economy, capital will flow to the location where it gets the best treatment. We want investment capital to come here, so reducing corporate taxes is in our best interest.
MIKE: The debt owed by our government is astronomical. To whom does the government owe money? Does the government have the power to just print more money than it takes in to pay the debt? What is the solution?
WANT TO COMSUME
MORE THAN THEY
PRODUCE AND HAVE
BEEN WILLING TO
BORROW MONEY IN
ORDER TO DO IT.”
VIC: Thanks to fiat currency and foreign governments’ and individuals’ willingness to lend our government money, American politicians have had the luxury of promising voters more benefits than they ultimately can deliver in real terms. The problem is compounded by an aging population, which is partly caused by the legalization of abortion and changes in American views regarding family size. We are in a slow-moving train wreck that will unfold over the next several decades. We will likely see some combination of higher taxes, reduced government benefits, shorter retirements, euthanasia, rationing, and reduced purchasing power for our money in response to these twin problems of too much debt and bad demographics.
The Fed can always print more money and theoretically buy an infinite amount of new government debt with it; thus, a legal default of failing to pay principal and interest when due can be avoided. However, flooding the planet with exponentially increasing amounts of dollars would erode our currency's purchasing power. The resulting inflation might force the government to choose between rapidly rising inflation and some form of default. It would be better to get our debt and spending on a sustainable path.
MIKE: If you were president of the United States, what would you do to get us out of this economic mess?
VIC: Our government is overly focused on the redistribution of wealth at the expense of incentivizing the creation of wealth. However, given the right incentives and structures, the American people have proven to be very good at wealth creation. These incentives and structures include simple rules of fair conduct (e.g. less complex regulation), lower taxes, smaller government, sound money, balanced budgets, and fair international trade (if I buy something from you, you buy something from me). We also need to summon the political courage to restructure many of the promises made to retirees through numerous state and federal programs. It would be wonderful to deliver on all those promises, but it may not be possible to do it in real terms. Better to do the hard things now than wait until our problems become greater.
The ultimate answer to our economic dilemma is not to try to know the future, because no one knows the future, but to know the One who does know the future and holds the future in His hands. The best advice for anyone regarding the future is to seek first the Kingdom of God and His righteousness and all these things (the things we all need) shall be added unto you.