‘Grasshopper’ economics are sure to thwart growth

During the Great Depression, Einstein knew that potential upheaval might herald the death knell for capitalism and expressed frustration over “the hopeless confusion of opinions among the experts.”

Three seminal views, not necessarily conflicting, eventually emerged over the causes of the turbulent 1930s. While Irving Fisher, John Maynard Keynes and Milton Friedman focused on different aspects of debt, all emphasized short-run stabilization measures over long-term sustainability.

Little has changed: The debate still hinges on whether increasing debt is a stimulus, a depressant, or both. Political factions cling to “some academic scriber of a few years back,” more for ideological support than illumination. The resulting litany of pat answers tends to stress tax, spending and monetary mechanisms.

Like the magical Wizard of Oz, pull one lever and something happens while fiddling with another produces a different result. But what if the levers don’t do anything or are actually part of the problem?

The current “recovery” is certainly not what we have seen before. The data suggest that the primary reason for our anemic rebound is our immense debt burden, 80 percent of which is private — although the political rhetoric stresses federal debt.

For decades, businesses, households and governments spent more and saved less, but at a cost. Too much debt due to past expenditures limits spending today and in the future. We spend 30 percent of today’s GDP on last year’s consumption versus half that in 1960. Excessive spending on debt is like the effects of gravity — invisible but gradually eroding both growth and consumer confidence.

Although ownership and freedom explain two-thirds of statistical variation in per capita income around the world, capitalism has an Achilles heel — the human desire for more now, not later. Paradoxically, to spend more we must first save more, as supported by the fact that nations with higher savings rates also have more rapid GDP growth.

The ancient Greek storyteller Aesop fully understood the constancy of human nature when he told of the hard-working ants that saved for the coming winter, and the easygoing grasshoppers that lived only for the current, sunny day. The timeless tradeoff remains — the short-term pleasure of consumption now through debt versus the pain of saving to support higher spending later.

Much of what people do, they are not even aware of. Subliminally, when things look safe, it’s full speed ahead; however, at the first sign of danger, we panic. Neuroscience — which explains how our brain’s wiring impacts our behavior — provides evidence for why the human drive for pleasure, while avoiding pain, hasn’t changed since Aesop’s time.

Consider that contemporary “ants” who saved 10 percent per year would consume 25 percent more over their lifetimes versus impatient “grasshoppers” with the same income level who borrowed 10 percent per year over their careers. Until retirement, the grasshoppers would consume 15 percent more than the ants — but upon retirement would be both bankrupt and dependent. In contrast, the self-reliant ants would have a nest egg worth several million dollars.

The irony of the modern fable is that both couples consumed the same amount after adjusting for timing (present value). In a broader context, society is maximizing short-term pleasure at an extremely high long-term risk — deeply discounting the value of savings, leading to no retirement safety net outside of a questionable Social Security program.

Changing demographics (certain age groups borrow more), in combination with gradually declining inflation/interest rates, caused the national savings rate to plunge over the past three decades while consumption soared. While moderate increases in debt stimulate growth, intemperate splurges retard it — explaining why the economy isn’t going to expand until debt burden is trimmed.

Attempts to artificially stimulate private consumption through unfunded federal spending are simply offset by higher debt and slower growth rates. Low interest rates haven’t worked either, since few can afford to borrow more.

Congress should be asking, “Why subsidize financial leverage while discouraging savings?” One mitigation policy would be to eliminate the interest deduction on home mortgages — making the market less prone to speculative bubbles while adding a trillion dollars to federal coffers over a decade, which could be used to help retire its own debt.