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nomic path that is the equivalent of fat, drunk, and stupid cannot have a
good ending. The three “pillars” of the U.S. economy are: (1) govern-
ment deficit spending, (2) the Federal Reserve™s easy money policy, and
(3) profligate spending by U.S. consumers.

Pillar #1: Deficit Spending
When the federal government runs a budget deficit, it sells U.S. Treasury
bonds to make up the slack. From the beginning of the 1960s up until the
late 1990s, the U.S government generally spent more than it collected in
taxes so the supply of bonds grew. By the late 1990s, however, the gov-
70 The Old Art of Macroeconomics

ernment was actually running a budget surplus and using the extra cash
to buy back lots of its bonds. During the technology bubble, the govern-
ment was raking in lots of taxes (often paid on stock market gains).
Surprisingly, some economists thought that the U.S. debt was becom-
ing too small! They feared that persistent U.S. government budget sur-
pluses would lead to paying off the entire national debt and make U.S.
Treasury bonds extinct. This could cause problems because some
investors buy U.S. Treasury bonds as key parts of their financial strategy
(e.g., insurance companies). As we see in Figure 4.1, the fear of govern-
ment surpluses leading to a debt shortage was unfounded.
In an amazingly short time, the fear of government surpluses evapo-
rated and we have returned to the good old days of deficit spending. In
just four years, the budget swung from a surplus of more than $200 bil-
lion to a projected deficit in excess of $500 billion.

Pillar #2: Loose Money
After the stock market bubble popped, the Federal Reserve cut interest
rates dramatically to soften the economic pain. The popular press believes
that monetary policy can come to our rescue. Alan Greenspan is often
Federal surplus or deficit ($Bns)






* part of year

FIGURE 4.1 Uncle Sam the Borrower
Source: Office of Management and Budget
U.S. Economic Snapshot 71

called the second most powerful person in the United States. Every state-
ment by the Federal Reserve is scrutinized for the slightest nuance of
monetary policy.

Pillar #3: Consumer Spending
Every month the government reports on American consumer spend-
ing. Wall Street cheers every report showing that we are continuing to
spend like 1920s bootleggers and boos any hint of frugality. The assump-
tion is that the more the U.S. consumer spends, the better for the U.S.

Can a country really become rich by spending more than it earns and by
printing money?
No. Government deficits promote waste. Loose money creates infla-
tion, not wealth. Finally, it is possible for consumers to spend too little
(e.g., Japan), but the U.S. personal savings rate is close to zero. If profli-
gacy and printing presses were the way to grow an economy, then many
countries that are now bankrupt would be economic superpowers. Simi-
larly, seven years of fat, drunk, and stupid would be a good start to college.

Bear #2: Financial Hangover

When I was a graduate student, I played on the Harvard Ultimate Frisbee
team. One of our rivals, Williams College, had an excellent team for
some years until most of their star players graduated in the same class.
The next year, the Harvard team destroyed Williams. In their dazed and
defeated state, the Williams players gathered to regroup. One of the opti-
mistic players said, “We can learn and improve,” to which another
responded, “But who is left to teach us?” The pessimistic answer: no one.
The financial hangover argument looks at the purchasers of U.S. prod-
ucts and asks who will buy? The pessimistic answer: no one.
To make the effects of financial hangover clear, Figure 4.2 classifies
the purchasers of U.S. production. The diagram looks at actual purchases.
72 The Old Art of Macroeconomics

For example, the money that the government collects for social security
is almost immediately sent back from the government to individuals.
Thus, social security taxes collected by the government are counted in
the U.S. consumer category. Similarly, U.S. consumers™ purchases of for-
eign goods are not included.
There are four major groups of purchasers of U.S.-made products and
services. We™ll look at the financial health of these four groups of buyers
and see that most buyers are not in a position to increase purchases: (1)
U.S. consumers; (2) U.S. businesses; (3) foreigners; and (4) governments.

U.S. Consumers
Consumer spending is driven by both wealth and income. That is, how
rich we are and how much we earn.

Figure 4.2 Buyers of U.S. Output
Source: U.S. Department of Commerce Estimates, 2004
U.S. Economic Snapshot 73

Because of financial market declines, the total wealth of U.S. families
in 2004 was almost identical to that in 2000.2 Even as wealth has not
increased, U.S. consumers have continued to spend. Unfortunately,
income growth has also slowed considerably. The average annual growth
rate of disposable personal income dropped from 4.0% in the five years
ending in 2000 to 2.7% so far in the twenty-first century.3
So if U.S. consumers are not getting richer, and have less income to
spend, is there hope of continued spending? Yes, but it will have to come
by decreasing the savings rate. Figure 4.3 shows the savings behavior of
U.S. consumers.
From a historical level of around 10%, the U.S. personal savings rate
has declined toward zero. While it is possible for the savings rate to
decline even further, I read the chart to indicate a possible rebound in sav-
ings. A return to a higher U.S. savings rate is a positive development for
the long run, but it means that the U.S. consumer is unlikely to be the
engine of economic growth over the next few years.
This idea that increased savings hurts the economy is known as the

12 %
U.S. Personal Savings Rate









* part of year

FIGURE 4.3 Americans Do Not Save Very Much
Source: U.S. Commerce Department
74 The Old Art of Macroeconomics

“paradox of thrift.” Saving money is prudent and good for the individual,
but the more people save, the less they buy.
To summarize the state of the U.S. consumer, both wealth and income
growth have slowed. For U.S. consumers to continue to support the econ-
omy, the savings rate would have to decline even further. If consumers
return to their more traditional, higher rates of savings, their rediscovered
frugality will place a serious drag on the economy.

Conclusion: The U.S. consumer is unlikely to be a major source of eco-
nomic growth.

U.S. Businesses
What about investment by U.S. businesses? One of the important factors
driving business investment is the amount of idle production capacity.
Simply put, companies with idle facilities are not likely to be aggressive
purchasers of new equipment. Figure 4.4 shows the percentage of idle
capacity for U.S. businesses.
U.S. businesses have about one-quarter of their capacity sitting idle,
and this level has increased rapidly since the bursting of the bubble.
Companies have enough spare capacity to accommodate years of eco-
nomic growth without any additional investment.
The two recessions of the early 1980s and 1990s also had high levels
of idle capacity. The personal savings rate diagram (Figure 4.3), shows
that those recessions ended when U.S. consumers sharply decreased their
savings rate throughout the 1980s and 1990s. In previous recessions,
high levels of idle business capacity were put to use when consumers
increased spending.
Thus, a key to U.S. business spending lies with the U.S. consumer. If
consumers increase their spending, business investment will follow. If
the U.S. consumer cannot be an engine of growth, then businesses are
unlikely to increase their investment spending.

Conclusion: U.S. businesses may follow, but they are unlikely to lead
economy recovery.
U.S. Economic Snapshot 75

U.S. Idle Capacity (% of total)







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