How to Avoid Great Global Depression?

Effective Governance

Utility of Wealth, Governance and Competitiveness

Sankarshan Acharya[1]

Abstract

A barometer of success of a democracy is economic freedom, as opposed to bondage, which can be measured only by net assets of voters. Democracies surprisingly do not measure net household assets, making it impossible to know if the majority enjoys economic freedom.  Any simmering depression due to economic bondage of the majority  – that is entitled to rule in a democracy – can suddenly transform into a catastrophe like great global depression.  Democratic governments should adopt optimal policies to maximize individual utility of wealth while minimizing the social cost stemming from individual actions.

1.   Introduction

Policies in a democracy are enacted by representative lawmakers elected by voters, who are citizens above certain age.  Elected lawmakers serve for fixed terms.  They can enact laws that benefit themselves and a few special corporate interests, but hurt the interests of the majority.  Even if the majority deciphers the fine prints in such laws, it cannot easily organize protest rallies or sue the lawmakers to stop enactment of the laws.   The majority may choose a different group of lawmakers during the next term.  But the new lawmakers may be no different in its approach to enact laws that benefit themselves and a few corporate interests while hurting the majority. 

The majority may thus chase a mirage of equal opportunity to enhance their prosperity, leading to a deterioration in net household assets and an economic depression that can hurt even the special interests over time.[2]

How are the humans behaving myopically?  Individuals tend to maximize utilities of their wealth to make decisions, subject to constraints imposed by public policies promulgated by government.  A government representing the interests of such individuals chooses optimal public policies by maximizing the aggregate utilities of individuals.  This current policy paradigm seems rational, at first blush, for individuals with finite lives.  But it may eventually harm the collective human welfare, cause social instability and not beget equal opportunity for all.

The current policy paradigm ignores how individual utility maximizing actions can undermine collective human welfare in future, if not immediately.  It can also degrade utilities of individuals in future, if not now.  Government policies should not be, therefore, predicated only on individual utility maximizing efforts. 

A truly rational public policy paradigm should maximize aggregate individual utilities of wealth while minimizing the cost to humanity of individual utility maximizing actions.  The current economic paradigm, maximizing individual utilities of wealth, propagates a myth about what the humans should consider as rational.  It panders to and promotes the baser temptation of humans to focus on individual utilities of wealth. 

To enhance long run welfare of humanity, democratic governments must be responsible to design laws based on the truly rational paradigm and tell the truth about the long-run adverse effect of pandering only to immediate human desires. 

A Nobel Memorial Prize on Economics has been awarded to the utility maximization theory.  This prize must have contributed to promotion of models and policies based on individual utility maximization.  Propagation of such models must have accentuated the self-serving individual behavior, and thereby blinkered a democratic government’s role in enhancing collective welfare of humanity.  This must have resulted in laws to serve special interests at a huge long run cost to the majority. Long run human welfare can be promoted only through worldwide awareness – with efforts of governments, media and academia – about how individual utility maximization paradigm may unduly accentuate self-serving behavior to undermine collective welfare.  This year’s Nobel Peace Prize on global warming will certainly help in spreading the truth about the adverse impact on humanity of the individual utility maximizing actions.    

The rest of this article argues how the individual utility maximization paradigm can lead to the recurrence of a devastating Great Depression.  It then proposes policies to enhance stability amid prosperity of humanity in a democratic world.

2.   Genesis of Great Depression

Lincoln’s contribution to democracy and freedom is nonpareil.  But his task was easier because the slavery (bondage) then was based on color.  The current threat to democratic stability is due to potentially severe financial bondage of American households stemming from deterioration of their net assets and negative net income.  Financial bondage is colorblind and maybe harder to eradicate.  Households with negative net income, due to increasing costs of living and stagnant incomes, are piling up debt and forfeiting their financial liberty.  It is perhaps a potent simmering threat to democratic stability.  To gauze the degree of such threat, if any, we need data on growth or decay in net assets or wealth of households that are not currently collected by democracies.    

Political leaders, hedge fund managers, lawmakers, economists and everyone else with rational thinking considers net assets as the best gauze of their financial prosperity and security, judging from their own actions to enhance their net worth. That is how they seem to measure the stability and prosperity of their own households.  It is not unreasonable to presume that every other household too tries to enhance its own financial stability and prosperity likewise.  Then a democratic government representing people should measure net assets that every household considers paramount. 

Growth in gross domestic product camouflages true prosperity, namely, net assets as judged by every household. A great depression, maybe globally, can happen even with low unemployment.

Economic insecurity of a household stems from declining net assets and negative net income.  It may result from prolonged periods of unemployment or severe underemployment, defined as zero or negative net income.  Economic insecurity of a vast majority over a prolonged period may lead to a recurrence of the Great Depression. 

The prevailing belief that the Great Depression was due to high unemployment and credit squeeze has led to a policy of low unemployment through continual money injection. Continual money injection may have already created severe underemployment. The Great Depression can recur as the net household assets may have deteriorated due to prolonged severe underemployment.[3]  Low unemployment, low inflation and growth in gross domestic product can mask the true indicators of Great Depression: declining net assets and negative net incomes. 

Zero net income for the U.S. economy would only mean negative net income for the vast majority who are net borrowers of about $38 trillion credit in the financial system.  The current latent underemployment-indicated by the negative net income of the vast majority of households-is obviously due to unfettered money injection over the decades following the Great Depression.  A fear that credit tightening triggered the Great Depression has perhaps led to the prevailing policy wisdom for continual money injection during periods of economic weakness.  But continual money injection has perhaps brought us to severe underemployment or negative net income.  At the same time deterioration of net assets of the vast majority may be taking place irrespective of the current monetary policy.  This shows that the current monetary policy may not safeguard against recurrence of the Great Depression. 

The only insurance against recurrence of the Great Depression is to arrest the deterioration of net assets of households of the vast majority, whether or not such deterioration is due to high unemployment or severe underemployment.  But to think of such insurance, we must first record periodically the data on net assets of individual households and monitor this statistic for the middle majority, say 75%.  We have to then pin down all major factors that can cause deterioration in net assets including unemployment and underemployment. 

Suppose in the absence of data that net assets of a vast majority of households have deteriorated over some time.  This cannot be only due to a prolonged period of underemployment of the vast majority of households. The prime latent factor for deterioration of net assets of the vast majority is perhaps the current system of governance predicated on pre-Great Depression era policies that have been foisted by hedge funds to wangle wealth from a vast majority.  This system of governance basically recycles most of the created money to a few households. 

Despite benevolent intentions of money injection, the vast majority continues to be robbed because the prevailing system of governance may not be serving the best interests of the vast majority.  It is true that the vast majority wields voting power to change policies in a democracy.  But the current system of governance does not generate, let alone disseminate, information on net assets of individual households for the vast majority to propose rational amendments to existing policies. 

In spite of low unemployment, the vast majority is now facing the brunt of rising prices, declining net income and perhaps eroding net assets.  The problem facing the U.S. households is not due to China accumulating foreign currency reserves or the low value of yuan. The problem is most likely the current system of governance (policies) designed to wangle wealth of the vast majority of American households. 

The U.S. has to rectify its current system of governance for the sake of prosperity and stability of a beautiful democratic country and thereby lead the world for the betterment of humanity everywhere.  One should salute great American leaders like Abraham Lincoln who have correctly veered the destiny of a great democracy.  I believe that the current leadership too on a bipartisan manner can visualize the real malaise and devise optimal rules.

3.  Governance and Competitiveness

Competitiveness of a country can be measured by the net exports and foreign exchange reserves.  To achieve a goal of prosperity amid social stability, the country must enhance its competitiveness while averting a potential depression. Governments have used two policy instruments - money injection and interest rate - to accomplish this goal. But such instruments have not helped a country like USA, judging by the measures of competitiveness.

The U.S. economy is beset with continual liquidity-credit crises and potential depression, which are being preempted by new money injection and interest rate reduction. These policy instruments have basically served as antipyretics to contain a relapsing fever without really treating the ailment (source of depression and un-competitiveness) that underlies the fever.  Continual application of antipyretics has debilitated the economic patient, the U.S. economy.  

The system of governance needs to be more efficient in letting money at reduced interest rate flow to the effective producers and exporters of globally competitive goods, services, ideas and creativity.  The U.S. economy will exhibit higher inflation and face threats of depression if money continues to flow to the ineffective, those who are unable or unwilling to produce globally competitive goods, services, ideas and creativity.  How the money now flows to the ineffective is illustrated below:

1. When regulated banks ail, the central bank injects new money to stem the systemic risk of banking panic.  But some banks reach the brink of failure primarily because of excessive executive pays in comparison to bank earnings.  By injecting new money, the central bank funds excessive pays of ineffective executives.

2. Politicians continually create new money by borrowing for their pet schemes.  Most of this new money is almost freely passed on to their ineffective constituents.

3. When governments increase borrowing to fund new tax cuts, the borrowed funds flow freely to taxpayers.  Those taxpayers, who merely hoard their tax savings as credits by lending back to government or other borrowers, are rendered ineffective.

4. The current law allows creation of mutual fund companies with BOD members floating their private hedge funds to trade collusively with subordinate fund managers to reap mutual benefits at a cost to taxpayers-investors in those funds.  This law makes American talents ineffective.

5. The current law permits hedge funds to borrow (with equity-to-debt ratio of 1:20) from federally regulated banks to take huge bets to deflate stock prices temporarily to cause panic for investors-taxpayers.  The law permits the Federal Reserve to pump new money to save the federally regulated banks which are construed to be too big to fail.  The law permits such banks to form firewalled subsidiaries to borrow massively from federally regulated banks to take bets designed to make taxpayers lose portfolio wealth and bear the brunt of higher prices due to federal monetary infusion.  Such laws make American talents ineffective.

6. The education, health, defense and government sectors have effectively propped up the U.S. by inducing continual inflows of human and monetary capital.  They have effectively exported America’s security, education and healthcare. These sectors may be amassing hoards of credits less effectively now. They may have reached points of diminishing returns.  They need reform. 

A more effective system of governance will be based on reforms of laws that will permit the flow of money at lower rates to the effective.  As money continues to flow disproportionately at lower rates to the ineffective, the trade imbalance grows, currency depreciates, inflation soars, standard of living falls, social instability surfaces and depression looms.  The only solution is to let money flow to the effective at drastically lower interest rate. 

Lower interest rates do not necessarily lead to higher inflation as the case of Japan should illustrate amply.  The abundance of money with the ineffective is the source of inflation.  This money produces little, but takes huge bets to raise the prices of consumable goods.  Such bets would be limited in a more effective system of governance that makes money flow to the effective, as in China. 

The ineffective in the U.S. could take huge highly leveraged bets because their collaterals of mortgage backed securities were valued higher due to higher interest rates.  But the Federal Reserve has been raising interest rates simply in response to rising commodity prices, quite like administering antipyretics to contain fever without diagnosing and treating the underlying ailments.  The households could no longer support the rising interest rates, as indicated by unprecedented housing foreclosures. 

The Federal Reserve Board should not be confused about the currently observed downward sloping yield curve and rising commodity prices, because the abundance of money with the ineffective and the current system of governance are the reasons for the “conundrums.”  The current state of U.S. households (in terms of net assets) is more depressing than the Japanese to support any rate of interest more than 0.5%. 

Only the ineffective will desire to raise the interest rate and to keep the current system of governance unchanged.  They will even lobby through generous political contributions and induce talking heads through largesse to spread the myth about the rectitude of their paradigm.  It is their dharma to hoard credits ineffectively.

The dharma of a government is to enhance competitiveness of a country, avert potential depressions and achieve prosperity amid stability.  This can be done only by reforming the current system of governance and by letting money flow at drastically lower interest rates to the effective: real producers of globally competitive goods, services, ideas and creativity.[4]

The lawmakers cannot gainsay that stability, prosperity and competitiveness should be the primary national goals of any progressive democracy.  They should, therefore, optimally mandate that the CB achieve these goals–not some flaky targets like inflation and unemployment–by collecting all necessary data.[5]

4.   Conclusion

Democracy can maintain social stability only if the system of governance can effectively foster equal opportunity for enhancement of individual wealth based on perseverance, talent and skills.  The majority wields power to formulate rules in a democracy.  It is, therefore, important that the government ensures growth, not decay, in wealth of the majority.  Otherwise, there may be social instability leading to dictatorship and irrational rules.  Growth in wealth tends to keep individuals psychologically stable. 

The government can foster equal opportunity only through rules that maximize individual wealth while minimizing the social cost stemming from individual actions.  In this regard, certain policy reforms are necessary to contain lopsided wealth transfer, which is possible under the current rules providing unequal advantage to a few by sacrificing the interests of the majority.

The role of a government is to enhance competitiveness of a country, avert potential depressions and achieve prosperity amid stability.  This can be done only by letting money flow effectively at drastically lower interest rates to the real producers of globally competitive goods, services, ideas and creativity.