15 September 2006

Unwinding Keynes

About a year ago, congress passed legislation that made it harder for folks to walk away from bankruptcies, leaving the irresponsible and unlucky burdened with more debt than before. Even ignoring the audacity of this congress - the one that has reversed a record surplus into a record deficit - passing a bill that supposedly forces more fiscal discipline onto American households, this is bad policy.

About half of all bankruptcies are the result of health problems. Perhaps only 10 or 20% of bankruptcies result from what we typically think of as irresponsible spending. Many people need to incur debt just to start their careers - investing in a college education. Homes, too, are expensive and mortgage payments often leave young families with very little breathing room between fixed costs and expected income. A serious health problem that costs $100,000 or more can be just enough to tip people over the edge and into bankruptcy.

Even if this were not the case, think about the consequences of more punative bankruptcy legislation. People are willing to spend money on college, refigerators, houses, and vacations in part because they feel like if they do fail to pay they will find someway to recover. When that hope is taken from them, they will become more hesitant about buying. This could, in time, cause a perceptible slump in consumption.

During the days of debtor's prisons, there was little money and little consumption. The big factories that emerged at the tail end of this era literally produced more goods than people could buy. One of the ways that capitalists became rich was by granting credit to consumers who otherwise could not have afforded the new product that came off the assmebly lines. This created a virtuous cycle of economic activity: granting credit stimulated spending which stimluated production which stimulated employment -- and the employed could buy more which allowed companies to employ more and on it went. The economic growth of the last century has in no small part been stimulated by easier credit.

What happens when credit is tighter? The next economic slump - and there are always more slumps coming - could lead to a economic contraction that is disproportionate to its initial cause, as people cautiously reduce their spending in response to economic uncertainty. When such caution becomes widespread, it inevitably justifies itself with a recession.

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