The Central Banks create money, (in the US they call it the federal reserve). The government issues them bonds, and may also extend credit through a tax credit or government grants (such as student loans) to individuals and companies. The governments create public debt which they owe and must pay off, and do so through taxes. The private banks also borrow from the central bank and then issue the credit to individuals and corporations for a higher interest rate than what they borrow at. The individuals and corporations then put money into the economy by paying whoever it is they got the loan to buy. Commonly they will either go into credit card debt to pay for things like gasoline or to go shopping, or they will go into debt to buy a house. The person collecting the money who is selling there house will probably pay off existing debt, and possibly if any is left over deposit money into the bank. The banks typically have some sort of "reserve" that is perhaps 10% of the money loaned out. In other words, for every $1 in deposits the bank has, it has lent out $10. With every loan come more deposits, and with every deposit comes the ability to create more loans. Before the financial crisis of 2008, banks like Lehman Brothers were leveraged 40 to 1 meaning for every $1, it lent out $40. One might think that this is inflationary because of all the money it creates in the system.
However, you must also understand that for every $40 lent out,over the course of the loan at a rate of perhaps 5% per year, over 30 years the borrower will pay nearly twice that at $77.30.
So with leverage comes lots of risk. On one hand you have lots of money in the system as leverage expands. On the other hand, if you don't have new money being created as prior debt obligations come due, not everyone will be able to make the payments. The system requires inflation of the monetary supply, or delinquent payments, default and foreclosure. The 2008 crisis was bad because of the housing bubble created prior to 2008. When a few people start to default and confidence in real estate exists at all time highs and you are unable to sustain that speculation (which will ultimately happen), you suddenly have not as many people who want to buy, and it doesn't take many that want to sell. On top of that you have banks foreclosing and listing properties at 25% of the market value, and soon everyone else has to reduce their price since there isn't enough buying demand, and those still in a home soon see that driving down price, they then end up owing more money then their house is worth, and then they might walk away or stop making good on their payments and foreclosure occurs again, and the bank must liquidate more properties. Since so many jobs are leveraged to real estate and leveraged to easy credit in the system, it's very difficult to get the confidence going again and that is why the 2008 crisis lead to systemic risk. It certainly wasn't the only reason, but that ishow capital markets work.
To try to counteract these effects, the government really expanded, spending a lot more, and going into deficit spending. In the processes, now they went into debt, created a lot of government jobs to try to counteract the job losses and get the economy moving again. The problem with that is rather than just borrow to pay for it and grow the economy, this actually has limited growth. The government was consuming the job demand. While even though the dollar during the peak of the crisis may have been worth about 50% more than it's low point, the debts still had to be paid in dollars, not what they were worth. Salaries and the amount companies were supposed to pay employees had to be paid in dollars.
business activity slowed and companies had debts to pay and couldn't make payroll. There wasn't enough money around to sustain the previous levels of activity. The companies could not make payments because goods and services were bought when the dollar was low, inventories were high. People were laid off in 2008 because they owed everyone money in dollars which now had increased 50%. Since the debts were not adjusted lower 50% to keep them in line at an equal value with what they were lent out at, and because the payments to employees were not cut in half, the companies had to cut them in half another way... Through firing people. Of course this accelerated the decline because that mean less income available for the economy. If instead you made the banks cut their payments and principal corresponding to the strength of the dollar, it may have made a different impact. However, the dollar was very volatile and the federal reserve lowered interest rates and injected money into the system and bailed out the banks.
See a debt crisis that only Julius Caesar Understood.
The government instead capitalized by seizing more control in a power grab. They kept the payroll tax which means that the businesses have to pay money for hiring employees aside from what they pay the employees creating a burden much greater. The government went into deficit spending and had the public sector displace the loss in jobs by the private sector. Instead if they cut the debts owned by individuals and corporations even partially, it would have made things easier on corporations to produce more, charge less, and employ more people and restore confidence and sustain the real estate prices without creating such a shock to the system.
Instead the government with it's "unlimited" budget, forced corporations to compete with the government wage scale (while the government doesn't have to pay a payroll tax, if it did, it would be to itself anyways) in a time when the dollar was in massive demand and during a consumer confidence shock. As a result, the easiest option for businesses was to only keep overseas employees and cut American salaries and wages where possible. Those consumers the government hires may be able to go out and spend on the economy, but at what cost? Taking away money from those who produce in the economy and innovate and find ways of providing cheaper and cheaper goods and to do more and more with less and less through innovation. That requires MORE businesses competing with each other in the business/private sector, rather than the government grabbing greater control and a larger share of the job market, and the large, politically connected businesses only to survive without having to do as much. The big government supporters fail to realize that this type of action of growing government just reinforces the negative aspects of a monopoly. In a corporate boom, a monopoly is only possible if a company finds completely new ways of delivering at prices consumers are willing to pay, rather than growing through political power and influence and using the politicians to make it tougher on new start up businesses that could otherwise create jobs.
I'm not hypocritical of the government hiring and doing what it needs to do in a crisis, just the current paradigm of economics not taking into account that post bretton woods there was the closing of the gold window and debt is just another currency that just happens to pay interest. I certainly think the bailouts and stimulous were more benneficial to the economy for the time being than if they hadn't. I just think that we passed on some of the burden down the road, and there's a real failure to understand how borrowing money is very costly. The government's deficit spending has not raised the amount of private productivity and profit overall, and they can't tax business enough to pay all their debt obligations. Nevermind if the dollar continues it's bull market with government debt already so high and GDP stagnant. Nevermind what will happen to debt if interest rates skyrocket. (it will go up when the debt is rolled over to the new interest rates)
What's worse, is STATE governments actually cannot expand the money supply like the fed and now state governments are likely going to be forced to cut back like Detroit did. I don't believe the problem was stopped, it was only shifted and delayed.
This is the wage environment in 1900 vs 1980
Agriculture is a small small portion of the economy because of the invention of modern farming. However, the service industry and manufacturing bases most likely shrunk in share in 2008 as the government grew in size. That won't last. The government has been shrinking and unemployment has been rising and is still in an uptrend since it's low in 2000, even if it may be declining from the spike high depending upon if you count people "out of work" but not collecting benefits as unemployed (the government does not).
Unemployment is rising from the public sector.
As people were laid off, they had less money to spend and pay for the products and services. This was a huge problem. But cutting the amount owed would have created a boom immediately and all at once, hurting savers, but providing them with much higher interest rates than they would have had if they solved it by having the fed burn up a portion of it's bonds that the government owes it, eliminating some of the debt burden on the government, and injecting unbacked excess cash into the system that was so in demand. The government wouldn't have to raise the debt ceiling as they did, and yet they could spend what they wanted to. The private sector would get their bailout through reducing the mortgage cost. The boom created would be an inflationary one that wouldn't do so in a way that created huge costs, and instead would reduce the costs causing it to be good for america. The ramifications are still complicated, but you could stop the deteriorating confidence while also creating a very strong shift in economic power to the government, which historically has severe long term conseqences.
The domestic view is still complicated, capital rotates around the different areas in the US. In theory rising interest rates is bad for the economy because it means the costs to borrow are higher. In theory lower interest rates are good for the economy because more people borrow. But in reality people recognize the falling market, and understand that the cost to get a loan will be cheaper in the future since it is a falling interest rate environment. Economics 101, opportunity cost says that if it costs you $100 to save $50, it isn't a decision worth making. If it costs you $50 to save $100 it is. In this case, the cost is time, and giving up time by waiting to refinance and waiting to be a first time home-buyer, expects to yield savings on your annual interest rate payment, especially when home prices are also falling. Only when rates finally begin to rise do suddenly people recognize that the cost to WAIT become extremely expensive.
Theory is not reality, but we've only scratched the surface. The question is, are you willing to see how far down the rabbit hole really goes, Neo?
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