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April 18, 2009

At the Heart of America's Economic Problems
by Paul Mladjenovic

Any healthy economy has a reasonable balance of consumption and production. This is the manifestation of the age-old equation of "supply and demand". When you hear that there are "imbalances" in an economy, it sounds tame but it could mean anything from a bad problem to a massive crisis. America needs to address this balance of consumption and production if it is going to be back on a sound foundation for economic growth and prosperity. The problem is that government policy created the massive imbalances in recent years and current policy initiatives will only make matters worse.

The recent $787 billion "stimulus" plan and the immediate follow-up $410 billion "omnibus" plan were meant to stimulate demand. This stems from the Keynesian idea that stimulating demand through increased spending by government would boost the economy and get it moving forward.

By the way, I made a vow to myself that every time I mention Keynesian economics or John Maynard Keynes that I must refer to him as a "crackpot" so that readers don't interpret anything I write as legitimizing his...uh...crackpot economic theories.

This "spending and consuming" mentality has finally brought us to today's massive economic difficulties. The government is doing a full-court press on massive spending in a misguided and dangerous attempt to stimulate the economy. Right now, because of this, America has multi-trillion debt that is beyond our society's ability to pay. This is indeed an imbalance of massive and mind-boggling proportions. Excessive consumption, spending and borrowing and dwindling production capacity is the "mother of all imbalances".

Let's remember a few simple points in all this:

Stimulating Demand (consumption) is EASY.
Creating Supply (production) is very, VERY HARD.

Demand is easy because all of us have wants and needs. Our "needs" are relatively limited to the basics of life such as food, water and shelter. However, our "wants" can be virtually unlimited. Who wouldn't want an endless supply of vacations, fancy restaurants, goodies for the home, new cars and so on. Demand is easy. We really don't have to encourage anyone to be a consumer...it comes naturally when you think about it. But how about production?

Production is HARD. To be a producer means lots of work and innovation. It requires work, effort, diligence, resourcefulness, efficiency and yet more work and effort. And in today's environment, producers have to deal with government controls, regulations, taxes, labor issues, environmental issues, etc. More production comes from more business. Starting, running and succeeding in business, for example, is hard work even if you do everything right. This is why profit is both a social and economic good. People and businesses need a strong incentive to produce goods and services. Profit is the reward for producing and taking risks. Profit is the driving force of business growth and this means more jobs. Well-run businesses make a profit while poorly-run businesses lose money and are punished with bankruptcy. But things such as "production" and "profit" are VOLUNTARY transactions. Nobody forces a consumer to buy from any particular business. Businesses must produce and offer what consumers want and need or else they go "out of business".

During 1995-2009, America's central bank, the Federal Reserve, flooded the economy with trillions of dollars through increased money supply and easy credit and this triggered a massive consumption boom along with several bubbles such as the stock and housing bubbles. All of this created artificial "stimulated demand" as consumers bought and bought and grew more and more indebted as they spent beyond their means.

This leads to the next point...

Getting into debt is EASY.
Managing it and paying it off is HARD.

Stimulating demand (again, through spending and more indebtedness) artificially stimulated production. As consumers spent more (Debt is easy), businesses added more capacity to meet this demand. For example, during 2000-2001, retail square footage grew 5 times faster than the growth of our population. Can you see that imbalance coming? As consumer spending became exhausted, business was then stuck with over-capacity. The end result is that business had to re-trench; factories and stores had to close and jobs that were previously created (again...artificially) had to disappear since the imbalance became unsustainable. How about now?

Fast forward to 2009-2010. The government is basically pushing forward policies that...

"Stimulate" total demand by spending trillions (your money...not theirs).
Punish Production through increased business taxes and regulations
Reward failing enterprises with bailout money that comes from taxpayers that are doing will (such as people and organizations that produce).

Putting forth incentives to increase consumption while putting in coercive disincentives to decrease production is more than just an "imbalance"...it is a prescription for disaster. It is actually the core dynamic in socialism and this approach has been tried 1,000 times in history and 1,000 it has produced the same result; Economic Pain and eventual collapse. If you don't believe that, do some simple research. You will find the following...

The 50 poorest countries in the world have the same symptoms that all of us see; grinding poverty, low incomes, restrictive, authoritarian laws, hunger, etc. But closer examination reveals that all of them have (in various degrees) the same operating ideology; Socialism. Is that a coincidence? Not really. If you apply an approach that restricts or destroys a free market, banishes awards (such as profit) for economic gains, has a huge, suffocating government bureaucracy, punishes production while ultimately leaving consumers impoverished then you will get what those countries get; the absence of prosperity.

And yes...many of those countries have tried a "Keynesian stimulus plan". A good example is Zimbabwe. That country's wretched statist economy is experiencing a horrendous inflation and those citizens are suffering tremendously. History has an abundance of examples here.

What America should do:

I had a reader email me from a prior essay with a justifiable challenge: "Sure you can point out the problems...but how about some solutions?"

These are some that come to mind immediately:

Put an immediate freeze on government spending at all levels. Right now, government spending is massively out-of-control (at all levels). It has risen faster than the rate of inflation, the growth rate of our population and any reasonable yardstick you can think of.
Let failed enterprises (banks, auto companies, etc.) go out of business. Let them be replaced by new companies (what normally happens in a free market).
Make it much easier to start a business. Right now, it can be a bureaucratic nightmare to start a business. Permits, fees, taxes, waiting periods, etc. make the act of starting a business a difficult pursuit. Our country needs more business formation, not less. Especially now.
Put severe restrictions on money supply growth. The Federal reserve is producing trillions of dollars and easy credit and the end result will be inflation.
Cut taxes at the federal, state and local level. Governments don't produce anything; they merely siphon money away from the private economy to fund their huge and growing bureacracies. If people have more of the fruits of their labor, that means more money for investing, spending, saving, etc.

I think that those are a good start. I doubt that any of these will be implemented any time soon so expect America's economic problems to either not be solved or probably get worse. Right now, the driving force for worsening the economic fundamentals is the aggressive application of Keynesianism by the federal government. So what should we do?

What individuals should do:

Get money out of harm's way. Look over your portfolio (retirement accounts, etc.) and avoid vulnerable sectors such as retail, manufacturing, consumer discretionary, financials, real estate, etc.
Focus on "human need". As I have written in prior essays, stocks and ETFs tied to human need will do well in this unfolding economy. Focus on food, water, energy, etc. These defensive sectors will win in the long term.
Turn your spare time into money. All of us have talents, skills, hobbies and expertise that can be turned into a profitable side-line, home-based business. In these times, I think that a home business is an economic necessity.
Buy gold & silver bullion. As in prior essays, I emphasize that owning physical gold and silver is a common sense portion of a diversified portfolio.

There are many more things that you can do to educate yourself and easily do some simple strategies to help yourself and your family to survive and thrive in this wretched economic environment (Find out more at www.ProsperityNetwork.net).

Considering that this is tax month, don't forget to start arranging your financial affairs to minimize your federal, state and local taxes for the 2009 calendar year. Considering what is coming during the next few years, you will definitely need to.

As total tax liabilities keep increasing and get more burdensome on the private economy, they will become yet another "imbalance" that our society will unfortunately have to deal with. The folks at the April 15th "Tea Parties" get it; let's hope our leaders do as well.

Paul Mladjenovic, CFP
www.ProsperityNetwork.net

Paul Mladjenovic, CFP is the author of Stock Investing for Dummies and his national investing & financial seminars are at www.ProsperityNetwork.net. His blog is at www.Mladjenovic.blogspot.com and he is the editor of the Prosperity Alert newsletter.