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Was the Economy an Illusion Anyway?

Ok, I’m not an economist. As I understand it, though, one of the factors in markets rising is increased consumption. In theory. That’s why President Bush wants to give everybody $800 to spend.

And I’ve also been reading for months (example) that apparently people have been spending more and more on credit in the last few years. Also, people have been borrowing against their houses even more with HELOCs and the like. Heck, you can even get debit cards from your 401(k). There is literally nothing that people can’t borrow against nowadays…and they’re borrowing.

If people have been getting a huge percentage of their spending power from debt, was any economic rise essentially an illusion to begin with? Are we just seeing the natural results of what happens when the amount of debt available declines?

HELOCs only go so far. The 401(k) debit card can’t (I think) go past zero. We’re all spent out.

This is really just my musings on the situation—as I said above I’m not an economist and such.

What do you think? Do you know more about economics and think I’m completely wrong? Or does this sound kind of logical?


Curtis January 23, 2008 at 12:36 pm

As a part-time undergradute Economics instructor, I have to say you are right on the money. In the past, the cost of money was low and the supply was high, so demand followed.

Now, as the price of money has gone up the last few years, and the supply of money has dwindled, the demand for spending that money is also greatly reduced. That’s the cyclical nature of market economies. The Fed’s job is to try and minimize the swings from one side to the other because they both tend to feed themselves further that direction without some help.

Randall January 23, 2008 at 12:52 pm

I don’t think the economy was an illusion, but it was fueled by something (cheap money/loans) that has dried up for everyone.

One of the main factors in getting into debt turns into the servicing of that debt. When you pass the ‘tipping point’ (can’t make minimum payments even) many people start using other debt to pay existing debt (HELOCs, re-finance mortgages, etc).

For some, this gives them enough time to figure something more permanent out. For others, it just deepens the hole.

I see the government’s money as a small SMALL flotation device to keep those just before the tipping point from going over. It isn’t going to help everyone, but it might provide a little more time to those that aren’t past help.

Eden January 23, 2008 at 1:13 pm

Yes, that’s basically it in a nutshell. The interesting thing for me is to wait and see what happens- will people stop borrowing and get smart with their money or will there just be another new easy way to borrow in order to spend money we don’t have?

I think the tax rebate is a poor solution (do we really think our government is going to SAVE that money from a different category on their budget?), but it will allow people to have some short-term relief. If I end up with any ‘free’ money from the government, it will be going directly to my current debt so I guess I’ll be ‘hurting’ the economy.

Amanda @ Me vs Debt January 23, 2008 at 1:20 pm

I’m thinking the same thing. The crappy part about consumption based on debt is that is reduces future buying power. Talk about a house of cards… Maybe we are in need of some kind of recession to get everyone back to responsible spending habits.

Becca January 23, 2008 at 1:48 pm

Is it bad that every time people talk about the rebate, all I can think of is this West Wing episode?
[Leo and Charlie walk and talk.]
LEO: Yeah, it sounds like you’re getting tripped up by 1783.
CHARLIE: Which is?
LEO: HR 1783; it’s a tax rebate from last year.
CHARLIE: Why would that affect my return for this year?
LEO: Did you get a tax rebate last year?
LEO: There’s the answer.
CHARLIE: Where’s the answer?
LEO: Your rebate came off of this year’s taxes. That’s how we paid for it.
CHARLIE: Hang on. The money I got back last year has to be paid for?
LEO: Yeah.
CHARLIE: That’s not a rebate; that’s an advance.
LEO: Well, technically I guess…
CHARLIE: Not technically. This is like getting a Christmas bonus and having it deducted from your
January paycheck.
LEO: This doesn’t sound like very patriotic talk to me, Charlie. [They enter Charlie’s office.]
CHARLIE: It’s not. Why did you call it a rebate?
LEO: So people would spend it. If they thought it was an advance, they might save it.
CHARLIE: It was an advance.
LEO: Did you spend it?
CHARLIE: I paid my VISA bill.
LEO: We would have preferred it if you’d ate in a restaurant or travelled.
CHARLIE: Me too.
LEO: Well, in any event… [puts out his hand]
CHARLIE: What? [Leo starts wiggling his fingers] Oh, what are you the collector?
LEO: He used the rebate to pay off his VISA bill.
CHARLIE: It wasn’t a rebate; it was an advance.
BARTLET: A trip to Banana Republic would have killed you? [to Leo] Let’s go.
To get back on subject, you’re exactly right. Credit created a rise in the economy that was inflated by accelerating future consumption; this, of course, was borrowed against future earnings. With the credit drying up, we’re stuck in the “repayment” mode. Ever since FDR the answer to these crises has been to increase the government deficit and prop up the economy through government spending or rebates to encourage consumer spending.

I don’t think the rebate will help. After all, the Japanese housing crash took over a decade to recover from–I’d be surprised if the US handles ours any better. I’m not convinced there’s been a pop in the credit bubble, either.

Jim January 23, 2008 at 1:58 pm

@Amanda – I could not have stated it better. A House of Cards.

This is a short term fix. The problem being is the ones that can really use the “Tax Rebate” will not get it. The rebate will be only if you have paid taxes. The lower economic classes do not pay in and are most effected by higher fuel costs, higher grocery bills, etc. They will continue to be the ones that struggle to make ends meet.

Long term we need to get the national debt (both governement and individual) under controll or the cards will come down eventually. Then China will own us. They already own most of the “US Debt” due to Iraq. We are a creditor nation to our biggest potential rival.

Aryn January 23, 2008 at 2:31 pm

I think your theory is one reason why the stock market got all excited by the Fed rate yesterday, and then are over it today. And why I’ve never liked the Fed’s policies(didn’t like Greenspan either.) They’re reactive, not proactive. This rate drop won’t help the average person by much. It probably won’t even bail out many mortgages because many of those are tied to the LIBOR rate. The LIBOR has fallen, but not by so much that people who could only afford teaser rates before can now afford reset mortgage rates.

A tax rebate won’t help much either. I used the last one to pay some bills, and I’ll use the next one to pay bills, too. I don’t see how giving people what amounts to an advance on their refunds helps the economy long-term. Sure, they may spend it now, but then they don’t have it to spend later. It’s nothing more than an election year crutch.

vh January 23, 2008 at 5:08 pm

Well, I’m no economist, but I sure do recall that the Wizard of Oz was a short ineffectual little guy behind a lot of smoke & mirrors. Surely life doesn’t imitate art….does it?

Dad January 23, 2008 at 5:30 pm

An excellant point. The great depression in the US came about in part because a lot of stock market investment was made on margin (credit). The investor only needed to put down 10% of the prices and borrow 90% against the value of the stock. Now that you asked your question, this sounds like a similar situation. Scary. However, many people rode out the depression.

oxymoron January 23, 2008 at 8:41 pm

i have a an issue with “throwing money” at the problem. Amanda said it very well. I heard a caller on a nationally syndicated talk show make an argument about this plan. This is a paraphrase. He is a small business owner with a family. His business did not do so well, so as a business he does not have to pay taxes. As an individual he will get back over $2k in refunds. His complaint was he is going to get an additional $800 for something he did not have to pay into. To his credit he does not believe he deserves it.

Who has to fund this? We do! You can’t close your eyes and throw the dart. It will not work. It makes me think that stagflation is just around the corner.

But as frugal people, we have the opportunity to save, bank and invest and be well ahead when the playing field levels.

Ryan S. January 24, 2008 at 12:11 pm

I also wouldn’t say the economy is necessarily an illusion, but yes, many people are living and spending way beyond their means. 401(k) debit cards are the scariest idea I’ve heard of in decades.


War Gold January 24, 2008 at 12:19 pm

The 401 debit cards seem to be future fuel for the current fire, from a man who seems all too keen to score points now and let someone else deal with the future consequences.

Catherine Lawson January 24, 2008 at 1:19 pm

Those 401 debit cards sound like a bad idea. If someone has a spendng problem they could easily wipe out their retirement fund.

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