When this financial mess began two years ago, most world sovereign bankers rushed to the rescue of their private bank brethren and counseled monetary easing.  This sunk interest rates and poured taxpayer money by the trillions into insolvent private banks — particularly the large international bank variety.

From most perspectives this appears to have worked.  The big banks, with a few notable exceptions, are still with us.  In fact, they’re bigger than ever and making money hand over fist according to the bonus money that’s been handed out to bank executives.

Economic ships all over the world (again with notable exceptions) appear to have stopped shrinking.  The largest of them all, the United States, most recently looks to have a small recovery underway.  Although private companies are reluctant to hire, some hiring is being done nevertheless.  Even with real unemployment at 15-16% in the US, that still leaves 85% of the population working.  And based upon the number of hours being worked, employers are squeezing the most possible productivity out of the employed.

That said, a dominant theme for what to do now counsels austerity for government spending — particularly for the developed economies in Europe and the US.  Because these economies weren’t sitting on large savings when the recession hit and because deficits and debt increased from the recession effects of decreased revenues and increased spending for bailouts and stimulus, political leadership now leans towards austerity for all, most particularly government spending.

Two economic philosophies are now in public combat.  One believes any government dollar not spent means the private economy gains a dollar.  This school of thought believes that extra dollar in private hands will better create investment and follow on jobs and income.  Therefore austerity now will result in a faster recovery than otherwise would be the case.

The opposing philosophy believes that a recessionary weakened private economy cannot by itself resurrect economic growth.  To withdraw government spending now will only further weaken economies and make matters worse and recovery less, not more, likely.  This school of thought believes concern over short term deficits is misplaced.  They point out that during the Depression of the 1930s, a strong recovery underway in the mid 1930s was derailed by such concerns and the economy then plunged right back to near Depression levels.   The only way to fight the recession is to keep stimulating the private economy by forcing demand to rise.

It appears that the austerity philosophy will win the political debate, particularly in Europe and possibly in the United States.

Beezer believes the wrong side is winning, and a repeat of the 1930s experience is the likely result.

These are large economic ships, however, and difficult to turn.  A merchant marine friend of Beezer said a large oil tanker takes 8 nautical miles to turn.  Not all that nimble.  If these economies are in recovery, then it is possible that recovery will continue.  But if history is any guide, the more probable outcome of decreased demand will, in fact, turn the nascent recovery around. 

At ground level, at the household level, anxiety will increase dramatically as government stimulus is withdrawn.  Every one’s wallet will slam shut.  Everyone will hoard as much cash as possible.  This will accelerate the declines in demand.  A double dip is baked in this cake, Beezer believes.

Another possible result will be a double dip in the banking sector.  A continued, or even worsened, recession makes servicing debt more difficult.  And debt resides on bank balance sheets worldwide.  Those counseling austerity are going to be hard pressed to justify more bank support under this scenario.  This problem may be most acute in Europe where, according to what serves as conventional wisdom today, big banks haven’t yet taken sufficient bad debt write downs.

Equity markets are staggering right now.  Could this be because professional investors fear the double dip recession austerity might create and are withdrawing their exposure to further private recession (don’t ever forget that it is the private sector that plunged into too much debt)?

Who knows what the public thinks about all this.  Polls indicate the majority concern is about jobs, either keeping the one they have or getting one to replace the one they lost.  Debt matters, of course, and the public is concerned there too.  But if you’re unemployed, or seeing your pay cut, you understand whatever debt you have will be harder to pay down.  If not impossible.

The only hope is that politicians here in the US start to understand that come November elections, the public may realize that it’s only Uncle Sam who has the ability to spend into the winds of recession, and they’ll toss the so-called conservatives out on their behinds. 

If they don’t then the most suffering will come out of those already naked to a further recession.  At some point even the most dim-witted citizens will realize they’re been mislead.

The philosopher Montaigne once observed that ignorance made a nice pillow upon which to sleep.

But ignorance is costly because the lack of information, or the understanding of information, will lead to poor decisions. 

Now studies are showing that folks who don’t know diddly, don’t even know they don’t know diddly.  In fact, they often think they do know diddly.

From a New Yorker magazine article, entitled “Greater Fools,”  the following.

The public needs to first understand bookkeeping in order to solve our current economic malaise.  It’s a dry discussion certainly, but necessary nonetheless.  Failure to understand guarantees that the economy will remain weak or worse.

The nation’s budget has three main components:  Private spending and revenue; public spending and revenue; exports and imports.

We had a private debt bubble that finally and inevitably burst.  The first part of this debt bubble to burst came in the private sector’s housing industry.   Because a banking system is the arbiter of debt, this implosion made many of our banks insolvent, particularly our largest banks, which had magnified the mortgage bubble by severely leveraging their capital into that industry.

Capitalism normally resolves this problem by allowing banks to fail, wiping out bank shareholders and bondholders.  But because of the size of these failures, the nation’s leadership decided to shore up the tottering banks rather than risk a full blown Depression.

They did this primarily by having the public budget assume almost $3 trillion in bad private debt, much of it mortgages, but also credit card and other private debt.  The debt still existed, but it was shifted over to the government side of the nation’s collective budget.  As a result of this shift, and also as a result of a plunge in government revenues due to the private recession, the government’s budget debt increased to $13 trillion.   To appreciate the size of the private debt bubble one need only know that the private debt totals $42 trillion even after being relieved of $3 trillion.

This shift of private debt to the government ledger is easy to see because the government meticulously accounts for its revenues and spending.  Suddenly, the public could “see” this now public debt.  Suddenly the debt problem became clear and the calls for reducing the public debt grew instantly.

Herein lies the first failure to understand.  This debt came from the private sector, not the public sector.  Failing to understand where the debt came from means the public will support the wrong policies, likely making matters worse and economic recovery less likely.

If the debt came from the private sector, what government policies make sense?

Any policy that creates jobs will create income and investment.  Income and investment gains allows debt to be reduced.  But any policy that further dampens demand will also dampen income and investment, which will decrease the private sector’s ability to reduce debt.

How do we do this?  Any number of ways.  To give just one example, the nation needs to invest almost $500 billion per year over the next three years just to maintain its public infrastructure.  From bridges, to roads, to canals, levees and water supply systems, the list of projects is already identified.  Making this investment represents a direct cash infusion into the private economy.  Which creates private sector jobs and income that will reduce the private debt. 

The public debt will increase, but not at a dollar to dollar ratio for the decline in private debt, which is the underlying problem that created our current financial recession.   As demand returns to the private sector the economy will recover and the private debt will decline.

Which does not cure the dynamics that created all this private debt to begin with.   These dynamics have to change otherwise the debt bubble will eventually return, once again throwing the nation’s bookeeping out of balance.

Laws and regulations need to actively discourage over borrowing and encourage prudent capital standards that can reasonably support borrowing levels.  That will help and the current financial regulation reforms address some of these needed changes.  But it wasn’t poor capital standards and over borrowing alone that got us into trouble.

It was also what we did with the borrowed money.  Instead of investing in productive activities, too much of that borrowed money went into consumption.  Consumption does not create revenue to pay down debt.

The problem the nation has is primarily on the revenue side of the national budget.  The private sector’s leveraged spending went too much into consumption, which starved revenue and the nation’s ability to sustain debt.

That’s the true understanding of our current recession:  The unemployment, the increase in safety net government spending, the government debt increase, the moribund private sector unable to pay down its debt — all of these ailments — derive from a failure to invest in productive economic activity.

So how do we encourage this?  The nation does this by protecting its industry and by maintaining balanced trade.  This doesn’t mean the nation should protect inefficient companies, but it does mean it should protect its companies from unfair competition.  And in a global economy, unfair competition comes in many forms.

The most prevalent form is currency manipulation.  Foreign competitors can “peg” their currency value below the dollar.  This amounts to the imposition of a tariff on American products for export, and a subsidy on foreign products for import to America.  And not coincidentally, it encourages American debt because the foreign country needs to buy American dollars with its export profits in order to maintain it’s “peg” — which lowers interest rates and makes debt “cheap.”

It would be preferable if maintaining currency exchange rates were internationally coordinated.  But if  imposing currency discipline cannot be done cooperatively among nations, then America needs to go it alone.  Failure to do this will continue its underinvestment in productive activity and the resulting decline in national revenue — both public and private.

What would the pharmaceutical industry look like if the government simply bought out the patents of new drugs and then turned around and allowed generic manufacturers to make and sell the new drugs for a lot less than our current systems allows?

Say Merck comes up with a blockbuster drug for Alzheimers.  Under our patent system this drug would be patent protected for 12 years.  Merck therefore has a 12 years window to make their development money back and turn a profit.  They’d have to build up manufacturing capacity and then unleash a marketing and sales army to bring in the revenue.

Might Merck’s business plan be better if they could simply sell the patent (for US sales) and turn an instant profit?  And avoid 12 years of expenditures at the same time!   Plus the instant profit could be invested in inventing more blockbuster drugs. 

Why don’t we try it out?  Negotiate with pharma on the next great drug discovery.  Not having to wait for a profit must be worth something.  If it doesn’t work out, so be it.  But we won’t know the cost/savings unless we try.

The social positives are obvious.  New breakthrough drug discoveries would be available sooner to the population, and at less cost because generic manufacturers would be producing the new drug.  There has to be a net expenditure by the government, but that would be lessened somewhat by generic manufacturing royalty payments to the government, which owns the patent.

The total payment by patients would be less because the inventor wouldn’t incur the cost of production and marketing, and wouldn’t have to wait years to make real profits.

So we’d develop a two tiered pharma industry.  One whose sole role is to discover new medicines.  Another whose sole role is to manufacture and distribute the new medicines.

Is it worth trying?  Beezer thinks so.

Beezer’s been reading “Keynes, The Return Of The Master,” written by Lord Robert Skidelsky, professor of political economy at Britain’s Warwick University.  Although the book is obviously about Keynes and how his philosophy might relate to today’s developed economies, Skidelsky provides insights of his own.  Many of them are powerful.

His distillation of what caused our recent financial meltdown and the ensuing recession is one of those examples of powerful insight.   From pages 168 and 169 in Chapter 8, entitled “The Need To Rethink.”

“One can see that there were three kinds of failure.  The first was institutional: banks mutated from utilities into casinos.  However, they did so because they, their regulators and the policymakers sitting on top of the regulators all succumbed to something called the efficient market theory:  the view that financial markets could not consistently misprice assets and therefore needed little regulation.  So the second failure was intellectual.  The most astonishing  admission was that of former Federal Reserve chairman Alan Greenspan in autumn 2008 that the Fed’s regime of monetary management had been based on a ‘flaw’.   The ‘whole intellectual edifice’, he said, ‘collapsed in the summer of last year’.  Behind the efficient market idea lay the intellectual failure of mainstream economics.  It could not anticipate or explain the meltdown because the majority of economists are committed to the view that markets are self-correcting, sooner or later.

The economics profession both sanctioned and rationalized a business model of society which supported a minimally supervised rule of markets.  As a consequence, the failure of markets has marginalized economics itself.  It is left on the sidelines as politicians try to salvage something from the breakdown of the market order.

But the crisis also represents a moral failure: that of a system built on money values.  At the heart of the moral failure is the worship of economic growth for its own sake, rather than as a way to achieve the ‘good life’.  As a result, economic efficiency — the means to economic growth — has been given absolute priority in our thinking and policy.  The main moral compass we now have is a thin and degraded notion of economic welfare, measured in terms of quantity of goods.  This moral lacuna (definition: blank space or missing text) explains uncritical acceptance of globalization and financial innovation, and the sanctification of those practices which give the pursuit of wealth priority over other human concerns.”

Beezer.  So our failures were institutional, intellectual and moral.  Those are very basic failures.  In order to step back and return some prudence and sanity to our system, we need to do more than re-install regulatory vigilence.  We need to also re-install some of those ‘other human concerns’ .

And what might those be?  Full employment is one and should be a priority concern for our economic system, our economic well being.  It’s not ‘he who dies with the most toys, wins’.  That kind of attitude should be disdained in a moral society.  Elevated for admiration should be people who’s efforts are life supporting and worthy of emulation not because of wealth but because of helping society provide the ‘good life’ for as many citizens as possible.

Capitalism may indeed be the best basic economic system to lift more people out of the tunnel and onto the slope of prosperity.  But in doing so, prosperity cannot remain solely the provence of price and quantity.  Abandoning our morals and ethics to a raw hypothesis of ‘efficient markets’,  is an obvious mistake.  

We can do much better.  And must.

From the ultra conservative Cato Institute (I get a kick out of using Cato on this blog!):

“The United States has over 200,000 troops stationed in 144 countries and territories. At any given time, it usually has another 20,000 sailors and Marines deployed afloat on Navy ships. In the more benign post-Cold War international environment, why does the United States need all of those forces positioned overseas?”

OK enough of Cato.  How about the Washington Post, reporting on a new Congressional task force report about military spending?:

“With the fixation on shrinking the budget deficit, why is over $700 billion in annual defense spending almost always off-limits for discussion? The mainstream media rarely explore possible cuts in the nation’s largest discretionary spending item, and most politicians refuse to even consider the issue…..

But, the report argues, “significant savings” may depend on rethinking “our national security commitments and goals to ensure they focus clearly on what concerns us the most.” It goes on to describe “a strategy of restraint — one that reacts to danger rather than going out in search of it…. We need not stick around in foreign lands often. “Our military budget should be sized to defend us. For this end, we do not need to spend $700 billion a year — or anything close. We can be safe for much less, provided that we capitalize on our geopolitical fortune. Our principal enemy, al-Qaeda, has no army, no air force, and no navy . . . . The hunt for anti-American terrorists is mostly an intelligence and policing task…

It will require rethinking our role in the world, as the task force report suggests. Is America Globocop or responsible Republic? As Globocop, we have spent over $1 trillion on the wars in Afghanistan and Iraq alone. Isn’t it time we had an honest and open debate on that question?”

Beezer here: While the deficit hawks, or austerians as I prefer to call them, counsel we should shrink ourselves back to prosperity one can’t help but notice most of the sacrifice they recommend will fall on the lower income, social security/Medicare dependant types.  Not to mention the longterm unemployed tossed aside because of a recession created by wild west, Wall Street investment banks.

If we’re going to balance our budgets, then we should cut where we can afford to cut — like a bloated military complex.  And as for revenue enhancement, those who drank the most from the punch bowl, should pay higher tax rates when the poorer people are being asked to give up necessities.

Let’s see if the hawks are indeed hawks, instead of vultures.