False Profits: Recovering from the Bubble Economy

Fine study of the crisis

Dean Baker, co-director of the Center for Economic and Policy Research in Washington, has written a brilliant little book on the cause of the US economic crisis. He contends that the crisis' 'fundamental cause [is] the huge overvaluation of the country's housing stock'.

From 1895 to 1995 house prices rose at the same rate as the prices of other goods. By 2002, they outpaced the overall rate of inflation by 30 per cent, although nothing had changed on the market's supply or demand side. From 1996 to 2006, house prices rose by more than 80 per cent.

Baker writes, "The core problem is that the economy developed serious imbalances as a result of the growth of the housing bubble. In the short term, the only way to offset the loss of demand caused by the collapse of the housing bubble is through massive deficit spending. In the longer term, a reduction in the value of the dollar will be necessary to restore more balance to our US trade. However, the political elites, led by the managers of the financial industry, do not want to allow for a discussion that results in a policy prescription of large deficits and a lower valued dollar. Such policies would go directly against their financial interests and indirectly indict the policy agenda they have promoted for more than a decade."

The US Treasury lent banks $700 billion, with no conditions, like cutting bonuses, dividends or evictions. The Fed lent the banks another $2 trillion.

Obama let AIG executives get $165 million in bonuses: their contracts were sacred. Yet he told General Motors and Chrysler workers to give up health benefits they had worked 30 years for, and which they were guaranteed under union contracts. Obama's $800 billion stimulus package, although a step in the right direction, was far too small, when the shortfall was $1.3 trillion.

Baker exposes Wall Street's scare stories about inflation and debt. He notes, "The well-being of future generations will depend on the health of the economy and the society that we pass on to them. If we maintain and improve the physical capital stock, ensure that our children get a good education, and act to protect the environment, they will be prosperous even if the United States has a large public debt. This country's period of greatest prosperity was in the three decades following World War II, when the ratio of debt to GDP began at 120 percent. Such a ratio translates into a national debt of $18 trillion given the size of the economy in 2009." Total US debt now is less than $11 trillion.

10 per cent unemployment equals a 20 per cent loss of GDP. He points out, "The country having to endure long periods of high unemployment is wholly unnecessary for the simple reason that we know how to prevent it. Ever since Keynes, we understood that high unemployment, as occurred in the Great Depression or what we are experiencing in the housing crash recession, is caused by a lack of demand in the economy. The way to address high unemployment is to create demand. In other words, the answer was and still is to throw money at the problem. . Nothing is more harmful to the economy presenting a downturn than government spending cuts and tax increases that amplify the downturn's impact."

He argues that the USA needs more funding for national and local government programmes, universal health coverage, publicly-funded clinical drug trials and subsidies for public transport.