One profound observation of Keynes was that a capitalist economy causes wide swings of the business cycle. In the bust phase there is excess supply and poor demand. The shrinking demand leads to layoffs which reduce incomes, further depressing demand. A downward spiral of this sort leads to depression. Keynes suggested that at such times it is essential for the government to run appropriately large deficits and increase spending to maintain jobs and income to end this collapsing economic contraction. What is forgotten by America is that during the boom phase, Keynes recommended that the government should be prudent and keep budgets balanced or in surplus. The US has been running huge trade, budget and current account deficits in expanding economic cycles and now runs vastly bigger deficits in the contracting part of the business cycle. This leads to geometrically rising deficits and greater borrowing and debt with a larger part of the national budget being spent merely as interest payment on the debt, thus starving productive investments.

When you add to this tax and investment policies that favor shifting manufacturing and services overseas, where labor is cheaper and environment regulations lax, the reduced incomes and unemployment are increased even more. We don’t make toys, textiles, shoes, sports equipment, televisions, stereos, electronic gadgets, phones, DVDs, cars, fans, refrigerators, air conditioners, Christmas ornaments and most household goods. These are all imported from China or elsewhere. There is thus an unbridgeable monthly trade deficit. It has burgeoned from a few billion dollars to an annual sum of 800 billion dollars or nearly 6% of our GDP in 2008. No wonder the dollar has lost so much value against the European and Japanese currencies. It has not done badly against the pound and some Asian currencies because those countries have mismanaged themselves worse than us. Furthermore even our households have indulged in borrowing and lived beyond their means, so our national debt is held by foreigners to a large extent. This means that the interest on our debt is sent abroad and boosts foreign economies. Even the US government deficit Keynesian spending partly increases employment abroad in countries which export to us. By restricting such Keynesian spending to US products leads to trade wars like the one going on with China. China, Japan and even Germany depend on exports for their prosperity and are unlikely to run trade deficits or allow their currencies to appreciate sufficiently against the dollar to permit us to have a trade surplus. Japan has a greater percentage ratio of debt to GDP than us, but its debt is held by Japanese so it can muddle through the lost decades by deficit spending with much less effect on the lives of its citizens.

We are spending hundreds of billions of dollars per year on food stamps, unemployment compensation and extra financial aid to states which have large deficits because of reduced income taxes from unemployment and are unable to print money like the federal government. Our unfunded liabilities mainly for medicare and medicaid are in the tens of trillions and our healthcare costs are rising faster than our GDP. Social Security will face similar but lesser problems in two or three decades. The new healthcare bill will not even address these problems and there will have to be severe rationing, curtailment of benefits and large increases in premiums to fix the problem. It is only a matter of a few years before the credit rating of the US is downgraded, interest rates balloon upwards and other countries refuse to lend us money. Despite all these looming catastrophes, we keep on fighting useless and expensive wars and are on the way to starting new ones in Yemen, possibly Iran and Pakistan.

Lenin, no friend of ours, did make a poignant observation. He said that increased production capacity would drive capitalism to colonization to increase captive demand. This would then prevent unrest and revolution by the proletariat of the capitalist colonizing country, as they would escape the dire fate predicted by Marx. Much of world history from the industrial revolution in Europe bears this out. The newest doomsday predictor who has been vindicated is our own capitalist economist Hyman Minsky. His contention that our debt and leverage based expansion would lead to increasing instability inherently, until the Minsky moment of collapse. That is what happened in the current meltdown.

The euphoric rally in the stock market in view of the above problems, reminds me of an ancient Indian story from the Mahabharata, which I have quoted in the past and am giving below.

A traveler, who is thirsty approaches a well. In the torture of his insatiable thirst, he loses his judgment and leans over more than he should into the well. He topples over and to save his life, grabs on to some protruding shoots. He looks down and sees the ultimately fatal snakes at the bottom of the pit, waiting to sting him to death. He thanks the good fortune, which prevented him from falling to the bottom of the pit to be stung to death by the snakes, but then he sees the rats, who are gnawing at the roots, he is holding on to and then to his utter disappointment, he sees a mad elephant trying to uproot the very tree (banyan) whose roots he is holding on to. As luck would have it, he has uprooted a bee-hive and angry bees are stinging him, but in the process, quite a few drops of honey are dislodged and they fall on his lips and he smiles happily. Such indeed is the story of human life. They know that the serpentine specter of death faces them all the time, and old age like rats gnaws at their happiness, while catastrophes like elephants are waiting to create a disaster and minor irritants of life like bees, hover to sting, but so stupid or short- sighted are humans that they take enough solace in the few drops of honey (Stock rally which reduced portfolio losses but not fully), that fall by accident on their tongue, that it is enough to keep them still running on the treadmill. On that note, happy new year to all.