Wednesday, October 22, 2008

The Stimulus Package and The Need for Wealth Distribution

In my first post on the financial crisis, The Depression in the Financial Markets – The Solution is Wage Inflation via Tax Policy posted on September 16th, I suggested that the root cause of our financial woes is ultimately a lack of demand. At the root of this problem is wealth inequality.

The middle class squeeze leads to low consumer confidence. People begin to stop spending. For example, high gas prices pulled people's discretionary funds into fuel and retail sales of items like cars begins to slow. Such a trend begins to spiral into recession. The root cause is a lack of wages rising with prices of vital items. Low wages lead to lowered demand which leads to recession.

In the current crisis, this slowing demand is multiplied by a crisis in the financial markets. The financial crisis has many causes but one of them is that on the fringes people that are squeezed begin to default on their homes. In situations where financial institutions are highly leveraged the result is failed banks.

So what is needed of course is a bailout of the financial institutions by creating liquidity and the government acting as the guarantee of certain failing types of financial services. Basically, the government has to inject into the system more cash. This addresses the financial crisis but what about the recession. The recession is addressed by one fundamental type of action. The government must put money in the hands of consumers. This happens though tax cuts, a stimulus plan and general wealth distribution.

Yes, wealth distribution.
Why Wealth Distribution is Needed
Lets simplify the scenario to make the situation clear. Let's say that one person owns all the food and has all the cash. What will happen to his food selling business. The food will rot and the people will starve. The problem is people cannot buy the food. There is no demand. In this situation, in order to save the wealthy man's business, he has to give money to the consumer. In order to stop a recession and save capitalism requires wealth distribution when wealth inequalities are overly polarized.

Life is like a game of monopoly. If one person has all the money, the game is over. The game comes to a halt. In order to start the game again, you have to give some money to the losers. In times like these, we need demand side economics to drive demand and re-start the economy. Some politicians may call this socialism but in fact this is simply economics 101.


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