Only you can prevent financial fires

The American economy is poised in a very tenuous position and there is dramatic lack of consensus as to what we should do about it. Do we spend money to fight deflation or should we be more concerned about sparking inflation? Do we encourage people to borrow and consume or do we place a renewed emphasis on savings and investment? Do we stimulate the economy with deficit spending or do we work to pay down the debt?

If one thing is clear it is this: We have very little tolerance for pain.

It is this fact that I want to start to focus on today. Our reaction to the pain of economic change explains a large part of how we got to where we are today and, for better or for worse, how we can start to work our way out of this mess. First an analogy.

In Jared Diamond's brilliant book Collapse he details how the fire suppression policies of the United States have created a situation where we are at very great risk for catastrophic conflagrations. Until recently, ever since we have had the technical wherewithal to do so, our policy with forest fires has been to put them out. When a fire would pop up we would immediately suppress it so that we would not run the risk that it would burn out of control and do serious damage. A fire is easiest to control when it is small and so we set up early warning and quick reaction systems to detect and put out fires as soon as possible.

Of course we now realize that this has had two damaging side effects. First, by suppressing the fires before they had a chance to burn, the forest floor was able to accumulate an unnatural amount of "fuel" (burnable material). While nature would periodically wipe out this fuel with a localized burn, we circumvented this process and the natural cleansing cycles of forest fires by our suppression approach. Over the years the amount of fuel has been allowed to grow to explosive levels and we have a near certainty that someday a conflagration will spin out of control.

The second damaging side effect is that people, reacting to the perceived safety of living in forested areas where there are no forest fires, have now built billions of dollars worth of homes in the woods. This has raised the stakes of our policy quite a bit because, even if we now decided it was a better approach to let these fires burn when they start, we really can't do it. Too many people would be hurt and, if it spun out of control, it could be catastrophic.

So when it comes to forest fires we are in this negative feedback loop. The more we suppress the more people feel safe and choose to move to the forest, but also the more fuel is added and the more dangerous the situation becomes. The more dangerous the situation becomes, the more we are forced to suppress. How does this not end in catastrophe?

The first presidential election I was able to vote in was Clinton versus Bush and Perot in 1992. The mantra of that election was coined by the Clinton campaign: "It's the economy stupid." Bill Clinton characterized the extremely mild 1991 recession this way in a famous speech on the economy given at the Wharton School of Business:

The current administration has compiled the worst economic record in 50 years. George Bush's Presidency has produced slower economic growth, slower job growth, and slower income growth than any administration since the Great Depression -- and the biggest deficits and highest middle-class tax burden of any administration in history.

Once elected this over-the-top rhetoric turned into policies designed to stimulate the economy back to recovery, which happened in one of the biggest postwar booms. I don't use Clinton here to be partisan -- G.W. Bush did stimulus and encouraged us all to spend while Greenspan helped out with interest rates. I don't really think the problem is politicians.

The problem is us.

Keynesian economics -- the idea that we could make up for falling demand with stimulus spending and other government policy interventions to prop up the market -- gave us this powerful tool to fight downturns. When the economy starts to slow down, we need to cut taxes, spend more, borrow more and lower interest rates to get it back moving again. Once we figured out we can do this -- that policymakers like "The Maestro" as Greenspan was nicknamed can fine tune the economy like a Stradivarius -- we started demanding that they do so at every market hiccup.

Put out the fire! Put out the fire! Quick! Put out the fire!

One of my favorite professors in graduate school used to say that a recession now and then is a good thing. Periodic recessions are painful, but they are a way of toughening the economy, of allowing it to adapt and evolve to be stronger over time. We've robbed ourselves of that toughening process over the last sixty years and, as a result, much of our economy -- private sector and public sector -- is old, brittle and overdue for a major conflagration.

Case in point: Too big to fail.

Or how about: General Motors.

As painful as it would have been, the averted crisis of that past would have cleared poorly run companies, outmoded ways of doing business and dead ideas. It would have allowed creative destruction and the flood of new innovation -- and better systems - to come forward. Of course, this is easy to say in retrospect. We didn't realize the forest fire problem until it had become too late either.

So how much longer can we prevent a major conflagration? It is hard to say, but I think we all kind of sense it is coming. As Nassim Taleb indicated in a speech late last week, we may have averted immediate pain but we've really only made the long-term situation worse. 

“Obama did exactly the opposite of what should have been done,” Taleb said yesterday in Montreal in a speech as part of Canada’s Salon Speakers series. “He surrounded himself with people who exacerbated the problem. You have a person who has cancer and instead of removing the cancer, you give him tranquilizers. When you give tranquilizers to a cancer patient, they feel better but the cancer gets worse.”

Today, Taleb said, “total debt is higher than it was in 2008 and unemployment is worse.”

Again, this is not a partisan statement. The TARP spending started under Bush, who also did a lot of stimulus spending. And "quantitative easing" (aka printing money) is the policy of the Federal Reserve. This is not a partisan problem, it is an American problem. We've not toughened our economy and, like we ourselves as a people, its gotten soft. Which brings me to my final thought.

Where do we start the controlled burns and how do we keep them from spinning out of control? That is a serious question that I don't know the answer to - if there even is one or if we would have the political will to do it if we could identify it. I fear what a major economic conflagration would mean to our towns and neighborhoods, many of which are barely hanging on today despite our best efforts to fight this fire. Only a Strong Towns approach can truly provide us economic security over the long term.


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