The “Paradox of Thrift”… explains a lot.

Here’s why much of Stimulus has been ineffective in actually stimulating the economy …

The meltdown occurred largely because consumers (and businesses) were over-leveraged. That is, they were carrying too much debt – way too much debt.

When asset values plummeted (think home prices) panic understandably set in.

So, any “free cash” that flows in (think gov’t rebate checks) goes to retiring debt (i.e. deleveraging) instead of consumption.  That’s good for balance sheets, but doesn’t stimulate the economy.

Economists call it the “paradox of thrift.”

^ ^ ^ ^ ^

Excerpted from Why There’s No Case for Healthy Economic Growth, Jul 23, 2010

The consumer is simply carrying too much debt.

In the US, consumption represents 70% of GDP, but the consumers’ debt/GDP ratio, which spurted from 100% in 2001 to more than 135% in 2008, still stands at 126%, nearly three years after the recession began.

Much of the nine-percentage-point decline is due to financial institution write-offs as opposed to debt repayment, so it appears that the consumer has a long way to go to even get back to the 100% ratio. The next healthy economic upswing must await the healing of household balance sheets.

Unfortunately, to get a healthy consumer balance sheet, savings must increase to repay the debt, which leaves less for consumption.

Lower consumption means slower economic growth with all the attendant implications for employment.

This is known in the economics profession as “the paradox of thrift.”

Unfortunately, the politicians are promoting ill-conceived schemes that wind up only prolonging the agony — like “Cash for Clunkers” and the “homebuyer tax credit.” These programs promote more debt which will have to be reduced in the future

The need to work off debt together with the loss of retirement income by the baby boomers will cause them to put off retirement for several years.

This will trickle down to the younger generation who will find it increasingly difficult to find satisfactory employment.

We’ll see the U6 unemployment measure (which counts the underemployed) continue to stay high – very high.

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