07/06/2009 05:12 am ET Updated May 25, 2011

Ignore the Scaremongers - Watch out for the Truly Scary

As a banker noted recently, there is no constituency for pessimism. Americans, he suggested, believe in optimism as a human right. This bright buoyancy is one of this nation's greatest strengths, lapped up by jaded Europeans.

But it was optimism that also enabled Americans to max out on credit cards and other forms of borrowing -- in the mistaken belief that debts are always payable -- sometime in the future.

Such optimism did not help millions of Americans prepare for the shock of losing their job, or for the move into part-time work last year.

Optimism did not prepare investors for the reality check that finally forced Bernard Madoff to admit deluding and defrauding investors. And it probably did not help the shareholders and directors of General Motors prepare for the collapse of auto sales last year -- or for the shock of the biggest industrial bankruptcy in American history.

So while optimism is great; reality checks are vital for a balanced outlook. What is the real world economic outlook now? Although we are clearly still in the midst of the 'Banker's Recession,' the stock market is soaring upwards; there is much talk of 'green shoots' and of consumer confidence rising. Should we start shopping again? Invest in the stock market? Take the plunge and buy a new house?

These are critical decisions, and the economics profession does little to provide Josephine Public with the kind of straightforward analysis that would assist her in making wise decisions.

So how should we realistically view the economy? I would suggest that we do it by summoning up courage and looking the truly scary in the eye; and by rejecting mere scaremongering. But decisions about what is truly scary and what is merely scaremongering can be, of course, subjective. So I will list mine, and leave you, dear reader, to make your own judgment.

This is what I find scary. First: 23.6 million Americans out of work, or forced into part-time work. That is truly scary. 23.6 million Americans short of cash, unable to pay off debts; and unable to finance mortgages. 23.6 million Americans citizens that do not participate in the nation's economic life, and are disillusioned and angry. Many will be devastated, prepared to self-medicate with alcohol or drugs, and many thousands will act out their rage and humiliation. These citizens do not pose a threat just to themselves, to their families and to society. They also pose a threat to the finance sector -- because they will default on debts. The Mortgage Bankers Association's report of record increases in delinquencies and foreclosures by those with prime mortgages is but one example of the impact of unemployment on the banks. To all those bankers celebrating their taxpayer-funded profits that must be truly scary.

Second: a 40% rise in business bankruptcy filings in May. Small, medium and large businesses destroyed, economic capacity wasted, hopes destroyed, jobs lost. That's scary.

Third: a collapse in investment in the first quarter of 2009. According to Global Insight "real spending on equipment and software plummeted 33.8%, the largest percentage drop since the first quarter of 1958." Green shoots when investment plummets furthest in 50 years? Without investment, there is no future for new economic activity, for green technology, for an end to job losses -- for economic hope.

There's plenty more I find scary, but these three are top of my list. Now for the scaremongering.

The parties guilty of this crime, in my humble view, are once again to be found in the finance sector -- in the bond markets. Having forced the US government to nationalize the debts of bankers and financiers -- debts racked up during one of the most reckless, frenzied and self-serving financial expansions in history -- the finance sector is now warning of Armageddon. Why? Because the government's rescue programs for the economy and for the finance sector have -- unsurprisingly -- helped inflate government debt. The talk in all the financial papers and on all the financial blogs is not of unemployment, or insolvencies or the collapse in investment. No, the talk is of the threat of another "wave" of government debt brought on by social programs: of players in the bond markets going on strike and refusing to finance this debt at reasonable, low rates of interest.

On the 3rd June, Governor Ben Bernanke warned Americans that they would have to make "difficult choices" about how much resources to devote to government programs "including entitlement programs." This is the same Governor that, without congressional approval, committed at least $3 trillion over the past two years in lending to banks and to other financial institutions. By his own account, the Governor summoned up these sums out of thin air.

"Asked if it's tax money the Fed is spending, Bernanke said, "It's not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed. It's much more akin to printing money than it is to borrowing."

So no "difficult choices" made there then? If Governor Bernanke could conjure up $3 trillion for bankers, why can he not conjure up money for entitlement programs? Why rely on gamblers in bond markets?

In my view the Governor, and his colleagues in the economics profession, are scaremongering. Calling for austerity, for further losses and suffering for blameless American taxpayers.

This is scaremongering because the government's spending programs, far from posing a threat (in the way that unemployment, insolvencies and the collapse in investment do) -- are absolutely essential to economic recovery. Without public investment in an economy in which private investment has collapsed -- the economy has no hope of recovery.

The government deficit will fall once the economy recovers, as sure as night follows day. This requires Americans -- and especially Josephine Public -- to understand one of the fundamentals of economics: that public debt will only be repaid through the creation of income, and income will only be generated by employment. Indeed, it is absolutely essential for the reduction of the government deficit that employment should rise. That wages should rise. That insolvencies should fall, and that investment should rise. That economic activity should revive.

Right now, both economists and their friends in bond markets are scaremongering in the hope of achieving the exact opposite: cuts in government programs, rises in unemployment, lower wages, more suffering, more destruction of value.

This is lunacy, parading as economics.

Let the sane keep reminding themselves: that without job creation, wage rises and investment, income will not be generated to pay down the government deficit. But as soon as the economy recovers, when employment, wages and investment rise -- the government deficit will fall -- like a stone.

To argue otherwise is not just scaremongering, its lunacy.