Why the deficit is too small

No, I'm not kidding.

Our economy is the sum total of all dollars spent in this country. When you and I spend a dollar, it contributes a teeny tiny fraction to the growth of the GDP. If we don't spend that dollar, the GDP doesn't grow. Spending is what keeps the economy running. When the spending stops, so does the economy.

Keep that in mind as you read on.

Think of what happens when you throw a rock into a pond. Do the ripples from the rock stay the same size? No, they expand. The collapse of the housing bubble was the rock. The collapses of the banks that lent the money was one of the ripples. The layoffs that followed was another, and the subsequent troubles of the automakers was yet another. Get the picture? Each ripple was an expansion of the original problem, making the situation worse. Making people and companies stop spending. Making the economy slow down.

Actually, making the economy start to contract (the GDP was shrinking). Nobody was spending - not the banks, not the automakers, and not any of those who got laid off. As I said, it takes spending to keep the economy going, and nobody was spending.

In fact, there was a real possibility that the lack of spending would cause some of the biggest lending institutions (and two automakers) to go out of business. If the lending institutions and the automakers had gone under, the ripples would have become a tsunami. I'm guessing it would have ended up costing us about 8-10 million more jobs, and that would have resulted in a worldwide depression that made the 1930's look like a cake walk.

So, if the private sector and consumers weren't spending, who could? The only one left was the biggest consumer in the country: the government. Remember that it's spending that keeps the economy running. That's where the stimulus package came in. It was designed to stop the contraction by injecting enough spending to keep the economy from continuing its downward spiral. And that's exactly what it did. Job losses went from 600,000 a month to a relative trickle within months. The GDP stopped contracting. The stimulus stopped the bleeding.

But now some people want the government to stop spending, claiming that the deficit is more important. Well, since consumers are just now starting to spend a little more (retail sales are up for the 8th month in a row), a sudden contraction in government spending will likely have a negative effect on the economy.

Actually, there's historical precedent for that. In 1937, the economy was recovering (slowly) from the depression. The GDP was back to where it had been at the collapse in 1929, and unemployment was starting to come back down. What happened? FDR was pressured and agreed to cut spending, and when he did, the economy tanked again. Most people think the 1930's was just one long depression, but it wasn't. It was a collapse (1929-1933), followed by a slow, steady recovery until 1937, followed by a steep recession in 1937, with another (slow) recovery until the onset of WWII. And why did WWII spur the economy? Because the government went into MASSIVE debt to finance the war, spending all kinds of money to build ships, planes, tanks, etc. It was government spending that got us out of the depression.

It's spending that keeps the economy running, and when nobody else is spending, the government has to.