Paper Wealth and the Economic Crisis

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Dean Baker
Talking Points Memo, November 28, 2008

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Back when President Bush wanted to privatize Social Security he visited the office in West Virginia where the government bonds owned by the Social Security trust fund are stored. After viewing the bonds, Bush held a press conference and announced that "they're just sheets of paper."

Bush was absolutely right about the "sheets of paper" part of the story, but the "just" needs some further qualification. The value of these bonds depends on the taxing authority of the U.S. government. That is still the most valuable guarantee in the world.

Of course other claims to wealth, like stock certificates and house titles, are also sheets of paper. One way to describe the current crisis is that these sheets of paper turned out to be much less credible than the government bonds held by the Social Security trust fund.

Because house prices have plummeted and shares of stock have lost close to half of their value, the paper wealth of the country has been radically diminished over the last year. We have lost more than $8 trillion in stock market wealth and close to $6 trillion in housing wealth.

This loss of paper wealth has sent consumption plummeting. People consume based in part on their wealth. The average homeowner has lost more than $70,000 in home equity over the last two years. If they had money in a retirement account invested primarily in the stock market, then they would have lost close to 40 percent of their retirement wealth.

The families that have experienced this enormous and sudden loss of paper wealth are now putting off consumption in the hope of rebuilding their savings. This is especially important for the huge baby boom cohort that is at or close to retirement age. Tens of millions of baby boomers are now looking at a retirement in which they will have no pension and almost nothing in the way of retirement savings or home equity to sustain them in retirement. They will be almost totally dependent on Social Security and Medicare.

This backdrop should be kept in mind as Congress considers a stimulus package in the next two months. Congress can and should be considering very large sums for the stimulus package, possibly as much as $600 billion per year.

Spending of this magnitude is needed because that is the amount of demand that must be replaced. With consumption plunging, and housing, non-residential construction, exports and state and local government spending all headed downwards, a large dose of government spending is all that stands between us and a long steep downturn. Ideally, this money will address real needs - repairing infrastructure, reducing energy use, extending health care coverage - but the key point is that we need spending, and lots of it.

Those who worry about the deficit and the resulting debt that will be created, and what we are passing on to our children, must think more carefully about sheets of paper. With the stock market plunging by 40 percent, it is now far cheaper for our children and grandchildren to buy the country's capital stock. In other words, they can expect far better rates of return on money that they invest for retirement and other purposes as a result of the stock market's plunge.

Similarly, the fall in house prices is great news for our kids. They will be able to get homes for 30 percent, 40 percent, in some areas even 50 percent less than would have been the case without the recent plunge in prices. They should be very happy.

Even the debt itself is not a net burden on our children. Someone must own the debt. In 50 or 60 years, most of us will be gone. The holders of the debt will be our children and grandchildren. While those with an ax to grind, such as cutting Social Security and Medicare, have tried to portray the government debt as redistributing income from future generations of workers to those currently alive and paying taxes, this is absurd on its face.

As a practical matter, our concern must be with the state of the economy. The only way that we can keep employment high, and maintain the infrastructure and investment needed to keep the economy prosperous in the future, is through massive amounts of deficit spending over the next two years.

The debt created by this spending will not be a burden to our children, rather, by building a stronger economy we will have hugely benefited our children. The real crime to our children will be if we let misguided concerns about paper debt prevent us from taking the actions needed to pass on to them a healthy economy.


Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer. He also has a blog on the American Prospect, "Beat the Press," where he discusses the media's coverage of economic issues.