Oct 22 2008

The “bright side” of the economic meltdown… have Americans really learned to live within their means?

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Newsweek international edition editor Fareed Zakaria explains in clear terms the root causes of the United State’s economic hardships. Simply put, Americans have lived beyond their means for far too long.

When a household, a firm, or a national government spend more than it earns (in income or tax revenues), it must borrow to do so. The only problem with this type of deficit financed spending is that at some point “the only way people will keep lending you money is that you have to pay higher and higher interest rates…” This, according to Zakaria, is why the US economy has begun to slow down. Higher interest rates make borrowing and spending less and less attractive, while making savings more attractive.

Savings rates have started to rise in America as our debts have come due. Higher savings means less spending, less spending means weak Aggregate Demand, which means slower growth and rising unemployment. There you have it, the root cause of our economic meltdown. Americans have spent beyond their means for far too long; the question is, have we learned our lesson? Will our current hardships teach us to spend more responsibly in the future?

About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

4 responses so far

4 Responses to “The “bright side” of the economic meltdown… have Americans really learned to live within their means?”

  1. Joelon 28 Oct 2008 at 6:19 am

    I believe that the current economic crisis represents a burst in the American consumer bubble. What left an impression on me when I visited America last was the sheer consumerism of the place. It seems that every aspect of people's daily lives is consumer-oriented.

    For example, its hard to access your credit card total, and younger people in America are being issued with them. It's basically allowing consumers to keep on purchasing with money they don't have. This is, as recent events have shown, true with mortgage credit too.

    Indirect tax, for instance, is also part of this consumerist society. I ended up having an argument with a vendor at Haagen-Dasz in Washington DC, when I paid him $5 dollars for my smoothie. It said $5 on the price board. But no, he said, there's a tax of 30 cents or so. I am used to tax being included in Switzerland. So out came my wallet, again! This stealth tax is trying to get consumers to view products as lower priced than they actually are.

    While I recognise that this consumerism has contributed to America's incredible economic size, I am glad that the bubble has finally burst. All good things must come to an end. Pay up America!

  2. Jason Welkeron 28 Oct 2008 at 7:34 am

    Joel, interesting observation about the nature of sales taxes in America. I never thought of the question: "why don't sellers just include the tax in the sale price in the US?" I think you nailed it on the head when you said that in the states, people like to think of things as cheaper than they are because then they're more likely to actually buy them. When sellers exclude the tax from the sale price, this kind of slyly increased the quantity of "stuff" that American consumers are actually willing to buy… of course, the real burden on the consumer is then born when they pay the tax ON TOP of the sale price.

    I wonder if this is also a means by which producers in the US are better able to pass the entire burden of indirect taxes onto the consumer, rather than bearing a portion of that burden in the form of a lower price kept by the seller. We study in microeconomics the burden of an indirect tax, an according to our model a tax is always born by both producer and consumer, except in the extremely rare instance of a good for which demand is perfectly inelastic. Only in such an extreme theoritical instance would the consumer bear 100% of a tax burden. But WOW, I think you have just shown that by ignoring the impact of a tax on the price until the buyer is at the register, sellers in America manage to dump the entire burden of a sales tax onto the consumer. Of course, this represents a transfer of welfare (or surplus) from consumers to the government, in a case where theroretically welfare is supposed to be transferred from both producers and consumers.

    Are Americans being screwed by businesses? Or are we perfectly happy to go on paying 100% of a tax burden that is intended to be shared? Thanks for getting me thinking!

  3. celineon 03 Nov 2008 at 4:25 am

    The Bright sinde?

    Will we learn something?

    No. I do not belive that we will learn anything out of this financial crisis, because we never do.

    A smart person once told me that each generation has the right the do the same mistakes, and we do.

    An interesting point to argue is that the whole corporate covernance story will not change,

    as long people lead corporations they do not own, they will always only look at their own advantages (their salery, bonuses etc.)

    great exampls are the swiss managers of banks and the Pharma corporation which get multiple MILLIONS of swiss francs Only as BONUS…

    This kind of behavoir will not change with our nor the next generation..

    this crisis only shows these people that it is no problem to cheat the people and get rich because if the s**t hits the fan, the government bails us all out. So why not do it??

    learning a lesson??

  4. Deirdre Stensonon 21 Nov 2008 at 5:58 pm

    I would still argue that for the most part, the majority of Americans are not living within their means. They are now simply forced into paying the consequences of spending more than they actually had. However, I do believe that after an economic ‘meltdown’, many Americans will be forced into seeing the way many other nations live.

    As mentioned by Joel, the American society is deeply rooted in consumer spending. However, as many consumers do not realize that they cannot purchase goods for which they do not actually have the financial means to pay for.

    I believe that it will be the next generation that will truly be able to benefit from the knowledge of experience with the current economic stance of the United States. In particular, the consumers of the next generation will be able to look at the direct effects of overspending and see the negative consequences that come with this. For this reason, therefore, I do believe that this will be the ‘bright-side’ or positive effect of an economic crisis now.