Baker: What politicians won't say about U.S. economy -- MUST READ!

It's evident that Obama doesn't want to blame the bad economy on G.W. Bush, although he has every right to talk about the s**it sandwich that he was served up by his predecessor: two costly foreign occupations; 7 million jobs lost; and a burst housing bubble that removed $1 trillion a year from the U.S. economy.  I'm not sure most Americans understand the size of the hole we must dig ourselves out of.

Recently Obama got creamed by the media for saying the private sector was doing "fine," but in certain ways, it's doing better than just fine, as Dean Baker points out: corporate profits are at a 50-year high, and corporate taxes being paid are at a post-WWII low.  Gains in U.S. productivity are far outpacing gains in workers' wages.  And we have the best rating among larger countries for the ease of doing business.  Although my man Joe Stiglitz says our economy has hidden structural defects that the housing bubble only covered up, most economists, including my man Paul Krugman, believe the fundamentals of the U.S. economy are sound.  The problem is a gaping hole in aggregate demand.

Thus Romney's recycled Republican campaign mantra of "unleashing the private sector" is especially deceitful.  Where is all the pent-up demand supposed to come from that business investments are going to meet?  In other words, who in the world has the purchasing power to buy all the stuff that "unchained" U.S. companies are ostensibly going to produce once Romney has slashed their taxes and chainsawed their regulators?  

The truth is that we're in for a long, painful recovery that could be made a bit shorter and less painful with more government spending.  The multipliers of that gov't consumption would grow the economy and replace the spending with more tax revenue, rather than continuing to slash, slash, slash government while the economy shrinks in unison.

The Story of the Housing Crash Recession That Politicians Don't Want to Tell

By Dean Baker

June 19, 2012 | Yahoo! Finance

The economy is certain to occupy center stage in the presidential race this fall. Unfortunately, neither Governor Romney nor President Obama is likely to give us an accurate account of the economic problems we are now facing.

Romney's efforts seem intended to convince the public that President Obama has turned the country into the Soviet Union, with government bureaucrats shoving aside business leaders to take the commanding role in the economy. He will have lots of money to make this case, which he will need since it is so far from reality.

Corporate profits are at their highest share as a percentage of the economy in almost 50 years. The share of profits being paid in taxes is near its post-World War II low. The government's share of the economy has actually shrunk in the Obama years, as has government employment. Perhaps Romney can convince the public that the private sector is being crushed by burdensome regulation and taxes, but that has nothing to do with reality.

A Better Explanation

Unfortunately, President Obama's economic advisors have not been much more straightforward with the American people, never offering a clear explanation of why the economy has taken so long to recover. They have pointed out that economies often take long to recover from the effects of a financial crisis like to the one we experienced in the fall of 2008, but that is not an explanation for why we have not recovered.

The basic story is actually quite simple. The housing bubble had been driving the economy prior to the recession. It created demand through several channels. A near-record pace of housing construction added about 2 percentage points of GDP to annual demand or more than $300 billion in the current economy.

The $8 trillion in ephemeral housing wealth created by the bubble led to a huge surge in consumption. Tens of millions of people borrowed against bubble-generated equity or decided that they didn't need to save for retirement. When house prices were going up 15 percent-20 percent a year, the house was doing the saving. The result was a huge consumption boom on the order of 4 percent of GDP or $600 billion a year.

In addition, there was a bubble in non-residential real estate that followed in the wake of the housing bubble. This raised non-residential construction above its normal levels by close to 1 percent of GDP, or $150 billion a year.

A Bubble Generated

Adding these sources of demand together, the bubble generated well over $1 trillion in annual demand at its peak in 2005-2007. When the bubble burst, this $1 trillion in annual demand vanished as well. That is the central story of the downturn.

To recover we must find some way to replace this demand; however, that is not easy. People will not go back to their old consumption patterns because they know they need to save more. Tens of millions of people have much less wealth than they expected at this point in their lives after they saw the equity in their homes largely vanish. Tens of millions of baby boomers are approaching retirement with almost nothing but their Social Security to support them.

Given the huge loss of wealth from the collapse of the housing bubble, it is not reasonable to expect consumption to rise to fill the demand gap. It doesn't make much more sense to expect investment to do the job. Historically, investment in equipment and software has been close to 8 percent of GDP. It is pretty much back to that level today. To fill the demand gap created by the collapse of the housing bubble, the investment share of GDP would have to nearly double to 14 percent.

This would be almost impossible to imagine at any time, but it is especially far-fetched at a time when much of the economy is operating far below its capacity. Businesses are unlikely to spend a lot of money expanding their facilities when the existing capacity is sitting idle regardless of how nice we are to job creators.

Boosting Demand

Over a longer term we can expect that net exports will fill the demand gap. If we bring our huge trade deficit close to balance by selling more abroad and importing less, it will provide a substantial boost to demand. However, this will require that the dollar fall in value relative to the currencies of our trading partners, making U.S. products more competitive. That is a process that will take time. With many of our trading partners also in severe slumps, we cannot expect any major improvement in our trade balance in the immediate future.

This leaves government as the only remaining source of demand. This is not a question of whether we prefer the government or the private sector. We need the government sector to fill the gap in demand because the private sector will not do it. And that will be true no matter how much we love the private sector and its job creators.

Until we get our trade deficit closer to balance, we will need large government deficits to fill the gap in demand created by the housing bubble. That is the simple reality that neither party seems anxious to tell the people.