Whats Really Wrong With The American Economy Most people think the big problem with the economy is the level of debt, or spending too much. Even though many economists agree, this is dead wrong. The primary problem is basically not a matter of money. Money is a means to influence what happens in the real world of production and distribution; a means to influence what people are actually doing. Money is not itself the real economy. We have somehow convinced ourselves that all that matters are these counters [dollars] which merely symbolize economic activity. It was once clearly articulated by economists that money is a veil through which we view the world of work and production. This is not to say money doesnt play an important role. Because money represents a call on goods and services in the economy either now or in the future, it can allocate planned and actual resources among people and uses, i.e., it can influence how much of each thing is produced, for whom and when. Probably the most significant reason for the mistaken perception that money is the economy, or at least all that is worth thinking about from an economic policy perspective, is that a malfunctioning financial system (i.e. interruptions in the of the flow of money) often seriously disrupts the real economy. The real economy is composed of engineering-managerial-institutions and their relationships which result in the production and distribution of goods and services. Some economic dips in the last hundred years were primarily a result of non-monetary events, such as the two post-World-War recessions (the result of disruptive real-economy switch-backs from wartime production to peacetime production) and the recessions in the 1970s (real-economy disruptions due to oil shocks). The Great Depression and the present Great Recession, however, were initiated primarily the result of disruptions in money flows in the economy. As awful as the two Great Depression/Recessions were, after the Keynesian analysis, the short term cure for an economy in trouble because of money and credit flow stoppages was obvious, i.e., restoration of the disrupted flow of funds by any available means, including the use of direct government purchases of goods and services if necessary. In the case of the Great Depression, Roosevelts New Deal initiatives from 1933 to 1937, although without this objective clearly in mind, had largely succeeded in restoring the flow of funds in the economy and with it, started a real economy rebound from the depression. The balanced budget initiative in his second term, however, almost reversed the process until gigantic defense spending in 1939-1941 got money flowing in a big way. In the case of the current recession, an early but modest stimulus program (modest in comparison to the scale of the monetary-flow/GDP fall) and Federal Reserve actions fended off the worst short-term real-world effects due to disrupted financial flows. As of the end of 2012, however, the flow of funds is still a problem compared to pre-Great Recession levels. Arguably, part of the stoppage of monetary flows and credit in both the Depression and Recession can be traced back to accumulating problems in the real economy. That is, unsustainable trends in real-world production and distribution built to the point that money and credit system players, finally recognizing unsustainable growth trends in some parts of the economy, ceased providing money and credit. It is critical to recognize, however, the Great Depression-era wholesale shut-down of the monetary system affected not only those relatively few parts of the real economy where overproduction or other unhealthy trends existed. Virtually the entire production system was affected. Instead of switches of production and distribution away from types of goods or services to others that were more needed (analogous to a switch from wartime to civilian production) which would cause only a minor drop in living standards while resources were redirected, the whole economy was unnecessarily affected by money and credit stoppages. With most of the economy involved, idle production across the board and wide-spread unemployment resulted in a serious drop in average living standards. In the case of the recent Great Recession, unsustainable overproduction in housing, commercial real estate, and financial services also almost led to a near-wholesale stoppage in the flow of money in the economy, but as noted previously was mitigated by a timely stimulus program and other actions. Once funds began flowing in the Depression economy, the engineering-managerial-institutional production economic engine could be started once again. So successful was the restart that production doubled in World War Two and was available to support unparalleled prosperity for a generation or more following the war. In todays economy, however, the situation is vastly different. We have almost no production engine to start. America is not producing goods. We are distributing, but not many of these goods (and increasingly, services) originate in the USA. Officially only fifteen percent of the US economy is now devoted to manufacturing, and even this overstates the case in terms of the civilian economy because a large part of domestic production is devoted to defense and weapons. Even if money and credit were flowing as freely as before the recession began in 2007, due to the lack of an appreciable production component of the economy, it is virtually certain that unemployment would remain high and living standards further stagnate or fall. Before Great Recession officially began, inflation-adjusted wages had been stagnant for a generation. The percentage of the employed population in the US had been falling for seven years before the onset of the financial crisis. With services, including financial services, comprising most of the US economy one might ask how an economy can function without much in the way of actual goods production. The answer is that it functions by importing things from other nations. Manufacturing, mining, farming, and other US production activities have been declining as a percent of the economy for decades. Imports have exceeded exports by a large margin for most of latter part of the 20th Century and all of the 21st to date. Normally the expectation in international trade is that any temporary excesses or deficits run by any nation will tend over time to even out and that one nation cannot run a permanent deficit or surplus. The US, however, has run a trade deficit in goods so large and for so long that it almost looks like a permanent condition. Running such an international trade deficit as the US has done and is continuing to do is possible only under very special conditions. Instead of trading US goods and services for an equal value of goods from other nations, the US for decades has been able to exchange IOUs (i.e. dollars, US securities and paper assets) for physical production from other countries. Unlike the US, other nations find this continued borrowing impossible to do for any length of time. A stack of accumulated IOUs, unable to be exchanged for desirable goods in the issuing country, would quickly become worthless. More IOUs would not be accepted. Why have other nations throughout the world continued to accept dollars, when they do not want to exchange them for US goods of equivalent dollar value? Foreigners continue to accept dollars (or government securities and other assets that can be readily turned into dollars) in otherwise unequal trade simply because the US dollar is not only the US national currency, but it is (largely though accidents of history) the defacto world currency. It is not the world currency primarily for the reasons usually given; i.e., that the US is a safe haven and has a stable open democratic system. These reasons may have some subsidiary validity, but the main reason is historical. The US after World War Two constituted the biggest part of the world economy, and as such the dollar began to be accepted everywhere. This acceptance everywhere continues despite the fact that the US economy is now a relatively small portion of the world economy, especially in terms of the production of goods. Universal acceptance for the dollar continues not just out of habit, but because of the international convenience of a single currency combined with lack of international agreement on another unit as the international medium of exchange. The important point to grasp is that there is no insurmountable barrier to the replacement of the dollar as the worlds international (i.e. reserve) currency. Growth of the world economy and trade, besides motivating foreigners to accept far more US trade debt over a longer period than would otherwise be the case, and hold greater and greater amounts of dollar-denominated assets, also results in a stronger dollar than would be the case based purely on its value in trade for US goods and services. That is, a dollar will buy more foreign goods and services (and more of other currencies) than would be justified purely by its value in trade for US goods and services. Despite its apparent success as the world monetary standard since World War Two, the dollar has considerable disadvantages to foreigners as a world currency. Probably the biggest disadvantage is that they pay for the continued use of dollars for non-US commerce by having to pay in real goods for increasing amounts of US IOUs. Another very significant disadvantage is that the US manages the size and growth rate of its money supply (of dollars) based mostly on prevailing domestic economic conditions, not economic conditions in the world as a whole. US boom and bust cycles are therefore transmitted to the whole world economy by US domestic monetary policy even though the US now constitutes only about twenty percent of the total and on a downward path. The (from the world perspective) ill-timed tightening or loosening of the international monetary supply frequently damages otherwise healthy economies and makes planning for the future almost futile. There are ill-effects on the US economy as well. The almost permanent trade imbalance (enabled by almost unlimited borrowing ability), cheap foreign goods (due to the strong-dollar), and US goods made expensive to foreigners (due to the strong dollar), has driven most US manufacturing and other productive activities out of business or to moving production offshore. High US labor costs, environmental and other regulatory requirements, and harder working or more skilled foreign workforces are the usual reasons given for US manufacturing and trade difficulties leading to offshoring or going out of business. These factors, however, are very minor compared to the continuous economic headwind faced by US business in dealing with an overvalued currency and the almost free credit granted by our trading partners. The US reserve currency status once served a useful purpose for the US and the world at large. It is now, however, more a detriment to US and world prosperity than help. There are good reasons to think a root cause of the world real estate boom and subsequent financial crisis of 2007-8 was in large part related to an unbalanced US economy, unbalanced US trade, and consequently a world awash in dollars.