What If The Bubble Never Happened?

Lots of bad stuff has happened to the economy over the past three years. The deficit is huge. Inflation is creeping up. The Federal Reserve is printing money. These three topics, more than anything else, have occupied the minds of anxious consumers and businesses lately.

Understanding how we got here is crucial. By their nature, debating these three topics is somewhat fruitless -- there will never be consensus. A few numbers, though, should help put the topics in perspective.

Let's start by stating the obvious. Today's deficit is higher than when the recession began in 2007. Same for overall prices. And money supply. And all three aren't just higher -- they're much higher.

Have things fundamentally changed course since 2007, or have the past four years simply been an extension of the past decade? Often, the latter's the case.

Take the federal budget deficit. It should come in at about $1.4 trillion this year, up from just $400 billion in 2004. While today's deficit is enormous and out of control, it is, for the most part, a continuation of a trajectory set last decade. From 2000-2007, federal outlays grew by 6.22% annually, while tax receipts grew by 3.45% annually.

If revenue and outlays from 2007-2011 had simply grown at the same rate, today's deficit would still be more than $700 billion -- less than it is now, but far higher than most would be comfortable with. Interestingly, about half of the additional $700 billion increase in the actual deficit owes to mandatory recession spending like unemployment benefits and food stamps. 

Then there's inflation. The Consumer Price Index is now 5.7% higher than it was when the recession began in late 2007. That's average growth of 1.75% per year, a statistic that plenty of people find wretched. From 2000-2007, however, the index grew by 2.65% per year. Had it grown at the same rate since the recession began, overall prices would be about 2% higher than they are now. Even over the past year, when inflation worries have really begun startling investors, inflation growth has stayed consistent with the 2000-2007 average.

Finally, we'll move on to money supply. Since the recession began in 2007 and the Federal Reserve came out swinging, M2 (a broad metric of money supply) has grown by 5.51% per year. That's high, but not as high as the 6.22% annual clip at which it grew from 2000-2007. Had M2 followed the same path over the past three years as it did the preceding seven, money supply would be $200 billion higher than it is today. (How can that be, after the Fed's quantitative easing programs? Because most of the money "printed" during QE never entered the economy; it remained at the Fed as excess reserves held by banks.)

None of this absolves policymakers from the severity of our problems. Instead, it shows that the root of so many of our problems didn't begin with the bursting of the housing bubble, or the entrance of new political leadership. These troubles began at least a decade ago. They're deeply ingrained trouble that have more to do with long-held culture than any response to a recession.  

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel doesn't own shares of any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On May 13, 2011, at 5:24 PM, xetn wrote:

    I believe the Austrian Theory of the Trade Cycle explains how we got here very well:

    http://mises.org/tradcycl.asp

    It was first conceived by Ludwig von Mises in (I believe 1912) and further refined by his Noble winning student F.A. Hayek.

  • Report this Comment On May 13, 2011, at 5:36 PM, xetn wrote:
  • Report this Comment On May 16, 2011, at 1:15 PM, Tygered wrote:

    And who occupied the White House from 2000-2007? Bushie. Enough said.

  • Report this Comment On May 16, 2011, at 8:45 PM, FutureMonkey wrote:

    I was always under the impression the biggest danger to the economy between 2007-2010 was deflation, not inflation. Seems monetary policy helped us avoid that particular land mine.

    Sure commodity prices and energy prices have fluctuated higher as demand has returned from the desperate lows of the recession, but not higher than expected based on that demand. I won't be an inflation worrier until unemployment draws down and there are wage increase. Inflation will likely be tame as long as wages remain flat. When MacDonald's drops it's dollar menu, then I'll really worry that inflation has arrived and is taking off quickly.

    FM

  • Report this Comment On May 16, 2011, at 8:47 PM, FutureMonkey wrote:

    or McDonalds for those spell checkers. I couldn't careless if I misspelled their name. A french fry by any other name smells just as delicious.

    FM

  • Report this Comment On May 20, 2011, at 5:02 PM, ynotc wrote:

    The spending is the primary problem. Even if you adjust tax revenues, as you often suggest, the data in this article shows that government spending would still exceed it. Until we get some rein via a balanced budget amendment or such this is not going to change.

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