The Ignorant Investor

I've been seeing a lot of talk about the liquidity trap. This occurs when people cut back spending in times of a slowing economy due to fears over losing jobs and needing to build a cushion against future financial stress. Because everyone is cutting spending, there's less economic activity and so more people lose jobs, leading more people to save more money, causing less economic activity. There's a spiraling downwards, and that's the point where Keynesian economists say government stimulus is needed to push the economy up and out of the liquidity trap.

The difficulty with applying that model to our economy comes from the wastralized, debt-ridden rake's life Americans have been living for the past 10-20 years. A liquidity trap that occurs after people have been leading normal financial lives- i.e., saving a portion of their wages, investing money prudently, borrowing within their means- can be solved by a short term jolt of government medicine. But when people are addicted to spending through debt, strung out on consumptive highs, and have no savings to rely on- cutting back on spending is part of the cure for what ails the body, not a disease that needs to be corrected by government action.

Reading about the Great Depression, I'm struck by how much debt people carried in the 1920s and how a sudden crash in demand followed years of wild spending by Americans.