America is on the way to a crisis

What caused the Great Recession?

I won’t pretend to be audacious enough to answer this question. But, while the exact cause of our economic catastrophe is difficult to pinpoint, we do know some factors that played major roles, one being personal debt.

Everyone has been quick to assume that greed and irresponsibility caused millions of Americans to max out their Visas and it’s certainly true that those played a part.

What people haven’t said, though, is that resisting living above one’s means can be difficult or nearly impossible when one’s means aren’t enough.

As last week’s issue of The Economist pointed out, stagnated wages combined with an increasing cost of living forced people to borrow to maintain their standard of living.

The Economist did a poor job, however, of addressing why wages have stagnated.

It mentions the dismal rate of job creation – only 400,000 more Americans were employed at the end of 2009 than 1999 despite a population increase of almost 30 million – and argue the scarcity of jobs has pinned down wages.

But that is where the explanation stops. And that is untruthful.

The Economist presents stagnated wages and a lack of job growth in the face of an otherwise seemingly healthy economy as a matter of fact. But in reality, a funny thing happened on the way to the financial crisis.

An explanation exists. And that explanation is important as we look forward, past the recovery, and begin to implement policies that will hopefully prevent a similar economic catastrophe. The explanation is this: Wage stagnation is inextricably linked to income inequality – at least in this instance.

In 2006, Paul Krugman contributed an article to Rolling Stone magazine titled “The Great Wealth Transfer” in which he explained that even though the economic pie was getting bigger, most Americans were getting smaller slices. Why? Because a few Americans were getting much, much bigger slices.

While noting that income disparity is nothing new, Krugman stated, “For the first time in our history, so much growth is being siphoned off to a small, wealthy minority that most Americans are failing to gain ground even during a time of economic growth.”

Their failure to gain ground, of course, is just what The Economist is talking about. The lack of financial gain for most Americans led to rising personal debt as people fought to keep up with rising prices.

The point of the story is not to get hung up on the past, rather, it’s to look forward to the types of legislation that could prevent another economic collapse caused, in some part, by personal indebtedness.

There’s no way to get around it; personal debt must be reined in. But that is much easier to do, and happens much more naturally, when the incomes of all American families – not just the top 1 percent – are rising.

Reform should address income disparities, focus on strengthening America’s middle class and bettering the plight of the working poor.

We’ve seen where relying on credit card balances and mortgages has gotten us – we need policies that won’t force us to rely on debt just to keep up with prices.