So really only the U.S. economy’s growth was fueled by your own local housing bubble and a gross injection of cheap capital from U.S. pension funds.

Germany’s economy, for example, while under pressure from the global lending crisis and at risk by the CDS-disaster waiting to happen, will most likely maintain most of the growth that happened over the last 3 years and only shrink by a minuscule amount this year (<1%). I.e. Provided that we don’t see a huge collapse in the US consumer credit market… but then all bets are off anyway.

I just wanted to add this to the discussion to reiterate that we have to take a differentiated look at the worlds’ economies.

Economies grow for other reasons, too: Manufacturing efficiency gains, removal of other transport and trade frictions, increasted trust lowers the cost of protecting the transactions (ie: why prostitutes in low income areas need pimps) etc.

The proper course of action for the government would have been to tighten the money supply when the economy was growing without underlying fundamentals, but politics didn’t allow that. It seems to me that what we want is people feeling okay to spend money again, and it seems like the right way to do that is to make a strong public commitment to social security. Take those two or three (or more) trillion bucks of debt we were going to give to cronies and campaign contributors and the Wall Street power structure and say to the common man “go forth and consume, you will have a retirement!” My fear with infrastructure spending and similar things is that they’ll both turn into amazing boondoggles (much like the Paulson plan already has), and that they’ll put us in a situation like Japan: Lots of capital expenditures on projects that now need upkeep, and are mostly unused.

I also think we need to see a return to an economy with 401k and similar retirement plans that aren’t so blatantly a “give favors to Wall Street”, where investment can be made to startups and smaller enterprises so that ordinary citizens feel vested in the power of the economy once again. Because right now making money feels like random chance rather than the result of hard work, goals, and savings, and as long as that continues there’ll be more incentive to buy lottery tickets than to do something productive.

Government spending programs might increase wealth by increasing wages, and investing in things that generate job growth, not equity growth. GDP in the mid 30’s was clipping along in the 8% range according to NPR’s Planet Money.

So it may be that getting the economy to size XL is possible with government stimulus, but it really needs to be on the backs of wages, not equity bubbles, which would be sustainable and work for more people.

The NPR piece quoted the theory that if the initial push in 34 had been sustained longer, it would have recovered the economy faster and cheaper than having to come around with the second round of stimulus in 37.

I guess it remains to be seen what happens, there is a lot of talk of free money, low fed rates, etc., which supposedly devalues the dollar, but with wage stagnation and unemployment, most people are experiencing deflation. The stimulus package has to not be aimed at equity bubble control (like fed funds), but at wage earners to get the economy running smoothly and sustainably. We’ll see what happens.

I definitely wasn’t comparing the merits of government spending versus irresponsible consumer spending, but more looking at the goal, which is to manage the changing size of the economy to prevent shock.

If we have a stimulus that makes it far less painful to move from XL to L then I’m for that, I just don’t think that we can expect the stimulus to keep us at size XL, which is what some people seem to be advocating.

My take is: The government needs to stretch the shirt just enough so that we don’t have to lose weight too quickly as we resize to the L size – which is probably where we should be.

The problem isn’t just that the economy is contracting. It’s that it’s contracting in so many areas so quickly that it’s having a snowball effect. If we are not careful the response will cause an overshoot and the shirt will become an M and things will get really painful.

Many people now need to limit spending so that they can pay off the over spending that they engaged in in the past. Once those debts are paid off, it will free up some available cash for more spending at a more sustainable pace (L).

L is the ‘right’ size for the economy.

We suddenly went from XL to M. All we should reasonably expect is to go from M back to L. XL wasn’t sustainable before, and we shouldn’t strive to go back to that size, because any method we employ will also be unsustainable.

(Side note: we might again get back to XL some day via conventional means: productivity increases, sensible monetary policy, sound regulation of investments, population growth, etc.)

For instance, people keep screaming, “We’ve got to get banks lending again!” Well, they’re not going to lend like they did before, and we shouldn’t hope that they do. We hope to get them lending more than they are now, but only a reasonable, sustainable level.

But, that (assuming I’m right) is an ugly truth that nobody wants to really state. Though, when Obama suggested yesterday that the recession could last several years, that was a much more frank statement than I’ve come to expect from all sides–federal government, economists, Wall Street, and, unfortunately, the media.