I’m not an expert in economics, but I am trying to make heads or tails of the growing debate over what to do about our economy.  We’ve pulled back from the brink we were on early last year.  But now we’re stalled. There’s a non-trivial chance we’ll fall back for a double dip recession similar to what happened in 1937.  There’s also some chance the world confidence in the dollar will fall and we’ll go into full-blown collapse ala Greece.  Then there’s a large chance we’ll just languish with 10% unemployment and be dead in the water like the Japanese were through most of the 90’s.  Oh yeah, and there’s some small possibility we’ll actually get things humming along again so we can all see our 401k’s at 2007 levels and have lots of job prospects for us and our children.

Many are calling for fiscal austerity, arguing that large deficits are the road to ruin.  Many of those same folks are calling for the Fed to raise interest rates as a hedge against inflation.  On the flip side, others argue that more government stimulus is needed and that we need to spend our way back to prosperity.  Frankly it all makes my head hurt.

Let’s start with the common ground.  No one thinks deficits are a good idea.  Most can agree that there are times where you borrow money to make appropriate investments, but that running deficits year on year without ever seeing the plus side of the balance sheet is not a healthy thing.  As a minimum, I would very much like to see everyone remember this the next time we do have a thriving economy so that we actually raise taxes or cut spending such that we get to a debt neutral position.  But that’s water over the dam now.  The issue is figuring out how to get out of where we are.

The austerity folks are fond of making the analogy of the U.S. economy to your household.  That is, if you lose your job or otherwise are taking in less money, then you need to cut back your expenses such that you are also paying out less money.  Responding to a layoff notice with a spending spree at Best Buy would be pathologically stupid.  There’s additional rationale that if there isn’t a show of some fiscal discipline, creditors will lose faith in the ability to pay the debts and call the notes due.  This would effectively result in bankruptcy.

There’s an elegant simplicity to that analogy, but after careful consideration, I think it’s the wrong one.  The major missing element is that in the home analogy, your spending doesn’t have a relationship to your income.  But in the U.S. economy case, it does.  That is, if people are broke, if goods are not sold, then there are no tax revenues to collect.  But I think there’s a simple analogy that does reflect this relationship.

Consider a small family business, let’s say a local Bar & Grill.  The tavern falls on hard times because the factory up the road shut down and a lot of their regular customers no longer have lunch there or hang out there after work.  As the owner, you’re faced with a significant drop in revenue.  You have two basic choices.  You can try and restructure your business to fit within the revenue you’re making, or you can borrow and invest in things to attract new customers.  While there may be some things you can do to cut costs, many of the obvious things you might try will ultimately hurt your business.  Reduce the variety and quality of the food menu.  Reduce staff.  Reduce hours of operation.  Water down the drinks.  Sure, these things save you money, but they likely will also cost you revenue as additional customers will become disappointed and leave.  In general, this strategy is a death spiral.  Alternatively, you could gather a few local investors to finance adding a stage on the back and offering live music.  Do additional advertising.  Hire a top chef to create an exceptional menu.  These things have the opportunity to expand your business, and thus your revenue, which hopefully you’ll use to pay down your debt.

Yet even in this analogy, it’s important to recognize that there are no guarantees.  Yes, maybe in the austerity case you’ll get lucky and some new company will re-open the factory and your business will take off again.  Yes, in the investment scenario you might make lots of improvements, and still nobody comes to your establishment and you go under with additional debt.  The key difference for me is that the austerity case is entirely hanging your future on luck and prayer.  It’s outside of your control.  While the investment scenario gives you a path to drive your own success, or at least die trying.

Bringing this back to the U.S. economy, it means to me that the federal government needs to keep investing.  Not spending wildly, but investing smartly in things that have future upsides.  Green energy technology comes to mind as a great industry investment.  In general, loans to small businesses and start-ups.  Unemployment payments to keep people off the state welfare rolls such that they prop up consumer spending so that larger companies stop hoarding cash and go back to investing in their own businesses.  Not every program will work, but we need to keep trying.

There is a time to be frugal, but this isn’t it.  There is no indication this is a passing storm such that if we just hunker down we’ll be fine in a few months.  The storm has already ravaged the town.  We need to decide whether to rebuild or to decide to get used to living in the rubble.