We live like gods, and we don't even know it.

We fly across oceans in airplanes, we eat tropical fruit in December, we have machines that sing us songs, clean our house, take pictures of Mars. Much the total accumulated knowledge of our species can fit on a hard drive that fits in our pocket. Even the poorest among us own electronic toys that millionaires and kings would have lusted for a decade ago. Our ancestors would be amazed. For most of our time on the planet, humans lived on the knife-edge of survival. A crop failure could mean starvation and even in good times, we worked from sun up to sundown to earn our daily bread. In 1600, a typical workman spent almost half his income on nourishment, and that food wasn't crème brûlée with passion fruit or organically raised filet mignon, it was gruel and the occasional turnip. Send us back to ancient Greece with an AK-47, a home brewing kit, or a battery-powered vibrator, and startled peasants would worship at our feet.

And yet we are not happy, we expected more, we were promised better. Our economy is a shambles, millions are out of work, and few of us think things are going to get better soon. When I graduated high school, in 1975, I assumed that whatever I did, I would end up somewhere in the great American middle class, and that I would live better than my father, who lived better than his. Today, my son doesn't have nearly the same confidence. Back in those days, you could go off to India for seven years, sit around in an ashram, smoke pot and seek spiritual fulfilment, and still come home and get a good job as a copywriter at Ogilvy and Mather. Today kids need a spectacular resume just to get an unpaid internship at IBM. Our children fear any moment not on a career path could ruin their prospects for a successful future. Back in the 1970s, pop stars sang songs about of the tedium and anomie of factory work. Today the sons of laid-off autoworkers would trade anything for that security and steady wage.

On the one hand, technology has made us all much more productive than we were 30 years ago. On the other, jobs have evaporated. Steel that used to require hundreds of men to manufacture now can be made with a dozen. A small businessman no longer needs to hire a secretary or a bookkeeper. Inexpensive software and a personal computer lets him do their jobs in a fraction of the time all by himself. The internet puts specialist knowledge that used to be almost impossible to find instantaneously on our laptops. The personal computer is doing to the office worker what the internal combustion engine did to the horse a century ago, making him obsolete.

Most of us are working harder, for less money and with no job security. My father and I both worked at the same large corporation but there was a difference, a difference determined by our respective eras: he was staff, I was freelance. When he got sick, the company found him doctors, paid his salary, put considerable effort into his recovery. Had I ever gotten sick, they would have simply forgotten my name. He yelled at the CEO habitually without any fear of losing his job. I mouthed off once to a middle manager and was never hired again. He had a defined benefit pension paid for by the corporation, the government gave me a tax break should I choose to save for my own retirement. The company had legal and moral responsibilities to him, which both he and they viewed as sacrosanct. All they owed me was a day's pay for a day's work. His generation gave their youth to a corporation, and the corporation took care of them in their old age. Today loyalty, if it exists at all, goes just one way. Many of my college buddies, are unemployed at 50, or earning less than they did ten years ago.

Most of us joke that we expect to fund our retirement by winning the lottery. Even investment bankers, who make more money than God, also work longer hours than galley slaves. Twenty-five-year-olds live with their parents; 50-year-olds borrow money from them. The conviction that each generation would live better than the last has evaporated. Emerging from the financial crisis won't be enough. For most of us, even the boom wasn't all that great. From 1950 to 1970, the typical American worker doubled his salary in real terms. Since then, even before the 2007 bust, inflation adjusted wages for the median male worker have actually gone down.

It is a paradox: our ever-growing productivity and our more insecure lives. Our understanding of economics is stuck in the past, in a world of scarcity, a world without advertising, where making things rather than selling them was the fundamental economic problem. Technology and the free enterprise system, to an extent that would amaze our ancestors, have solved much of the problem of supply. Our homes are more solid, our clothes more fashionable, our food tastier than our grandparents would have dreamed. In a world where even the residents of housing projects own more computing power than NASA did when they put a man on the moon, we cannot think that making stuff is the problem.

Supply side economics was invented by a journalist, a second rate academic, and two politicians (Jude Wallinski, Arthur Laffer, Dick Cheney, Donald Rumsfeld). Practical folk know better.

Ask any entrepreneur, and he will tell you making stuff, be it specialty steel, a low budget movie, saltimbocca a la romana, a collateralized loan obligation, a back massage, or an oil tanker is the fun part. It is selling it that keeps you up at night, breaks your heart, drives you into bankruptcy. That is why salesmen get paid more than engineers. Our problems today are purely problems of demand.

Picture an empty restaurant. The maître d' standing by the till, faking confidence, trying to will customers through the door. The waiters sweeping nonexistent breadcrumbs from immaculate tablecloths. The sauces are prepped, the fish purchased at dawn glisten, waiting to be pan-fried. A couple approaches, peruses the menu, looks through the window, and walks away. The chef runs numbers in his head, calculating how much money he owes, how he can manage to meet his next interest payment. All that preparation, all that investment, all that energy and potential, for nothing. Until a customer decides to spend his money, it is for naught. Marx knew it. Keynes knew it. More to the point, every businessman knows it. Lack of demand is the Achilles heel of modern capitalism.

There were no recessions in Stalinist Russia or in Carolinian Europe, instead, just generalized poverty. Command and feudal economies were not nearly productive enough for supply to ever dream of outstripping demand. Every grain of wheat was consumed, every iron pot in use. The classic image of Brezhnev's Russia is a line of shoppers, outside a store, making a cue while not knowing what is for sale. Advertising is redundant in a world of scarcity, where consumers will buy everything that is up for sale. Supply, not demand, was the problem back then. A recession, by definition, is a lack of aggregate demand, an unwillingness of firms and households to consume as much as the society can produce. It is a sign of the incredible capacity of capitalism that our fundamental problem is we make more stuff than we want to buy.

The empty restaurant, writ large, is the predicament of the world economy today. No war, no hurricane has destroyed the productive capacity we had during the halcyon days of the boom. But consumers are not spending, firms are not hiring, households are paying off debt, corporations are sitting on piles of cash, banks are cautious about lending, and governments are hoping to reduce their deficits. Seven years after the real estate bust, five years after the collapse of Lehman brothers, four years after the recession first officially ended, we still find ourselves stuck with high unemployment, slow growth, a stagnant economy.

Progressive economists, led by Paul Krugman, have argued persuasively that what the world economy needs now is government deficit spending to put money in workers' wallets, to stimulate consumption, to give the private sector a reason to invest and expand. This is the classic Keynesian solution, one proved by years of experience. Krugman tells us that the problem with the world economy now is lack of demand. Indeed, solving the problem of demand has been the essential capitalist dilemma of the past 80 years. As productivity rises, we can make more with the same level of inputs. Demand has to rise just as fast or the economy shrinks. For an economy to be at full employment, demand needs to equal the society's productive capacity. If it does not, then supply will shrink to meet demand and millions of workers will become redundant. To achieve full employment, we must find a way to instead push demand up to meet the economy's productive capacity. Since the Great Depression, we have solved this problem of demand three different ways: war, rising wages, and debt.

The Great Depression shocked the capitalist world. The first real recession occurred in 1820, in the aftermath of the Napoleonic Wars, but until the 1930s, no downturn had never been so deep nor so long. Radicals hoped it might be the end of capitalism. John Maynard Keynes, for all the distaste he evokes amongst free marketeers, saw his task as saving capitalism from itself. According to conventional models, long-term unemployment was inconceivable. Most economists at the time believed that markets, if left alone would inevitably self-equilibrate. Unemployment would drive wages down until, at some certain level, workers would be so cheap to hire that once again, men would be put to work and growth could return.

Keynes saw the fallacy in this reasoning. He recognized that workers, after all, are also consumers. Drive down their wages, you also drive down their ability to purchase goods and services. Lowering wages was no panacea; it would just knock demand even further down. And since entrepreneurs base their decisions to invest and hire on whether sales are increasing, lower wages would lower sales, which would lower investment and so just increase misery without raising employment. It is a fallacy of composition. If I reduce my workers' wages, I increase my own profits, but if everybody else also lowers the wages of their workers, sales will fall for all. From this misery some sort of equilibrium would emerge, but Keynes insisted it would not be a full employment equilibrium.

When Roosevelt was inaugurated in 1933, "one third of the nation was ill-clothed, ill-housed, ill-fed" because close to one third of the nation was also unemployed. Were they all working, they could also be clothed, housed, fed. Conventional economics, what Keynes called the "Treasury View," believed that supply should be driven down to the level of demand. Keynes and Roosevelt figured why not drive demand up to the level of supply instead? Combining idleness with scarcity was criminal. Instead, demand should be stimulated to meet the economy's productive capacity.

World War II finally ended the Depression and proved Keynes right. New Deal deficit spending was too small, too timid to restore the animal spirits of entrepreneurs battered by years of debt deflation. War is the least productive, most destructive of human activities with negative economic benefit, but the US government, by printing money and using it to hire workers knocked unemployment, which had been close to 20 percent in 1938 down to barely over 1 percent six years later.

It is important to understand that making bombs and blowing up cities is not what shrunk unemployment. It was the printing of money, the hiring of workers, the creation of demand by deficit spending. Had the US government spent as much as it had on fighting Hitler on promoting the arts, or building schools or even digging ditches and then filling them, it would have had just as beneficial an economic effect as did the war. Blowing stuff up is the opposite of investment. From an economic point of view, bombs and bullets are purely consumption goods, not nearly as beneficial as education or infrastructure. The reason defense spending has become the common means of stimulating demand is largely political. Conservatives who cannot stomach deficit spending for any other reason are willing to forgo their hard money prejudices in time of national emergency.

When the war ended, policy makers feared that without the stimulus of defense spending, the United States and the world would sink back into recession. The end of wars had been the cause of economic slowdowns in 1818, after the Napoleonic Wars, and in 1919, after World War I, and indeed, 1946 saw the US GDP shrink slightly. But the economy soon recovered and for the next 25 years, the world experienced the greatest growth in its history. The fundamental source of Golden Age growth was rising incomes that brought millions out of poverty and into the middle class. Their demand for luxuries that were fast becoming necessities created a mass consumer market, and corporations grew rapidly by satisfying it. In 1939, 25 percent of Americans didn't have running water, only 65 percent had indoor toilets, and none had television.

The rich grew richer during the Golden Age, but so did everyone else. Golden Age policies of progressive taxation, unionization, regulation are the opposite of what conservatives advocate today, but they were much more successful than the supply side policies that have dominated our more inequitable era. Inflation adjusted GDP growth was greater in the 1950s, 1960s, and even 1970s, than it ever has been since.

In the 1970s, for a variety of reasons, corporate profitability went south. The positive feedback loop that raised the income of workers and businessmen alike fell apart. The Golden Age depended on capital and labor cooperating, and both profiting. In the 1970s, their social pact fell apart. The inflation of that era can be seen as capital and labor each trying to shift the cost of oil price hikes to the other. At first, organized labor won that battle and grabbed a larger share of the pie. Workers, especially organized workers did well in the 1970s. Wage growth, even taking inflation into account, was greater than it ever has been since. Capital, on the other hand, had a terrible decade. From 1966 to 1982, the stock market fell more than three quarters in real terms. Bonds did even worse. With inflation greater than nominal interest rates, putting money into the bank meant that after a year you had less money than you put in. The 1970s were a bad decade to be rich. No wonder John Lennon sang about working class heroes. No wonder the children of millionaires dressed like farmers or factory workers. In the 1970s, a union cameraman made more money than most stockbrokers. But the glory days of labor were about to evaporate.

In 1980, capital struck back.

In response to a seemingly inexorable inflationary spiral in which rising goods prices sparked cost of living wage hikes, which naturally increased the prices of goods and services, Federal Reserve Chairman Paul Volcker raised interest rates provoking the most brutal recession in 50 years. Unemployment soared, and so the Volcker and Thatcher recessions broke the back of inflation. When workers fear for their jobs, they no longer demand higher wages. In June 1980, when Volcker started raising interest rates, US inflation was over 14 percent. Since then, it has averaged around 2 to 3 percent. Simultaneously, both in the United States and the United Kingdom, the government attacked the basis of union power. When Reagan fired the obstreperous air traffic controllers and planes did not fall out of the sky, he shattered the confidence of organized labor. If we could do without trained air traffic controllers, then what is the bargaining power of unionized truck drivers, construction workers, steel workers, cameramen?

And so, starting during the recession of the early 1980s, corporations were able to reduce real wages, fire workers, get rid of staff and replace them with freelancers. Power on the shop floor shifted from the unions to management. Risks that had been absorbed by the corporation (you get sick you still get paid) now became the worker's responsibility (if you are freelance, you get no vacation, you have no job security, and if you get sick and you don't work, your employer has no responsibility to you). On a company by company level, this policy was remarkably successful. Cutting labor costs, if it does not affect output, goes straight to the bottom line. Lower wages for the worker mean higher profit for the entrepreneur. The decline in corporate profitability that signalled the end of the Golden Age was reversed and even today, in the midst of economic stagnation, corporate profits remain strong.

But on a society wide level, cutting wages creates as many problems as it solves. Your workers, after all, are my customers, and vice versa. Lower their wages, they will spend less in my store. For an economy to grow, demand needs to grow as well. For the past 30 years, we have solved the problem of creating demand in a world of stagnant wages by going ever deeper into debt. In 1965, private sector interest payments as a percentage of GDP were around 5 percent. At the top of the bubble, they were close to 25 percent.

Going into debt allowed families to keep consuming more even as their wages did not grow. This willingness to absorb higher levels of debt meant that lower wages did not mean lower demand. This required a profound change in attitudes toward borrowing. Golden Age workers, children of the Great Depression, had a horror towards spending more than they earned. They would rather do without than place themselves in a situation in which they might have difficulty repaying their debts. By the 1980s, this attitude evaporated. Saving became passé, having huge amounts of credit card debt nothing to be ashamed off. If the origin of capitalism, according to Max Weber, was in the willingness of Protestant entrepreneurs to forgo immediate gratification in order to save and invest in productivity enhancing machinery, today capitalism requires us to spend more than we make. Forgoing immediate gratification can be disastrous to the economy, thus George W. Bush's suggestion to the American people after 9/11 to "go out and shop".

That today's youngsters want to spend more than they earn is not that surprising. What does require an explanation is the reason banks were eager to lend. The answer, and the key to the growth paradigm of the period 1982-2007, is asset price inflation. Since 1971, when Richard Nixon severed the final link between money supply and gold, the quantity of money in the world has skyrocketed. According to the standard textbooks, this should have caused an explosion of inflation. It hasn't because of globalization. Globalization is essentially a deflationary phenomenon. It destroys pricing power. Corporations can't charge more for their goods because a factory in China can make it cheaper. Meanwhile increasing job insecurity means that workers cannot demand higher wages.

But all that money coursing through the world financial system has to go somewhere and despite the lack of goods and wages inflation, it sparked inflation in real assets. Houses on my block in the United Kingdom that cost £3000 in 1970 are now going for over £1.5 million. Companies, which traditionally had a price to earnings ratio of 8, soared to over 45. The rising value of real assets did have a wealth effect (if your house doubles in value, you feel richer and are more likely to splash out), but more important, it means the value of collateral goes up.

When you borrow money, you have to give the bank collateral, the right to take something you own should you miss your interest payments. As collateral goes up, banks are more willing to lend. Yes, bankers would like to believe you will earn sufficient income to repay your loan, but what gives them confidence to lend you money is the certainty that if you default on your payments, they have something of equal or greater value that they can take from you and sell.

So the chain of causality goes like this: globalization - low inflation - central banks set low interest rates - easy money - asset price inflation - strong collateral - more loans - easy money - asset price inflation. And it all adds up to debt-fuelled consumption.

From 1982 to 2007 when the last bubble finally popped, it was debt-fuelled consumption that allowed the global economy to grow. If an American did not max out his credit card, a factory in China closed. With wages stagnating, wage growth could not keep demand growing at the pace of supply.

One common, and naïve, notion blames Alan Greenspan for the financial crisis. This argument states that had he not cut interest rates in the wake of the dot-com bust, he wouldn't have sparked the real estate bubble and so the subsequent bust could have been avoided. But had Greenspan kept rates high after 2000, then the Great Recession would have just occurred seven years earlier. It was the central bankers complicity in creating bubble after bubble that allowed the perpetual motion debt machine to keep rolling on for as long as it did.

August 9, 2007 was the moment greed turned to fear, the appetite for debt disappeared, and the asset price inflation/debt fuelled consumption paradigm finally fell apart. Two years of falling house prices infected bank balance sheets. As foreclosures rose and a handful of hedge funds specializing in mortgage backed securities went under, wholesale lenders became frightened that these securities weren't actually worth as much as the banks claimed. Fearing that their counterparty banks were undercapitalized, wholesale lenders stopped rolling over their short term deposits as they came due. This "run on the bank" by wholesale lenders rippled through the system. Bank balance sheets had to shrink. Instead of lending more, banks instead had to call in existing loans. Households accustomed to spending more than they earned finally had to cut expenses in order to repay debts incurred in happier days.

When you are strapped for cash and owe more than you can afford, reducing your expenditures is a sensible response. Unfortunately, when everyone is cutting back, the economy slows. When consumers stop spending, firms have no reason to invest in increased capacity, no reason to hire more workers. And when workers fear for their jobs, they cut consumption even more. In 2007, the debt-based feedback loop that had kept the economy ticking went into reverse.

The specific details of the housing bust and its effect on bank balance sheets are important and illuminating, but the bigger truth is that we had dodged a similar bullet several times before. We might have dodged it again in 2007, as central banks used the same tricks that calmed financial markets before, but this time, the wholesale money markets that lent money to the banks were not reassured, and when the banks had less money to lend, they had to stop extending more credit.

"Bang" - the party was over.

The interaction between falling house prices, mortgage-backed securities, and third party repo agreements was the trigger of this disaster, but the larger lesson is that we are in this mess today because our post-scarcity world economy cannot produce sufficient effective demand required to keep everybody employed. From 1938 to 1945, war created that demand. From 1945 to 1973, prosperity, rising wages, and advertising created that demand. From 1982 to 2007, debt fuelled consumption financed by ever rising asset prices created that demand. In 2007, as fear roiled the markets, banks stopped lending, and when we could no longer spend beyond our means, the economy collapsed.

The most important thing to remember about the faux-prosperity of the last 30 years is that it was manufactured on the basis of paper profits. If my house was worth £3000 in 1973 and £1.5 million in 2012, it is still essentially the same house and gives me the same pleasure to live in. If we could manufacture demand by making bombs and if we could manufacture demand by making houses quadruple in price, then we can manufacture demand in other ways, perhaps more satisfying ways as well.

What is to be done?

Our policy makers are desperately hoping that ultra-low interest will spark a new asset price bubble and we can return to the fool's paradise of 2005, right before house prices started falling in Nevada and mortgage-backed securities started stinking up bank balance sheets. Not only is this looking unlikely, it also ignores that debt fuelled consumption didn't give us strong or equitable growth. Remember, real GDP growth during the bubble years was lower than it was even the unlamented 1970s.

In the short run, the first thing we should do to emerge from this debacle is to increase government deficits and focus this spending on infrastructure and education. These investments in our future create jobs today, and by putting money in workers wallets, give the private sector reason to hire and invest in increasing capacity.

This is a no brainer.

Pundits and economists enamored with austerity argue against this policy and insist that firms require lower government deficits before they have confidence to invest. This shows a breathtaking lack of understanding of the business world. Only one thing makes entrepreneurs expand capacity and that has nothing to do with government tax policy. A businessman will hire more workers and invest when his inventory is shrinking, specifically, when he is able to sell more than he is able to produce. If stock is sitting on his shelf, he instead fires workers, no matter what his tax rate. Only someone living in Washington who has never run a business could assume that entrepreneurs are fixated on the possibility of future tax hikes. Of course, like all of us, businessmen would rather pay less tax, but what makes employers hire is the realization that they cannot meet the demand for their goods and services with existing staff. If they do not expand production, customers willing to buy their goods will have to leave the store empty handed and spend their money instead at a competitor's shop.

The need for increased government spending is basic Economics 101. Gross national product equals consumption plus investment plus government spending. If households are consuming less and firms are investing less, government has to increase spending is the economy is not to shrink.

Austerity has been a dreadful failure. A return to sensible Keynesian policies is the first step to restoring prosperity.

But in the longer run we need to figure out a better way to stimulate demand than either war or going into debt to buy more stuff. Personally, I favor government spending targeted on making the lives of citizens richer and more cultured. Some may say, this is elitist of me, to which I reply, what is wrong with elitism? Call me bourgeois, but Tolstoy is better than Adam Sandler and playing the piano more uplifting than playing Call of Duty 2. Consumer capitalism in its current form nurtures our basest urges, from unseemly spending to internet porn. From that commercial perspective, all spending is equal, all spending is good, and YouPorn is as valid as Shakespeare.

I would want government to counteract this "bread and circuses" perspective with a Reithian attitude. Let us spend on education and on high-speed rail, but let us also spend on culture. The Works Progress Administration created beautiful murals in post offices all over America. This is a model we should expand on. If dance classes for housewives seem silly, then what is wrong with skate parks and concerts and playgrounds and parties and parades? The actual form of spending, though, is merely up to our taste. The key is to create demand to match the productive capacity of the economy. How we decide to do it should be democratically determined. That we should do it is just sound economics.

"You never want a serious crisis to go to waste," said Rahm Emanuel, President Obama's chief of staff, right before he let the financial crisis go to waste. The past 30 years, even before the popping of the latest bubble, were a period of mediocre growth, stagnant wages, and rampant inequality. We can do better. The first step is to open our minds to the implications of post scarcity economics.

Tom Streihorst is a filmmaker and writer who publishes articles on finance and economics on both sides of the pond.

http://www.sott.net/article/264063-Post-Scarcity-Economics