There is a mathematical problem running through the mainstream of economic thought, one that has been expressed in various forms since the time of Adam Smith. There is apparently a shortcoming to capitalism that springs forth from the very basic, elemental idea of profits. If businesses can make a profit on their endeavors, necessarily paying only a portion of their revenue to labor, then who will buy all the products they produce?

If we view the customer base of business in general to be the very workers that allow the means of production to occur, then the mathematical fact that those same businesses pay their labor force less than the full value of what they produce (the leftover part is the capitalist profit) has to leave a desperate shortfall in the economy. If labor is receiving less than full value, it cannot, on its own, finance the purchase of everything that is produced. Something else must step in to fill the gap between labor's earned income and the receipt of total revenue for production, maintaining the level of production and profit.

This problem of "underconsumption" forms the basis of modern economic thought in certain vital areas, and underscores the political motivations of the economic hierarchy. While the first big debates about underconsumption took place between Thomas Malthus and David Ricardo in the early 19th century (Malthus arguing for it, Ricardo against), the idea has been passed down in many strands of political thought from that point.

Even Karl Marx's critique of the capitalist system (since it is apparently fashionable now to acknowledge the apparent prescience of Marx) contains a strand of what might be thought of as underconsumption in certain situations (though he rejected the idea of capitalism's troubles residing on the demand side, he saw this as a problem of production, so the semantic term underconsumption might not be the best way to phrase this). For Marx, capitalism has an inherent flaw where the long run rate of profitability tends to decline over time (a long topic for another day). In response to this central problem, capitalists, at times, try to squeeze as much profit as possible out of their workforce. In doing so they reduce the overall proportion of revenue paid to the labor force at the cost of essentially shorting their paying customers. This was the basis for the fuss Nouriel Roubini caused when he said that Marx was right about capitalism destroying itself - it seems to accurately describe our current predicament.

It was really the 1920's that got the idea of underconsumption into the mainstream consciousness, particularly in the political arena. It influenced Herbert Hoover and Franklin Roosevelt's similar responses to the growing Great Depression (as well as Marriner Eccles, Chairman of the Federal Reserve from 1934 through 1948, and a very influential economist of demand-side thinking). It also formed an essential basis for John Maynard Keynes.

The point of this brief and intentionally oversimplified review of economic history is to demonstrate that the political ends of the economic policymaking process have been dealing with what they see as a vital economic shortfall inherent to the system. What Keynes did (as Marx before him allowed for) was correctly interpret that the wage shortfall against production could be overcome by using the larger pool of existing savings, even commandeering it during a crisis. He turned the historic problem of underconsumption into the modern idea of aggregate demand.

The larger pool of societal savings, largely through borrowing and lending, can produce additional economic activity on top of the wage-based portion, thereby erasing the underconsumption shortfall. In times of recession, it follows from this line of thinking that governments should appropriate a larger share of the pool of savings to create economic activity, thus filling in the hole in aggregate demand where businesses and households (especially if they are under wage pressure) are reluctant to expand.

In many ways this idea of underconsumption within aggregate demand and the wider use of the pool of savings reminds me of the problem the telecommunications industry ran into in the 1990's and early 2000's. The industry spent tens of billions of dollars on high-tech, high-speed networks (the very models of efficient uses of resources and energy) to connect major metropolitan areas. But, once these metro markets were connected there was no easy or apparent way to finish the "last mile". Spaces within metro areas had been built up and wired over the previous decades by all sorts of different technologies, and owing to the complications of trying to build in densely populated areas, these high speed networks were essentially at the mercy of how the efficient trunk lines eventually connected to your house. They would feature state of the art fiber optics and switching equipment, but at some point data would have to transit from the trunk to century old copper wires or first generation cable systems to complete the circuit.

In economic terms, the most efficient transmission of money through the economy is through wage income to labor, paralleling the high-speed trunk line. How society's pool of savings is used to fill in the rest is essentially the economic "last mile" problem. As the telecomm industry found out, often the hard way, there were massive variations in the success of each individual solution to the last mile. Each had its own set of efficiencies and cost effectiveness, meaning that the selection of a method of resolution greatly impacted the ultimate success of the entire network.

That is the economy that we see today. How the economic system uses its pool of savings in transmitting economic flow as the "last mile" is important in determining the ultimate success of the economy ( I should note here that I am not advocating or accepting the idea of aggregate demand, I am merely attempting to demonstrate, albeit simplistically, why certain actions have been taken).

In 1965, the Federal Reserve did not operate as it does today. The Fed was ultimately subservient to the Treasury Dept., at the very least monetary policy played second fiddle (a distant second) to fiscal policy. The various economic problems of the time were to be decided by fiscal factors - the last mile problem was left as a political consideration. That year marked both the escalation of the Vietnam War and the passage of programs that would form the Great Society. That meant a large escalation in the amount of debt issued by the federal government.

Since the Fed's primary monetary policy job in 1965 was to ensure the smooth auctions of US treasury securities, it would release reserves into the banking system in anticipation of debt issuing auctions. After the auction, the Fed would re-absorb those reserves to maintain a relatively constant money supply over time. As the pace of debt expanded in 1965 and especially 1966, the Fed found itself constantly expanding reserves without the ability to re-absorb them. As inflation rose due to this semi-permanent expansion in the money supply, the Fed sat on the sidelines as the "fix" to inflation was debated in 1967 and 1968 as some kind of tax increase.

Politically, the government was building a permanent method of bridging the "last mile" through transfer payments, on terms that were more social than economic. It brought the Fed and its money supply control along for the ride. According to the theory, if the government could tax the wealthy (who contribute disproportionately to the larger pool of savings) and transfer that money to the "poor", it would be connecting the last mile of potential savings to those who would spend. It was thought that this was an economically as well as socially beneficial arrangement (not much has changed).

Of course inflation raged out of control for more than 15 years after that inflection in last mile thinking. Finally in 1979 and 1980, the Federal Reserve under Paul Volcker instituted another inflection where monetary policy would assume relative economic dominance. The Fed decided that interest rates needed to float to very high levels (to defend the dollar, ironically in light of today's policies) to finally put an end to the inflationary spiral. Conventional wisdom has always held that the Fed was successful in its efforts, and it was in the narrow space of consumer price inflation. What came out of the early 1980's, however, was nothing more than a different form of inflation: asset inflation (the junk bond bubble, the mini real estate boom that brought down the S&L's, the stock market's wild ride - rising nearly 40% in 1987 before crashing that October).

But discounting asset inflation as it did (and still does), the Fed believed it had found the Holy Grail of economics. It had "solved" the last mile problem through the management and control over the credit system. The answer to aggregate demand or underconsumption or the last mile is always and everywhere, for the Fed, debt.