Of the numerous disturbing and troubling aspects of Arnold Schwarzenegger’s insane “let’s destroy the safety net!” proposal is how the need to cut has become conventional wisdom in Sacramento. So says Darrell Steinberg:

Democrats realize they will have to agree to “painful” cuts and have vowed to comb through programs to find waste and inefficiencies, said Senate President Pro Tem Darrell Steinberg, D-Sacramento.

“But we must continue to find a way to invest in health care for children, invest in college opportunities and scholarships for young people, to continue to invest in helping people from assistance to work,” Steinberg said. “So, we need to be surgical in the way we go about in cutting, and cut we will.” [emphasis mine]

Actually, Senator Steinberg, what you will be doing is ensuring California suffers a prolonged and deep Depression.

Cutting the safety net is an act of economic suicide. Given the reasons for the current downturn, cutting away the safety net will merely reinforce the recession and ensure that California experiences no near-term economic recovery. California’s 121 Herbert Hoovers will drive the state into Depression the way Hoover himself did in 1930-31 by insisting on massive cuts to government spending.

Here’s how it works. As Edward Harrison explained at Naked Capitalism yesterday the US economy likely faces a “balance sheet recession” caused by a massive increase in saving as people seek to purge debt:

Richard Koo goes further in his book “The Holy Grail of Macro Economics.”  Here, he argues that the unwind of great bubbles suffers from what he labels a ‘balance sheet recession.’  In essence, companies go from maximizing profits, as they had done in normal times, to a post-bubble concern of reducing debt. Regardless of how much priming of the pump monetary authorities do, the psychology of debt reduction will limit the effectiveness of monetary policy as a policy tool.

In my view, the catalyst for this change of psychology is the ‘debt revulsion’ that ushers in the panic phase of an asset bubble collapse…. the household sector has gotten religion about debt reduction as the savings rate has increased dramatically since Lehman. In fact, I would argue that companies learned their lesson about debt from the aftermath of the tech bubble.  It is the household sector in the U.S. (and the U.K.) which is heavily indebted. Therefore, if the psychology of a balance sheet recession does take form, it will be the household sector leading the charge.

In sum, the psychology after a major bubble is very different than the psychology before its collapse.  The post-bubble emphasis becomes debt reduction and savings, making monetary policy ineffective, not because financial institutions are unwilling lenders but because companies and individuals are unwilling borrowers. These are forces to be reckoned with for some to come.

And sure enough, the saving rate is still on the increase as Americans, and Californians in particular, stop spending and use their incomes to pay down debt and put money in the bank for a rainy day.

It’s that phenomenon which is acting like a scythe across the economic landscape. Nobody spends, so companies aren’t making money. Unless consumers feel capable of spending again, there will be no economic recovery.

What Harrison doesn’t examine is the importance of the safety net. If people feel confident that their basic needs – housing, food, health care – can be met if they lose their job, then the mania to save, save, save would be eased. However, if they do not feel confident that the safety net is there, they will save every penny they can, reasoning that they’ll need it to live.

I know that’s true for me. I use one of my two monthly paychecks to pay bills, and the other goes straight into the savings account. I’d be a fool not to. As California is poised to eliminate its safety net, it would be irrational and reckless to not hoard every dollar that came in.

That’s why Arnold’s budget cuts are so economically stupid. They will reinforce the trend toward saving and ensure that we do not have an economic recovery.

There is one other pernicious aspect of Arnold’s cuts. In some ways we can see the health care cuts in particular as a bailout of the private insurers. By ending state aid for children’s health care – even though Arnold gives up 3 times as much federal money as CA would save – and ending other key health care services, Arnold will force families that need treatments to send money out of their own pocket to private corporations. That will help enrich a few wealthy executives, but it will do absolutely nothing to improve the balance sheets of already strapped households, and will merely reinforce the “save at any cost” attitude.

Other aspects of Arnold’s budget are economically ruinous – the negative impact of park closures on tourist-dependent towns, the negative impact of mass state worker layoffs to the entire Sacramento region, the negative impact of mass teacher layoffs, etc.

If Arnold and the Democrats wanted to ensure California experienced a prolonged Depression, they could do no better than to follow the policies they have so far supported. Just as Keynes identified the future Great Depression in the flawed and punitive Treaty of Versailles, so to can we identify unending misery in the flawed and punitive 2009-10 budget.