Wednesday, August 22, 2012

Government spending is always a "net good" - not so much

I recently got into a debate with a friend on facebook about fiscal policy. He posits the following:
"Economics 101: Fiscal Policy levers are taxation and government spending to regulate the economy. In a recovering economy we need to keep taxes low and keep government spending. I find it very interesting that of our two future leaders claim to want to help the economy, one wants to increase taxes, and the other cut government spending, both HURTING the economy. HUM??? (a conundrum)..."

"... government spending IS a net gain to the economy and that it does not need tax dollars to support it. All the rules changed in 1974 Bretton Woods when we went off the gold standard and a fixed exchange rate world. We are now a "fiat" currency and the controller of it and at the top of the pyramid. And our modern monitary system is done with keystrokes on the computer, and Ben Bernanke is sitting at the helm. With the bailouts in 2009 when Ben Bernake was on 60 minutes getting grilled that they spent tax payer money, he said "no we didn't, we simply used the computer to mark up the size of the accounts." People today and our polititians still think about things in an old system and talk about making the economy better, which as I stated initially, their plans will both hurt it. So what they are really talking about is the "deficit." Here lies where the problem is and people/politians belief that the deficit is bad, when it is not. In todays world there is no arbitrary limit to the deficit and we really need to look at the economy and that is keep taxes low, keep spending, and most importantly get us more productive and get people working. So then back to taxes, what is its purpose if not for governement spending? It is to keep the value in the dollar. Because by having a tax it forces people to work for dollars, trade goods and services in dollars, so that they have dollars to pay their taxes. Think about it for a while, I did! :)"

He disagrees with Obama who "wants to increase taxes" (so far so good).  However, he then says the other one (Gov. Romney) wants "to cut government spending" (ok not so good).

*[Please note for the record, this post is not an endorsement for Mitt Romney]

Well, I could not let this stand without a response when it was presented under the auspices of "Economics 101."

Unfortunately, my friend's entire premise (and that of all Keynesians) is incorrect about government spending being a net positive. Government spending is always a net loss to the economy since Government does not create anything it doesn't take from someplace else.

It can do this by 3 ways: taxing (which we agree is bad), deficit spending (maybe not as bad as taxes, but worse in other ways), and/or printing of money (reducing the purchasing power of money). All three methods extract resources out of the private sector in different ways and more importantly distort the economy in different ways. I will omit taxes from discussion since no disagreement exists regarding its harm to the economy.

Let's describe how both deficit spending AND money printing are both bad for different reasons.

Implications of Massive Deficit Spending

By creating an expansionary fiscal and monetary policy, the money that is used by government to spend goes to projects that CONGRESS and those who get the NEWLY created dollar bills (or bank reserves). Instead of the free market determining what projects get funded, a central planning board of technocrats shells out money to those constituencies that will vote for them during election time.

A government "investment" is an oxymoron. Government is "groping in the dark" (as Mises once said when writing about Economic Calculation in the Socialist Commonwealth when it enacts central planning of resources.

In the socialist commonwealth every economic change becomes an undertaking whose success can be neither appraised in advance nor later retrospectively determined. There is only groping in the dark. Socialism is the abolition of rational economy.

This is what happened in the Soviet Union. It is not a business which must make a profit or use cost accounting to evaluate its opportunity costs for making widgets or getting information feedback.

L. v. Mises (1920)
However, these fact do not stop Congress from determining winners and losers. It simply calculates politically speaking which businesses should be bailed out (i.e. GM or the UAW workers or Big Banks who knew the government would back stop their risky lending). Ventures that make no economical sense are given billions of dollars (whether it is Solyndra or failing municipalities with giant unfunded liabilities). The list goes on and on.

When government issues T-Bills, this affects the credit markets by crowding out other lenders who are also issuing billions of bonds (think Corporate Bond which rise in price above what they would otherwise be without Gov't floating it's own bonds). This is evident with Greece, Spain, etc. They are finding few bidders for their massive amounts of debt since no one thinks they will receive their interest let alone the initial principal back if they buy the sovereign debt/bonds from these countries.

How an Expansive Monetary Policy Hurts the Economy

With Monetary policy and the Fed, this charade of an ever increasing deficit can continue for a little while since the Fed can buy up this debt and hold it on its balance sheet (that expands with the press of a key on a computer). But, by continually expanding monetary base (M1 or M2)., the purchasing power of these dollar will most assuredly fall year over year. More and more money chasing the same amount of goods will always result in price inflation.

Inflation is the most insidious form of theft. Inflation robs savers and holders of dollars of their purchasing power. Even if the Fed wanted to add a couple of zeros to everyone's bank account, this would not make people on net wealthier. It would make people poorer seeing as some people would spend their newly received money faster than others. The people who recognized this phenomenon would benefit while those who did nothing would suffer as prices were bid up around them.

But, in reality, new money does not come to everyone equally. Certain people get the new money first (similar to those who are first to receive the money that flows out of congress on various spending projects). Someone who is retired on a fixed income and living off of the interest of their savings gets killed in this scenario since they will be the LAST to receive the new money or receive none at all. All the while certain goods are bit up around them and they have to pay more for food, clothing, gas, shelter, etc. Again we see those who were savers and who were prudent with their money get the short end of the stick.

As to the point of there being no limit to how high the deficit could go and/or how much money can be printed, we need only look to the best cases of history where this was tried in 1920s Germany and in the present day Zimbabwe (up until recently). Once a government refuses to pay it's debt obligation, it either a default on its debt obligations or experiences hyperinflation. Both are bad, but hyperinflation is probably worse in my opinion.

Bernanke is trying to reflate the bubble.  The boom turned to bust but it was not allowed to fully correct. We have only prolonged the pain and have not cured anything. All of the mistakes have simply been papered over.  Yes, asset prices have been reflated in certain areas (stock market, cars, some real estate, other capital goods), but as soon as interest rates rise, or price inflation eventually starts heating up, or the money supply slows down (which is what caused the slowdown in 2007 after massive price inflation), a crash is likely - it's just not know how severe or to what degree.

The quickest read that explains the cause and cure of a booms, busts, and recessions/depressions is Murray N. Rothbards, Economic Depressions: Their Cause and Cure. Everyone is taught Keynesian economics - in a recession we need to have the government fill in the spending hole. This is 100% wrong and a complete fallacy. The business cycle is caused by an artificial expansion of money and credit that must eventually slow down or retract. This causes a correction since the boom is unsustainable. The recession is the CURE and natural process for correcting the malinvestments that went  into the boom. Fiat money is an inherent cause of much of this process in addition to the fractional reserve banking system.

What SHOULD Government Do?

If government should do anything, it should be to protect our property rights, enforce and uphold contracts, and promote liberty. Even these goals are a difficult task for reason I will not mention at this time.  Government should stay out of intervention in the market since it is always and everywhere a drain.  It has no resources it provide without first acquiring other resources through some form of confiscation and coercion.

1 comment:

  1. Plenty of the political discourse in Washington seems to roll about taxes these days. Every person in Congress has their own belief of what we should be doing with our tax code. What is the distinction? Where do you even kickoff looking up facts? How do you see if the figures you do stumble on is impartial? Look at this site with some valuable figures on the issue, plus a excellent location to begin researching.