Thursday, August 23, 2012

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

Here is the breakdown of the latest counterpoints my friend submitted to me.  The debate continues as follows:

I 100% agree that there are major problems within our current government structure on spending policies, taxation policies, and regulation policies. I am for capitalism and less government embedded in the bedrock of our economy. I am for major reform in all of these areas. I do also agree there were many mistakes leading into the financial crisis and out of them that I would love to see not happen again. I do believe that continuing to operate with misperceptions at the macroeconomic level will plague us for some time."Andy, sticking just at a macroeconomic level, I disagree that government spending deficits take away from the people. Taxation takes away from the people. With our basic accounting summary of this, either the government side or the private/public/people side runs the deficit. It is not healthy for the people to be running deficits and the government surpluses because we wont have money to buy the goods and services we need and stall economies into recession. On the flip side it is healthy to keep the deficit on the government side. For 15 years we have run deficit spending on top of our taxation revenues. So this is possible to spend more then we bring in and budget deficits do not take away from savings.   You bring up inflation concerns, but the last 15 years have had excess spending "creation of dollars" and below historic inflation. From the reading of Stephanie Kelton, this is because we are not at max production and there are surpluses of goods and services on the market today, so the creation of dollars is not inflationary. If we were at max production where all goods and services were spoken for then yes the creation of dollars would cause inflation. The examples you site of Germany, Argentina, Zimbabwe are all examples where they were on a fixed exchange system or pegged to another currency, so when those currencies were mass created in relation to the fixed exchange placed on them, that caused the hyper inflation.  The U.S. dollar has the luxury of being at the top of the monetary pyramid not fixed to rate, gold or any other currency. Everyone thinks that because we at the state level, city level and household level have to balance our spending to our in flows make it so the Fed has to do the same. This is not true. The reason a state, city or we can go broke is because we don't have the luxury of creation of dollars at our disposal. States, cities, and people rely on their income alone. This is also the case for Spain and Greece running out of a finite resource of Euros and could not control getting more.  My readings have focused in the Post-Keynesian school currently being cultivated by Warren Mosler and Stephanie Kelton. Warren's book "The 7 Deadly Innocent Frauds of Economic Policy" It is a quick read, and a few of your comments fall under his innocent frauds that we believe are true.

Here is my response.

Awesome. I'm glad you are for capitalism, less government, regulatory reform, not repeating the mistakes that caused this depression, and learning from the mistakes we've made.

The only problem is that all the policies you advocate contradict this entire statement. Infinite government deficit spending and centrally planning the supply of money and credit does not coincide with any of the ideals you say you espouse. And that is what frustrates me the most. So, I'll try and offer some commentary.

Taxation, deficit spending, AND printing money (or creating bank reserves through digits on a keyboard) ALL take away from the people as well as the economy. Deficit spending must be repaid through future taxation or future inflation of the money supply through more fiat paper dollars. Your statement that it is not healthy ("on the flip side") for people to run deficits AND the government to spend less than it receives in revenue is incorrect. The less the government spends the better - 100% without equivocation (for reasons I've stated in my previous post). And your premise of why a recession occurs is another place where you are unfortunately incorrect. 

The REAL reason an economy booms and then busts is that artificial expansion of the supply of money and credit occurs (whether in the 1920s or during the early 2000s) without enough real savings. The money inflation is mistaken for real saving and both investment (capital goods) and consumption increases. This bids up asset prices and makes people FEEL richer. But, soon all prices start rising (including consumer prices) as well as interest rates rise.  When this happens, the Fed is faced with 2 choices - keep expanding the money supply and introduce hyperinflation or stop the money supply growth.  When the money supply contracts (through raising interest rates or other methods), the euphoria is over and a massive correction ensues to let prices fall back to the sustainable levels. This causes a lot of pain since many people thought they were richer and it was after all just inflation in their asset prices (think houses, equities, balance sheets, capital goods, etc).  Resources must then be deployed elsewhere to satisfy the real wants and needs of consumer goods that are most needed. This causes capital goods to fall much lower than consumer staple/service goods.

Yes, we have run deficits for years and years and years. But, there comes a point when a country cannot service its debt obligations (think 1920 Germany after the Treaty of Versailles). Two things must happen - monetize the debt or default on the debt owed to the creditors. Some might say (and I agree with them) that monetizing the debt is a virtual form of default. Either way, it is extremely painful and more like a choice of being hanged or shot (you pick which is which).

I'm not sure what you are using to measure price inflation (which is what I think you mean). And, there is a difference between price inflation and money inflation. Price inflation is a by-product of inflating the money supply. Inflation is always and everywhere a monetary phenomenon. I'm not sure why you only go back 15 years to track inflation. But if you want to use 15 years as a benchmark we can evaluate this. I personally cannot think of many things at all that cost less than what they did when I was 17 years old (15 years ago). Gas was below a dollar, you could purchase a can of pop for $0.35, go to the movies with someone for under $10. I could go on and on. The only "deflation" has been in electronics and there is a reason for this, but i won't go into why. 

But, the point here follows that money inflation does not bid up all prices at once. Money inflation affects capital and producer goods first and then eventually bids up consumer/staple prices. An example of this is commodity prices most notably with Corn going above $8.00. Commodities (such as oil and petroleum products) are all priced in DOLLARS and not Yen or Euros. So, if the purchasing power of the dollar falls in relation to other currencies, it is going to cost more to buy goods denominated in dollars. 

Full employment is not the ideal for an economy. If that were the case, having people retire (who have saved a stockpile of cash) would be a drag on the economy. Wealth, prosperity, and personal satisfaction are the ideal. Working is simply a prerequisite required to reach this ideal (goal + ideals). I work 40 hours a week, yet i spend 40 hours a week sleeping. Does that mean I'm not in a state of "full employment". This common fallacy of full employment was demolished by Henry Hazlitt decades ago 

You talk about 1920s Germany. As far as I remember, in 1920 we were still on a gold standard. So, I think you need to read more about 1920s Germany (which i do not think is entirely comparable to our situation, but a very very important study). A good book that chronicles this is Adam Fergusson's, When Money Dies.

I 100% agree with you that the U.S. Dollar's only saving grace is that it is the world's reserve currency. This allows the U.S. to continue to deficit spend as long as it is the reserve currency. However, nothing is set in stone that it will continue to be the case, States do not have a monopoly on the issuance of their own currency like the Fed does. However, you are wrong in regards with the Euro. The ECB could create an infinite amount of money if it wanted to do so (which I do not think it will do). It is a fiat currency like any other currency around the world and suffers from the same problems. I'm not sure about how serious mario draghi is about buying up sovereign debt with Euros, but anything is possible.  A great book on the Euro is by Philipp Bagus', The Tragedy of the Euro.

The likely action I see happening in a world of international fiat money backed by nothing is that all Central Banks inflate together. And while this might keep government solvent, it will lead to a continued decrease in the purchasing power of each type of fiat currency - otherwise known as massive price inflation.

I disagree vehemently with your premises, but I hope what I've said might stop our Mexican Economics Standoff. I've read Post-Keynesians, New-Keynesians, neo-Keynesians and they all share something in common. They are all Keynesians. While Keynes was no doubt one of the most influential economists of the 20th Century, I have spent the better part of the last 4 years determining how wrong Keynes was in the field of macroeconomics.

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