This could alternately be entitled, “Problems with Keynesianism.” The premise is simple: the West is currently infatuated with the idea that governments can, in some way, manage economies. While true central planning appears to be disappearing (as history proves it to be a failure), most of the Western world still stubbornly believes that the major problems that plague economies (mainly, unemployment and inflation) can be managed and controlled via monetary policy and currency manipulation. This is a fallacy.
The premise behind Keynesianism is simple: in bad times, governmental deficit spending and tax breaks can “stimulate” the economy and create employment by injecting money into the economy so people can be hired, products can be produced, etc. An increase in the money supply, however, creates inflation. That is, just like an increase in the number of apples makes apples worth less vis-a-vis other commodities, an increase in the amount of dollars make the dollars worth less. Imagine if everyone in the bar has $20. The bartender can sell beers for $2 a piece, but not $8 a piece. But if everyone in the bar has $1,000, the bartender could easily sell beers for $8. The increased price of beer is not because the beer has increased in value. The increased price of beer is a reflection of the decreased value of the money. People with lots of money spend it more freely than those with very little money. Ever notice how basic goods are more expensive in wealthy areas than in more depressed areas? Bread is bread. It is the scarcity of money (or lack thereof) that often drives the price. And, Keynesians do not deny the fundamental economic reality of inflation. Keynesians simply believe that once the economy has been thoroughly stimulated they can simply reduce spending and hike taxes to curb the inflationary effects of the deficit spending. This is because inflation is not felt immediately. As the supply of dollars increases, it takes years for the inflationary effects to be felt. Thus, Keynesianism holds that this back-and-forth of the spending/taxing cycle can stimulate economies while preventing inflation. Unfortunately, deficit spending has not proven to stimulate economies in the long term, but those committed to ideology before ideas refuse to acknowledge this reality. Thus, they generally argue that more spending is necessary (“the economy is not recovering because we have not spent enough!”). As politicians continue to spend in hopes of generating true stimulus, the deficits grow so large that politicians have begun to combine tax hikes with government spending (this is usually accomplished by claiming that certain segments of society are not “paying their fair share,” etc.). So, Keynesianism today often means high spending and high taxation.
So, why doesn’t Keynesianism work?
Let’s start with the idea that “spending” can stimulate the economy. Remember, government does not “earn” money. For government to spend money it must either take it from individuals via taxation, borrow money from somewhere, or print money at the central bank. The ability to borrow and print money is how the government is able to “deficit spend,” i.e. spend more money than it actually has. The government could raise a million dollars via taxation, yet also borrow or print a million dollars in currency. In this way, the government has two million dollars to spend despite only having one million dollars in receipts. In this example, the government is running a one million dollar deficit.
First of all, as one can plainly see, the idea of taxing and spending to generate stimulus doesn’t make much sense. By taxing the people, you are taking money out of the private sector – you tax private citizens and reduce their actual wealth by the amount they are taxed. The government then “spends” this money to stimulate the economy. Immediately we see that this government “spending” is not an influx of new capital. The same one million that was removed is just put back in to the same economy (in actuality, due to the bureaucratic costs of taxing and spending, less than the full one million makes it way back). Thus, all that is really happening is that money is being moved around. Government takes one million dollars from people (and, by default, from the places they would have spent it), and re-injects it into the economy where the government sees fit. It is nothing but a redistribution of wealth from where private hands would spend it to where bureaucrats think it should be spent. As we’ve seen, most government expenditures are hardly efficient. From bailed out companies going belly up, to billions being lost in bureaucracy and graft, it is no wonder that deficit “spending” has failed to create the promised stimulus. And all of this with money that would have been spent more wisely by private hands. But the main point to be made here is that spending via taxation is not an increase in value added to an economy.
But what about the stimulus money that doesn’t come from taxation? What about that portion of the stimulus money that came from borrowing or printing new currency? Unlike taxation, this is new currency that otherwise would not be part of the economy, and is thus added wealth, right? The answer is, “No.” First, borrowing: You cannot generate wealth by creating debt or expanding credit. Are you wealthier when you borrow $200,000? No, because while you now have $200,000, you have the corresponding debt. Even if you buy a $200,000 house, you now have an asset valued at $200,000 on one side, balanced with a $200,000 debt on the other side. You have not created any wealth. It’s a net zero. In fact, since the debt will exist even if the asset is devalued or destroyed, and since the debt repayment comes with an interest rate, you are, practically speaking, less wealthy after incurring debt. You will, as a rule, pay far more than $200,000 over the life of that loan – probably almost twice that much! Thus, by borrowing more than you have, you are, in fact, less wealthy. Are you wealthier when your credit card limit is moved from $5,000 to $10,000? Of course not. Again, any purchase has a corresponding debt with interest-bearing terms of repayment. You clearly do not create wealth by simply creating debt or expanding credit. Likewise, our government must service it’s debt. The more debt, the more interest that must be paid, and when you are paying interest, you are not actually paying down the debt. Thus, while the government was originally taxing one million dollars in order to inefficiently spend one million dollars in the hope of stimulating the economy, the government is now spending a larger and larger portion paying interest on the debt, so even less of the original taxed dollars are getting put back into the economy – that is, now the government is removing money from the private sector via taxation and not returning it to the economy at all! And for what? Borrowing does not increase wealth!
And printing money? This causes probably the most insidious problem of all. By printing money, the government increases the supply of money artificially. As mentioned, per basic supply and demand principles, this creates inflation over time (that is, the increase in supply of dollars brings their relative value down, just like an increase in the supply of any product brings its value down, while scarcity brings its value up). Simply put, the dollar becomes worth less as more of them are pumped into existence. Imagine a loaf of bread. 50 years ago, a loaf of bread cost maybe 22 cents. Today, a cheap loaf of bread is closer to $1.50. Now, bread is not scarcer than it used to be, nor is it more difficult to make. In fact, with technology and resources available in 2012, the cost of making bread, in general terms, is a fraction of what it used to be. Thus, if bread was 22 cents in 1962, you’d expect it to be less today. Well, it’s not that bread has become more expensive, or that the supply has gone down, or that demand has gone up. The dollar bill has simply become less valuable due to its increase in supply. In 1962, I would give you a loaf of bread if you gave me 22 cents, because that 22 cents could go a long way. These days, 22 cents is nothing. If you want this loaf of bread, I need 5 or 6 times that amount, not because the bread is special, but because your 22 cents is not what it used to be. Why is this inflation insidious? First of all, because it is so slow people rarely “see” it, and when people do see it, they rarely recognize that the cause of the inflation is not what’s happening now, but what happened many, many years ago. Second of all, ask yourself who can afford an increase in prices / decrease in the value of money. If the price of eggs, milk, bread, and gasoline slowly climbs, does it affect the rich people? No. They won’t miss a thing. Will it affect the middle class? The middle class will certainly be affected by a rise in basic commodity prices moreso than rich people, but the middle class will be able to slowly weather the inflationary storm. It will eat in to their savings, though, and in the long-term this means less money the middle class has to spend in the economy. But, what about the poor? The poor already live paycheck-to-paycheck, and already are forced to “go without” when it comes to basic luxuries. Can they afford the creeping prices of basic commodities? No! In this way, inflation slowly robs from the poor. It is, for all intents and purposes, slow thievery from the poorest people (the very people stimulus spending is supposed to help!). And remember where those stimulus dollars went originally. Did any poor person get stimulus dollars directly from the government? No, when those dollars were printed, they were handed to bankers, auto manufacturers, etc. as part of the stimulus. The “rich” used those dollars before the increased circulation slowly decreased their value through its inflationary effects. That is, the rich got full use of the dollars pre-inflationary value, and by the time they made their way deeper into the economy, they had already robbed from the poor. So not only does it rob from the poor, but it works out as a handout to the rich.
Econ 101. But this is what the US government has done in hopes of creating wealth and growth. Under President Bush, deficit spending climbed to as high as $1,413 billion dollars by FY2009. The national debt went from nearly $6 trillion to $10.7 trillion in 8 years, an increase in $4,756,366,301,176 actual dollars. Bush bailed out banks. Bush spent money we did not have. We hit a recession. Obama said he would “break from the failed policies of the past,” as if Bush had been some economic conservative who’s conservative policies got us in to the mess, and now Obama would be an economic liberal and save us. In fact, Obama has been a Bush 3rd term, economically-speaking. Deficit spending under Obama is projected to be $1,327 billion for FY 2012. In four short years, the national debt has risen to $15,856,367,214,324, an increase in $5,156,562,349,712 in actual dollars. Obama’s debt increase has been greater than Bush’s and in only half the time. The argument that Obama’s debt increase is “less dangerous” because it is smaller “as a percentage” is a frivolous point. Debt from $1 to $2 is a 100% debt increase. Debt from $2 to $3 is a 50% debt increase. Both increases were $1. Is the second one really any different in terms of the effects on the debtor? Obama bailed out the banks and the auto industry. Obama spent money we do not have. We are still in a recession, and it is not getting any better. Official unemployment is stuck above 8%, while real unemployment is 14.7%. Both Presidents have increased our debt and expanded the nation’s credit to “fix” the recession. As we know, however, you do not generate real wealth by creating debt or expanding credit.
Even ignoring the aforementioned fact that you aren’t creating any wealth by taxing and spending, creating debt and expanding credit, or printing money, that diminishing return of dollars that do find their way back to the economy are always funding malinvestment – not growth. If any area were already worthy of investment or an influx of capital, it would be there. That is, people invest their money in ideas, goods, products, and services naturally if they find them beneficial, or worthwhile. Conversely, when people do not feel an idea, good, product, or service is beneficial, capital flows the opposite direction. When the government spends money in a stimulus program, it is artificially pumping capital into an area that the market has already determined, for one reason or another, is not worthy of a capital influx. So government money “props up” or “bails out” an industry the private sector has ignored in hopes of encouraging growth and wealth creation (another reason why industries and companies receiving stimulus money seem to disproportionately fail – by design, they get money precisely because they are doomed to fail). But, often enough, as long as the government money pours in, the industry can “survive” (I could stand to lose money in my business if the government gave me tax dollars to offset my losses). Eventually, however, the government money stops coming. Then what? Well, the government has artificially created demand or artificially increased prices (see housing) in whatever industry the tax dollars were flowing, and when the tax dollars stop flowing, the industry collapses because there is no money flowing in naturally from the private sector. Prices crash, etc. The government simply created a malinvestment bubble by pumping money into an area and manipulating the market. No real growth. Despite the failed track record of the Keynesians, they keep trying.
The government does not exchange a good or service for the equivalent in currency. The government (when not printing money) extracts money via force. You pay taxes or you go to jail. Every dollar the government spends is a dollar it took from someone else. Every tax dollar consumed by the government is a dollar that was earned by you or I, and would have been spent in the economy – at the grocery store, at the mall, at the local concert hall, or to pay your employees, buy merchandise, or even take a vacation. The “Big Government” lie is not only a net destroyer of jobs and robber of the poor, but it’s a private-sector capital reducer via taxation.