Saturday, May 2, 2009

The Network of Fallacies Supporting Government Stimulus

The U. S government is attempting to reverse the economic downturn with a two-pronged policy of monetary inflation and fiscal stimulus. In previous essays I have exposed the role of the central bank in supporting the very monetary system—fiat money, produced in unlimited amounts by our fractional reserve banking system--that has triggered the Austrian business cycle, AKA the boom/bust business cycle. Once begun there is no way that the bubble, so induced by the expansion of credit not supported by real savings, can continue indefinitely. The bubble must burst and a recession must follow, which is simply saying that losing businesses must close and capital and people must find new, more market-oriented employment.

Nevertheless, our Federal Reserve Bank has expanded its lending—illegally, I might add—to non-member institutions such as insurance companies in addition to its massive expansion of reserves to the banking system. It has not worked and it will not work.

The Fallacy of Insufficient Consumer Spending

But in addition to this money expansion, the government has proposed a massive spending program, although the term “program” is too kind a word for this mishmash of boondoggle earmarks to all the left’s favorite socialist programs. Supposedly, it doesn’t matter where or how the money gets spent. Oh, no. All that matters is that it gets spent on something, anything, well…anything that meets the left’s agenda anyway. Solar panels and windmills are fine; drilling for oil in Alaska and off our coasts is not. The theoretical justification in this assault upon the pocketbook and common sense of the taxpaying American lies in a network of complementary economic fallacies that have become ingrained in university campuses and the halls of government. The short explanation is that insufficient consumer spending causes all recessions; therefore, the government must step into the breech and pick up the slack. For those who love formulas—which includes most university economic departments—here is their favorite formula: C + I = GNP. Consumer spending plus investment equals gross national product.

Of course, if one accepts this formula as representing reality, then it is easy to see that if consumer spending drops—C goes down—and investment does not pick up the slack—perhaps it goes down, too!—then GNP goes down. But, is that the cavalry I hear? Yes, it is the federal government, armed with its checkbook drawn against its account of newly created fiat money at the central bank. All government (G) has to do is increase its spending. The new formula becomes: C + I + G = GNP.

But the law of diminishing marginal utility tells us that government spending can never deliver the same satisfaction to the market as private decisions. We may acquiesce in some government spending as the necessary cost of civilization—for example, spending on public safety and an efficient and honest system of courts—but other government spending preempts private choice by purchasing goods and services for us. In addition to the presumption that such spending is good for us despite the fact that we can choose to purchase these goods and services ourselves, if we so desire, government spending is inefficient for it lacks the profit motive and the all-important feedback mechanism of the market. Ludwig von Mises explained that such government interference in the market place cannot succeed in satisfying human wants, due to the absence of socialist calculation. For example, choosing which services, quantities, techniques, etc. for the proposed universal healthcare system is beyond the capability of any planning agency. Therefore, a better formula to the one above would show that for each dollar extracted by the government from the private sector is returned to it in the form of something less than a dollar’s worth of satisfaction. This would be the new formula: (C + I – G) + .8G = GNP. The greater the government spending (G), the lower GNP becomes. In addition, investment declines, which restricts future growth, and it becomes ever more difficult to save enough capital to replace the depreciating existing capital stock. Welcome to the new Great Depression.

The Fallacy of the Paradox of Saving

A fellow traveler in this network of fallacies is the so-called Paradox of Saving. This is the under-consumption idea wrapped up in pseudo-scientific garb. Now the individual becomes subservient to the collective, for this fallacy states that what may be good for the individual—in this case saving—can be bad for society. Individual saving causes the dreaded decrease in total demand for goods and leads to a never-ending downward spiral from which the economy never recovers.

The idea that consumers lack the means to buy all of industry’s production is centuries old, but it took on new life in the 1920s and 1930s. In the 1920s Americans Waddill Catchings and William Trufant Foster wrote numerous essays on the subject and gained notoriety by offering a substantial reward to anyone who could successfully refute their thesis, as judged by a panel of referees. Future Nobel Laureate Friedrich Hayek was teaching at the London School of Economics at the time and did not learn of the challenge until it had expired: nevertheless, he wrote the definitive refutation. Defending Say’s Law—that supply and demand always tend toward equilibrium—Hayek explained that producers will drop the price of their goods to match supply; the market will learn from this error; and, no large scale malinvestment will emerge. All depends, of course, on the unhampered free market. Government interference to prop up prices or subsidize continued malinvestment would prolong and deepen the necessary market correction.

Unfortunately, John Maynard Keynes made the Paradox of Savings fallacy even more attractive by advocating massive government interventions at a time when most of the economic profession was becoming more socialist oriented. Government planning of production and control of prices during the recently ended Great War (World War One) had offered the heady allure of power to formerly obscure economists. This destructive partnership of interventionist economic theory wedded to activist politics survives to this day.

The Fallacy that a Growing Economy Depends upon a Growing Money Supply

But where will government get the money those socialist economists demand must be spent? Will not government be forced to raise taxes or increase debt, sapping the very purchasing power of the private sector that they are so determined to supplement? Will not each boost of government spending reduce consumer spending even more until the government has socialized the entire economy? This appears to be an insurmountable problem. This is the fear of the Austrian School economists. No, say the interventionist economists, for another fallacious theory rides to the rescue—that economic growth depends upon an increased money supply. In his masterful book The Ethics of Money Production, Professor Jorg Guido Hulsmann calls this “The most widespread monetary fallacy…” This fallacy gives the central banking authorities theoretical permission to print money and spendthrift politicians a duty to spend it. Neither taxes nor the interest rate need by raised, which might alarm the public to the danger that exists. But the danger will become apparent in the future when the additional money works its way through the economy, causing price increases as it travels, and leaving behind a devastated structure of production that cannot meet the needs of the market. The nation is left with an even greater inventory of unsold goods, such as houses it neither desires nor can afford and cars that are shoddy and overpriced compared to those produced by more market oriented companies. The only lasting legacy is that of increased public debt, an inheritance that guarantees a lower standard of living for our children, grandchildren, and generations beyond.

Austrian School economists proved that any quantity of money is sufficient for a growing economy. The money stock is part of the market economy and, as such, is subject to the same laws as any other marketable good. Its supply depends upon its demand. Of course, only commodity money is consistent with a free market economy, requiring no monetary authority to manage it. Say’s Law—that supply and demand tend toward equilibrium—applies to money as it does to all other goods in a free market. Fiat money, managed by a central bank, is incompatible with the free market. Our boom/bust business cycle and periods of rapidly rising prices, to be followed by rapidly falling prices, are symptoms of this incompatibility of the free market with unfree money.

This network of economic fallacies that give support to increased government spending must be challenged by free market economists armed with the truth of the superiority of freedom and liberty in all things.

No comments:

Post a Comment