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A Chinese Tale
Once upon a time there were, in China, two great cities: Chin and
Chan. They were connected by a magnificent canal. One day the Emperor sent
for his chief mandarin, Ching, and said: "Look
yonder". Ching opened his eyes and looked. And
he saw scores of barges laden with cargo, plying between the ports of Chin
and Chan. The Emperor then commanded: "We must stop that traffic, in
order to increase employment in the Celestial Empire.
You will have huge blocks of stone thrown into the canal to put it out of
service." At first Ching did not see the
point. and said: "Son of Heaven, you are making
a mistake." However, the Emperor's mind was made up, and he said: "Ching. do as you are bid. We are
going to stimulate the economy. You come back after three moons have passed,
and take another look."
When he came back. the
Emperor said: "Look yonder." As he looked. Ching
saw thousands of carts and innumerable pedestrians carrying heavy burdens on
their shoulders, as they were making their way from Chin to Chan, and from Chan to Chin. They looked like a swarm of
migrating ants. The Emperor declared: "It was the destruction of the
canal that provided jobs for these poor people. We shall make it public
policy to stimulate the economy by all available means." Chin remarked
in admiration: "I should have never thought that the government could
create so many jobs so quickly and so easily."
When the Emperor died, his successor sent for Ching and ordered him to have the canal reopened. Ching prostrated himself nine times and said to the new
Emperor: "Son of Heaven, you are making a mistake." But the Emperor
was adamant: "Do as you are bid. We must facilitate the movement of
people and goods between Chin and Chan, by making transportation less
expensive. Then the people may have rice, tea, and silk at a lower
cost." Ching thought he was ready with the
answer: But what is the use of lower prices, if no one can pay them, because
everyone is unemployed?" The Emperor was losing his patience: "Ching, you are talking like a fool. Come back after three
moons have passed, and take another look."
When Ching came back, the
Emperor said: "Look yonder." Ching looked
and saw more traffic in the canal than anybody had ever seen before. The
barges were moving day and night, bumper to bumper, there was no hint of
unemployment. The Emperor dismissed Ching with
these words: "You can divert and displace labor,
but you can never create new employment by erecting obstacles. Remember the
wisdom of the old sages, that the secret of good
government is to leave people alone."
Quality of credit
The sole aim of fiscal policy is to keep the credit
of the government at the highest possible level and above all suspicion. This
principle implies that the government borrows only if it can see the revenues
which, in the years coming, will be available to retire the debt. If this
principle is respected, then the rate of interest will be stable, and it will
be the lowest possible rate consistent with economic conditions. Otherwise,
the rate of interest will be higher and unstable. Moreover, the rise and
instability will be commensurate with the extent to which this principle has
been compromised. This will make it difficult for some and impossible for
other private producers of wealth, to reinforce their enterprise by
borrowing.
The quality of credit in a country cannot be higher
than that of the government. Therefore, the deterioration of the government's
credit adversely affects every single producer in the country.
The canal carrying the trade between Chin and Chan
symbolizes a national economy that respects the principle of fiscal policy. By
deviating from this principle, the government puts the canal out of service. The
blocks of stone symbolize the higher rate of interest which private producers
of wealth pay after all the borrowing needs of the government are satisfied. This
would not stifle the national economy but would certainly render it more
inefficient. A dilution of the principle of fiscal policy is usually couched
in a language which would appeal to those susceptible to demagogy. Deficit
spending is called "priming the pump," "an essential stimulus
to the economy," indispensable to the maintenance of full employment. Yet
it is clear that the stimulus of deficit spending is at best dubious in the
short run, and completely absent in the long run. The short-term effects have
the nature of prestidigitation, as government spending can be targeted to
pockets of slow economic activity in order to produce spectacular results. It
is the long-run effects where the damage to the economy becomes visible.
Accumulation of public debt versus accumulation of
capital
The accumulation of public debt is a convenient
trick through which a temporary semblance of prosperity may be achieved. In
the long run, however, this policy will only aggravate the situation, as it
harms the economy by weakening productive capacity. The longer the government
succeeds in maintaining false prosperity by increasing public debt, the
greater the ultimate damage.
Mainstream economists ridicule this concern about
the negative effects of the rising public debt on future economic growth. There
is no way - so the argument goes - to shift the economic burden to future
generations. You can only consume what has been produced. Under these
circumstances, how can a nation live beyond its means? This argument is
designed to appeal to simpletons. The basis for all economic growth, rising
real per capita income, increased production and consumption, is the result
of entrepreneurs investing their own and other people's funds in more and
better tools, which permits a steady increase in man-hour productivity. Economic
growth, and a rising standard of living, are
ultimately dependent upon uninhibited capital accumulation.
Capital accumulation, however, is not an automatic
process regulated by mother nature. To produce capital goods - factories and
machinery - a corresponding amount of productive facilities must be released
from other employment. It is not enough that technology and know-how is
available to create new factories and modern machinery. Investors and
businessmen must be willing to accumulate capital by doing the necessary
investing. Furthermore, the creation of credit must not be confused with
capital accumulation. People see idle factories and wonder why they cannot be
used to produce the much-needed goods, with the aid of easier credit, if
necessary. They fail to understand that the plants have become obsolete
because adequate reserves were not set aside for depreciation and
replacement. Or, if it is a new plant, people fail to understand that its
construction in the first place was based on a miscalculation due to the
false signal of easy credit. Rising costs have made a profitable operation
impossible. People find it hard to see the thin edge of the wedge between
capital accumulation and capital decumulation.
Capital decumulation,
therefore, is the result of government action, such as the departure from the
principle of fiscal policy. As the government creates more money and credit
through deficit spending, prices and wages rise. Operating costs tend to rise
faster than revenues, thus reducing profits. The result is idle factories and
idle men. In short, the effect of deficit spending is more of the same
condition that it was supposed to eliminate in the first place. Thus a
vicious circle is put into place: deficit spending creates idle capacity and
unemployment, which then call for more deficit spending, to create still more
idle capacity and more unemployment.
Kick the garbage upstairs
There are those economists who suggest that the
process of deficit spending can continue indefinitely. According to them, the
public debt need never be repaid. It can go on growing indefinitely as long
as a stable relationship between the debt and the gross national product is
maintained. In the Ninth Pillar we shall see why this is a fallacy. Here we
may content ourselves with the observation that accumulating debt at the
expense of accumulating capital is like dumping garbage in the attic. At one
point, the attic is bound to give way and all the garbage will come crashing
down.
Antal E. Fekete
September, 2005
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