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Despite the
massive fiscal stimulus package of nearly $800 billion approved by the
Congress early last year, and trillions of dollars pumped by the Fed, the
rally in various key economic data seems to be coming to an end. After
falling to 32.5 in December 2008 the ISM manufacturing index peaked at 60.4
in April this year. In August the index stood at 56.3. Also the unemployment
rate remains stubbornly high at 9.6per cent with almost 15 million Americans
out of work.
Also the
housing market remains depressed despite the stimulus policies and record low
interest rates. In July the yearly rate of growth of existing home sales
plunged by 25.5per cent while new home sales fell by 32.4per cent.
Furthermore, according to the Fed’s August report, known as the <em>Beige
Book</em>, the US economy has shown widespread signs of slowing with an
ample supply of qualified applicants for open positions.
Against
this background some economic commentators and the US President Barack Obama
are of the view that there is a need for another stimulus program to lift the
economy out of the black hole. In fact on September 8 the US President
proposed $50 billion more in infrastructure spending and a $100 billion
extension to a tax credit on research and development. But why should another
stimulus program be effective given that the previous program appears to have
failed? Some commentators hold that the last year’s stimulus package
wasn’t big enough to revive the economy.
It is
argued that given a $15 trillion US economy in terms of GDP, the $800 billion
was far too small to make a meaningful impact — a much larger stimulus
is required. For some commentators such as Paul Krugman only a very large
stimulus program is likely to produce the needed result. According to Krugman
the main focus of any stimulus program should be to generate as much
employment as possible in a short period of time.
With
improved employment consumer demand will follow suit and this will lift the
economy, so it is held. This way of thinking is based on the view that
initial increases in consumer outlays tend to set in motion a reinforcing
process which supposedly strengthens the total output in the economy by a
multiple of an initial increases in consumer spending. The popularizer of the
magical power of the multiplier, John Maynard Keynes, wrote:
If the
Treasury were to fill old bottles with banknotes, bury them at suitable
depths in disused coal mines which are then filled up to the surface with
town rubbish, and leave it to private enterprise on well-tried principles of
laissez-faire to dig the notes up again (the right to do so being obtained,
of course by tendering for leases of the note-bearing territory), there need
be no more unemployment and with the help of the repercussions, the real
income of the community, and its capital wealth also, would probably become a
good deal greater than it actually is. (J.M. Keynes, The General Theory of
Employment, Interest and Money, Macmillan & Co. LTD 1964, p. 129).
For
Krugman and other Keynes followers the key here is monetary expenditure. The
larger the expenditure the larger the income and real economic growth is
going to be, so it is held. Is funding about money? It is also argued
by the proponents of a larger economic stimulus package that in the present
economic slump boosting employment by means of various stimulus programs is
not going to be at the expense of other activities. This means that employing
more Americans is going to be costless. Accordingly to the proponent of this
view, Paul Krugman,
The point
is right now we have mass unemployment. If you put 100,000 Americans to work
right now digging ditches, it is not as if you are taking those 100,000
workers away from other good things they might be doing. You are putting them
to work when they would have been doing nothing.(Paul Krugman CNBC interview
31 August 2010.
But how is
the increase in employment going to be funded? Who is going to pay for this?
It seems that Krugman and most commentators hold that funding can be easily
generated by the central bank by means of printing presses. Contrary to
Krugman and other commentators funding is not about money as such but about
real savings — final consumer goods. It is the flow of final consumer
goods and services that maintains people’s life and well being. When
baker trades his saved loaves of bread for potatoes he in fact provides a
means of sustenance to the potato farmer. Equally the potato farmer provides
a means of sustenance i.e. his saved potatoes, to the baker.
Note that
the real savings sustain producers in the various stages of production. (Real
savings support the producers of intermediary goods and the producers of
final consumer goods and services). Observe that in order to maintain their
life and well being what people require is final goods and services and not
money as such, which is just a medium of exchange. Money only helps to
facilitate trade among producers — it doesn’t generate any
real stuff. Paraphrasing Jean Baptiste Say Mises wrote,
Commodities,
says Say, are ultimately paid for not by money, but by other
commodities.Money is merely the commonly used medium of exchange; it plays
only an intermediary role. What the seller wants ultimately to receive in
exchange for the commodities sold is other commodities ( Ludwig von Mises, Lord
Keynes and Say’s Law, in The Critics of Keynesian Economics,
edited by Henry Hazlitt, University Press of America 1983, p. 316.)
Various
tools and machinery or the infrastructure that people have established is for
only one purpose and it is to be able to produce the final consumer goods
that are required to maintain and promote peoples life and well being. The
greater the production of consumer goods for a given consumption of the producers
of these goods, the larger the pool of real savings or funding is going to
be. A larger pool of real savings can now sustain more individuals to be
employed to enhance and expand the infrastructure. This of course means that
through the increase in real savings a better infrastructure can be built and
this in turn sets the platform for a higher economic growth.
Higher
economic growth means a larger quantity of consumer goods, which in turn
permits more savings and also more consumption. With more savings a more
advanced infrastructure can be created and this in turn sets the platform for
a further strengthening in economic growth. Note that the savers here are
wealth generators. It is wealth generators that save and employ their real
savings in the buildup of the infrastructure. The savings of wealth
generators are employed to fund various individuals that specialize in the
making and the maintenance of the infrastructure. (Real savings also fund
individuals that are engaged in the production of final consumer goods).
Contrary
to Krugman and other commentators the artificial creation of employment such
as digging ditches is not going to be cost free. The unemployed individuals
that will be employed in useless projects must be funded. Since government
doesn’t produce any real wealth the funding will have to be diverted
from wealth generating activities. This however, is going to undermine wealth
generators and is going to weaken the real wealth generation process. The
following simple example encapsulates the situation: In an economy, which is
comprised of a baker, a shoemaker and a tomato grower, another individual
enters the scene. This individual is an enforcer who is exercising his demand
for goods by means of force.
Can such
demand give rise to more output as the popular thinking has it? On the
contrary, it will impoverish the producers. The baker, the shoemaker, and the
farmer will be forced to part with their product in an exchange for nothing
and this in turn will weaken the flow of production of final consumer goods.
Since government doesn’t produce any real wealth obviously it cannot
save and therefore it cannot fund any activity. Hence for the government to
engage in various activities it must divert funding i.e. real savings from
wealth generators.
Can
something be generated out nothing?
Can an
increase in the demand for consumer goods lead to an increase in the overall
output by the multiple of the increase in demand as suggested by Keynes and
Krugman? If this can be achieved then one could conclude that something
useful can be generated out of nothing. To be able to accommodate the
increase in his demand for goods a baker must have the means of payment i.e.
bread to pay for goods and services that he desires. For instance, the baker
secures five tomatoes by paying for them with the eight saved loaves of
bread. Likewise the shoemaker supports his demand for ten tomatoes with a
saved pair of shoes.
The tomato
farmer supports his demand for bread and shoes with his saved fifteen
tomatoes. Whenever the supply of final goods increases this permits an
increase in demand for goods. Thus the baker’s increase in the
production of bread permits him to increase demand for other goods. In this
sense the increase in the production of goods gives rise to demand for goods.
Please note again that people are engaged in production in order to be able
to exercise demand for goods to maintain their life and well being.
Note again
that what enables the expansion in the supply of final consumer goods is the
increase in capital goods or tools and machinery. What in turn permits the
increase in tools and machinery is real savings. We can thus infer that the
increase in consumption must be in line with the increase in production. From
this we can deduce that an increase in consumption cannot cause production to
increase by the multiple of the increase in consumption. The increase in
production is in accordance with what the pool of real savings permits.
Production cannot expand without support from the pool of real savings i.e.
something cannot emerge out of nothing. This of course means that only wealth
generators can set in motion an expansion in real wealth.
Why data
by itself cannot produce facts
How then
are we to reconcile the so called facts that are supposedly presented by
various studies i.e. the ‘fact’ that stimulus programs can grow
the economy? For instance in his New York Times article from September 5 2010
Paul Krugman suggests that it is the massive government borrowing during the
war in 1940 to 1945 that laid the foundation for long-run prosperity. Thus in
1943 the budget deficit as per cent of GDP stood at almost 28per cent. The
rate of growth in real GDP after falling to minus 11per cent in 1946 jumped
to almost 8per cent by 1951. Note that the so-called economic growth here is
assessed in terms of real GDP, which depicts monetary expenditure. Hence we
suggest that an important force behind the strong increase in real GDP must
be the monetary factor. Indeed we had strong increase in the money supply
rate of growth from minus 11per cent in January 1947 to 6per cent in May
1951.
Now, even if we were to accept that
notwithstanding all the shortcomings of real GDP and grant that the US
economy had prosperity after 1946, it doesn’t necessarily follow that
this occurred on account of large budget deficits as suggested by Paul
Krugman and other commentators. Contrary to popular way of thinking data
cannot talk by itself and present so called facts. The data must be assessed
by means of a framework that can withstand some basic scrutiny such as
whether the government whilst not being a wealth generator can grow the
economy.
Once we
reach the conclusion (based on logical analysis) that the government cannot
grow the economy we can emphatically reject various studies and assertions
that tell us the exact opposite. This means that the long-term prosperity in
the US took place on account of the expanding pool of real savings and in
spite of aggressive government spending during the war. (We have seen that
without the expansion in the pool of real savings no economic growth is
possible). It must be realized that the data out of which various so called
“facts” are produced appear to be supportive of various empirical
research conclusions as long as the private sector of the economy generates
enough real savings to support productive and non productive activities.
As long as
this is the case various so called empirical studies can produce
“support” for any pie in the sky theory such as that the
government can grow an economy and that something can be created out of
nothing. Whenever the ability of wealth generators to produce real savings is
curtailed economic growth follows suit and no amount of money that a
government pushes into an economy can make it grow. (Again the government
cannot create real savings, it can only divert the existing real savings from
wealth generators).
Once the
process of wealth generation is damaged and loose policies become ineffective
in “reviving” the economy various commentators such as Krugman
are quick to suggest that the laws of economics must have changed. For them
this means forgetting logical analysis based on the essential laws of
economics and going for massive spending. Now if the laws of economics have
changed, on what grounds can Krugman and others employ the 1940′s
events to make their policy recommendations? If everything is in a state of
flux why should laws that were valid in 1940 be applicable today? According
to Krugman,
We are at
unusual times where usual intuition doesn’t apply here, getting this
economy moving is the best thing we can do, not just for the present, but for
the future and for our children (Paul Krugman CNBC interview August 31
2010.)
What we
can suggest here that if the pool of real savings is in trouble adopting
Krugman’s advice i.e. introducing a massive fiscal stimulus package,
will only make things much worse and plunge the US economy into a much more
severe economic slump. If the pool of real savings is still holding then
there is no need for stimulus programs — the growing pool of real
savings will revive the economy.
Conclusion
Despite
the massive $800 billion fiscal stimulus package introduced last year the US
economy is struggling to recover. Various economic indicators, after having a
short rebound, are starting to display visible weakening. Many experts,
including the US President Barack Obama, are of the view that a larger fiscal
stimulus package might do the trick. Our analysis indicates that not only can
fiscal stimulus not revive the economy, but on the contrary, it can make
things much worse. The key factor for a sustained economic recovery is the
buildup of real savings. This buildup can only be secured by wealth
generators and not by government spending, which weakens the process of
wealth formation.
Frank Shostak
Frank
Shostak is a former professor of economics and M. F. Global's chief economist.
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