Rebirth of Reason


Government Stimulus Packages are Attempts to Deny Reality
by Edward W. Younkins

Many economists and politicians think that the effective way to increase output is by means of a fiscal stimulus package (i.e., by increasing the overall spending in the economy). They do not understand that there must first be a flow of real savings if producers are to fund the purchase of capital goods and other goods and services necessary to increase production. The construction of additional plant and equipment is made possible only by increased savings (i.e., a decrease in current consumption). Capital dictates the economy’s ability to produce goods and services, to employ labor, and so on. This is what makes an increase in future consumption possible. This was recognized two centuries ago by classical economist, John-Baptiste Say. Unfortunately, his insight was supplanted by the ideas of John Maynard Keynes who thought that the economic system usually has sufficient capital or perhaps sometimes even too much capital.

Consumptionism Disproved Two Centuries Ago

According to John Baptiste Say (1767-1832), the original supply-sider, wealth is created by production and not by consumption. Consumption actually uses up utility or wealth. Demand (i.e., consumption ) follows from the production of wealth. People demand from the wealth their production created. What a person demands is predicated upon what he supplies. Say thus recognized that all men are both producers and consumers and that if a person wants to obtain a good he must provide something in return that is desirable to another. Money is the necessary means to acquire the goods that one desires. However, in order to procure money, a person must first produce a good or service that will exchange for money. No one can legitimately demand something before first supplying a product or service of value to others.

According to Say, it was possible to have a surplus or a shortage of any specific commodity. Production can be misdirected and too much of some products can be produced for which there is insufficient demand. He said that gluts of production did not occur through general overproduction, but instead through overproduction of certain goods in proportion to others which were underproduced. Say thus admits that there can be short-term gluts of a particular commodity. The market, left to its own devices, permits such imbalances to be corrected through adjustments of prices and costs. Any disequilibrium in the economy exists only because the internal proportions of output differ from the proportions preferred by consumers, not because production is excessive in the aggregate. It follows that Say’s Law in no way implies that all products will ultimately be demanded in the market. The supply of a good does not guarantee it will be an effective demand by the producer of that good for other goods. If inventory does not sell, prices will be cut until, and if, it does. It follows that lower prices of some goods means that people have more money to spend on other goods and services. Through the price system, supply and demand adjust and markets clear if the market system is left free to perform the balancing and proportioning functions. It is through the change of prices that today’s supplies are rationed among today’s demanders. Prices bring about proper proportions and price signals communicate information for future allocation and supply decisions.

Say understood human nature and the fact that people tend to be rational but are not omniscient. It follows that overproduction of particular commodities by individuals firms and producers is possible when mistakes have been made. The glut of a specific commodity can arise from its production in excessive abundance outrunning the total demand for it or from the shortfall in the production of other commodities. A glut can only take place temporarily when too many means of production are applied to one type of product and not enough to others. This type of disequilibrium is normally quickly remedied in a free market economy as market incentives and rational self-interest lead to adjustments in production, prices, marketing strategies, and so on. People have a rational self-interest in correcting their errors.

What about savings? People do not spend all of the wealth that their production created. The demand for current goods and services fails to match the value of what has been produced as people choose to hold some of it in monetary form. According to Say, savings is beneficial and better than consumption because it is used in the production of capital goods or in additional production. Contrariwise, consumption does not provide a stimulus to wealth. When production exceeds consumption, the difference is savings, which goes toward the production of investment goods, and investment is the basis for future growth. Such a reinvestment process is fueled by entrepreneurs. If money is stored in the form of bank-created money such as checking accounts, the held-back consumption power will be transferred to borrowers from the bank that created it. In other words, the power to consume is shifted to the borrower. There will be no deficiency in aggregate demand as long as the banking system is free to carry out the process of transforming depositors’ savings into borrowers’ spending. As long as savings are reinvested in productive uses in the aggregate there need be no decreases in income, production, or consumption. Say argued that savings searching for profits goes quickly into investments for production.

Higher rates of savings bring about higher rates of subsequent growth in aggregate output. This takes place because someone else borrows the money that will produce an even greater number of goods. It follows that people need incentives for working, saving, investing, and risk-taking. Say’s insight was that incomes are always totally spent on commodities satisfying current wants (i.e., consumption) or on commodities satisfying future wants (i.e., savings accumulation) and that savings are essential if the economy is to grow. Demand thus comes from supply whenever you demand it. People save in order to expand their production or to live on their savings when and as they need them. Savings buy time for people to do more than just work. It could be said that consumption is the final cause of production and that saving is the efficient cause of production. Say taught that income not devoted to consumption will be spent on investment and that the market would automatically and fairly rapidly return toward equilibrium.

Keynes’s Flawed Theory

John Maynard Keynes, the underconsumptionist, unlike Say, thought that production and consumption are disconnected activities. In addition, in the Keynesian system, saving and investment are not two perspectives of the same phenomenon. Instead, he saw them as two separate, unequal, and often discoordinated activities. For Keynes, the decision to save is not automatically coordinated with the amount of investment needed and desired by businessmen. He says that whether or not entrepreneurs and businessmen invest depends upon a number of subjective and irrational psychological factors instead of simply depending on the availability of savings at a low interest rate. According to Keynes, too much savings in the economy is the cause of the unemployment of resources. He contended that the Saysian system was only true in the special case of when savings equals investment. He says that, because this is rarely the case, economists need a general theory to explain unemployment. Keynes believed that the breakdown of Say’s Law came about because of a lack of aggregate demand which results from the disequilibrium of planned savings and planned investment. For Keynes, savings can be too high or too low. Either way, he considers savings to be dangerous, self-defeating, and the source of the problem. According to Keynes, savings is a destructive “leakage” from the economy. In the end, after a series of convoluted discourses, Keynes concludes that (1) when savings are less than investment, government action is necessary to stimulate investment, and (2) when savings are greater than investment, government action is needed to encourage consumption expenditures. In both cases, it is up to the government to step in.

Keynes’s solution to unemployment is an increase in government spending. His theory thus shifts from the classical economists’ concern with production to a concern with consumption. He said that when supply outstrips demand some goods will not be sold and, as a result, production and employment will be cut back. His proposed solution is to increase consumption through government spending. Keynes says that general overproduction is the problem and that men are unemployed because they have produced too much. His proposed solution is to stimulate consumption and beat down production. He says that “aggregate demand” can be too low relative to “aggregate supply” and that government spending is needed to fill the gap left by private-sector demand to ensure full employment. For Keynes, spendthrifts, rather than savers, are virtuous. He holds that both consumer spending and government spending are the means to economic growth. His spending theory has enjoyed great popularity with statists who equate government spending with economic stimulus.

Keynes’s solution for stimulating the economy is to have the government spend money thus bridging the gap between savings and investment. He advocates government schemes to pump up consumption such as printing and spending new money (which debases the currency and results in inflation), deficit spending, public works projects, higher taxes on producers, and the punitive graduated income tax which puts more money in the hands of the poor, who are said to spend a greater portion of their income.

Keynes maintains that sometimes people want to hoard money instead of saving it. When this money is withheld from investment, the result is unemployment which, in turn, causes overproduction. Unemployed people are not able to buy the previous output of products and depression results. According to Keynes, there will be an absence of savings during a depression as people withdraw money to survive. He goes on to say that (1) without savings there will be no investment; (2) without investment there will be no employment; (3) without employment there will be no spending; and (4) without spending there will be unsold goods.

Keynes explains that savings can overshoot the demand for investment in capital equipment, resulting in excess savings and the withdrawal of funds from circulation and from the necessary sufficient demand for goods. Drawing money away from the purchase of finished commodities makes them less profitable at the very same time that firms are seeking to set up additional capital resources to produce finished commodities. Keynes maintains that a deficiency of purchasing power is inevitable, resulting in an increased supply of, and a diminished demand for, products. As a result, profitable production cannot be continued and crises and depression begin. Keynes’s solution for preventing or alleviating depressions is to either reduce the amount of savings or to stimulate consumption through government spending and/or the issuance of new money.

Keynes says that in a free market interest rates fail to perform the function of a market clearing price and that wage rates do not adjust. The result is underconsumption and unemployment in an unregulated economy. As a cure to bolster consumption, he proposed state management of the money market to supplement fiscal policies with respect to taxation and government spending.

Economic Recovery Requires Savings and Capital Accumulation

In a recent two-part article posted in his blog, economist George Reisman explains that the economy is not functioning correctly because it has lost capital which is accumulated on the underpinning of savings. He observes that recessions stem from the effort to build capital on a foundation of credit expansion rather than on savings. Such credit expansion causes overconsumption and the loss of capital due to bad investments.

The housing bubble is a prime example of overconsumption and bad investments caused by credit expansion as many loans were made to “homebuyers” who were not worthy of the amount of credit involved. Although the houses represented capital to the homebuilders and to the financing banks, they did not represent wealth to the unworthy “purchasers” who had not contributed comparable wealth and capital to the economic system and who had no realistic possibilities of doing so. To add to the problem, many of these people borrowed using the increased market value of their homes as collateral and then spent what they had borrowed. Their consumption came at the expense of capital that had been invested by others in the economy. When the housing bubble burst and house prices fell drastically, the effect accentuated the losses experienced by lenders as people abandoned their houses thus requiring the creditors to lose by the amount of the decreases in the prices of their houses. This loss of capital is what caused a large decrease in the amount of available credit, resulting bankruptcies, unemployment, and decreased consumption expenditures. Lenders currently do not know which prospective borrowers to trust due to the problems of the capital markets that accompanied the bursting of the housing bubble.

Reisman explains that economic recovery requires that the economy must rebuild its stock of capital and that to do so necessitates greater savings relative to consumption. Greater savings and the accumulation of new capital is needed to make up for the losses brought about by credit expansion and the overconsumption and bad investments that stemmed from it.

Government Spending Does Not Bring Prosperity

He emphasizes that the use of stimulus packages will result in the additional loss of capital. A stimulus package begins with the consumption of already produced wealth that is a component of the capital of the business that owns it. The money received by the company does not come the production of any corresponding comparable wealth on the part of the government or by those to whom the government has given the money. When the good consumed by a non-producer is replaced, the result is the consumption of some of the firm’s assets. In turn, the replacement production is followed by additional consumption. Each succeeding act of production is accompanied by new consumption that is equal to it. It is clear that real economic recovery requires increases in production that exceed increases in consumption and that stimulus packages only aggravate the problem of the loss of capital that is the fundamental cause of economic recession.

Government demand-management policies aimed at stimulating economic activity do not and cannot create any new wealth—economic stimulants will not succeed. Government stimulus proposals are illogical. The government cannot inject money into the economy without first removing it from the economy. The government can distribute funds only by collecting more taxes, borrowing from the private sector, or printing additional money. There can be no stimulus if the government increases the ability of some people to spend by decreasing other people’s ability to spend. When a government taxes or borrows it simply transfers spending power from private owners to political spenders.

By taxing people who create real wealth, the government impairs the process of wealth-generation and diminishes the likelihood of economic recovery. In addition, people who lend money to the government bypass the private sector uses for which that money could have been employed. Furthermore, when the government prints money the result is inflation which, in turn, leads to hesitant businessmen and entrepreneurs and continuing capital decumulation. The additional “profits” due to inflation are taxed as though they are true profits thereby impairing the ability of companies to replace their assets. All of these result in a less than zero-sum game because government handouts are likely to be less productive (or even counterproductive) and because money distributed by the government creates less because government employees such as tax collectors and dispensers have to be paid. On top of all of this, a stimulus plan will devalue United States currency.

Stimulus: Euphemism for Deficit Spending

A stimulus package requires the federal government to go further into debt creating a burden on future generations. New debt has to be repaid with interest through taxation in the future. Government budget deficits cause a continuing depletion of production and output because of the stimulated detour into consumption. Every dollar spent from government securities issued to fund a deficit is a dollar that will not be invested in a private company.

Increased government spending will transfer more of the American economy to the public sector thereby raising the burden of government to America’s citizens. On the other hand, if the government reduces both taxes and spending more money will remain in the hands of private individuals who constitute the productive sector of the economy.

A recession is a time period when businessmen need to recognize and correct their past errors. A recession comes about due to the effects of the great amount of unproductive debt that financed a multitude of unwise ventures such as loans to homebuyers who were not creditworthy. Through the community investment act, the government required banks to make many such loans to accommodate local community groups. This resulting debt burden should be reduced through bankruptcy proceedings, write-offs, rescheduling, and so on.

True Wealth Creation

Economic recovery requires that the stock of capital be rebuilt in the economic system. Markets will need the freedom to adjust to slow conditions through price and wage rate reductions. In addition, unsound investments should be sold off. There should be no bailouts and the assets of the mortgage giants should be liquidated. Allowing some businesses to fail and others to begin would provide an incentive to redirect capital into more productive and profitable uses. True entrepreneurs do not request nor obtain government assistance. When a failed or faltering business is rescued by a government handout, it is no longer a business. Likewise, when a businessman obtains his results by receiving special privileges such as subsidies granted by the government, he forfeits his status as a businessman.

Government intervention prevents the efficient functioning of the market. Increasing government involvement makes the investment climate more risky and less certain and reduces the motivation of entrepreneurs to innovate.
Because of the integration of all individual markets into one functioning system, it has to be the reality that government does not have to be concerned with artificially stimulating demand. Markets clear if not interfered with.

Government efforts to stimulate the economy via direct spending and efforts to stimulate consumer spending are counterproductive. When the government spends an investment it must expropriate money from businesses to do so, thus ensuring a misallocation of resources. Government should get out of the way by reducing taxation, spending, regulations, and government control of money and the interest rate.

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