Freeman

ARTICLE

Save Us from Government Spending

NOVEMBER 14, 2008 by SHELDON RICHMAN

If you’re a glutton for torment as I am, you watch cable-TV news shows most nights. These days the shows are feeding viewers a steady diet of 100-proof Keynesianism as the cure for our economic woes. Leading in this department is Chris Matthews of MSNBC’s “Hardball.” (I call it “Nerf Ball.” Matthews’s idea of a hardball question for a politician is, “Are you running for president?”)

Matthews declared last week, “We’re all Keynesians now,” and each night he pontificates on why the government must start to spend massive amounts of money, even though it doesn’t have massive amounts of money. We’ll worry about the consequences later. Why must it spend? Because we aren’t doing it and that’s putting the economy in recession. Someone has to spend, Matthews says, and the government is spender of last resort.

I don’t mean to pick on Matthews. Many other commentators say similar things. It’s as though they took a couple of college economics courses in the 1970s from a Keynesian professor and never wondered if anyone had ever challenged that approach to the subject. (“Friedman? Quaint. Mises and Hayek? Who?”) Since then they’ve had their worldview reinforced countless times by opinion makers they regard as authoritative, such as New York Times columnist Paul Krugman and most other op-ed and business writers.

It never occurs to the talking heads that their position makes no sense. Let’s begin at the most basic level. Government has no money it has not first “printed,” or taxed or borrowed from someone in the marketplace. (In today’s world of money creation, the government’s central bank can conjure up money without physically printing it.)

If the government prints it, prices rise, robbing the rest of us purchasing power, a form of taxation. It also distorts investment by artificially lowering interest rates. That doesn’t sound like a promising road to genuine recovery.

If the government taxes or borrows the money, the government clearly is not “injecting” liquidity into the economy when the bureaucracies spend it. It was already in the market! All the government did was move it around. (It will have to tax us later to pay off the debt.) Why is the government’s spending stimulating but not ours?

Antisocial Saving

Here’s where the pop Keynesians get pseudo-sophisticated. We are not spending our money, they say, or at least not enough of it. We are saving it, which depresses retail sales, lowers business profits, and causes layoffs. This has a rippling effect throughout the economy, as businesses reduce purchases from their suppliers, creating similar effects up the line. Only government can jumpstart the system. Left to its own devices, the economy will stagnate and even spiral further down. Government must increase aggregate demand if we won’t do it ourselves.

Thank goodness for fiscal policy!

The government can work its magic in a few ways. It could send us all checks, calling it a tax rebate, which is what it tried to do last spring. But it didn’t have the intended effect. Apparently too many of us unpatriotically saved the money or — curses! — paid off debt. So the new stimulus action being talked about has little if any emphasis on individual tax rebates. Instead, advocates of stimulus want the government to spend directly in various ways, including rebuilding roads, bridges, and dams. “[W]hat the economy needs now is something to take the place of retrenching consumers,” Krugman writes. “That means a major fiscal stimulus. And this time the stimulus should take the form of actual government spending rather than rebate checks that consumers probably wouldn’t spend.” (Aside: re infrastructure, private owners wouldn’t have waited for a recession to start thinking about keeping it in good repair.)

But let’s not get ahead of ourselves. Can it really be that saving, which is usually thought to be a good thing for the saver, can be bad for society as a whole? And can the government possibly know what the right level of aggregate demand is? Is Krugman right when he says, “[I]ndividual virtue can be public vice … attempts by consumers to do the right thing by saving more can leave everyone worse off”?

This approach to the issue opposes saving to spending. It is true that when a person saves a dollar, he chooses not to spend it right then. But why does anyone save in the present? He saves so that he (or, say, his children) can consume more in the future. Few people renounce consumption for good. Anyone who did so would probably give his money away rather than save it.

Moreover, people don’t save typically by stashing their money in a home safe. (Not that there’s anything wrong with that. No economist has standing to condemn people for increasing their demand for ready cash.) Most savers put their money into some kind of interest-bearing account or money-market mutual fund, or buy stocks or bonds. In other words, they invest. This means the money moves along to others who intend to spend it one way or another. If the money ends up in the coffers of firms, it may be used to buy improved capital goods to make workers more productive. That’s new business for capital-goods makers and their suppliers at earlier stages of production. The resulting increased supply of improved and lower-priced goods is then available to consumers. Moreover, some of the saved money might be borrowed by consumers who want to buy cars, homes, and other big-ticket items.

Saving thus does not conflict with spending. It permits spending that would not have occurred otherwise. As Henry Hazlitt put it in Economics in One Lesson, “‘Saving,’ in short, in the modern world, is only another form of spending. The usual difference is that the money is turned over to someone else to spend on means to increase production.” What makes anyone think the politicians know better how money should be spent?

Ah, the Keynesian will say, what if most people aren’t curtailing their consumption spending because they plan to consume more in the future? Instead, what if they do so because the economy is slowing down and they fear for their jobs? As a result, maybe businesses won’t borrow and invest in expansion. They may also exercise caution in fear of the future.

If that’s the case, there already is a recession. So saving can’t be the cause.

Ending a Recession

This shifts the question from “How do we increase spending to the ‘proper’ level?” to “How do we get the economy to regenerate after a recession has begun?” A recession is a correction of malinvestment induced by unsustainable government policies, such as monetary inflation or, say, government programs to artificially direct capital into mortgage lending and home building. Once the investment errors are revealed, they have to be liquidated, creating unemployment and other hardship, until the structure of production is brought back into line with consumers’ true preferences.

In this case the temptation to have the government spend must be resisted because it impedes the realignment of investment and consumer demand — for which savings are indispensable — putting off the day of reckoning and worsening the consequences. Government spending is not guided by market signals and the search for profitable ventures; rather, it’s directed by political considerations, such as the satisfaction of special interests in order to assure reelection.

Recovery from a recession can be unpleasant, but the fault lies with the government policies that distorted the economy in the first place. Once the distortion has occurred, the consequences cannot be wished away. Economic logic will avenge itself — now or later. Better earlier, quicker, and milder than later, slower, and harsher.

Two key things should be kept in mind in understanding this matter. First, production must precede consumption. The idea that we can consume our way to prosperity is absurd. Imagine if Robinson Crusoe tried it.

Second and relatedly, the economy exists in time and space in a world of scarcity. The government might be able to push people into buying consumer goods today. But what then? Without savings, how will the goods be produced? How will the machines that make the goods be produced? How will the machines that make the machines that produce the goods be produced? And so on.

In a free market, prices would coordinate production and consumption across time. Consumers would signal the intensity of their preference for present goods over future goods by increasing or reducing their savings, thereby lowering or raising the interest rate. Producers, in competition with each other, would respond in order to best satisfy consumers when they want satisfaction and earn profits. The system would work reasonably well (perfection is not an option) unless the government intervened, garbled the signals, misled producers, and upset the intertemporal allocation of scarce heterogeneous resources. When this happens, the only way to speed recovery and minimize pain is to let the market process sort things out, reveal the true value of assets, and get back into its groove. Government or government-induced spending is destructive of this process.

Memo to Chris Matthews: Consumer spending is the effect, not the cause, of economic growth.

ABOUT

SHELDON RICHMAN

Sheldon Richman is the former editor of The Freeman and TheFreemanOnline.org, and a contributor to The Concise Encyclopedia of Economics. He is the author of Separating School and State: How to Liberate America's Families.

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