Now focusing on Robert Reich's failure to realize that large government deficits hurt rather than help the economy (2).
According to Mr. Reich, the "1.5 dip" recession "should cause deficit hawks to stop squawking about future debt" and "Herbert Hoover's ghost seems to have captured the nation's capital. We're back to 1932 (or 1937) and the prevailing sentiment is government can't and mustn't do anything but aim to reduce the deficit, even though the economy is going down."
First of all, Mr. Reich is being rather economical with the truth about Herbert Hoover. He is implying Hoover Hoover wanted balanced budgets instead of "fiscal stimulus." Hoover, contrary to the myths, did not believe in laissez-faire, free markets, or the "liquidationist" proposals for recovering from economic crises. He never believed in any of these, not before he was president, not in the beginning of his presidency, and not at the end of his presidency.
Herbert Hoover ran the largest peacetime deficits of any president who came before him. He explicitly repudiated all of the laissez-faire and "liquidationist" proposals for economic recovery. He embarked on a massive scheme of government intervention to hold up wages, keep employment up, to use the government to "fix" the market.
To quote Hoover in 1932: "We might have done nothing. That would have been utter ruin. Instead we met the situation with proposals to private business and to Congress of the most gigantic program of economic defense and counterattack ever evolved in the history of the Republic . . . Some of the reactionary economists urged that we should allow the liquidation to take its course until we had found bottom . . . We determined that we would not follow the advice of the bitter-end liquidationists."
FDR is usually credited with coming after the "laissez-faire liquidationist Hoover" and "fixing" his lack of intervention in the economy with his New Deal. In fact, FDR's platform in running against Hoover consisted of reining in government spending, deficits, and intervention. The "New Deal" was a creation of Herbert Hoover, and we never had a great depression like the Great Depression until we had the Hoover "New Deal" and the FDR New Deal.
We can, in fact, say that the government is currently channeling the ghost of Herbert Hoover. Just take a look at a graph of the federal deficit. Hoover's deficits, the highest peacetime deficits in history then, barely show up when this graph has to show the deficits of the Bush and Obama administrations. Obama is channeling Hoover 700-times over with his "New Deal" type policies. (For a more extensive historical analysis of Hoover's "New Deal," see the third part of Murray Rothbard's America's Great Depression, available free).
The assumption in Mr. Reich's indictment of the deficit hawks is that government deficits directly help economy recovery, while reducing the deficit harms economic recovery. Many people hold this view and therefore see the issue as a trade off between the economic benefits of a better economy and the economic damages done by increasingly large government debts.
In reality, there is no such trade off. Government deficits are unequivocally damaging to economic recovery in every way possible. The attempt to justify the opposing view springs from the faulty notion that reductions in consumer spending are necessarily bad for the economy. Therefore, as this "economic depression as lack of aggregate demand" theory goes, to "support" the economy the government has to make up for any reduction in consumer spending.
This fallacy is based off of the focus placed on a single, simple tautology: that the total amount of money income is equal to the total amount of money spent. All "consumptionist" fallacies come from the use of this tautology, which obviously must be true in monetary or nominal terms, and by trying to ascribe to this fact a significance which it does not have. A fall in consumption expenditures in monetary terms does not mean that real income will necessarily fall, or that any real aspect of the economy will fall.
That total consumption is falling is totally irrelevant to the proper working of the economy, and merely indicates either a shift to more saving and investment or a demand for higher cash balances, neither of which is harmful. In fact, if people on the market are actively demanding more investment or higher cash balances, any attempt to prop up consumption spending prevents adjustment to these changed conditions and draws out the discoordinated period of time, extending the length of the economic depression.
In fact, to the consmptionist, a fall in income that results from a fall in consumption supposedly leads to further drops in consumption, resulting in a vicious cycle from which the economy cannot recover unless the government intervenes to either prop up spending or prevent monetary income from falling. This view, of course, does not explain how civilization could have possibly developed before the coming of Hoover, FDR, and Keynes and the support for massive government deficits to "stimulate" the economy.
What deficit spending does accomplish is a three-fold distortion of the economy, and therefore a three-fold compounding of the economic problems facing a depressed economy. The first distortion is the spending of the government itself. Every penny the government spends affects prices and production on the economy in a manner inconsistent with the ultimate demands of market participants. Since economic recovery can only occur when prices and production are coordinated and aligned with the demands of market participants, government spending is a retardant to economic recovery and growth.
The second distortion accomplished by governmental deficit spending is the eventual appropriation of taxes to pay for the increased level of spending. At some point, every penny the government spends has to either come from taxes or inflation (inflation will be discussed in part 4). Taxes distort the economy by taking income from certain individuals in the economy and thereby adversely affecting their consumption and production plans, adding uncertainty to people's present day actions and thereby dampening the kinds of activities essential to rehabilitating economic activity.
The last distortion is the effect on the interest rate caused by government borrowing. When the government enters the loan markets, it has a completely unfair advantage. It is the only entity in the economy with a guaranteed source of revenue, and therefore it can easily attract lenders. It can also offer whatever interest rates it wants to because it has this unchecked potential for raising future revenue (even if it has to inflate to get this revenue).
This position in the economy causes the government to attract the savings in the economy, diverting them from use in actually useful, valued investment projects. This is particularly damaging in a depression because the causes of an economic depression stem from a lack of savings in the economy to complete lengthy and capital-intensive projects in the economy. The usual response after an economic crisis hits is for people to save more, thereby relieving some of the pressure on the shaky investment projects. Deficit spending simply adds to the pressure.
With no upside to governmental deficit spending and a host of difficult problems that result from it, the fact that the deficit is higher than it ever has been is cause for alarm, and more importantly, a change in policy. Let us kick out the ghosts of Hoover and FDR and return to a policy based on the reality of economics, that associated with Andrew Mellon and the liquidationist, laissez-faire proposals for economic recovery.
Friday, July 23, 2010
Thursday, July 22, 2010
The Many Wrongs of Robert Reich
Today's target: Robert Reich, and his article "We're in a One-and-a-Half Dip Recession." The absurdity of the title immediately caught my eye (I'd like to see a graph with one-and-a-half minimum points), as I sorted through the Huffington Post's daily articles looking for a true gem of ignorance--a task they make quite easy. Surely Mr. Reich has some reasoning for naming this a "one-and-a-half-dip" recession rather than simply a "double dip" recession, but if he does he fails to share it with the reader.
This is trivial, however, when compared with the actual body of the article. Mr. Reich's main contention is that "The 1.5 dip recession should cause the president to demand a large-scale national jobs program including a new WPA that gets millions of Americans back to work even if government has to pay their wages directly," this, and his general "government must do something!" attitude.
Unemployment is obviously bad, so we could hardly fail to expect someone, some simpleton, ignorant of all cause and consequence, to propose that the government should do anything and everything possible to get rid of it. Indeed, Mr. Reich characterizes opponents to his plans for society as being concerned not with the economy, not with the unemployed, and not with real people, but with supposedly meaningless budget figures and deficit numbers.
The many wrongs of Mr. Reich include his failure to realize that (1) massive government employment projects do not help with the problem of unemployment or with the underlying problems in the economy; (2) his failure to realize that large government deficits hurt rather than help the economy; (3) his failure to realize that unemployment benefits do not help by providing "fiscal stimulus"; (4) and his failure to realize that having the Fed print more money and throw it in the economy distorts, destroys, and sets back the economy.
Analysis time: (1) The root of the unemployment problem is discoordination in the labor markets: the supply of labor exceeds the demand for labor at current wage-rates. With sudden change in market conditions, such as the onset of an economic crisis, the labor-requirements of different industries and of different firms within industries suddenly change, requiring that workers move from industries where they are less urgently needed to those where they are more urgently needed. Industries whose consumer demand fall are rendered less profitable, and they correspondingly cut down on production and the amount of labor they employ. Other industries have increased consumer demands and a concomitant increase in profitability, encouraging them to increase production and their employment of labor.
The objection that a "general fall in consumption" makes all industry unprofitable and therefore drives employment in all industries down is untenable because it ignores the relevance of changes in prices in determining profit and loss. If a firm invests $100 in a production process to make 10 widgets, but can only get $8 for each widget, thereby making its revenue $80, or $20 less than its expenses, a superficial analysis will declare that this widget-making firm suffered losses. In reality, the purchasing power of the monetary unit, as determined by general changes in prices, has to be taken into account. If in this same example the purchasing power of the dollar rose by 30% over the firm's period of production, then the firm has made a "real" profit, even if it looks like a nominal loss. Math: ($80)(130%)=$104 which is greater than $100, which is a profit (abstracting from originary interest which is beyond the scope of this article).
If consumption on all goods falls because of a general increase in people's demand for money to increase their cash balances (usually denigrated as "hoarding"), then the purchasing power of money rises, all other things equal. Consumption at some level has to continue to occur regardless of how bad the economic crisis is, and therefore even with a potential reduction in nominal revenue across all sectors of the economy and all firms, the phenomenon of real entrepreneurial profits always persists, as adaption to the changing balance of consumer demand between different goods and services continues.
However, if prices are falling across the board, then all prices have to follow suit. Especially important is the price of labor, or wage-rates in the economy. As has already been pointed out, the problem of unemployment is that supply and demand for a particular labor service are unequal at the current wage-rate. The solution is obviously that the current wage-rate is not correct and has to be lowered for employing the unemployed to become profitable. That wage-rates fall in nominal terms, however, does not necessarily mean that those workers are poorer as a result, because as we have already seen, the purchasing power of money is rising/prices for consumption goods are falling, leaving real wage-rates generally intact.
Government work or unemployment projects that take unemployed workers and give them artificial employment at the expense of taxpayers, either present or future (through deficit spending), do not relieve any of the problems of unemployment. Au contraire, they actively prevent labor from moving from unprofitable uses to profitable uses by stratifying workers in newly made unprofitable uses. The senselessness!
It also cannot be argued that these government projects help relieve the suffering of the unemployed during the recovery or transitional period while the economy "recovers." The assumption is that these unemployed people can simply not find any work at all. The ludicrousness of this assumption is clear if we just think of who would not employ several dozen unemployed workers if these workers were willing to work for just one cent per hour. Obviously, if every unemployed person in the market were willing to work for such a low wage, there would be no unemployment left. Unemployment is almost always simply a sign that wages need to fall, at least in nominal terms. And unemployment is always voluntary in that a person remains unemployed because they do not like the types of jobs offered or the wages they pay.
The economy does not "recover" until economic resources have been returned to their most profitable uses (a process that never stops, hence the consistent phenomenon of entrepreneurial profits. Yet, during an economic depression, factors of production such as labor are particularly maladjusted to reality). If the government make-work programs are implemented, economic recovery can never occur because the labor diverted into these projects is not in its most highly valued uses as determined by market conditions! You can't just employ people in artificial projects until the economy recovers for this reason, the government merely creates permanent economic depression that will only end when the artificial projects end, and then the problems of maladjustment still have to be corrected by transitions of factors of production (mostly labor) away from the artificial make-work project and into actually useful jobs.
And of course, this is all without even mentioning the negative effects of taxation or deficit spending required to fund these projects.
Next post, we'll move on to the issue of deficit spending.
This is trivial, however, when compared with the actual body of the article. Mr. Reich's main contention is that "The 1.5 dip recession should cause the president to demand a large-scale national jobs program including a new WPA that gets millions of Americans back to work even if government has to pay their wages directly," this, and his general "government must do something!" attitude.
Unemployment is obviously bad, so we could hardly fail to expect someone, some simpleton, ignorant of all cause and consequence, to propose that the government should do anything and everything possible to get rid of it. Indeed, Mr. Reich characterizes opponents to his plans for society as being concerned not with the economy, not with the unemployed, and not with real people, but with supposedly meaningless budget figures and deficit numbers.
The many wrongs of Mr. Reich include his failure to realize that (1) massive government employment projects do not help with the problem of unemployment or with the underlying problems in the economy; (2) his failure to realize that large government deficits hurt rather than help the economy; (3) his failure to realize that unemployment benefits do not help by providing "fiscal stimulus"; (4) and his failure to realize that having the Fed print more money and throw it in the economy distorts, destroys, and sets back the economy.
Analysis time: (1) The root of the unemployment problem is discoordination in the labor markets: the supply of labor exceeds the demand for labor at current wage-rates. With sudden change in market conditions, such as the onset of an economic crisis, the labor-requirements of different industries and of different firms within industries suddenly change, requiring that workers move from industries where they are less urgently needed to those where they are more urgently needed. Industries whose consumer demand fall are rendered less profitable, and they correspondingly cut down on production and the amount of labor they employ. Other industries have increased consumer demands and a concomitant increase in profitability, encouraging them to increase production and their employment of labor.
The objection that a "general fall in consumption" makes all industry unprofitable and therefore drives employment in all industries down is untenable because it ignores the relevance of changes in prices in determining profit and loss. If a firm invests $100 in a production process to make 10 widgets, but can only get $8 for each widget, thereby making its revenue $80, or $20 less than its expenses, a superficial analysis will declare that this widget-making firm suffered losses. In reality, the purchasing power of the monetary unit, as determined by general changes in prices, has to be taken into account. If in this same example the purchasing power of the dollar rose by 30% over the firm's period of production, then the firm has made a "real" profit, even if it looks like a nominal loss. Math: ($80)(130%)=$104 which is greater than $100, which is a profit (abstracting from originary interest which is beyond the scope of this article).
If consumption on all goods falls because of a general increase in people's demand for money to increase their cash balances (usually denigrated as "hoarding"), then the purchasing power of money rises, all other things equal. Consumption at some level has to continue to occur regardless of how bad the economic crisis is, and therefore even with a potential reduction in nominal revenue across all sectors of the economy and all firms, the phenomenon of real entrepreneurial profits always persists, as adaption to the changing balance of consumer demand between different goods and services continues.
However, if prices are falling across the board, then all prices have to follow suit. Especially important is the price of labor, or wage-rates in the economy. As has already been pointed out, the problem of unemployment is that supply and demand for a particular labor service are unequal at the current wage-rate. The solution is obviously that the current wage-rate is not correct and has to be lowered for employing the unemployed to become profitable. That wage-rates fall in nominal terms, however, does not necessarily mean that those workers are poorer as a result, because as we have already seen, the purchasing power of money is rising/prices for consumption goods are falling, leaving real wage-rates generally intact.
Government work or unemployment projects that take unemployed workers and give them artificial employment at the expense of taxpayers, either present or future (through deficit spending), do not relieve any of the problems of unemployment. Au contraire, they actively prevent labor from moving from unprofitable uses to profitable uses by stratifying workers in newly made unprofitable uses. The senselessness!
It also cannot be argued that these government projects help relieve the suffering of the unemployed during the recovery or transitional period while the economy "recovers." The assumption is that these unemployed people can simply not find any work at all. The ludicrousness of this assumption is clear if we just think of who would not employ several dozen unemployed workers if these workers were willing to work for just one cent per hour. Obviously, if every unemployed person in the market were willing to work for such a low wage, there would be no unemployment left. Unemployment is almost always simply a sign that wages need to fall, at least in nominal terms. And unemployment is always voluntary in that a person remains unemployed because they do not like the types of jobs offered or the wages they pay.
The economy does not "recover" until economic resources have been returned to their most profitable uses (a process that never stops, hence the consistent phenomenon of entrepreneurial profits. Yet, during an economic depression, factors of production such as labor are particularly maladjusted to reality). If the government make-work programs are implemented, economic recovery can never occur because the labor diverted into these projects is not in its most highly valued uses as determined by market conditions! You can't just employ people in artificial projects until the economy recovers for this reason, the government merely creates permanent economic depression that will only end when the artificial projects end, and then the problems of maladjustment still have to be corrected by transitions of factors of production (mostly labor) away from the artificial make-work project and into actually useful jobs.
And of course, this is all without even mentioning the negative effects of taxation or deficit spending required to fund these projects.
Next post, we'll move on to the issue of deficit spending.
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