Deficit Spending: The Many Wrongs of Robert Reich Pt. 2

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.