The Keynesian Stimulus Dogma

American Thinker ^ | March 07, 2010 | Mark W. Hendrickson

[neverdem]

Most Americans don't believe that the way for Washington to address its gargantuan debt is to increase deficit spending and go deeper into debt.

Nobel laureates Joseph Stiglitz and Paul Krugman disagree. Stiglitz, for example, in an interview televised on Feb. 17, denigrated "deficit fetishism" and assured listeners that more "stimulus" spending now would augment American prosperity, both short-term and long-term.

There are several major defects in Professor Stiglitz' analysis.

1) Thralldom to the Keynesian macro-economic paradigm. 

The Stiglitz/Krugman perspective is thoroughly Keynesian. They attribute today's economic sluggishness to insufficient aggregate demand; hence, government must compensate for this deficiency via increased deficit spending to stimulate the economy. The Keynesian diagnosis is spurious. 

Sound economic analysis looks at the demand for specific goods and services, not at statistical abstracts like "aggregate demand." Falling demand for particular economic goods indicates that fewer people still value or want them anymore at that price.

In a free market, consumers communicate to producers through price signals whether to produce more or less. This generates the ongoing, healthy process Schumpeter dubbed "creative destruction," whereby new entrepreneurs supplying higher-valued goods supplant those supplying lower-valued goods.

Government policies, both monetary and fiscal, distort price signals, thereby stimulating overproduction of lower-valued goods while shifting inputs away from the production of higher-valued goods (destruction without Schumpeter's creative component). Government stimulus spending, by prolonging and propping up unwanted, uneconomic production, is inherently counterproductive, delaying the necessary realignment of misallocated resources to the rational (i.e., wealth-creating instead of wealth-extinguishing) production that produces an economic recovery.

2) Blindness to history. 

The Keynesians' faith in deficit spending as the key to economic recovery represents a triumph of hope over experience.

Exhibit A: The massive deficit spending of Franklin Roosevelt in the 1930s didn't stop the Great Depression. In fact, despite FDR spending more money in his first five years in office than all 31 prior presidents combined, his Secretary of the Treasury Henry Morgenthau stated in 1939 that "[w]e are spending more than we have ever spent before and it does not work. ... I say after eight [sic] years of this Administration we have just as much unemployment as when we started ... And an enormous debt to boot!" 

Exhibit B: The massive deficit spending of Japan's government over the past two decades has led to protracted economic sluggishness. Japan still limps along, but now the nation suffers from the largest debt-to-GDP ratio of the developed world at almost 200%. 

Exhibit C: Last year's so-called stimulus plan has produced the same results as FDR's stimulus-stagnant employment and mushrooming debt.

The Keynesian economists have a huge blind spot when it comes to history. That is because they tend to view economic history as divided into two eras: the years since the Keynesian revelation (Dec., 1935, when the master, John Maynard Keynes, enlightened the world with his General Theory of Employment, Interest, and Money, and pre-1935 when all was supposedly darkness.   They seem oblivious to the historical fact that, before Hoover and Roosevelt, Uncle Sam didn't ramp up spending during recessions /depressions, and those downturns were of shorter duration.

The most instructive example is the Depression of 1920-21, which featured the most rapid fall in production, employment and GDP in our history.  Rather than trying to stimulate the economy, Presidents Harding and Coolidge slashed government spending in half.  Markets made the necessary adjustments, the depression lasted for approximately a year, and employment and production made rapid, robust recoveries.

3) An enormous faith in government competence.

In his Feb. 17 interview, Stiglitz asserted, "All we need to make sure that our long-run national debt is lower" is for government to increase spending on investments that would produce an "easy ... 5 or 6%" return.

This is a breathtakingly glib assertion. If making profits of 5% or 6% is so easy, why are so many experienced businesspersons and entrepreneurs losing money these days? Stiglitz's comment reminds me of the facile assumption made by Vladimir Lenin, the first leader of the Soviet Union, that running businesses was a piece of cake. After he assigned the management of state-owned enterprises to political allies and then saw how quickly production declined, Lenin humbly conceded that managing enterprises efficiently is much harder than it looks.

The Keynesian faith in government macroeconomic planning is eerily similar to socialists' master plans. Both involve centralized decision-making by political elites. Both regard markets as inherently defective and unreliable, so government must intervene. Thus, Stiglitz apparently believes that federal bureaucrats or Obama-appointed czars can make profits where private firms cannot. He also overlooks an inconvenient fact of life: Government programs (notoriously inefficient to begin with) operate outside the profit-and-loss marketplace, so there is no way to measure profitability and prove Stiglitz' claim of 5%-6% returns.

4) Dangerous assumptions about the capital markets.

"Run up more debt," the Keynesians urge, apparently regarding the world's capital markets as a bottomless well.

Besides the trillion and a half dollars that Uncle Sam will need to borrow to finance this year's expenditures, European countries will require more than $2 trillion. Japan's budget calls for a record-high debt issuance of 44.3 trillion yen. According to Forbes.com Senior Editor Daniel Fisher, "National governments will issue an estimated $4.5 trillion in debt this year, almost triple the average of mature economies over the preceding five years." Asian countries may be booming, but they can't produce enough capital for both themselves and all the first world's needs.

Furthermore, there are limits to how much debt a country's government can incur. The Greenspan-Guidotti rule (formulated in 1999 by Alan Greenspan and Pablo Guidotti) states that a government needs liquid reserves sufficient to cover 100% of its short-term external debt. If a country lacks such reserves, foreign creditors will realize that the debtor government is essentially broke. In consequence, the country's currency will plunge on foreign exchange markets, triggering massive upheavals throughout the economy.

As reckoned by investment analyst Porter Stansberry, the U.S. government has approximately $500 billion of ready reserves, comprised of foreign currencies, gold, and oil. It also has current-year funding needs of over $4 trillion ($1.5 trillion budget deficit, $2 trillion of Treasury bills coming due in fiscal year 2010, and at least another trillion dollars of longer-term debt instruments maturing). That would imply a crackup this year. Perhaps, if existing creditors roll over their Treasury holdings and banks continue to borrow dirt-cheap from the Fed and purchase Treasury debt instead of making business loans, the day of reckoning can be delayed. Clearly, though, Uncle Sam is perilously close to insolvency and a consequent inflationary monetization of the debt by the Fed, to be followed by a massive depreciation, if not total destruction, of the paper dollar and concomitant economic and social disruptions.

For all of the above reasons, the Stiglitz-Krugman-Keynesian pleas for more stimulus and more deficits are reckless and irresponsible. Stimulus plans haven't worked, won't work, and we can't afford them. We are already in great economic danger from deficit spending. A policy to plunge us even deeper into the debt abyss is kamikaze economics. We should take a pass on that course of action.

Mark Hendrickson teaches economics at Grove City College and is Fellow for Economic and Social Policy at the Center for Vision & Values. 

[eyedigress]

Start the debt vs inflation argument and basically your off and running. Monetize the debt and inflation will catch up.

[dsc]

“Stimulus plans haven’t worked, won’t work, and we can’t afford them.”

You don’t even have to be smart to see that. You just compare the number of times it has been tried and failed (all of them) and the number of times it has been tried and succeeded (0).

[sheik yerbouty]

This is more like Kenyan economics..

[whitedog57]

Keynesian dogma is all about moral hazard. In the name of restoring employment and the economy, we will recklessly spend money on our friends even though we know it doesn’t work.

A crisis is a terrible thing to waste, don’t you know.

[vaudine]

These people need a course at the Ludwig von Mises School of Economics. Von Mises believed that it was better to have a crisis near term and let the market recover; he believed that govt. intervention prolonged the crisis and made it worse.

He also wrote a book about the sameness of Socialism, Communism, and Fascism, while pointing out the differences. They are all dictatorships with the people as slave workers tightly controlled by govt.

vaudine

[Vehmgericht]

“Don’t be so skeptical. This is not Keynesian dogma. It is the successful policy developed by Gideon Gono, Financial Minister of Zimbabwe. This policy resulted in the creation of several million trillionaires. He also raised the life expectancy from 60 all the way up to 30.” - Professor Leroy Mudbone PHd

[rawcatslyentist]

Not to worry, soon we'll all be trillionaires!!!!

[LoneStarC]

Keynes was solidly socialist and his notorious theory was never intended as an economic model in the sense of intending to improve or even understand the economy.

It was an elaborate rationalization of deficit spending originally intended to enable socialism in Great Britain and was the cornerstone of FDR’s policies that made our great depression “great.”

Keynes himself, in an interview in Chicago not long before his death in 1946, famously responded to the question, “But haven’t your policies always, in the end, failed?” with the answer, “In the end, we’re all dead.”

In other words, “Who cares if Keynesian economics destroys the economy as long as it achieves its intended objective of establishing socialist government?” - or - “So what, we got what we wanted.”

[LoneStarC]

Of course, “birthers” insisting that Obama was born in Kenya are way off base.

Clearly, he must have been born in Keynesia!

[Uri’el-2012]

Rothbard Libertarian Austrian School economist and economic historian Murray Rothbard wrote a strongly worded critique of Keynes entitled Keynes the Man.[91] Rothbard accused Keynes of being an intellectual lightweight, fixated on simple short-term solutions to complex long-term problems, obsessed with his own ego and influence, and one of the most destructive statist intellectuals of the 20th century.

[cliff630]

The stimulous spending only does ONE thing. It rewards those who were responsible for lax lending policies. Without stimulous, those charlatans would lose their ill-gotten gains and learn a valuable lesson.

"THERE IS NO FREE LUNCH!!"