President-elect Obama announced today that as soon as he takes office he will submit a “stimulus package.” To most of the news media (maybe all) this is a good thing. I am sure that Stephen Moore of the Wall Street Journal for one would not agree, but he would be a rare exception. After all, both candidates pledged in the last election “to get the economy moving again,” thus revealing their ignorance of economics. It is here that the “package” analogy comes in.
When a person saves money, that money came from his producing a good or service that some other people wanted. Those other people took their discretionary funds and purchased the good or service. Those discretionary funds came from their production of some good and/or service that others wanted, and so forth. The money saved in a bank or in the purchase of corporate bonds or stocks goes to finance new projects, thus creating new wealth in the forging of those new products and services that people are willing to pay for. The economist Jean-Baptiste Say told us of this: the funds generated making all the goods and services in society will eventually be used to buy up those very goods and services. This came to be called Say’s Law. This doesn’t mean that there will never be any economic downturns. Entrepreneurs make errors and outside factors, like OPEC, complicate things. But the current crisis, as I have written before, was mostly government-caused, originated by the expansion of the money supply, and then by pressuring banks to lend to unqualified persons for the purchase of homes. This expansion of the money supply came from “whole cloth.” The Federal Reserve merely “creates money” by a bookkeeping entry made in the account of a bank that sells government securities to the Fed at a premium. There is no creation of actual wealth, as wealth comes from the increase of real production of new goods and services.
The economist who was the hit of the town since the 1930s, John Maynard Keynes, rejected Say’s law. He believed that savings took money out of the economy. I asked one of my economics professors if he thought that Keynes was tempted to say this because people were putting their money in mattresses at the time, because they did not trust banks. He told me that that was probably the case. But we can see that this is not the case today. People do use banks and other investment tools, and their money is put back into the economy in order to buy capital goods, which then make new things which people want and buy.
But Keynes is alive and well in the politician’s and media’s mind, even though most of the economics profession saw in the 1970s, with stagflation, that Keynes was wrong, something that this writer knew as a college freshman in 1966. Keynes believed that an economic downturn was caused by people spending less on goods and services than the companies planned to sell. The result was a recession. He did not believe that wages and prices would adjust to accommodate the lack of purchasing, as all classical and Austrian economists believe, and that thus the only remedy was an injection of government funds without a concomitant rise of taxes—i.e., deficit spending. This, of course, would be on top of what we do now. This is exactly Obama’s “stimulus package.”
Let us see why this stimulus package is similar to the package of one who has had too much to drink. Always look at the microeconomic foundations of any macroeconomic idea. The economy is founded on the actions of individuals, whether acting separately or in firms. A government stimulus package is called “fiscal policy” as opposed to “monetary policy,” which is an injection of money into the banks by the Federal Reserve Bank. In fiscal policy, the government undertakes projects in society that the society doesn’t necessarily need or want, but which employ people. William F. Buckley, Jr., said facetiously that fiscal policy was like the government paying people to throw stones into the ocean, and then paying other people to retrieve them. Prior to his election, president-elect Clinton wanted to build a federal swimming pool in Los Angeles, financed by deficit spending. President-elect Obama’s plan will have many, many similar projects in it so that billions will be injected into the economy, thus adding to the deficit, but, and here’s the big point, without any increase of productivity. This means that this injection of money is not real wealth. However, people will begin to spend more. This will put pressure on the consumption side of the economy. Without any increase of production to produce the extra wealth, this will push prices up, as things become scarcer. The same thing happened recently with the housing market. The artificial injection of money into the economy by the Fed caused an artificial building boom, pushing up prices of land, supplies, and labor, until housing became too expensive for people to buy, and then the builders were stuck not only with houses they already built but cannot sell, but with contracts for materials and labor that they cannot now use. When a person has their first or second drink of the evening, they feel good, happy; they get more sociable. As they have more, the “stimulus package” of liquor gets them to do more and more things they would not ordinarily do, because their view of their milieu is artificially stimulated by the alcohol. Here is where they put a lampshade on their head and dance on the table, an action which will result in their falling off, thus making a fool of themselves, and getting kicked out of the party.
Now let’s take the case of the bakery that used to be in my neighborhood elevated train stop in New York. As you came down the stairs, you could smell the baked goods, and, no doubt, this aroma got hungry workers to buy goodies on their way home. Now, with extra money in the pockets of the persons coming off the train, the bakery begins to sell more baked goods (and people plump up nicely). The baker does not know the reason for this; he only knows that he is moving more stock. To keep up with the increased demand, he hires more workers, buys a new machine, contacts his suppliers for more sugar, flour, etc. But to stimulate demand without a concomitant increase of actual wealth through production is to put stress on the current, non-expanding system.
This forces prices up—first of suppliers. To compensate with the increased price of supplies, the baker raises the price of his baked goods. So does everybody else. Now the consumers are paying higher prices for everything, and they realize that this increase in money in society merely forced prices up, thus making it more expensive to live, and thus eating up any extra cash they might have. So they reduce their spending to pre-stimulus package levels. The bakery loses sales, has to let the extra help go, has to sell the new machine, which is now a used machine, so it cannot recoup the full price paid, and has to reduce the supply orders it recently made. This is the economic hangover which occurs after the binge of the stimulus “package.” Gee, the analogy does work, but, now that I think about it, the partygoer did not intentionally drink too much. He was drinking the punch that he was told was not alcoholic, but all the while the government was spiking it. By the time he realized it, he had a “package.”
Please, Mr. Obama, don’t spike the economic punch. The market can have its own fun at this party.