Yesterday we brought you Ron Paul’s insane scheme to destroy the economy.
Basically, he wants to instantly slash about $1 trillion in government spending, which, purely due to maths, would result in a minimum 7~% contraction to GDP, not counting the knock-on effects from all the people put out of work, etc.
In short, that kind of GDP shock would create a recession.
Au contraire say the Paulistas, just spending a lot of money does not a healthy economy make.
Here’s Austrian thinker Tom Woods responding to us with a straightforward reductio ad absurdum, designed to point out the folly of spending money for spending money’s sake.
Perhaps we should build some pyramids while we’re at it, since “spending” is all the economy is about. Not allocating resources in such a way as to satisfy consumer wants at the least cost in terms of opportunities foregone. Just “spending.” Nevermind all the micro-level corrections throughout the economy that need to be repaired, and which an extra $1 trillion would go a long way toward repairing. Let’s think instead in terms of a crude macro aggregate — “spending” — and see if politically determined, economically arbitrary “spending” will just happen to redirect resources to those sectors where consumer demand wants them, following the years and years of misdirected resources that occurred during the artificial boom.
Now typically, we would respond with something like: Well, we’re not planning on building something as pointless as a pyramid, we want to rebuild our roads, bridges, airports, and lay high-speed rail all up and down the coasts.
But just for the sake of Woods, let’s take on his example directly: Even building a pyramid would make sense, and here’s why:
The fundamental problem facing this economy is private sector deleveraging.
We’ve established this again and again, but let’s just run over a few charts.
One thing that makes this recovery so distinctive is the ongoing decline of the household debt stock.
Meanwhile, household debt vs. income continues to be very high, representing a major drag on end demand.
The effect of this drag on demand show up all the time.
Time and again, businesses say in surveys that lack of sales is the #1 problem for business right now: That’s far ahead of other things like taxes, regulations, or whatever else people complain about.
Here’s an NFIB table of small business worries, via Mish.
So the #1 priority for the economy is getting back to strong household balance sheets. Everything depends on that.
There are basically two ways to do this. One is to increase exports, which may be a decent long-term goal, but it’s very tough.
The other way to do this is to lever up the public sector.
This chart, via PragCap, shows something important: Public sector deficits are the mirror image basically of private sector surpluses.
The way to create private sector savings is to spend public sector money.
This chart has some very important implications. Not only is public sector spending associated with private sector deleveraging, public sector surpluses are associated with private sector debt. This is why the Bill Clinton surpluses — which everyone thought were so great at the time — were so awful, because that’s when the seeds of the latest credit-boom were really on display.
Think of it another way: When the public sector is running a surplus, then the government contribution to GDP is negative (reverse stimulus) and so to keep the economy in place, homeowners have to go deeper into debt just to tread water.
So let’s circle back around: If the only thing the government did was build a gigantic, $2 trillion pyramid, that would be $2 trillion added to the deficit, and $2 trillion going to repair private sector balance sheets. That in itself would get us closer to the finish line in terms of helping the economy.
Of course, there are no worries about public debt sustainability either. The demand for U.S. Treasuries is enormous.
We’re not actually advocating building a pyramid, because there are clearly better things we can think to do with all that labour: Rebuilding bridges and airports and improving the country’s internet infrastructure come to mind.
Now you might object and say: OK, we can keep people employed with a sugar high as long as we want by having them do make-work, but once the project runs out, don’t we just crash again?
Well the answer is no, because at that point, households have a “fortress” balance sheet.
Going back to our critic Tom Woods, he unwittingly acknowledges this, when making the case that cutting spending doesn’t destroy the economy.
What about when the federal budget was cut by two-thirds after World War II? Then as now, Keynesians predicted catastrophe. Nine million would be unemployed! they said. We can’t just stop building tanks! (Alvin Hansen actually said that — we can’t stop building tanks even when we’re no longer fighting. Hansen was Keynes’ most significant American disciple.) I talked about this a bit in this video.
The actual result? The single greatest year for the private economy in U.S. history, with civilian output increasing by 30 per cent. True, the GDP figures didn’t look good, but that goes to show what a lousy proxy they can be. No one in his right mind thought the economy was poor in 1946 (though writers like Miller and Blodget use the same flawed figures to argue that the U.S. was prosperous during World War II — an equally absurd conclusion). And Keynesians shouldn’t bother pretending that “pent-up consumer demand” solved the problem — neither the timing nor the magnitudes involved will allow that conclusion.
He’s right. After the massive Federal spending program called WWII, U.S. households had extremely strong balance sheets, and were ready to pick up the football of economic growth once the government handed it off.
What Tom Woods fails to realise is that there’s a huge difference in slashing spending after a huge spending boom like WWII, and slashing spending when the private sector has so much debt.
All you have to do is look at Japan, which experimented with fiscal consolidation before things had gotten better. The economy shrunk dramatically, and deficits got worse (!) as this Richard Koo chart shows.
Bottom line: The goal isn’t to have everyone do nonsense, make-work, public sector jobs building pyramids. The goal is to fix private sector balance sheets. When that’s done, we can have another conversation about where to go next.
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