Government Spending Cannot “Stimulate” the Economy

“Looking N – US Treasury Building – Treasury Place – Washington DC – 2012” by Tim Evanson is licensed under CC BY-SA 2.0

Government economic policy is completely backwards. We are told that massive deficit spending, interest rates driven to zero, and now higher taxes on the “rich” will bring the American economy out of the doldrums or whatever fake malady seems to be popular. It is hard to imagine an economy in the doldrums when unemployment, the scourge of mankind for decades, is so low that businesses cannot attract enough workers. That’s number one; i.e., is the US economy really so bad? I admit that it always could be better, but we are not in the Great Depression of the 1930’s in which one fourth of those seeking work could not find a job. At least not yet. Stay tuned though.

Stimulus Spending and the Cantillon Effect

But let’s get back to the main point; i.e., that whether or not the US economy is underperforming, can government spending help? That has been the mantra since Keynesianism swept the economic and then government hallways shortly after World War II. So, we may ask ourselves, just how does government stimulus spending work? Well, from what I can conclude, the government sells its debt to the Fed (called monetizing the debt, which increases the monetary base), spends it on all kinds of programs, some (but not all) of us get more money in our pockets and spend it. So, we can see that, from government’s perspective, spending is the key. More spending MUST mean that the economy is doing better. Keynesian economists call this increasing aggregate demand, just a fancy name for more spending.

The implied mechanism is that more spending via money created out of thin air somehow draws more goods out of hiding. Why these goods were hiding is not quite clear, except that aggregate demand was deemed to be too low. On the face of it, it appears logical. Let’s say that you are the surprise inheritor of a great deal of money from a distant relative. Your personal lifestyle certainly will be stimulated. But let’s consider the source of this windfall–your distant relative. He certainly did not print buckets of money that he left you in his will. Either he earned the money himself or inherited it from someone who did. In other words, the source of your new found wealth was previous production. You are the new owner of that wealth. Whether you produced it or someone else, you are the new owner of what Professor Frank Shostak calls “something for something”. This is in contrast to receiving stimulus dollars printed by the government. Now you have received “something for nothing”. It is pure monetary inflation without any previous production in exchange. Therefore, any stimulus in the form of increased spending is pure smoke and mirrors, masking capital decumulation. The result is rising prices, at a minimum, and possibly hyperinflation if carried too far.

But let me give you two thought experiments. For the first one, let’s assume that you and some others are marooned on an uncharted island, similar to the plot of the hit TV comedy Gilligan’s Island. The only resources you have are whatever washed ashore when your ship sank, whatever natural resources are at hand on the island, and whatever survival skills you possess. Now let’s suppose that some large boxes wash ashore later. You rush to open them and find that they contain millions and millions of dollars in paper Federal Reserve notes. Not knowing when, or even if, you will be found, what good are these millions to you and your fellows? Do you all cheer, because now you all are rich? Since your most urgently desired goods certainly are not paper dollars, I doubt it. You all are left with the original resources–natural resources at hand, whatever goods were washed ashore earlier, and your survival skills. But, you may say, I do not live on an uncharted island. I certainly can spend the millions and enrich my life. OK, now let’s assume that in the middle of the night Federal Reserve Chairman Jerome Powell wakes you and slides a suitcase with a million dollars in Federal Reserve notes under your bed. Wow! What would you do? You might spend a little time thinking how to spend the money, but sooner or later you will take your suitcase of money and start to spend. Then you are shocked to find out that Mr. Powell, like a magical Santa Claus, visited every one of America’s three hundred million plus citizens and gave everyone of them a suitcase with a million dollars in Federal Reserve notes, too. You find that all the luxury cars are gone from dealers’ lots. When you enquire about ordering one, you find that the price has skyrocketed. When government engages in stimulus spending, the same thing happens only on a smaller scale. A fortunate few, mostly bankers and bond dealers, get the newly printed money first. They buy current goods at current prices. Good for them! But subsequent receivers of the new money find that prices have gone up and their newly acquired money really doesn’t do them that much good. Then people much further down the line as recipients of the new money find that prices have gone up and their incomes haven’t gone up nearly as much or not at all (think of retirees on fixed pensions). Rather than enticing production out of hiding, government stimulus spending has caused a transfer of wealth from the later receivers of new money to the earlier receivers of new money. This is know in economic circles as the Cantillon Effect.

A Four Point Plan from Forty Years Ago

So, what can government do, if anything, to aid the economy? I have four main points, all from the Republican platform of 1980. (These four points were articulated by Vice Presidential candidate George Herbert Walker Bush on the steps of the Capital Building in Springfield, IL in the summer of 1980. I was in attendance.)

  • Number one, return to sound money by freezing the money supply. That requires two reforms. First, do not increase the monetary base by selling government debt to the central bank. Government must spend only what it raises in taxes or obtains through honest borrowing in the bond market. Secondly, forbid the ability of banks to engage in credit expansion through fractional reserve banking, whereby banks themselves create money out of thin air when they increase lending.
  • Number two, cut government spending. Of course, this is exactly opposite of what government does today, but government spending is parasitical on the real economy. Government does not create goods and services itself. It can only hand out what it has taken from others. It is the private economy that brings people what they most urgently want, not what government thinks they want or what government wants them to have.
  • Number three, reduce regulations. The free market economy and the legal system are all that is needed to bring people what they most urgently want . Disputes are best resolved in the commercial and criminal justice systems.
  • Number four, once the budget is balanced, finally goes into surplus and the debt is slowly being reduced, government can begin to cut taxes. Tax reductions will take money from the destructive power of government spending and increase the capital accumulation power of the private sector. Since the money supply has remained the same, increased production will result in a slow and steady fall in prices, benefiting all levels of society. The cost of living will fall and the standard of living will rise.

The American people need to be told the truth. Government can help the economy only by protecting you and your property. A free market economy, limited government, and the rule of law are the keys to prosperity and peace.

© Patrick Barron 2021 Website