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The economy tanks and the government resorts to snake-oil policies
Gerard Jackson
Business investment is hitting rock bottom and capacity utilisation continues to contract. This is definitely not good. Have no fear: the government is coming to the rescue with a $41,534,000,000 extravaganza. Although this spending is supposed to be spread over four years a great deal of it will be doled out in the first of half of next year and then another dollop in the next financial year. Treasury secretary Ken Henry rationalised this spending binge to a Senate committee by assuring its esteemed members that it would raise economic growth in 2008-09 by about 0.5 per cent and raise further by 0.75 per cent to 1 per cent in 2009-10.
This is pure Keynesian hogwash. First and foremost, economic growth is the process of capital accumulation. (The reality — like so many things in economics — is a lot more complicated than this bald statement would lead one to presume). Because of the manner in which GDP is calculated, it can grow even as business spending falls. One does not need to be a genius in economics to realise that if business spending if falling so is investment. Alas, the 'public mind' in its naiveté is unable to grasp subtleties of Keynesian thinking according to which any kind of government spending amounts to investment and so raises incomes, thanks to the Keynesian multiplier.
What we have here is an excellent example of the textbook mentality. If it is in the textbook it must be so. Not when it comes to economics. There are basically three sources of money for governments: taxation, borrowing and the printing press. Even Mr Henry would admit that to increase government spending by raising taxes cannot increase aggregate spending for the obvious reason that it involves a transfer of spending power from the taxpayer to politicians. Yet the same man will argue that government borrowing can actually perform the miracle of creating many loaves and fishes from five loaves and two fish. Someone should have told him that that was a one-off miracle.
If the government borrows x dollars from the public then it ought to be patently obvious that this involves a transfer of purchasing power of x dollars from the lenders to the government. It cannot in anyway raise total spending and hence GDP. But what about the surplus? The surplus consisted of dollars deposited with the Reserve. This means they were temporarily sterilised even though they were still part of the money supply. Spending these deposits will indeed raise aggregate spending.
However, two things need to be noted: firstly, this is a one-off event; secondly, its initial effect is — in a sense — the equivalent of a monetary injection, which brings us to the printing press and monetary policy. From May last year to December M1 rose by 13 per cent and bank deposits by 13 per cent while currency remained comparatively flat until September, after which they had expanded by nearly 10.8 per cent by December. During the same period the monetary base* jumped by 46 per cent.
It very much looks like the Reserve is counting on monetary policy to boost the economy. If this is so then we can expect it to continue cutting the cash rate until it detects signs of recovery or in its opinion prudence demands a halt to the expansion. No bank can expand the money supply at these rates without generating inflation.
Unfortunately it is not understood by a sufficiently large number of people — and the great majority of economists — that the economics of the printing press is the real heart of Keynesianism. In other words, Keynesianism is an inflationary doctrine that has at its core the belief that in times of economic crisis expanding the money supply will stimulate growth. In the meantime our economic commentariat is still focussing on Rudd's futile spending splurge.
Readers have asked for more examples of bad economics from the commentariat. No problem, I am here to please. Michael Stutchbury, economics editor of The Australian asserts that Rudd's stimulus will lift "aggregate demand closer to the economy's overall supply capacity... [and] temper the rise in unemployment." (Dash of Friedman needed, 10 February 2009). We already know that's nonsense. He then complained that it was "over-borrowing and overspending got us into this fix." What got us into this mess — as I have pointed out so many times before — it is loose monetary policies that do the dirty deed. Where does this bloke think all the credit came from in the first place? He is just like the rest of the commentariat: money supply has no place in his world.
Alan Wood, also of The Australian, argues that cutting interest boosts economic growth by raising the disposable income of debtors "who tend to have a higher propensity to spend". (Can RBA take rates to zero?, 20 February 2009). More nonsense. The income part of this argument could only hold up if the payments made to the banks by mortgagees were held in 'idle deposits', meaning that the banks never loaned or paid the money out to anyone. I consider this to be a highly unlikely situation.
His biggest error, however, is the consumption fallacy according to which consumer spending drives the economy. More nonsense. Savings fuels an economy and entrepreneurship drives it. Therefore all consumer spending comes at the expense of investment. Put another way, investment is forgone consumption in favour of a greater amount of future consumption.
Finally we come to David Uren, The Australian's economics correspondent. According to this distinguished economic historian "1930s, governments were hamstrung by the gold standard, which obliged their central banks to redeem currency for gold at a fixed rate for anyone who wanted it". (Inflation bears now gold bugs , 16February 16 2009). Complete bulldust. The US was on a gold standard, the UK was on a gold bullion standard while the rest of Europe was either on a gold exchange standard or bullion standard.
Under a gold bullion standard people could not redeem the currency for gold. So the idea that this standard "hamstrung" governments is nonsense. Furthermore, under the gold exchange standard a country maintained its reserves in 'hard currency' like pounds. So the more pounds it acquires the greater will be its reserves and hence monetary expansion unless the pounds are sterilised. Rather than hamstringing governments these bastardised gold standards viturally gave them cart blanch to print money.
It is also a myth that the nineteenth and early twentieth gold stand restricted monetary growth. For instance, in June 1920 the US gold stock was $2.6 billion and the money supply was $34 billion. Come December 1929 the gold stock had risen to $4 billion and the money supply to $45 billion. This makes nonsense of any assertion that in the 1920s or 1930 the quantity of gold limited the quantity of money. The situation was a damn sight more complex than that.
Monetary conditions were not much different before WW I. According to Sir George Paish before 1913 the gold reserve of the Bank if England never exceeded $50,000,000 (about £10,000,000). Jacob Viner noted that the British banking system rested on an extremely low ratio of gold to liabilities. He estimated that the ratio "fell at times to as low as 2 per cent and never between 1850 and 1890 exceeded 4 per cent" (Jacob Viner Studies in the Theory of International Trade, Harper & Brothers, 1937, p. 264).
This should put to rest the erroneous idea that there was ever a 100 per cent gold reserve during the heyday of the gold standard. Moreover, though the gold standard is still blamed by some for causing economic and social distress in nineteenth Britain these problems were in fact cause by severe deviations from the gold standard.
*The currency held by individuals and firms and bank reserves kept within a bank or on deposit at the central bank.
Gerard Jackson is Brookesnews' economics editor
BrookesNews.Com
Monday 23 February 2009