Will a tidal wave of red ink sink the American economy?
Gerard Jackson
Obama's economic policy will see Americans facing trillion dollar deficits for years to come. The first thing to note is that there is absolutely no economic justification for this policy of reckless spending and borrowing. It is driven by pure ideology, a desire to permanently enlarge the power of the state irrespective of the damage it will do to living standards. Those who sneer at this observation need to be reminded that Obama publically admitted that he intended to raise capital gains taxes even if it reduced economic growth because to do otherwise would not be "fair".
Only an ideologue could possibly think this way. Yet not a single journalist challenged him to explain what is fair about a policy that would keep living standards than they would otherwise be. But this article is not about Obama the callous ideologue for whom the welfare of Americans ranks far below his desire for a greatly enlarged state but the economic consequences of this policy.
Obama's massive borrowing proposals would strangle growth in two ways. First it would direct spending from private investment to government spending. This does not matter to Keynesians for whom aggregate spending is what matters. But they are disastrously wrong. It is not aggregate spending but the pattern of spending that is important. Failure to see this stems from the refusal to admit that production takes place through time and consists of innumerable stages. Moreover, this production structure, as it should be called, consists of heterogeneous capital goods. The structure is coordinated by the market rate of interest and the structure of relative prices.
Because of the vital role that time plays in shaping the structure massive borrowing by the state will shorten it and therefore keep living standards lower than they would otherwise be. That's the optimistic view. If the borrowing is heavy enough it will lead to capital consumption and a continuing fall in real wages. The process by which this happens is pretty straightforward. The more the government borrows the less there is for private investment.
It ought to be clear that a point can be reached where there will be insufficient funds to maintain the structure's length. When this happens the ratio of capital to labour drops along with real wages. What is generally overlooked by those who understand this fact is that the process is hastened by increased government spending which distorts the structure of relative prices in favour of more consumption over investment. So the effect of this increased government spending is the crowding out of investment in capital goods in favour consumption goods. This is exactly what happened in Austria after WWI. It was calculated that from 1918 to 1930 Austria lost something like 79 per cent to 87 per cent of its capital. This caused Fritz Machlup to caustically note:
Austria was successful in pushing through policies which are popular all over the world. Austria has most impressive records in five lines: she increased public expenditures, she increased wages, she increased social benefits, she increased bank credits, she increased consumption. After all those achievements she was on the verge of ruin. (Fritz Machlup, The Consumption of Capital in Austria, Review of Economic Statistics, II, 1935, p. 19).
At the end of WWII General Juan Peron did basically the same thing to Argentina, reducing one of the world's richest countries to penury. The idea that once capital has been accumulated it becomes a permanent and self-sustaining fund that yields a continuous income is a dangerous fallacy that history has refuted more than once but which a great many economists still cling to.
The fact that Obama is going to try and borrow massive sums from abroad does not change the argument. Let us say that he borrows from China. All that will probably happen is that China will use its dollar surpluses to buy more US notes instead of private assets. The effect on America's production structure will still be the same. (It still has not sunk in to the skulls of most economists that China's massive dollar surpluses were created by the Fed). We should also not forget that massive borrowing requires massive interest payments which in turn can only be obtained by raising taxes. Whichever way one turns Obama's borrowing proposals become an attack on living standards.
When the burden of debt becomes too great governments resort without exception to the printing press. In the case of Obama the Fed has acted with a remarkable degree of indecent haste to accommodate him. I did predict that Bernanke would readily oblige Obama — but not this quickly. The result has been the most rapid increase in the monetary base in US history. It is plain that Bernanke is aiming to flood the country with the green stuff and the inflationary consequences be damned.
Obama and his economics advisors — all of whom are Keynesians — are concocting a witches' brew that will wreak havoc with the economy if not countered. Unfortunately there is no way of stopping it. At the moment America is basically one-party state under the Democrats and they are enthusiastically supported by a viciously corrupt media.
The only thing that can prevent America from becoming an economic basket case is a sensible electorate. I know America is not Argentina — thank God — but should enough Americans become wedded to Obama's statist 'vision' then the country will become a banana republic along with everything that entails. And those millions of Americans who would vote for this disaster will be no different form those Argentineans who mindlessly still vote for Peronist policies and then go home and bitterly whine about their miserable living standards.
Gerard Jackson is Brookesnews' economics editor
BrookesNews.Com
Monday 27 April 2009