Economic Fantasies

Economic fantasies are proliferating. They seem to have a common meme, that is chartalism, the root of the Keynesian idea that one can solve economic problems by government spending. The basic idea is that the government simply prints money and spends it in sufficient quantity to grow the economy at some desired rate. Then the government taxes away money at a rate sufficient to keep inflation moderate. However, there is no particular link between government spending and government revenue, or taxation.

There are numerous flaws in this notion. Let me pick a few:

  • Hyperinflation occurs when the populace is no longer willing to hold money as a form of liquidity. Money coming in is converted as quickly as possible into tangible assets. Blatant money printing is the obvious way to convince people that money has no real value and so should be spent immediately, while there is still an opportunity to spend it. The velocity of money goes through the roof and you have hyperinflation faster than you can blink, and certainly long before the government can respond with taxation. I have a framed hundred trillion dollar note from Zimbabwe in my office to serve as a reminder of this.
  • Recessions occur because the demand for goods and services changes. For example, the housing bubble caused millions of people to enter the real estate industry – building, selling, financing and handling transactions in houses. Pretty soon we had all the houses we needed, and then far more than we needed. Demand evaporated and prices collapsed, putting many of the people in the real estate industry out of work. The bubble occurred because banks were encouraged to create money – through lending – for people to buy houses. Undisciplined government spending will do the same – it will distort price signals so that more bubbles will occur, with the same devastating consequences.
  • It will increase the role of government in the economy, which in the past has tended to favor consumption over investment simply because consumption provides immediate gratification. This will continue the “hollowing-out” of the economy that has been proceeding for the last thirty years or so, driving goods-producing activities overseas and allowing our infrastructure to crumble. The reason we are having this conversation at all is because we are dealing with the failure of this strategy of deficit spending. Simply declaring that deficits don’t matter because government debt is not being created is nonsense, printed money is simply interest-free government debt and is just as dangerous as bond issuance. Government deficit spending is what creates inflation and suppresses economic growth.

Here, thanks to Mark Grant, author of Out of the Box, is a list of corollary dreams:

  • Eurobonds will be forthcoming shortly.
  • The ECB will be doing another round of LTRO any day now.
  • Greece will not exit from the Eurozone.
  • Spain will not need to approach the EU for financial assistance.
  • Germany and France will reach a compromise position.
  • Portugal and Ireland will be just fine and not need any further funding.
  • America has decoupled and will not be impaired by the recession in Europe.
  • The Euro is stable and will not decline further.
  • Treasuries cannot have lower yields from here.
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