In virtually every nation on earth the ruling government plays a massive role in the lives of all citizens. The actions, laws, and policies implemented by those in power often have drastic and far reaching consequences for each and every person. Recently, confronted with an economic crisis like no other, the US government has taken bold and aggressive action, initiating a number of massive "bailout" and "stimulus/spending" packages, which many see as necessary to pave the road back to economic prosperity. While these plans will undoubtedly have a significant impact not just on Americans, but on people all over the world, exactly what that effect will be is unknown. The people in power, as well as many of those in the mainstream media, portray this unprecedented government action as crucial for economic recovery, and even go as far as to say that the government, and only the government can get the economy growing again. However, by examining in a logical manner the path that the government is taking, one will find that unfortunately the proposed actions are not the answer to what ills the economy, and instead will do much more harm then good.
In most cases the advocates of the government's economic policies use Keynesian economics and a concept proposed by John Maynard Keynes known as the paradox of thrift, to try and persuade people that what they are doing is not only correct, but the best and only solution. Basically, the paradox of thrift states that "if everyone saves more money during times of recession, then aggregate demand will fall and will in turn lower total savings in the population because of the decrease in consumption and economic growth". From this it is presumed that in order to dampen the effects caused by the decline in consumption, governments should step in and fill the void with spending projects of their own. Doing this it is believed will lead a country out of a recession and back towards growth. While the US and many other economies are indeed experiencing declines in consumer spending, as well as increases in personal savings rates, the proposed solutions by the government will certainly not help. Furthermore, the Keynesian line of thinking is incorrect and illogical, and the consequences of taking action based on these beliefs will only lead to a worse economic crisis down the road.
Firstly, to see why following Keynesian economic principles will not speed up economic recovery, but instead make the problem worse, one needs to understand what savings is and how it contributes to growth in an economy. While many politicians as well as the majority of talking heads in the media, will have you believe that spending is the engine of economic growth, this is not the case as in fact it is savings that is the real engine of growth. Spending is just a means of acquiring goods, or a form of barter, basically one party takes the money they have earned through the production of goods and services and exchanges (spends) it for goods and services that others have produced. This means that without an existing pool of goods and services (which in present day economies provides one with money), one cannot partake in spending. Savings on the other hand, occurs when someone produces a surplus of goods and services and thus earns a quantity of money above the amount that they need to acquire the goods and services they wish to obtain. This excess of goods and services allows a person to lend or invest some of their money with a borrower, the borrower can then use the money (which is backed up by goods and services produced by the lender) to support themselves while they produce goods and services of their own. So it is actually real savings which leads to economic growth, as real savings when transferred to a borrower, provides that person (such as an entrepreneur) with the means of producing more goods and services (growing the economy), and eventually repaying the lender.
It is important to realize that when an individual decides to save, the money that they save does not just go under a mattress, therefore being removed from economic activity. Instead the money is usually put into a bank where it is lent out and invested in other areas. Banks do not only lend to consumers, but more importantly to entrepreneurs and businesses. Acquiring money from banks allows entrepreneurs and businesses to start new projects, expand operations, purchase new equipment, etc..., all with the hope of increasing productivity, profits, and therefore the aggregate supply of goods and services in the economy. Some critics will say that during times when there is a banking crisis (such as 2008 and 2009) that savings deposited at banks are not lent out. However, this is misleading because while banks may not lend as much to consumers or businesses whom they believe to have a high risk of default, they do continue to invest in areas that they believe will create a suitable rate of return based on the amount of risk they are undertaking. Another reason that it is important to let savings increase during recessions, and especially during recessions that are accompanied by banking crisis, is because a rise in savings rates allows for a bank's capital to be replenished. Higher savings means that more money is deposited into banks and as banks recapitalize they can then partake in more lending, further helping with economic recovery.
When one understands the crucial role that savings plays in an economy they realize that is utterly foolish for politicians to talk about the need for a stimulus package that discourages savings. The fact that the government is attempting to prevent people from replenishing the pool of real savings is one major problem relating to the economic plans in 2008 and 2009, but it is certainly not the only problem. A further downfall is the government spending associated with these plans as it will only lead to greater problems, and examining the effect that government spending has on the long term health of an economy reveals just how damaging it can be.
When one understands the crucial role that savings plays in an economy they realize that is utterly foolish for politicians to talk about the need for a stimulus package that discourages savings. The fact that the government is attempting to prevent people from replenishing the pool of real savings is one major problem relating to the economic plans in 2008 and 2009, but it is certainly not the only problem. A further downfall is the government spending associated with these plans as it will only lead to greater problems, and examining the effect that government spending has on the long term health of an economy reveals just how damaging it can be.
As was mentioned earlier in order for one to spend they need to have something which others will accept in exchange for the goods and services they wish to acquire, and in modern economies money is used for this purpose. While the majority of economic participants earn money through the production of goods and services, the government does not. Governments do not produce anything, instead they obtain their funds through two primary methods; taxation and the printing money. Taxation which can be defined as "a charge against a citizen's person or property or activity for the support of the government", provides governments with funds to support their spending, while at the same time decreasing the available funds that individuals have for their own purposes. Taxation is obviously quite unpopular as it produces a noticeable effect on an individual's wealth. For this reason politicians usually avoid increasing tax levels substantially as they understand that doing so could seriously harm their re-election chances. The other method governments use to obtain money, which is preferred by most politicians, is printing money, or in other words increasing the money supply. Like taxation, increasing the money supply also decreases the purchasing power of private citizens and leads to a decline in their level of real wealth. While it is easy to see how taxation decreases ones wealth, increases in the money supply effect wealth in an indirect and discreet manner.
Printing money leads to inflation, and this causes a decline in an individual's wealth level, whether it is noticed or not. Inflation can be defined as an increase in the total money supply in an economy, which subsequently leads to a decrease in the relative purchasing power of each dollar. This definition is different from the common perception of inflation, that being an increase in the price of goods, or an increase in the Consumer Price Index (CPI ). However, it is crucial to understand that an increase in the price of goods is a consequence of inflation, but not the cause of it. It is actually possible to have inflation but not necessarily see an accompanied rise in the price level, or to have an increase in the price level but not have any inflation (this can be further understood by reviewing this article on the topic). Furthermore, it should be noted that when a government prints money, in order for it to lead to inflation the new money must enter the economy, and this usually occurs either through direct government spending or by banks making loans and taking advantage of the fractional reserve system. However, if the government prints $1 billion for example, but the banks that have access to these funds decide not to expand lending and instead leave the money sitting in reserves, this will not lead to inflation as these new dollars do not enter into economic activity. So to be more accurate inflation should be thought of as a net increase in total money in the economy, with total money including both dollars printed by the government and total credit supply.
When a government increases the money supply by printing new dollars to fund economic plans, what happens is each dollar that was in existence before the printing took place, declines in value or purchasing power when these newly printed dollars enter the economy. This is because there becomes a greater supply of dollars competing for an unchanged number of goods and services. Thus, like taxation, printing money shifts wealth from the private sector to the government. Taxation is an obvious transfer of wealth as the government takes money directly from each individual, thus lowering the absolute number of dollars each person has. Printing money, on the other hand, is discreet as the absolute number of dollars each individual has does not change. Instead after the government has printed money each dollar is worth less, meaning an individual can purchase fewer goods and services with the same amount of money then they could have prior to the money supply increase. Realizing this makes it quite obvious why politicians favor using the printing press to fund their spending habit rather then increasing tax rates. Using the printing press can be thought of as a silent tax, or one that the majority of citizens do not even realize they are paying, and therefore it is certainly not as threatening to a governments survival as an outright increase in tax rates.
When a government increases the money supply by printing new dollars to fund economic plans, what happens is each dollar that was in existence before the printing took place, declines in value or purchasing power when these newly printed dollars enter the economy. This is because there becomes a greater supply of dollars competing for an unchanged number of goods and services. Thus, like taxation, printing money shifts wealth from the private sector to the government. Taxation is an obvious transfer of wealth as the government takes money directly from each individual, thus lowering the absolute number of dollars each person has. Printing money, on the other hand, is discreet as the absolute number of dollars each individual has does not change. Instead after the government has printed money each dollar is worth less, meaning an individual can purchase fewer goods and services with the same amount of money then they could have prior to the money supply increase. Realizing this makes it quite obvious why politicians favor using the printing press to fund their spending habit rather then increasing tax rates. Using the printing press can be thought of as a silent tax, or one that the majority of citizens do not even realize they are paying, and therefore it is certainly not as threatening to a governments survival as an outright increase in tax rates.
After one realizes that to fund spending and bailout packages the government takes money from each citizen, transferring wealth away from private hands, the question then becomes will the government spend the money in a more beneficial manner then the private sector. And beneficial is meant in the sense that the money is being spent in areas with the highest productivity levels, the greatest rates of return, and the best growth potential. Money being spent in this fashion is essential because for a true economic recovery to take place money and resources need to be transferred from failing sectors, industries, and companies, to productive, innovative, and fast growing ones. When this is allowed to happen job creation increases, productivity rates increase, the level of goods and services increases, wealth levels rise and the overall economy grows in a strong and sustainable manner.
Unfortunately, one will quickly find that governments do not spend or invest in areas that will strengthen the economy and kick start a recovery. Instead they primarily put money back into uncompetitive, wasteful, and low productivity industries and individual companies, as these are often the sectors of the economy which lobby politicians the most. In 2008 and 2009 banks, insurers, and car manufacturers, or more specifically companies like GM, Citigroup, AIG, and Bear Stearns to name a few, were the beneficiaries of the transfer of wealth. The private sector of the economy on the other hand, will invest its excess savings in a much more efficient and optimal manner then governments. For example they certainly won't invest huge sums of money into companies such as the ones just mentioned, as they realize that these are failing companies which are unlikely to grow or create strong rates of return, and thus will be a hindrance to profit potential and economic growth if allowed to survive. Instead private hands look to find areas to invest in that are most likely grow, prosper, and create a return on the money invested, and allowing the private sector to divert money in this fashion is essential for an economic recovery to take place. It should be noted that while not all money invested and spent by private hands goes into the most productive areas of the economy, as bad decisions are made, overall much more will be diverted to the right areas with private investment then under government control. One needs to remember that while the private sector is motivated primarily by profits, governments and politicians are more motivated by lobbyist, constituents, special interest groups, and above all by the need for survival. And this fact alone makes it easy to see why private hands will divert money throughout the economy in a far more beneficial manner then governments ever will.
Unfortunately, one will quickly find that governments do not spend or invest in areas that will strengthen the economy and kick start a recovery. Instead they primarily put money back into uncompetitive, wasteful, and low productivity industries and individual companies, as these are often the sectors of the economy which lobby politicians the most. In 2008 and 2009 banks, insurers, and car manufacturers, or more specifically companies like GM, Citigroup, AIG, and Bear Stearns to name a few, were the beneficiaries of the transfer of wealth. The private sector of the economy on the other hand, will invest its excess savings in a much more efficient and optimal manner then governments. For example they certainly won't invest huge sums of money into companies such as the ones just mentioned, as they realize that these are failing companies which are unlikely to grow or create strong rates of return, and thus will be a hindrance to profit potential and economic growth if allowed to survive. Instead private hands look to find areas to invest in that are most likely grow, prosper, and create a return on the money invested, and allowing the private sector to divert money in this fashion is essential for an economic recovery to take place. It should be noted that while not all money invested and spent by private hands goes into the most productive areas of the economy, as bad decisions are made, overall much more will be diverted to the right areas with private investment then under government control. One needs to remember that while the private sector is motivated primarily by profits, governments and politicians are more motivated by lobbyist, constituents, special interest groups, and above all by the need for survival. And this fact alone makes it easy to see why private hands will divert money throughout the economy in a far more beneficial manner then governments ever will.
When a government decide to undertake a massive spending or bailout plan, such as those implemented in 2008 and 2009, essentially they fund these plans by transferring wealth from private hands into government control. Governments justify their actions using Keynesian economic principles which they portray as being the only ideas that if followed will guarantee economic recovery. However, by following these views governments are instead impeding recovery and actually making the situation worse. The spending and bailout plans attempt to prevent increases in savings rates and instead transfer money away from the private sector and put it back into unproductive, stagnant, and in some cases completely failing industries. This type of action hinders economic recovery and growth, and also leads to greater economic problems in the future. Until it is realized that the solution to a recession is not to transfer money away from the private sector and private decision making, but instead to allow individuals and private entities to move money and resources away from the failing industries to more productive and higher growth areas, a true, prosperous, and enduring recovery sadly will not occur. To conclude the following quote by Ludwig von Mises possibly best reveals why we are in this mess and how important it is for the dominant economic beliefs of Washington to end their influence on the American economy:
“The unprecedented success of Keynesianism is due to the fact that it provides an apparent justification for the “deficit spending” policies of contemporary governments. It is the psuedophilosophy of those who can think of nothing else than to dissipate the capital accumulated by previous generations. Yet no effusions of authors however brilliant and sophisticated can alter the perennial economic laws. They are and work and take care of themselves. Notwithstanding all the passionate fulminations of the spokesmen of governments, the inevitable consequence of inflationism and expansionism as depicted by the “orthodox” economists are coming to pass. And then, very late indeed, even simple people will discover that Keynes did not teach us how to perform the “miracle … of turning a stone into bread”, but the not at all miraculous procedure of eating the seed corn.”
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