July 2, 2009

Fairy Tale Economics - Part 3

[NOTE: Italicized text is repeated from Part 1 for contextual purposes.]

Politicians would have you believe most anything. They'll say anything to get elected. They themselves might absolutely believe the words they are saying when they say them. But when it comes to governing, they are often confronted with the realities of the situation that cause their promises to become forgotten promises. In that light, the GOP being regarded as the party of 'No.', on the surface appearing to be simply obstructionist, is in reality a good position to be in. It's a lot easier to promise NOT to do something, NOT to spend money and then deliver on that promise, than it is to promise to do something that turns out to be unwise or impossible to deliver upon after being elected. In that case you've got to go back on your word, or plow ahead with a bad idea that will do more harm than good in the long run.

It's one thing to believe that your solutions are smart ones when the aren't, it's entirely another and far more sinister when politicians are deliberately misleading the public into believing in a set of principles that are patently flawed. The United States as a nation finds itself in one of those situations right now. The recessionary meltdown currently being navigated by the economy is the problem, and believe it or not, the solution as it stands is a big part of the problem too. There are three distinct culprits in getting us to this crisis point: (1) President Obama (2) The mainstream news media and (3) the inattentive, gullible and naive American public. The truth is that the culpability is pretty evenly spread between those three.

Previously, looking at the problem itself the focus was on Taxation (See Part 1 here) and additional Government Borrowing (see Part 2). Also in Part 2, the problem was more specifically defined;

The problem is that the economic crisis the nation currently finds itself in, cannot be solved the way the government is going about doing so. In essence, the initial problem of a recession is being compounded by the solution.

The Problem

The economy is in rough shape but it can't be cured by Fairy Tale Economics. Those following the economy will look at things like unemployment rates and the stock market and draw their conclusions about the nation's health based on them (or similar indicators). But that's taking a microscopic look at an economy that has a macroscopic problem. The unemployment rate is the symptom of the problem, not the problem.

You don't solve the economic problems by solving the unemployment rate issue. That's like thinking you'll cure your cold by taking cough syrup. If it was as simple as creating jobs then as someone pointed out (source unknown), then the government could take the stimulus money and hire workers, and handing out shovels to 2 groups of people - one to dig holes and one to fill the holes back in. And why not pay them $200,000 each to do it? Surely that would be more stimulating than $35,000 each, no?

The fairy tale economics yarn that the Democrats are spinning is that the government will create jobs and demand for goods and services by creating projects and spending money on them. The politicians will argue that consumers are not demanding goods and services so the government has to step in to fill the void until consumers appetite for buying returns. The government may indeed need to fix roads, build more Hoover Dams etc., but that's not the issue here. The economy is the issue, and their solution does not work. It's pretty a simple matter to figure out why.

In the simplest context, the government has to get that money from somewhere. They have 3 options available to them (i) they can raise taxes on consumers and/or businesses (ii) they can borrow money from domestic and/or foreign lenders (banks or governments) and then pay it back later or (iii) print more money and use it for the government spending. Of course the politicians could also decide to do a combination of some of all three of those options. The result would then be a mix of the results of each option taken in isolation.

Printing More Money To Spend

Money doesn't grow on trees. It's not a renewable resource in the sense that you simply can't make wealth out of nothing. Wealth has to be created by adding value to something or for someone. There has to be value for money to have meaning. Printing money doesn't add value or wealth to the economy, it dilutes value of existing wealth.

The economy might seem to some to be simple to this example;

Harry and Nancy both have $10. They are the ones responsible for printing their own money. They are in a store where there are goods for sale. Every item in the store costs $1. Thus each of them can buy 10 items. But if they print another $10 each then they could each buy 20 items. They get more and the store gets more money.

Where's the flaw? Let's say one of the goods is a pot and one is kettle. They are worth the same equal value as each other. And they are both worth $1. But there's only one of each in the store. Harry wanted a pot and Nancy wanted the kettle. But now that they've both got twice as much money, they both want a pot and a kettle.

There's only one of each but demand for two of each. What's a smart store keeper to do? Raise the price of the kettle to $2 and the pot to $2. Harry and Nancy are back to the same situation as where they started - Harry gets a pot for $2 instead of one and Nancy gets a kettle for $2 instead of one. In other words, the shopkeeper sells the same two items but gets twice as much money (inflation). But even the shopkeeper is no better off - if he wanted to buy the kettle back, the price has been set at $2 now. No one is any wealthier.

All that has happened is that the value of the dollars have gone down. $1 used to buy a kettle, now it buys half a kettle. The money does not add any value, and therefore no 'wealth'. The only way for there to be more wealth is to get more kettles or pots into the store. They need to be made.

What printing $20 extra has done is caused inflation. What printing an extra trillion dollars does is the same thing but on a much bigger scale. And what it does in the real world is also devalue the American dollar compared to other currencies.

If printing extra money happens on too large of a scale the results can be disastrous. Two relatively recent examples are the Wiemar Republic and even more recently, Zimbabwe. These choices have real world consequences.



There are lessons to be learned from the past.

Clearly, the way forward is full of danger.

Next Up: In Part 4 - whose fault is this? How did America get to this point?

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