Keynes Warns: A Trillion Here and a Trillion There
posted by Lawrence Cunningham
The sums are staggering. One million dollars is one thousand thousand dollars. One billion dollars is one thousand million dollars. One trillion dollars is one thousand billion dollars.
The budget that President Obama presents is $3.7 trillion, which is three thousand, seven hundred, billion dollars; that would leave a deficit between outlays and receipts of one thousand, seven hundred billion dollars.
Government remains committed to investing or providing similarly mind-boggling sums buying into large companies, especially banks, and adding similar amounts to get people buying cars, houses, boats and the like, as in the old days. These confounding figures translate into record-level percentages of the total economic output of the economy.
Where does government get all of this money? The government gets much from taxes, on wages, on certain consumption items, on estates, and on interest and investment returns. But it far from relies on those sources, which are formal, transparent and legitimate tools of transferring private resources for public use.
A principal source of government spending, and borrowing, is simply printing money. The Treasury and the Federal Reserve simply issue it, by fiat. Since 1971 when President Nixon withdrew the US from the gold standard, there is no law that limits the government from printing as much as money as it wants, any time, for any purpose.
There is, of course, a cost to government printing more money. The cost is that it increases the general level of prices in an economy. There is more money chasing any given amount of property, goods and labor. The results are rising prices and wages. That, indeed, appears to a purpose of the current borrowing and spending spree, especially to prop up housing prices, stock prices (as President Obama’s investment advice yesterday suggests) and car prices.
But there is also no way that the printing of money can pinpoint which target prices are to be affected or for how long. Indeed, extensive printing of money, like we are seeing, triggers inflationary pressures that last for long periods of time across unpredictable economic sectors. There is also no way to calibrate the intended stimulus that borrowing and spending triggers with actual real economic growth in the economy.
Inflation that occurs as a result of government money printing has the effect of devaluing the currency. When inflation is high relative to the rate of real economic growth in an economy, the effect is for real values and wages in the private sector to fall. This is a functional reallocation of wealth and spending power from the citizens to the government. In short, inflation is a tax, although one that is hidden from citizen view, notoriously hard to measure, essentially impossible to manage, and therefore bearing dubious legitimacy among taxation schemes.
Many have remarked on the US government’s unlimited spending habits and plans in the Bush and Obama administrations. Much attention (including by me here last week) rivets on how the Obama Administration plans to raise taxes on the people who earn the most money in the country (the 5% at the top) and spare others (the other 95%).
Yet far less attention is given to the effect on all citizens of the hidden tax that inflation constitutes. This may be because it is easy for everyone to understand what it means for a 20% income tax to be imposed on those earning $100,000 annually and a 10% income tax on those earning $35,000 annually, for example. It is easy to characterize such a measured program for its relative degree of progressivity (taxing higher earners more) versus regressivity (hitting lower earners disproportionately harder).
It is more difficult to understand and explain the hidden tax that inflation poses and more difficult to assess its relative progressive-regressive character. Yet, no doubt, there is evidence that inflation is a regressive mode of taxation.
John Maynard Keynes explained such problems, and probed dangers they pose to the legitimacy and sustainability of a market economy, when he wrote in his 1919 book, The Economic Consequences of the Peace, as follows:
By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. . . .
As the inflation proceeds and the real value of the currency fluctuates . . . , all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.
. . . There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one [person] in a million is able to diagnose.
Fed Chair Ben Bernanke and Treasury Secretary Tim Geithner are on an unapologetic, conscious course of money printing on an imponderable scale. They purport to be following other parts of Keynes’s wisdom, written during the Great Depression to prescribe massive government spending to get economies out of the Great Depression.
But Keynes did not endorse such massive government spending to prevent economies from getting into depressions—rather as the only course to get an economy out of one. The US is not in a Great Depression that warrants Keynes’s emergency medicine. The economy seems to remain on the side where Keynes warned about the dangers of inflation. These dangers are hidden, pernicious, profound, probably regressive, and ultimately financial destabilizing. Some caution about scale seems in order.
March 5, 2009 at 10:30 am
Posted in: Current Events
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Responses (5)
Contrarian Profits - March 5, 2009 at 12:01 pm
Economic indicators show that inflation threats are right around the corner. Eric Fry of the Rude Awakening examines 6 ETFs and how to prepare for the “near-certain arrival of inflation.” He says now is the time to be wary of price increases and these ETFs act as an “insurance policy” to hedge against them.
A.W. - March 5, 2009 at 1:20 pm
I am so depressed for my country right now. my god, what a collossal f— up obama is turning out to be. We are 3 months in, and i am staggard how bad their response is. It is getting to the point that some are wondering if he is purposefully destroying the economy based on various theories, and it is seeming more plausible every day.
A.J. Sutter - March 5, 2009 at 10:34 pm
What’s very curious to me is that the dollar is strengthening at the moment compared to many other currencies, even though it’s obvious that so many more dollars will be printed. In the case of Japan this is understandable — and temporary: the Japanese government is intervening until fiscal-year-end here (03/31), so that Japanese exporters will be able to report higher yen-denominated profits for fiscal 2008. From 04/01, the yen should probably strengthen again. But against other currencies, the dollar’s strength is very counterintuitive, in light of the points made in this post.
Christa - March 8, 2009 at 11:27 am
Two questions:
1. When the government prints money, which people are most harmed or helped? Those who are carrying cash are harmed. And those who have real property, goods, etc., are helped. But, what about in credit relationships? Is it the case that those who have debt on something to which they have title really benefit from inflation, like home owners who owe a lot on their mortgage but are able to pay each month? It’s really bad for banks, though, unless they are able to foreclose (and thus get the property which will increase in value due to inflation).
Is that all correct? I’m not sure.
2. I’m not an expert on the Depression, but wasn’t inflation a huge problem? How did increasing inflation help? Also, what is the difference in strategy for depressions and recessions?
Lawrence Cunningham - March 10, 2009 at 1:08 pm
Christa,
1. That all seems correct, in general. But when inflationary pressures are unleashed, it is impossible for any one to know, exactly, which groups will be helped or hurt.
True, as you suggest, people with significant amounts of mortgage debt and consumer installment debt may gain from inflation, to the extent that they are able to repay these debts in depreciated dollars. Yet that effect can have second-order effects, which ultimately hurt those people and others.
For example, this effect encourages borrowing. That can stimulate speculative investment which, in turn, encourages excessive risk-taking. It may be difficult for people to meet their debts as they come due. They become illiquid and insolvent. Businesses make lay offs and shrink work forces. Unemployment rises. [And that, of course is a big part of the story of the problems leading to the world’s current crisis!]
As for investors and lenders, they tend to incur losses in real terms. That, in turn, may encourage them to buy assets seen as stores of value, especially gold or silver, rather than investing in productive enterprise. That contributes to the viscous cycle mentioned in the previous paragraph. Interest rates tend to rise, causing damage to financial markets, especially on the prices of bonds and other fixed-income securities.
Businesses and individuals may become more prone to consume than to invest, including by hoarding goods whose prices are rising particularly rapidly, worried about future ability to obtain them. That can result in shortages of those goods.
All forms of fixed dollar payments are eroded, including principal, interest, rent, salaries, wages, annuities, and insurance policies. The disorder stimulates public demand for government to provide protection against declining real values in these things. Often that means calls for wage or price controls. But those policies usually backfire badly, causing further dislocation and shortages.
The upshot is massive, unpredictable, arbitrary, and serious dislocation. And that is just the economic story. Other even more important effects cannot even be measured, let alone anticipated. Examples include effects of a behavioral sort, such as optimism versus pessimism, tensions among social groups perceived to be losing less (or even gaining) from the phenomenon. Ultimately, as Keynes warned, government commands much greater power, and confiscates not only a share of the wealth of the nation’s citizens but maybe their social stability as well.
2. The 1930s Great Depression was characterized by deflation, the opposite condition, of a substantial and continuing fall in general price levels and increase in the value of money. Conventional wisdom at the time said the national response to that should be to reduce government spending; Keynes’ breakthrough was to prescribe the opposite. Many economists since Keynes have embraced a broader approach, prescribing government spending to prevent countries from sliding into depressions. Economists know that means the risk of sparking a sustained inflation and they recognize that means the related risks summarized above.
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