At least one of us has no idea how an economy works, and I don’t think it’s me

I don’t normally do this, but I was asked about this article at The Conversation, Why the federal budget is not like a household budget, and out of pure exasperation I sent off this reply. My title is, “An Endless Supply of Keynesian Nonsense” of which there is no shortage. I shouldn’t write things at two in the morning since the exasperation does seem to overwhelm me, but here it is for what it’s worth.

The state of economic theory today truly is a scandal. The effect of Keynesian theory on the way economists think is so disturbing that the reality is there is no likelihood anytime soon that things will begin to come good. Let me take a case in point, which comes from the article by Warwick Smith which came with the title, “Why the federal budget is not like a household budget”, which I suppose is true, but it all depends on what conclusion you therefore draw.

He also says that, “the whole deficit/surplus thing has been greatly exaggerated”, which again I am willing to accept, depending on how he follows up from this. He goes on to add that “the focus on deficits and surpluses distracts us from what’s really important in the macro economy.” OK. So just what is it that is the really important thing? And this is his great insight:

“Inflation is the limiting factor for government expenditure, not taxes or borrowing”.

That is, governments can keep spending right up until we reach the point where prices begin to rise too much. There is therefore plenty of room for government stimulus that is not limited to the amount of spending that is covered by one’s revenues. Here are his words:

“A government that can create money doesn’t need your money from taxation or from borrowing in order to spend. There is no limit to how much money a sovereign government can spend, but if government spending plus private spending exceeds the productive capacity of the economy then you get inflation.”

Until the government reaches the point where the economy is at its capacity level, it can, it seems, keep spending without taxing or borrowing, and it is all to the good. The economy will keep growing and inflation will remain under control. Here is his conclusion, in his own words so you can see for yourself I am not making it up:

“Times like these represent opportunities for the government to finance productivity improving infrastructure and provide much needed services for nothing. I know it sounds too good to be true but this is the reality of a fiscally sovereign government.” (My bolding)

How is it possible to believe anything like this and call yourself an economist?

So here is the answer to why this is nonsense, which I hope will also help you understand why the American economy is falling to bits, and if we are not very very careful, ours will do exactly the same.

An economy only grows by producing goods and services whose value is greater than the value of the inputs plus labour-time used up during production. There was a time every economist understood this. If you have some timber, a hammer, a few nails and some time, you can do many things with them, but only some of the things you might do will end up with the value of what was produced greater than the value of the timber, nails and time used up.

The belief that a government has any idea where value adding activities can be found is one of the dopeyist ideas ever concocted. Governments can certainly spend the money they create, and some of what they do is value adding, but hardly everything. To believe that what governments produce automatically has greater value than the resources they use up is so nonsensical it is hard to believe any economist would ever peddle such a notion.

Take our own stimulus. The two major projects were pink batts and school halls. If you ask me if we are better off with a larger number of insulated houses and a better school infrastucture, I am happy to say that, all things being equal, we are. But if you ask me whether we have had a return of more than $43 billion on our outlay – the approximate price tag of this spending – then the answer is that we have not had anything like that amount of benefit.

You may delude yourself from now till the end of time that these benefits were provided “for nothing”, but have you not seen our own reality. The dollar is falling, our standard of living is being dragged down and unemployment is on the rise.

Ah, but where is that inflation? For most, real incomes are not rising, so however small the official inflation rate may be, it is plenty high enough to erode our ability to demand. Have you tried to buy a house lately to take one example?

But the real damage comes through the other mechanism in which inflation affects an economy, which is the deterioration in our capital stock. Our economy is just not being maintained, never mind allowed to grow, because the government is diverting our resources into its own projects, instead of allowing businesses to replace their capital as it erodes during production. The real side of the economy is slowly but ever so surely falling to bits.

If you don’t understand it, well you are in good company since people with economics degrees apparently don’t seem to understand it either. But even if you don’t understand the process, you can certainly feel the effects.

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