Seeking Liberty

Liberty is the Fruit from Which All Progress Grows

Fix the Balance Sheet, Fix the Economy

Just about everybody realizes that the Stimulus did did not stimulate our economy. In fact, it was probably quite counter-productive, since the borrowed debt and newly printed Dollar Bills have severely weakened the Dollar in comparison to other currencies like the Euro, Yen and Pound Sterling. Now, with the realization fully in the mind of the American people, President Obama and others are suggesting that we pull the repaid from the TARP program and unspent stimulus funds to spend it on “job creation.” Fortunately, some in Washington oppose these ideas.

Pardon me, but wasn’t this what the Stimulus Bill was for? Wasn’t it passed to stem the rising unemployment rate at no more than 8 percent? Shouldn’t the funds in the Stimulus Bill have already been spent “creating” jobs?

The answer, of course, is no. The Stimulus was based on Keynesian economic theory, developed in the early 20th Century by the John M. Keynes (for whom the theory is named). Keynes and his followers (called “Keynesians”) believed that government could, in times of economic downturn, spend money out of their treasuries to build infrastructure and replace inventories of depleted or outdated government equipment. After the ensuing economic expansion, the government could then replenish its treasury with the increased tax revenues.

The money spent in such economy-stimulating spending would filter out into the economy, in what is called the “multiplier effect,” a concept not invented by Keynes but which was key to his theory to work. Companies hired to build roads and bridges might buy new paving and earth-moving equipment and hire additional employees. The companies that build the bulldozers would hire more employees and buy more steel. The steel manufacturers would buy more iron and coke. The coal mine would upgrade its digging equipment. This “trickle-down” effect is the basis of all government “stimulus” plans, whether that plan is one of tax-cuts or additional spending. It works–to a point.

The problem is that Keynes assumed such spending would be out of the Treasury. “Treasury” being defined as the money and resources a government has stored in its possession. This means that money that is already part of the system is not currently active is added to increase the liquidity of the system. “Liquidity” is a term that refers to how much money is flowing through the economy, essentially a ratio comparing durable goods and wealth to circulating money. The idea of a stimulus is to “fix” a liquidity ratio from too low (too few dollars and too many fixed assets).

For those who are unaware, the Treasury of the United States currently has a$12 TRILLION hole in it. Our Federal Balance Sheet is so lop-sided that the only reason anyone still lends us money is that we’ve never defaulted on anything.

Yet.

So, in order for our Federal Government to spend any money, it must first print, borrow or tax it from somewhere else. We have no reserves from which to spend on a Keynesian-style stimulus plan. Rather than adding money to the economy, we must first take the money out through taxes or borrowing, skim a bit off the top to pay the bureaucracy the administers it, and then insert the money back in. This accentuates the liquidity problem in the near term, making the economy suffer more and reducing the effect of the “new” stimulus dollars when finally spent.

The government, being the owner of the presses that print Dollar bills, could simply print more bills. This would quickly solve the liquidity problem without having to pull money out of the economy first. There’s just one problem: Money without wealth to back it up is adds nothing. Government revenue by taxation is money taken from wealth. Somebody or some entity did something valuable to earn that money, and the government took a percentage of the profit. Borrowing is similar: Someone took their wealth and chose to place it in the “safe” hands of the government, instead of a bank or market investment.

When government spends from its treasury, it is returning wealth to the economy. When government just spends newly printed bills, it is not returning wealth, it is merely adding dollars, increasing the number of dollars per amount of wealth and reducing the value of every dollar including those already in the system. This is the opposite problem of too little liquidity, resulting in inflation since more dollars can be spent but with no increase in wealth.

Today, Keynes would be appalled at the excessive government spending and the massive borrowing and printing required to effect the stimulus plans he envisioned. His theory was founded on the idea that a spend-thrift government would have a healthy balance sheet and reserves in its Treasury, not the lop-sided and poorly managed debts we have today.

The answer to fixing our economy and creating jobs lies not in additional government spending, despite what the economic sophomore Elites in Washington might tell us. Rather, it lies in fixing our spending policies such that the value of the Dollar, and thus the wealth of our nation, is not deflated by poor money management. The Federal Reserve must discontinue its policy of trying to steady our economy and focus once again on stabilizing the supply of money. The Federal Government must stop spending money it does not have, instead focusing on reducing its deficits and debts to a manageable level. A fix as simple (!) as correcting our Federal Balance Sheet will go a long will toward fixing our national economy.

Cross-posted at The Minority Report Blog.

Filed under: economics, taxes, wealth, , , , ,

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