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December 28, 2008

Obama's Spending Spree Won't Rescue the US Economy from Recession
by Gerard Jackson

In the past I have referred to Obama as an intellectual sponge, one of those people -- of whom there are a great many -- who soak up the ideas that are fed to them. Having absorbed them they then unknowingly find himself unable to learn not only from their own mistakes but also the mistakes of others. This is more than plain enough in Obama's adoration of FDR and his determination to follow in his dismal economic footsteps.

To ensure that FDR's failed policy of spending the US out of recession is implemented Obama has surrounded himself with Keynesians, a sure sign that things will turn out badly. Although they believe that a stimulus is necessary none of them have ever been able to explain why this medicine has never worked. It certainly didn't work for FDR and it as sure as hell never worked for anyone else. Yet the "best and the brightest" (now where did I hear that phrase before?) seem fairly confident that it will be different this time. And ain't that always the case.

There are a number of criticisms of why Obama's spending binge won't work. I think it would be instructive to take a quick tour of these objections:

• The spending would be wasteful because government involves high transaction costs that would absorb much of the money.

• Such spending is temporary and would be quickly exhausted

• Most of it would be wasted because people are careless with taxpayers' money

• The stimulus would distort state and local spending priorities

• Because spending would come from taxpayers it would not affect total demand

• Any spending funded by borrowing from the fed or the commercial banks -- where there are sufficient excess reserves available for a considerable monetary expansion -- would amount to creating money which would be inflationary.

Of these objections only the last two have a sound economic base. (In the case of the second objection, the stimulus need not involve short term spending). The remainder present no cogent argument against the theory that government spending promotes economic activity. If the money is taken from taxpayers then total spending does remain unchanged.

In addition, the change in the composition of spending brought about by government intervention could lead to serious distortions in the pattern of production that could retard recovery, depending, of course, on the amount of the spending. This certainly happened during the Roosevelt administration. Unfortunately as most of Obama's critics lack any knowledge of capital theory they are unable to fully grasp just how economically damaging these spending programs could be.

Now that it is apparent that Obama has conceded -- at least for now -- that raising taxes could sink the US economy it seems he is really only left with the printing press, so to speak. Considering that his coterie of economic advisors are Keynesians who, in turn, consult only other Keynesians we should expect to see a huge monetary surge in the near future. Bernanke has already laid down the foundations for such a strategy. Since last January the money supply has grown by about 18[1 per cent. And just to prove to Obama's economic advisors how big a Keynesians he is he raised the monetary base from $980,914 billion on 8 October to $1,233,679 5 November, a 24.7 per cent increase in a matter of four weeks. These are dreadful monetary figures and one should never lose sight of that fact.

(In January 2001 I warned that "Greenspan's cheap money policy " was "laying down the foundations for another recession". The US recession: how long and how deep?, The New Australian, 21 January 2002).

That Obama's economic crew is now standing by at the monetary spigots raises an interesting question: if printing money is a such a great expand a deficit why not do so by cutting taxes instead of unleashing inflationary forces? Keynes was no enemy of tax cuts when it came to fighting unemployment and recession[2. Paul Samuelson who could be called the Keeper of the Keynesian Flame stated that

...dollars of tax reduction are almost as powerful a weapon against mass unemployment as are increases in dollars of government expenditure. Such a program may involve a larger deficit than would an expenditure program. But it also means that there is no expansion of the government’s sector of the economic system. (Paul Samuelson, Economics, 10th edition, McGraw-Hill 1976, p. 245).

The key phrase here is "almost as powerful". Obama's advisors could be arguing that an application of the net tax multiplier through a monetary expansion would provide a much stronger and sustained "jolt" to the economy than any old fashioned tax cuts. As we used to say when we were very young kids: "Ruhbarb!" This concept is another mutated version of the Keynesian multiplier and every bit as fallacious.

Obama has for now ditched the idea of tax increases. On the other hand, he refuses to implement tax cuts despite the fact that their remarkable powers of economic recuperation have been amply demonstrated. But to advocate tax cuts now would not only make a mockery of the Democratic Party's economic arguments (never a difficult task in itself) it would also have the mortifying effect of vindicating President Bush.

I'm afraid Americans are stuck with what is going to be a highly inflationary policy that will have disastrous consequences if persevered with. Part of the problem is that as Keynesians Obama's team will be focused on the rate of unemployment and this will be used to justify their spending program. The target of 2.5 million so-called green jobs is evidence enough of their line of thought. This policy could generate a consumer boom that would only add to the imbalances that the economy has accumulated.

The idea that focusing on jobs through consumption will fuel a recovery in manufacturing displays an enormous ignorance of capital theory. What the US could end up with increased consumer spending while manufacturing stagnates. The same goes for his so-call alternative energy investment schemes. The more resources directed to these malinvestments the greater will be the damage to the capital structure. This is the kind of interventionist thinking that helped prolong the Great Depression.

Finally, what about interest rates stimulating manufacturing? The view that investment is a simple function of the rate of interest has led to the dangerous notion that economic growth can be promoted by forcing down interest rates. But this is precisely what causes the boom bust cycle. And as we can see, US manufacturing is still contracting even as interest rates fall to historic lows. One should have thought that this phenomenon would have given Bernanke second thoughts. Apparently not.

Lower interest rates cannot stimulate investment without the prospect of profits. No profits, no investments. Slashing corporate taxes while simultaneously abolishing the capital gains tax could help spark an investment-led recovery. By setting his face against this policy of expanding capacity and to rely entirely on monetary expansion to promote recovery while at the same time promising higher energy prices in the future and a huge tax hike in 2010 or 2011 Obama will be fuelling uncertainty as well as inflation.

1.The Austrian definition of the money supply consists of the following: currency component of M1, total checkable deposits, US government demand deposits and note balances, demand deposits due to foreign commercial Banks, and demand deposits due to foreign official institutions, and savings deposits. There is some dispute about whether savings deposits should be included. If savings accounts are not transformed into checking accounts then including them in the money supply would be double counting, even if the bank lends the savings out to clients.

2. It is largely forgotten that Keynes was a hawk when it came to fighting inflation. In 1937 unemployment in the UK was 12.5 per cent. Nevertheless, Keynes publicly called on the British to end new public works projects, and warned it against the inflationary effects of any "general stimulus" (T. W. Hutchison, Keynes v. the 'Keynesians'...? The Institute for Economic Affairs, 1977, p. 11).

Gerard Jackson
BrookesNews.Com

Gerard Jackson is Brookes economics editor.

Copyright © 2005-2009 Gerard Jackson

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