Will Spending Borrowed Money Create Wealth?
There seems to be near universal agreement at all decision making levels of government that we can borrow and spend ourselves into prosperity. Let’s consider some worthwhile contrary opinions.
When Barack Obama takes office on Tuesday, his first order of business will be a stimulus package estimated to be close to $1 trillion. Sages nod that replicating aspects of FDR’s New Deal will help pull the country out of a recession. But the experience under FDR largely provides a cautionary tale.
Mr. Obama’s policy plans are driven by the conventional economic wisdom that the New Deal economic programs ended the Great Depression. Not so. In fact, thanks to New Deal policies and programs, the U.S. economy faltered for years longer than it might otherwise have done.
President Roosevelt came to office much as Barack Obama will, shouldering an economic crisis that began under his predecessor. In 1933, Roosevelt’s first year, unemployment hit nearly 25%, as people lost jobs and homes in towns across the country. Believing that government played a key role in restarting growth, FDR, within his first 100 days as president, created an alphabet soup of new agencies that mandated actions or controlled public spending and impacted private capital flow within the U.S. economy.
At first, it seemed to be working. Then things turned for worse again: By the fall of 1937, the U.S. entered a secondary depression and unemployment began to rise, reaching 19% in 1938.
By 1939 Roosevelt’s own Treasury secretary, Henry Morgenthau, had realized that the New Deal economic policies had failed. “We have tried spending money,” Morgenthau wrote in his diary. “We are spending more than we have ever spent before and it does not work. . . . After eight years of this Administration we have just as much unemployment as when we started. . . . And an enormous debt to boot!”
Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson have been correctly focused on shoring up financial institutions to prevent a collapse of the financial system, and stave off a severe decline in the general price level. If that were to occur, the unspoken fear has been that the U.S. and global economy could go into a deflationary death spiral that would cause the collapse of the international financial system.
As a short-term matter, the moves of the Fed and other central banks have been correct, but in the long term a return to growth will depend on dynamic job creation by American business — not the U.S. government.
As a result, the New Deal forced the allocation of money away from the private sector. As economist Henry Hazlitt wrote back in 1946, New Deal programs prevented the creation of the types of jobs which have the multiplier effect of successful businesses. Creating “work” prevented innovation and new jobs that would create other jobs.
Governments cannot create wealth by taxing and borrowing to fund make work jobs. The expenditure of massive amounts of money on politically inspired spending will simply deprive the private sector of needed capital. Central economic planning has never worked nor will it work now. The fact that there appears to be near unanimity in Washington that we need to borrow and spend our way to “prosperity” is enough to cause grave concerns since at a minimum it implies that there will be little constructive debate on the merits of the consensus view.
The Obsession With Government Spending
The U.S. is enacting a “stimulus” program of gargantuan peacetime proportions to rejuvenate our recessed economy. We are not alone in this. Japan, China, Europe and numerous other nations are doing the same–not yet as big as our program but based on the idea that governments can rekindle growth.
It’s all mostly wasted effort.
Despite its sheer size, the impact of the new President’s fiscal program, after the initial euphoria, will be painfully limited. Instead of a jolt like from downing a six-pack of Red Bull, we’ll get the economic equivalent of a tepid cup of decaffeinated tea. In fact, the waste and misuse of much of the money–inevitable in any quick, massive government-managed or -directed program–will negate much of the good in parts of this infrastructure-spending package.
The blunt truth is that government spending is a poor substitute for private business and consumer investing and spending. Were it otherwise, the Soviet Union would have won the Cold War, and Japan, which had numerous Obamaesque stimulus packages in the 1990s, would have boomed instead of remaining dead in the water in what was a 12-year recession.
Why this belief in government spending? After surveying the wreckage of the Great Depression, British economist John Maynard Keynes posited that markets left to themselves were inherently unstable and that government intervention could prevent debilitating economic slumps.
So why did such an approach fail so miserably in the 1930s?
What about Japan’s spending binge in the 1990s that still left its economy stagnant?
What about western Europe, which has had a massive government presence during the last 30 years but has created only a small fraction of the private-sector jobs that the U.S. has?
Despite adverse experience, the Keynesian stimulus idea has a viselike hold on policymakers, pundits and academics.
Events can also roil economies, as we experienced after 9/11. But most often, bad government policies bring on the most damaging downturns. The Great Depression was ignited by trade wars, high taxes and bad monetary policies. The great inflation of the 1970s was caused by the Federal Reserve’s excessive money printing. The current crisis was brought on by the weak dollar, the reckless extravagances of Fannie Mae and Freddie Mac and regulatory errors, such as mark-to-market accounting.
The fact that policy makers best solution is nothing more than a continuation of past failed policies reinforces the intellectually bankrupt theory of a borrow and spend solution. Hurry up and do something, anything, would best describe the stimulus plan.
Final Steps To Insolvency?
Mr. Obama has been handed an opportunity. He will put the welfare state on a path to solvency or he won’t, and we’re likely to find out soon. His stimulus spending plans will blow up in his face unless the bond markets (which will be called upon to finance them) are convinced the dollar will remain sound and spending under control.
Sadly, to those from whom much is expected, sometimes not enough is given. FDR can have been a great leader who sought the best for his country, and the ’30s still have been a succession of political disasters. Both things can be true. Presidents ride the tiger. Without apparent cognitive dissonance, Mr. Obama already has taken to denouncing Washington’s “anything goes” culture while simultaneously outlining plans to borrow perhaps $1 trillion to distribute to anybody and anything that happens to fit the wish list of some Democratic Party constituency group (and a few GOP ones too).
He certainly will meet with a gratifying success in the spending portion of his plan. The revelation will be whether he can deliver anything else.
Government solvency now has to be considered by serious minds as we see numerous countries headed down that path. The rush to spend massive amounts of borrowed money is a sign of fiscal insanity. Large government programs are always instituted in haste after a crisis has occurred. Invariably, the government solution only makes the original problem worse. Let us hope that at a minimum, any major government initiatives are properly debated before enactment and sharply curtailed.