Tuesday, September 11, 2012

Keynesian Economics is Simply Wrong

I find the most dividing idea between libertarians and the other ideologies is Keynesian economics. It comes down to whether or not people believe if it is a true representation of what happens within an economy. Does the economic cycle begin with demand and consumption? Does the Keynesian supported government stimulus work? Those are interesting questions and I will offer my views on them here.

To answer the question on the economic cycle, we must look at how the most basic economic transactions occur. Imagine being any animal on Earth and imagine how you will satisfy your most basic needs such as food, water and shelter. I suggest imagining being an animal first, so you do not jump to the wrong conclusions. It is easy to quickly assume so much is true that in reality is not.

Obviously, you will wish to solve the above mentioned problems. Your very nature demands you fulfill those needs or you will perish. So, you just go out and consume, right? No, that would be impossible, unless your water, food and shelter just occurred without any effort on your part. Every creature must create their access to the necessities of life. So, you must forage or hunt for food and then eat it.. You must find a water source and drink from it.  You must discover or build a suitable den and then enter it. You may have had a desire for those things, but you had to work for them first. You had to produce the results needed before you could consume them in order to continue living.

This is the most important point I will make in this whole article. Production occurs before consumption. In the animal model it is easier to see that truth. In the modern world demand seems to lead to consumption and then to production. However, no consumption can ever occur before production, even if is only picking the berry to put in your mouth, that must be done first. Today, when you are hungry you go to the store and buy food. Demand directly leads to consumption, right? No, you bought the food using money which is a representative place holder for the production you have already done. Money is your previous production that you then trade for your needs. You have already produced products and services which you then trade for other products and services. Your consumption came after your production. This is where modern civilization confuses the matter a lot. Money seems to be poorly understood. Few people consider that a week's pay is short term savings of your labors in order to trade for the labors of others. When you add in credit, the ability to buy based on your future earnings, it gets even more confusing.

It is clear, as we have seen in many communist (totalitarian socialist) nations, demand is never the problem. Demand is infinite! Bare shelves are the problem and that is a production problem. The reason Keynes suggests "priming the pump" and government spending is due to the false belief that consumption comes before production. So production (jobs) is mostly a side effect of consumption. As a side effect it doesn't matter where the consumption comes from, just as long as you consume. So, when the people are cash poor, the government can borrow from the future or inflate the currency to increase consumption in the present which appears to grow the economy. Unfortunately, they do not see how the nation gets poorer when they do this. What they miss is production comes first and production needs investment which comes from society's excess past production, aka savings.

The reason the government spending paradigm fails is that inflation kills it in the end. Do you really think a government couldn't spend an infinite amount of money to create an infinitely great economy?  Money without production is worthless. As I said, demand is infinite. If the government money generation is equally limitless, then we have a situation where the government creates fake production (money is the representation of past production) with unending demand. That will only create poverty. Think of it this way, imagined production does not fill the shelves and the unlimited demand means lines will form to buy items which do not exist. Soviet style queues will form and  that simply is a pure, if not hellish,  poverty. You are not allowed to gain access to goods, yet the government is unable to deliver them, either.

Now, we are at the government stimulus part of the issue? Does stimulus work? Short answer is no. If government spending was the solution to all economic problems, we would have no economic problems. Simply every entitlement program would grow the economy and we would have zero debt, zero unfunded liabilities and endless prosperity. Somehow that happy result hasn't happened. We have untold levels of unemployment, $16T of debt and $120T of unfunded liabilities.

Why does this happen? First, you need to understand what investment is. Investment is the lending of money to others in order to create the future means of production in return for a specific portion of the profits. Keep in mind that the investment is the money you can afford to invest after you have produced enough to cover your immediate needs. In the animal model, it is everything you do before you die to get the result you want. It includes the thinking, the chase and the kill in the hunt. It includes the choice of a good place for your den and the creation thereof. Simply, you are living off your past success in order to achieve another success. If, as an animal, you cover your costs you live another day. If, you have a profit, you live many more days. In the modern world, people can use their excess production to buy stocks, bonds and other financial instruments in order to assist in building the future means of production for a return on that investment. The investment cycle is the often ignored part of the economy. Many feel you can skip that if government doles out the investment.

The biggest error of that concept is that government never lives or dies on their investment. They may always raise taxes to overcome their poor investments. Common investors lose money on poor investment choices. If a company makes a mistake, they risk bankruptcy. They will fail. Businesses have accounting practices which clearly shows, whether or not, their investments raise revenues. Government never does that. They love the cloudiness of their actions. If government was scientific, they would make very small changes in the laws and measure the success by the growth of revenue. Simply, if a single change in the tax code increased revenues by 10%, that would mean they did something right. Government does not care about that. They only care about whether or not you comply to their will.

That clearly shows that government will never be the best place to invest from. They just cannot do it for their very existence is never on the line. Only private individuals and private businesses can invest. They are the only rational entities capable of investing. They inherently have a true interest in a successful investment. The only way people profit from investing is when the means of production changes in a positive way that the free market agrees with.

The other issue with the government's "investment" in people, industries and programs is that if whatever they do does not boost production in needed commodities and services, they have just thrown our money away. Poor investment seems to be only a private sector problem due to ”irrational exuberance" (Alan Greenspan). In fact, some of their "investments" are merely social programs which push consumption without any true investment in the means of production. Simply, you are consuming without a serious amount of production, so in the end there are less products and services. Few ever question the government's poor investments due to the foolish laws passed to control human behavior. People usually will find a way around the rules and ultimately the government's rules do not have the desired results in the end. Think about it. The government spends billions to change behavior and it fails. Where does the money go? Down the toilet! It is wasted. The biggest disasters are that the private sector didn't get the chance to keep the money taken through taxes and wasted. The private sector didn't get the chance to borrow that money for true investment in the means of production.

A great example of poor government investment is Solyndra. The government spent money trying to boost a solar energy company in order to artificially create a public market for solar technology. It was a company favored by the government to create solar energy solutions. In the end, they went bankrupt and the American taxpayer is now on the hook for the guaranteed loans. You and I never picked that stinker as an investment. Our government did and we are now stuck.

GM is reported to still be on the road to bankruptcy. More of our money was spent by our government to prop up a privileged company and the taxpayer will be stuck with the tab. That is crony capitalism and not free market capitalism That is not careful investment, but payouts to campaign contributors. Those contributions are both direct from the company or indirect from the unions which wished to prevent the judgment day on their foolish contract demands which aided the demise of a once great company.

Finally, I will summarize the horrible affect of government action. The inflation of the currency or piling up of insane debt in order to grow the economy managed by government is counter productive. The money the government destroys hurts every American citizen and business. Every dollar the government borrows is a dollar a wise, free market business doesn't have the opportunity to borrow.

A truly free economy will be prosperous for no other reason as it can react as fast a free people's ability to choose the most beneficial use of that economy. There is no long wait for the government to act, the free market driven choices occur immediately and continuously.

The best economy is the economy the people choose. Government with lobbyist's money may not choose the economy we need. We deserve a free economy with the direct influence of a free people using the free market.

 I offer you two things I truly believe. 

The economic cycle is most honestly described as: Demand, Production and then Consumption.

The free market is the most direct, honest director of the economy.

No comments: