Nobel Prize winner William Vickrey wrote an article with an amusing title, Fifteen Fatal Fallacies of Financial Fundamentalism, in which uses the usual Keynesian thinking to disagree with sound economics.
Never one to miss an opportunity for winning a Noble Prize, Dave decided he will show the errors in Vickrey’s thinking. When Dave’s article gets the attention it deserves, surely the Prize committee will take back the prize from Vickrey, who knows nothing about economics, and hand it over to Smiling Dave, who could use the money and prestige to live the high life.
As always, quotes in italics, me in normal font. Let’s dive right in to the first supposed fallacy Vickrey supposedly refutes:
Deficits are considered to represent sinful profligate spending at the expense of future generations who will be left with a smaller endowment of invested capital.
He refers to deficits in the govt’s budget. Very well put. That’s exactly what govt deficits are. So why does Vickrey think govt deficits are OK?
This fallacy seems to stem from a false analogy to borrowing by individuals.
What? No analogy here. The argument applies directly to govt spending, without resorting to analogies. Deficits means you are borrowing money. Which someone will have to repay with interest. Exactly what the “fallacy” says. Here’s why Vickrey think it’s a fallacy:
Current reality is almost the exact opposite. Deficits add to the net disposable income of individuals, to the extent that government disbursements that constitute income to recipients exceed that abstracted from disposable income in taxes, fees, and other charges.
In other words, the US govt borrows the money from the Chinese, and gives it away for free to all the happy citizens. Just like Greece and the other PIIGS did recently. What could possibly go wrong?
This added purchasing power, when spent, provides markets for private production, inducing producers to invest in additional plant capacity, which will form part of the real heritage left to the future.
The citizens take that free money and spend it. And now producers get all that money and will build new factories with it, which we will leave for our children and grandchildren to benefit from. So we are not ripping off the future generations when we borrow that Chinese money, says Vickrey. Just the opposite, we are making them richer, with increased productive capacity. They will look at all those factories we built and thank us.
Sounds lovely, no? Yes, it sounds lovely on paper. The reality is a bit harsher. Well, much harsher.
First of all, Vickrey’s cheery scenario assumes the citizens getting all that free money will buy local products with it. But for some odd reason, this never happens. The money always seems to go abroad. The PIIGS spent their free money on German and Chinese goods, not on PIIGy goods. The reason is, of course, that the PIIGS are so used to getting free money they don’t feel like actually working. Thus, nothing is produced in the PIIG countries, and so the money is spent abroad.
Same thing is happening in the US. We net import many billion dollars a day of Chinese goods, have been for many many years, basically since we started taking Vickrey’s Nobel Prize quality advice in the nineties. Now, maybe future generations of Americans will be very pleased at the lovely Chinese factories they helped build in China. But those Chinese factories will not belong to our children. They may form part of the heritage left to the future, but not our future.
This is in addition to whatever public investment takes place in infrastructure, education, research, and the like.
The money the govt borrows from the Chinese and keeps for itself, as opposed to handing out free to the voters, will be spent on bettering our situation, making us smarter as we tool around on our govt highways whose potholes have all been fixed. So says Vickrey.
Again, that’s not what happened, is it? Obama is whining about our infrastructure and education to this very day. All that borrowed money, trillions of dollars over the years, and our infrastructure is worse than ever, as is our education.
And why? Where is the hole in Vickrey’s reasoning? Simple. The govt does not borrow money to improve the lot of its citizens, to educate them and give them free education and free infrastructure. It borrows money to improve the personal lives of politicians. That’s just the way it is. Or maybe the last few decades were an exception, and from now on things will be different. But so far Vickrey is dead wrong.
Larger deficits, sufficient to recycle savings out of a growing gross domestic product (GDP) in excess of what can be recycled by profit-seeking private investment, are not an economic sin but an economic necessity.
In other words, people sometimes do something awful to the economy, say Vickrey. They save their money. They do this because they want to be able to retire, or pay for their children’s education, or other evil reasons. This is terrible, and we have to find a way to get that money out of their hands. Now some of it they will save in banks, who will lend the money to investors, and that’s fine. But what about the rest, the money these people stubbornly refuse to put in a bank, but stash under the mattress? We have to take that away from them.
Vickrey presumes that a nice fat govt deficit will take care of things. Just have the govt borrow enough money from the Chinese, and the money under the mattress will dissolve somehow. Of course, this makes no sense whatsoever. So Vickrey must be talking not about borrowing money from the Chinese, but about deficit spending that will be paid for by printing new money. That will cause inflation, and yes, it will indeed wipe out any savings people may have.
And this is a necessity, says Vickrey. We just have to make sure nobody can save anything. Vicker doesn’t explain why he thinks so, but Smiling Dave can read his mind. It’s because money saved supposedly reduces aggregate demand, which, like a good Keynesian, Vickrey thinks is a bad thing. We have written many articles explaining why he’s wrong [such as this one, which gives Mises’s reason].
But let’s note for now that Vickrey is admitting that inflation wipes out everyone’s savings. This may be important when he talks later about how great inflation is.
Even the analogy itself is faulty. If General Motors, AT&T, and individual households had been required to balance their budgets in the manner being applied to the Federal government, there would be no corporate bonds, no mortgages, no bank loans, and many fewer automobiles, telephones, and houses.
Even his reasoning is faulty. He doesn’t understand that there are two kinds of borrowing. You can borrow to consume, like a drug addict borrowing money to buy more drug, or you can borrow to increase your production, like corporations do. if you borrow to consume, you will go broke, because you have to repay the loan with interest. Only if you borrow to increase production can you use the profits from the increased production to pay off your loan, and have some profit left over.
The govt certainly does not borrow to increase production, because it does not produce anything. The govt borrows to consume, to spend, to use up resources for its own desires. Our children will be left having to pay the loans back with interest, and with their capital stock depleted by the govts present gobbling up of resources.
Well, we have dealt with only the first fallacy of Vickrey’s, and it’s already a long article. So we’ll end now, and see about future articles later.