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Tooth Fairy Economics



Thomas E. Woods, Jr.
Campaign for Liberty
February 18, 2009

So the "stimulus" package, a dagger through the heart of the economy, has passed. The geniuses who govern us, who insist that seizing the produce of the voluntary economy and devoting it to arbitrary projects will make us wealthy, have had their victory.

Much of the debate turned, unfortunately, on how much "pork" was in the bill. This or that spending program was silly or an obvious waste of money, critics said. All too true, of course, but unless we're looking to be hired by the Titanic's Department of Deck Chair Rearrangement, we're missing the point with arguments like this.

The primary fallacy of the tooth-fairy economics at the heart of the stimulus is the very idea that economic health is the product of government spending, which is financed either by borrowing (which leaves private businesses with a smaller share of the pool of savings for them to borrow from), printing money out of thin air, or direct seizure from the population. Whatever government spends the money on is necessarily arbitrary -- government lacks the profit-and-loss feedback mechanism that keeps the private sector from squandering resources and employing factors of production in ways that do not cater to consumer wants. It can seize its resources from the people without their consent, and it makes no difference to government whether or not people actually want or wind up using the things it produces. Meanwhile, the economy loses the goods that would have been produced by the voluntary sector had the government not seized these resources for its own use.

The more sophisticated Keynesians, if that isn't an oxymoron, will come back with the argument that while they really do agree with you in cases when the economy is experiencing "full employment," your point doesn't apply when there are "idle resources." In that case, we can "stimulate" those idle resources into action without drawing resources out of alternative employments. These resources currently have no alternative employments.

Nice try. But whatever projects our wise planners come up with to put these "idle resources" to work will inevitably draw complementary resources away from alternative employments that are more urgently desired than what the government intends to use them for. Resources will unavoidably be drawn from current employments in the attempt to kick-start "idle resources." So the "idle resources" argument doesn't really manage to evade the opportunity-cost problem.

Beyond that, pro-stimulus thinkers show remarkably little curiosity about why the so-called idle resources are idle in the first place. They are idle because of some previous entrepreneurial miscalculation. What might have caused systemic miscalculation of this kind? Could it be the Federal Reserve's manipulation of interest rates, which leads investors to make incorrect assessments of profitability and provokes false economic booms, as F.A. Hayek won the Nobel Prize for showing in 1974?

Consider a circus that comes to town for a few weeks. A restaurant owner may expand his seating capacity in the false expectation that the circus and the related demand for his food that it brings in its wake will last forever. But when the circus leaves town, he'll find he has "idle resources" on his hands. We should not want to put these idle resources to work. Doing so would only draw labor and other resources away from other sectors of the economy, where they are employed in the satisfaction of real consumer demand. The expansion of the restaurant should not have occurred in the first place. We should want this bubble activity to shrink back down to size, in order that other, non-bubble activities in the economy can be correspondingly strengthened.

In the wake of a previous, unsustainable boom brought about by the central bank's credit expansion, the market economy and its price system, left to their own devices, will adopt another arrangement of resources that employs available factors in the service of producing goods and services that correspond to real consumer demand. During the bust, free individuals interacting within the market nexus sort out which projects and business ventures are healthy and sustainable, and which are bubble activities that cannot survive without a constant artificial increase in the money supply, and cannot (and should not) survive now that reality has reasserted itself.

That's what the market was allowed to do in the long-forgotten depression of 1920-21. Instead of a "fiscal stimulus" package, the government cut its budget. The Fed, for its part, did little. Meanwhile, the economy was allowed to clean out the malinvestments of the false boom of previous years, thereby making a robust recovery possible.

The artificial housing boom made Americans feel wealthier than they really were. As a result, they consumed more than they would have if the Fed-created housing bubble had not distorted their assessments of their net worth. What the economy needs now, therefore, is not "spending" per se. Too much spending and debt caused the initial problem. People bought more house than they could afford, and on the basis of its seemingly incessant appreciation they went out and purchased more consumer goods than they now realize they should have. Americans are in more debt than they can pay back -- credit-card defaults will provoke calls for the next round of bailouts. How can "spending" solve this problem?

Meanwhile, part of the reason the American savings rate has been so low is that for many Americans, saving seemed superfluous: after all, they possessed an asset that (they falsely believed) was guaranteed to appreciate over time. That, after all, is what the experts told them. The dramatic rise in housing prices isn't an unsustainable bubble that has to burst, Fed economists said. It is a sustainable increase based on real factors.

Oops.

We should not want to "stimulate" an economy based on debt and overconsumption back into existence. We should want to restructure it along sustainable lines.

For instance, we're now learning that Starbucks, at least in its one-store-every-ten-feet business model, was a bubble activity. With the housing bubble having burst, people now have a more accurate estimate of their real level of wealth. They're now less likely to buy a $5 cup of coffee -- or, in the case of the ailing Cold Stone Creamery, spend $6 for an ice cream cone. These are resources that need to be freed up so business firms carrying out genuine, non-bubble activities can be strengthened and the recovery accelerated.

In his recent press conference, President Obama cited the case of Japan as if it were evidence for his side of the argument. Exactly the opposite is true. Japan has done everything to itself that our government has done and is threatening to do to us, and with no results. From partial nationalization of its banking system to "stimulus" packages amounting to trillions of yen, from propping up zombie companies and dropping interest rates to zero, they've tried it all.

Naturally, the Keynesian response is that Japan simply didn't spend enough. Oh? Thanks to the misnamed "stimulus" packages that the Japanese government imposed on its hapless people, Japan is the most indebted country in the developed world. So becoming the most indebted country in the developed world -- and that's saying something -- still isn't enough spending for Keynesians?

What would be enough, then? A quadrillion dollars? A googol dollars? Infinity minus one dollars? It'd be interesting to know what "stimulus" figure might make a Keynesian declare, "Now that's too much!"

If there's one silver lining to the crisis, it's that more and more people are figuring out that so-called respectable opinion has been dead wrong, and for a long time. The economics profession, by and large, has embarrassed itself with a Keynesianism so crude it would not satisfy a bright sixth-grader. People trotted out as experts, who failed to see the crisis coming and have no idea how it occurred -- "excessive risk-taking!" they say, in a non-explanation that merely begs the question -- have no idea how to solve it.

This, incidentally, is why I wrote my new book Meltdown, which gives a free-market overview of what caused the problem, where we are now, and how we get out. People are ready to listen to reasonable, previously neglected ideas, especially if the people who hold them managed to predict the current crisis -- as indeed the economists of the Austrian School did. It's up to us to bring them these ideas.

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Government is not the panacea for an ailing economy
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