As I read the various statements arising from the debate over the stimulus package, I have come to see the fundamental differences between supports of the bill and opponents as stemming from their conception of what money is.
All simplifications of complex phenomena have limitations. They nevertheless can be extraordinarily helpful in facilitating our understanding. Opponents of the stimulus package may be categorized as those who believe that money is a thing. In point of fact, many of these same people have advocated the position that only gold is ‘real’ money. In this view, there is only a fixed supply of wealth in the world and any increase in the money supply is an offense against the natural order. One supposes that the extremists holding this position believe that there should be no banks or lending.
Proponents of the package, by-and-large, understand money as a medium of exchange representing, ultimately, human effort. In this understanding, gold coins, for example, are merely tokens, just as are cowrie shells or pieces of paper. As long as the tokens are accepted as representing effort, they are money.
Many projections expect US gross domestic product to fall by 1.5 to 2 trillion dollars this year. It is funny to see how this can happen, given the fact that people still WANT as much this year as last year. They still need food, clothing, shelter, and DVD players. Folks still prefer shiny new automobiles to clunky older ones. Leaky roofs still need to be mended, kids’ cavities filled, the deceased to be buried. Yet somehow, there will be less of all these activities this year. Why? There are not fewer people.
The short answer is that there is less money this year than last. Banking creates money. (As I use ite here, ‘banking’ includes the whole panoply of allied activities that take folks’ idle wealth and put it into the (hopefully) productive hands of others (e.g. as the bond market).) As we all learned in Econ 1, a bank can turn $100 into far more money via the miracle of lending. The precise multiplier depends sensitively on the reserve requirements imposed by external regulators. The more lending in an economy, the more money there is.
Sadly, when banks (etc.) have to start calling in their markers, as they have had to do increasingly since August of ’07, the money supply can shrink just as much as it grew when the loans were out there. The net result of all this calling-in-of-loans has been to vaporize trillions of dollars. In a flash, money that was there and trusted vanished. Overnight, in some cases. All of a sudden, there was a lot less money in our (and the world’s) economy. As we know, it takes money to get things done – less money leads to less doing.
To counteract the resulting ‘liquidity crunch’ (lack of ready cash), the Federal Reserve has been pouring oodles of cash into the financial sector for the past 18 months and not just through the bailout approved last October. Without the Fed’s early action in this crisis, things would have come to a head sooner than they eventually did. There is debate over whether the resulting delay merely put off the final reckoning or whether it has softened the blow. Likely, it’s a little of both.
In any event, a contraction in the money supply has lead directly to a contraction in output – nothing else has changed. Raw materials are just as available as last year. Factories are still just as capable of producing. Workers want paychecks just as much as before. The only thing missing is the money.
In this circumstance, as John Maynard Keynes demonstrated nearly 80 years ago, it is devilishly hard to use standard economic devices to get the economy back to its proper productivity. The solution is, essentially, a massive influx of money. Sadly, no participant in the economy is capable of providing such an injection once all that money has vaporized. No one but the entity that issues the money, that is.
Keynes showed that when an economy is well below its productive capacity, the creation of money by the government (usually in the form of deficit spending) has an effective cost of zero. This is because the real costs of any choice are the other choices we must forgo in opting for a given one. If the choice we face is between something and nothing, then no such tradeoffs exist and there is effectively no real cost.
For example, Grand Coulee Dam was built at a time when the engineers, construction workers, truck drivers, cement plant operators, etcetera, would have been otherwise unemployed. That is, they would have produced nothing at all if they hadn’t been producing Grand Coulee. There was no opportunity cost because Grand Coulee was the only opportunity. For this reason, the real economic cost of the project was zero. But that is not to say the same for the benefits – Grand Coulee continues to produce electricity and irrigation resources that render the local and US economies wealthier than if it did not exist (I am conveniently ignoring the environmental costs of the dam – that’s a different discussion for another time. Here we’re simply speaking of money and economic output.)
The impact on the economy at the time Grand Coulee was being built was huge. Suddenly, thousands of people who had wants and needs had the money to satisfy them. In turn, those who were satisfying the wants and needs (grocers, farmers, railroads, physicians, the local school district and so on) suddenly found that they too had the money they needed to participate in the economy again. And so it went. The ability to produce goods and services hadn’t changed a bit. The only difference was that now folks had the money to spend on them again. In consequence, output rose to meet demand.
Opponents of the current stimulus package argue that it is too expensive, placing too great an obligation on our posterity. What has not been in evidence is a concern for the costs of NOT doing something. What of the up to $2 trillion in lost output? What of the costs of a protracted contraction of our output and the resulting impoverishment of ourselves and our posterity? Those are real, physical, human costs. How are we to pay for them?
Of course, in terms of cash outlay, nobody pays those costs. We nevertheless will bear them, some among us far more than others. Just as inflation benefits debtors at the expense of creditors, so deflation benefits creditors at the expense of debtors. To many of those who are arguing against the stimulus package, that is just fine – they are more likely to be creditors than debtors, after all. Despite such obvious conflicts of interest, valid concerns with the legislation do exist.
One rational objection to the stimulus is that the bill may end up instituting governmental organizations that will outlive their (hopefully brief) usefulness. This is a genuine concern, but I have heard of no specific example of the creation of such an entity in the present bill.
Another objection is that it is just so damned hard to know just how much stimulus is appropriate that it’s too easy to overshoot the mark and set off an uncontrolled inflationary spiral. This too is a legitimate objection. It seems, however, that spending $760 billion over two years in the face of a $1.5 – 2 trillion dollar annual shortfall in out putis within the safe zone on this one. Currently, we have too few dollars chasing goods and services so prices (and in consequence output) are falling. We could create a whole lot of dollars out of thin air before we have too many dollars chasing too few goods.
One more point: one thing that can never happen, for as long as it exists, is that the US Government will default on its debts. This is true for the simple reason that the US government IS the dollar. If some foolish creditors tried to demand all of the money that the US owed them, then the US could pay the debt in (increasingly worthless) dollars. [When you stop to think about it, it’s actually quite an amazing thing that any foreigner is willing to lend to a sovereign government in its own currency]. Now, paying interest on our accumulated debt is a separate matter and one that surely can lead to ruin.
Given the current mass of our public debt, paying the interest due (even with no further addition to the obligation) seems more likely to tank us if the economy contracts than is a 10% increase in our debt if we can get things back on track.
Spending money, even ‘uselessly’ is the way to get things back on track.
Keynes gave us the evocative image of paying one man to dig a hole and paying another to fill it in. He demonstrated that as long as they were being paid, the economy would benefit. Of course, the economy benefits more if we build bridges, highways, hiking trails, and post offices rather than digging and filling holes, but it is the spending, first and foremost, that matters.
Why this proposition remains controversial has nothing to do with the evidence and everything to do with the narrowly-defined self interests of the nay-sayers. For example, Senator Mitch McConnell made the flat out statement the other day that this stimulus sounded like the New Deal (which it does, kinda) and that the New Deal didn’t work. This is much like saying that organic evolution hasn’t occurred. It’s a perfectly reasonable position if the evidence before us is dismissed out of hand because it conflicts with one’s notion of one’s faith. On the other hand, if one’s opinions are at all influenced by evidence, such a statement is absurd.
True, by itself, the New Deal didn’t end the Great Depression – to end it took the largest public works project ever undertaken by the US Government (or any government, for that matter, as a percentage of world output). This publics work project is known by different names in different countries, but we usually call it World War II. Take a look at the bottom graph on the attached sheet, that shows the annual percent change in gross domestic output for the US from 1930 to 2006 (inflation-adjusted to the value of the dollar in the year 2000). Is there any striking period of growth? What years are involved?
We are not yet in a situation nearly as bad as the events that lead to the Great Depression, thank God. This may, in part, be owing to the actions of the Federal Reserve and other central banks and of the US treasury. These organizations have consciously avoided responding to the liquidity crisis the way they did in 1930 and this has probably averted a Depression-style disaster. All the same, output is still falling around the world and it’s all because there is less money today than there was a year ago. Get the money back and we’ll get the economy back.
All simplifications of complex phenomena have limitations. They nevertheless can be extraordinarily helpful in facilitating our understanding. Opponents of the stimulus package may be categorized as those who believe that money is a thing. In point of fact, many of these same people have advocated the position that only gold is ‘real’ money. In this view, there is only a fixed supply of wealth in the world and any increase in the money supply is an offense against the natural order. One supposes that the extremists holding this position believe that there should be no banks or lending.
Proponents of the package, by-and-large, understand money as a medium of exchange representing, ultimately, human effort. In this understanding, gold coins, for example, are merely tokens, just as are cowrie shells or pieces of paper. As long as the tokens are accepted as representing effort, they are money.
Many projections expect US gross domestic product to fall by 1.5 to 2 trillion dollars this year. It is funny to see how this can happen, given the fact that people still WANT as much this year as last year. They still need food, clothing, shelter, and DVD players. Folks still prefer shiny new automobiles to clunky older ones. Leaky roofs still need to be mended, kids’ cavities filled, the deceased to be buried. Yet somehow, there will be less of all these activities this year. Why? There are not fewer people.
The short answer is that there is less money this year than last. Banking creates money. (As I use ite here, ‘banking’ includes the whole panoply of allied activities that take folks’ idle wealth and put it into the (hopefully) productive hands of others (e.g. as the bond market).) As we all learned in Econ 1, a bank can turn $100 into far more money via the miracle of lending. The precise multiplier depends sensitively on the reserve requirements imposed by external regulators. The more lending in an economy, the more money there is.
Sadly, when banks (etc.) have to start calling in their markers, as they have had to do increasingly since August of ’07, the money supply can shrink just as much as it grew when the loans were out there. The net result of all this calling-in-of-loans has been to vaporize trillions of dollars. In a flash, money that was there and trusted vanished. Overnight, in some cases. All of a sudden, there was a lot less money in our (and the world’s) economy. As we know, it takes money to get things done – less money leads to less doing.
To counteract the resulting ‘liquidity crunch’ (lack of ready cash), the Federal Reserve has been pouring oodles of cash into the financial sector for the past 18 months and not just through the bailout approved last October. Without the Fed’s early action in this crisis, things would have come to a head sooner than they eventually did. There is debate over whether the resulting delay merely put off the final reckoning or whether it has softened the blow. Likely, it’s a little of both.
In any event, a contraction in the money supply has lead directly to a contraction in output – nothing else has changed. Raw materials are just as available as last year. Factories are still just as capable of producing. Workers want paychecks just as much as before. The only thing missing is the money.
In this circumstance, as John Maynard Keynes demonstrated nearly 80 years ago, it is devilishly hard to use standard economic devices to get the economy back to its proper productivity. The solution is, essentially, a massive influx of money. Sadly, no participant in the economy is capable of providing such an injection once all that money has vaporized. No one but the entity that issues the money, that is.
Keynes showed that when an economy is well below its productive capacity, the creation of money by the government (usually in the form of deficit spending) has an effective cost of zero. This is because the real costs of any choice are the other choices we must forgo in opting for a given one. If the choice we face is between something and nothing, then no such tradeoffs exist and there is effectively no real cost.
For example, Grand Coulee Dam was built at a time when the engineers, construction workers, truck drivers, cement plant operators, etcetera, would have been otherwise unemployed. That is, they would have produced nothing at all if they hadn’t been producing Grand Coulee. There was no opportunity cost because Grand Coulee was the only opportunity. For this reason, the real economic cost of the project was zero. But that is not to say the same for the benefits – Grand Coulee continues to produce electricity and irrigation resources that render the local and US economies wealthier than if it did not exist (I am conveniently ignoring the environmental costs of the dam – that’s a different discussion for another time. Here we’re simply speaking of money and economic output.)
The impact on the economy at the time Grand Coulee was being built was huge. Suddenly, thousands of people who had wants and needs had the money to satisfy them. In turn, those who were satisfying the wants and needs (grocers, farmers, railroads, physicians, the local school district and so on) suddenly found that they too had the money they needed to participate in the economy again. And so it went. The ability to produce goods and services hadn’t changed a bit. The only difference was that now folks had the money to spend on them again. In consequence, output rose to meet demand.
Opponents of the current stimulus package argue that it is too expensive, placing too great an obligation on our posterity. What has not been in evidence is a concern for the costs of NOT doing something. What of the up to $2 trillion in lost output? What of the costs of a protracted contraction of our output and the resulting impoverishment of ourselves and our posterity? Those are real, physical, human costs. How are we to pay for them?
Of course, in terms of cash outlay, nobody pays those costs. We nevertheless will bear them, some among us far more than others. Just as inflation benefits debtors at the expense of creditors, so deflation benefits creditors at the expense of debtors. To many of those who are arguing against the stimulus package, that is just fine – they are more likely to be creditors than debtors, after all. Despite such obvious conflicts of interest, valid concerns with the legislation do exist.
One rational objection to the stimulus is that the bill may end up instituting governmental organizations that will outlive their (hopefully brief) usefulness. This is a genuine concern, but I have heard of no specific example of the creation of such an entity in the present bill.
Another objection is that it is just so damned hard to know just how much stimulus is appropriate that it’s too easy to overshoot the mark and set off an uncontrolled inflationary spiral. This too is a legitimate objection. It seems, however, that spending $760 billion over two years in the face of a $1.5 – 2 trillion dollar annual shortfall in out putis within the safe zone on this one. Currently, we have too few dollars chasing goods and services so prices (and in consequence output) are falling. We could create a whole lot of dollars out of thin air before we have too many dollars chasing too few goods.
One more point: one thing that can never happen, for as long as it exists, is that the US Government will default on its debts. This is true for the simple reason that the US government IS the dollar. If some foolish creditors tried to demand all of the money that the US owed them, then the US could pay the debt in (increasingly worthless) dollars. [When you stop to think about it, it’s actually quite an amazing thing that any foreigner is willing to lend to a sovereign government in its own currency]. Now, paying interest on our accumulated debt is a separate matter and one that surely can lead to ruin.
Given the current mass of our public debt, paying the interest due (even with no further addition to the obligation) seems more likely to tank us if the economy contracts than is a 10% increase in our debt if we can get things back on track.
Spending money, even ‘uselessly’ is the way to get things back on track.
Keynes gave us the evocative image of paying one man to dig a hole and paying another to fill it in. He demonstrated that as long as they were being paid, the economy would benefit. Of course, the economy benefits more if we build bridges, highways, hiking trails, and post offices rather than digging and filling holes, but it is the spending, first and foremost, that matters.
Why this proposition remains controversial has nothing to do with the evidence and everything to do with the narrowly-defined self interests of the nay-sayers. For example, Senator Mitch McConnell made the flat out statement the other day that this stimulus sounded like the New Deal (which it does, kinda) and that the New Deal didn’t work. This is much like saying that organic evolution hasn’t occurred. It’s a perfectly reasonable position if the evidence before us is dismissed out of hand because it conflicts with one’s notion of one’s faith. On the other hand, if one’s opinions are at all influenced by evidence, such a statement is absurd.
True, by itself, the New Deal didn’t end the Great Depression – to end it took the largest public works project ever undertaken by the US Government (or any government, for that matter, as a percentage of world output). This publics work project is known by different names in different countries, but we usually call it World War II. Take a look at the bottom graph on the attached sheet, that shows the annual percent change in gross domestic output for the US from 1930 to 2006 (inflation-adjusted to the value of the dollar in the year 2000). Is there any striking period of growth? What years are involved?
We are not yet in a situation nearly as bad as the events that lead to the Great Depression, thank God. This may, in part, be owing to the actions of the Federal Reserve and other central banks and of the US treasury. These organizations have consciously avoided responding to the liquidity crisis the way they did in 1930 and this has probably averted a Depression-style disaster. All the same, output is still falling around the world and it’s all because there is less money today than there was a year ago. Get the money back and we’ll get the economy back.
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