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The Daily Capitalist: What Would Warren G. Harding Do?

Watch out for the Do-Something Congress, which is just itching to help

I’ve been watching TV reporters interview out-of-work people around the country. They are all good and worthy people not looking for a handout, and they deserve to have good jobs and financial well-being. Almost to a person they are looking forward to the success of President Obama’s stimulus bill. I talk to a lot of small businesses and many are hurting right now. They all believe — or hope — that the economy will start to rebound later this year. In fact, many are banking on this fact, so to speak.

Almost everyone in the media who discusses the crisis thinks some kind of fiscal stimulus is needed. Arguments about how and what are the only difference between Democrats and Republicans. Something has to be done is the usual response.

I’m a dissenter. I think the proposed bill will actually harm the economy and make things worse. Of course, I’m not the only one saying this. The problem with talking about this is that you have to get down into economic theory to convince people of your argument, and most people aren’t interested in economic theory. “Just do something!” the say.

Most people now accept as “common sense” that the government has to do something. They argue that since spending has contracted, all we need to do is have the government spend huge amounts of money, distribute the goodness throughout the economy, and this new wealth will “prime” the economic pump and “kick start” the economy.

Like all simple ideas applied with good will to a complex situation, they often backfire and achieve the opposite of what was intended. This is referred to as the Law of Unintended Consequences. In our situation, the proposed Keynesian massive government spending to stimulate the economy ignores basic laws of economics. Its proponents confuse wealth and money. Dropping money from the sky is just that: pieces of paper. If it worked, the people of Zimbabwe would all be rich.

On the other hand, what makes the economy go is wealth. Wealth is created by not spending or consuming all of what you produce. By saving goods that you produce “real” savings are created. If money were just a medium of exchange representing saved wealth, then money would equal wealth. But if you can just print money at will, it has no relation to wealth, and just spreading around cash does not make the economy prosper and grow.

The Fed does the money thing quite well. Every time it creates a lot of new credit (money), it starts up a new cycle that isn’t based of saved wealth. In our current cycle it went into the housing market. The time before it went into tech stocks. When we stopped printing money (creating credit) the boom collapsed because, to a large extent, it wasn’t supported by real wealth, just pieces of paper. This resulted in a lot of malinvestment in houses and securities related to housing debt.

Whoops, I’ve just discussed theory. Sorry for that. But isn’t this what our government is proposing to do? It will create credit, borrow money and spend it on projects it thinks are worthy. The chosen projects are based on political decisions not economic reality. This money will be wasted for the most part. If we get some roads built, fine, but at this point less than $30 billion of the total $800 billion will go for public infrastructure. Nothing will be created from this spending. Only the private economy can create businesses, jobs and wealth. The government just spends. Once the spending stops, the flurry of activity will stop.

Now this is something that the Japanese experienced from 1989 to about 2004. Japan had a real estate boom created by a credit cycle that crashed when the Bank of Japan increased interest rates. To cure the problems resulting from the crash, Japan slashed its “Fed funds” rate to zero and went on a huge government infrastructure spending binge. They tried this again and again but nothing worked. The result: Japan’s economy stagnated for almost 15 years, they had a lot of bridges to nowhere and their government ended up with huge debt.

I ask supporters of Keynesian-style stimulus to show us when massive government spending ever worked to revive an economy. They can’t because it has never worked. They have plenty of excuses for its failure: didn’t spend enough, didn’t spend soon enough, intervening circumstances, and the like. But the bottom line: it doesn’t work.

Nothing the Fed or the Treasury has done so far has worked. The stimulus bill will result in a lot of money going into things people don’t want to pay for and it won’t help the economy. We (American taxpayers) will end up with huge debt that will have to be serviced from tax revenues. There is a tax reduction part of the stimulus bill, and that may help the economy because it leaves money in private hands, which can be used to create wealth and grow the economy. Because they won’t stop spending we’ll still end up with huge debt and a weak dollar.

If after all of this I told you that we’d be better off doing nothing, would you believe me or would you still call for the government to do something? Here’s something to think about. In 1920 there was a market crash of almost 33 percent (in 1929 the market went down 17.2 percent), unemployment averaged 11.7 percent by 1921. By the end of 1921 the market was up 12.7 percent, in 1922 it was up 21.7 percent. The recession was over in 18 months. How was it cured? The government did nothing. It corrected itself quickly. Thank you, President Warren G. Harding.

— Jeff Harding is a principal of Montecito Realty Investors LLC. A student of economics, he has a strong affinity for free-market economics. This commentary originally appeared on his blog, The Daily Capitalist.

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