LESSONS LEARNED #80: “A nation’s government spends too much when its spending increases at a rate greater than its population growth.” – Old Pithy

Posted by PITHOCRATES - August 25th, 2011

Exchanging Dollars for Gold at $35/ounce was a Strong Incentive not to Depreciate the Dollar

It’s no secret.  Government spending is growing out of control.  It’s producing record deficits.  That caused S&P to downgrade America’s AAA sovereign debt rating.  No one denies that it’s a problem.  This spending.  Those on the Right want to address this via spending cuts.  Those on the Left just want to keep raising taxes.

LBJ exploded government spending with his Great Society in the Sixties.  Back then the U.S. was still on a quasi gold standard.  The U.S. honored an exchange of dollars for gold.  The point of this was to prevent the government from printing too much money.  Print too much and you depreciate the dollar.  So when you promise to exchange dollars for gold at $35/ounce you have an incentive not to depreciate the dollar.  Because as that $35 will buy less and less everywhere else, it will always buy an ounce of U.S. gold.

Well, with the Vietnam War and the Great Society, President Nixon had an unpleasant decision to make.  Unpleasant for a politician.  Either cut spending.  Or print money.  Politicians don’t like cutting spending.  So he printed money.  Which depreciated the dollar.  And countries were taking those cheap dollars and exchanging them for lots and lots of U.S. gold.  There was so much gold flying out of the country that Nixon did something shocking.  We call it the Nixon Shock.  He said the U.S. would no longer honor the dollars for gold exchange.  That was in August of 1971.  And prices have never been the same since.

The Growth of the CPI took off following the Nixon Shock

Keynesian economists were happy to see the end of the gold standard.  Because they like printing money.  And they’ve been advising governments to do just that.  To put an end to the business cycle.  And recessions as we know it.  For when the signs of recession are apparent, the government can pump a lot of dollars into the economy.  Thus avoiding a recession.  This was the policy since the adoption of the Federal Reserve Act in 1913.  Which put the nation’s best and brightest in charge of the American economy.  Who were unable to prevent numerous recessions.  A Great Recession.  And a Great Depression.

So the Keynesians have failed in preventing recessions.  Of all sizes.  Worse, their inflationary policies of freely printing and spending money has increased prices.  Caused a sharp increase in the growth rate of the Consumer Price Index (an inflation indicator).  As you can see in the following chart.  Where we graph government spending (outlays) and the CPI.  Dollar amounts are in billions of constant 2005 dollars.  Data is plotted in 10 year intervals.

 

(Sources:  Outlays, CPI)

You can see that the rate of growth in the CPI took off following the Nixon Shock.  That was the price for government printing money to keep spending beyond its means.  To make everything cost more in real dollars for us.  The consumers.  This shrinking of our paychecks put an end to the single wage-earner as we knew it.  Today the norm is that it takes two incomes to raise a family.  The exception is when one can do it.

Even before the Nixon Shock you could see that government was spending beyond its means.  Increasing its spending greater than the rate of inflation.  That means the size and number of government benefits was growing.  And it continued to grow until the Nineties.  When a Republican House forced a liberal president to the center.  After the Republicans won the 1994 midterm electionsBill Clinton‘s welfare reform decreased the growth rate of government.  For the first time after World War II.  But George W. Bush liked to spend the money.  Barack Obama, too.  Even more so.  Who took government spending to new highs with his $800 billion stimulus.  And his Obamacare.

The Number and Size of Benefits are growing Faster than the Population

Of course, you have to be careful not to let those benefits grow faster than the population.  Because government revenue comes from the taxpayers.  An increasing population means increasing tax revenue.  Because more people are paying taxes.  A decreasing population means declining tax revenue.  Because fewer people are paying taxes.

Likewise, spending that grows less than the population growth rate means a government is spending within its means.  Spending that grows greater than the population growth rate means a government is spending beyond its means.  And most probably running deficits.

We can see this if we graph population with government spending (outlays).  And we do that in the following chart.  Population is in numbers of people.  Outlays are in billions of constant 2005 dollars.  Data is plotted in 10 year intervals (to correspond with the decennial census).

 (Sources:  Population, Outlays)

Up until the Nineties, government spending increased at a greater rate than the population grew.  Clearly indicating that the number and size of benefits was growing relative to the population.  In particular, you can see an upward bend in outlays with the onset of the Great Society. 

This new growth rate remained consistent through the heyday of Keynesian economics.  The Seventies.  And through Reaganomics.  The Eighties.  Democrat Bill Clinton reduced the growth rate of government spending during his two terms in office.  Thanks to a Republican House.   But George W. Bush liked to spend the money.  For a couple of wars.  And a new Medicare prescription drug program.  And then Barack Obama became president.  And made George W. Bush look like a cheapskate when it came to government spending.

We are Spending Money at a Greater Rate than we’re Creating New Taxpayers 

Currently, the rate of government spending is increasing far greater than the population growth rate.  Meaning we are spending money at a greater rate than we’re creating new taxpayers.  Which can only mean one thing.  Record deficits.  Which we have.

We cannot sustain this spending.  It’s not a matter of insufficient tax revenue.  We’re just spending too much.  If we continue to spend at this rate there won’t be enough money to tax away from the private sector to pay for it.  Unless we have another baby boom.   Far greater than the last one.  But babies take time to grow up.  Before they become taxpayers.  Some twenty years or more before they pay any significant taxes.  So that’s a long-term solution at best.

But with the high cost of raising a family that isn’t likely.  Thanks to permanent inflation.  Courtesy of Keynesian economics.  With the way they (Keynesians) bent the CPI graph upward, big families are a thing of the past.  So that’s not an option.  That leaves one thing.  Spending cuts.  Significant spending cuts.  The very thing that would have preserved America’s AAA credit rating.

And you know how politicians love spending cuts.

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