Economic Stimulus

Posted by PITHOCRATES - November 5th, 2012

Economics 101

Prices match Supply to Demand letting Suppliers know when to bring more Goods and Services to Market

There is a natural ebb and flow to the economy.  Through good times and bad.  And you can tell which way the economy is heading by prices in the market place.  When prices are rising times are typically good.  As people are gainfully employed with money to spend.  As they compete with each other for the goods and services in the market place demand rises.  Growing greater than the supply of goods and services.  So prices rise.  Because when there are fewer goods and services they are worth more money.  For those who have them to sell.  Because demand is so great people are willing to pay top dollar for them.  To get them while supplies last.  This attracts the attention of other suppliers.  Who want to cash in on those high prices.  So they bring more goods and services to market.

In time supply catches up to demand.  And passes it.  Suddenly the market has more goods and services than people are buying.  As inventories grow retailers stop buying so much from their wholesale suppliers.  Who in turn stop buying so much from their manufacturers.  Who in turn stop buying so much from their raw material suppliers.  And manufacturers and their raw material suppliers begin laying off workers.  So there are fewer people gainfully employed with money to spend.  The fewer gainfully employed buy less than the more gainfully employed.  Causing inventories to grow larger as more goods are going into them than are coming out of them.  So they start cutting prices.  To unload these inventories before people start buying even less.  Because they spent a lot of money to build those inventories.  And it costs to hold these items in warehouses and stockrooms.

And that’s the natural ebb and flow of the economy.  What economists call the business cycle.  That goes from an expanding economy to a contracting economy.  From boom to bust.  From inflation to recession.  Something normal.  And natural.  Though it could be unpleasant for those who lose their jobs.  But it’s something that must happen.  To correct prices.  You see, prices make all of this work automatically.  They match supply to demand.  Letting suppliers know when to bring more goods and services to market.  And when they’ve brought too much.  When the economy goes into recession prices fall.  Which tells suppliers that supply exceeds demand.  And that anything additional they bring to market will not sell.  As they incur costs to bring things to market this is very good information to have.  So they don’t waste money.  Leaving their businesses short of cash.  Possibly causing their businesses to fail.

Whenever we Devalue the Dollar with Inflationary Monetary Policy Prices Rise

No one likes losing their job.  Because they need income to pay their bills.  And the government doesn’t like people losing their jobs.  Because they tax those incomes to pay the government’s bills.  And unemployed people pay no income taxes.  So the government tries to tweak the economy.  At the federal level.  To extend the inflationary periods of the business cycle.  And they do that with inflationary monetary policy.  Using their monetary powers to keep interest rates below the true market interest rate.  Hoping it will encourage suppliers and consumers to keep borrowing and spending money.  Even though supply had already caught up to and passed demand.  Such that everyone that wanted to buy something could.  While every supplier that wanted to sell something couldn’t.

Some people take advantage of these lower interest rates.  Some people will remortgage their homes to lower their monthly payment.  Which will give them a little more disposable cash each month.  Which they may use to buy more stuff.  But other people will take this opportunity to buy a large house just because of the low interest rate.  As some businesses may borrow to expand their business just because of the low interest rate.  Not for unmet demand.  These actions may not help the economy.  In fact they may hurt the economy in the long-term.  When the inevitable recession comes along and they are so overextended they may not be able to pay their bills.  They may lose their house.  Or their business.  For the worst thing to have whenever you suffer a reduction in revenue or income is debt.

But there is an even worse effect of that inflationary monetary policy.  When you increase the money supply you increase the total amount of dollars in the economy.  But they’re chasing the same amount of goods and services.  Which makes each dollar worth less.  Requiring more of them to buy the same things they once did.  Which is why whenever we devalue the dollar with inflationary monetary policy prices rise.  So, yes, there may be an initial expansion of economic activity.  But some people will have inflationary expectations.  That is, they know prices will go up in the very near future.  So they won’t increase production.  Why?  While an initial burst of economic activity may draw down those bloated inventories those coming higher prices will increase business costs.  Which businesses will have to pass on in the prices of their goods.  And how do higher prices affect consumers?  They buy less.  So manufacturers are not going to expand production when price inflation is going to reduce their sales in the long run.

Cutting Taxes and Reducing Costly Regulations have Stimulated Economic Activity every time they’ve been Tried

Perhaps the worst effect of inflation is the false information those higher prices give.  When consumer demand rises so do prices.  And it’s a signal to suppliers to bring more goods and services to market.  But when prices rise because of a depreciated dollar and NOT due to higher consumer demand, some may bring more goods and services to market when there is no demand for it.  So you have rising prices.  And expanding production.  Producing more goods than the market is demanding.  Creating a bubble.  Adding a lot of stuff to the market place at very inflated prices.  That no one is buying.  Then the bubble bursts.  And recession sets in.  As businesses lay off workers to adjust supply to meet actual demand.  And those inflated prices fall back to market values.  The higher inflationary monetary policy pushed those prices up the farther they have to fall.  And the more painful the recession will be.

You see, inflationary monetary policy interferes with the natural ebb and flow of the economy.  And the automatic price mechanism that matches supply to demand.  By trying to expand the inflationary side of the business cycle, and contract the recessionary side, governments make recessions longer.  And more painful.  Which is why Keynesian stimulus policies (lowering interests rates and deficit spending) don’t stimulate long-term economic activity.  Yet it is what most governments turn to whenever the economy slows. While there is another way to stimulate economic activity.  One that is not so popular with most governments.  Across the board tax cuts on business and personal incomes.  And reducing costly regulations on businesses.  These make a more business-friendly environment.  Encouraging businesses to expand and hire people.  Because these actions will have a positive impact on a business’ long-term outlook.  And with consumers having more disposable income (thanks to the cuts in personal income tax rates) businesses know there will be a market of any increase in production.

So there you have two ways to stimulate economic activity.  One way that works (tax cuts and reducing costly business regulations).  And one that doesn’t (lowering interest rates and deficit spending).  So why is the one that doesn’t work chosen by most governments over the one that does?  Because governments like to spend money.  It’s how they build constituencies.  By giving generous benefits to voters.  But to do that they need tax revenue.  Lots of tax revenue.  Produced by increasing tax rates as often as they can.  So they cannot stand the thought of cutting taxes.  Ever.  Which is why they always choose inflationary policies over tax cuts.   Even though those policies fail to stimulate economic activity.  As proven throughout the era of Keynesian economics.  While cutting taxes and reducing costly regulations have stimulated economic activity every time they’ve been tried.

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FT103: “If General Grant used Keynesian tactics he wouldn’t have given up the attack on Cold Harbor until all of his soldiers were dead.” Old Pithy

Posted by PITHOCRATES - February 3rd, 2012

Fundamental Truth

On the Eve of Cold Harbor Grizzled Union Veterans pinned Scraps of Paper with their Names and Home Cities Inside their Jackets

General Grant has a few reputations.  That he was a drunk.  He wasn’t.  He just couldn’t hold his liquor.  And he hated inactivity.  And being away from his family.  Two things that led him to drink.  They also called him a butcher.  That he cared little for his men.  Which wasn’t true.  The bloodiest single day of battle in the Civil War was the Battle of Antietam.  Grant wasn’t there.  The bloodiest battle was the three days at Gettysburg.  Grant wasn’t there.  One of the greatest Union defeats was at Fredericksburg.  Grant wasn’t there.  So it wasn’t Grant.  It was the tactics used in the Civil War.  Napoleonic tactics.  Massing great ranks of soldiers opposite great ranks of soldiers.  Fire a few shots.  Close in on each other.  Then finish the job with the bayonet.  And plenty of finishing was needed as those Napoleonic weapons weren’t rifled.  Or all that accurate.

The weapons were rifled, though, in the American Civil War.  And far more accurate.  So they killed a lot of soldiers as they massed and fired.  And killed even more as they closed in to finish the job.  They soon learned that massing troops in the open on the field of battle was not a good idea.  Instead they looked for good ground to defend.  At Antietam there was a sunken road in the center of the Confederate line.  One of the first trenches used in warfare.  Lee failed at Gettysburg because General Ewell failed to take the high ground on the eve of the first day of battle.  Over night the Union entrenched strong defensive positions.  That held for days 2 and 3.  At Fredericksburg there was another sunken road.  This one was behind a stone wall.  It was also on the high ground.  And that’s where the Confederates were when the Union attacked.  And lost the battle.

General Lee was a combat engineer in the Mexican War.  Some called him the King of Spades.  So fortifying defensive positions was something he was good at.  And became better at.  Building breastworks.  Which even the odds in battle when a numerically superior force attacks a smaller entrenched force.  Like at Cold Harbor.  Where the breastworks zigzagged for 5 miles.  Allowing the defenders to shoot into the front of the attacking force.  As well as into the side of the attacking force.  Which is why on the eve of battle the grizzled veterans in the Union Army pinned scraps of paper with their names and home cities inside their jackets.  An early dog tag.  So when they attacked those heavily fortified defensive positions in the morning their surviving comrades could identify their bodies and send them home to family for burial.  Which, sadly, proved very useful after the battle.

The Problem with Keynesian Economics is that it interferes with Market Prices causing Inflation and Bubbles

The attack was over in less than an hour.  Seven thousand Union soldiers fell killed or wounded.  Grant regretted his order to attack until his dying day.  And he wouldn’t give such an order again.  Because he learned the folly of attacking entrenched positions.  And began adjusting his tactics to match the technology of the battlefield.

Sometimes it’s easier to identify failed policies in war.  It may have taken some time.  But it eventually became clear.  For when the casualty rates soared people were less willing to send their sons off to war.  Making the cost of those failed policies very real.  And personal.  Not abstract numbers.  Like in economics.  Where few understand what Keynesian economics is.  Or how to identify if these policies work.  Or if they fail.  For if you listen to Keynesian economists they never fail.  And when they do it’s not because they’re wrong.  It’s because those using them weren’t bold enough.  Such as using a Keynesian economic stimulus to pull an economy out of a recession.  It didn’t work in the Seventies.  And it didn’t work in the most recent recession.  The Great Recession.  And how do Keynesians explain this failure?  The economic stimulus wasn’t big enough.

The problem with Keynesian economics is that it interferes with the market forces.  By denying reality.  The business cycle.  The cycle between good economic times and bad economic times.  From periods of expanding economic activity to periods of contracting economic activity.  It’s this second half of the business cycle that Keynesians were especially trying to deny.  Recessions.  Those things that correct prices at the end of a growth cycle.  Before inflation can set in and wreak its havoc.  And when Keynesians interfere with this market mechanism the market doesn’t correct prices before inflation sets in.  So prices keep rising.  And they create asset bubbles.  Like housing bubbles.  Like the one that led up to the Subprime Mortgage Crisis.  And because Keynesians interfered all they did was delay the inevitable.  Allowing prices to rise higher than they normally would have.  Which meant they had further to fall.  Creating a longer and more painful recession than there would have been had they not interfered.

Unlike a Keynesian, General Grant Recognized a Failed Policy and Stopped Using It

Keynesians try to reduce economics down to a set of mathematical equations.  That they accept on faith.  Blinded by their ideology.  And refuse to recognize their failure.  Which is why they continue to interfere with market forces.  And continue to make recessions longer and more painful than they need be.  While strewing a swath of economic destruction in their path.  Like all of those home owners who lost so much value in their houses that their mortgages are now greater than the market price of their house.  Many lost their retirement nest egg in the process.  Some even had to alter their retirement plans because of their losses.  Or go back to work in their retirement.

These aren’t bodies littering a battlefield.  But the Keynesian carnage has destroyed lives just the same.  Impoverishing future generations to pay for their inept policies.  For people not even born today will have a tax bill so great that it will diminish their living standard far below what we enjoy today.  As bad as that is what’s worse is that they don’t change their policies after these failures.  Believing that the only reason they’ve failed is because they didn’t try them on a grand enough scale.  Or the government quit them before they had a chance to work. 

Thankfully General Grant didn’t use such Keynesian thinking at Cold Harbor.  Had he used such reasoning he would have ordered a second assault.  And a third. And kept ordering them as long as he had living men to send in against that entrenched defense.  But he didn’t.  Why?  Because he was smarter than a Keynesian.  He recognized a failed policy.  And stopped using it.

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