Throw Away the Shovels and Stop Digging

It seems that more than one economist is saying the same thing. Throw away the shovels and stop digging. Would someone please explain this to the President , the Democrats and the idiot Republicans who have fallen for this claptrap! But lest I forget, throwing away shovels won't buy votes.

Keynesian policies are not the answer

John Montgomery | January 28, 2009

Article from: The Australian

"WHEN you are in a hole, stop digging." This sensible law was coined by Denis Healey, Britain's chancellor of the exchequer during the 1970s. Unfortunately, Healey did not take his own advice. Under his stewardship government finances collapsed, leading to the humiliating need to borrow from the International Monetary Fund. Within a year, Margaret Thatcher was in Downing Street. She revived Britain's fortunes by returning to sound money, cutting government spending, cutting taxes and allowing failing industries to go to the wall.

This is the exact opposite to the economic policy being followed in the US by Barack Obama, Nancy Pelosi and the Democrats, by Gordon Brown in Britain, and by Kevin Rudd here in Australia. Instead of sound money, the policy is one of throwing good money after bad.

The new policy of demand management through government spending - known as Keynesianism - will not work. It never has, for the simple reason that governments cannot run economies and they do not create wealth. By throwing government money around in any number of bail-outs, infrastructure programs and pet social projects, governments are running up debt and simultaneously failing to revive the economy.

Take, for example, the case made for infrastructure investment or public capital spending. The Keynesian argument is that this pumps money into the economy and helps fuel recovery and growth. This, the Left argues, was behind the success of Roosevelt's New Deal in the 1930s. But the New Deal was not a success: the recession was deep and lasted 10 years. It was the tooling up for World War II that ended the Great Depression, and the return of growth in the private sector. The New Deal actually made things worse because it delayed the recovery in the private sector. Similar policies were followed under national socialism in Germany: the building of autobahns, canals, dams, railways, airports, organic farming around the cities. Money was also pumped into the car industry.

Of course, there were infrastructure projects carried out at this time, no doubt many of them a good thing, including the Hoover Dam and the Tennessee Valley water project in the US. But they had little effect on reflating the economy in any immediate sense or even over a period of 10 years. The reason for this is that of funds committed to any project, only about 10 per cent is spent in the early years of planning and engineering. Moreover, most of what is spent goes on materials and land rather than on the payroll. From about year three of any project, at best 35 per cent of spending will feed into the economy in the form of wages and salaries. So capital projects take a long time to get up and running, and their economic impact is less than 35 per cent of total spending. By the time a large project is completed, the recovery in the economy should already be well under way. That is, if there is a recovery.

The most worrying thing about Keynesianism is that governments raise the money they spend from borrowing, issuing new bonds and, eventually, printing money. Printing money is a sure-fire recipe for inflation: real inflation, not the modest 3per cent of 2008 that was occasioned simply by movements in prices and the cost of oil. Real inflation is where your currency loses value because there are too many notes in circulation. The National Socialists introduced Mefo bills for this very purpose. In the US, Roosevelt introduced Swopism, a kind of corporate economy, based on the idea of nation-building and national unity, where big business and government effectively undermined free market competition.

Solving one problem will likely cause another, in this present case the return of inflation from about 2012. To deal with this, monetary policy will again be tightened, and by about 2016 there will be another mild recession. The pattern of boom and bust will continue, made worse not better by central intervention.

Cutting taxes and interest rates is a more straightforward and more immediate policy mechanism in normal times. Of course, the banking collapse made the recession we were already heading into - thanks to the interest rate hikes of 2006-2008 - much worse. Now the problem is a lack of liquidity as banks refuse to lend to each other. The reason they are so reluctant is that no one knows where all the bad debt from the US sub-prime mortgage fiasco is. So while the various banking bailouts have bought time and prevented a sudden run on the banks, they have not solved the basic problem of bad debt. In my view, it is now time to let a few banks go under in order to flush out the poison. After all, giving taxpayers' money to the banks to sit tight and not lend to anyone is in no one's interest.

My proposal then is to cut the government bank deposit guarantee to a sensible level - say $100,000 - and advise people to spread their savings among a number of accounts to that limit. At the same time, governments should freeze any loans they have made to the banks. The more money is moved around, the less control the banks will have and those that have the worst debts will fail.

Having thus cleaned out the stables, policy can then stimulate the private sector by a combination of low interest rates and tax cuts. Economic recovery will then follow, without the need for governments to hawk all our futures. This is because the fundamentals of economic life are still strong: new markets, new technologies, new demographics, new centres of wealth and new consumers. This is not rocket science. Capitalism will recover, but only when governments get out of the way and stop spreading doom and panic. I just hope Obama gets it before it is too late.

John Montgomery is a writer and consultant on economic development and urban growth. His latest book, The New Wealth of Cities, is published by Ashgate (2007).