We’ve heard over and over again that the state can stimulate the economy by creating money out of thin air. Doesn’t matter where it goes, they say (although it usually seems to go to their cronies), just create that money and you’ll be out of the recession in no time! Isn’t that what we’ve been told ever since the financial collapse? Well, I have a question about that, one I’d really like the statists to answer:
Transcript below the fold.
Okay, this video’s not going to be very long, it’s just a question I have for statists who believe that if government creates money out of nothing and spends it in the economy then it’ll stimulate the economy and lead to economic prosperity. After all, isn’t that what we’ve been told for four years? Isn’t that what we’re continuing to be told even though the economy is still languishing after a total “stimulus” of twenty trillion dollars?
My question has to do with something that happened during World War II. The Nazis engaged in Operation Bernhard, which is probably the biggest counterfeit operation in history. The Nazis wanted to destabilize the British economy, so in 1942 over a hundred counterfeiters were given the task of making counterfeit Bank of England notes £5 and up that were as close to the real thing as they could get, to be used to inflate the currency.
They did a phenomenal job! From the type of paper that was used, down to the thickness of the ink, the counterfeit notes they made were indistinguishable from the real thing. They even cracked the serial number code: what range of serial numbers matched notes made in what year and so on. They were then laundered and used to buy imported goods and pay German secret agents. A lot of the notes were introduced into the British economy simply by sending agents in with suitcases full of money to live up the high life!
They did such a good job with the counterfeit notes that not even the Bank of England could tell the difference! They looked at notes that had the same serial number, and knew that at least one had to be counterfeit, but couldn’t tell which one! Technically, this meant that the counterfeit notes were actually genuine Bank of England notes, since the law defined a genuine Bank of England note as one the Bank of England would accept. And since they had no way of detecting the forgery, the Bank of England did indeed accept these! The bank declared these forged notes “the most dangerous ever seen.”
The Bank of England was forced to withdraw all notes £5 and over, and redesign them to prevent further damage to their economy.
So, here’s my question for all these statists barking on about money creation being stimulus: why did the Nazis try to destroy Britain by stimulating their economy? Why did Britain react to this as a danger, instead of saying “Oh thank you Germany for stimulating our economy and making us rich”? Weren’t the Nazis doing them a favor by creating money and spending it in their economy?
Why is it a most dangerous attack when the Nazis do it to Britain, but “stimulus” when our government and the Federal Reserve do it to us? Do you have an answer for this? Well? Do you?
When they’re talking about fiscal stimulus, we all know they’re not doing what the Nazi’s did by printing notes. But why? Good question.
Printing money is a monetary policy, which has to do with the quantity and time-value of money. It’s usually controlled by open-market operations and quantitative easing–outside of the scope of this argument. Fiscal policy, on the other hand, is about cycling that money through the economy. The policies usually manipulate taxes and monies spent by the government. The problem necessitating it is usually a drop-off in business and consumer spending during recessions. The important thing here is that there are quantifiable multiplier effects which each dollar spent have on the rest of the players in the economy. (ie., you spend $100 on shoes, the shoemaker pays workers, the light company and the show maker, who all can buy a sandwich, which–assuming you own a restaurant–ends up back in your pocket to spend on more shoes!) Despite leakages and all sorts of other inefficiencies, the multiplier effect is economic theory the same way gravity is physical theory.
Let’s go on with fiscal stimulus. When the government lowers your taxes or increases government spending, this “greases the pipes” by pushing the economic cycle faster (usually to make up for a slow-down/recession). BUT, government spending is much more efficient at multiplying itself because when we lower taxes, part of that money in your pocket is not consumed, but rather saved–one of those leakages I mentioned. In contrast, government spending goes straight to contractors/government employees, who put it right back into the economic cycle.
Printing money (which is what the Nazi’s did) does none of these things, but rather deflates the value of all money. If we inject an extra $2 billion into an $8 billion currency cycle, but add little value through the multiplier effects of fiscal policy, then that $10 billion has to nearly equal the original $8 billion. What that means is that every $10 you had, are now equal to $8 before that injection–which is a bad thing in excess. However, some slight inflation is often used to increase spending and better the economy, but only in very moderate terms, and only in the short term. When you inject too much (pretty easy) you get inflation like Zimbabwe’s thousands of percents–but that’s also beside the point.
The point is that America is not Nazi Germany because the government isn’t planning on printing new (above replacement level) dollars. Rather, they’re planning on putting the nation into a little more debt to ensure that families and companies don’t go bankrupt, which would end a large portion of the tax stream for the future. The money they spend through fiscal policy does indeed add to our (nearly $17 billion) debt, again to ensure that not everyone goes bankrupt. This is ostensibly good economically, socially, (aesthetically, because I don’t like seeing too many bums on the street), and keeps us from going into the depths of the Great Depression. Herbert Hoover, president in 1929, on the other hand, didn’t spend, but rather cut government funding and raised taxes (though did ask big business to spend–but they didn’t because they’re not stupid). You see where that got us? Yes, 25% unemployment.
Hope that helps explain.
I realized after posting my response, that you were indeed referring to monetary policy–wasn’t clear until I saw the M1 chart on the written blog. Actually, that makes the question even juicier, and does draw closer the parallel between Nazi Germany and what we’re doing now.
These expansionary monetary policies are usually not just printing new money, though. They’re usually conducted through open-market operations and quantitative easing. Open market operations are when the Federal Reserve either buys (lowers interest rate) or sells (raises interest rate) short-term government treasury bonds in the market. When the economy is lagging, the government usually buys up bonds–which is really just repaying their loans to bond-holders before term–in order to lower interest rates. Lowered interest rates incentivize businesses and consumers to borrow money, because it’s time-value is relatively cheap (lower pay back over time). So this repayment of loans (bond purchases) floods the economy with money, which gets the wheel spinning without having to print new tender.
If the interest rates get to nearly zero, then they usually move to more drastic means–quantitative easing. QE is basically the Fed buying up more than just short-term bonds, but also long term bonds and other assets. (You can see why this is a measure of last resort). If the government doesn’t use this last resort, however, and just tries to wait it out, they will likely end the country up in a liquidity crisis. This crisis would indicate little confidence in the availability of money–liquidity–which basically freezes the money market and the economy as a whole. It’s sometimes exacerbated by real deflation, as was the case for Japan about 12 years ago.
So these two things are the largest likely factors for the fluctuations you see in the M1 money supply. M1 is just money in its most liquid form (cash) in the hands of companies and the public, and does not necessarily mean that they printed more money, aka “increase the monetary base”–but I’m leaving that for another day.
So these things are allowing a little bit more liquidity into the hands of the multitudes, which brings us back to the Nazis. What did they do differently? They flooded the market with cash at a time when interest rates were certainly not zero, and certainly not needed. This devalued the currency by probably a large percentage and sent “menu costs” and related problems of inflation through the roof. It’s like penicillin–you don’t want to have to use it, but if you do, definitely don’t use too much.
Additionally, the fiat money system we have–not based on physical bullion like gold–is entirely based on the presumption that a nations’ central bank can regulate the currency, and that the nation can pay back any debts in that currency. When any of those things get out of the control of the governing entities, it degrades the trust in the currency and puts its international repute at risk. So, although in theory, what the Nazi’s did to Sterling is little different from what the Fed is doing with the dollar. However, in practice, the doses, control, effect on currency trust, and effect on international policies are in the hands of the Fed–and while the Fed is certainly not infallible, I’m going to wager that they’re better than the Nazis.
“Open market operations are when the Federal Reserve either buys (lowers interest rate) or sells (raises interest rate) short-term government treasury bonds in the market.” Oh, now be honest: when you say “in the market,” you mean, “to the banks.” And as you yourself pointed out earlier, that means it’s taking wealth from the people to do so.
“Open market operations are when the Federal Reserve either buys (lowers interest rate) or sells (raises interest rate) short-term government treasury bonds in the market.” Didn’t happen that way when Paul Volcker reversed that policy in 1980. In fact, can you name ONE time when government “waiting it out” didn’t result in the economy recovering in a year or two?
“This crisis would indicate little confidence in the availability of money–liquidity–which basically freezes the money market and the economy as a whole.” Hence the need for the very savings and investment that Keynesians insist is the problem!
“and does not necessarily mean that they printed more money, aka “increase the monetary base”” Yes, but the Fed stopped publishing M3. (They still use it themselves, they just stopped telling us what it is.) M1 is a good proxy in this case because it response to increases in the monetary base (including new credit) better than M2 does.
“They flooded the market with cash at a time when interest rates were certainly not zero, and certainly not needed.” Really? So I’m just imagining the whole World War II thing? What were all the additional taxes and rationing and everything all about?
“It’s like penicillin–you don’t want to have to use it, but if you do, definitely don’t use too much.” The Nazis certainly didn’t have the resources to create $16 trillion in two years like the Fed did.
“it degrades the trust in the currency and puts its international repute at risk.” Wow, good thing that isn’t happening right now!
“and while the Fed is certainly not infallible, I’m going to wager that they’re better than the Nazis.” Gee, what a high bar you set there…
The problem is, there’s never been any scientifically-verified Multiplier Effect, and the theory behind it ignores what the private sector would have done with that wealth (Broken Window Fallacy).
Your point about savings is long-refuted Keynesian garbage, and I know of no serious academic economist who’s believed that since the 1970s (and by “serious academic economist,” I mean one with no political axe to grind; e.g., not Krugman or Stiglitz.)
The Fed creating money decreases the value of all money just as when the Nazis did it; that’s the whole point! And you don’t get around that just because it’s “planned”–and generally, the spending is “planned” based on who the political cronies of those in power at the time are (remember Solyndra?).
I do agree that Solyndra was a debacle; government money should go to university or lab research, not private company research. I get the feeling that’s going to get your hackles up, but you’d be “deluded” (as you kindly called me) to think that the invisible hand can really take care of everything for you, including all research and technology.
It’s also ludicrous that no serious economist believes in the multiplier effect. Have you ever heard of Mark Zandi? How about Thomas Herndon? The WTO also supports it. Most economists believe rather fervently that a) a lack of expansionary fiscal policy exacerbated the Great Depression, b) New Deal spending helped get the nation out of the Great Depression c) the stimulus package (American Recovery and Readjustment Act) did, in fact, stifle the recession. The only people that don’t believe in the multiplier effect are those who are too anti-social to want to pay taxes. Again, you have to pay to live in a society.
Solyndra was just an example; look at Ener1 for another. If government money is supposed to be able to stimulate the economy, why can’t it even stimulate the companies it gives the money to directly?
“but you’d be “deluded” (as you kindly called me) to think that the invisible hand can really take care of everything for you, including all research and technology.” You do realize that the “invisible hand” is just a metaphor for people, right? So what you just said is, I’d be deluded to think PEOPLE can do it–but government somehow can, even though it’s made of people, too.
Blinder and Zandi’s work has been discredited by many other economists. The WTO says that cell phones give you cancer, so I don’t take them seriously, either.
“a lack of expansionary fiscal policy exacerbated the Great Depression” Yes, but also they agree that it was the exact opposite that created it: a massively contracting fiscal policy enacted in fear of inflation. If someone lets the air out of your tires, you need to put air back in; that doesn’t change the fact that your tires would have been okay if they hadn’t done that to begin with.
“the stimulus package (American Recovery and Readjustment Act) did, in fact, stifle the recession.” The economic consensus is that it prevented the recovery. The few holdouts just say that it didn’t work because it wasn’t big enough (yeah, and the patient died because we didn’t use enough leeches).
“The only people that don’t believe in the multiplier effect are those who are too anti-social to want to pay taxes.” Wow. Just wow.
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