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Strategies & Market Trends : Mish's Global Economic Trend Analysis -- Ignore unavailable to you. Want to Upgrade?

To: Moominoid who wrote (52069)	6/5/2006 1:35:20 PM
From: Elroy Jetson	Respond to of 116555

Let's look at your example, "for a country that is fighting but not under domestic attack there is a short-term boost and a long term negative". If the extra military spending is funded with an immediate tax, there is no short-term boost, only a short term and long term negative effect on the economy. In addition, the labor spent fighting comes at the expense of the wealth which this labor could have otherwise produced. Sometimes you do have to divert resources to defend yourself, but this is not in itself a wealth creation strategy. If the extra military spending is funded with debt, a portion of the short-term negative is shifted to the future and becomes part of the long term negative. Thus the creation of debt appears to create a short term gain for the economy, by creating spending which crowds out consumption and investment which could have paid better returns. But his comes at the expense of creating the economic drag of debt which the future economy has to service and repay. Let's examine your other comment. "The bit which seems to make less sense is the claim that there isn't a way to mitigate the depression without causing more damage later". Certainly most would agree that unemployed people represents a permanent loss to the economy which cannot be recovered. If a program were created to employ these people, even in a marginally productive way, there is a net gain - unless their work also consumes resources other than labor which could be more productively employed elsewhere in the economy. Schumpeter would have agreed with this. If the wages for the people employed in this program is less or equal to the productivity they create, then every economist would agree this is a very good thing. More productive employment means more wealth for everyone. But if their pay exceeds the productivity they create, the balance of their pay is a transfer payment. Most will agree that charity (transfer payments) is an important social good which can allieviate suffering, and is sometimes valuable apart from economics. What about the economics? If this transfer payment portion of the pay for the unemployed is facilitated with an immediate tax you would be hard pressed to show any gain for the economy, even though there is a clear gain for the unemployed person receiving this transfer payment. You are more likely to show a net loss for the economy. But, you may say, what if we fund this transfer payment for the unemployed with new debt creation, the magical elixir. Schumpeter would tell you that you are using debt to mitigate the pain of today at the expense of compounded pain later. Yes spending more than you earn does make the present day more pleasant - but what of tomorrow? Alleged multiplier effects assume that the wealth created by the spending produced by the debt creation always exceeds the compound interest rate on the debt - but is this often the case? So can you find a way to mitigate the effects of an economic downturn today without creating a worse problem later? I'd agree with you that it seems like this should be theoretically possible, but tis very hard to accomplish. Attempting to mitigate the economic downturn with monetary inflation - liberal new debt creation or debasement of the currency, both very blunt tools - is more likely to lead to the false and unproductive expansion after WW-I which led to the collapse of the Great Depression. As a restaurant investor said, "many people believe that a busy restaurant is a successful restaurant, but I can tell you from experience that a busy restaurant is a busy restaurant." You can easily destroy wealth by making the economy into a "busy restaurant" which loses money on each meal sold. It may look productive, but the economy has less wealth each day the "busy restaurant" is in operation. Building the busy restaurant was an act of massive capital destruction which is only realized later - the economic depression. These mistakes happen, but it seems foolish to base your economic policy on deliberately creating wealth destruction engines because of an assumed multiplier effect created by the wages paid to the restaurant employees. As Schumpeter said, "inflation pushed far enough would undoubtedly turn depression into the sham prosperity so familiar from European postwar (WW-I) experience, and would, in the end, lead to a collapse worse than the one it was called in to remedy." .