Not fragile

Over the weekend, the Wall Street Journal opinion page editors published an opinion entitled "The Keynesian Dead End," arguing that world leaders were finally seeing the folly of the idea that government "stimulus" is required to prop up economic growth, and predicting: "We suspect that Mr. Obama will find a stonewall in Toronto when he pleads with his fellow leaders to join him again for a spending spree [a third round of government stimulus]."

That turns out to be exactly what happened. We believe this is a very good sign, although many policymakers in the US seem to have missed the memo, including the Federal Reserve, which continues to hold interest rates essentially at zero.

Calls for more stimulus (or to continue holding the Fed funds rates at "emergency" levels for over a year) are built upon the Keynesian assumption that the economy depends for the most part on the constant ministrations of the government, like a fragile patient on life support, or a rickety machine always in danger of clattering to a stop.

Listen to this story broadcast today on National Public Radio, which tends to approach most economic stories from this Keynesian point of view. In it, the narrator continuously refers to the economy and the recovery as "fragile" and in need of government "support" or "propping up."

The narrator describes a "warning from President Obama that big cuts in government spending could choke off the fragile economic recovery" and then repeats the same "fragile" description saying, "he warned that recovery is still fragile and says it would be a mistake for governments who have been propping up the economy to rush for the exits all at once."

Later, the narrator explains that Treasury Secretary Tim Geithner "insists the US will not repeat the common mistake after financial crises of withdrawing government support too quickly."

We have written extensively in the past that this view of economics is completely upside-down: free economies are surprisingly robust, and when they break down it is generally because of misguided government tampering (see for example this previous post). We have also presented arguments full of evidence from history that injecting them with government "stimulus" actually acts more like a sedative, and that the misguided stimulus plans of the past two years have actually retarded the recovery, which could have been even stronger.

The silver lining to the financial chaos of the past few years is that people everywhere (even in Europe!) appear to be waking up to the follies of such misguided economics (what the Wall Street Journal article calls the Keynesian "dead end").

Even better, they are rediscovering the truths articulated by economists who offered the antidote to the Keynesian view, such as Friedrich Hayek and Ludwig von Mises, as George Mason University economist Russ Roberts explains elsewhere in the Journal's opinion page today. For further arguments about the importance of Hayek, see our previous posts here, here, and here.

This last aspect is critical, because it slices through the artificial dilemma that NPR and other media commentators try to paint around this subject -- namely, the false choice between expensive "stimulus" and anti-growth "austerity," which is often a code-word for "higher taxes." The real way out, as Steve Forbes points out in yet another recent WSJ opinion piece, is to set the stage for growth. The way to do that is to incentivize innovation and entrepreneurship through low taxes, to stop drugging the economy with "stimulus," and to provide stable currency so that businesses can operate in a predictable environment.

Thus, while the rejection of more "stimulus" by the European leaders is heartening, they are probably still missing the other half of the story, since they are following the IMF-style austerity prescription of cutting spending and raising taxes. The best path would be to cut taxes and cut spending, or at least leave tax rates low and as flat as possible to encourage economic growth; the only thing that can pay for the profligate ways of politicians.

We believe that all investors should understand these issues, and that a working knowledge of these topics is extremely beneficial to sorting out the economic questions of the day and to deciding where and how to invest their capital.

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For later posts on this same topic, see also: