Some investors worry that government IV bags will run out

US markets are reeling again on increased concerns over European debt defaults and this morning's latest jobless-claims-number ticking back upwards across the 400,000 mark to 409,000.

Investors are voicing concerns that governments (especially the US government) don't have much ability to "help" out due to their deficits. For example, in this Wall Street Journal article from this morning, a professional investor declared, "I don't see much help from Washington."

What surprises us is the fact that anyone still believes the fallacy that "help" in the form of increased government spending has a positive effect on the economy. The evidence that increased government spending has a damaging effect on economic growth and on employment is overwhelming, as we will see below.

Nevertheless, NPR this morning ran an interview with University of Texas economist James Galbraith advancing the exact same argument, that government spending is good for the economy, especially in a sick economy. Professor Galbraith argued that government spending is like an "IV bag" that keeps a sick patient alive, saying:

Well, the IV bag in an emergency room provides fluid -- saline solution -- that keeps a patient who's very sick alive. What the federal deficit does -- the federal government spending in excess of what it takes out of the economy in taxes -- is to put money into the pockets of private individuals, businesses, and it keeps them able to continue their consumption, so it buffers the effect of the severe economic shock we had three years ago and makes it less difficult for ordinary citizens to get through tough times when their incomes are low and they may be experiencing bouts of joblessness.

The sheer wrong-headedness of this argument is shocking. As Dan Mitchell of the Cato Institute explains in the video below, the argument that the government can "put money into the pockets of private individuals" completely ignores the fact that in order to do so, the government must first take that money out of the pockets of private individuals!



Mr. Mitchell goes onto demonstrate that arguments like the one articulated by Professor Galbraith on NPR are not only illogical and theoretically unsound, but that these theories have been an utter failure every time and everywhere they have been attempted.

For example, he points out that Herbert Hoover boosted government spending by 47% during his term, during which time economic growth dropped and unemployment increased. Under Franklin D. Roosevelt from 1933 - 1940, government spending went up 106%, during which time the economy tanked and unemployment averaged 17.2%*. Gerald Ford in the 1970s and Japan in the 1990s had similar unsatisfactory results from their attempts to "stimulate" the economy.

There is a rising chorus of voices saying that further government stimulus cannot be attempted right now because "we can't afford it" from a budgetary perspective, but we wonder why there aren't more who instead argue against further government stimulus because it doesn't work!

In fact, we ran the above video about the bankruptcy of the argument for government "stimulus" over two years ago. Since then, government stimulus has resulted in slower economic growth and continued stubborn unemployment.

At the end of his NPR interview, James Galbraith says that cutting government spending "willy nilly" would be "like running through the emergency room pulling IV needles out of people's arms." We would suggest that his metaphor might be in need of a little modification. Government IV bags, instead of carrying helpful Ringer's solution, contain a mix of depressants that keep an economy weak, sluggish and dependent.

It's amazing to us that academia and the media continue to flog this tired old theory, and that people continue to buy into it.


* Henry Morgenthau, Jr. (1891 - 1967), FDR's Treasury Secretary, declared in 1939 in a quotation that is now famous (and should be more famous):

Now, gentlemen, we have tried spending money. We have spent more than we have ever spent before and it does not work. And I have just one interest, and if I am wrong, as far as I'm concerned, somebody else can have my job. I want to see this country prosperous. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises. [. . .] But why not let's come to grips? And as I say, all I am really interested in is to really see this country prosperous and this form of Government continue, because after eight years if we can't make a success somebody else is going to claim the right to make it and he's got the right to make the trial. I say after eight years of this Administration we have just as much unemployment as when we started.

Mr. Doughton: And an enormous debt to boot!

Mr. Morgenthau: And an enormous debt to boot!

Source: microfilm roll #50, Henry Morgenthau Diary, May 9, 1939. FDR Library, Hyde Park, NY. Pages 3 and 4 of the pdf scan of the microfilm; pages 42 - 43 of the original document. Hat tip to Burt Folsom, author of New Deal or Raw Deal, who linked to this microfilm source on his website in response to questions about the authenticity of the Morgenthau quotations. We note that we do not agree with Mr. Morgenthau's belief that "taxing the rich" would be the best solution to address the deficit FDR created (for reasons see here and here), but note that his frustration at the ineffectiveness of government spending to create jobs should be powerful evidence to anyone who still believes the myth of the "IV bags" perpetuated by NPR and James Galbraith.