Consumption Is Prosperity And Other Absurdities

Modern quackonomics teaches that consumer spending is crucial to the health of an economy. If consumers do not spend, businesses will not make profits and we are led on a downward spiral where wages fall, unemployment rises and recession and depression ensue. Hence the great effort expended by our government to track, monitor and stimulate consumer spending. You probably remember after the 911 attacks, President Bush urging everyone to be “patriotic” and “responsible” by continuing to spend their money like normal or even better, to spend more than before. If we failed to do so, we would be giving the terrorists what they wanted in the form of a tumbling stock market and a crashing economy. But to those who understand sound economic principles this doctrine is absurd on its face.

This idea is of course a product of Keynesianism. According to this school of thought, the reason why downturns occur is because there is some unexplained “demand shock”, resulting in unsold inventory and unused capacity. The solution is to stimulate spending so as to close the gap between supply and demand across the economy. If the correct amount of spending cannot be squeezed out of consumers, the government should step in and take up the slack by buying goods and dumping money into the economy. Interest rates are also tampered with to induce further spending and to convince businesses to invest.

There are numerous problems and inconsistencies with this approach, but we will examine only a few here. First of all, the real genius of Keynesian economics lies not in its accuracy, but in its utility with regards to the State. Lord Keynes provided government with justification for something they had long been doing, but which the public and classical economists generally regarded as harmful and dishonest; inflation of the money supply. Once Keynes’s ideas had been widely accepted, politicians felt no remorse in advocating deficit spending and an inflationary monetary policy. Not only were these things seen as being harmless, they were now the solution to all our problems.

Economists of the Austrian school had previously advanced their theory of business cycles, but it was swept under the rug during the “Keynesian Revolution.” What the Austrians claimed was that inflating the money supply was not the cure but the cause of the business cycle. Tampering with the interest rate and injecting the economy with phony money did not produce prosperity. Instead it distorts an economy’s production structure by misleading entrepreneurs and investors as to the actual state of consumer demand and the real amount of savings available for investment. What you get is all sorts of business ventures popping up that are only possible because of artificially low interest rates and excess cash being pumped out of the government spigot, but which under normal circumstances are not profitable or useful.

As long as rates stay low and the money keeps coming, these ventures can stay above water, but they misdirect capital and labor away from what would be more productive enterprises. Once the music stops, they cannot survive and must be liquidated. This is where consumer spending comes in. Inflation can only have its desired effect if people spend the new money they get rather than “hoarding” it under their mattress. If the party is to continue, consumers must keep dishing out their loot. Usually getting consumers to just spend their income is not sufficient. They must also be enticed to borrow heavily and then spend that money too. This way, as much paper as possible works its way into the system and the pseudo prosperity can be strung along even longer. That Washington has been extremely effective in implementing this policy is obvious with one look at U.S. consumer debt levels and America’s savings rate.

When these conditions stop (and in the long run, even if they persist,) the artificial, unsustainable boom is revealed for what it was and a recession or depression is required to liquidate mal-investment and return the economy to solid footing. This is obviously political poison for those in office during the downturn, so it is to be avoided at all costs.

This is a cat and mouse game where politicians are constantly seeking to stay one step ahead of the corrective forces trying to bring the economy back to earth. The trick is to keep the cash flowing and the good times rolling until you are out of office and then it is someone else’s problem. The public is rarely insightful enough to equate cause with effect so future politicians will get the blame for “ruining the economy,” while the masses hearken back to the good old days of easy money and low interest rates which they will associate with those who instigated and fueled the boom.

Having said all that let me restate it all in simple, logical terms. Societies and individuals do not get rich by borrowing and spending, especially when they are buying things they don’t need and leveraging their entire future livelihood to do it. The way to wealth remains unchanged from the dusty streets of ancient Babylon to the towering, bustling chaos of Wall Street. Savings and investment are the only way to increase a society’s capacity to produce and it is production, not paper money, that equals wealth. Without real savings, (not the kind produced by government fiat,) an economy’s capital stock, and thus its ability to produce, does not increase and eventually it will begin to shrink and fall into disrepair. This means stagnating and then declining living standards for everyone.

This is a major reason why many developing countries have much brighter futures than the heavily indebted and profligate West. They have extremely high savings rates. They have low levels of consumer debt. They very much resemble the West during the industrial revolution. Their populations are generally hard working, conservative, and thrifty; the kind of people who would have made Ben Franklin proud. For such people, the future is bright and promising, that is until their governments convince them of the evils of saving, the glory of inflation and the benefits of debt and over-consumption. When that happens they can join the rest of us on the road to economic ruin.