Stimulus Spending: When It Fails And Why

By Andrew Beattie | June 11, 2009 AAA
Stimulus Spending: When It Fails And Why

When Adam Smith wrote his landmark book, "An Inquiry Into the Nature and Causes of the Wealth of Nations", he dedicated long parts of it to the problems nations get into with debts and with debauching their currencies to get out. It was true in the 1700s and it's equally true now.

Downgrades
The near downgrade of UK's debt from AAA, the real downgrade of Ireland's debt and the possibility of more to come highlights the difference in how nations are approaching economic problems. The U.S. and same-minded nations are spending like drunken sailors hoping that consumers will do the same. We're also taking our show on the road to try and convince more nations that stimulus spending is the answer to our woes.

It's a hard sell in Europe, however, because Germany is taking a more conservative approach. This could be stubbornness on the part of the Germans, refusing to jump on the global stimulus bandwagon that will roll us right out of recession. But, then again, it could be that Germany has a better grasp of history.

Germany knows that government spending has to be paid for. When the German government was required to pay reparations after World War I, they stepped up their printing of currency to make the payments and unleashed devastating hyperinflation. The end result was the Nazi party coming to power, so it makes sense that Germany is hesitant.

Nothing's Free
The fact is that all this spending will be paid for through tax increases or a method the U.S. is already using - having the Fed buy up its own Treasury's bonds, a clever twist on simply printing more money to inflate the currency. We're all hoping that the government will know exactly when to pull the plug on financial restructuring, but the track record of Keynesian monetary policy has not been pretty. (See Giants of Finance: John Maynard Keynes and Can Keynesian Economics Reduce Boom-Bust Cycles?)

Consumers themselves are reigning in spending and trying to ride out hard times. This is a commonsense approach to crisis – reduce debts, bulk up emergency funds and wait for a bottom before buying back in to the market. If you were to go out, load up all your credit cards and exhaust every credit option, you'd find it next to impossible to secure another loan. Unlike a nation, you can't crank up your printer and scan $100 bills – well, you could, but someone would eventually notice and then debt wouldn't be your biggest problem.

Keeping Spending Under Control
Nations are debtors just like normal people and if they spend out of control and raise their chances of default (or inflation), they have to expect the price of lending to go up to reflect their rising risk. The fact that AAA ratings are being challenged should reassure us because at least someone is trying to inject some commonsense into the overenthusiastic application of stimulus spending. The ratings agencies and the impact of downgrades do the same job as the threat of arrest that keeps people from printing money in their basements. (For related reading, see Stagflation, 1970s Style.)

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