A dumbo comes up with a stupid idea, yells it in the
echo chamber where it is picked up by one dumbo after another, and before you
know it, a chorus of dumbos are echoing the same stupid idea.
This is what happened when David Weinberger picked up
an idea put out by Brian Riedl and repeated it, not knowing what he's talking
about. Weinberger did so in an article that came under the title: “No,
President Obama, You don't Deserve The Credit For Trump's Awesome Economy,” and
the subtitle: “Federal spending cannot and will not stimulate the economy. That
is one thing from the Recovery Act you can take to the bank.” It was published
on February 19, 2020 in The Federalist.
Here is the dumb idea: “Believing that government
spending causes growth is like believing that taking a bucket of water from one
end of the pool and dumping it into the other causes the overall water level in
the pool to rise.” Since I do not know in what context Brian Riedl made that
assertion, my critique is not directed at him. But I know the context in which
David Weinberger used it, and that's where I have concerns.
First, let me tell you something. When I was
teaching––before retiring––I discovered that when handling students in a
remedial class, the best way to explain a complex subject, was to begin by
defining the key words that will come up when the subject will be discussed in
detail ... and go from there. And so, I propose to follow that same approach
here.
When people speak of “tight money,” they refer to the
central bank (the Fed) making it difficult for businesses and individuals to
borrow money. By contrast, when someone remarks that the system is “awash” with
liquidity, they mean that the Fed has “flooded” the marketplace with money.
So, the question is this: How and why would the Fed do
such a thing? The answer is that the Fed is the source of all moneys. It can
print any amount it wants and push it into the economy. It can also suck back
any amount it wants and cause a tight money condition. This says that neither
the Fed nor the marketplace are a pool of money. The Fed is the creator as well
as the destroyer of money, but is not a pool. The economy is the wealth
producing engine that uses money to function, but is not a pool. The more that
money circulates in the economy and the faster it does, the more goods and
services it produces. That's assuming the system is not overloaded with too
much money, in which case it will heat up and blow the proverbial fuse.
The Fed interacts with the economy in two ways. One
way is initiated by the marketplace when the licensed banks that lend money to
businesses and individuals, borrow what they need from the Fed to service their
clients. The other way that the Fed interacts with the economy is when it
initiates the interaction by buying from or selling to the marketplace, assets
such as government or corporate securities.
In the first instance, the Fed controls the appetite
of the marketplace to borrow or not to borrow by raising or lowering the
interest rates. This is called setting the monetary policy. In the second
instance, the Fed allows its balance sheet to expand (when buying assets) or
contract (when selling assets) so as to complement or offset what the
government is doing with its own fiscal policy.
When the government sees the need to stimulate an
economy that is slowing down because it is saturated with goods and services
and cannot consume much more, or because something terrible has happened that
frightened businesses and the public, causing them to stash their money rather
than spend it, John Maynard Keynes has suggested that the government should
step in and do the spending by launching a program of public works such as the
repair or renewal of the infrastructure.
But from where does the Government get the money? In
the not too capitalistic regimes, the government borrows directly from the
central bank. In the capitalistic regimes, the government borrows from anybody.
But since all moneys are created by the central bank anyway, the net result is
that even the capitalist regimes end up borrowing from the central bank. But
there is a catch associated with that word “anybody”.
To borrow, the government issues bonds (and short-term
treasury bills.) The buyers come from the public and from the business
community. Most of the time the average Joe will invest in bonds, money that he
saves from working. Very few average Joes will take a “bridge loan” even on a
temporary basis to invest in bonds. But when they do, they make sure to pay it
back as soon as possible. The reason is that Joe will always pay a higher
interest on the money he borrows than he will receive on the money he invests.
That's because he is considered a subprime level of client and not a preferred
borrower.
As to the preferred borrowers, such as the banks and
other financial institutions, they'll borrow from the Fed at an interest rate
that is lower than what they will receive from the government bonds. They pocket
a huge profit, having lifted not one finger to work for it. They’ll do even
better with corporate bonds.