One of the myriad ways the social science of economics differs from the hard sciences of physics, engineering or mathematics is the tenacity with which ideas long since proven incorrect are maintained as subtle truths. Even after an idea has been repeatedly shown to be incorrect or fraught with all sorts of economic risk, economists continue to revisit it and recommend its implementation. While these ideas manifest themselves in all sorts of policy prescriptions, the ideas themselves typically have their origin in a single misconception. This misconception is merely the biggest fallacy of modern economic theory and the keystone on which John Maynard Keynes built his entire economic edifice; the belief that real wealth is measured in money, and the corollary that national governments have wealth at their disposal.
At first glance, the notion that wealth is measured in money makes sense. After all, the vast majority of people work for a living and are paid in money. Moreover, don't rich people always have more money than poor people? However, the measurement of wealth at issue here is the wealth of society. Wealth in a society is measured in terms of the goods that can be provided by the society. Wealthy societies produce more goods than poor societies. A poor society does not become wealthier by creating more money; a poor society can only become wealthier by producing more goods. Examples of this truism abound throughout history, and perhaps the best example of this is one of the most recent, Zimbabwe.
The leaders of Zimbabwe were convinced that the numerous problems the country was facing could be solved by creating money. After all, money is wealth - isn't that what Keynes figured out at Cambridge in the 1930s?. The banking system in Zimbabwe isn't nearly as sophisticated as it is in the United States and creating money can't be done with the stroke of a computer key; it has to be done the old-fashioned way by printing money. And print the Zimbabweans did. The central bank of Zimbabwe and its leader, Gideon Gono, created money like it was going out of style. However, the amount of goods being produced in Zimbabwe did not increase at anything remotely resembling the rates the money supply was being increased. The natural consequence of this was the cost of goods started to increase even faster than the money supply did! In fact, in 2015 the central bank of Zimbabwe was printing a bank note with a nominal value of $100-trillion Zimbabwe dollars, and even this wasn't enough. The $100-trillion Zimbabwe note was worth the princely sum of forty US cents! (1), (2)
In the 1970s, the United States suffered a disastrous inflation. The inflation had been building for many years and originated with the Great Society and Vietnam War spending of the Johnson administration in the 1960s. The inflation received an enormous boost when Nixon severed the last links the dollar had with gold. (3) A German-born economist, Hans Sennholz - who had personal experience with a society-altering hyper-inflation - discussed a key driver of the 1970s vintage inflation. This key driver was the notion - which was wildly popular in Ivy League economic departments at the time and which the Zimbabweans recently seized on - that government had real wealth at its disposal and should start spending this wealth. Sennholz succinctly captured everything wrong with this notion;
"The doctrine is as old as it is fallacious. It is built on the ancient myth that the stimulator and spender, i.e. government, is an entity outside and above the economic process, that it owns something that is not derived from its subjects, and that it can spend this mythical something for full employment and other purposes. In reply, we must again and again repeat the truism that government can only spend what it takes from taxpayers and inflation victims, and that any additional spending by government curtails the citizens spending by its full amount." (4)
If economics was as rigorous as physics the experience of the 1970s would have forever put to bed the notion that governments have real wealth at their disposal, or that real wealth is measured in money. However, economics is not a rigorous science, and the same truths have to be learned over and over again. This can be seen with the recent fascination with "modern monetary theory" (MMT). As the campaign for president gets underway in earnest, it is a virtual certainty that numerous candidates - and their PhD economist advisors - will base all sorts of policy prescriptions on all the merits of MMT. Over the next few weeks, the site will take a closer look at MMT and show that it is merely another variation on the fallacious theme of measuring real wealth with money.
03 FEB 2019
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(2) A very similar thing happened in Venezuela under the socialist regimes of Hugo Chavez and Nicolas Maduro. The economic irrationality has apparently run its course and reduced what was once one of the wealthiest countries in South America to a country where toilet paper is a luxury.
(4)Hans Sennholz, Age of Inflation, Western Island, Belmont, MA 1979, pp. 29-30