'Yes, Virginia, There Really Is a Free Lunch'

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It is time
to consider the recommendation and economic analysis of Yale University
economist Robert Shiller. He is widely respected, the co-designer
of the Case-Shiller index, which traces housing prices in 20 American
cities. He coined the phrase “irrational exuberance,” which was
made famous by Alan Greenspan in the mid-1990s.

Shiller is
a run-of-the-mill Keynesian. His opinions are highly regarded within
the mainstream. This is why he gained access to the Op-Ed
page of the New York Times on December 25
. He presented
a Christmas present to the readers: a free gift from the liberals’
replacement of a fat man with a long white beard.

It was the
perfect day to receive such a gift in digital Christmas stockings.
Readers of the New York Times are educated people, and therefore
much too sophisticated to believe in free gifts from a jolly man
from the North Pole. They have long since substituted another fairy
tale for the story of Santa: free gifts from the jolly people who
are elected to Congress.

Men’s faith
in free gifts from on high is found in all cultures. For the Israelites
in Moses’ day – or at least in the day of the late-eighth-century
B.C. scribes who are believed by New York Times readers to
have written fables in Moses’ name – there was manna from heaven.
Jesus later turned water into wine, though not stones into bread.

Modern Keynesians
and their disciples believe that the Federal government can perform
similar miracles. They believe that there is no irrevocable scarcity
of goods and services, but only a scarcity of public-spirited politicians.
They believe that there can be wealth, if not for all, then at least
for most of those who reside inside the borders of the United States.
They delight in the Keynesians’ version of “Yes, Virginia, there
really is a Santa Claus.”

This is why
Professor Shiller – a man with a most revealing last name –
had his “Yes, Virginia” letter published on Christmas in what used
to be known as America’s newspaper of record. It is today merely
the newspaper of mainstream liberal opinion.

THE
COLLEGE-EDUCATED EMPEROR’S WARDROBE

Before I present
my analysis of Prof. Shiller’s analysis, I owe the reader an explanation.
I begin with a premise: Keynesian economists cannot think straight.
It takes years of convoluted anti-logic, beginning with the freshmen
economics course, to train intelligent people to accept the anti-logic
of what is known as the neo-Keynesian/neo-classical synthesis.

In all of
modern thought, nothing better illustrates the Hans Christian Anderson
tale of the emperor with no clothes. A group of charlatans come
to a vain emperor and tell him that they can outfit him with the
finest clothes in the world. He accepts their claim. They pretend
to spin a wardrobe for him. There is no wardrobe.

We love the
story because it illustrates something we all know: those who are
rich and powerful are sitting ducks for hucksters and hypesters.
Their intellectual vulnerability is in direct proportion to their
vanity. They are easily manipulated.

In the story,
the adults who see the emperor walk down the street go along with
the emperor’s illusion. No one howls in laughter. No one shows derision.
Then a child, with nothing to lose socially and no incentive to
feign acceptance, shouts out the truth. The crowd breaks into laughter.

The story
is of course preposterous. Not because it suggests that an emperor
could be sucked in this completely, but because it suggests that
the crowd would ever show derision for the emperor. The kid would
be taken by his parent and beaten severely for not showing proper
respect.

The crowd,
if initially silent, would have remained silent. No one would admit
to himself or the person next to him that he had been fooled. Such
an admission would be an admission of stupidity. It would mean that
they were all no wiser than the silly emperor. Worse, it would be
an admission that they had temporarily suppressed their common sense
for reasons of social acceptance. What kind of person would play
the fool? Answer: most of them. What kind of a person would admit
in full public view that he had played the fool? Only a child with
more sense than experience. He would therefore pay dearly for his
frankness.

SHILLER
ON THE STIMULUS

Prof. Shiller
assured his readers that, when it comes to government-funded economic
stimuli, once is not enough. There is more where that came from
– lots more.
THE
$858 billion tax package signed into law this month provides some
stimulus for our ailing economy. With the unemployment rate at 9.8
percent, more will certainly be needed, yet further deficit spending
may not be a politically viable option.

Keynesians
see Congress as the equivalent of a dope pusher. “The first one’s
free kid. Try it. You’ll like it.” The official Keynesianism of
John Maynard Keynes proclaimed that there would be Federal deficits
in recession years and surpluses in boom years. There would be far
more boom years than recession years. Thus, the Federal debt would
not grow. It would shrink.

That nave
view of politicians is long since dead. There are no surpluses.
There are only deficits. No matter how large the deficit is, Keynesian
economists call for more stimuli.

Original Keynesianism
and conventional neo-Keynesianism have always argued that the stimulus
must be financed by increased government borrowing accompanied with
deficit budgets. The old slogan is “deficits don’t matter.” But
this is becoming a hard sell these days. There are voters who say
that deficits do matter. These deficits are too large. They must
be rolled back generally, although these voters do not say what
programs must be rolled back, and by how much, and for how long.

Professor
Shiller sees the change in public opinion. He wrote his essay to
deal with it. “Instead, we are likely to see a big fight over raising
the national debt ceiling, and a push to reverse the stimulus we
already have.” He announced the gospel – the good news –
of new, improved neo-Keynesianism.
In
that context, here’s some good news extracted from economic theory:
We don’t need to go deeper into debt to stimulate the economy more.

Here we have
the promise of a wardrobe specialist who has decided to take up
the task of public relations. He is not going to the emperor, who
fell for this sales pitch back in 1931, years before Keynes showed
up as head pitchman. He is going to those who will be the opinion-makers
in the crowd.
For
economists, of course, this isn’t really news. It has long been
known that Keynesian economic stimulus does not require deficit
spending. Under certain idealized assumptions, a concept known as
the “balanced-budget multiplier theorem” states that national income
is raised, dollar for dollar, with any increase in government expenditure
on goods and services that is matched by a tax increase.

Notice the
phrase in the passive voice: “It has long been known.” By whom has
this been known? What Keynesian economists have gone into print
previously to explain such a remarkable set of economic conditions?

Ever since
1936, Keynesianism has been known for its gospel of stones into
bread: deficits that revive the economy and thereby create positive
cash flow that negates the need for another round of deficits. But
the deficits never go away, including the Clinton-era deficits,
which were funded by Social Security taxes and exchanged for by
IOUs written against the Treasury.

Now, we are
being introduced to a supposedly old truth of Keynes, namely, that
the government can fund the stimulus without resorting to lenders.
Best of all, this reasoning is simple. It is simple, because Shiller
says so.

The
reasoning is very simple: On average, people’s pretax incomes rise
because of the business directly generated by the new government
expenditures. If the income increase is equal to the tax increase,
people have the same disposable income before and after. So there
is no reason for people, taken as a group, to change their economic
behavior. But the national income has increased by the amount of
government expenditure, and job opportunities have increased in
proportion.

He began with
a false premise, namely, that “On average, people’s pretax incomes
rise because of the business directly generated by the new government
expenditures.” Which people’s pre-tax incomes? Those who are at
the front of the line where the spending will begin. But that does
not constitute “on average.”

Then we are
told: “If the income increase is equal to the tax increase, people
have the same disposable income before and after.” That is a mighty
big if. It is an if that stands a good deal higher than the Empire
State Building.

Here is where
the spinning of invisible cloth begins. People’s pre-tax income
rises, even though they have the same disposable income before and
after.

Children begin
to giggle. “Stop that giggling!” Prof. Shiller says. “Stop it right
now!" Stop it, or you will not be invited to the grand parade.
He wrote: “There is no reason for people, taken as a group, to change
their economic behavior. But the national income has increased by
the amount of government expenditure, and job opportunities have
increased in proportion.”

He invoked
the sainted memory of the original spinner of invisible clothing.

During
the Great Depression, there was a debate about “pump priming” –
about whether the government had to go into debt to stimulate the
economy. John Maynard Keynes, who originated the Keynesian theory
in 1936, liked to emphasize that the deficit-spending multiplier
was greater than 1, because the income generated by deficit spending
also induces second and third rounds of expenditure. If the government
buys more goods and services and there is no tax increase, people
will spend much of the income that they earned from these sales,
which in turn will generate more income for others, who will spend
much of it too, and so on.

There it is
again: “If the government buys more goods and services and there
is no tax increase.” This man and his predecessors have dealt in
ifs. They are masters of ifs. But how, you might well ask, can the
government increase spending without tax increases? Keynes said:
“Borrow.” So have his disciples.

That answer
of course raises the question of where the money will come from
to increase the purchase of government debt. It raises the question
of the economic effects – negative – of such a re-allocation
of lenders’ spending. In short, it gets children giggling. For over
seven decades, Keynesian advance men of the political spinners of
invisible cloth have been working the crowds to head off such giggling.

In
contrast, the balanced-budget multiplier theory says that there
are no extra rounds of expenditure. You get just one round of spending
– meaning that the multiplier is 1.0 – but sometimes that
is enough.

Stones turn
into bread. But they need not be borrowed stones. They need only
be taxed stones.
Paul
Samuelson, an economist at M.I.T., first drew national attention
to the balanced-budget multiplier in 1943, seven years after Keynes
introduced his theory. The multiplier was an immediate consequence
of the Keynes theory, but Keynes didn’t articulate it himself.

I’ll say Keynes
did not articulate it! He did not want to be laughed into derision
for promoting this version of stones into bread. He knew he had
a large enough problem persuading the crowd that borrowed stones
would do the trick.

In 1943, the
Federal wage-withholding law went into effect. The level of tax
collection doubled. The entire country was under mass inflation,
price controls, and bread into stones: anyway, weapons. Ploughshares
were being made into swords. So, Samuelson came forth with a new
version of stones into bread: hike taxes, not just deficits. Nobody
in Washington listened. The deficit grew at astronomical rates.
By 1944, a lenders’ revolt threatened to make mandatory hyperinflation.

Samuelson’s
suggestion never got traction in Washington. Deficits continued.
Then, under Kennedy, top income tax brackets were cut. It happened
again under Reagan. Deficits rose. But back in 1944, economists
thought differently.
Economists
embraced this multiplier because it seemed to offer a solution to
a looming problem: a possible repeat of the Great Depression after
wartime stimulus was withdrawn, and when new rounds of deficit spending
might be impossible because of the federal government’s huge, war-induced
debt.

It turns
out that this worry was unfounded. The Depression did not return
after the war. But in the early 1940s, economists justifiably
saw the possibility as their biggest concern. Their discussions
have been mostly forgotten because they didn’t have much relevance
for public policy until now, that is, when we again have a huge
federal debt and a vulnerable economy.

So, Keynesian
economists got it wrong. When men returned from the war in 1945,
and price controls were finally abandoned by Truman in 1946, the
economy started to grow. The wartime deficits shrank. The money
supply slowed. Price freedom and new optimism led to a great boom.

The problem
Shiller faces is that there has never been a theoretical case, meaning
a logical case, for the multiplier. The government spends money
extracted from the private sector. If there is multiplication at
the government’s end of the spectrum, then there is division at
the private sector’s end.

That has always
been the dirty little secret of Keynesianism. Stones do not turn
into bread merely by watering them with the hose of taxes or debt.
Why not? Because most citizens get hosed.

Then Shiller
gave away the case:
Of
course, the balanced-budget theorem is only as good as its assumptions.
Other possible repercussions could make its multiplier something
other than 1.0. The number could be less, for example, if people
cut consumption because of psychological reactions to higher taxes.
Alternatively, it could be greater if income-earning people who
are taxed more cut their consumption less than newly employed people
increase their spending. We can’t be sure what will happen.

Citizens will
indeed cut consumption, not because of a psychological reaction
to higher taxes, but because of a pocketbook reaction. The people
taxed have less to invest. They do not invest in the private sector.
The jobs created by taxation are jobs in government and jobs dependent
on government.

He knows this.
“Researchers haven’t pinned down the deficit-spending multiplier
either, even though that has been the focus of their efforts.” I’ll
say they haven’t! We have been waiting since 1936 to find out how
stones get turned into bread – why money borrowed from one
group leads to greater national wealth. “The trouble comes in estimating
how people will react in generating those subsequent rounds of spending.”
This has always been the problem with Keynesianism.
But the balanced-budget multiplier is simpler to judge: If the government
spends the money directly on goods and services, that activity goes
directly into national income. And with a balanced budget, there
is no clear reason to expect further repercussions. People have
jobs again: end of story.

Or, put in
different terms, emperors do not march down the highway naked as
jaybirds. End of story.
What
kind of jobs? Building highways and improving our schools are just
two examples – as cited in 1944 by Henry Wallich, an enthusiast
of balanced-budget stimulus who would later become a Yale economist
and a Federal Reserve Board governor.

By golly,
it’s 1944 again. It’s time to get out those shovels. Get those high-tech
workers back on the job with shovels. Get those $20-an-hour union
members out into the highways and byways. That will do it.

A STRICTLY
POLITICAL ISSUE?

Prof. Shiller
insisted that there is no theoretical problem of stones into bread.
There is only a political problem.
At
present, however, political problems could make it hard to use the
balanced-budget multiplier to reduce unemployment. People are bound
to notice that the benefits of the plan go disproportionately to
the minority who are unemployed, while most of the costs are borne
by the majority who are working. There is also exaggerated sensitivity
to “earmarks,” government expenditures that benefit one group more
than another.

So, it’s a
political issue of who gets the newly baked stone bread. There is
no problem with the recipe. There is only a problem with distribution
of the bread. Those pesky Republicans will not let Congress cook
up its never-ending supply of stone bread.

“No, Virginia,
there is no Santa Claus under the tight-fisted rule of Republican
hard-liners, who drag their feet at increased taxation, forcing
the soup kitchen to rely on borrowed stones.”
Another
problem is that pursuing balanced-budget stimulus requires raising
taxes. And, as we all know, today’s voters are extremely sensitive
to the very words “tax increase.”

But, in the
world of the New York Times, Christmas will surely reappear.
Virginia will get another visit from the ultimate Santa: Congress.

But
voters are likely to accept higher taxes eventually, as they have
done repeatedly in the past. It would be a mistake to consider the
present atmosphere as unchangeable. It’s conceivable that an effective
case will be made in the future for a new stimulus package, if more
people come to understand that a few years of higher taxes and government
expenditures could fix our weak economy and provide benefits like
better highways and schools without increasing the national debt.

CONCLUSION

I have quoted
at length from Prof. Shiller’s article. Had I summarized it, too
many readers would conclude, “No one in his right mind would say
anything so preposterous.” They would be correct. That is the problem.
Keynesians are not in their right minds. It is necessary to quote
them verbatim to prove the extent to which they are not in their
right minds.

Call
me an advance agent of the gigglers. There are more gigglers out
there today than in 1936 . . . or 2006.

Someday, some
child is going to shout: “The emperor has no clothes!” And, lo and
behold, the crowd will start giggling.

Then they
will replace the emperor and go looking for the wardrobe spinners
and their advance agents. They will not go looking for them to grant
them tenure.

Until then,
those of us who are prone to giggling will enjoy the show.

There will
come a day when the New York Times will fold up financially
because it cannot sell day-old printed news, silly Op-Ed essays,
and the daily crossword puzzle. That will be a day for celebrating.
We can call it the ideological multiplier effect. More people will
be cheering than crying.

December
29, 2010

Gary
North [send him mail]
is the author of Mises
on Money
. Visit http://www.garynorth.com.
He is also the author of a free 20-volume series, An
Economic Commentary on the Bible
.

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Best of Gary North

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