As a follow on to last week's blog on Keynes, this blog will look at the other side to the argument which is normally based on the theories of the Austrian economist Ludwig von Mises. Mises concluded that printing money would never work for the simple reason that not only does more debt not solve the problem but unless you have the ability to clean the balance sheet up at a later date that every incremental increase in the level of debt from printing money out of thin air has a smaller and smaller impact on outcome. At some point in the future the amount of money required to have any impact is so large that the system collapses.
The issue is that the initial benefits are perceived to be linear rather than concave. On the surface if some money issued into the economy produces a decent effect then more must produce a larger effect in a linear fashion or a straight line - the more you add the more you receive in economic growth. This is a common fallacy and one that is truly debunked in the book Antifragile by Nassim Taleb. (Once again if you have not read this book then you really need to - or keep reading this blog as I will continue to beat the drum for him).
Size is the issue. As an example if everything was linear in the risk world then taking 50 jumps off stairs each one foot high would be the same as jumping off a 50 foot building. Obviously the impact on landing from the 50 foot jump would be far more severe (if not fatal) to the jumper than jumping one foot 50 times. The same can be seen in a mound of sand. You can keep adding bucket after bucket of sand but at some point the whole pile will collapse. That last grain of sand is all that is needed to dismantle the entire work of all the previous buckets that were piled on top of each other.
This philosophy can be used to show how size can destroy governments and businesses alike. Looking at the market the large banks are a big issue as if one goes they all go and the economy is gone. Lose a small regional bank and no-one is the worse off other than the few people that worked there. The FDIC can easily handle paying out depositors their funds and all goes back to normal quickly. If Bank of America goes under the problems are huge and the impact on the economy enormous. The theory goes that the government can and will step in to repair the damage but they are already leveraged to the maximum and are possibly the most inefficient group available to manage the problem.
Think about small business. Things get resolved quickly, there are no political debates or posturing (not always but mostly and if it is rife the business will fail) and new products and services are added quickly to take advantage of an opportunity. On the other side of the scale is large business which while able to take on global issues always sees the profit margin fall and the efficiency drop until there is a tipping point where the company size is ultimately its undoing.
The same for governments. The bigger they become the harder it is for them to shrink to a more manageable and efficient size. Feuds are rife and bureaucracy fosters inefficiency as the more inefficient you are the larger your budget and the more power you control. Become efficient and your budget and your power is cut. So the thought of a smaller efficient government that balances a budget is akin to asking a child if they would like another candy. Of course they would and of course the government size will continue to grow. The only time governments are reigned in is during times of crisis when they are forced to do their job and many lose theirs in a change of the political system.
Now last week I said that Keynes' theories of printing money and providing fiscal stimulus would work and it appears that I am now saying that they will not so let me clear that up. I believe that Keynes' theories would work if they were all done at once (money printing, shovel ready projects and tax reductions) and that once they were seen to stimulate the economy that the government would efficiently clean up their balance sheet and trim its size. In business language, push the product with marketing and then cut back to make sure that the profits flow and the debt level is paid down or off. The problem is, as I have detailed above, that the government will not balance its budget, nor will it cut its size and it is not using all three of the legs of the stool but only one or maybe two. Under this scenario the results are concave (see image below) in that the benefits are felt early but ultimately they are doomed to failure, it is just a matter of time.
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