Saturday, February 14, 2009

Paul Ryan: Return to stagflation?

Paul Ryan, Republican US House Representative from Wisconsin, is quickly becoming one of my favorites.

He has an Op-Ed in the NY Times yesterday that is right on the money.

Increased government spending is at best a short term boost to GDP at the larger expense of long term capital and investment. Government spending is very inefficient -- approximately 30% of every dollar that flows through Washington is wasted on administrative costs. I say wasted because all those administrative costs are completely avoided if people simply keep more of their own money and spend it directly. In addition, the government can only spend money after it taxes, borrows, or prints it. Lets take those one at a time:

1. Higher tax rates hurt the economy by discouraging higher productivity. If you could work additional hours at your job, make extra effort to educate yourself more, or install automation or technology to increase your business' productivity, but half of every dollar of increased income is taken by the government, you may not make that extra effort or investment. If the government raises the tax rate by 3% or 5%, more and more extra effort or investement is not undertaken, and the productivity of the economy as a whole suffers. Additionally, more money flowing through Washington means more government power and instrusion on citizens' lives, a loss of freedom. What proponents of larger government spending really believe is that they know better than taxpayers what their money should be spent on.

2. Borrowing money hurts the government's financial standing, and costs taxpayers hundreds of billions in interest annually. Borrowing is limited by how much money our citizens and other countries have to lend, and if we get so overburdened by debt that lenders lose confidence that lending to America is a safe investment, we are really in trouble. As Ryan points out in his Op-Ed, many other countries do not have the money to lend right now, so we may have trouble finding enough money to borrow to finance all this government spending. Anything that is borrowed today will have to be paid back by future generations which will be a significant drag on our economy at that time. The current rate of borrowing is completely unsustainable in the long term.

3. Printing money will cause inflation. If there is more money to spend, prices are driven up in the same way having extra money passed out to bidders at an auction would result in higher bids for auction items. At the end of the day, bidders simply paid more for the same items, and each individual dollar was less valuable and had less purchasing power. Inflation really hits the elderly and others on fixed incomes, as well as those on tight budgets, and eats away at investment income. Owners of real assets, such as real estate or equipment, are better off after inflation because they can now sell their assets at a higher price. So inflation hurts low income earners worst and helps more wealthy owners of real assets. While I actually agree with the concept of pumping more money into the financial system to stabilize it last year by counteracting the credit crunch, I don't know if anyone has a grasp on whether we've printed too much, too little or about right so far. What I do know is that as soon as confidence rebuilds and money starts coming off the sidelines, we must aggressively slow down the rate of printing money or risk double-digit inflation.

The lessons from the Japanese over the last 2 decades, and from the Stimulus checks sent out in 2001 and 2008, are that one time payouts to citizens only cause a small short-term increase in GDP from the short term spending, and hinder rather than help overall economic growth.

These lessons are completely lost by President Obama and Democrats in Congress, who are much more interested in pushing through a Democratic wish-list of spending projects while they have the votes and enough political cover from Obama's recent election victory and non-stop fear-mongering.

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