Jesse Jackson Jr. gave a speech recently on the floor of the United States House of Representatives, where he stated that the way out of this economic crisis can come through amending the bill of rights, specifically by adding the right to an iPod, healthcare, a home and a laptop (Mac or PC?). He says that mandating healthcare would create jobs for doctors and that mandating a home for every family would create a boom in home construction and therefore solve the housing crisis.
Honestly, I don’t think that Jesse Jackson is actually flat lying, because if he knew just how ridiculous he sounded, he would never have gone on the floor and made that speech. I’ll grant you that what the guy said was uniquely absurd, but in some ways, it is really the outgrowth of the softer, mainstream message that we can stimulate growth and steer the economy through mandates, specifically through mandated government spending. It is typical Keynesian economic thinking to believe that growth is fed by demand, and that all you need to do in order to create economic growth is to stimulate demand. So, by this logic, you can’t really blame Jesse Jackson Jr. for believing that all he has to do is get people to buy more houses or give people access to more healthcare. Of course, you also have to assume that Jesse Jackson, like anyone who believes this, has never started or run a business in his life, because if he had he would know that you can’t get something for nothing. This is common sense. Still, it is likely that Mr. Jackson does have some experience with economics, since he wasn’t exactly 100% wrong with everything that he said. Let me explain.
Anyone who has taken even the most basic type of economics class is familiar with the classic supply vs. demand dynamic. When viewing this paradigm as a graph, the lines of supply and demand run perpendicular to each other, with the horizontal axis of the graph representing the unit quantity of the good in question, and with the vertical axis representing the prevailing price. Increases or decreases in demand or supply are represented by shifts either to the left or to the right of either line. When the demand curve shifts to the left, the price of the good decreases, while a shift to the right means an increase in prices. The opposite holds for the supply curve. When the supply curve shifts to the left, the price of the good in question increases, while a shift to the right means a decrease in prices. These movements coincide with simultaneous moves up or down the opposite line, accounting for the concurrent change in the quantity of goods produced.
In the case of supply, this dynamic holds because a shift left represents a decrease in the supply of the good in question. If demand remains unchanged, this decrease in supply will increase the level of scarcity and cause people to bid up prices. The opposite occurs when the supply increases. If there is a larger than expected wheat harvest in any given year and the demand that year remains unchanged from the year before, then the price of each bushel of wheat will drop. In the case of demand, this dynamic holds because a shift right represents an increase in people’s demand for the good in question. If supply remains unchanged, this increase in demand drives up the price of the good in question, since there are more bidders willing to pay a higher price. The opposite occurs when the demand curve shifts to the left, representing a decrease in demand. If people start driving less year after year, causing a natural drop in demand for gasoline, all other things being equal, refiners and oil producers will have to drop the price of their product in order to sell more of it. All four of these causal examples are driven by the underlying desire of producers to maximize profits and by the underlying desire of consumers to minimize costs. That’s it. It’s that simple.
So, in the case of the housing market, an increase in the demand for houses at any given point in time, will lead to a temporary increase in the price of houses, since the supply of new homes cannot possibly respond faster to the increase in demand than prices can. This temporary increase in the price of homes acts as a signal to homebuilders that there is room for more supply, compelling them to begin building new homes in search of a profit. These new homes enter the marketplace, driving up the total supply and therefore adding downward pressure on prices. This dynamic continues until the market is cleared and a new price level is reached. You can see this dynamic at work in Figure 1.
So far so good, right? In fact, this increase in home building will lead to a natural rise in employment, which is precisely what Jesse Jackson Jr. is implying. He said, flat out, that if we increase the demand for goods and services, then we are going to increase jobs, and he’s right. My question to Mr. Jackson, and everyone who makes this argument, is “where is the demand going to come from?” Economists like Paul Krugman say that since the private sector is not prepared to spend money in order to create demand and therefore stimulate production and job growth, that the government should do it. But how does the government generate demand? Where does the government get its spending power from? Well, it gets it from the people, either in the form of taxes or debt issuance, the later of which eventually has to be paid back by these same people or inflated away gradually through money printing, which is just taxation by another name. In either case, we cannot escape the fact that demand must ultimately come from the savings of ordinary people. Now, where do these savings come from? Well, they come from earnings generated through work. So, in order to get the money to spend on goods and services (thus increasing demand and pushing the demand curve to the right), people need an income, and therefore need jobs. Without a job, you can’t earn, and if you can’t earn then you can’t demand goods and services that create the same jobs that provide you with the income needed to spend more. If this seems convoluted or confusing, it really isn’t. The only reason that this dynamic creates so many headaches for so many people trying to follow basic economic law is because they are caught in a linear, causal paradigm.
How many of you are familiar with the Möbius strip? The Möbius strip is formed by taking any rectangular strip of paper, giving it a half-twist, and then joining the ends of the strip together with a piece of tape to form a loop. See below:
The Möbius strip
The genius of the Möbius strip is that it shows how a linear figure (the strip) with a clear beginning and end point, can be transformed into an infinite loop. Both the original strip, and the subsequent loop are both created out of the same piece of paper, but whereas one is finite in its direction, the other is infinite. This analogy holds for the economy. If you only think about an economy from a demand or supply perspective, believing that one of these two drives the other, then you are missing the point. Both are driving each other simultaneously, and there is no start or end point. The economy is a Möbius strip. Demand cannot work without supply, and supply cannot work without demand. And the reason why? Because the economy is a closed system. There is no external bridge from our Möbius strip to some other source. Any demand or supply is and must be created on the strip itself, with the tools and resources that are available therein. For Keynesian economics to work, and for people like Jackson or Krugman to be correct in their belief that you can artificially generate sustainable job growth through government stimulus, the government would have to be located on some other planet, outside of our economy and not beholden to the same constraints that limit us. There would literally need to be some kind of straw protruding from the treasury reaching all the way to outer space from where wealth could be siphoned off. Or, maybe we would need a giant maid like the transformer from Space Balls the movie that could just suck the air out of Druidia each time we start running out of oxygen.
suck baby, suck!
I know what you are thinking. You are thinking, “wow, this makes perfect sense, but then how do we stimulate the economy to start growing again?” Sorry to break it to you, but the point of all of this is that you can’t stimulate the economy. No one actor can sustainably change the direction of growth in an economy, and if he tries he is bound to screw everything up. Just take China as an example. China has been keeping its currency artificially low for decades in order to facilitate an export-led boom in its industrial sector. This, along with all sorts of other subsidies and tactics, created products that were so cheap that the same people who were buying Chinese goods were losing the jobs that they needed in order to make the money to buy the stuff. So, what did the Chinese do? Well, they reinvested the money that they got from their foreign consumers in the form of I.O.U’s, effectively financing the borrowing of foreigners. This amounted to “stimulating demand” for Chinese goods, but there was a problem. The more the Chinese subsidized their consumers, the more indebted those consumers became, and the more indebted they became, the more unlikely they would ever be to pay back their creditors. In addition, because producers in China were responding to artificial demand signals created by cheap credit, they built more factories, mined more resources, and produced more of the type of things (flat screen TVs, computer chips, cell phones, etc.) that people ultimately could not afford at a non-subsidized price. And because subsidies never last forever, eventually, and that time is near upon us, the price of products made in China will rise for those consumers who have been buying them on credit for all these years. When this happens, not only will the living standards of China’s consumers decline, but so will those of the Chinese producers, who now will have potentially hundreds of thousands of factories sitting idle because the demand for their products has suddenly disappeared. These factories took time, energy, labor and materials to make, resources that could and should have been used for other purposes. Perhaps, instead of building factories to produce the latest electronic gizmo, entrepreneurs should have used that land to produce rice, or wheat or something else. Of course, if a businessman had done this during the subsidy period, he or she would have gone out of business, since the demand was simply not there. Therefore, introducing artificial stimulus into the economy through government spending and intervention not only does not work in the long term, but actually sets the economy back substantially by misallocating resources. This massive resource misallocation is akin to one giant boo-boo that is directly responsible for the tremendous wealth destruction that follows any boom. People made big economic mistakes, in large part by no fault of their own, and the price they must pay for these mistakes is in many cases abject poverty.
So, if we can’t artificially stimulate an economy to start growing again, or in some way or other guide the development of an economy so that everyone can live happily ever after, then what can we do? Well, we can start by growing up, and acknowledging that life is not a bed or roses. It never was, and it never will be. For close to a thousand years, the people on the continent of Europe were tilling the earth with their bare hands, drinking boiled cabbage and dying miserable deaths by their mid 20s. The forces that govern economics and life in general are greater than any of us can control, and so if we really want to maximize our standard of living and minimize the pain and suffering inevitably associated with life, then all we need to do is stop trying to play god. We need to stop asking the government to solve all of our problems, stop running up debts that we can’t pay back and stop living beyond our means, because all of these things lead to a misallocation of resources, that eventually and inexorably leads to a collapse. For now, however, we can do nothing to fix the damage done by decades of deficit spending, malinvestment and credit expansion. We will have to pay the price, and any effort to delay that punishment will only make the pain eventually that much greater, until we have absolutely no choice but to wholly capitulate. As the famous Austrian Economist Ludwig von Mises is quoted as saying:
“There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved.”
– Ludwig von Mises
