Government Can't Spend Money to Save Money

Everyone is familiar with the oxymoronic advertising slogan urging customers to spend more in order to save more. That kind of sales hoax is cropping up in the unlikeliest of places these days—in the halls of academia, where some well-known economists are advocating increased borrowing by the federal government because, quite simply, it's so darn cheap to do so.

At the International Monetary Fund's conference on "Rethinking Macro" in Washington last month, Brad DeLong, economics professor at the University of California, Berkeley, said the low yields on sovereign debt across much of the developed world were sending a clear message to governments that they need to borrow more.

"Isn't the debt of reserve-currency issuing sovereigns an extraordinarily valuable thing that is very cheap to make?" DeLong asked in his presentation at an IMF panel. "So shouldn't we be making more of it?" 

I suspect his question was rhetorical, but my answer is "no." Debt isn't a manufactured good or a "thing," as DeLong suggests. It is an IOU, a promise to pay the bondholder a specified amount at some future date plus interest. DeLong wants the government make lots of IOUs without any concomitant guarantee of the means to make the payment.

For Harvard's Larry Summers, the slowest expansion since World War II is evidence of secular stagnation, a term coined by economist Alvin Hansen in 1938 to explain why the Great Depression lasted so long. The cure for both DeLong and Summers is more deficit spending, which just so happens to be "the same policy progressives always favor," says Andy Laperriere, head of U.S. policy research at Cornerstone Macro.

There are a couple of problems with their proposed solution to secular stagnation. As described by Hansen, secular stagnation was a supply-side phenomenon. He posited that all the ingredients for economic growth—technological innovation, population growth, territorial expansion—had dissipated. 

The post World War II economic boom proved Hansen wrong, but that's never stopped economists from resurrecting a debunked theory.

The second problem is the nature of the proposed cure. If the problem is secular, why is the solution cyclical? Old-fashioned pump-priming, where the government borrows and spends because the private sector isn't, has always been the fallback during recessions. Are DeLong and Summers suggesting that a perpetual Keynesian stimulus is required to achieve healthy economic growth? 

It seems so. In addition to "structural measures to promote private investment," Summers advocates open-ended expansionary fiscal policy, an added benefit of which would be a reduction in the debt-to-GDP ratio, he claims, citing an IMF paper. In other words, spend money to save money.

There is a good case to be made for government investment in crumbling infrastructure with the Treasury able to borrow at historically low rates of interest. Just last week, for example, the Wall Street Journal reported that major ports in this country are ill-equipped to handle the growing volume of cargo. 

But borrowing for the sake of borrowing is a lousy idea when the ratio of publicly held debt to GDP stands at 74 percent, double the share before the 2007-2009 recession, on its way towards 100 percent in 2039, according to the Congressional Budget Office.

DeLong's advice is reminiscent of John Maynard Keynes, who wrote in The General Theory of Employment, Interest and Money that building "two pyramids, two masses for the dead," is twice as good as one.

If a lack of investment is what ails the U.S. economy, it makes infinitely more sense to address the problem head-on. Reduce the U.S. statutory corporate tax rate, which at 35 percent is the highest in the developed world. Simplify burdensome rules and regulations that act as an impediment to small business formation. As I have written before, if businesses aren't investing, it isn't because the cost of capital is too high. It's because the perceived return is too low.

Economists should be more concerned about the apparent collapse in potential GDP. The rate at which a country can expand is circumscribed by the growth of the labor force and growth of productivity. Both are depressed right now. The labor force has increased at an average annual rate of 0.2 percent since the end of the recession while non-farm business productivity growth has averaged 1.3 percent. Both are well below historical averages of 1.4 percent and 2.2 percent, respectively.   

If the economy's productive potential were strong, it would make sense to find ways to stimulate demand. As it is, the United States needs help on the supply side, which in turn will boost spending. It's not clear why former Federal Reserve Chairman Ben Bernanke, who has challenged Summers on his economic diagnosis, views secular stagnation as a story about inadequate aggregate demand. 

Whenever I hear that nonsensical phrase, I'm reminded of an economist friend, who puts an immediate end to any discussion of such a concept with his stock response. "Insufficient demand?" What, everybody has everything he or she wants?"

I rest my case.

Caroline Baum is a contributor to e21. You can follow her on Twitter here.

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