Obama
Puts the Economic Cart Before the Horse by Peter Schiff
- February
28, 2009
In
his first televised speech before Congress, President Obama
asserted that prosperity will return once the government restores
the flow of credit in the economy. It may come as a surprise
to him, but an economy cannot run on consumer loans. Furthermore,
credit stopped flowing in the U.S. for a very good reason:
there was no more savings left to loan. Government efforts
to simply make credit available, without rebuilding productive
capacity or increasing savings, are doomed to destroy what’s
left of our economy.
The central tenets of Obamanomics appear to be that access
to credit will enable people to borrow money to buy stuff,
the spending will spur production and employment, and thus
the economy will grow. It’s a neat and simple picture,
but it has nothing whatsoever to do with how an economy works.
The President does not understand that consumption is made
possible by production and that credit is made possible by
savings. The size and complexity of modern economies has obscured
these simple concepts, but reducing the picture to a small
scale can help clear away the fog.
Suppose there is a very small barter-based economy consisting
of only three individuals, a butcher, a baker, and a candlestick
maker. If the candlestick maker wants bread or steak, he makes
candles and trades. The candlestick maker always wants food,
but his demand can only be satisfied if he makes candles,
without which he goes hungry. The mere fact that he desires
bread and steak is meaningless.
Enter the magic wand of credit, which many now assume can
take the place of production. Suppose the butcher has managed
to produce an excess amount of steak and has more than he
needs on a daily basis. Knowing this, the candlestick maker
asks to borrow a steak from the butcher to trade to the baker
for bread. For this transaction to take place the butcher
must first have produced steaks which he did not consume (savings).
He then loans his savings to the candlestick maker, who issues
the butcher a note promising to repay his debt in candlesticks.
In this instance, it was the butcher’s production of
steak that enabled the candlestick maker to buy bread, which
also had to be produced. The fact that the candlestick maker
had access to credit did not increase demand or bolster the
economy. In fact, by using credit to buy instead of candles,
the economy now has fewer candles, and the butcher now has
fewer steaks with which to buy bread himself. What has happened
is that through savings, the butcher has loaned his purchasing
power, created by his production, to the candlestick maker,
who used it to buy bread.
Similarly, the candlestick maker could have offered “IOU
candlesticks” directly to the baker. Again, the transaction
could only be successful if the baker actually baked bread
that he did not consume himself and was therefore able to
loan his savings to the candlestick maker. Since he loaned
his bread to the candlestick maker, he no longer has that
bread himself to trade for steak.
The existence of credit in no way increases aggregate consumption
within this community, it merely temporarily alters the way
consumption is distributed. The only way for aggregate consumption
to increase is for the production of candlesticks, steak,
and bread to increase.
One way credit could be used to grow this economy would be
for the candlestick maker to borrow bread and steak for sustenance
while he improves the productive capacity of his candlestick-making
equipment. If successful, he could repay his loans with interest
out of his increased production, and all would benefit from
greater productivity. In this case the under-consumption of
the butcher and baker led to the accumulation of savings,
which were then loaned to the candlestick maker to finance
capital investments. Had the butcher and baker consumed all
their production, no savings would have been accumulated,
and no credit would have been available to the candlestick
maker, depriving society of the increased productivity that
would have followed.
On the other hand, had the candlestick maker merely borrowed
bread and steak to sustain himself while taking a vacation
from candlestick making, society would gain nothing, and there
would be a good chance the candlestick maker would default
on the loan. In this case, the extension of consumer credit
squanders savings which are now no longer available to finance
other capital investments.
What would happen if a natural disaster destroyed all the
equipment used to make candlesticks, bread and steak? Confronted
with dangerous shortages of food and lighting, Barack Obama
would offer to stimulate the economy by handing out pieces
of paper called money and guaranteeing loans to whomever wants
to consume. What good would the money do? Would these pieces
of paper or loans make goods magically appear?
The mere introduction of paper money into this economy only
increases the ability of the butcher, baker, and candlestick
maker to bid up prices (measured in money, not trade goods)
once goods are actually produced again. The only way to restore
actual prosperity is to repair the destroyed equipment and
start producing again.
The sad truth is that the productive capacity of the American
economy is now largely in tatters. Our industrial economy
has been replaced by a reliance on health care, financial
services and government spending. Introducing freer-flowing
credit and more printed money into such a system will do nothing
except spark inflation. We need to get back to the basics
of production. It won’t be easy, but it will work.
President Obama would have us believe that we can all spend
the day relaxing in a tub while his printing press does all
the work for us. The problem comes when you get out of the
tub to go to dinner and the only thing on your plate is an
IOU for steak.
Peter
Schiff is president of Euro Pacific Capital and author of
The Little Book of Bull Moves in Bear Markets and Crash Proof:
How to Profit from the Coming Economic Collapse.