Thursday, June 4, 2009

A Reader Writes

The Lehmann Letter ©

A reader raised the following issue regarding the federal stimulus:

“When private parties borrow from banks, the money is partially
from such things as deposits, but then multiplied by a factor of 20 or
so as the banks "create" money. If the people borrowing can pay the
money back with interest, because their businesses are profitable or
they have a healthy income, everybody is happy. But if consumers can no
longer buy your products at the hoped for level, and people lose their
jobs, then you and they can't repay the loans, and the banks fail.

“If, as you have shown, the government now replaces private
borrowers and lenders, it too creates money, but instead of investing it
in production of things people will buy (various kinds of widgets), it
invests in "infrastructure", which nobody buys. It creates or maintains
jobs; but the people getting paid are not producing anything that
directly generates revenue.

“I guess the theory is that people with those government created
jobs will buy things, and this will stimulate the private sector to get
back into profitable production. Maybe this will work. But I don't have
confidence that where the private sector fails in investing and
managing, "the government" is somehow going to do better.”

I responded by saying (edited for locale):

“It's not so much that the government is going to do better, as it is that the private sector ground to a temporary halt. So, for the time being, it's a choice between nothing (private sector) and something (government). When the private sector recovers, the government can and should pull back.

“In general the government does not do a good job providing goods and services to the market. That's why the private sector provides the vast majority of our goods and services and most of the goods and services the government provides are public goods (light houses, police, fire, national defense, streets, parks, etc.), public works (Shasta Dam, California Water Project, Bonneville Dam, San Francisco Bay Bridge, etc.), natural monopolies that private enterprise abandoned (San Francisco Municipal Railway, NY subways, etc.) and services that society wanted but the private sector did not adequately provide (public schools, postal service, etc.). I don't support the government taking over activities the private sector does well, e.g. the city taking over our local electric and gas company. But I generally believe the public/private mix makes sense given the economic and historical and societal forces at play. So I don't see danger in a temporary government surge.

“To me, the far greater danger in the current situation is the erosion of the private sector's balance sheet: Particularly the huge ratio of debt to liquid assets. Our economy now depends on private borrowing and spending that is imperiled by existing debts. Public borrowing and spending is no permanent substitute because the public sector can't endlessly incur more debt. So who's going to spend? It's a real problem.”

© 2009 Michael B. Lehmann

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