Tuesday, August 30, 2011

Mythbusters II: The Great Hotdog Hoodwink

"They" keep telling us that Americans are deficient in math skills. That's when "they" are not telling us that we're deficient in the other two Rs, our knowledge of science, our rate of savings, our sensitivity, our coffee drinking, or whatever the cause du jour happens to be on a slow news day. One would think that the media are in the business of making us feel bad about ourselves instead of filling their proper position as peddlers of prurient pabulum to pacify the purposeless populace (you didn't think I could do it, did you).

You know something? "They" may be right. This morning's Wall Street Journal tootled that consumer spending is up. Since (as every semi-educated non-economist knows) consumer demand drives the demand for new capital, and thus new, sustainable job creation, that's a good thing.

No, really. As Dr. Harold Moulton analyzed the situation in The Formation of Capital (1935), consumer demand leads and provides the justification for investment in new capital. As he explained,

"The general conclusion reached in this and the preceding chapter, that a growth of capital does not take place unless expansion of consumption is also occurring, does not appear upon close analysis to be surprising. The motivating force in all economic activity, under a system of private initiative, is the wants and demands of people. The base of the economic pyramid is the production of consumption goods — first, primary necessities, and then comforts and luxuries. In the ascending scale of goods that are relatively indispensable we find new plant and equipment at the top. This is simply because the demand for plant and equipment is derived from the demand for the consumption goods which such plant and equipment can produce." (Harold G. Moulton, The Formation of Capital. Washington, DC: The Brookings Institution, 1935, 71-72.)

Okay, it's clearly evident that we have to increase consumption if we want to have a sustainable economic recovery. That should be easy, for there are all kinds of people in the United States alone who are currently not able to satisfy ordinary wants and needs. Plus, if we manage to provide sufficient marketable goods and services to the people in the U.S., there's millions, maybe billions of people in the world whose needs are not being adequately met, much less their wants.

Here's the problem. The Keynesian solution to kick-starting economic recovery — "priming the pump" — is to inflate the currency by increasing government spending, permitting the government to emit bills of credit backed by the present value of future tax collections, thereby spreading effective demand out through the economy. This will stimulate consumption, and thus provide an incentive for producers to form new capital and create jobs.

So far, so good, right? Wrong. Printing money does increase effective demand. That is correct as far as it goes. More money in circulation allows more people to buy more products. Again, that's fine, as far as it goes.

Unfortunately, it goes a little further. Just printing money that is backed by the present value of future taxes that the State might collect (emitting bills of credit), instead of the present value of future marketable goods and services that a private sector business is reasonably certain to produce (bills of exchange) is an iffy proposition . . . to put it mildly.

For one thing, the citizens might get fed up with the rate of taxation and refuse to give their consent to the present rate of taxation, much less any additional taxes in the future needed to pay off the increased debt. This could result in a stalemate in Congress, as legislators try to balance the demand for increased spending against the desire to make somebody else pay for it.

Could? It did. Remember the Tea Party and the debt ceiling crisis?

For another, creating money by emitting bills of credit doesn't really create effective demand. It redistributes existing demand, taking from some for the benefit of others through the "hidden tax" of inflation. Because there is no real increase in consumption, there is no true incentive for producers to finance new capital formation. Increased government spending is an artificial stimulus. As was shown by the "Depression within the Depression" in the mid-1930s, past a certain point the stimulant ceases to have the desired effect, and simply causes inflation without new capital investment or job creation until it caves in itself.

Artificially induced inflation causes what we have decided (at least for this posting) to call "The Hotdog Effect." If you've been in the grocery store lately, you might have noticed that prices seem to be increasing. You don't see this too much in the newspapers or on television, because food and fuel are not factored in to the official statistics.

Thus, while no one seems to be taking official notice, food is costing you more. We'll take hotdogs for an example, simply because we noticed it there first. In the store we frequent, hotdogs and that sort of thing are right after fruits and vegetables and fresh meats, both of which are more subject to price changes and sales than non-seasonable items like processed meats and cheeses.

A year or so ago we noticed that the 50¢ pound packages of hotdogs that we'd been buying for 79¢ seemed to level out at 99¢. We also noticed that the $2.99 three-pound packages of kielbasa we'd been getting had plateaued at $4.99. Then, some months back, the hotdog section was festooned with signs declaring that a number of products had been discontinued.

Discontinued? That seemed odd. Our increasing demand for the raw materials for hotdogs and rice, or sausage in paprika gravy alone should have been sufficient to keep the products in stock. Why would they be discontinued?

A few weeks later, it appeared that maybe some (other) customers had complained, for the products were all back in stock, although at pretty hefty price increases. The polish sausage was now $5.99 a package (20% increase), while the hotdogs were $1.25 (25%). Something of an ouch, but we supposed it was bearable. Barely.

We picked up a package of the kielbasa to put it in the cart, and noticed that it felt "funny." Looking closer, we discovered that the formerly 3 pound package for $4.99 was now a 2-1/2 pound package for $5.99. We decided to look at the hotdogs. The 99¢ pound package was now a $1.25 12-ounce package.

You can do the kielbasa kalculation yourself, but we did the wiener workout in our head. It was a nearly 70% increase in price — 66.67%, meaning the price was two-thirds more than the old price. That's a bit more than 25% (one-fourth), and was enough to cause us to return both the polish sausage and the hotdogs to the case. A 66.67% increase is almost double the price.

Going through the store, we noticed other, similar changes. Different brands of the same product in different sized packages were "unit priced" differently as if the object were to make comparison-shopping on the basis of price more difficult. A 9.5-ounce package of something might be unit priced in ounces, while the 12-ounce package right beside it unit priced in pounds, and the 16-ounce package unit priced in . . . units, or the number of items in the package!

And (in case you were wondering) the eight-count package of hotdog buns that cost 50¢ two years ago is now $1.25.

The point to this is that it illustrates the fundamental problem with the Keynesian "solution." The Wall Street Journal might trumpet that consumer spending is up by a tiny fraction, but the sort of hoodwinking we've seen in hotdogs hides what's happening. (Sorry, that alliteration just slipped out.) Yes, people are spending more, but they're getting less. Consumption spending is up, but consumption is down.

Do you see the problem yet?

Okay, here's the giant swindle of Keynesian "pump priming": the demand for new capital is derived from increases in consumption, not consumption spending.

The problem?

The Keynesian idea is that inflationary price increases force people to reduce consumption, and thereby meet the presumed necessity to reduce consumption so that producers have the wherewithal — "savings," always defined as "reductions in consumption" — for them to be able to finance new capital. Government spending redistributes existing demand so that people who couldn't consume before are now able to consume. Consumption in aggregate goes down, but because consumer demand is less elastic than the money supply, prices go up faster than consumption decreases. This provides a safety margin that buys time for the new capital formation to create jobs and generate new effective demand without the government having to keep pumping money into the economy to redistribute existing effective demand.

What we've seen is that, yes, producers are accumulating vast amounts of cash — savings — possibly in excess of $2 trillion in the U.S. at this point. What is baffling to the Powers-that-Be, however, is that producers are not using this cash to finance new capital and create jobs. The government has pumped trillions of dollars into the economy, prices are up, consumer spending is up, and yet producers stubbornly resist carrying out their part of the bargain: they aren't financing new capital and creating jobs.

Why? It should be obvious. No sane producer is going to finance new capital formation until and unless there is a solid and sustainable increase in consumption to make the new capital financially viable.

"But," the Keynesians wail, "there IS an increase in consumption! The statistics say so!"

Alas, no. Keynesian economics is built on the assumption that you can have your cake, and eat it, too, that is, you can contradict yourself. By manipulating the currency, you apparently increase effective demand at the same time that you decrease consumption.

The Keynesian sleight-of-hand is insidious. You apparently avoid what Moulton called "the economic dilemma" — you can't finance capital except by cutting consumption, but if you cut consumption you won't finance capital — by playing word games.

Redistribution through inflation seems to increase demand at the same time that it decreases consumption — but that is only because you have, at one and the same time, defined increases in "effective demand" as both inflationary increases in the money supply that cut consumption, and increases in real income that increase consumption.

Yes, it's complicated, a lot more so than this attempted simplified explanation. The bottom line is that, while consumer spending is up, consumption is down. Nevertheless, the demand for new capital (and thus new jobs) does not depend on increased consumer spending, but on increased consumption.

Consequently, producers have no real incentive to finance new capital. They're making more money at present levels of production, getting more for less as inflation accelerates, and real consumer demand is falling.

A better solution, as Moulton pointed out in Income and Economic Progress (1935), would be to let prices fall, rather than raise them. Consistent with the laws of supply and demand, this would increase demand as consumers could get more for less instead of the Keynesian less for more. Consumption would go up, and producers, seeing a chance to make a profit by increasing production, would finance new capital and create jobs. Instead of Keynesian "forced savings" that shifts value from consumers to producers through inflation so that producers can accumulate cash, financing for new capital should come from the expansion of commercial bank credit.

The best solution? As Kelso and Adler pointed out in The Capitalist Manifesto (1958) and The New Capitalists (1961), make certain that all new capital financed through the use of "pure credit" (that is, without relying on past savings), is broadly owned so that sustainable consumption demand from production instead of taxation or inflationary redistribution is spread throughout the economy.

Then maybe we could afford to buy a hotdog every once in a while.


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