Both Keynesians and monetarists believe that increased government spending, or more money injected into the economy, is sometimes necessary. The intervention is in the form of unfunded government spending, artificially low interest rates to boost demand for money and bank credit, or a drive to make the currency “competitive” by lowering it. These methods have been tried unsuccessfully time and again, and they must be denounced if we are to understand our true economic condition.

The reason they don’t work can be summarised as both an oversight and a fallacy. The oversight is to look at only one side of a government spending proposal: a new bridge, hospital or school is a visible benefit. What is easily ignored is the cost, which is spread between many individuals’ savings and earnings. If these resources were not redirected, they would be available to consumers to spend as they see fit. This is important, because it is consumer demand that drives innovation and economic progress, not government redistribution.

The basic fallacy is to subscribe to ideas that are consistent with the cost of production, or the labour theory of value, and to try to shoe-horn it into the reality of consumer price subjectivity. The list of economists who have made this mistake is far longer than those that understand the error, including Thomas Aquinas, Adam Smith, David Ricardo, John Stuart Mill and Karl Marx. It is the bedrock of socialist thought, which divides us pejoratively into the exploited and capitalist classes. The truth is very different: the consumer through his choices decides prices and what is made, and any producer that fails to respond goes out of business.

The nub of the problem is mainstream economists do not understand prices. They draw supply and demand curves that illustrate, other things being equal, lower prices stimulate demand. Putting to one side the fact that other things are never equal, that is a reasonable starting point. This is then contradicted by macro-economists who believe that falling prices defer and suppress demand, and moderately rising prices stimulate demand.

Therefore the contradictions start from the most basic level, and from there the errors multiply. Instead of abandoning cost-of-production theories, mainstream economists seek to subsidise producers, either directly or by monetary means. It amounts to a subsidy for businesses that would otherwise fail. Furthermore successful businesses are encouraged to seek subsidies and discouraged from redeploying their capital into genuinely profitable investment.

Through relentless government propaganda nearly everyone today believes that state intervention is a force for good, but the truth is very different. Government intervention amounts to reducing wages and destroying savings through monetary inflation, while putting prices up. Admittedly, there can be a short-term artificial boost from lower interest rates and monetary expansion, but this is quickly reversed when prices start to rise.

A reasoned analysis of the true effects of government intervention reveals the truth: it comes at considerable economic cost, disrupting economic progress and leaving us all worse off as a result. Is it any surprise that reflation has now finally ceased to even generate short-term benefits?

Alasdair Macleod runs FinanceAndEconomics.org, a website dedicated to sound money and demystifying finance and economics. Alasdair has a background as a stockbroker, banker and economist. He is also a contributor to GoldMoney - The best way to buy gold online.

© 2013 Copyright Alasdair Macleod - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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