Nouriel Roubini and the Folly of Fiscal Stimulus

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Whereas before there had been almost no framework to explain what Roosevelt was doing, now a respectable one was forming. Spending promoted growth, if government was big enough to spend enough. Amity Shlaes, The Forgotten Man

NYU professor Nouriel Roubini is presently the economist of the moment. Having correctly called the economic troubles in our midst for arguably the wrong reasons, his celebrity recently took him to Capitol Hill, where once again his prescriptions reveal a misreading of the problems at hand.

Roubini’s analysis has attracted a lot of attention of late for his view that the moderation of this decade’s housing boom would lead to a financial crisis. The problem with his thinking involved his assumption that housing is an essential input to real economic growth.

The above sounds nice on its face, but whether it’s New York, Los Angeles or Palo Alto, housing in all three was and will continue to be a consumptive effect of otherwise strong economic growth. Housing surely didn’t build any of the three cities (nor did it grow Miami, Dallas or Seattle either), but thanks to productive economic activity in all three, housing was the certain consumptive result.

Importantly, just as housing was the hot asset class in the early and late ‘70s, so was it this decade not due to economic growth per se, but thanks to currency debasement that always leads to a flight to the real. In short, the subsequent moderation of home prices has not been an economic retardant so much as it’s been the result of economic sluggishness that always reveals itself when currencies are allowed to weaken.

Roubini holds the reputation of soothsayer at present, but the very analysis that has made him all-seeing was faulty on its face. Lower home prices are an undeniable good for less capital going into the ground, as opposed to the entrepreneurial economy. What led to housing’s moderation of late was paradoxically what caused its boom. When currencies decline, hard assets do well, and investment in real economic activity withers.

But the money illusion that bolsters the nominal price of hard assets such as housing only lasts so long. Eventually the economy had to atone for monetary mischief, and with currency debasement bating 1.000 when it comes to economic hardship due to the aforementioned investment slowdown working in concert with the evisceration of paychecks, the servicing of mortgage debt was eventually going to be difficult.

In short, Roubini made the correct call a few years ago about looming economic difficulty, but the call ignored the real cause which decidedly was the weak dollar. Happily for Washington’s political class, Roubini’s suggestions for “stimulating” the economy absolve it of its own mistakes, all the while allowing it to do what it does best: spend the money of others.

Indeed, rather than proposing that Congress follow its constitutional mandate when it comes to shoring up and stabilizing the dollar’s value, Roubini’s economic prescription was surely music to many legislators’ ears. He asked for a second stimulus plan of $300 to $400 billion, which would dwarf the previous one by a multiple of three.

But if mere government spending were the solution to our economic troubles, one might ask why Roubini is being so thrifty. Instead of $400 billion, why not $1.2 trillion?

Importantly, the answers why are obvious. If the federal government spends $400 billion to stimulate the economy, then the private citizens from whence that money came would have $400 billion less to spend or invest in the private economy.

Roubini testified that absent the stimulus he proposes, “Six months from now, everything we’ve done to backstop the banks is going to be undone by a collapse in aggregate demand.” What Roubini misses is the origin of what he deems aggregate demand.

Put simply, there is no aggregate demand to speak of absent productive work effort first. The ability of any individual to demand things is the direct result of that same individual’s productivity; that or the productivity of others who are then willing to lend in order for the same individual to consume. So when the federal government taxes the private economy in order to pass around money, there is no economic growth to speak of. Worse, taxes are nothing more than a price put on work effort, and if they’re raised to fund stimulus plans, the incentives of the productive to work more are reduced.

And there lies the major fallacy of Roubini’s latest economic analysis. Captive to an economic model centered on demand, Roubini believes the path to economic recovery lies in reaching into one set of pockets in order to line the pockets of others.

The above certainly cannot be true based on simple logic. Generator of no revenues itself, the federal government can only spend to the extent that private individuals produce. Looked at from today’s perspective, the federal government is only able to spread the wealth created by others if the “others” are working productively in the private economy such that the government has true wealth to tax. You can’t profit from the same transaction twice, but in the fantasy world of Washington and certain economists, this is a possibility.

Basic economics tells us something quite at odds with today’s conventional wisdom. Given the reality that any government’s ability to spend is the direct result of real economic growth, fallacious assumptions suggesting that an economy can be stimulated by revenues created in the private sector quickly fail the most basic of smell tests. Indeed, the only good that might come from Roubini’s proposals being passed is that so inimical are they to real economic growth, their certain failure will lead to a reassessment of the establishment consensus which suggests wealth redistribution actually causes people to work.

Back in the real world, economic growth and recovery will be the same as it ever was; the result of stable money values, low taxes on work effort, light regulation, and the liberty to trade one’s surplus with others irrespective of border. Any program that doesn’t promote those four basic inputs will harm, rather than stimulate our economy.

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