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Keynesians Crowd Out Common Sense

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July 31, 2010 – Comments (18)

And don't get me started on Chartalists. 

If you'e curious about the subject of "crowding out" investment, this is a great article by Austrian economist Gary North.  It is such an elementary concept, you'll be left shaking your head that this is even debated among academics. 

David in Qatar

Crowding Out Our Future Wealth by Gary North

If you persuade someone to sell you something, your offer has crowded someone else who wanted to buy it. ...

...The would-be borrower must accept a second-best solution to his problem. That is what crowding out means. He has been crowded out from the best solution by a more aggressive borrower.

The funds used to finance a borrower's project can be used for only one project at a time. The winning bidder for the funds is now able to bring his project to completion. All other would-be borrowers must find other low-cost sources of the funding. They did not have such low-cost alternative sources prior to the winner's bid.

THE WORLD OF KEYNES

This sounds elementary. Anyone should be able to understand it. But Keynesian economists do not understand it. When the government does the borrowing, they insist, there is no crowding-out effect. We read this on a site that provides definitions of economic terms. This is the definition for "crowding out."  

"Theory that heavy borrowing by a government (which can pay any interest rate) soaks up the available credit, leaving little for the private sector at affordable interest rates. Opponents of this theory point out that new sources of credit emerge at every stage of an interest rate increase."

Got that? The opponents argue that when Joe cannot borrow money from Fred, because Fred lends the money to their Uncle Sam, Bill will lend Joe the money, but at a higher interest rate. "But," you say, "that is what crowding out means: Joe is crowded out at the low rate that Uncle Sam agreed to pay." You are beginning to get a sense of the level of sophistication of this dictionary.

"But this cannot be representative of common economic opinion," you respond. "This is some sort of oddity." So, I direct you to the definition provided by The Economist, generally regarded as the most sophisticated of all general audience economics magazines.

"When the state does something it may discourage, or crowd out, private-sector attempts to do the same thing. At times, excessive GOVERNMENT borrowing has been blamed for low private-sector borrowing and, consequently, low INVESTMENT and (because the economic returns on public borrowing are typically lower than those on private DEBT, especially corporate debt) slower economic GROWTH. This has become less of a concern in recent years as government indebtedness has declined and, because of GLOBALISATION, FIRMS have become more able to raise CAPITAL outside their home country."

"Government indebtedness has declined." When was this entry written? In Grover Cleveland's Administration? Second, firms can supposedly borrow from abroad. But so can Uncle Sam . . . which he has done incessantly, to the tune of about half of the debt he owes to the public.

The definition assumes that by appealing to foreign lenders, the definition changes. "You see, Joe can now borrow what he wants from foreigners, which he was unaware of before Fred lent Uncle Sam that money." In literary terminology, this is a Deus ex machina, which is a source of causation that was outside the original plot's presentation of the facts. The solution to the plot's otherwise unsolvable problem is delivered from the realm of the gods. Thank Deus!

How can this sort of intellectual subterfuge go on? Because of this:

FULL ARTICLE

18 Comments – Post Your Own

#1) On July 31, 2010 at 11:10 PM, tomlongrpv (82.10) wrote:

Too bad the wild private borrowing of the housing bubble wasn't crowded out.  The assumption that private borrowing produces more socially useful results and more wealth than public borrowing is just that--an assumption.  Many great public works that created considerable increases in the standard of living and considerable increases in wealth were the result of public borrowing.

The article also seems to assume that all defecit spending leads to public borrowing--an assumption that is true only if the money supply is static.

 

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#2) On July 31, 2010 at 11:19 PM, ragedmaximus (< 20) wrote:

I noticed a cnn  money article from 4-28-2008 titled FIRST STIMULUS CHECKS ARRIVE-WHAT YOU NEED TO KNOW. In an effort to boost the economy and only a few weeks later the dow started falling of the dow 13000 to dow 6600 this was after the initial slide from 14000 to 13000. So you see there are the same things going on now that was going on then except it really is worse now and the next crash is coming so i suggest stay in cash till the dust clears.

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#3) On July 31, 2010 at 11:24 PM, whereaminow (42.87) wrote:

tomlongrpv,

Many great public works that created considerable increases in the standard of living and considerable increases in wealth were the result of public borrowing.

The art of economics is not only seeing the bridge being built, but also the many projects left unfinished because of the transfer of wealth from private citizens to the public sector.

In other words, you assume that those "great public works" were the only investments possible.  They were, in fact, by definition, not the first choice of the holders of money.  Otherwise, they would have engaged in the project through private borrowing.  That's the definition of crowding out.

Don't "seem to assume" the article. Read it. If you have better things to do, then do them.

David in Qatar

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#4) On August 01, 2010 at 9:36 AM, MoneyWorksforMe (< 20) wrote:

Great article. I agree with him. He has an interesting and very intelligible point that is commonly overlooked.

I would like to add that many Keynesians are claiming there is a fundamental lack of business demand for loans, due to uncertainty and a lack of business confidence. This is why Keynesians believe they must do the borrowing--they are the only ones who will in this environment.

The anecdotal evidence is mixed with many businesses asserting they cannot acquire the capital they need to expand their businesses while others are saying there is just too much uncertainty about the future and they rather sit on piles of cash than take on more leverage. Keynesians use the latter as justification for their methodology.

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#5) On August 01, 2010 at 12:47 PM, tomlongrpv (82.10) wrote:

Of course private investments are possible and of course public investments (whether or not based on public spending or taxes) can crowd out private investments where the money supply is static.  It's all an issue of priorities--are the things that private investment builds more important than the things that public investment builds?  Sometimes they are, and sometimes they are not.  That's the policy issue that both you and the author of the article you cite are missing.  You and the author have faith that private investment is always better and always more important.  But faith is just a weak substitute for critical thought.

Do you really think that public investing crowding out private investing would have been bad in the housing bubble? The private economy was investing in things that were unsustainable.  More public investing could have allowed infrastructure improvement that would have made us more competitive.  Few roads, dams, sewers, storm drains, etc. are built with private investment. 

 #4 has got a good point too.  Many businesses are just hoarding cash.  Thus at least in some cases private investment is not being "crowded out," it is "sitting out."  What does a libertarian do about that?   The answer seems to be nothing.

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#6) On August 01, 2010 at 1:56 PM, whereaminow (42.87) wrote:

tomlongrpv,

It's all an issue of priorities--are the things that private investment builds more important than the things that public investment builds?  Sometimes they are, and sometimes they are not. 

That's a subjective evaluation.  There is no way to evaluate public sector projects.  In the private sector there is (profit and loss.) 

You and the author have faith that private investment is always better and always more important.  But faith is just a weak substitute for critical thought.

It's not faith, it's theory - i.e. critical thought. See here.  Besides, "better" is a subjective criteria.  I'm more interested in who gets to decide what's "better," again since it is always subjective and individual.  There is no collective "better" judgment. 

Do you really think that public investing crowding out private investing would have been bad in the housing bubble? The private economy was investing in things that were unsustainable. 

Central bank policy that pushed interest rates too low for too long and government programs to increase home ownership had absolutely nothing to do with it, right?  It's just animal spirits, I know. This line of debate bores me and has been covered endlessly here, for example.

Many businesses are just hoarding cash

They don't know their future costs. It has something to do with the trillions sitting on the sideliens waiting to be unleashed. See the discussion here.

What does a libertarian do about that?  

A libertarian doesn't pretend that the world is his own game board where the pieces can be moved around by whim or decree. 

David in Qatar

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#7) On August 01, 2010 at 2:47 PM, zymok (< 20) wrote:

Good post.  It highlights a topic that many people overlook.

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#8) On August 01, 2010 at 3:20 PM, tomlongrpv (82.10) wrote:

So when private investment does poorly it's government's fault and when it does well it's free enterprise at work?

I am not going to waste my time listening to Ron Paul ask questions.  I am surprised you would.

How unfortunate that the only measure of social utility you can see is profit and loss statements.  Plenty of investments that yield no monetary profit are socially useful and improve the quality of life.  If you don't understand this basic concept then you really have no means of assessing the value of anything.

 

  

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#9) On August 01, 2010 at 3:42 PM, whereaminow (42.87) wrote:

tomlongrpv,

 So when private investment does poorly it's government's fault and when it does well it's free enterprise at work?

A bust/crash is a cluster of business investments that collapse.  Are you familiar with business cycle theory - not just Austrian Business Cycle Theory - but any business cycle theory?

I am not going to waste my time listening to Ron Paul ask questions.  I am surprised you would

It wasn't Ron Paul saying businesses were uncertain about costs. It was the Fed economist.  Again, if you have better things to do, then do them. Otherwise, actually research your opponents.  (I'm stuck at work on a Sunday night playing with servers.  I don't have better things to do.) 

How unfortunate that the only measure of social utility you can see is profit and loss statements. 

That would be unfortunate, except that I didn't say that.  I said the only objective measure of an investment's usefulness is profit and loss.

Plenty of investments that yield no monetary profit are socially useful and improve the quality of life. 

I didn't argue otherwise.  Back to the whole "bridge being bulit" concept from above that you still don't grasp.

If you don't understand this basic concept then you really have no means of assessing the value of anything.

Actually, all valuations are subjective.  That was my original point.  "Better" is allowing private individuals to make the subjective judgements with their own money.

Sorry if I sound bored but at least investigate the theory that I propose.  Then criticize it. It's a more effective form of debate, anyway.

see here.

David in Qatar

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#10) On August 01, 2010 at 6:53 PM, devoish (99.06) wrote:

What does a libertarian do about that?   The answer seems to be nothing. - tomlongrpv

A libertarian doesn't pretend that the world is his own game board where the pieces can be moved around by whim or decree - Hopelesslylost

What does a Libertarian do was the question. Besides evade reality and questions. The Libertarian as defined by G.North, sits fearfully on his money, then complains when Government beats him to the investment opportunity, whining in fear again about Government guns while unwilling to see those possessed by Xe.

Do you really think that public investing crowding out private investing would have been bad in the housing bubble? The private economy was investing in things that were unsustainable.  -tomlongrpv

Central bank policy that pushed interest rates too low for too long and government programs to increase home ownership had absolutely nothing to do with it, right?  It's just animal spirits, I know. This line of debate bores me and has been covered endlessly here, for example. - Hopelesslylost

Thanks for telling us that.

Do you really think that public investing crowding out private investing would have been bad in the housing bubble? The private economy was investing in things that were unsustainable.  - tomlongrpv

Try again.

I am not going to waste my time listening to Ron Paul ask questions.  I am surprised you would - tomlongrpv

It wasn't Ron Paul saying businesses were uncertain about costs. It was the Fed economist. - Hopelesslylost

You have decided to take a Fed Economist at his word? A Keynesian Fed Economist? A corrupt Government Capturing Keynesian Fed Economist is your trusted informant? Why not call Krugman himself? When it suits you I guess.

- The Grand High Exalted Mystic Totally Disappointed in Hearing you go to a Fed Economist for Corroboration, King Devoish

PS. You can ignore my last comment, it was just for fun. You can go for corroboration to any source you choose. I would like to hear you try to answer tomlongrpv's questions though.

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#11) On August 01, 2010 at 7:07 PM, whereaminow (42.87) wrote:

I would like to hear you try to answer tomlongrpv's questions though

An Austrian economist treats the root cause (excessive expansion of credit) by either establishing 100% reserve banking (making the Fed unnecessary)  or heavily regulating frb's in the meantime.  But don't take my word for it. It's in the first paragraph of the Wiki on ABCT.  I was hoping he'd do his own homework.  I have no hope for you.

David in Qatar

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#12) On August 01, 2010 at 8:39 PM, NOTvuffett (< 20) wrote:

David,

Another great post.  I have been thinking about this subject for the last few weeks although I didn't know there was formal terminology for it.  Even the CBO, which is supposed to be non-partisan, is projecting deficits of $1 trillion a year for the next decade.  That would be about $3,000 per annum per capita.  As the debt mounts, I am sure that the guarantee that treasuries are backed by "the full faith and credit" of the US govt. will sound increasingly hollow and creditors will demand higher interest on their money.  A borrower in the USA would almost certainly have a higher chance of default than the govt. that has unlimited authority to tax them so interest rates would be higher to take the risk.  So obviously the amount of public debt will control both the availability and rates of credit for the private sector.

tomlongrpv said, "The article also seems to assume that all defecit spending leads to public borrowing--an assumption that is true only if the money supply is static.".  Well, I guess this is technically true- you can inflate the money supply as well.  Right now the govt. is looking for more revenue from increased taxes, borrowing, and inflating the money supply.  None of these address the core problem- too much spending.  I am not saying that the money supply should be static, it shouldn't be.  But it would be nice if the purchasing power of the dollar was held at a near constant value. 

Nobody in business borrows money to put people to work.  They borrow money to meet demand for their product or service, and increased employment is a natural outgrowth of demand.  

Perhaps a few companies can't get financing at reasonable rates right now, but my small company gets 2-3 offers of credit each week.

I wish more people knew of Adam Smith's lesson of the "hidden hand" than they did of Monica Lewinsky's exploits or the theories of Keynes.

 

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#13) On August 01, 2010 at 9:40 PM, devoish (99.06) wrote:

 I was hoping he'd do his own homework.  I have no hope for you. - Hopelesslylost

You know I do my own homework. You just do not like my that my homework convinces me your vision of "free markets" are 100% doomed to failure.

The Grand High Exalted Mystic Up All Night Reading King Devoish

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#14) On August 01, 2010 at 9:47 PM, whereaminow (42.87) wrote:

NOTvuffett,

Great points.  I didn't respond to his "the article seems to assume" because the article didn't assume anything.  My newest troll's favorite debate tactic is insinuating people said things that they clearly did not.

Nobody in business borrows money to put people to work.  They borrow money to meet demand for their product or service, and increased employment is a natural outgrowth of demand.  

That's right on, man!  I agree 100%

David in Qatar

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#15) On August 05, 2010 at 1:05 AM, tomlongrpv (82.10) wrote:

As devoish points out there are no answers to my questions above.  In sum, the article and the post provide no meaningful support for the assertion that public borrowing is "crowding out" private borrowing.  There are a lot of assumptions, quasi-religious libertarian faith, but nothing of substance.

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#16) On August 06, 2010 at 12:24 AM, whereaminow (42.87) wrote:

What's it like to stone faced lie, even when the refutation of your lie is only 4 comments above your comment?  How does a person do that?  Seriously, I know all trolls are pathetic, but how exactly how pathetic are you?  Can it be quantified?

David in Qatar

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#17) On August 06, 2010 at 3:51 PM, Melaschasm (64.15) wrote:

Interesting article, but I would like to point out one minor issue with your reference to keynesian economics.

According to keynesian economics, increasing government spending during times of economic growth (see Bush and Clinton), will tend to create asset bubbles (see housing and dot com bubbles).  Because government spending during times of economic growth is procyclical, it tends to make the crash/recession following such asset bubbles deeper, and longer than would be the case if the government had not spent more money.

While the austrian/libertarian model of economics does differ greatly during bad economic times, they directionally agree about fiscal policy during times of economic growth. 

Because of this shared view of economics during times of economic growth, I am calling for both keynesian and austrian economists to set aside their differences and demand aggressive spending cuts during the years 2012 - 2015.  I hope that you, and those who agree with you will join me in this effort.

~ CAPs newest Keynesian 

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#18) On August 06, 2010 at 5:09 PM, whereaminow (42.87) wrote:

Melaschasm,

According to keynesian economics, increasing government spending during times of economic growth (see Bush and Clinton), will tend to create asset bubbles (see housing and dot com bubbles). 

You're going to have to point me to this.  I can't find any Keynesian theory on bubbles.  A Control-F on the Keynesianism Wiki page yields no results.  A Google search for "Keynesian theory bubbles" gets me nowhiere.

Can you help?

And my follow up would be, if there is such a theory and the corresponding evidence of these circumstances, why were Keynesians universally surprised by the crash and consistently in denial of a bubble?

David in Qatar

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