Economic Stimulus as Folly

The only means to shorten the period of bad business [depression] is to avoid any attempts to delay or to check the fall in prices and wage rates.

Ludwig von Mises, Human Action (1949, p. 570)

The trillion dollar economic stimulus package will fail to resolve the current economic crisis and here is why.

Growth in employment, and the economic good times that it brings, occurs during periods of credit expansion. When credit is expanding, banks are creating money by making loans to people who hire other people to serve them. This happens regardless of whether the credit is issued to employers or consumers. Credit expansion occurs when creditors are optimistic about getting their loan money repaid.

Growth of unemployment, on the other hand, occurs during periods of credit contraction. When credit is contracting, banks are reducing the money supply by recalling loans to people who employ other people. Credit contraction occurs when creditors fear that loans will fail and should therefore not be issued.

In terms of credit contraction, it is important to note that creditors not only want a return of the loaned money, but they also want the loaned money to have the same value when repaid as it had when it was loaned out.

The government’s distribution of new money for no other consideration than to “stimulate” the economy tends to dilute the existing money in the economy, including the money that creditors have on loan to their clients.

Most creditors are smart enough to know that if they loan out $100 that will only be worth $90 when it is repaid, they will actually lose real economic value by making the loan. Therefore, the already pessimistic creditor becomes more pessimistic and tends to contract his credit even more.

The more the government threatens to dilute the value of the loaned dollar, the more creditors will keep their money in their pocket and let other people lose their jobs.

So, what is the solution to an economic crisis such as the current one? As von Mises points out in the above quote, the only real solution is to let the economy heal itself. This involves letting some bad investors take their losses while allowing wiser investors to buy back at a new “ground floor” and use their wisdom to create new jobs in an economy where resources are allocated more efficiently.

Left to itself, the economy would actually come out of the recession stronger than ever, but because of government intervention, credit contraction will be prolonged, unemployment levels will remain high, and an economy trying to correct itself will never fully heal.