Www. Vickrey William 1996 15 Fatal Fallacies of Financial Fundamentalism

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    Vickrey, William. 1996. 15 Fatal Fallacies ofFinancial Fundamentalism

    Much of the conventional economic wis-dom prevailing in nancial circles, largelysubscribed to as a basis for governmental

    policy, and widely accepted by the media and the

    public, is based on incomplete analysis, contrafac-tual assumptions, and false analogy. For instance,encouragement to saving is advocated without at-tention to the fact that for most people encouragingsaving is equivalent to discouraging consumptionand reducing market demand, and a purchase bya consumer or a government is also income to ven-dors and suppliers, and government debt is also anasset. Equally fallacious are implications that whatis possible or desirable for individuals one at a timewill be equally possible or desirable for all who

    might wish to do so or for the economy as a whole.

    And often analysis seems to be based on the assump-tion that future economic output is almost entirelydetermined by inexorable economic forces inde-pendently of government policy so that devotingmore resources to one use inevitably detracts fromavailability for another. This might be justiable inan economy at chock-full employment, or it mightbe validated in a sense by postulating that the Fe-deral Reserve Board will pursue and succeed in apolicy of holding unemployment strictly to a xednon-ination-accelerating or natural rate. Butunder current conditions such success is neitherlikely nor desirable.

    Some of the fallacies that result from such modes ofthought are as follows. Taken together their accep-tance is leading to policies that at best are keeping usin the economic doldrums with overall unemploy-ment rates stuck in the 5 to 6 percent range. This isbad enough merely in terms of the loss of 10 to 15percent of our potential production, even if shared

    equitably, but when it translates into unemploy-ment of 10, 20, and 40 percent among disadvantagedgroups, the further damages in terms of poverty,family breakup, school truancy and dropout, illegi-

    timacy, drug use, and crime become serious indeed.And should the implied policies be fully carried outin terms of a balanced budget, we could well bein for a serious depression.

    Decits are considered to represent sinful proigatespending at the expense of future generations whowill be left with a smaller endowment of investedcapital. This fallacy seems to stem from a false ana-logy to borrowing by individuals.

    Current reality is almost the exact opposite. Decitsadd to the net disposable income of individuals,to the extent that government disbursements thatconstitute income to recipients exceed that abstrac-ted from disposable income in taxes, fees, and othercharges. This added purchasing power, when spent,provides markets for private production, inducingproducers to invest in additional plant capacity,which will form part of the real heritage left to thefuture. This is in addition to whatever public in-vestment takes place in infrastructure, education,research, and the like. Larger decits, sucientto recycle savings out of a growing gross domesticproduct (GDP) in excess of what can be recycled byprot-seeking private investment, are not an eco-nomic sin but an economic necessity. Decits inexcess of a gap growing as a result of the maximumfeasible growth in real output might indeed causeproblems, but we are nowhere near that level.

    Even the analogy itself is faulty. If General Motors,AT&T, and individual households had been requiredto balance their budgets in the manner being ap-

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    Vickrey, William. 1996. 15 Fatal Fallacies of Financial Fundamentalism

    plied to the Federal government, there would be nocorporate bonds, no mortgages, no bank loans, andmany fewer automobiles, telephones, and houses.

    Urging or providing incentives for individuals totry to save more is said to stimulate investment andeconomic growth. This seems to derive from an as-sumption of an unchanged aggregate output so thatwhat is not used for consumption will necessarily

    and automatically be devoted to capital formation.

    Again, actually the exact reverse is true. In a moneyeconomy, for most individuals a decision to try tosave more means a decision to spend less; less spen-ding by a saver means less income and less savingfor the vendors and producers, and aggregate savingis not increased, but diminished as vendors in turnreduce their purchases, national income is reducedand with it national saving. A given individual mayindeed succeed in increasing his own saving, but

    only at the expense of reducing the income andsaving of others by even more.

    Where the saving consists of reduced spending onnonstorable services, such as a haircut, the effect onthe vendors income and saving is immediate andobvious. Where a storable commodity is involved,there may be an immediate temporary investmentin inventory, but this will soon disappear as thevendor cuts back on orders from his suppliers toreturn the inventory to a normal level, eventuallyleading to a cutback of production, employment,and income.

    Saving does not create loanable funds out of thinair. There is no presumption that the additional bankbalance of the saver will increase the ability of hisbank to extend credit by more than the credit sup-plying ability of the vendors bank will be reduced.If anything, the vendor is more likely to be active inequities markets or to use credit enhanced by thesale to invest in his business, than a saver respondingto inducements such as IRAs, exemption or deferral

    of taxes on pension fund accruals, and the like, sothat the net effect of the saving inducement is to re-duce the overall extension of bank loans. Attemptedsaving, with corresponding reduction in spending,does nothing to enhance the willingness of banksand other lenders to nance adequately promisinginvestment projects. With unemployed resourcesavailable, saving is neither a prerequisite nor a sti-mulus to, but a consequence of capital formation, as

    the income generated by capital formation providesa source of additional savings.

    Government borrowing is supposed to crowd outprivate investment.

    The current reality is that on the contrary, the ex-penditure of the borrowed funds (unlike the expen-diture of tax revenues) will generate added dispo-sable income, enhance the demand for the productsof private industry, and make private investment

    more protable. As long as there are plenty of idleresources lying around, and monetary authoritiesbehave sensibly, (instead of trying to counter thesupposedly inationary effect of the decit) thosewith a prospect for protable investment can beenabled to obtain nancing. Under these circums-tances, each additional dollar of decit will in themedium long run induce two or more additionaldollars of private investment. The capital createdis an increment to someones wealth and ipso factosomeones saving. Supply creates its own demandfails as soon as some of the income generated by thesupply is saved, but investment does create its ownsaving, and more. Any crowding out that may occuris the result, not of underlying economic reality, butof inappropriate restrictive reactions on the partof a monetary authority in response to the decit.

    Ination is called the cruelest tax. The perceptionseems to be that if only prices would stop rising,ones income would go further, disregarding theconsequences for income.

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    Vickrey, William. 1996. 15 Fatal Fallacies of Financial Fundamentalism

    Current reality: The tax element in anticipated ina-tion in terms of gain to the government and loss tothe holders of currency and government securities,is limited to the reduction in the value in real termsof non-interest-bearing currency, (equivalent to theincrease in the interest rate saving on the no-inte-rest loan, as compared to what it would have beenwith no ination), plus the gain from the incrementof ination over what was anticipated at the time

    the interest rate on the outstanding debt was esta-blished. On the other hand, a reduction in the rateof ination below that previously anticipated wouldresult in a windfall subsidy to holders of long-termgovernment debt and a corresponding increase inthe real impact of the debt on the sc.

    In previous regimes where regulations forbadethe crediting of interest on demand deposits, theseigniorage prot on these balances, reecting theloss to depositors in purchasing power, that would

    be enhanced by ination would accrue to banks,with competition inducing some pass-through tocustomers in terms of uncharged-for services. In aneconomy where most transactions are in terms ofcredit card and bank accounts with respect to whichinterest may be charged or credited, the burdenwill be trivial for most individuals, limited to lossof interest on currency outstanding. Most of thegain to the govern