www.mises.org/story/1568
Next Story >> As an American historian who knows something of economic law, having learned from the Austrians, I became intrigued with how the United States had remained prosperous, its economy still so dynamic and productive, given the serious and recurring economic fallacies to which our top leaders (political, corporate, academic) have subscribed and from which they cannot seem to free themselves--and alas, keep passing down to the younger generation. Myth #1: The Broken Window One of the most persistent is that of the broken window--one breaks and this is celebrated as a boon to the economy: the window manufacturer gets an order; In truth, of course, the economy is no better off at all. True, there is a sudden burst of activity, and some persons have surely gained, but only at the expense of the proprietor whose window was broken, or his insurance company; and if the latter, the other policyholders who will pay higher premiums to pay for paid-out claims, especially if many have been broken. The fallacy lies in a failure to grasp what has been foregone by repair and reconstruction--the labor and capital expended, having been lost to new production. This fallacy, seemingly so simple to explain and grasp, although requiring an intellectual effort of some mental abstraction to comprehend, seems to be ineradicable. After the horrific destruction of the Twin Towers in September 2001, the media quoted academic and corporate economists assuring us that the government's response to the attacks would help bring an end to the recession. What was never mentioned was that resources devoted to repair, security, and war-fighting are resources that cannot be devoted to creating consumer goods, building new infrastructure, or enhancing our civilization. Myth #2: The Beneficence of War A second fallacy is the idea of war as an engine of prosperity. Students are taught that World War II ended the Depression; many Americans seem to believe that tax revenues spent on defense contractors (creating jobs) are no loss to the productive economy; and our political leaders continue to believe that expanded government spending is an effective way of bringing an end to a recession and reviving the economy. The truth is that war, and the preparation for it, is economically wasteful and destructive. Apart from the spoils gained by winning (if it is won) war and defense spending squander labor, resources, and wealth, leaving the country poorer in the end than if these things had been devoted to peaceful endeavors. During war, the productive powers of a country are diverted to producing weapons and ammunition, transporting armaments and supplies, and supporting the armies in the field. William Graham Sumner described how the Civil War, which he lived through, had squandered capital and labor: "The mills, forges, and factories were active in working for the government, while the men who ate the grain and wore the clothing were active in destroying, and not in creating capital. yet it continues to elude the grasp of our teachers, writers, professors, and politicians. The forty year Cold War drained this country of much of its wealth, squandered capital, and wasted the labor of millions, whose lifetime work, whether as a soldier, sailor, or defense worker, was devoted to policing the empire, fighting its brush wars, and making weapons, instead of building up our civilization with things of utility, comfort, and beauty. Some might respond that the Cold War was a necessity, but that's not the question--although we now know that the CIA, in yet another massive intelligence failure, grossly overestimated Soviet military capabilities as well as the size of the Soviet economy, estimating it was twice as large and productive as it really was. The point is the wastefulness of war, and the preparation for it; and I see no evidence whatever that the American people or their leaders understand that, or even care to think about it. An awareness and comprehension of these economic realities might lead to more searching scrutiny of the aims and methods that the Bush administration has chosen for the War on Terror. Only a few days after 9-11, Rumsfeld declared that the war shall last as long as the Cold War (forty plus years), or longer--a claim the administration has repeated every few months since then--without eliciting the slightest notice or questioning from the media, the public, or the opposing party. Would that be the case, if people understand how much a second Cold War, this time with radical Islam, will cost us in lives, treasure, and foregone comfort and leisure? Myth #3: The Best Way to Finance a War is by Borrowing Beginning with the War of Independence and continuing through the War on Terror, Americans have chosen to pay for their wars by borrowing money and inflating the currency. Adam Smith believed that the war should be financed by a levy on capital. This way the people of the country understand how much the war is costing them, and then can better judge whether it is really necessary. While he conceded that borrowing might be necessary in the early part of a war, before the revenue from war taxes began to flow into the treasury, he insisted that borrowing be kept to a minimum as a temporary expedient only. Borrowing increases the costs of war in the form of interest. Inflating the currency, which often accompanies massive borrowing, as it did during the War of Independence, the War Between the States, and the War in Vietnam (just to name three), is the worst method of war finance, for it drives up prices, increases costs, enlarges debt, spawns malinvestments and speculation, and worsens the redistributive effects of war spending. In 1861, the Lincoln administration decided that the people of the north would not stand for much taxation, and that it would increase the already considerable opposition to the southern war. According to Sumner, the financial question of the day was "whether we should carry on the war on specie currency, low prices, and small imports, or on paper issues, high prices, and heavy imports?"
The easy route was taken again (specie payments were not resumed until 1879, fourteen years later, and almost twenty years after the 1861 suspension) and the consequences were an inflation-driven stock market and railroad boom that culminated in the panic of 1873, the failure of the House of Cook, and the Great Railway Strike of 1877, the first outbreak of large-scale industrial violence in American history. Myth #4: Deficit Spending Benefits the Economy and Government Debt Three years ago, when then treasury secretary Paul O'Neill objected to the Bush administration's policy of guns, butter, and tax cuts he was told by the vice president, Dick Cheney, that, "deficits don't matter." Of course, they don't matter--to him, but they matter to the country. John Maynard Keynes's prescription for curing a recession included tax cuts and increased government spending. "We are all Keynesians now" should be the new motto inscribed on the front of the Treasury building in Washington. However, Keynes taught that once the recession was over government spending should be reduced, taxes increased, and the deficit eliminated. Current American policy is to continue deficit spending after the recession is over, and to borrow in peace as well as war. One longstanding criticism of such policies is that government borrowing "crowds out" private investment, thus raising interest rates. In an era when credit creation is so easy, and interest rates remain low despite massive deficits reaching $500 billion per annum, economists no longer take this objection seriously. Another criticism is that an accumulating debt saddles future generations with a heavy burden, which is both unfair and detrimental to future growth. Once again, economists and politicians regard this objection as groundless. They reason that future generations derive benefits from deficit expenditures--greater security, more infrastructure, improved health and welfare--and that since the principal need never be paid, it is not much of a burden anyway. By avoiding having to increase taxes, borrowing hides the pr...
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