Sunday, February 01, 2009

Obamanomics: The Mythical Money Multiplier Effect

The Obama administration styles its members as smarter, wiser and far better educated by higher quality schools than their predecessors. In fact, these are supposed to be the most intelligent lifeforms in our part of the universe.

How, then, did they all manage to miss 6th grade? For how else but by missing the lesson can we explain the Obama team's continued faith in the mistaken myth of a "money multiplier" for government spending?

According to the administration's economic leaders, each one dollar of spending by the federal government generates $1.50 of economic activity. I debated this point years ago, arguing on what seemed to me to be the essential point driven by common sense: if the myth is true, why not increase government spending to the point where it equals GDP? That way, the economy would grow massively, up a full 50% the first year. Repeat once and we're up 125%. It wouldn't take more than three or four years and we could all stop working and live well, increasing well, on the winnings.

What a deal! If only it were true. But it's not and history has shown it to be as false as the alchemist conjuring lead into gold. Sadly, though, President Obama and Secretary Geithner seem to believe this economic fairytale. Worse for us, they're behaving as though it is real.

Real is basic mathematics, the sixth-grade variety that most of us learned just after memorizing multiplication tables. The convention on math expressions specifies the order of operations of the simple equation: Given that the government can only spend in the economy what it has first taken out of the economy, the so-called multiplier can only be zero.

It really doesn't take a Harvard MBA or long career on Wall Street to understand the problem, notionally described thus

(-100 *1.5) + (100 * 1.5) = 0
where the first operation is the government taxing or borrowing $100 out of the economy and the second operation is the injection of the same borrowed or taxed dollars back in. Note that it makes no difference whatsoever the size, or even the existence, of a multiplier effect. Nor does it change the outcome to change the order of the operations. Unless you believe in magic incantations, the answer to the equation cannot change. It can only be zero
To gin up a different answer is to build a black box solution, a magician's touchstone or, perhaps more in line with the current state of affairs, an emperor's new suit of clothes.

Perhaps we've stumbled on why President Obama needs to keep the Oval office so warm. Those new clothes don't handle a chill very well at all.


Anonymous said...

lol, genious, I love you long long time...

Anonymous said...

The flaw in your theory is that the federal government is not limited to spending money it already has. It can, and does, borrow the money from other countries or simply print money.