In 4 simple lessons (from the Austrian Insider):
Since Keynesian economics has reined supreme among mainstream economists for decades, you might want to know some of the basics.
Rebuttal: The classical economists knew from studying economic history that increasing the money supply always results in higher prices. The current Chief Economist of the European Central Bank has even admitted this.
Of course, higher prices may lead to an increase in nominal GDP. And since nominal GDP is deflated by removing inflation to get real GDP, theoretically such inflation will have no effect on real GDP.
However, higher prices make consumers worse off because they can’t buy as much stuff as they used to. It should be apparent to even the most ardent Keynesian that this decline in Consumption may actually make real GDP fall. Ergo, increases in the money supply may actually result in less economic growth.
Rebuttal: Before Keynes, all economists knew that Savings = Investment. That is, savings were good for the economy because they would be used to start new businesses, loan money to others, etc. But to Keynes, Savings are bad because they reduce Consumption. And when Consumption falls, so does GDP. And when GDP falls, it means that the economy is in a recession and that is bad.
To see how wrong Keynes was, all you have to do is compare the U.S. to China today. The U.S. has a savings rate of around 3%, China has a savings rate of around 25%. And the Chinese are now using their savings to buy things like houses, land, buildings, and businesses in the U.S. Meanwhile, the U.S. government is over $19 trillion in debt. Not to mention the fact that moving factories to China has killed manufacturing in the U.S. Somewhere, Confucius is laughing his ass off.
Rebuttal: The idea is that lower prices will result in companies going bankrupt, people losing their jobs, and Consumption spending and GDP cratering as a result. But that’s not quite how it works. A reduction in the price of a good means that consumers who were purchasing the good or service before now don’t have to pay as much as they previously did for it. The reduction in price also leads to the Added Buyer Effect: people who couldn’t afford the good or service before are now able to purchase it at the lower price. Others who were not willing or able to pay the market price before may now be able to obtain the good or service at the new, lower price. Thus, a decrease in price leads to more consumers being able to purchase the goods and services whose prices have fallen.
And let’s not forget what actually happened from 1814 to 1913, when there was price deflation on a global scale:
4. The deflation that the gold standard permitted wasn’t such a bad thing. In fact, it was understood that increases in productivity under a gold standard would necessarily lead to prices falling.
6. On the whole, the classical gold standard worked remarkably well (while it lasted). The 100 years of prosperity from 1814 to 1913 bear this out. Economic growth peaked during this period, both in the U.S. and elsewhere.
Thus, a decrease in prices may actually lead to an increase in GDP (i.e., economic growth)! BAZINGA!!!
Rebuttal: The idea here is that replacing all of the stuff that we break provides jobs making more of the stuff that we just broke. So, according to the Keynesians all you have to do to make yourself richer is to…destroy everything you own?
Yeah, that makes sense.
This argument was debunked by Frederic Bastiat in the 1800s. What people who make this argument forget is that the money that will be spent fixing or buying replacement stuff could have been used to buy something else. It’s called the Broken Window Fallacy:
In Bastiat’s tale, a man’s son breaks a pane of glass, meaning the man will have to pay to replace it. The onlookers consider the situation and decide that the boy has actually done the community a service because his father will have to pay the glazier (window repair man) to replace the broken pane. The glazier will then presumably spend the extra money on something else, jump-starting the local economy.
The onlookers come to believe that breaking windows stimulates the economy, but Bastiat points out that further analysis exposes the fallacy. By breaking the window, the man’s son has reduced his father’s disposable income, meaning his father will not be able purchase new shoes or some other luxury good. Thus, the broken window might help the glazier, but at the same time, it robs other industries and reduces the amount being spent on other goods. Moreover, replacing something that has already been purchased is a maintenance cost, rather than a purchase of truly new goods, and maintenance doesn’t stimulate production. In short, Bastiat suggests that destruction – and its costs – don’t pay in an economic sense.
Remember: never trust anyone with a PhD in economics.