Thursday, July 16, 2009

Obama: Please Try This at Home

If you want to understand why “stimulus” programs do not work in the sense of generating economic growth, try the following experiment at home or at your place of business.

Go up to someone and hand them $20 and tell them that by giving them this money, you intend to “stimulate” the local economy. Observe what happens. The recipient now has $20 to spend or do whatever. However, note that you have $20 less to spend. Therefore, there will be no net affect on the local economy. All that has happened is that the recipient has twenty of your dollars to spend on something he wants, and you have $20 less to spend on something you want.

What if you were to borrow the money to give to the person? Would that make a difference? Try it. Borrow $20 from someone you know, and then give it to the recipient again. Observe what happens. He now has $20 to spend again, but the lender has $20 less to spend. And, you now owe the lender the money, so you have to find a way to come up with the $20. Therefore, there will be no net affect on the local economy, but you are in debt.

What if you found a printing press so that you could counterfeit paper money? Would that make a difference? Try it (or not since it is illegal unless you work for the Federal Reserve). Print twenty fresh paper dollars off of your machine and hand them to the recipient. He now has $20 to spend and you don’t owe anyone anything! Hurray! You have found a way to stimulate the economy. Proceed immediately to Sweden to get your Nobel Prize.

But, wait. Since you have created artificial demand, that is, you have created demand in the form of paper dollars without any corresponding production of anything, the net effect of the recipient’s spending will be to increase the price of everything on which he spends money. Although the recipient initially received $20 worth of goods, subsequent purchases made by others in the local economy will have to be made at the higher price. Therefore, all that happens is that the person who was first to spend the $20 benefited at the expense of all those who must pay higher prices now.

With respect to the latter case, you might say that the spending of $20 could not affect the price of anything. Maybe not, but if you created 1 trillion dollars, it certainly would.

So, there you have it. Taxing some so that others can spend it will not "stimulate" the economy. Deficit spending through borrowing will not stimulate the economy. Printing money to buy government bonds so that the government can deficit spend will not stimulate the economy.

I might add that just as taxing, borrowing, and creating paper money does not lead to production, innovation, and economic prosperity, neither does wishing, praying, hoping, crying, marching, picketing, legislating, voting, chastising, or threatening. To see this, try it at home.


Stella said...

Simply and beautifully put.

Daniel said...

Those same people who like stimulus packages should love credit card companies. They take $20 from an unproductive fool (the man who knows so little about money management that he builds up huge amounts of credit card debt) and loan it for some wealth-creating project.

Of course, the stimulus lovers are the same people that are regulating the credit card companies out of existence.

Mike N said...

Good post Doug. Mind if I copy and give to a friend who has no knowledge of economics?

Doug Reich said...


Please feel free to copy, link, etc.

I was aiming to reach people without a knowledge of economics and get them to grasp that it is really this simple.

It's amazing that with all the phd.'s, pundits, politicians, etc. these simple ideas never get mentioned. Of course, that fact is a symptom of the larger cause which is the total bankruptcy of epistemology.

Michael Labeit said...

There's a whole host of fallacious but nevertheless persuasive neoclassical/Keynesian counterarguments to everything you've written.

Yes, taxing $20 and spending that same $20 doesn't represent any new introduction of real goods. But a shrewd Keynesian would say that spending that $20 is "stimulating" because if Obama had not taxed to receive that $20, it wouldn't have been spent by the original owner in the first place. He would go on to say that we need an increase in aggregate demand to overcome the recession and that by taxing and spending $20 Obama is contributing to aggregate demand (demand manifests itself through spending).

The same applies to credit. Our Keynesian friend would say that debt incursion is necessary to boost aggregate demand.

Monetary inflation is a bit more complicated. Monetary inflation is the only thing that causes price inflation; expanding the money supply necessarily increases prices macroeconomically - to us. Laissez-faire liberals believe monetary inflation necessarily causes price inflation because an increase in the money supply decreases the marginal utility of that supply; as more money is added to the money supply, the utility of each new successive money unit decreases. The laws of supply and demand which determine prices are logically derived from the law of marginal utility. This is why monetary inflation.

HOWEVER, the idea that the laws of supply and demand are based necessarily upon the law of marginal utility is no longer vogue within the neoclassical/Keynesian community. They're empiricists - they certainly have no such reverence of economic laws possessed, say, by the Austrians.

Keynesians also believe they can fool the general economy through monetary policy given that few people pay close attention to it. And again, even though monetary inflation redistributes wealth, a Keynesian would say that such measures are imperative to encourage increasing aggregate demand.

Doug Reich said...


I'm glad you brought this up. What you are describing is the Keynesian arguments for "stimulus" and "inflation" which have dominated the economics profession for 100 years. Such theories provide the underlying economic justification for all of the nonsensical government policies thrust upon us.

For a thorough refutation, see Dr. George Reisman's treatise "Capitalism" which can be found in its entirety at:

Although the entire work can be seen as a refutation of Keynes, he systematically takes this on in Chapter 18.

Let me mention a few high level points related to your comments.

The idea that Obama needs to tax the $20 because otherwise the owner would not spend it and the rest of your examples relate to a confusion between what constitutes "spending", the nature of saving, and what he calls productionism vs. consumptionism

For example, if the person did not "spend" the money on a consumer item, he would likely have saved it in a savings account or by purchasing stock or bonds. Such savings provide the stock of capital that is lent to businesses or consumers to buy cars, homes, refrigerators, etc. All that happens in this case, is that rather than the owner saving his money, the money is spent by the government on something stupid.

Your example demonstrates precisely why "stimulus" spending is actually worse than a zero sum game. It is profoundly destructive to the extent that it diverts productive capital into consumer expenditures.

(If one was to argue that people "hoard" cash and that goverment spending is necessary in this sense, Dr. Reisman refutes this point by showing how such effort increases the return on capital and induces people to invest rather than hoard.)

Ironically, he points out that inflation actually induces more cash since rising prices and a flood of dollars provide inducements to illiquidity).

The more fundamental issue in these Keynesian formulations is the idea of productionism vs. consumptionism which Dr. Reisman covers in Chapter 13. I blogged about it here:

The basic flaw is the idea the irrational view that "consumption" comes before production and that the goverment's job is to get people to spend money because there are too many goods. Dr. Reisman brilliantly refers to this theory as "anti-economics" which is exact.

Say's Law tells us that "demand" is production. In other words, one must produce something before he can buy something. If you were on a desert island, you would need to make something before you could trade it. "Demanding" something in the sense of merely wishing to spend does not get you anything. Such a view is consistent with the primacy of existence, reality, and these most simple examples.

The whole field of economics should be devoted to the problem of production amid unlimited human desires. Keynes turns this on its head and values "spending" in the face of unlimited goods ("the goods are here..."). This is why he calls it "anti-economics".

Dr. Reisman wrote a recent blog post titled "Credit Expansion, Crisis, and Myth of the Saving Glut" which offers even more.

Let me know if this helps.

Michael Labeit said...

Most certainly. Reisman's text is an epic in economics. I especially enjoy his discussion of the market price system and the deleterious effects of price controls. I also share his misgivings about fractional reserve banking though Richard Salsman and other Objectivists insist that he is mistaken. Yet I don't see how a monetary irregular deposit contract that ensures the full availability of the tantundem to the depositor at all times can be integrated with any financial scheme that in turn violates the principle of full availability. I'd like to post a critique of frb on the O'ist carnival but am reluctant given that many O'ists support frb but I've never read an satisfactory pro-frb arguments.
Jesus Huerta de Soto's text "Money, Bank Credit, and Economic Cycles" (you've referred to it before) is definitive in my mind regarding the contradictiory and detrimental nature of frb.

Reisman's posts on are very insightful as well, especially his critiques of environmentalism. His critiques of Keynesianism are longish compared to standard Mises posts but are very well reasoned.

Whenever I hear the Keynesian aggregate demand argument I respond with the argument that the recession is a necessary process of liquidation, of cleanse the market of mal-adjustment caused by artificial credit expansion and that savings reduces the time it takes recessions to cleanse the market.

Doug Reich said...


Good points.

Re frb, as you noted, I have posted before and taken the position that frb should be illegal. Where I think I might differ from others is that I see this as an issue of law not of economics.

The law must define property and I agree with De Soto and others that the law must distinguish between a transfer of property rights (as exists in a loan where you transfer rights to the borrower in exchange for a promise of future payment) and a deposit of property (where title is not transferred and the holder agrees to make your property available to you at any time).

I hold that allowing one to "transfer" property rights but allowing them to maintain title at the same time is a contradiction. There were several seminal cases in the 19th century on this which ended up conflating the concepts with respect to banking.

It is not surprising that frb results in continual disasters even under private banking pre 20th century(although the disasters are not that bad as long as the state upholds the banks contractual obligation to redeem).

This is not an issue of "freedom of contract" just as we can not contract to commit murder. One can not contract to perpetrate a fraud and expect the courts to recognize it.

I may do a follow up post to the ones I have done before to stimulate some debate on this. I have not heard a good argument for frb either so we agree.

Re your point about recession being necessary. Yes, I agree. The boom created by credit expansion results in malinvestments, inducement to illiquidity (since credit is readily available), and many other perverse effects.

As soon as the credit expansion stops, any investment that depended on continual credit expansion (like real estate in the housing boom) will bust and all of the capital that was sunk into this area will be seen as malinvestment.

Further, as bankruptcies occur, firms and individuals look to rebuild their cash holdings which were small during inflation and this process can turn firms that were net lenders of capital to borrowers resulting in a credit crunch.

(In fact, this demand for cash can result in a state where the Fed keeps printing money but prices actually fall as the demand curve for cash outpaces the supply curve. We are seeing this now.)

This whole process of deleveraging, credit crunch, falling asset prices, etc. are exactly what one would expect and Dr. Reisman explained it in great detail...over 20 years ago!

Michael Labeit said...

So the demand for money and the supply of money are in a race to outperform each other. The demand for money in the form of increased social savings thus is what's hedging against price inflation. Once this recession is over, consumption will increase and price inflation will rear its ugly head as all that Fed-manufactured cash is released by less risk-averse economic agents. But if the Fed wants price inflation that badly, surely it can print money faster than people can demand it. Historical instances of hyperinflation show that money expansion can overcome the demand for money. Also, if people expect future price inflation (which can easily be created by the Fed) they will dishoard their money in the present while it retains its purchasing power. This will cause the expected future inflation to manifest sooner.

I expect to critique frb but not necessarily claim its fraudulent per se (both the depositary and depositor can in theory agree to a fractional reserve based contract). At its core though it involves a contractual contradiction.

Doug Reich said...


Yes, I agree. Of course, the Fed can always print faster. Lately, the Fed has shown an unwillingness to "print" faster. In fact, I have heard estimates that the Fed would need to create over $10trillion to overcome the deleveraging and demand for cash pressures. It has created about $1trillion so far and found clever ways to keep this cash from entering the banking system, viz., through paying interest on excess reserves to banks who hold reserves at the Fed.

That is whole other story.

Not to pick a scab on frb, but I do hold it is fraudulent per se in the following way. If one deposits their property at a warehouse, they retain title to the property. You could contractually agree to allow someone to do whatever they want with it but a court would rightly say that you effectively transfered ownership of your property to that person when you agreed to let them do whatever.

In the same way, a deposit must be distinguished from a loan in the same way a title to property is different than a transfer of property. If one can hold title to property, but then allow someone else to do whatever they want with the property while at the same time demanding that the other party make it available to them - it results in a contradiction which can not be properly resolved by courts.

I would therefore conclude that the law must demand that someone takes title to property and that you can't use it and lend it too.

Michael Labeit said...

Perhaps your definition of "fraudulent" is broader than mine. Accroding to Lectric Law Library's description of fraud under contracts, fraud is "Any trick or artifice employed by one person to induce another to fall into an error or to detain him in it, so that he may make an agreement contrary to his interest. The fraud may consist either, first, in the misrepresentation or, secondly, in the concealment of a material fact. Fraud, force and vexation, are odious in law. Fraud gives no action however, without damage and in matters of contract it is merely a defence; it cannot in any case constitute a new contract."

This is why I say frb is not necessarily fraudulent because, according to the above definition anyway, to be "fraudulent" must mean to be deceitful, to be deceiving. A depositary may try to deceive depositors (which is usually the case) but its possible that both a depositary and a depositor are aware of the contradictory nature of demand deposit contracts based upon a fractional reserve. The contract would remain contradictory but the association not necessarily fraudulent.

Doug Reich said...

Point taken but consider that the bank issues a note against the deposit or the depositor writes checks against account so deposit is used as money - the note claims it is reedemable any time etc so it in this sense that a fraud is perpetrated

garret seinen said...

Doug, good post. I agree with everything you've said but for my personal clarification I see the counterfeiting aspect somewhat differently.
I see money as only an entitlement to a market good or service, an IOU. In that respect it makes no difference if you print the money or if the government does. An IOU not backed by previous production is counterfeit. Our entitlement to market goods comes from our own productivity, not a printing press.
The confusion come from accepting that our laws are the only consideration we need to determine legal or illegal, but the issue is really one of morality rather than legality.
If we focus on the morality of why we are allowed to be market participants, the moral depravity of the fractional reserve banking system become obvious. As you say, there can be no entitlement to spend and loan the same thing. It is fraudulent.
I'd just like to add that I think that is the major flaw in economics, the determination to try to make non moral evaluations. As Ayn Rand said, money is moral.

Harold said...

Paul McKeever on Ayn Rand's ethics and fractional reserve banking.

Per-Olof Samuelsson said...

If you're interested, I recently wrote a long essay called "Objectivism and 'Austrian' Economics - Compatible or Not?"

One of the things I take up is the issue of "fractional reserve banking".

Also, I listened to McKeever's lecture and I think he has got it right. There is also a blog post by him on the same subject.

Doug Reich said...

Per Olof,

Thanks for posting. I quickly read through but not thoroughly. That will take some more time since there is a lot there. So far, I really enjoyed it and thought it was spot on. I am certainly not as versed as you are and found the discussion very enlightening. Thanks again and e-mail me at if you want to discuss offline.

I listened to McKeever and he took the view that FRB was not fraudulent or that he didn't buy into that argument. Obviously, I disagree with him since I hold that FRB is fradulent, but the rest seemed to be ok.

Re Seinen's argument that "money as only an entitlement to a market good or service, an IOU", I have to disagree. Money is not necessarily an IOU. For example, gold is not an IOU but constitutes final payment. An IOU can be money. For example, one could accept an IOU for an amount of gold as payment. For that and many other reasons, I very much disagree with your argument that "it makes no difference if you print the money or if the government does".

I am going to continue to work on a follow up post to make my views on FRB and money more clear to address some of the points here.

Brad Williams said...

Hi Doug, good post!

FRB is fraudulent because, as many have pointed out, it involves on demand accounts that are, by design (hence the deceit), NOT payable on demand -- all outstanding checks on all checking accounts cannot be cashed simultaneously. Counter-arguments about how the parties involved agree to the same terms miss the point: the terms themselves are fraudulent. I agree that the propriety of FRB is primarily an issue in the philosophy of law, not economics. Ideally, an Objectivist legal philosopher would analyze it -- though it is a great shame that Reisman's explanations are under-appreciated (to put it mildly). FRB is not a particularly difficult issue to grasp, if one looks at the rights facts. I look forward to your post, I have been planning to write my own post on FRB, but want to wait until I do some more reading.

Speaking of which: Mises reflects negatively upon FRB-type transactions in part 4 of The Theory of Money and Credit, which we will soon be studying in SGO,

Per-Olof Samuelsson said...

Doug: McKeever had an odd argument to the effect that FRB is theft rather than fraud. I don't see that there is any essential difference.

Unfortunately, I am very busy at the moment (I am moving into a new apartment), so I don't have time for lengthy discussions. Maybe some time in the future. I am just happy to see that I am not the only Objectivist who understands what's wrong with FRB.

Taylor O said...

Great post. I agree.

I'm playing devil's advocate here so don't shoot the messenger; the stimulus e-mail going around goes as follows:

"A Stimulus Story

It is the month of June, on the shores of the Black Sea, it is raining, and the little town looks totally deserted. It is tough times, everybody is in debt, and everybody lives on credit.

Suddenly, a rich tourist comes to town. He enters the only hotel, lays a 100 Euro note on the reception counter, and goes to inspect the rooms upstairs in order to pick one.

The hotel proprietor takes the 100 Euro note and runs to pay his debt to the butcher.

The Butcher takes the 100 Euro note, and runs to pay his debt to the pig grower.

The pig grower takes the 100 Euro note, and runs to pay his debt to the supplier of his feed and fuel.

The supplier of feed and fuel takes the 100 Euro note and runs to pay his debt to the town's prostitute that in these hard times, gave her services on

The hooker runs to the hotel, and pays off her debt with the 100 Euro note to the hotel proprietor to pay for the rooms that she rented when she brought her clients there.

The hotel proprietor then lays the 100 Euro note back on the counter so that the rich tourist will not suspect anything. At that moment, the rich tourist comes down after inspecting the rooms, and
takes his 100 Euro note, after saying that he did not like any of the rooms, and leaves town.

No one earned anything. However, the whole town is now without debt, and looks to the future with a lot of optimism.

And that, ladies and gentlemen, is how the United States Government is doing business today. "

Doug Reich said...

the hotel proprietor never got paid

The 100 euro asset (loan) was paid to him, but he had to use it to pay the tourist back even though the tourist never stayed at the hotel.

The hotel is still down 100

Doug Reich said...


I'm changing my answer and putting in a new post.


Doug Reich said...


My full answer is at:

Let me know if you agree by commenting there and thanks for putting this out.

garret seinen said...

With apologies Doug. I can see where my previous comment jumped to a conclusion before establishing the argument. Here's an attempt clear it up.

I agree, with a gold standard, gold settles all debt, but I consider that very few people work for gold. Rather they work for what that gold can be exchanged for.

Money is the medium of indirect exchange. The freely chosen medium in common use in a society will be whatever appears to best retain the value of those exchanged good and services. Value retention requires that the money in common use be either a hard currency or if government paper IOUs are to be used, that government must have a commitment to preserving the productive wealth as opposed to redistributing wealth.

As Ayn Rand said, money is frozen effort. I see money as an unexercised entitlement to a market good or service, an IOU. Unless a money IOU is backed by previous production, it becomes a counterfeit IOU. Our entitlement to market goods comes from our own productivity, not from a printing press. I can not see that it makes a difference, if we or a third party, runs the press. It only becomes a matter of who unjustly benefits. Legality and morality are not the same. If fact, in today's world laws are used to thwart morality.

By focusing on the morality of why we are allowed to be market participants, the moral depravity of the fractional reserve banking system become obvious. FRB claims an entitlement to spend and loan the same thing and adds a great number of unjustified market entitlements to the mix. It is fraudulent.

Anthony said...

Stop taxation, and fractional reserve banking will probably go away all by itself. The FDIC would never last without promises of government support - in fact it'd probably be bankrupt already if it wasn't for the government bailouts. And without taxation government bonds would drop drastically in value, causing pretty much every bank in the country to become insolvent.

That said, I think the claim that FRB is *inherently* fraudulent is misplaced. Yes, bank deposits are "payable on demand", but under federal and state law that term really means "payable within 30 days". Objectionable language, perhaps, but 1) your checking account agreement almost surely makes this explicit; and 2) removing any terms that say "payable on demand" is trivial.

Maybe banks could get away with a slightly fractional banking system, even in a gold-backed system. But nothing like the 10% reserve requirements for checking (and 0% for savings) that we have today.

Doug Reich said...


I agree that under a true system of laissez-faire in which there was no taxation, no FDIC, and hard asset money, frb would be a small problem from an economic standpoint. A similar agrument was made by Dr. George Reisman in his book "Capitalism".

However, this issue is not really en economics issue so much as it is a legal issue in terms of how "property" is defined and regarded by the courts. I highly recommend Jesus Huerta de Soto's book "Money, Banking, and Economic Cycles" for more. Michael Labeit has an excellent post summarizing de Soto at:

I have a more detailed post at

FRB, even under a gold standard as existed in 19th century America, still caused problems insofar as collapsing banks were able to put political pressure on the government to continually suspend specie redemption. Such precedents led ultimately to the creation of a central bank as the lender of last resort, etc. Now, under true laissez-faire, all the government had to do was allow the banks to fail and uphold their contractual obligation to redeem but it still caused a mess.

More importantly, as de Soto shows, their is no basis for banks to regard deposits as loans. They are mutually exclusive and should be treated as such. Common law precedents conflated the two legal concepts and led partially to the disaster we now have.

I'm still working on a follow up post, but Labeit's is excellent.

Doug Reich said...


Thanks for your comments as always.

I agree with the thrust of your comment, that money must be backed by production or else it is counterfeit and that FRB facilitates fraud by allowing the exchange of an IOU on demand for something that is also being loaned.

However, in context, I object to your use of the term "entitlement" (even if it's not what you meant) in discussing the nature of money. Gold is just a value that may or may not be exchanged for something depending on the two parties. The use of the term "entitlement" is problematic since it connotes "legal tender" laws, i.e., government coercion in the acceptance of a particular medium of exchange.

Again, gold or anything of actual value is just something that most if not all people will find valuable. But no one is "entitled" to anything by virtue of possessing it in the sense that the other party "MUST" exchange a good or service. I'm sure that is not what you meant but I think that your use of the term "entitlement" can confuse the issue.