Why Stimulus Spending Spree Is Most Damaging to Those Who Need It

In March 2021, Congress passed the American Rescue Plan Act of 2021 to help relieve the economic stress of the Coronavirus Pandemic. The $1.9 trillion package came after the Consolidated Appropriations Act, 2021, which provided $900 billion in relief and the CARES Act of March 2020, which provided $2.2 trillion of relief. For those keeping score, that total is $5 trillion, a number that would make any sensible economist require a ventilator.

Average Americans, on the other hand, seem to welcome this news. More stimulus means more checks and unemployment benefits. They are mainly concerned with their rent and putting food on their tables. The stimulus bills certainly help in that regard to some degree, so everyone welcomes the spending. Taking a wider view, however, it is clear just how disruptive this spending will be and how destructive, even for those struggling to pay rent.

To understand what consequences this spending spree will have will require a systematic understanding of monetary policy and where this money comes from. In short, to provide this money for relief, the Treasury simply invents the money out of thin air. And, while that might sound fantastic for anyone who has been out of work for 15 months, the damage is severe. And, as we will see, it is most disastrous for average Americans who are struggling the most.

Overview of Monetary Policy

The most significant way governments control prices is by controlling the supply of money. Ever since paper money became the dominant form of currency throughout world economies around 100 years ago, and especially since that paper money was removed from a gold standard in the United States in 1971, the amount of money in the system has been under the sole control of state governments, which can print or destroy billions of dollars whenever it sees fit. Laws restricting alternative currencies bolster this command and, ultimately, the money supplies of all major countries have become a matter of government fiat.

Like other controls, adjustments to the money supply have been urged to accomplish very specific and often rather logical goals. Mostly, they have been aimed at countering fluctuations in the Business Cycle. As was explored on an earlier page, the Business Cycle has long been seen by prominent economists as naturally unsteady, responsible for creating an unpredictable sequence of booms and recessions. Neither are particularly healthy for the economy. The booms cause gluts in output, and the recessions create deficiencies in effective demand. Thus, when a free-market economy is growing, it tends to swell into bubbles and, when it is shrinking, it tends to collapse into crashes and panics.

It has been argued that the free market gets out of control because of its self-perpetuating nature. When things go well, people have more money to invest, and so more business is done and people continue to improve their condition. On the other hand, when things are going poorly, people have less money to invest, and so less business is conducted and the condition continues to worsen.

This self-perpetuating nature is based in large part on the way money multiplies in a modern economy. The fractional reserve banking system actually multiplies the amount of money in an economy by using and reusing it in layers of investment. A $100 base, for example, can turn into some $500 in active exchanges throughout the economy given a reasonable reserve requirement of 20%.

Of course, just as the fractional reserve system multiples the money stock in good times, it shrinks the money supply when things turn sour. A $100 withdrawal from a bank means that some $500 must be withdrawn from the system as a whole. Investments diminish as a result, which means fewer new enterprises, fewer jobs, and ultimately fewer consumers buying things on a retail level. With lower consumption, businesses struggle and have to cut back hours, and the effect is a self-perpetuating loss of liquidity.

As early twentieth-century economists concluded, the swings in the economy are caused, not by any inherent change in supply or demand—which would take much longer to be realized than the relatively short-lived booms and busts—but rather by severe fluctuations in the money supply. Heated financial bubbles, it has been deduced, are caused by too much liquidity; long-lasting recessions are caused by less liquidity.

By infusing more paper money into the economy during down times, and withdrawing money during booms, the government can turn an inherently unstable situation into a reliable, steady condition. The result is an even keel and an end to the booms and busts that have plagued free markets for centuries.

The Unintended Consequences of Printing Money

Fairly reasonable on the surface, the plan has two fatal oversights. The first is that officials who are in charge of running the countercyclical policies have to answer to forces of governmental bureaucracy, which always tend in the direction of spending and away from higher taxes. This means that monetary policy almost always seeks to increase the money supply and rarely to decrease it. As such, half of the essential strategy is neglected. And while it may seem nice to watch money grow as if it were from trees, this one-sided tendency necessarily defeats the original purpose of monetary policy, which was to maintain an even keel. Indeed, if too much liquidity is ever a problem, then the monetary policy of strict augmentation is explicitly harmful because it never attempts to counterbalance that growth.

This flaw is based in human nature and can be avoided given the right personnel, though it is not conceivable that, in a large, modern economy such as the United States, vote-hungry politicians will seek to deprive their electorates of liquidity. All politicians depend on making promises, and it is infinitely easier to follow through on those promises if they can tap into a limitless supply of funds. The politician who does not tap into those resources is not able to follow through and thus does not get elected or reelected.

But modern monetary policy is flawed in another, more fundamental way as well. Its second fatal flaw concerns the basic consequence of price controls in distorting supply and demand. Price controls of any kind skew supply and demand such that the inevitable result is either a surplus or a shortage. This also goes for controls of the money stock because money, like any other commodity, is not only a measure of the price of the good or service it buys; it is a good itself with a price of its own. And, like any other commodity, the price of money is dependent upon its supply and demand; when its supply and demand change, so too does its price. Just as with diamonds and water, the more money that is available, the less value it will have; the less money there is, the more valuable it will be.

Furthermore, since money is involved in nearly all exchanges in the modern economy, its price affects the price of every other good and service in the system. The consequence of shifts in the price of money is a corresponding shift in the price of real goods and services. When money is worth more, the goods and services one buys with that money are worth less, and vice versa. The Spanish Scholastics learned this lesson well with the influx of precious metals from the Americas in the sixteenth century. They knew that an increase in the money supply causes price inflation and that, conversely, a decrease in the money supply causes price deflation. To deny this fact of political economy is to deny the Scholastics’ advances and revert to mercantilist doctrine, a return that takes us back to the sixteenth century or before.

The Money Supply Affects the Price of Everything

To examine this consequence more closely, we can take another look at prices in general. A price represents the amount buyers will pay for a certain good or service. As the supply and demand of that good or service change, so too does the amount one will be willing to pay for it. Say a fur goes for $3,000 in the free market. A sudden increase in the supply of furs will invariably cause the price to go down. Fur retailers will have a harder time selling their goods, and so will lower their prices to entice more customers. Instead of $3,000, for instance, one might offer $2,000. Because of the shift in supply and demand, the furrier must accept less for his product.
With this simple example, we see how changes in supply and demand can alter the price of a good or service. But the example does not only show a change in the price of furs; one will note that it also indicates a change in the price of the other commodity exchanged as well—in this case, money. Just as a fur went from being worth $3,000 to $2,000, a dollar went from being worth 1/3,000th of a fur to being worth 1/2,000th. As the fur became less expensive in terms of dollars, the dollar became more expensive in terms of furs.

Ultimately, all economic exchanges show the price for both items being traded. It’s not just that an iPhone is worth $399, but that a dollar is worth 1/399th of an iPhone; a flight to Greece is not just worth $787, but a dollar is worth 1/787th of a flight to Greece; and so on. And when the supply or demand of any of the goods in an exchange shifts, the price of both items will change.

The more abundant the currency, the more of it will be required to purchase a good or service. To mirror the hypothetical above, if the furrier had all the money he wanted—if money grew on trees, for example, or was dropped out of helicopters into his backyard—the price of that money would go down in terms of furs. Instead of valuing a dollar at 1/3,000th of a fur, the furrier might value it at 1/4,000th. If, on the other hand, money became scarcer, its price would go up in terms of furs. If the furrier’s money supply diminished by some amount, he might want dollars more, and so value them at 1/2,000th of a fur instead of 1/3,000th.

Extending the principle, we find that, in general, the more money there is in an economy, the less valuable it is and the less each individual participant can get in exchange for it. When the money supply increases, the consumer of groceries can get fewer apples or peaches or boxes of cereal for his money, just as the consumer of furs can get a smaller fraction of that luxury item with each dollar. Whereas the consumer used to be able to buy two apples for a dollar, he can now buy only one. This kind of price inflation is ingrained in the mentality of any modern Westerner. The assumption is that prices rise as a part of their nature—that the price of a movie or the cost of an automobile will go up every year, and that, to counter the trend, our wages must go up as well. The reason for this is because the government, with the help of the Federal Reserve, has set a policy of positive monetary growth. As the money supply increases, it is only natural for prices to increase with it. And so we can see that, though it may appear to be a natural occurrence, inflation is a wholly artificial phenomenon, conjured up by economists and perpetrated by the Federal Reserve.

Of course, most people don’t look to see how much money is in the economy and therefore cannot know how much the money they have or don’t have is worth. In fact, the bureau that is in charge of the money supply in the United States does not publish the figures showing how much money is in the economy for fear that such figures would distress the public.

Still, the amount of money in a given economy can be perceived by the average citizen and so can affect the prices of everyday goods and services. Because the price of those everyday goods and services are usually based on the price of supplies and overhead costs, and supplies and overhead costs are based on industrial and manufacturing prices, and so on, a change in one affects all corners of the economy. To sum up: When there is more money in the economy, people tend to spend it more freely; when money is spent more freely, producers tend to raise their prices to keep up with demand; rising prices cause a domino effect, and eventually the entire economy undergoes a price inflation.

Those Closest to Government Benefit Most

This process has its origin at the very source of the increased money supply—the government. Let us consider the typical process whereby the government increases the money stock. Congress signs into law a bill that will direct $70 billion to the construction of a bridge. In order to raise the funds needed to pay for the project, the government might issue debt in the form of bonds by selling T-bills on the open market. The government can then hire a construction company with the newly acquired money. Just like that, $70 billion is generated and thrust into the economy.

But, as this money is introduced, the supply and demand begin to alter. The new contract increases demand for the construction company’s work. As with any product that experiences an increase in demand, the construction company’s price—the amount for which it is willing and able to conduct new work—will rise. This is the spark that ignites the inflation. Price levels will continue to rise on two fronts—by those customers who require the contractor’s services and must bolster income to cover costs, and by those companies and individuals who are on the receiving end of the contractor’s increased expenditures. If the government contractor and its employees are labeled Group A, the second wave of price increases will occur for goods and services offered by Group B. Similarly, Group B will cause price increases in Group C, and so on.

The number of companies and individuals in each group will grow as the inflation carries on, and, eventually, the process will expand to include every person in the economy. Ultimately, the prices for every good and service will be raised to meet the new volume of currency. This finishing point is not reached by a direct path nor, given the number of variables, is it reached without delay; but the result is inflation across the board.

Now, it must be said that the amount of money is not the only factor involved in the price of goods. As illustrated above, the supply and demand of goods and services also affect prices. Still, the money supply is the most important factor because its rate of change can be so much greater than that of goods and services. Output of goods and services is generally slow to increase or decrease, especially in the aggregate, given its natural dependence on multiple gears of industry. When it does increase or decrease, it does so based on widespread technical advances that the economy as a whole absorbs gradually and can usually accommodate so that prices remain fairly steady.

Meanwhile, the money supply can be adjusted speedily by simply printing or destroying bank notes. This can be done as quickly as the presses can turn. And, theoretically, since the numbers on the face of the money can be as high as the officials want them to be, the notional value could be infinite. The difference between the two kinds of economic adjustments can be seen in extreme examples of both. To look at the variance in the output of real goods, we can turn to two different countries during completely different times. At the height of Japanese economic growth after World War II, output increased at an annual rate of 10%; and, from peak to trough during the Great Depression in America, from 1929 to 1932, output fell by about 40%. These extremes illustrate the extent to which output can increase or decrease over finite periods. The average change in output over the course of the twentieth century for the United States was about a 3% increase every year.

By contrast, at the height of German hyperinflation after the first World War the money supply increased 300% per month. Such a rapid expansion can only be attributed to the efficiency with which paper money can be produced. With a strictly fiat currency, there is no real barrier to its growth. This is why the preeminent monetarist of our age, Milton Friedman, stated that price inflation is strictly a monetary phenomenon without a disclaimer on the effect of output.

Altogether, it must be said that monetary policy manifestly works against its intent. The original goal of monetary policy was to alleviate the severity of the Business Cycle by increasing the money supply during times of economic trouble and decreasing it during times of economic growth. But, if this tactic were successful, consumers would actually have lower purchasing power during down times and higher purchasing power during boom times.
By increasing the money supply, the government makes dollars worth less and so further hinders the people it intends to help. At the same time, decreasing the money supply makes dollars worth more and so reinforces the people it intends to check.

The Farthest from Government Benefit the Least

What’s more is that monetary policy, however egalitarian its intentions, is designed in such a way that it affects different people at different times, placing a disproportionate burden of the inflation or deflation on a fraction of the population while allowing others to enjoy the benefits without much in the way of costs. With regard to the illustration above, we can see how those in Group A benefit from the boost in money supply because their incomes increase before prices do. In effect, their purchasing power rises at first while everyone else’s falls to some extent.
Group B also benefits because their incomes rise before any widespread inflation occurs, though they have to pay higher prices for some of the goods and services provided by Group A. The same goes for Group C to a lesser extent, and so on down the line. The latter groups in the process, however—Groups X, Y, and Z, for instance—find that the prices for most of the goods and services they buy have increased before they see any increase in their incomes. These latter groups—the largest, most independent groups—are the ones upon whom the real burden of inflation rests, because theirs is the purchasing power that is diminished to the greatest degree by the time they can enjoy a boost in prices.

Milton Friedman’s famous helicopter fable, recounted in his financial history Money Mischief, demonstrates the kind of trouble that adjustments to the money supply can cause. In the tale, Friedman describes an isolated society that suddenly encounters a mysterious helicopter that drops bags of money in everyone’s backyard.

The exercise is supposed to reflect to some degree what happens when the government increases the money supply. Using the fictitious citizens’ rationales, Friedman shows that the event inevitably leads to price inflation, and that, the earlier one picks up the money and uses it, the more he will benefit.

Monetary policy, then, like practically all state action, disproportionately rewards those closest to government—contractors, banks, lobbies, legislators, lawyers, and so on—and penalizes those who are displaced from it—sole proprietors, unorganized laborers, moms and pops, and so on. Just as the good intentions of minimum wage laws, rent controls, and farm subsidies often end up hurting those they propose to protect, adjusting the money supply actually harms the average citizen it is aimed at helping by lowering his purchasing power and raising that of the elite.

Monetary policy has become, in short, just another way for the upper class to exploit the underprivileged. In a way, as Henry Hazlitt put it, the inflation that arises from monetary policy is nothing more than a kind of tax, taken from the independent workers and underprivileged in the economy and given to the well-connected and well-established. It is a mere extension of the practices that jeopardize the free choice necessary for markets to work and threaten the well-being of the economy as a whole.

This edited excerpt comes from the upcoming 10th Anniversary Edition of Juggernaut: The Rise and Fall of an Economic Behemoth. Available in bookstores June, 2021.

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