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Government Spending and Capital Destruction

 
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PostPosted: Sun Apr 12, 2009 2:03 pm    Post subject: Government Spending and Capital Destruction Reply with quote

If the private sector spends $1 to produce $1.20 in output, then it creates $0.20 of capital. If the public sector spends $1 to produce $0.80 in output, then it destroys $0.20 of capital. If both tax cuts and government spending generate similar multiplier effects, e.g. $1 into $1.50, a tax cut will create $0.30 in capital, while government spending destroys $0.10 in capital (i.e. $0.10 gain in private sector and $0.20 loss in public sector). So, government spending will cause both interest rates and inflation to rise.

Comment from JRJ:

I remember a "60 Minutes" story several years ago that said that of money govt received in taxes for welfare programs,only 20% gets to the recipient.So 80% is lost(eaten up by govt employees,overhead,waste,etc.) in the process of stealing from one person and distributing to another.All this govt spending should produce huge waste and further impoverish America.The U.S. Dollar is the common stock of the country and will take the brunt of this waste.Look for the Dollar to devalue faster in the future.At some point there will be a run on the Dollar as no one will want to hold a declining asset.

My reply:

Yes, that $0.80 in output for every $1 in inputs may be overstated. The U.S. had excess capital in the 2000s (e.g. a record 20 consecutive quarters of double digit U.S. corporate earnings growth and massive foreign capital inflows) and that capital had to be distributed in the U.S. to those who weren't creditworthy, including overleveraged investment banks and unqualified homeowners (to clear the market of excess capital).

Obama's plan is to destroy that excess capital, which will shift the capital market towards equilibrium. It's similar to destroying excess houses (e.g. bulldozing them or setting them on fire) to stabilize the housing market and increase asset value.

The Fed's balance sheet has quadrupled. I wonder if there will be much demand (including foreign demand) to buy U.S. Treasury bonds when the Fed unwinds its balance sheet to preempt inflation.
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