How to ruin what’s left of the economy, or
The Multiplier Effect also runs in reverse

by Win Wenger, Ph.D.
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Austerity is good for individual families and households

Indeed, it is essential. What’s spent by a household goes out of that household, and very little of what gets re-spent out of that household into and beyond the community finds its way back to that household. Wealth becomes correspondingly more scarce for the individual or household which spent it, and what it spent for one service or commodity is no longer available to that individual or household to spend on something else. Austerity is a good strategy for individuals and households, keeping back some of that wealth to spend on needs or to use on better opportunities and investments.

 Austerity is disastrous for nation-states

Here is why programs of austerity are wrecking Europe and threatening to destroy the American economy. Wealth spent within the community gets re-spent and re-re-spent within the community, and some of that re-spending finds its way back to products or services offered by that household, enterprise or family. That moves products and services, signals and pulls people and resources into productive activity, and keeps them productive so that more wealth is being produced.

This is the “Multiplier Effect” economists talk about—how a dollar does the work of several dollars as it passes from hand to hand in the exchange of goods and services. The more work that a dollar does—let’s say, its passage pulls into play five dollars’ worth of goods and services—the higher is that particular infusion’s “money velocity,” in this instance a value of 5.0.

Austerity means less money in circulation, less wealth being created, less wealth pulled into play, and fewer people and resources being pulled into productive activities to create that wealth. One hardly needs to be a follower of the leading economist, John Meynard Keynes, to understand and appreciate his analysis of what happened in the Great Depression: that if you take away people’s ability to buy your goods and services, you are not expanding your market very well!

Austerity programs in Europe have taken away the ability of most people and enterprises there to buy products and services from each other. Thus the wealth is not being created there, the taxes and revenues from which would retire the overload of debt, which was the reason given for the austerity demands in the first place.

The austerity we have been practicing here in the States is a large part of why our recovery from the panic of ’08 has been so slow and painful. The austerities forced by our (the USA’s) fall over the fiscal cliff, combined with those forced by our immediately pending collision with the statutory debt ceiling—for all that both situations are artificial, having been caused by our short-sighted and reckless political maneuverings—are likely to do far more damage than anything we have seen to date. Some Congressmen and some millionaires can play their games and then move their monies to variously sheltered accounts elsewhere in the world ; the rest of us pay for whatever mistakes are being made.

Nation-states DO need fiscal restraint and responsibility; otherwise, they soon find that they can’t purchase much for their promises. But the Multiplier Effect also runs in reverse. If the money you withhold and take out of the economy has a velocity of 5 and you take $100 billion out of the economy, other things being equal, you have reduced the wealth of that economy by a half trillion dollars. The grocer and his employees can no longer afford to buy from the baker; the baker and his employees can no longer afford to buy from the grains and flour wholesaler, who can no longer afford to buy from the miller, and the farmer likewise, etc. And so the withdrawal of the dollar, whose infusion into the economy does the work of many dollars, creates the absence also of many dollars when it is withdrawn; and the many people involved are no longer receiving the returns and signals and inducements for the productive activities which create wealth.

Prediction:   Inflation is going to strike heavily at Europe before, and much more strongly than, it hits the American economy. Prices spiraling upward is the result of too much money chasing too few goods and services. A scan of the media or of the Net has by now shown you dire predictions by various economic pundits of major inflation hitting the States. Maybe so, but then Europe will be much harder hit, because austerity there has rendered many more of its people and businesses unable to buy products and services from each other.

Thus Europe, now in the second “Dip” of the Double-Dip Recession, is producing far fewer products and services. The third “Dip” will be when further interruption of productive processes will occur from resulting social disorders that we saw in the Great Depression. The pity of all that is that as we head into the new crash, the latest economic reports were showing that both unemployment and the housing market were finally healing at a much-improved pace of recovery from the wounds inflicted in 2008, so that sanity—so often the last thing to recover—would soon have had a chance to result in rational economic and political decisions and behaviors. The darkness into which we appear to be headed may, instead, last for a very long time.

The more that austerity ruins a nation’s economy, the more unsound that economy appears, and the greater impetus there is toward imposing more austerity.

Any idea or theory or practice or ideology, if extremely pursued to the exclusion of all other considerations, gives rise to monstrosities. If our doctrinaire economists and idealogues weren’t so tunnel-visioned, this lesson—which should have long since been driven home by our experience of the cascade of wealth-stream interruptions which gave us The Great Depression and eventually World War II—should have been painfully obvious to any of our experts who have been entrusted with handling such matters. Let’s not be Keynesians or anti-Keynesians; let’s simply recognize that in the affairs of great nations, the Multiplier Effect is a major factor compared with the situation of individual families and households where wealth once spent is much less likely to come back to pocket. You need a different balance between austerity and investment, and both are needed together, not in exclusion of each other. “Balance” is the key.

The household that practices consumer restraint and austerity will tend to survive, having preserved some of its wealth for when need arises and for when more advantageous purchasing opportunities arise. Where little or none finds its way back to you once you’ve spent it, there is no Multiplier Effect to help you, and practice of austerity—other things equal—is well recommended.

In the affairs of nation-states, the Multiplier Effect is one of the main elephants in the room, and our doctrinaire and careless pursuit of austerity sets us up for some pretty severe trampling.

It may not yet be too late to be able to have a rational discussion on this matter, one in which we can truly hear and learn from one another. Your comments are welcome and warmly invited.

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