Taking money from John to give to Jim and dismantling the capital structure in the process

 

There is really no end to the constant political influence of our representatives when the economy (locally or on the state level) is concerned. The next headline comes from www.zagrebancija.hr.

In the article which is making headlines all across Zagreb, a massive government spending program is being initiated. The following picture that was taken shows the construction team in place already demolishing the previous meadow. This meadow is adjacent to the National Library Building. The meadow is really huge and one of its purposes used to be walking dogs, recreational walks and the such.

 

Our great major, Mr. Bandic has decided to implement a 20 million HRK project to build a fountain. Yes, that’s not a typo – he is spending 20 million HRK ( = $3,6 million) to build a fountain.

Now, a typical Keynesian economist will say that the G in GDP = C + I + G + (X – N) is government spending, and an increase in this variable will lift the national income statistic and give a boost to GDP. Arithmetically, this is true; economically, this makes no sense. The government in its infinite wisdom has decided how to spend my money and transfer this purchasing power to the construction company which I am sure got a deal with a large premium over the market. The building materials and labor hours will be wasted in the process and the lost factors of production and resources will be diverted from either home building, sewage construction or just used as idle capital stock as an insurance in case of future economic need for real purposes.

An economy doesn’t grow by spending money. Especially in this way when to generate this growth, you have to take the resources from the economy and implement such a project. In essence, this pork barrel project is nothing but a large shell game. A wasted resource is undermining the capital structure of the industries that need these resources, creating a permanent loss for the local government budget.

The main point is, spending money doesn’t do anything. Its resource utilization that matters. Why not build 1000 fountains? Because it makes no sense. This so called meritorious good benefits only the individuals that have a direct contact with this good or service. In this case, only the construction workers that will get a boost to the detriment of the rest of fellow Zagrebites and the politicians are ensured a sure vote.

Present goods in form of money are wasted in such projects and society therefore gets poorer.

A bankers dream: Subsidies and bailouts

During the recent bubble in real estate in Spain, banks amassed a nice gargantuan sum of loans (created more or less ex nihilo through the fractional banking process) which are now not worth their carrying value.
To match their balance sheets with reality, they are forced to write these assets at market value. This will mean a massive balance sheet contraction and a subsequent unwillingness of banks to further expand credit due to losses, and a weak economic outlook forces them to retrench without additional credit demand.
According to business.hr, Spanish banks need 65 billion euros of fresh capital.:

“Eurozone finance ministers agreed on Saturday that the Spanish government needs to borrow up to 100 billion euros to help banks after the bursting bubble in real estate markets and banks have problems with uncollectible loans.”

Well, this is what happens when you try to short circuit the wealth generation problem through credit expansion. Interest rates shoot up to signal a shortage of available savings to complete the initiated projects and the asset side of the balance sheet contracts. Gee, I wonder where the money is going to come from? Savings? Future taxes? Credit expansion?
Its really unbelievable that even after the crash, politicians are still fixated on generating overall aggregate demand to offset the credit collapse. They are fixing a debt issue with more debt. Brilliant. And after the banks receive this cash, just as they did with LTRO and LTRO II, where are they going to use thus liquidity? To increase loaning out to business ventures. I doubt it. They will use these funds to offset their loan losses and add to their loss provisions.
Certainly, they will pay no taxes in the immediate future, thanks to the tax carry forward loss.  Lavish bonuses will be paid and everything will look fine until the bill is due once more and the loan has to be rolled over at an even higher yield.
The ring-around-the rosy continues.

Common economic sense

 

I’ve decided to post an interesting cartoon that may escape the most literate mainstream economist of our day – the simple truths are the ones that evade us the most.

Straight from the Circle Bastiat, a glimpse into the puzzling world of “why does GM manufacture cars that nobody wants”. Enjoy.