Germany Provides Insights into Stimulus

by Mike Renzulli

November of last year marked the 20th anniversary of the collapse of the Berlin Wall. This historic event signaled not only the end of Communism but also economic central planning. Unfortunately, despite the obvious example of central planning ruining countries that embrace it, it is being used by American politicians in hopes of rescuing our country's economy.

During November 2009, The Wall Street Journal published a blunt and provocative commentary [1] authored by Wolfgang Hummel who is deputy director of the State Ministry of Finance for Berlin.

In his essay, Mr. Hummel discusses the results of German reunification. He points out that the success of unification has mainly been symbolic. Popular politically, but not sound financially.

According to Hummel, the dirty little secret among German politicians is that East Germany would still have a hard time standing on its own two economic feet and, despite the initial results of infrastructure spending which seems beneficial, East Germany is a region whose economy is stagnant.

Since 1990, West Germany still siphons large amounts of Euros to the East to the tune of up to $1.9 trillion yet the region itself continues to produce little.

Mr. Hummel states when the Warsaw Pact countries collapsed with the fall of the Soviet Union, the West German government valued East Germany's currency on a 2 to 1 basis and regional wage payments were valued 1 to 1 which was clearly an over valuation. People in the East were allowed to keep their savings but lost their jobs and the East's overall infrastructure was in shambles.

Hummel goes on to point out that one of the major steps to reunification was a massive spending program on the part of the German government. In addition to spending on infrastructure, money was paid out even to East German companies to continue for them to produce.

Wages were even raised using the subsidies despite low productivity.

Yet the initial shock of the region's economic collapse was, and still is, hampered by Germany's onerous employment rules pushed by the country's unions that remain to this day and give regional employers an incentive to move to neighboring countries (like The Czech Republic, Austria, Switzerland or Poland) were labor rules are more flexible.

This in addition to the generous amounts of welfare payments doled out and the high taxes used to pay for them, puts Germany in an untenable position to compete economically which hinders the ability of East Germany to recover.

East Germany's recovery has been nominal and residents of the region mostly rely on welfare payments for sustenance when, in reality, the solution to the East and entire country's recovery is a true economic one.

The German experience is an indication as to what will happen with President Obama's stimulus plan which has been the subject of much debate in the media recently as to whether or not it has been of any benefit to the U.S. economy.

Economies do not recover by government spending much less consumers incapable of producing that it takes handouts in order to get them to consume or even work in government financed projects or rescuing companies on the verge of collapse with bailouts.

If Germany is any example, there is no benefit to giving money extracted by force in order to bail people or companies out of their risky investments, enact infrastructure spending or to give consumers checks to buy products just for the intrinsic value of buying just for buying's sake.

A government finance recipient's nominal revenues goes up initially but not in real terms. Stimulus spending gives the illusion to companies that there is an actual demand for their products and services (such as cars or homes) and to consumers that their wealth is higher thinking they can afford to buy things.

The reality is that consumers can't actually afford to buy products, and the actual profits of the companies isn't higher than it was. It is true the company's nominal revenues, in dollars, goes up, but not their actual receipts in real terms. As a result, labor and production costs go up due to the newly created money in circulation.

Those fooled by the inflation of the money supply, the net result (in real terms) is that they buy things they can't afford and the producers make things at a loss. All parties involved in the transactions utilizing stimulus spending see their real wealth shrink.

The money spent goes to the producer, but the product itself is gone. If a party saves money it is invested which, in turn, is spent on production.

For example, when an employer pays wages to employees, the employees will use their earnings to buy livable items such as food, clothes, homes, entertainment, and cars. Then the employees consume the products they have purchased in which their consumption is the payment for their labor.

Consequently, you are paid interest out of the profit in the form of more products, services and jobs created in real, not artificial, terms.

In this case, savings is spent. All money that is not kept in cash balances is spent. The crucial issue is not spending for spending's sake but the nature of the spending itself. In the case I outline above, the money is spent not only in real terms but on actual production. Not consumption per se.

What is needed for an economic recovery is not enacting a dime store Keynesian-oriented plan based on intrinsic spending using the mantra of stimulus which encourages more borrowing, more spending, and encourages less liquidity.

Instead, a return to reality overall is needed by embracing true laissez faire in which a good start would be a return the Classical economic principle of savings and liquidity on the part of individuals and companies which would, in turn, encourage true production and real job creation.

Yet it is liquidity and savings that the stimulus packages enacted under both the Democrats and Republicans that are obviously geared to prevent and will maintain the pains of ecnomic adjustment associated with the past and present inflation of the money supply that lead to our economic debacle in the first place.
 

[1] Hummel, Wolfgang. November 8, 2009. Twenty Years of Stimulus for East Germany. Retrieved on November 21, 2009. Online at: http://online.wsj.com/article/SB10001424052748704402404574523211895097756.html