A Fallacy in the Forecasts

January 12, 1953

A business forecast, as frequently explained in this column (see “Pitfalls of Forecasting,” Newsweek, Nov. 22, 1948), can never be anything better than a guess. The future of business depends on countless factors, and no human mind can encompass them all. But some guesses are better informed and better reasoned than others. What troubles me about the current crop of forecasts for 1953 is that most of them rest on fallacious assumptions. The most important of these is the assumption that the future of business activity at this time depends primarily on the government’s defense-spending program. If that rises, we are told, business activity and prices will rise; if it is sustained, the boom will be sustained; but if it declines, there’s no telling how much business will deteriorate, unless the government steps in and does something desperate.

This is the assumption, for example, that runs through the 80,000-word report on “Markets After the Defense Expansion” released by the Department of Commerce on Dec. 29, 1952. The report thinks it a “strong probability” that business will be good in 1953, but fears it will turn down in 1954—both largely based on the assumption that defense spending will rise next year and decline thereafter.

If this were true, it would mean that the more resources we are forced to devote to making guns and tanks and shells, instead of consumer goods, the richer we become. Many people do in fact embrace this absurdity. They even go on to tell you with a knowing wink that we owe our prosperity to Stalin and Korea, and that if a real peace broke out it would be an economic disaster.

This conclusion is just as preposterous as it seems. People arrive at it by combining a fallacy with an illusion. The fallacy consists in looking only at the government’s defense payments and forgetting that the money for these comes ultimately from taxes. If defense payments suddenly dropped from the present $50,000,000,000 a year to only $10,000,000,000, taxes could also be cut by $40,000,000,000. Then the taxpayers—both individuals and corporations—would have $40,000,000,000 more to spend than they had before, to make up for the $40,000,000,000 drop in government spending.

Of course such a change would very importantly affect individual industries. Defense output would be hurt as much as nondefense output would be helped. The pattern of production would be transformed. But there is no reason to suppose that the overall volume of output or activity would decline.

The confusion here arises because defense buying is most often financed by inflation. Instead of taking from the taxpayers the money that it uses to buy war goods, the government in effect prints the added money. But we can easily have inflation (if that is what we want) without defense spending. If we simply cut tax revenues by the same amount as we cut defense spending we can keep the same deficit and finance it by continuing to print money. In fact, most of the people who believe that continued prosperity depends on continued defense spending are logical enough to advocate inflation in some other form if we ever have to terminate defense inflation.

It is strange that the superstition that defense spending is necessary for continued prosperity should still prevail. The whole theory got a crushing refutation at the end of the second world war. Immediately after Japan surrendered in August 1945 there was a sweeping cancellation of war contracts. Government economists predicted that unemployment would reach 8,000,000 by the following spring. Nothing of the sort happened. By May of 1946, employment was actually higher than in July of 1945. So were prices. The primary reason was that the government continued to inflate the active money and credit supply. This was pushed up $8,000,000,000 between the beginning of August 1945 and the end of that year. I don’t put this forward as an argument for monetary inflation, but as proof that prosperity is not dependent on defense contracts.