February 12, 2012

Barry Ritzholtz Thinks WWII Was a Permanent Entitlement Expense

At least that's the logical conclusion of his argument.  He has criticism for John Maudlin's commentary as follows:

[Maudlin:] As I continuously argue, the most important issue facing the US is dealing with its deficit, just as that is the defining issue in much of Europe and will soon be in Japan. [BR: This is a s political, not economic or Fiscal assumption. While we need to deal with the deficit, it is not nearly the issue made out by the far Right -- the US has had bigger deficits, i.e., WW2, and resolved them]

Really, so Medicare/Medicaid/SS and all the other standing entitlement programs are equivalent to WWII spending?  The one thing that was pretty certain about WWII was that it would end, and therefore the borrowing expense could be paid down.  In fact, the US ran balanced budgets through the 1960s--an "austerity" program-- for twenty years following WWII in order to pay for it.  The current deficit is structural, because unless we start a new credit bubble going or the political will to address entitlement spending it's going to get worse and worse.  Economists are howling over any talk of austerity to address the deficit.  How exactly is the WWII one-time expense comparable to our current situation?

January 03, 2012

Dean Baker Discovers That Debt and Logic Don't Matter

Dean Baker has discovered a way for governments to go infinitely into debt and not worry about paying back.  The idea is that because Treasuries are ultimately sold to banks and other players whose principals will be dead in the future, and future bankers are part of the next generation, then spending now and hitting our children's tab technically isn't accurate.  No, such debt is not a burden on the entire next generation.  Only 99.9999 percent of it.  Ergo, debt doesn't matter.

He follows up this remarkable sophistry by saying that the real legacy to the future is climate change.

I modestly propose combining his observations.  The US government can borrow $100T to purchase a like quantity of solar panels.  This will not only provide more than enough clean electricity, but also ensure full employment for awhile.  Assuming indefinite 2% interest rates (because any other assumption is unthinkable), the future P&I burden per household might be around $10,000 per month.  Fortunately, in the Dean Baker future, this will be offset by each household having $10,000 per month in income from their multi-million dollar T bond portfolio, because "it's money we owe to ourselves".  We could repeat this to solve all other social problems.

January 01, 2012

Greg Mankiw on the Burden of Debt

Greg Mankiw refers us to an old paper he wrote with Lawrence Ball on the burden of national debt.  I have a couple of disagreements with his conclusions:

1. Mankiw writes:

In many developed economies, the average growth rate over long periods has exceeded the average interest rate on government debt. In the United States, for example, average growth of nominal GDP from 1871 to 1992 was 5.9 percent, and the average interest rate on debt was 4 percent. If these trends continue, a policy of rolling over the debt (and using taxes to pay for current government services) will cause the debt to grow more slowly than GDP.

Economists (Mankiw is far from the only perpetrator) often dismiss debt burden by simply comparing interest rates and growth rates; if the latter is larger then everything is ok.  This misses some important dynamics.  Since Mankiw and Ball wrote this paper, the debt to GDP ratio has risen past 100% in a very low rate environment.  This is because the rate of new borrowing--new principal--has exceeded GDP growth for most recent years.

The marginal productivity of debt both public and private (increase in GDP for each unit increase in debt) has declined since the 1950s and reached negative, interestingly, in 2006.

The selection of years going back to 1871 lets one capture the highest growth rates in US history into the average.  The trendlines for the past 20 and 10 years respectively have been 2.6% and 1.6% respectively.  It's a good thing the Fed has subsidized interest rates...what happens if they lose control?

Finally, averages of rates do not tell the whole story, because interest rates are mostly constant while GDP can fluctuate into negative territory.  Even if a depression is followed by a growth spurt, GDP growth doesn't catch up the growth comes from a lower baseline than the monotonically increasing debt.

In conclusion, comparing 140-year averages of GDP growth and interest rates doesn't really provide very good support that the US government can continue its, in Mankiw's words, "Ponzi" game.

2. This is more of an ongoing criticism of the entire GDP equation that economists treat as fundamental.  Mankiw writes:

When budget deficits reduce national saving, they must reduce investment, reduce net exports, or both.  The total fall in investment and net exports must exactly match the fall in national saving.

This assumes a world where credit doesn't exist.  In such a world, every dollar in existence must either be invested or put under a mattress, and a great many of them are earned from exports.  This completely ignores the effect of private credit.  In any given year, significant amounts of credit are pumped into the economy, disrupting the classic S = I + NX equation.  This allows both current-year S and I to be pumped up irrespective of NX, with the caveat that a future year liability is created.  

GDP equations, in my opinion, are at best incomplete as a reasoning model because of their exclusion of credit and finance. This is why the economics profession keeps being surprised by financial crises.  They aren't random "black swans" or "sudden psychological collapses in aggregate demand"; they are predictable outcomes of debt-financed excess consumption and malinvestment.

December 31, 2011

Hotel Proprietors, Prostitutes and Monetary Velocity

The following story is often told to explain monetary velocity and how government money printing helps us all:
In a small town in the United States, the place looks almost totally deserted. It is tough times, everybody is in debt, and everybody lives on credit.
Suddenly, a rich tourist comes to town.
He enters the towns only hotel, lays a 100 Dollar Bill on the reception counter as a deposit, and goes to inspect the rooms upstairs in order to pick one.
The hotel proprietor takes the 100 Dollar Bill and runs to pay his debt to the butcher.
The Butcher takes the 100 Dollar Bill, and runs to pay his debt to the pig farmer.
The pig farmer runs to pay his debt to the supplier of his feed and fuel.
The supplier of feed and fuel takes the 100 Dollar Bill and runs to pay his debt to the town's prostitute that in these hard times, gave her "services" on credit.
The hooker runs to the hotel, and pays off her debt with the 100 Dollar Bill to the hotel proprietor to pay for the rooms that she rented when she brought her clients there.
The hotel proprietor then lays the 100 Dollar Bill back on the counter so that the rich tourist will not suspect anything.
At that moment, the tourist comes down after inspecting the rooms, and takes back his 100 Dollar Bill, saying that he did not like any of the rooms, and leaves town.
No one earned anything ... However, the whole town is now without debt, and looks to the future with a lot of optimism.
Sounds like we have discovered a perpetual motion machine, right?  Let's deconstruct.

Nobody in the town is actually in debt.  Each party has a receivable account of $100 and a payable of $100.  These net out to zero.  That's the setup for the magic trick.  What the story describes is a process for settlement of mutual A/R and A/P, in which the "tourist" unwittingly plays the role of short-term credit provider.  This is one of the fundamental purposes of banks and financial institutions, but even they are not strictly necessary for settlement.  There are multiple ways this could happen without a "tourist" or government printer:

If the parties sold their A/R to each other or to a third party, the third party could net out the accounts with no money exchanged.  For example, if the chain went in the opposite direction you wouldn't need the tourist at all.  The prostitute could sell her A/R with the fuel supplier to the hotelier to settle her account, the fuel supplier could do the same with his A/R, and so on.  The hotelier would wind up settling his debt with the butcher by tearing up the butcher's A/P with the pig farmer that he now owns.  We didn't need the tourist, and yes this type of transaction goes on all the time in the real world.

If any party (e.g. the pig farmer) factors their invoice or otherwise gets a short-term line of credit, the entire chain can be settled in cash.  This type of trade credit is self-liquidating and is indeed the lifeblood of commerce.  The town didn't need the tourist.

It is important to note that no economic activity occurred--this is simply moving money around to settle accounts, with the tourist providing self-liquidating short-term credit (for free, bless his soul).

Therefore this story, which simply illustrates how offsetting A/R and A/P can be settled, cannot be expanded to a larger analogy with monetary velocity or government stimulus.  In the current environment, profitable businesses have no problem getting credit to pay A/P while floating A/R--i.e. managing cash flow.  We are awash in liquidity.  Government stimulus money is never used for such short-term problems.

The kind of monetary velocity increase that is beneficial is demand-driven: the hotelier buys more meat and prostitution services because he has more paying guests.  Faster settlement of A/R doesn't reflect increased economic activity.

The real problem is that the hotel proprietor, the butcher, the pig farmer, the fuel supplier, and the prostitute all owe the bank hundreds of thousands of dollars in debt they aren't servicing, funded by leveraged credit against their own pension funds, while government spends against their children's account.  You're going to need the tourist to actually stay in the hotel to solve that problem and hope he spends a lot of time in the restaurant.

Edit: Other writers have the same idea: View from the Wilds: How a Bailout DOESN"T work

October 08, 2011

Bloomberg Says Wall Street Protestors Trying to Destroy Jobs

NY Mayor Michael Bloomberg says the Occupy Wall Street protests are a bunch of people trying to destroy jobs.

Thanks, Mike.  I'll put on my Save the Banksters button now and counter-protest.  I, too, find the peasants' revolt revolting.

September 29, 2011

How Much To Buy a George F. Will Article?

George Will opines that Barney Frank's attempt to strip the banking industry's right to appoint a majority of the Fed board is an attack on the Fed's independence and inflation-fighting mandate.  For example,
Heavy representation of the economy’s financial sector in the governance of the central bank does not seem bizarre.
Sort of how we should have drug companies running the FDA and Mexican drug cartels running the DEA.  Does Will endorse the virtual ownership of the SEC by Wall Street brokerages, too?  Will concludes:

...one of liberalism’s steady aims is to break more and more institutions to the saddle of centralized power.

It takes a truly great editorialist to portray the Fed as a victim of power centralization instead of a poster boy for its dangers.  I would like to know how much the banking industry had to pay Will for this article.

September 21, 2011

Republicans Don't Like Class Warfare

Republicans led by US Rep. Paul Ryan are decrying the idea of setting a progressive income tax standard around a so-called "Buffet Rule" whereby those making more than $1M per year must be taxed at at least the same rate as those in middle class brackets.

“Class warfare will simply divide this country more. It will attack job creators, divide people and it doesn’t grow the economy,” Rep. Paul Ryan said on FOX News Sunday. “Class warfare may make for really good politics, but it makes for rotten economics.”
This tells us that what we need is a fully regressive tax system in order to grow the economy and create jobs.  Let's cut the job-creating wealthy class taxes to zero and we'll see all sorts of quality jobs created due to all of this extra walking-around capital:

- Yacht captains
- Dog groomers
- Landscapers
- Horse groomsmen
- Life coaches
- etc.

If we tax those paychecks at 80%, we'll solve the deficit problem in no time flat!  Perhaps we can bring back feudalism, and cut the wasteful government taxation middleman out of the picture altogether.

September 04, 2011

Krugman: More Regulatory Frictional Costs = Economic Growth

A recent Paul Krugman blog post not only rejects the broken windows fallacy (i.e. that destroying things and forcing people to spend to replace them does not actually create prosperity) but makes the case that when government creates regulatory compliance costs for businesses, it forces them to spend the excess cash that they are supposedly hoarding and thereby creates GDP growth.  Krugman writes:

As some of us keep trying to point out, the United States is in a liquidity trap: private spending is inadequate to achieve full employment, and with short-term interest rates close to zero, conventional monetary policy is exhausted.
This puts us in a world of topsy-turvy, in which many of the usual rules of economics cease to hold. Thrift leads to lower investment; wage cuts reduce employment; even higher productivity can be a bad thing. And the broken windows fallacy ceases to be a fallacy: something that forces firms to replace capital, even if that something seemingly makes them poorer, can stimulate spending and raise employment. Indeed, in the absence of effective policy, that’s how recovery eventually happens: as Keynes put it, a slump goes on until “the shortage of capital through use, decay and obsolescence” gets firms spending again to replace their plant and equipment.
And now you can see why tighter ozone regulation would actually have created jobs: it would have forced firms to spend on upgrading or replacing equipment, helping to boost demand. Yes, it would have cost money — but that’s the point! And with corporations sitting on lots of idle cash, the money spent would not, to any significant extent, come at the expense of other investment.

There is no doubt that government can create compliance industry jobs.  H&R Block owes its existence to a byzantine tax system.  It allows government to mop up excess labor and redistribute income, and does it in a less objectionable way than declaring war.   According to researcher Michael Hodges of the Grandfather Economic Report, regulatory compliance is already a $2T component of our economy and rapidly growing in recent years.  Is that a good natural solution to the problem of too much labor and too few jobs, or is there a downside?

Regulatory compliance costs obviously reduce competitiveness vs. foreign companies who do not have the equivalent regulatory burden.  As this could be overcome compensatory tariffs I do not think this is necessarily a deal-killer.  The more important objection is that it puts us further and further down the course of what Ayn Rand objected to: a handful of private producers are surrounded by a growing parasitical class of persons who, instead of being paid to dig holes and fill them in again, are instead paid to administrate an ever-growing set of mandated regulatory spending.  Regulators and consultants get paid by companies for:

- Tax compliance
- Clorofluorocarbon emission (ozone) compliance (Krugman's post cited this specifically as a job creator)
- CO2 emissions compliance
- Green energy compliance
- Racial/gender/religious/etc. equity compliance
- Sarbanes-Oxley compliance
- OSHA workplace safety compliance
- Security compliance
- Hazmat/pollution compliance
- Pricing compliance
- Insurance compliance
- Marketing compliance
- Labor compliance

And so on.  This is not meant to dismiss the need for regulation in the whole; clearly we are better off for having Hazmat and food inspection frictional costs and no economic argument should sway us from ensuring companies are not poisoning the public.  But also in the whole, these frictional costs are already 17% of our economy while not producing any tangible economic value, irrespective of the social value.

Creating jobs and spending through regulatory frictional costs is a slippery slope.  What happens when 5% of the population provide goods and services, and the other 95% are employed in make-work government compliance jobs supervising that 5%?  When 80% of a company's expenditures are mandated by government?  Who is John Galt?