Posts tagged ‘debt’

The Trade Deficit is Not A Debt

If you search Coyoteblog for the title of this post, you will see a number of others with the same title.  It seems to be a theme we keep having to come back to.  Here is one example of where I tried to explain why the trade deficit is not a debt.

Take the Chinese for example.  One thing that people often miss is that the Chinese buy a LOT more American stuff than the trade numbers portray.  The numbers in the balance of trade accounts include only products the Chinese buy from the US and then take back to China to consume there.  But the Chinese like to buy American stuff and consume it here, in the US.  They buy land and materials to build factories and trade offices.  They buy houses in California.  They buy our government bonds.  None of this stuff shows up in the trade numbers.  Is it somehow worse that the Chinese wish to consume their American products in America?  No.  How could it be.  In fact, its a compliment.  They know that our country is, long-term, a safer and more reliable place to own and hold on to things of value than their own country.

Dollars paid to a Chinese manufacturer have to get recycled to the US -- they don't just build up in a pile.   If I am a construction contractor in LA and build that manufacturer a new office or a local home and get paid with those recycled dollars, I am effectively exporting to the Chinese, only the goods and services I sold them never leave the country and so don't show up in the trade numbers.  So what does this mean?   In my mind, it means that the trade deficit number is a stupid metric to obsess over.

Another way I think about it is to observe that the US is winning the battle of stuff.   Money as money itself does not improve my well-being -- only the stuff (goods and services) I can purchase with it can do so.   So i t turns out that other countries ship far more stuff to the US than we ship out. And then these folks in other countries take the money they earn from this trade and buy more stuff in the US and keep keep that stuff here!

I am reminded of all this because several other folks are taking a swing at trying to make this point to the economically illiterate.   Don Boudreaux does so here, and Dan Ikensan here.  And here is Walter Williams as well.

Cargo Cult Economics And Why We Should Stop Fetishizing Home Ownership

I have always thought that government policy to encourage home ownership was  counter-productive, even beyond its role in creating bubbles.  My sense is that those who advocate for such programs are engaging in what I call cargo cult economics.

Once upon a time, government officials decided it would help them keep their jobs if they could claim they had expanded the middle class.  Unfortunately, none of them really understood economics or even the historical factors that led to the emergence of the middle class in the first place.  But they did know two things:  Middle class people tended to own their own homes, and they sent their kids to college.

So in true cargo cult fashion, they decided to increase the middle class by promoting these markers of being middle class [without any consideration of which direction the arrow of causation ran].  They threw the Federal government strongly behind promoting home ownership and college education.  A large part of this effort entailed offering easy debt financing for housing and education.

I tend to be a lone voice in the wilderness on this (even those who oppose government programs for libertarian reasons often tend to fetishize home ownership).  But Ike Brannon at Alt-M seems to agree:

The pro-home-building folks aver that homeownership fosters civic involvement and helps people become more tied to their community, which encourages other behavior beneficial for the economy.  And for a good proportion of homeowners the majority of their net wealth is in their home, so it can be an important source of savings.

But another way to look at it is that correlation is not causation:  The reason that homeowners are more civic-minded and involved in the community is because such people are much more likely to have the wherewithal to save enough to make a downpayment on a house.  Ed Glaeser, the renowned housing economist from Harvard, puts little stock in the notion that homeownership has significant positive societal externalities.

What's more, there's some evidence that high homeownership rates have downsides as well.  In the last four decades the predilection for moving has slowed significantly:  only half as many people moved across state or county lines in any year this decade as was the case in the 1950s, for instance.  This is problematic because it means that our economy is worse at matching up workers with where the available jobs are.  The lingering unemployment in many rust-belt states would be less if some of their unemployed could be persuaded to move to another community where there are jobs.  There has been a decades-long move of people from the midwest to the Sunbelt, of course, but the data suggest there's ample room for more.  This hasn't happened in part because people are tied down by the homes that they own and are reluctant to sell while they are underwater.  That people are unable to ignore sunk costs isn't economically rational, of course, but it nevertheless governs how many people consider whether to move.

China as a Test of Keynes vs. Hayek

Let's start by saying that I have an imperfect layman's view of Keynes and Hayek.  This is my understanding and over-simplification of how these camps deal with economic downturns.

  • Keynes:  Economic downturns result from some sort of failure of aggregate demand.  There are positive feedbacks in the system such that a small downturn can lead to a larger downturn if left unchecked (but on the flip side mean that a small stimulus can have a disproportionately large effect on demand).  The proper government response to a downturn is to create demand through government deficit spending.   Failure to emerge in a timely manner from a recession likely is the result of the government not being aggressive enough in its spending.
  • Hayek:  Economic downturns result from mis-allocation of savings and investment capital, often due to government policy by not necessarily so (one can argue the housing bubble was driven by government policy, but the first Internet bubble likely was not).  The proper government response to a recession is to stop any distorting government policy that drove it and let the economy sort itself out by restructuring.  Failure to emerge in a timely manner from a recession is likely due to interventions that slow this necessary restructuring (e.g. bailouts, government-directed investment programs).

I will say that if my Hayek description is not correct for the Austrians, it is correct for me -- this is what I believe happens.

That said, I have long thought the Japanese lost decade(s) were pretty much final proof of the Hayek vs. Keynes explanation, and I am sort of amazed people still argue about it.  I remember in the 80's people in the US admired the Japanese MITI system of industrial management that carefully directed investment into government-preferred industries and, by the way, stomped on the Japanese consumer (including laws that kept both the retail and agricultural sectors backwards) in favor of promoting the export market.

In the 20+ years since Japan slid into a downturn, they have been the poster child for Keynesian stimulation.  They have deficit spent like crazy and have driven up -- by a longshot -- the largest government debt as a percent of GDP of any of the industrialized nations.  Yet still they flounder -- I would argue precisely because they had an Austrian recession, based on years and years of government-enforced mal-investment, but have refused the Austrian solution.  Watching it evolve over the years, I have thought it impossible to miss the point, but it appears that Krugman-Keynesians can always argue, not matter how much government debt was run up, that the problem was that they just didn't spend enough.

Well, in my view we have another such test coming, perhaps even more stark -- in China.  China, perhaps more than Japan, has filled their economy with investment distortions -- the huge empty cities that get shown on the Internet seem to be one example.

China empty city

And over the past year or two, China has been deficit spending and stimulating like hell -- both at the central government level as well as with policies that have encouraged the accumulation of debt both locally and in industry.

This is why I think the crash is coming in China, and the longer they manage to delay it by artificial means, the worse and longer the crash will be.  There is probably a bet that could be had here, but I am not sure how it would be structured.

And This is Different from the US, How?

I am out of the country (currently in Thailand for a wedding).  I read this in the local Asian WSJ, an article about money and patronage in the Malaysian political process.  And while I suppose I was supposed to think "wow, Malaysia is sure screwed up" -- all I was really left with at the end of this article was "how is this any different from the US?" How does 1MDB differ from, say, various green energy funds at the Federal level or community development funds at the local level?

Malaysian Prime Minister Najib Razak was fighting for his political life this summer after revelations that almost $700 million from an undisclosed source had entered his personal bank accounts.

Under pressure within his party to resign, he called together a group of senior leaders in July to remind them everyone had benefited from the money.

The funds, Mr. Najib said, weren’t used for his personal enrichment. Instead, they were channeled to politicians or into spending on projects aimed at helping the ruling party win elections in 2013, he said, according to a cabinet minister who was present.

“I took the money to spend for us,” the minister quoted Mr. Najib as saying.

It still isn’t clear where the $700 million came from or where it went. But a six-month Wall Street Journal examination revealed that public entities spent hundreds of millions of dollars on a massive patronage machine to help ensure Mr. Najib’s United Malays National Organization stayed in power. The payments, while legal, represented a new milestone in Malaysia’s freewheeling electoral system, according to ruling-party officials....

The effort relied heavily on the state investment fund Mr. Najib controlled, 1Malaysia Development Bhd., according to minutes from 1MDB board meetings seen by The Wall Street Journal and interviews with people who worked there.

The prime minister, who is chairman of 1MDB’s board of advisers, promised repeatedly that the fund would boost Malaysia’s economy by attracting foreign capital. It rolled up more than $11 billion in debt without luring major investments.

Yet Mr. Najib used the fund to funnel at least $140 million to charity projects such as schools and low-cost housing in ways that boosted UMNO’s election chances, the Journal investigation found.

The minutes portray a fund that repeatedly prioritized political spending, even when 1MDB’s cash flow was insufficient to cover its debt payments.

This illustrates one (of many) reasons why those lobbying to reduce campaign spending are on the wrong track.  Because no matter how much one limits the direct spending in elections, no country, including the US, ever limits politicians from these sorts of patronage projects, which are essentially vote-buying schemes with my tax money.

The reason there is so much money in politics is because supporters of large government have raised the stakes for elections.  Want to see money leave politics? -- eliminate the government's ability to sacrifice one group to another while subsidizing a third, and no one will spend spend a billion dollars to get his guy elected to public office.

By the way, in this current Presidential election we are seeing a vivid demonstration of another reason campaign spending limits are misguided.  With strict spending limits, the advantage goes to the incumbent.  The only people who can break through this advantage are people who are either a) already famous for some other reason or b) people who resort to the craziest populist rhetoric.  Both of which describe Donald Trump to a T (update:  Trump has spent virtually no money in this election, so he should be the dream candidate of clean elections folks, right?)

Keynesians Have Shot Their Only Bolt -- How Will They Spend Their Way Through The Next Crisis?

Governments have spent so much, to so little effect, to try to stimulate the current economy, I wonder where they will find the resources to spend more the next time?  Because you can be sure that despite the fact that we are likely near the top of a weak cycle, no one is paying back what was spent in the last recession or proposing to reduce central bank balance sheets.

This is a couple of years old, but tells the story pretty well:

The financial crisis that began in late 2007, with its mix of liquidity crunch, decreased tax revenues, huge economic stimulus programs, recapitalizations of banks and so on and so forth, led to a dramatic increase in the public debt for most advanced economies. Public debt as a percent of GDP in OECD countries as a whole went from hovering around 70% throughout the 1990s to almost 110% in 2012. It is now projected to grow to 112.5% of GDP by 2014, possibly rising even higher in the following years. This trend is visible not only in countries with a history of debt problems - such as Japan, Italy, Belgium and Greece - but also in countries where it was relatively low before the crisis - such as the US, UK, France, Portugal and Ireland.

So over a third of the debt that has been built up in all of history by Western nations was added in just a few years from 2007-2012.  At the same time, the central banks of these countries were adding to their balance sheets like crazy, essentially printing money in addition to this deficit spending.  In the US, the Fed's balance sheet as a percent of GDP hovered around 6% until the second half of 2008.   That had tripled to over 18% in 2012 (source).  At the same time, European central bank assets grew from about 7% to over 16% of GDP.

James Taranto has a regular feature named after a reporter named Fox Butterfield.  The feature takes statements such as "Despite Mary getting a PhD in Peruvian gender studies from Harvard, she has struggled to find a job" and argues that the "despite" should be replaced by "because".

This is certainly true of the statement that "despite record stimulus and Fed balance sheet expansion, the economy has remained sluggish".  That "despite" should be "because of".  The government continues to distort the allocation of capital and wonders why investment is sluggish and tends towards bubbles in certain assets.  Japan has stimulated for 25 years to absurd levels of debt and has gotten 25 years of sluggishness in return.

All this reminds me of a story in one of my favorite business books, "Barbarians at the Gate."  Back in the day, tobacco companies had a practice of jamming inventory into the channel just ahead of the semi-annual price increase.   They called this "loading."  The channel liked it because they got cheap product to sell at the new higher prices.  The tobacco companies liked it because it boosted quarterly revenues at the end of the quarter.  But that boost only happens once.  To show growth the next quarter, one must load even more.  Over time, they were jamming huge amounts of inventory into the channel.  I have never been a smoker, but apparently freshness is an issue with cigarettes and they can go stale.  Eventually, the company was loading so much their sales started to drop because everyone was buying stale cigarettes.

In find this a powerful metaphor for government interventions in the economy today.

Postscript:  I will give another example.  In Arizona, we are on a July-June fiscal year.  Years ago, some government yahoo had the bright idea to close a budget hole by passing a law that all businesses had to pre-pay their estimate of sales taxes due in July a month earlier in June.  For that one glorious year, politicians had 13 months of revenue to spend rather than 12.

But to set things aright the next year, they would have to live with just 11 months of revenue.  No way they were going to do that!  So they did the pull-forward thing again to get a full 12 months.  And they have done it every year since.  It has become an institution.  All this costs a ton of money to process, as the state must essentially process a 13th return each year, presumably paying overtime and temp costs to do it.  All for the benefit of one year where they got the use of one month of revenue early, we have been stuck with higher state operating costs forever.

Some More Thoughts on Greece -- When European Charity Runs Out, All That is Left is Inflation

People keep talking about reducing Greek debt to a sustainable level, but part of the problem is that there is not such level.  Even at zero.  The problem is that Greece is running a government deficit even before any debt service, so if creditors were to waive all of its debt, it would still need to be borrowing new money tomorrow.  Debt forgiveness is not enough -- what the Greeks need is for Europe to write off all its debt, and then (having lost all their money on the old debt) start lending new money immediately.  Note also that any bailout agreement reached this month will just put everyone back in the exact same place a few months from now.

This situation cannot be expected to change any time soon, for a variety of reasons from demographics (Greece has the oldest population in Europe, and a relatively rich pension system) to ideology (the current pseudo-Marxist government will never implement the reforms needed to turn the economy around, even if they promise to do so under duress).

With structural solutions unlikely, Greece has only the options of charity and inflation. Greece still seems to be hoping for charity, which they make harder by spewing derision at the same folks whom they are begging for alms.  Europe, certainly Germany, is in no mood to be charitable any longer, but may still do so depending on their calculation about which action -- bailout or exit -- has the worse long-term consequences for keeping Portugal, Spain, and Italy both in the Euro and continuing to pay their debts.

Lacking charity, the only thing left is inflation.  Some folks think I am advocating that option.  I am not.  The best possible hope for Greece is to slash its economic regulation, privatize business, and cut back on the public sector -- but that is not going to happen with the current government.  Or maybe any government.

I say inflation is the only option because that is what balances the budget and "solves" debt problems when politicians are unable or unwilling to make any hard choices.  It is sort of the default.  If they can't balance the budget or figure out how to pay off debt, then inflation does it for them by reducing the value of pensions and outstanding debts**.  This is what will happen with a Grexit -- a massive bout of devaluation and inflation what will greatly reduce the value of any IOU, whether it be a pension or a bank deposit.

Eventually, the one good thing that comes from inflation and devaluation is that the country becomes really cheap to outsiders.  Tourists will flock in and olive oil will sell well internationally as the new drachma loses its value, creating value for people holding stronger currencies and potentially forming the basis for some sort of economic revival.  My wife and I decided a few months back to postpone the Greek vacation we wanted this year -- too much turmoil is still possible -- and wait for it to be a bargain in 2016 or 2017.

 

**Postscript:  This is exactly why the Euro is both immensely seductive and a dangerous trap for countries like Greece.  Seductive, because it could pursue any sort of destructive banana republic fiscal policy it wished and still have a strong currency.  A trap because it can no longer print money and inflate away its debt problems.

If We Are Using Every Stimulus Tool in the Book at the Top of the Cycle, What Are We Going To Do In The Next Downturn?

From the Telegraph

The world will be unable to fight the next global financial crash as central banks have used up their ammunition trying to tackle the last crises, the Bank for International Settlements has warned.

The so-called central bank of central banks launched a scatching critique of global monetary policy in its annual report. The BIS claimed that central banks have backed themselves into a corner after repeatedly cutting interest rates to shore up their economies.

These low interest rates have in turn fuelled economic booms, encouraging excessive risk taking. Booms have then turned to busts, which policymakers have responded to with even lower rates....

“Rather than just reflecting the current weakness, [lower rates] may in part have contributed to it by fuelling costly financial booms and busts and delaying adjustment. The result is too much debt, too little growth and too low interest rates.

"In short, low rates beget lower rates."

The BIS warned that interest rates have now been so low for so long that central banks are unequipped to fight the next crises.

Dear Paul Krugman: Please Explain Labor Demand Elasticity in Puerto Rico

Paul Krugman and a surprisingly large portion of Leftish economists have staked out a position that labor does not act like any other commodity, such that higher minimum wages have no effect on demand.  I have had people on the Left tell me that this absurd, common-sense-offending position is actually "settled".  So explain Puerto Rico:

Another problem is that just 40 percent of the population [of Puerto Rico] has a job—or is even looking for one. That figure has plummeted in recent years. In the United States as a whole, it is 62.9 percent....

The report cites one surprising problem: the federal minimum wage, which is at the same level in Puerto Rico as in the rest of the country, even though the economy there is so much weaker. There are probably some people who would like to work, but because of the sickly economy, businesses can't afford to pay them the minimum wage.

Someone working full time for the minimum wage earns $15,080 a year, which isn't that much less than the median income in Puerto Rico of $19,624.

The report also cites regulations and restrictions that make it difficult to set up new businesses and hire workers, although it's difficult to know just how large an effect these rules might or might not have on the labor market.

By the way, the fact that the author thinks this is "surprising" just goes to show how far this anti-factual meme of a non-sloping labor demand curve has penetrated.

As pointed out in several places today, Puerto Rico has a surprising number of parallels to Greece.   It seems to have zero fiscal restraint, it has structural and regulatory issues in its economy that suppress growth, and has its currency pegged to that of a larger, much richer nation.  It is apparently facing a huge $70+ billion potential debt default.

Greece's Lesson for Gold Bugs

I have been predicting for years that the only solution for the Greece problem is for it to exit the Euro, go through a horrible economic crisis and deal with substantial devaluation, and then hopefully move on with a cheaper currency that makes its tourist industry look better and plugs the hole between taxing and spending with inflation.  It appears we are closer than ever to this actually happening.  The Greeks would likely be moving forward now, like Iceland, if they had taken their medicine years ago rather than try to kick the can.  Now it is just going to be worse.

I have been enamored off and on with the idea of a gold standard but Megan McArdle made some powerful points today about how the Greek situation teaches us that a gold standard doesn't necessarily impose discipline on governments.

It's easy to moralize Greece's feckless borrowing, weak tax collection and long history of default, and hey, go ahead; I won't stop you. But whatever the nation's moral failures, what we're witnessing now shows the dangers of trying to cure the problems of weak fiscal discipline with some sort of externally imposed currency regime. Greek creditors and Brussels were not the only people to joyously embrace the belief that the euro would finally force Greece to keep its financial house in order; you hear the same arguments right here at home from American gold bugs. During the ardent height of Ron Paul's popularity, I tried to explain why this doesn't work: "You don't get anything out of a gold standard that you didn't bring with you. If your government is a credible steward of the money supply, you don't need it; and if it isn't, it won't be able to stay on it long anyway."

This goes double for fiscal discipline. Moving to a fixed exchange rate protects bond-holders from one specific sort of risk: the possibility that inflation will erode the real value of your bonds. But that doesn't remove the risk. It just transforms it. Now that the government can't inflate away its debt, you instead face the risk that they are going to run out of money to pay their bills and suddenly default. That's exactly what happened to Argentina, and many other nations on various other currency regimes, from the gold standard to a currency peg. The ability to inflate the currency had gone away, but the currency regime didn't fix any of the underlying institutional problems that previous governments had solved with inflation. So bondholders protected themselves from inflation, and instead took a catastrophic haircut.

Postscript #1:  I had one issue with McArdle's piece when she writes

The only people this will be good for is people who long to vacation on the Greek Islands. If Grexit actually happens, book those plane tickets now, but hold off on the hotel. It will be cheaper in six months. Then try to enjoy it as you remember that those fabulous savings are someone else's whole life evaporating.

Hey, if Grexit occurs, you have no reason to feel guilty about taking advantage of the weak currency and low prices for a Greek vacation.  There is nothing the Greeks need more than for you to do exactly that.   It is the single best thing you could do for the Greek people.

Postscript#2:  Here is why exiting the Euro, devalutation, and inflation are the only way out for Greece at this point. Creditors allow countries to run long-term deficits and keep lending despite rising debt (see: Japan) because of a combination of a) the country can always just print the money they need; b) the country can raise taxes and take the money it needs or c) the country can keep spending flat and grow their way out from the debt.

None of these are available to Greece. They can't print money, at least without running up new debts (excess printing of Euros is automatically added to Greece's debt to the ECB).  They can't raise taxes because their citizens don't pay the taxes that already exist.  And they can't grow their way out because there is zero support for austerity or market-based reforms that would be necessary, and besides a huge portion of Greek deficit spending is for inherently unproductive activities.  At this point Greece's only option is charity, that the other countries of the EU will forgive debt or write them new debt, either to be nice or to avoid bad precedents with other PIGS countries.  But  the EU seems at the end of its charity rope, and besides given zero prospects of any sort of Greek recovery, even after a major write-off of debt the EU would be in the position of still having to send Greece new money for its new debts.

What I Think is Going on With Greece

I want to offer a perspective on the Greek financial mess.

I am not confused about the Greek desire to get out from under their debt load - past governments have built up intolerable levels of debt which is costs a huge portion of Greek GDP to pay off.

At one time in my life I would have been confused by folks, often on the Left, who argue that the answer to Greek debt problems is ... deficit spending.  This might have seen inexplicable to me earlier in life as a wondered how the same behavior of fiscal irresponsibility that led them into debt would get them out.  But I have learned that there is no limit to the optimism Keynesians hold for the effects of government spending.  The last trillion of debt may have not done anything measurable but the next trillion is always going to be the one that turns us around.  Sort of like Cubs fans.

No, what confuses me today is the fact that other institutions and countries are still willing to buy Greek debt and even entertain some sort of debt swap where they end up with even more Greek debt.  I have heard it said by many experts that it is unrealistic to expect that lenders will get even a fraction of their principle back from these loans.  So why loan more?

The key for me in understanding this is the book "Engineering the Financial Crisis".  In that book, the authors presented the theory that the Basel capital accords, which set capital requirements for banks, had a lot to do with the last financial crisis.  Specifically, the rules allowed bank investments in two types of securities to be counted at 100% towards their capital levels.  Any other type of investment was severely discounted, so there were enormous incentives in the regulations to focus bank investments on these two types of securities.  What were they?  Sovereign debt and mortgages (and mortgage-backed securities).

In the authors' view, which I find persuasive, a lot of the last financial crisis was caused by these rules creating a huge artificial demand by banks for mortgage securities.  This created a sort of monoculture that was susceptible to small contagions spreading rapidly.  As this demand for mortgage backed securities inevitably drove down their returns, it also created a demand for higher-yielding, riskier mortgage investments that might still "count" as mortgage securities under the capital requirements.

Anyway, for the Greek crisis, we need to look at the other piece of these capital requirements that give 100% capital credit:  sovereign debt.  Now, I may have this wrong, but for Euro denominated credit, it all counts as 100% whether its German or Greek, which is a bit like saying a mortgage to Bill Gates and a mortgage to Clark Griswold's country cousins count the same, but those are the rules.

So here is the problem as I understand it:  Greek debt, because of its risk, paid higher returns than other sovereign debt but still counted the same against capital requirements.   So European banks loaded up on it.  Now that the debt is clearly bad, I am sure they would love to get paid for it.  But what they want even more is to continue to get credit for it on their balance sheets against capital requirements.  So what the banks need more than getting paid is for the debt to still exist and to (nominally) be current so that they can still count it on their balance sheets.  Otherwise, if the debt gets written off, that means banks need to run out and raise hundreds of billions in new capital to replace it.

Yes, I know this seems insane.  If everyone knows that the debt is virtually worthless, isn't it a sham to keep taking expensive steps (like issuing even more new debt) just to make sure the debt still appears on the books at 100%?  Yes, of course it is.  This is a problem with just about every system ever tried on bank capital requirements.  Such requirements make sense (even to this libertarian) in a world of deposit insurance and too big to fail, but they can and do create expensive unintended consequences.

Question for Keynesians: What Are You Doing To Prepare for the Next Cycle?

When I was in school learning macro 101 from Baumol and Blinder, my memory is that the theory of Keynesian stimulus and managing the economic cycle was that deficits should be run in the bottom part of the economic cycle, paid for with surpluses in the top half.   So we are now almost certainly in the top half of the cycle.  But I don't hear any Keynesians seeking to run a surplus, or even to dial back on government deficits or spending.  In fact, our Keynesian-in-chief says he is done with "mindless austerity" and wants to start spending even harder in 2015.

Its enough to make one suspicious that all the stimulus talk is just a Trojan Horse for a desire to increase the size and power of government.

But for Keynesians who really believe what they are saying, that deficit spending somehow saved us from a depression in 2009 and 2010, then I ask you -- what are you going to do next time?  It appears that when we enter the next recession in this country, that US debt as a percentage of GDP is going to be almost twice what it was entering the last recession.  Don't you worry that this limits your flexibility and ability to ramp up deficit spending in the next recession?

The situation in the US is the same as it is worldwide.  While those evil private short-term-focused private actors have used the improving economy to de-leverage back below 2007 levels, governments have increased their debt as a percentage of GDP by just over 50% since just before the last recession.

20150205_debt1

 

Since 2007, according to my old friends at McKinsey, global government debt has risen by $25 trillion since 2007.  If you really care about Keynesian stimulus in recessions, and not just "mindlessly" (I can use that term too) increase government spending, wouldn't you want to be building up some reserves for next time?

In China, It's 1928

I know I have been warning about a Chinese recession/depression for a while, but it takes a while (and still will take some time) for this disaster to play out.  But the warning signs are all there.  This article today in the WSJ is a great example.  

A little over a year ago, a Chinese credit agency downgraded a government-owned financing company in this dusty industrial city. Default—nearly unheard-of in China on government bonds—was a possibility, it said.

But during discussions with lenders, city officials made sure Wuhan Urban Construction Investment & Development Corp. could keep borrowing, officials with knowledge of the matter say. The city during those discussions said it backed the finance firm, essentially guaranteeing the debt, and helped the company restructure its assets to entice investors to lend more.

Borrowing by firms like Wuhan Urban is a big reason China’s debt load is expanding. The International Monetary Fund says China’s debt is growing more rapidly than debt in Japan, South Korea and the U.S. did before they tumbled into deep recessions. Local-government borrowing is responsible for one-fourth of the buildup in China’s overall domestic debt since 2008....

Even before its latest step, Beijing had put forward plans to slow local-borrowing growth. But China’s local governments have a surprising ability to resist policies. Another central-government priority—reducing excess production in steel, cement and other industries—has foundered due to local opposition.

“The guys running local government financing operations won’t roll over and die,” says Fraser Howie, co-author of “Red Capitalism,” a study of China’s financial system. “These companies take on a life of their own.”

Perhaps we should call this the looming Thomas Friedman recession, as China goes bankrupt doing exactly what Friedman admires - building more and more infrastructure and then taking out debt and building even more.

There is absolutely no reason to believe, as folks like Friedman do, that this investment in infrastructure automatically has a positive return, and in fact there are a lot of reasons to think it does not (ie gluts of housing and basic materials).  As I have written before, like light rail spending in the US, these infrastructure investments pay their benefits mostly in prestige to local government officials and rents for politically connected contractors and government workers and not in real returns to future economic growth.

I tend to accept the Austrian theory of recessions, which I would simplify (perhaps inaccurately) as mis-allocation of capital and labor investments leading to economic downturns as the economy restructures.  The longer the reckoning is put off, the worse the recession.   These mis-allocations can sometimes be due to private causes (e.g. over-euphoric investments in early Internet companies in the late 1990's) but they often have public causes (e.g. artificially low interest rates or government programs to promote investment in a single industry like, say, housing).

I am convinced this is what brought down Japan -- after years of admiration for Japan, inc. and MITI economic management, it turns out the government had directed all capital into a few export manufacturing industries, while continuing to protect retail and agriculture locally from any real change or competition.  Which is why 25 years of government directed deficit spending has not fixed the recession -- it just doubles down on the original cause.  For those of you too young to remember, the Friedman-types of the world were all praising Japan to the hilt in the late 80's as the model we should all be following.  People like this don't admit error, they simply shut up about Japan and started praising the same behaviors in China.

The same reckoning is coming to China.  Probably not this year or the next, but within the next 5 years almost for sure.  It is 1928 in China.

Postscript:  By 1928, I mean a year of apparent prosperity before the Great Depression in 1929.  I am not referring to the nominal reunification of China or start of the "republic" under Chiang Kai-shek.

Quantitative Easing and the Left's Relationship to the Rich and to Large Corporations

The Left spends a lot of time railing against the rich and large corporations.  But in practice, they seem hell-bent on lining the pockets of exactly these groups.  Today the ECB announces a one trillion plus euro government buyback of public and private securities.

Between Japan, the US, and now Europe, the world's central banks are printing money like crazy to inflate securities values around the world -- debt securities directly by buying them but indirectly a lot of the money spills over into stocks as well.  This has been a huge windfall for people whose income mostly comes from capital gains (i.e. rich people) and institutions that have access to bond and equity markets (i.e. large corporations).  You can see the effects in the skyrocketing income inequality numbers over the last 6 years.  On the other end, as a small business person, you sure can't see any difference in my access or cost of capital.  It is still just as impossible to get a cash flow loan as it always was.

Surprise! Greek Problems Were Not Solved By Kicking the Can Down the Road

Greece is looking like it's falling apart again.  Or perhaps more accurately: Greece continues to fall apart and the lipstick Europe put on the pig a few years ago is wearing off and people are noticing again.

I warned about this less than a year ago:

Kevin Drum quotes Hugo Dixon on the Greek recovery:

Greece is undergoing an astonishing financial rebound. Two years ago, the country looked like it was set for a messy default and exit from the euro. Now it is on the verge of returning to the bond market with the issue of 2 billion euros of five-year paper.

There are still political risks, and the real economy is only now starting to turn. But the financial recovery is impressive. The 10-year bond yield, which hit 30 percent after the debt restructuring of two years ago, is now 6.2 percent....The changed mood in the markets is mainly down to external factors: the European Central Bank’s promise to “do whatever it takes” to save the euro two years ago; and the more recent end of investors’ love affair with emerging markets, meaning the liquidity sloshing around the global economy has been hunting for bargains in other places such as Greece.

That said, the centre-right government of Antonis Samaras has surprised observers at home and abroad by its ability to continue with the fiscal and structural reforms started by his predecessors. The most important successes have been reform of the labour market, which has restored Greece’s competiveness, and the achievement last year of a “primary” budgetary surplus before interest payments.

Color me suspicious.  Both the media and investors fall for this kind of thing all the time -- the dead cat bounce masquerading as a structural improvement.  I hope like hell Greece has gotten its act together, but I would not bet my own money on it.

In that same article, I expressed myself skeptical that the Greeks had done anything long-term meaningful in their labor markets.  They "reformed" their labor markets in the same way the Obama administration "reformed" the VA -- a lot of impressive statements about the need for change, a few press releases and a few promised but forgotten reforms.  At the time, the Left wanted desperately to believe that countries could continue to take on near-infinite amounts of debt with no consequences, and so desperately wanted to believe Greece was OK.

I have said it for four years:  There are only two choices here:  1.  The rest of Europe essentially pays off Greek debt for it or 2.  Greece leaves the Euro.  And since it is likely Greece will get itself into the same hole again some time in the future if #1 is pursued, there is really only leaving the Euro.  The latter will be a mess, with rampant inflation in Greece and destruction savings, but essentially the savings have already been destroyed by irresponsible government borrowing and bank bail-ins.  At least the falling value of Greek currency would make it an attractive place at for tourism if not investment and Greece could start rebuilding its economy on some sort of foundation.  Instead of bailing out banks and Greek officials, Germany should let it all fall apart and spend its money on helping Greece to pick up the pieces.

By letting Greece join the Euro, the Germans essentially let their irresponsible country cousins use their American Express Platinum card, and the Greeks went on a bender with the card.   The Germans can't keep paying the bill -- at some point you have to take the card away.

Keynesian Moving Target on What Constitutes Austerity

The other day I said I was confused by what exactly creates Keynesian stimulus, and in reverse, what constitutes austerity.  I had thought that it was deficit spending that creates the stimulus, but then sometimes it seems to just be spending and in the case of the Kevin Drum post I was discussing, he says it is not the level of spending but only the first derivative of per capita real government spending (with no reference to whether it is debt or tax funded) that matters.

I figured that I was just confused because I had not formally studied economics past my undergrad years, but apparently practicing economists are also confused.  Here is Scott Sumner:

What is the proper measure of austerity?  The textbooks talk about deficits.  But most of the Keynesian bloggers focus on government purchases.  So which is it?  And if it’s purchases, why did these same bloggers claim that austerity would result from big tax increases in the US in 2013, and a big tax increase in Japan in 2014?  And why does the measure chosen (ex post) usually seem to be the one that best supports their argument in that particular case?

As a postscript, I will add that every climate skeptic can totally empathize with this Sumner concern:

A number of Keynesian bloggers have recently expressed dismay that the rest of us don’t buy their model.  Maybe it would help if they’d stop ignoring our criticisms of their model, and respond to our complaints.

Explaining the Financial Crisis: Government Creation of a Financial Investment Mono-culture

Arnold Kling on the recent financial crisis:

1. The facts are that one can just as easily blame the financial crash on an attempted tightening of regulation. That is, in the process of trying to rein in bank risk-taking by adopting risk-based capital regulations, regulators gave preference to highly-rated mortgage-backed securities, which in turn led to the manufacturing of such securities out of sub-prime loans.

2. The global imbalances that many of us thought were a bigger risk factor than the housing bubble did not in fact blow up the way that we thought that they would. The housing bubble blew up instead.

What he is referring to is a redefinition by governments in the Basel accords of how capital levels at banks should be calculated when determining capital sufficiency.  I will oversimplify here, but basically it categorized some assets as "safe" and some as "risky".  Those that were risky had their value cut in half for purposes of capital calculations, while those that were "safe" had their value counted at 100%.  So if a bank invested a million dollars in safe assets, that would count as a million dollar towards its capital requirements, but would count only $500,000 towards those requirements if it were invested in risky assets.  As a result, a bank that needed a billion dollars in capital would need a billion of safe assets or two billion of risky assets.

Well, this obviously created a strong incentive for banks to invest in assets deemed by the government as "safe".  Which of course was the whole point -- if we are going to have taxpayer-backed deposit insurance and bank bailouts, the prices of that is getting into banks' shorts about the risks they are taking with their investments.  This is the attempted tightening of regulation to which Kling refers.  Regulators were trying for tougher, not weaker standards.

But any libertarian could tell you the problem that is coming here -- the regulatory effort was substituting the risk judgement of thousands or millions of people (individual bank and financial investors) for the risk judgement of a few regulators.  There is no guarantee, in fact no reason to believe, the judgement of these regulators is any better than the judgement of the banks.  Their incentives might be different, but there is also not any guarantee the regulators' incentives are better (the notion they are driven by the "public good" is a cozy myth that never actually occurs in reality).

Anyway, what assets did the regulators choose as "safe"?  Again, we will simplify, but basically sovereign debt and mortgages (including the least risky tranches of mortgage-backed debt).  So you are a bank president in this new regime.  You only have enough capital to meet government requirements if you get 100% credit for your investments, so it must be invested in "safe" assets.  What do you tell your investment staff?  You tell them to go invest the money in the "safe" asset that has the highest return.

And for most banks, this was mortgage-backed securities.  So, using the word Brad DeLong applied to deregulation, there was an "orgy" of buying of mortgage-backed securities.  There was simply enormous demand.  You hear stories about fraud and people cooking up all kinds of crazy mortgage products and trying to shove as many people as possible into mortgages, and here is one reason -- banks needed these things.  For the average investor, most of us stayed out.   In the 1980's, mortgage-backed securities were a pretty good investment for individuals looking for a bit more yield, but these changing regulations meant that banks needed these things, so the prices got bid up (and thus yields bid down) until they only made sense for the financial institutions that had to have them.

It was like suddenly passing a law saying that the only food people on government assistance could buy with their food stamps was oranges and orange derivatives (e.g. orange juice).  Grocery stores would instantly be out of oranges and orange juice.  People around the world would be scrambling to find ways to get more oranges to market.  Fortunes would be made by clever people who could find more oranges.  Fraud would likely occur as people watered down their orange derivatives or slipped in some Tang.  Those of us not on government assistance would stay away from oranges and eat other things, since oranges were now incredibly expensive and would only be bought at their current prices by folks forced to do so.  Eventually, things would settle down as everyone who could do so started to grow oranges. And all would be fine again, that is until there was a bad freeze and the orange crop failed.

Government regulation -- completely well-intentioned -- had created a mono-culture.  The diversity of investment choices that might be present when every bank was making its own asset risk decisions was replaced by a regime where just a few regulators picked and chose the assets.  And like any biological mono-culture, the ecosystem might be stronger for a while if those choices were good ones, but it made the whole system vulnerable to anything that might undermine mortgages.  When the housing market got sick (and as Kling says government regulation had some blame there as well), the system was suddenly incredibly vulnerable because it was over-invested in this one type of asset.  The US banking industry was a mono-culture through which a new disease ravaged the population.

Postscript:  So with this experience in hand, banks moved out of mortage-backed securities and into the last "safe" asset, sovereign debt.  And again, bank presidents told their folks to get the best possible yield in "safe" assets.  So banks loaded up on sovereign debt, in particular increasing the demand for higher-yield debt from places like, say, Greece.  Which helps to explain why the market still keeps buying up PIIGS debt when any rational person would consider these countries close to default.  So these countries continue their deficit spending without any market check, because financial institutions keep buying this stuff because it is all they can buy.  Which is where we are today, with a new monoculture of government debt, which government officials swear is the last "safe" asset.  Stay tuned....

Postscript #2:  Every failure and crisis does not have to be due to fraud and/or gross negligence.  Certainly we had fraud and gross negligence, both by private and public parties.  But I am reminded of a quote which I use all the time but to this day I still do not know if it is real.  In the great mini-series "From the Earth to the Moon", the actor playing astronaut Frank Borman says to a Congressional investigation, vis a vis the fatal Apollo 1 fire, that it was "a failure of imagination."  Engineers hadn't even considered the possibility of this kind of failure on the ground.

In the same way, for all the regulatory and private foibles associated with the 2008/9 financial crisis, there was also a failure of imagination.  There were people who thought housing was a bubble.  There were people who thought financial institutions were taking too much risk.  There were people who thought mortgage lending standards were too lax.  But with few exceptions, nobody from progressive Marxists to libertarian anarcho-capitalists, from regulators to bank risk managers, really believed there was substantial risk in the AAA tranches of mortgage securities.  Hopefully we know better now but I doubt it.

Update#1:  The LA Times attributes "failure of imagination" as a real quote from Borman.  Good, I love that quote.  When I was an engineer investigating actual failures of various sorts (in an oil refinery), the vast majority were human errors in procedure or the result of doing things unsafely that we really knew in advance to be unsafe.  But the biggest fire we had when I was there was truly a failure of imagination.  I won't go into it, but it resulted from a metallurgical failure that in turn resulted form a set of conditions that we never dreamed could have existed.

By the way, this is really off topic, but the current state of tort law has really killed quality safety discussion in companies of just this sort of thing.  Every company should be asking itself all the time, "is this unsafe?"  or "under what conditions might this be unsafe" or "what might happen if..."   Unfortunately, honest discussions of possible safety issues often end up as plaintiff's evidence in trials.  The attorney will say "the company KNEW it was unsafe and didn't do anything about it", often distorting what are honest and healthy internal discussions on safety that we should want occurring into evidence of evil malfeasance.  So companies now show employees videos like one I remember called, I kid you not, "don't write it down."

Bubble Prices are not Wealth

Conservative sites are running with this story:

OBAMANOMICS IN ACTION: Typical US Household Worth One-Third Less Than Under Bush

Seriously?  The bursting of the housing bubble, which actually began under Bush, is Obama's fault?  Because that is what likely drove middle class household worth down (while the Fed-sponsored asset boom in financial instruments drove up wealth of the top 1%).  I suppose one could say that the Republicans sponsored a bubble that helped the middle class while Obama is sponsoring a bubble that helps the wealthy.

I won't say this stuff is meaningless to the economy, because clearly they affect people's perception of wealth and thus spending and optimism.  But sound long-term economic growth has got to come from stable and rational monetary policy that allows interest rates and financial assets to find their correct level.  Getting political mileage out of bubble pricing of assets only creates incentives for politicians such that they will never stop fiddling with interest rates and credit.

When Regulation Makes Things Worse -- Banking Edition

One of the factors in the financial crisis of 2007-2009 that is mentioned too infrequently is the role of banking capital sufficiency standards and exactly how they were written.   Folks have said that capital requirements were somehow deregulated or reduced.  But in fact the intention had been to tighten them with the Basil II standards and US equivalents.  The problem was not some notional deregulation, but in exactly how the regulation was written.

In effect, capital sufficiency standards declared that mortgage-backed securities and government bonds were "risk-free" in the sense that they were counted 100% of their book value in assessing capital sufficiency.  Most other sorts of financial instruments and assets had to be discounted in making these calculations.  This created a land rush by banks for mortgage-backed securities, since they tended to have better returns than government bonds and still counted as 100% safe.

Without the regulation, one might imagine  banks to have a risk-reward tradeoff in a portfolio of more and less risky assets.  But the capital standards created a new decision rule:  find the highest returning assets that could still count for 100%.  They also helped create what in biology we might call a mono-culture.  One might expect banks to have varied investment choices and favorites, such that a problem in one class of asset would affect some but not all banks.  Regulations helped create a mono-culture where all banks had essentially the same portfolio stuffed with the same one or two types of assets.  When just one class of asset sank, the whole industry went into the tank,

Well, we found out that mortgage-backed securities were not in fact risk-free, and many banks and other financial institutions found they had a huge hole blown in their capital.  So, not surprisingly, banks then rushed into government bonds as the last "risk-free" investment that counted 100% towards their capital sufficiency.  But again the standard was flawed, since every government bond, whether from Crete or the US, were considered risk-free.  So banks rushed into bonds of some of the more marginal countries, again since these paid a higher return than the bigger country bonds.  And yet again we got a disaster, as Greek bonds imploded and the value of many other countries' bonds (Spain, Portugal, Italy) were questioned.

So now banking regulators may finally be coming to the conclusion that a) there is no such thing as a risk free asset and b) it is impossible to give a blanket risk grade to an entire class of assets.  Regulators are pushing to discount at least some government securities in capital calculations.

This will be a most interesting discussion, and I doubt that these rules will ever pass.  Why?  Because the governments involved have a conflict of interest here.  No government is going to quietly accept a designation that its bonds are risky while its neighbor's are healthy.  In addition, many governments (Spain is a good example) absolutely rely on their country's banks as the main buyer of their bonds.  Without Spanish bank buying, the Spanish government would be in a world of hurt placing its debt.  There is no way it can countenance rules that might in any way shift bank asset purchases away from its government bonds.

Root Cause

Arnold Kling argues that the root cause of mortgage and student debt problems is not the structure of mortgage and student debt contracts

What these forms of bad debt have in common, in my view, is that they reflect clumsy social engineering. Public policy was based on the idea that getting as many people into home “ownership” with as little money down as possible was a great idea. It was based on the idea of getting as many people into college with student loans as possible.

The problem, therefore, is not that debt contracts are too rigid. The problem is that the social engineers are trying to make too many people into home “owners” and to send too many people to college. Home ownership is meaningful only when people put equity into the homes that they purchase. College is meaningful only if students graduate and do so having learned something (or a least enjoyed the party, but not with taxpayers footing the bill).

Everything Looks Like a Nail When You Have A Hammer

Kevin Drum quotes Hugo Dixon on the Greek recovery:

Greece is undergoing an astonishing financial rebound. Two years ago, the country looked like it was set for a messy default and exit from the euro. Now it is on the verge of returning to the bond market with the issue of 2 billion euros of five-year paper.

There are still political risks, and the real economy is only now starting to turn. But the financial recovery is impressive. The 10-year bond yield, which hit 30 percent after the debt restructuring of two years ago, is now 6.2 percent....The changed mood in the markets is mainly down to external factors: the European Central Bank’s promise to “do whatever it takes” to save the euro two years ago; and the more recent end of investors’ love affair with emerging markets, meaning the liquidity sloshing around the global economy has been hunting for bargains in other places such as Greece.

That said, the centre-right government of Antonis Samaras has surprised observers at home and abroad by its ability to continue with the fiscal and structural reforms started by his predecessors. The most important successes have been reform of the labour market, which has restored Greece’s competiveness, and the achievement last year of a “primary” budgetary surplus before interest payments.

Color me suspicious.  Both the media and investors fall for this kind of thing all the time -- the dead cat bounce masquerading as a structural improvement.  I hope like hell Greece has gotten its act together, but I would not bet my own money on it.

Anyway, that is a bit beside the point.  I found Drum's conclusion from all this odd:

If this keeps up—and that's still a big if—it also might be a lesson in the virtue of kicking the can down the road. Back in 2012, lots of commenters, including me, believed that the eurozone had deep structural problems that couldn't be solved by running fire drills every six months or so and then hoping against hope that things would get better. But maybe they will! This probably still wasn't the best way of forging a recovery of the eurozone, but so far, it seems to have worked at least a little better than the pessimists imagined. Maybe sometimes kicking the can is a good idea after all.

For those that are not frequent readers of his, I need to tell you that one of the themes he has been pounding on of late is that the US should not be worried about either its debt levels or inflation -- attempting to rebut the most obvious critiques of his strong support for more deficit spending and monetary stimulus.

I would have thought the obvious moral of this story was that austerity and dismantling all sorts of progressive labor market claptrap led to a recovery far faster than expected**.  But since Drum opposes all those steps, his  conclusion seems to be simply a return to his frequent theme that debt is A-OK and we shouldn't be worried about addressing it any time soon.

** I don't believe for a moment that Greece has really changed the worst of its structural labor market, regulatory,  and taxation issues.  This story gets written all the time about countries like, say, Argentina.  Sustained incompetence is not really newsworthy, which is likely one reason we get so few African stories.  They would all be like "Nigeria still a mess."  A false recovery story gives the media two story cycles, one for the false recovery and one for the inevitable sinking back into the pit.

Media Accountability -- When The Arizona Republic Tried to Get Scottsdale To Bankrupt Itself

Three cheers for Greg Patterson holding the media accountable for their past support of costly corporate welfare.

You may have seen the recent Wall Street Journal Story about the financial fiasco that is Glendale Arizona.

Here's the Republic's take on it. 

Glendale ranked second in the U.S., according to the story, thanks to a $26.6 million negative fund balance at the close of fiscal 2012, due largely to sports-related debt.

Glendale has made a lot of mistakes, but I think that there is near universal agreement that the critical error was their decision to build the hockey arena.

Yep.  I have written about the egregious hockey deals that have bankrupted Glendale on several occasions.  George Will even quoted me on the topic.

Greg Patterson went back and looked at what the Arizona Republic was writing before the Glendale deals went so noticeably bad.  I have written before about how the media goes into full cheerleader mode on those crony stadium deals.

Before Glendale bankrupted itself to subsidize the hockey team, Scottsdale was offered the "opportunity" to do so and turned it down.  The local paper Arizona Republic excoriated Scottsdale for passing on the chance to subsidize rich sports team owners, saying that "Once-in-a-lifetime projects are just that".  Here is the best quote from the 2004 Republic editorial:

Our view is that Scottsdale's mishandling of the arena idea was a leadership blunder of biblical proportions. Enough with the blame game. We hope that Scottsdale at least has learned some tough lessons from the disaster.

And this is classic:

Some city officials seemed content to nitpick, complain, second-guess and haggle over details. They're right to be diligent. Certainly nobody endorses a Pollyanna-ish panel of rubber-stampers. But at the same time, people who are forever looking for stuff to complain about always seem to find it.

I bet Glendale wishes it had more second-guessers on its city council.  The whole thing is worth reading.

Postscript:  This is one recommendation from the Republic I can agree with:

Think twice about ever launching a redevelopment effort like this again. Sensing that the Los Arcos Mall area was hurting economically, the council formed the Los Arcos Redevelopment District in December 1995. The council adopted a redevelopment plan the following July, and the Ellman Cos. subsequently acquired the 42-acre site. Not too surprisingly, Ellman was the only one to answer the city's request for proposals.

Ellman owns the Los Arcos property. That gives him a lot of advantages, including a position of negotiating authority. It allows him to stoke political outrage by wearing down the patience of neighbors who would like to see something built on this key corner. Got a great idea about what should be done at Los Arcos? Too bad. Ellman still owns it. Condemnation is not a viable political or financial course for the city, and Ellman knows it.

Redevelopment almost always means "crony giveaway" nowadays.

KlearGear Sucks

I don't have a lot to add about this story.  A company called KlearGear trying to fine customers for writing a bad review about it (based on some BS prior restraint on criticism buried in their terms and conditions) and then hounding the customers' credit rating through debt collection agencies.  But I am all for the Streisand effect bringing karmic retribution to such folks, so here is my contribution to Google.

By the way, I found their current header warning to be odd:

notice-tues

Anyone ever heard of a "business hour" before?  Since most customers would not really freak at a 48 hour or 2-day order processing time, anyone want to bet that this means 6 business days (6x8 hours) or over a week, but is meant to fool folks into thinking only two days?  I would ask them directly but there is no way to send them an email without registering first as a customer.  Since by registering, I apparently cede my ability to ever criticize them, I won't be able to write them for clarification.

Our business gets mostly positive reviews, but we get bad ones from time to time.  Every bad review is both a pain in the butt (as they hang around forever on the Internet) but also an opportunity for me to learn and identify problems in the business.  On a couple of occasions I have identified personnel problems through online reviews that let me fix a real problem before something much worse happened.

Update:  The bottom of their home page says "As seen on ABC's Good Morning America".  Yup.  LOL

 

My Corporate Tax Plan

Some folks on the Left are starting to question the corporate income tax, recognizing what economists have known for years, that a lot of the tax is paid by consumers, making it more regressive than just (say) punishing Exxon for being large and productive.

There are many other reasons to hate the corporate income tax

  • It does not raise very much money
  • Its administrative costs (think corporate tax attorneys) is very high
  • It is hugely distortive.  The tax preference for debt over equity helped drive the LBO boom, for example
  • It is the font of much corporate welfare and cronyism.  A LOT of political paybacks get made within the corporate tax system

So here is my simply two-point plan

  1. Eliminate the corporate income tax.  Entirely
  2. Tax dividends and capital gains as regular income on individual tax returns

Done.  All corporate profits get taxed but only when they pass through to individuals as capital gains or dividends.  I think this would actually raise more money but rates could be adjusted (or better yet deductions eliminated) if needs to keep it neutral.

I believe the economic benefits of this would be immediate and substantial.

Of course, corporate tax attorneys are rich and powerful and would cut their throats to stop this.  It would be enormously entertaining to see them try, and in turn see what the reaction of their clients was to this.

 

Nearly Two Centuries of Borrowing in One Day

It took into the mid-1960's for the Federal government to accumulate $328 billion in debt (yeah, I know, nominal dollars).  It rose that much in one day last week.

Trading $1 in Debt for 85 cents of Economic Activity

UPDATE:  Mea culpa.  One point in the original post was dead wrong.  It is possible, contrary to what I wrote below, to get something like a 0.7%  difference in annual growth rates with the assumptions he has in the chart below (Drum still exaggerated when he called it 1%).  I don't know if the model is valid (I have little faith in any macro models) but I was wrong on this claim.  Using the 0.7% and working more carefully by quarter we get a cumulative GDP addition a bit lower than the cumulative debt addition.  There is still obviously a reasonable question even at a multiplier near 1 whether $1 of economic activity today is worth $1 of debt repayment plus interest in the future.  

I am not a believer, obviously, in cyclical tweaking of the economy by the Feds.  To my thinking, the last recession was caused by a massive government-driven mis-allocation of capital so further heavy-handed government allocation of capital seems like a poor solution.  But what really drives me crazy is that most folks on the Left will seductively argue that now is not the time to reduce debt levels, implying sometime in the future when the economy is better will be the appropriate time.  But when, in any expansion, have you heard anyone on the Left say, "hey, its time to reduce spending and cut debt because we need the fiscal flexibility next time the economy goes wrong."

I will leave the stuff in error below in the post because I don't think it is right to disappear mistakes.  For transparency, my spreadsheet reconstruction both confirming the 0.7% and with the updated numbers below is here:   reconstruction.xls.

 

Kevin Drum is flogging the austerity horse again

I see that Macroecomic Advisors has produced a comprehensive estimate of the total effect of bad fiscal policies. Their conclusion: austerity policies since the start of 2011 have cut GDP growth by about 1 percentage point per year.

Something seemed odd to me -- when I opened up the linked study, it said the "lost" government discretionary spending is about 2% of GDP.  Is Drum really arguing that we should be spending 2% of GDP to increase GDP by 1%?

Of course, the math does not work quite this way given compounding and such, but it did cause me to check things out.  The first thing I learned is that Drum partook of some creative rounding.  The study actually said reductions in discretionary spending as a percent of GDP reduced GDP growth rates since the beginning of 2011 by 0.7% a year, not 1% (the study does mention a 1% number but this includes other effects as well).

But it is weirder than that, because here is the chart in the study that is supposed to support the 0.7% number:

click to enlarge

Note that in the quarterly data, only 2 quarters appear to show a 0.7% difference and all the others are less.  I understand that compounding can do weird things, but how can the string of numbers represented by the green bars net to 0.7%?  What it looks like they did is just read off the last bar, which would be appropriate if they were doing some sort of cumulative model, but that is not how the chart is built.  If we interpolate actual values and are relatively careful about getting the compounding right, the difference is actually about 0.45%.  So now we are down to less than half the number Drum quoted see update above (I sent an email to the study author for clarification but have not heard back.  Update:  he was nice enough to send me a quick email).

So let's accept this 0.45% 0.7% number for a moment.  If GDP started somewhere around 16 trillion in 2010, if we apply a 0.45% the quarterly growth numbers from his chart, we get an incremental economic activity from 2011 through 2013:Q2 of about $333 billion.

So now look at the spending side.  The source says that discretionary spending fell by about 2% of GDP over this period.  From the graph above, it seems to bite pretty early, but we will assume it fell 1/12 of this 2% figure each quarter, so that by the end of 2013 or beginning of 2014 we get a fall in spending by 2% of GDP.  Cumulatively, this would be a reduction in spending over the 2.5 years vs. some "non-austere" benchmark of $388 billion.

Thus, in exchange for running up $677 billion $388 billion in additional debt, we would have had $445 billion $333 billion in incremental economic activity.  A couple of reactions:

  1. Having the government borrow money and spend it definitely increases near-term GDP.  No one disputes that.  It is not even in question.  Those of us who favor reigning in government spending acknowledge this.  The question is, at what cost in terms of future obligations.  In fact, this very study Drum is quoting says

    Economists agree that failure to shrink prospective deficits and debt will bestow significant economic consequences and risks on future generations. Federal deficits drive up interest rates, “crowding out” private investment. If government borrowing supports consumption (e.g., through Social Security and major health programs) rather than public investment, the nation’s overall capital stock declines, undermining our standard of living. The process is slow but the eventual impact is large.2 In addition, accumulating debt raises the risk of a fiscal crisis. No one can say when this might occur but, unlike crowding out, a debt crisis could develop unexpectedly once debt reached high levels.

    High deficits and debt also undermine the efficacy of macroeconomic policies and reduce policymakers’ flexibility to respond to unexpected events. For example, in a recession, it would be harder to provide fiscal stimulus if deficits and debt already were high. Furthermore, fiscal stimulus might be less effective then. Additional deficit spending could be seen as pushing the nation closer to crisis, thereby forcing up interest rates and undercutting the effects of the stimulus. With fiscal policy hamstrung, the burden of counter-cyclical policy is thrust on the Federal Open Market Committee (FOMC) but, particularly in a low interest-rate environment, the FOMC may be unable (or unwilling) to provide additional monetary
    stimulus.

  2. I guess we have pretty much given up on the >1 multiplier, huh?  Beggaring our children for incremental economic growth today is a risky enough strategy, but particularly so with the implied .66 .85 multiplier here.

This is not the first time Drum has taken, uh, creative data approaches to cry "austerity" during a mad spending spree.