Thursday, September 30, 2010

Then? "Balanced Budgets." Now? Austerity!

If your finger is bleeding, cut it off.

If the stump is bleeding, cut off your hand.

If your wrist is bleeding, cut off the arm.

If the economy is bleeding, maybe we need some doctoring that is a little more thought out than just cutting everything in sight.

"The Hour Is Getting Late"

How is it that the world's greatest nation, the world's richest nation, can become in a generation the world's biggest debtor? How can it be we cannot even afford health care? How can it be we don't make our own stuff anymore?

I know there are stories and explanations and excuses that try to answer those questions. I don't care. I'm asking if it makes sense. And I'm saying it does not. There are problems in America, serious problems, that have yet to be acknowledged. Simple problems that have grown serious through neglect.

No... Not neglect. The simple problems have grown serious because we misunderstand the problem, and our solutions make things worse.

The Yin-Yang Effect

When you go to the bank and borrow a dollar, a dollar of new money is created, and a counterbalancing dollar of new debt is created.

A dollar of money is a dollar with no strings attached. But a dollar of credit exists as a dollar of money along with a dollar of counterbalancing debt.

That is just a way of looking at things, a way that I find useful.


I don't read anywhere near enough Keen.

Focusing on the good bit, one reason we got into this predicament in the first place was because private sector, debt-based money swamped public sector, fiat money. Ultimately we need to return to the public-private money balance we had in the 1950s and early 1960s.

YES: Monetary imbalance is the problem.

So why aren’t we “Back To The Future” already? Why isn’t the economy booming once more, and why is inflation giving way to deflation?

Because, though the money supply is back to where it was in 1960, the debt to money ratio is utterly different. Even after Ben’s Helicopter Drop, the debt to base money ratio is almost twice what it was in 1960, and over 3 times what it was back in the Golden Days of the 1950s.

YES: Debt per Dollar is the problem. (It is the same problem as monetary imbalance.)

I should add that things are not as good as Keen suggests. He says, "the debt to base money ratio is almost twice what it was in 1960..." But that is debt relative to base money. The ratio is still far from 2 to 1 if you look at M1 money. People don't spend base money.

I’ll focus on the obvious message from the above chart: if the government simply pumps its money into the system without restraining the financial system from financing speculation on asset markets, the best we can hope for is a repeat of this crisis, on an even larger scale, some years down the track.

YES: We must not only increase the quantity of money, but also decrease the reliance on credit.

Wednesday, September 29, 2010


Suppose economists recognized the benefits of credit use but for some reason failed to observe the harmful aspects of credit use. What would be the likely outcome?

Likely we would use a lot of credit.

And suppose it went on for many years, economists and policymakers acknowledging the benefits of credit use but failing to recognize the harmful aspects. What would be the likely outcome?

Likely, we would come to rely excessively on credit.

And just suppose that economic growth was inadequate, and one of the recognized benefits of credit use was its "growth-boosting potential." What would be the likely outcome of that?

Likely we would rely even more excessively on credit.

And suppose it so happened that the economy continued to deteriorate, and the underlying reason for inadequate growth was the excessive reliance on credit. What would be the likely outcome?

Likely, economists and policymakers would continue to strengthen and expand the policies that they thought most likely to improve growth: They would continue to rely ever more heavily on credit. Likely, they would be unable to solve the growth problem. Likely, the problem would endure.

I'll try again

Krugman of 29 September, quoting Adam Posen:

We will only know we will have done enough with QE [quantitative easing] or other monetary stimulus when we have clear indications that our policies are moving the desired variables — market interest rates, wages, output, employment, and inflation expectations — sufficiently and in the right directions on a sustained basis.

In other words, the central bank will (or should) continue increasing the quantity of base money until the quantity of M1 money starts to climb.

By that time, buddy, it's gonna be too late.

If you want to increase M1, then increase M1 instead of messing around with base money. If you're gonna print a trillion, then use it to pay off a trillion dollars of existing debt, so that the people who owe that debt don't have to subtract a trillion from M1 by paying it off, themselves.

Does that make any sense at all?

The Cost that Crippled Growth

Paul Krugman of 26 September:

I have no problem in principle with the idea that shifts in the economy can temporarily lead to a large rise in the “natural” rate of unemployment. Let me offer a case in point: it was quite clear, circa 1990, that Britain was no longer capable of running unemployment rates as low as those of the 1960s and early 1970s.

But how did we know this? First, through experience: the Lawson boom of the late 1980s never brought unemployment below 7 percent, yet it was accompanied by a sharp rise in inflation. Clearly, the economy was hitting speed limits even at relatively high unemployment by previous standards.

Clearly it was.

I don't know why this Krugman post fascinates me. Why it bothers me. Clearly it does.

I think it's this: It's just matter-of-fact. There were "shifts in the economy," and then POOF!! -- the "natural" rate of unemployment had changed.

And then when Krugman explains it, he doesn't explain it. He only says it again, in that second paragraph. He offers no explanation.

An explanation would go something like this: During the so-called "golden age of post-war capitalism," increasing credit-use propelled economic growth. But increasing credit-use also propelled the accumulation of debt.

At some point -- specifically, 1973 -- the cost of that accumulating debt suddenly took precedence over the animal spirits that had been driving growth. Thus ended the golden age.

Since that time, economists and policymakers have done all in their power to restore credit-use to a level that would again drive golden-age growth. They tried everything. Everything except reducing the accumulation of debt.

They failed to reduce the cost that crippled growth. So the economy has never again achieved the kind of growth it achieved in the good years.

A Simpler Game Plan

Last I looked, Bernanke had about doubled the monetary base. Now I see he has about tripled it. This is not good. It must not continue. Why? Because it is not working. They are laying the groundwork for an inflation that, when it does come, will be devastating.

The Fed dramatically increases the monetary base by its actions. Those actions are being repeated, indicating that deflation continues to be a threat. The deflation comes from people paying down debt, which takes money out of circulation. Paying down debt reduces M1 money, regardless of the tripling of the monetary base.

So I had a thought. The Fed already bought all this debt, instead of paying it off. And the debt still exists and is still a drag on the economy. So the solution, the simpler game plan, is for the Fed to run that debt through the shredder.

That's probably even legal. The Fed may not be permitted by law to pay off debt for people. But if it is debt they already own, debt they already bought up, they can shred the documents and make the debt go away.

A dumb idea? Maybe so. But it would be the smartest dumb thing the Fed ever did.

Tuesday, September 28, 2010

Rinse and Repeat

Krugman of 25 September:

I think it’s fair to say that a majority of economists believe that excessive private debt played a key role in getting us into this economic mess, and is playing a key role in preventing us from getting out.

Q: What's that?

A: Private debt.

Q: huh?

A: Private debt

Q: What??

A:  Private debt is the problem.

There, I've Said It Again

Krugman of 25 September:

I think it’s fair to say that a majority of economists believe that excessive private debt played a key role in getting us into this economic mess, and is playing a key role in preventing us from getting out. So, how does it end?

In the end, I’d argue, what must happen is an effective default on a significant part of debt, one way or another.

Or, we could just print money and use it to pay off debt.

Hero Worship


In the "Hero Worship" episode of Star Trek: Next Generation, Picard brings the Enterprise into a black cluster to track down a missing ship, the Vico. As they enter the cluster, gravity waves threaten. Enterprise raises shields for protection from the waves. As they travel deeper into the cluster, the waves grow stronger and more threatening. Again and again, Enterprise increases power to the shields. Ultimately, Geordi diverts power to the shields from the warp drive, the ship's greatest source of power.

But the next approaching wave is stronger yet. The crew fears all is lost. The captain braces for impact. At that moment Mr. Data discovers that the shields have been causing the gravity waves. He tells Captain Picard to shut down the shields. With no time for argument or discussion, Picard chooses to trust Data's judgement and orders the shields down. Seconds from impact, the wave dissipates. Enterprise and her crew survive.

Sometimes you have to stop doing the thing that was always the right thing to do. In that episode of Star Trek, the gravity waves grew stronger as Enterprise traveled deeper into the cluster. It appeared that the gravity waves grew stronger because Enterprise traveled deeper into the cluster. But as Mr. Data discovered, that was not the case.

When you have a standard procedure that you use to solve a problem, it can be very difficult to believe that your procedure is the cause of the problem. On Enterprise, they always raise shields to protect the ship. This time, inside the black cluster, standard procedure was the cause of the problem.

For economists, politicians, and policy-makers today, the standard procedure is to apply monetary policy to the inflation problem, and tax policy to the growth problem. But we have traveled in this direction for so long that we have come to a different environment, a sort of black cluster where standard procedure only makes matters worse.

To save Enterprise, we need to drop the shields. We need to stop using monetary policy to fix the inflation problem, and stop using tax policy to fix the growth problem. My advice to the Captain? Use tax policy to fix the inflation problem, and monetary policy to fix the growth problem. At least until we're out of this cluster.

Monday, September 27, 2010

Money from Nothing

It's not really from nothing.

If the money was from nothing, we wouldn't have a "fractional reserve" system.

The money is from a little bit of "starter" money. Sort of like taking a few loaves and fishes, and feeding a whole big crowd.

Power and Money

The Federal Reserve issues money into the economy and withdraws money from the economy. So do you. When you borrow money and spend it, you take money that is not circulating, and circulate it. When you pay down a debt, you take money that is circulating, and put it back into cold storage.

It costs us money to do that. It costs the Fed power when we do it.

The higher the level of private-sector savings, the bigger the pool of loanable funds. This pool of funds competes with the Federal Reserve as an issuer of money. The bigger the pool, the more it can interfere with the Fed's plans.

Monetary policy has become less effective against inflation because the pool of loanable funds has grown large.

It is no coincidence that our word "investment" also has a military meaning.

Sunday, September 26, 2010

"First Principles"

From A special report on debt: Repent at leisure, The Economist, 24 Jun 2010

To understand why debt may have become a burden rather than a boon, it is necessary to go back to first principles. Why do people, companies and countries borrow?

Why do people do anything??? For profit or for personal satisfaction, according to an old tax document I read. (If they do it for profit, they use a business tax form. If they do it for personal satisfaction, they use an individual tax form. Cut'n'dry.)

But why do we borrow this much instead of this much? Depends who ya ask, I guess. But I say: Because of policy.

Policymakers got it wrong. They thought too much money would cause inflation but too much credit-use wouldn't. So they restricted the money we spend, and encouraged us to save and borrow. These encouragements are embedded in policy.

If we borrowed too much, it is because of policy. If we didn't save enough, it's because we didn't have money to save because they restricted it. If we had inflation, it was because we spent too much credit-money, not too much M1 money. If we accumulated too much debt, it is because policy allowed and encouraged that behavior.

The way the world is today, is the result of policy. Bad policy.

Why do we borrow so much? Because of policy.

Saturday, September 25, 2010

Even Martin Wolf

Blended Purple links to Martin Wolf on supply-side economics. Wolf is one of the best and brightest. But this time he wanders into political muck:

My reading of contemporary Republican thinking is that there is no chance of any attempt to arrest adverse long-term fiscal trends should they return to power. Moreover, since the Republicans have no interest in doing anything sensible, the Democrats will gain nothing from trying to do much either. That is the lesson Democrats have to draw from the Clinton era’s successful frugality, which merely gave George W. Bush the opportunity to make massive (irresponsible and unsustainable) tax cuts. In practice, then, nothing will be done.

He's trying to deal with economic issues, but it sounds like he has political favorites. Tough to separate the one from the other.

Let me reduce Wolf's paragraph to its economic essence if I can: We saw "successful frugality" in the 1990s. (That's all there is, with politics and prediction removed.)

We balanced the federal budget -- briefly -- in the 1990s. That's what Wolf means by the phrase "successful frugality."

We cut spending enough to balance the budget. There's the frugality. (We also had tax hikes mixed in with frugal spending, as I remember. But let that go.)

And this frugality was "successful" because the budget actually got balanced. Okay?

So, what all this means is simple: Martin Wolf, like everybody else, thinks it necessary for the federal government to be frugal enough to balance its budget.

More simply: Even Martin Wolf thinks spending is the cause of debt.

But even Martin Wolf is wrong about this. Debt is not created by spending. Debt is only created by the use of credit.

Friday, September 24, 2010

Judging a Book by its Cover

So the wife signed up for some work-related schooling. One of the books she got is Winning the Cost War by Dale R. Geiger. Cover price $14.95 (between seven and 8 times the price of the Marc Bloch book from yesterday's post).

Even without opening the book, I wanted to base a post on its title.

First, the obvious: Of course it is necessary to pinch pennies and cut corners and otherwise alliterate, doing everything we can to stretch a dollar and make ends meet. It is necessary to cope with the cost problem. Not even I would deny it.


The cost problem is not the problem. The cost problem is a result of the problem. I don't want to cope with the cost problem. I'm tired of coping with the cost problem. I want to fix the underlying problem, and make the cost problem go away.

See where I'm coming from? I was trying to make the same point in my review of professor Mark C. Taylor's ideas here. Coping with a problem is not the same as solving the problem. Coping with a problem is fiddling while Rome burns.

The underlying problem is getting worse. Look: Everybody thinks they know we just have to balance the federal budget and that will solve the problem. And then they go off on a tangent about personalities and corruption and dishonesty and character.

But if the problem is economic, then the solution must also be economic.

The federal debt and deficit are the least of our debt problems. But set that aside, I don't care. Here is the simple fact: Debt is not the result of excessive spending... Debt is the result of credit use.

Now you're gonna say I want to increase government spending. Wrong: I don't care about the level of government spending. That's all politics, far as I'm concerned. If you want to have smaller government, that's fine with me. I don't care. But making the government smaller is not gonna solve the economic problem.

We have to solve the economic problem, the problem that creates all this debt. And separately, we can have whatever size government you want. Actually, the people who want bigger government will have no leg to stand on, after we fix the economy.

Why do we have all this debt? That's the problem, right?

We have all this debt because we use credit for money.

So, why do we use credit for money?

We use credit for money because everybody thinks using credit will help the economy grow. Because using credit, years ago, did help the economy grow. But it doesn't any more. It hasn't for a long time.

Actually using credit used to be great for the economy. But we just accumulated debt instead of paying it off. We kept old credit circulating. But old credit does nothing to stimulate the economy. Old credit is just debt.

We should have been paying down that old debt all along. Doing that, we would have removed money from circulation. Paying down debt destroys money, removing it from circulation.

Paying down debt destroys money, just as borrowing creates new money. We should have been paying down debt all along, completing those credit transactions, destroying the money we created by borrowing. But we didn't.

Instead, we let the Federal Reserve remove money from circulation in order to fight the inflation that was caused by money we created by borrowing.

So, we borrowed, which created new money and also created debt. And the Fed took the new money away, to fight inflation. And we were left with the debt, and no money to pay it off. This is our economic policy. This is our normal economic policy. It's why we use credit for money. Because of policy that encourages the reliance on credit.

Economic policy encourages the reliance on credit, and removes money from circulation without destroying debt in the process. That's why we have all this debt, and why we can no longer afford it. Because of policy.

If you want to win the cost war, fix the policy.

Thursday, September 23, 2010

The First Feudal Age: Trade and Currency

From Feudal Society by Marc Bloch. Volume 1: The Growth of Ties of Dependence. Phoenix Books; The University of Chicago Press, 1968. Translated by L.A. Manyon. Cover price: $1.95

From Chapter 4:

The First Feudal Age: Trade and Currency

The life of the Europe of the first feudal age was not entirely self-contained. There was more than one current of exchange between it and the neighbouring civilizations, and probably the most active was that which linked it to Moslem Spain, as witnessed by the numerous Arab gold pieces which, by this route, penetrated north of the Pyrenees and were there sufficiently sought after to become the object of frequent imitations. In the western Mediterranean, on the other hand, long-distance navigation was now practically unknown. The principal lines of communication with the East were elsewhere. One of them, a sea-route, passed through the Adriatic, at the head of which lay Venice, to all appearance a fragment of Byzantium, set in a world apart. On land the Danube route, for a long time severed by the Hungarians, was almost deserted. But farther north, on the trails which joined Bavaria to the great market of Prague and thence, by the terraces on the northern flank of the Carpathians, continued to the Dnieper, caravans passed back and forth, laden on the return journey with products of Constantinople or of Asia. At Kiev they met the great transversal which, running across the plains and from river to river, linked the riparian countries of the Baltic with the Black Sea, the Caspian or the oases of Turkestan. For the West had missed its chance of being the intermediary between the north or north-east of the continent and the eastern Mediterranean, and had nothing to offer on its own soil to compare with the mighty comings and goings of merchandise which made the prosperity of Kievian Russia.

Not only was this trade restricted to very few routes; it was also extremely small in volume. What is worse, the balance of trade seems to have been distinctly unfavourable -- at any rate with the East. From the eastern countries the West received almost nothing except a few luxury articles whose value -- very high in relation to their weight -- was such as to take no account of the expense and risks of transport.

Money was no object to those in the West who could afford luxuries from the East.
In exchange it had scarcely anything to offer except slaves. Moreover, it seems that most of the human cattle rounded up on the Slav and Lettish territories beyond the Elbe or acquired from the slave-traders of Britain took the road to Islamic Spain; the eastern Mediterranean was too abundantly provided with this commodity from its own sources to have any need to import it on a large scale. The profits of the slave-trade, in general fairly small, were not sufficient to pay for the purchase of precious goods and spices in the markets of the Byzantine world, of Egypt or of nearer Asia. The result was a slow drain of silver and above all of gold. If a few merchants unquestionably owed their prosperity to these remote transactions, society as a whole owed scarcely anything to them except one more reason for being short of specie.

Mmmm yes, trade imbalance. We know of that, these days.
However, money was never wholly absent from business transactions in feudal Europe, even among the peasant classes, and it never ceased to be employed as a standard of exchange. Payments were often made in produce; but the produce was normally valued item by item in such a way that the total of these reckonings corresponded with a stipulated price in pounds, shillings and pence. Let us therefore avoid the expression 'natural economy', which is too summary and too vague. It is better to speak simply of a shortage of currency. This shortage was further aggravated by the anarchic state of minting, another result of the subdivision of political authority and the difficulty of communication: for each important market, faced with the threat of shortage, had to have its local mint. Except for the imitation of exotic coinages and apart from certain insignificant little pieces, the only coins now produced were denarii, which were rather debased silver pieces. Gold circulated only in the shape of Arab and Byzantine coins or imitations of them. The libra and the solidus were only arithmetical multiples of the denarius, without a material basis of their own. But the various coins called denarii had a different metallic value according to their origin. Worse still, even in one and the same area almost every issue involved variations in the weight or the alloy. Not only was money generally scarce, and inconvenient on account of its unreliability, but it circulated too slowly and too irregularly for people ever to feel certain of being able to procure it in case of need. That was the situation, in the absence of a sufficiently active commerce.

But here again, let us beware of too facile a formula -- the 'closed economy'. It would not even apply exactly to the small farming operations of the peasants. We know that markets existed where the rustics certainly sold some of the produce of their fields or their farmyards to the townsfolk, to the clergy, to the men-at-arms. It was thus that they procured the denarii to pay their dues. And poor indeed was the man who never bought a few ounces of salt or a bit of iron. As to the 'autarky' of the great manors, this would have meant that their masters had gone without arms or jewels, had never drunk wine (unless their estates produced it), and for clothes had been content with crude materials woven by the wives of tenants. Moreover, even the inadequacies of agricultural technique, the disturbed state of society, and finally the inclemency of the weather contributed to maintain a certain amount of internal commerce: for when the harvest failed, although many people literally died of starvation, the whole population was not reduced to this extremity, and we know that there was a traffic in corn from the more favored districts to those afflicted by dearth, which lent itself readily to speculation. Trade, therefore, was not non-existent, but it was irregular in the extreme. The society of this age was certainly not unacquainted with either buying or selling. But it did not, like our own, live by buying and selling.

Moreover, commerce, even in the form of barter, was not the only or perhaps even the most important channel by which at that time goods circulated through the various classes of society. A great number of products passed from hand to hand as dues paid to a chief in return for his protection or simply in recognition of his power. It was the same in the case of that other commodity, human labour: the corvée furnished more labourers than hire. In short, exchange, in the strict sense, certainly played a smaller part in economic life than payment in kind; and because exchange was thus a rare thing, while at the same time only the poorest could resign themselves to living wholly on their own produce, wealth and well-being seemed inseparable from authority.

Wealth and well-being seemed inseparable from authority: a wonderful insight.
Nevertheless, in an economy so constituted the means of acquisition at the disposal even of the powerful were, on the whole, singularly restricted. When we speak of money we mean the possibility of laying by reserves, the ability to wait, the 'anticipation of future values' -- everything that, conversely, the shortage of money impedes.

Sorry to interrupt mid-paragraph. But that last sentence there, the one that begins "When we speak of money..." -- I have to discuss it. In my copy of the book I highlighted it heavily, some years back. But when I read it today I found it confusing. Bloch, writing When we speak of money, is referring to us, the people of our day, or Bloch's day more specifically. Block (1886-1944) originally wrote Feudal Society in 1939 (according to Wikipedia).

So he lived through the Great Depression and wrote that sentence near the end of it. I would have thought his view of money then would be similar to ours today. But it isn't. When I think of money I do not think of "laying by reserves," of setting money aside, of waiting to make that special purchase. I think of getting the paycheck and paying the bills. Bloch thought of money as a store of value. I think of it as a medium of exchange.

Perhaps I am still too near the time before our crisis, and still think in pre-crisis mode.

I think in our day there is a shortage of money. Most people know better. But I know we have a lot of credit in circulation, which looks like money in circulation and works like money in circulation but costs more to use, and has to be paid back besides. We don't have a lot of money. We have a shortage of money, and a lot of debt.

In feudal times the wealthy collected ornaments -- "the crown, the goblet, or the crucifix" -- made largely of gold. They had a shortage of money because so much of their gold was in these ornaments. We have a shortage of money too, but money is different now. Circulating money is in short supply because so much of the money has been stashed away as savings. It looks like we don't have a shortage of money because the savings get lent out, creating credit-in-circulation which looks just like money but costs so much more.

It is true that people tried to hoard wealth in other forms. The nobles and kings accumulated in their coffers gold or silver vessels and precious stones; the churches amassed liturgical plate. Should the need arise for an unexpected disbursement, you sold or pawned the crown, the goblet, or the crucifix; or you even sent them to be melted down at the local mint. But such liquidation of assets, from the very fact of the slowing down of exchange which made it necessary, was never easy nor was it always profitable; and the hoarded treasure itself did not after all constitute a very large amount. The great as well as the humble lived from hand to mouth, obliged to be content with the resources of the moment and mostly compelled to spend them at once.

The weakness of trade and of monetary circulation had a further consequence of the gravest kind. It reduced to insignificance the social function of wages. The latter requires that the employer should have at his disposal an adequate currency, the source of which is not in danger of drying up at any moment; on the side of the wage-earner it requires the certainty of being able to employ the money thus received in procuring for himself the necessities of life. Both these conditions were absent in the first feudal age. In all grades of the hierarchy, whether it was a question of the king's making sure of the services of a great official, or of the small landlord's retaining those of an armed follower or a farm-hand, it was necessary to have recourse to a method of remuneration which was not based on the periodic payment of a sum of money. Two alternatives offered: one was to take the man into one's household, to feed and clothe him, to provide him with 'prebend', as the phrase went; the other was to grant him in return for his services an estate which, if exploited directly or in the form of dues levied on the cultivators of the soil, would enable him to provide for himself.

Now both these methods tended, though in opposite ways, to create human ties very different from those based on wages. Between the prebend-holder and the master under whose roof he lived the bond must surely have been much more intimate than that between an employer and a wage-earner, who is free, once his job is finished, to go off with his money in his pocket. On the other hand, the bond was almost inevitably loosened as soon as the subordinate was settled on a piece of land, which by a natural process he tended increasingly to regard as his own, while trying to reduce the burden of service. Moreover, in a time when the inadequacy of communications and the insufficiency of trade rendered it difficult to maintain large households in relative abundance, the 'prebend' system was on the whole capable of a much smaller extension than the system of remuneration based on land. If feudal society perpetually oscillated between these two poles, the narrow relationship of man and man and the looser tie of land tenure, the responsibility for this belongs in large part to the economic regime which, to begin with at least, made wage-earning impracticable.

The first feudal age was part of a long, slow recovery from a great-great-great depression that we call the Dark Age.

My idea of "recession" is not that everyone is worse off, but that fewer people do better. I think my idea of recession comes from this Marc Bloch excerpt. In those unfortunate times, there were not so many monetary transactions. And a lot of those were large-scale, gold-coin transactions -- buying a neighboring feudal village, perhaps. And yes, even the peasants and serfs used money on occasion. But more silver than gold. And less silver than base metal. It was very much like "the two economies" that John Edwards (the presidential candidate) used to speak of.

Wednesday, September 22, 2010

(no financial crises)

Go right now and find the first graph in this PDF.

Here is the article that sent me there.

Tuesday, September 21, 2010

It's in the Percentages

If we allow the money supply to grow 3 percent per year, and we allow credit-use to grow 5 percent per year, and we do it year after year after year, what will happen?

Well obviously credit-use will get bigger and bigger and bigger, relative to the quantity of money. And at some point there might not be enough money to pay off the debt that has to be paid. So then we'd have a financial crisis.

I'm sure you know this, but if you want to reduce debt, you can't do it on credit. You need money in order to reduce debt.

Oh, and I'm sure you know this, too: Debt is the measure of credit in use. If you have debt it means you have credit in use, and it is because you used credit and did not yet pay it off.

Okay. So if we let credit-use grow faster than the quantity of money, after a while we cannot afford the debt anymore, and we have to have a financial crisis. But surely, nobody would be dumb enough to let that happen. Surely, policymakers would never let credit grow faster than money...

There is a PDF available from the New York Fed: Monetary Aggregates and Federal Reserve Open Market Operations by Paul Meek and Rudolf Thunberg. It is from the "Monthly Review" of April, 1971.

The opening paragraph of the PDF comes immediately to our topic:

In 1970 the Federal Open Market Committee (FOMC) began to establish longer term objectives for the growth of selected monetary and credit aggregates as an integral part of its instructions for the conduct of open market operations...

On the following page, we get to the interesting part:

The policy record for [the March 10] meeting indicates that the Committee was setting as its objectives a growth rate of 3 percent for the money supply (currency outside banks and private demand deposits) and 5 percent for the adjusted bank credit proxy over the second quarter.

The Federal Reserve's goal was to have credit-use grow faster than the money supply. Granted, the March 10 directive was the plan only for a period of weeks. But they wanted credit-use to grow faster than the money supply.

I'm thinking if they did it once, they did it often. I don't know all the details of the historical record of Fed policy. But I know that what happens in the economy happens because of policy. And I know credit-use grew faster than the quantity of money, because that's what this graph shows:

Because of policy, credit-use grew faster than the money grew. Credit-use grew a lot faster than money grew. We had to have a financial crisis, eventually. I'm just surprised we avoided it for as long as we did.

A better economic policy would mind the balance between money and credit-in-use.

Monday, September 20, 2010

Everybody Thinks

Everybody thinks printing money causes inflation. I think printing money and the use of credit (either, or both) cause inflation.

Everybody thinks they printed too much money, and that's why we had inflation. I think they didn't print enough, but instead encouraged the use of too much credit. (Perhaps because they thought credit-use would not cause inflation.)

Everybody thinks they printed too much, and borrowed too much too. Doesn't make sense to me. (Why do both?) I think they borrowed too much, and the borrowing created both debt and inflation.

Oh, one more thing: Everybody thinks "they" is somebody else. I think "they" is us.

Sunday, September 19, 2010


People assume government spending is the source of our economic troubles. I say it is not the source of our troubles.

My first bit of evidence is that after 30 years of red shift in the political spectrum, we have not yet solved the economic problem. My second bit of evidence is that the red shift has even failed to stem the growth of federal debt and deficits. My third bit of evidence is Ross Perot.

Look at Ross Perot's analysis of the problem, from his 1992 book United We Stand:

From the Acknowledgments:

For years I watched with concern as the national debt mounted and our competitive position declined.

That is the first sentence. Perot brings two concerns together, and attributes one to the other without any evidence or explanation.

From the Introduction:

I do hope that people who agree with me about the symptoms of our national disease, even if they dispute some of my proposed cures, will use this book...

Symptoms and cures. How about a diagnosis?

This blog, my blog, is almost all diagnosis. Perhaps I'm overly sensitive to Perot's omission. But without a proper diagnosis, we will never solve the problem.

From Chapter One:

The Federal debt is now $4 trillion. That's $4,000,000,000,000. Our political leaders will add over $330 billion to that debt in 1992 alone.

We add about $1 billion in new debt every 24 hours.

Does anyone think the present recession just fell out of the sky?

A bit of nostalgia in those numbers.

"Just fell out of the sky." Note that once again Perot links the federal debt to our economic problems, with no explanation and no justification.

People are unhappy with our economic performance. People are unhappy with government debt. People assume the one is the cause of the other.

No diagnosis. This is why we are unable to fix the problem. It's 18 years since Perot wrote that book, and we're worse off now than ever. That's what happens when you leap from symptoms to cures, and skip the diagnosis.

You can't cure symptoms. You have to determine causes.

Saturday, September 18, 2010

The Role of Government

We the people of the United States, in order to form a more perfect union, establish justice, insure domestic tranquility, provide for the common defense, promote the general welfare, and secure the blessings of liberty to ourselves and our posterity, do ordain and establish this Constitution for the United States of America.

"promote the general welfare"

When the economy fails to perform to our expectations, we are right to hold government responsible. When the economy fails to perform for 40 years or more, we are right to be angry.

But this does not mean that government spending is the problem.

Friday, September 17, 2010

The Thrill Is Gone

From A special report on debt: Repent at leisure, The Economist, 24 Jun 2010

Hyman Minsky, an American economist who has become more fashionable since his death in 1996, argued that these debt crises were both inherent in the capitalist system and cyclical.

Inherent, and cyclical. Agreed. At The Economist, they know an impressive statement when they see it, at least if the speaker is fashionable.

Debt increased at every level, from consumers to companies to banks to whole countries. The effect varied from country to country, but a survey by the McKinsey Global Institute found that average total debt (private and public sector combined) in ten mature economies rose from 200% of GDP in 1995 to 300% in 2008... There were even more startling rises in Iceland and Ireland, where debt-to-GDP ratios reached 1,200% and 700% respectively.

"Debt increased," the Special Report says, but "the effect varied." The excerpt suggests the "effect" was that debt increased, and the variation was that it increased to various levels. This is not an impressive analysis.

At The Economist, they are unable to identify the effect of increasing debt. They are also insensitive to warning signs from the economy:

From early 2007 onwards there were signs that economies were reaching the limit of their ability to absorb more borrowing. The growth-boosting potential of debt seemed to peter out.

"The growth-boosting potential of debt seemed to peter out." All they can muster is that the beneficial effect of debt "seemed to" peter out. Are they not sure of it?

The growth-boosting potential of debt has been bending the support beams of our economy in obvious ways since the early 1970s. Not "from early 2007 onwards." At The Economist, they are grossly insensitive to the signals our economy sends to us. As their own graph shows, debt is a depressant and it is getting worse.

Oh, and I think the word is "onward," not "onwards."

To understand why debt may have become a burden rather than a boon, it is necessary to go back to first principles. Why do people, companies and countries borrow? One obvious answer is that it is the only way they can maintain their desired level of spending. Another reason is optimism; they believe the return on the borrowed money will be greater than the cost of servicing the debt.

They are still unwilling to commit to the notion that debt has become a problem: "...why debt may have become a burden..." Unbelievable.

And the "first principles" story only shows they don't know why debt has become such a burden. Why is debt a burden? Because of the cost of it, plain and simple.

Remember when "buy now, pay later" was a sales pitch and a way of life? Well, the economy today is in the "pay later" phase. "Buy now" stimulates the economy, but "pay later" is the counterbalancing depressant. It's a yin-yang thing.

Or we can do cost-benefit analysis: The benefit of credit use is clear to the user, and stimulative to the economy. But credit-use creates debt. And the cost of debt is the counterbalancing depressant.

It is not debt that boosts growth. The use of credit boosts growth. Debt -- the evidence of credit use -- is the burden we're left with, after the thrill is gone.

The problem with debt, though, is the need to repay it.

No. Debt must always be repaid. Every act of lending is supported by the assumption that the debt will be repaid. And though it may sometimes happen that a debt goes unpaid, borrowers also recognize the obligation they assume. The "need to repay" is not the problem with debt. The problem is the excessiveness of debt.

To use numbers from the Special Report, debt at 200% of GDP is not such a problem, but it becomes a problem at 300% or 700% or 1200% of GDP. It becomes a problem when it becomes excessive. It's not rocket science.

Another reason why debt matters is to do with the role of banks in the economy. By their nature, banks borrow short (from depositors or the wholesale markets) and lend long. The business depends on confidence; no bank can survive if its depositors (or its wholesale lenders) all want their money back at once.

Is the problem confidence, or is the problem debt? And if the problem is confidence, is it not a problem because of the excessive level of debt?

This excerpt, if it says anything at all, says it would be wise to prevent debt from reaching excessively high levels. Only, The Economist doesn't say that.


The beneficial effect of debt, as the Special Report points out, is its "growth-boosting potential." But at The Economist, they cannot identify the effect of increasing debt on that potential. They do not understand the economy's response to excessive debt.

They are vague and unsure of the problem. They say the benefit of debt "seemed to peter out." But they are confused as to whether the trouble is with debt or with "confidence." They say debt "may have" become a burden, but they are not certain. They are unwilling to commit even to the view that debt has become a problem.

They present us with an awkward phrase: "economies were reaching the limit of their ability to absorb more borrowing." And they observe this limit arising in 2007. But in 2007 the recession was beginning, and our financial crisis was in the works. Surely the problem was glaring by then, at least in hindsight.

They ignore the long-term difficulty we've had, since the early 1970s, achieving an acceptable level of growth. They fail to relate that difficulty to levels of debt that were already high in the 1970s. They fail to observe that everything we've done to boost growth, everything we've done since the 1970s has fallen short, and that only debt itself has continued to grow with any vigor.

They cannot even identify the problem with debt: Excessiveness.

Thursday, September 16, 2010

Understatement of the Millennium

From A special report on debt: Repent at leisure, The Economist, 24 Jun 2010

"Such turmoil is a sign that debt is not the instant solution it was made out to be."
I wonder: Did The Economist ever make such a bold statement before the financial crisis hit? In that earlier time, the special report says, "Those who cautioned against rising debt levels were dismissed as doom-mongers." Was The Economist cautioning its readers back then, or dismissing the doom-mongers?

(Observe the use of the passive voice in the phrases "it was made out to be" and "were dismissed." Who made it out to be, and who did the dismissing, are carefully hidden.)

It is easy, now, to speak wisely of the dangers of debt. Now the dangers are obvious. But the reasons there are dangers remain much less clear. If The Economist was unable to see those dangers beforehand, then surely it did not understand those reasons then, and very likely it does not understand those reasons now.

Wednesday, September 15, 2010

Two Problems, Two Solutions

Yesterday I was happy to think our debt problem is that we use debt to solve our debt problems. I still think that. But Krugman doesn't:

Whenever the issue of fiscal stimulus comes up, you can count on someone chiming in to say, “Only a moron could believe that the answer to a problem created by too much debt is to create even more debt.”

Well, yeah.

It sounds plausible — but it misses the key point: there’s a fallacy of composition here. When everyone tries to pay off debt at the same time, the result is contraction and deflation, which ends up making the debt problem worse even if nominal debt falls.

According to Krugman, it won't work if we all pay off debt at the same time. He wants people to stop complaining about the growth of government debt until the paydown of private debt turns around.

I think there are two things going on here, two problems that get blurred together. The one problem is our continuing financial crisis. This is the problem that most concerns Krugman.

The other problem is the long-term growth of debt. This is the problem that most concerns most people. For good reason: Long-term growth of debt is the problem that created the financial crisis.

The crisis is called "the crisis" because it is a big problem. It is an economy destroyer. We have to deal with it. Krugman is right about that. Where Krugman goes wrong, I think, is that he doesn't acknowledge the problem with the long-term growth of debt, the problem that concerns everybody else.

Or, he does acknowledge the problem but has no solution for it. Krugman thinks we should solve the long-term debt problem later. Last July he said "the sensible thing" would be to "run deficits while the economy is depressed, then turn to budget-balancing once recovery is well in place." In other words, later.

But, when "later" gets here, there's no solution. And everybody knows it.

We need to resolve the crisis AND we need to fix the long-term problem.

To fix the crisis, I would let the Federal Reserve print dollars by the trillion and use the money to pay off people's debt, and do that only until the economy recovers.

To solve the long-term problem, I would create tax incentives to accelerate the repayment of debt. This would let us repay debt as a way of fighting inflation.

The existing method of fighting inflation restricts the quantity of money. It restricts the money we could use to pay off debt. It makes paying off debt more difficult.

The Arthurian solution fights inflation by reducing debt.

Tuesday, September 14, 2010

The Solution Is the Problem



From A special report on debt: Repent at leisure, The Economist, 24 Jun 2010

The answer to all problems seemed to be more debt... When the European Union countries met in May to deal with the Greek crisis, they proposed a €750 billion ($900 billion) rescue programme largely consisting of even more borrowed money.

I have the same complaint. When the problem is debt, the only solution our leaders can think of is more debt.

Well, at least that answers the question How did we get into this mess?

Monday, September 13, 2010

Supply-Side Economics

Adam Smith on the purpose of economic activity:

Consumption is the sole end and purpose of all production...

Maynard Keynes on the purpose of economic activity:

Consumption — to repeat the obvious — is the sole end and object of all economic activity.

'Nuff said?

Update 30 December 2010.

Also from The General Theory (Book II, Chapter 5) --

All production is for the purpose of ultimately satisfying a consumer.

Sunday, September 12, 2010

On "Meet the Press" Today...

...Ron Brownstein said, "What's really changed is people's optimism about the future."

Yeh. That's a problem. That's why we don't want to let the downturn continue. It's why there is an urgency about economic recovery.

When optimism drops a notch, that affects "consumer confidence" or "animal spirits" or whatever. And then economic performance drops a notch. And pretty soon optimism drops another notch...

We cannot let this continue.


"Demand-pull" is the classic explanation of inflation: There is enough demand for what you're selling that you can raise your prices, and the customers just keep on coming.

Okay. That could happen. I don't think it has happened in the USA, not for a long time. I think the only evidence for it is that there was "inflation." But suppose demand-pull inflation does happen. Is your retail business better off, or worse because of it?

Better. You raise your prices because you can. Your profits are good. Pretty soon, you are expanding and hiring more help.

Does that sound like where we are today? Not so much. Because we don't have demand-pull inflation.

We have cost-push inflation. Profits are squeezed. You raise your prices because you have to. Money is tight. Fewer customers stop in, and few of them buy. Times are not so good. This is cost-push inflation.

You can tell the kind of inflation we have, by the state of the economy.

Saturday, September 11, 2010

They're Getting Warmer...

JB Peebles sends a link to a pretty good article: "Time for Helicopter Ben to Drop Some Money on Main Street," by Ellen Brown at Truthout, dated 8 September 2010. I want to review that article now.

Excerpts from the original article are in the white boxes here, and my remarks (as always) are on the parchment. The purpose of this post is to compare and contrast my thinking with that expressed in the linked article.

The Federal Reserve is proposing another round of "quantitative easing," although the first round failed to reverse deflation. It failed because the money went to banks, which failed to lend it on. To reverse deflation, the money needs to be funneled directly to state and local economies. The Fed may not be authorized to "monetize" state bonds, but it COULD buy bonds issued by state-owned banks.

The first round of QE failed because the money went to banks, which failed to lend it on. Yes. The money needs to be funneled directly to state and local economies. Yes. The Fed should buy bonds issued by state-owned banks. No.

The economic problem is monetary imbalance: an excess of credit-in-use (which is measured by total debt outstanding) and a relative shortage of non-credit, "medium of exchange" money. This problem cannot be solved by issuing more bonds.

It seems logical enough. If there is insufficient money in the money supply (deflation), the solution is to put more money into it. But if deflation is so easy to fix, then why has the Fed's massive attempts to date failed to do the job?

The word "deflation" occurs four times in these first two excerpts. The Truthout article presents deflation as if we were deep into it. I am admittedly slow to notice things, but it seems to me we are still waiting to see whether the outcome will be inflation or deflation.

Worries about inflation do seem less common lately, now that I look for a juicy link. But many people are still hesitant to say deflation is here. And I see gasoline prices varying around the $3 level, not falling.

(Minor point: I think it is an odd visualization to say "If there is insufficient money in the money supply, put more money into it." The money supply is not a bucket that holds money. Money is the money supply.)

The mechanics of how QE works were revealed in a remarkable segment on National Public Radio on August 26, describing how a team of Fed employees bought $1.25 trillion in mortgage bonds beginning in late 2008. According to NPR:

"The Fed was able to spend so much money so quickly because it has a unique power: It can create money out of thin air, whenever it decides to do so. So ... the mortgage team would decide to buy a bond, they'd push a button on the computer - 'and voila, money is created.'

The "mechanics" of how it works is much like a description of how a transporter works on Star Trek: You just push a lever!

Reading the article, I was struck by how much Ellen Brown dwells on the creation of money from nothing. It seems to me that many many people, when they finally figure out the "money from nothing" thing, can focus on nothing else. When at last they see it, they see it as the central problem. Well, it's not the central problem. It is simply the way things are done. Don't sweat it. It's not a big deal. It's actually a good thing, or it would be if we had the sense to use it right.

"Extraordinary measures" was a reference to Section 13(3) of the Federal Reserve Act, which allows the Fed in "unusual and exigent circumstances" to buy "notes, drafts and bills of exchange" (debt instruments) from "any individual, partnership or corporation" satisfying its requirements. The Fed was supposedly engaging in these extraordinary measures to "reflate" the money supply and get credit flowing again. Yet, the money supply continued to shrink. The problem, as Roche explains, is that the dollars were merely being swapped for other highly liquid assets on bank balance sheets...

I would say yeah, Roche has a good explanation there.

So the Fed printed some dollars and used those dollars to buy up lots of "highly liquid assets" or "toxic assets" or debts on the verge of going bad. The banks (or whoever) that sold those toxic assets got money for them, and got rid of a lot of risk. So the banks were then in better shape. And the whole financial system was no longer in danger of imminent collapse. All well and good.

But what about the poor bastards in danger of losing their homes? Not only the banks were facing big losses. Now the banks have been rescued. The poor bastards have not.

Suppose the Fed printed some dollars and used those dollars to pay off a lot of debt for a lot of people. Where would the money go? It would go to the banks!! Where would the debt go that was paid off? It would go away. And where would the money go that was printed? It would be destroyed by the repayment of debt.

After that, people would have a lot less debt. We'd be better able to meet our remaining expenses. We might even be tempted to buy more on credit -- which is the way we make the economy grow. (Yeah, we have to fix that problem, too. But not in this post.)

And banks would have a lot less assets earning income, and a lot more credit available to lend, because old debts were paid off. And if the banks wanted to increase their earnings, they would have to increase their lending. And again, that is the way we make the economy grow.

And we could make all this happen, by having the Fed print money and use it to pay down debt for people. But while it is legal for the Fed to buy debt from individuals, perhaps it is not legal for the Fed to pay off debt for individuals. I would say the people who messed up the economy with their policies should just admit they made mistakes, and do a quick-fix to solve the problem. But they won't.

But maybe Congress would like the idea of taking a trillion or two of new dollars from the Fed, and then Congress could pay down our debt for us. Yeah. They might all want to get in on that.

A bit farther down, under the heading
The Textbook Money Multiplier Model … and Why It Is Obsolete

we have
The theory is that increasing the banks' reserves will stimulate this process, but both the Federal Reserve and the Bank for International Settlements (BIS) now concede that the process has not been working in the textbook way...

In other words, the Federal Reserve and the Bank for International Settlements do not understand what the economy is doing.

The article quotes from "a BIS working paper called 'Unconventional Monetary Policies: An Appraisal,' as follows:
"[T]he level of reserves hardly figures in banks' lending decisions. The amount of credit outstanding is determined by banks' willingness to supply loans, based on perceived risk-return trade-offs, and by the demand for those loans. . . .

To restore economic growth, in an economy that relies on credit as heavily as we do, it is necessary (1) to restore "banks' willingness to supply loans," and (2) to restore "the demand for those loans."

These requirements can be most easily met by simply eliminating existing debt by one means or another. (I propose to print money and use it to pay off a bunch of that debt.)

The BIS working paper quote continues:
"The aggregate availability of bank reserves does not constrain the expansion [of credit] directly. The reason is simple: ... in order to avoid extreme volatility in the interest rate, central banks supply reserves as demanded by the system...

Central banks supply reserves to other banks, which the other banks lend out, creating more debt in the economy. That's the way our monetary system works.

The operating principles are in error. An economy needs to have mostly non-credit money as a medium of exchange, not mostly credit-in-use.

Anyway, if the Fed is gonna create reserves on demand, then that's a good reason we need anti-inflation policy in our tax code.

Another interesting aside arising from all this is the suggestion that the government could actually print its way out of debt - it could print dollars and buy back its bonds - without creating inflation...

Without creating inflation? Easier said than done.

Perhaps the plan would work -- now, while we have monetary imbalance. But with that plan in place, it won't be long before the imbalance is corrected, and then prices will be going up like crazy, and policymakers won't understand why.

Anyway, if you print money and buy back bonds, the money is going to people who have so much money they don't have to spend it. I say, print money and use it to pay down debt. The creditors get it, anyway.

The failed QE experiments in Japan and the US suggest, however, that there is a third alternative. Printing dollars to pay the debt (referred to by Russell as "inflating the debt away") might actually eliminate the debt without creating inflation...

Yeah, that's what I'm saying. Yeah. But in the article when they say "eliminate the debt" they're talking about eliminating the federal debt.

We'll get better results if we print money and use it to pay down private-sector debt, people's debt, mortgage and credit card debt and such. Reduce debt in the sector where debt must be reduced before the economy will grow again.

Then, when the economy begins to achieve sustained growth at a healthy rate, the federal debt will fall, effortlessly.

A Moment of Silence

Friday, September 10, 2010

"A Negative Fiscal Multiplier in Brazil"

Excerpts from the July 21, 2010 post by Antonio Carlos Lemgruber at Roubini Global Economics...

From the BRICs to Southern Europe, economic analysts are beginning to discuss the conditions for a negative fiscal multiplier.

I'm just gonna point this out now, and then I'll let it go: Lemgruber's article is not about Brazil. It is not about any negative fiscal multiplier in Brazil. It is simply about the notion of the negative fiscal multiplier.

An increase in current government expenditures tends to reduce real GDP through many different sources and channels, with an emphasis of course on financial variables such as the interest rate, the availability of internal and external credit for the private sector, the exchange rate, expectations of inflation, and the risk of government default.

If it is true that increases in government spending "tend to reduce real GDP" then it is important to note Lemgruber's "emphasis of course on financial variables." This is not the first time issues of finance have arisen on this blog. Arthurian economics identifies excessive finance as the cause of our economic troubles (and policy errors as the cause of excessive finance, to finish that thought).

I suggest that if increases in government spending now have a completely opposite effect than they did when times were good, that this change may be just another result of excessive finance in our world today.

This is perhaps the major macroeconomic debate of the day, which is behind the present discussion about increasing or reducing government déficits and government debts. On one side, we still hear hyper-Keynesian views, always talking about what happened in the thirties. On the other side, based on recent empirical work by Alberto Alesina and others, there is evidence from the last three or four decades, showing that the new globalized world is perhaps more prone to negative fiscal multipliers, due to financial globalization and to the international capital markets who penalize excessive government debt.

"Due to financial globalization and to the international capital markets who penalize excessive government debt."

My knee-jerk reaction is to look for excessive government debt. Just a glance or three.

I just don't see it. I don't see "excessive government debt." I just see excessive debt, most of it private.

Lemgruber writes, "An increase in current government expenditures tends to reduce real GDP." But since the 1980s economic performance in the big economies has been falling. And if economic performance has been falling for decades, then one could probably claim of anything, that "it tends to reduce real GDP."

Falling economic performance does not stand as proof of such claims.

Thursday, September 9, 2010

"Since 1970"

Krugman of August 27 (Nobody Could Have Predicted) links to Krugman of December 27, 2009 (Stimulus timing), below which the first comment begins well:

As Alesina and Ardagna showed in a recent study of 91 episodes in OECD countries since 1970 when governments attempted to stimulate the economy. cuts in business and income taxes are successful, while increases in government spending fail.

I've not read that study. (I put it on my list.) But I have to comment on the comment.

1. All "91 episodes" have occurred since 1970. That's not the beginning of time. It is, however, the beginning of our time of economic troubles as defined on this blog. As defined by Ross Perot in the chart from yesterday's post. And as defined by those who write of a golden age of post war capitalism." So the entire 91-episode study is an examination of an economy in trouble.

2. The comment points out that since 1970, "cuts in business and income taxes are successful, while increases in government spending fail."

Excessive reliance on credit gives rise to increased financial costs throughout the economy. Because of these increased costs, consumers and businesses -- and governments -- have trouble making ends meet. "Cuts in business and income taxes" relieve some of that stress in the private sector.

On the other hand, "increases in government spending" leave government with bigger deficits in an age when everyone has too much debt already. But then, so do business and income tax cuts.

Wednesday, September 8, 2010

Line of Demarcation

From: United We Stand, by Ross Perot (1992) page 14
Remember this graph? From the time of Ross Perot's third-party assault on the White House. (That's my red-pen "1973" there, and my funny little arrowheads.) Perot's graph is just another way of looking at the slowdown of GDP growth.

The after 1973 bar is 7½ times higher than the before 1973 bar. Big difference. After 1973, the economy grew a lot slower than it did before 1973.

So, no matter what numbers we're looking at, if we divide those numbers by GDP we will see a big difference between the "before 1973" and the "after 1973" results. Or if we "evaluate the effect of X on growth" we will see much less growth in the "after 1973" period, no matter what X we choose to evaluate!

Tuesday, September 7, 2010

Deviation from Trend

A Non-Random Disturbance in the Force

Lots of things that grow, grow "exponentially." That means they double in size at regular intervals. It is a natural phenomenon. For some reason, one of the things that tends to grow exponentially is debt. The graph of total debt looks very similar to an exponential trend-line:

Graph #1: Total Debt and the Exponential Pattern

That closeness fascinates me. But the graph above is an old one, from my Google Site. I want to take another look, using debt numbers from the sources I found recently. You know: three sources, but one of'em doesn't line up...

It didn't make me happy, but I set the "mismatch" data aside. That left me with the 1956-1995 numbers and the 1975-2009 numbers. The numbers in the two sets are close. So I just took the 1956-1974 numbers from the one set and stuck them in front of the 1975-2009 data. And then added the exponential curve:

Graph #2: Total Debt and the Exponential Pattern

Pretty similar to the old graph. But then I started wondering about those little gaps between the red and blue trend-lines. I wanted to see the difference between debt and the exponential trend-line. I wanted to graph the difference. I got thinking, Suppose I use the exponential curve as a base line...

So I divided the actual debt number by the exponential trend number, subtracted 1 from the ratio, and showed the result as a percentage. The result amazed me. It is far less random than I expected. There is a pattern to it. It looks like a sine wave:

Graph #3: A Sine of the Times

We take the actual numbers for total debt in America. We figure out how much these numbers differ from a purely mathematical pattern -- the exponential curve. And amazingly, the difference looks very much like another purely mathematical pattern -- the sine wave. Except of course for that collapse, there at the end.

Clearly, there is more at work here than politics. The graph tells me that debt growth is more a function of mathematics than politics.

Monday, September 6, 2010


Leafing through Milton Friedman's Free to Choose. In Chapter 9 Friedman writes:

Financing government spending by increasing the quantity of money looks like magic, like getting something for nothing. To take a simple example, government builds a road, paying for the expenses incurred with newly printed Federal Reserve Notes. It looks as if everybody is better off. The workers who build the road get their pay and can buy food, clothing, and housing with it. Nobody has paid higher taxes. Yet there is now a road where there was none before. Who has paid for it?

The answer is that all holders of money have paid for the road. The extra money raises prices when it is used to induce the workers to build the road instead of engage in some other productive activity...

What about the possibility that the workers who built the road didn't do it instead of some other productive activity. What if the economy was slow and they were out of work, engaged in no productive activity at all? Friedman's logic of 'instead' is a lot like Fama and Cochrane's logic of would otherwise. It builds generalizations on top of faulty assumptions.

But what bothers me most about Friedman's statement is that he presents us with a static economy, an economy not growing. If the government builds a new road, that's infrastructure. One can imagine communities arising along that road. One can imagine growth. That is, after all, the whole reason for having infrastructure in the first place.

Milton Friedman is famous for his view that inflation is linked to "the quantity of money relative to output." But in order to make his road-building example work, Friedman ignores the normal expectation that the economy will grow. And he ignores the commonsense rule that says expansion of infrastructure encourages growth.

In order to make his road-building example work, Friedman must ignore the growth of output. He must assume a static economy. Because if output increases, an increase in the quantity of money is justified, according to Friedman's own rules and standards.

But it was years ago that I was troubled by Milton Friedman's assumption of a static economy. The reason the "static argument" arises now is that I find the same argument in the work of the father of Ricardian Equivalence. No, not Ricardo.

In Chapter 14 of Robert J. Barro's Macroeconomics: A Modern Approach, Chapter 14, we find a table of U.S. and U.K. debt, a couple graphs of debt, and lots of copyright warnings.

Beginning on page 349 there is a simple example of "Ricardian Equivalence." This example begins with several simplifying assumptions:

  • interest rates are stable
  • prices are stable
  • the quantity of money is stable
  • "real transfers" are zero
  • the government starts with no debt, and
  • government spending plans, whatever they are, do not change in this example.

Note that among the assumptions we do not explicitly find the following:

  • population is stable
  • technology is stable
  • productivity is stable
  • output is stable

Barro's simple example is a two-year run. In the example, government cuts taxes for one year, then in the second year raises them enough to pay the principal and interest.

But the example does not allow for economic growth. If the economy grows enough, there is no need to raise taxes in the second year. If we assume the economy doesn't grow, then taxes have to be raised or revenue won't cover expenses. But the normal, everyday assumption is that the economy will grow. Barrow has to go out of his way, avoiding the normal presumption of growth, in order to make the example work.

Of course, in the real world, the economy tends to grow more slowly than the deficit, so that taxes are liable to increase. And it is true that slow growth is a key part of the economic problem of our time. But our topic here is not slow growth. Our topic is the presumption of no growth, which is a trick too often used to make bad examples work.

Barro's example is invalid because it fails to consider the possibility of growth. Milton Friedman's example is invalid for exactly the same reason.