"Suggested remedies"

MY APPROACH ALWAYS IS TO TRY TO UNDERSTAND THE ECONOMIC PROBLEM. SO IT WAS OUT-OF-CHARACTER FOR ME TO "JUMP TO THE END" AND LOOK FOR SOLUTIONS IN MY POSTS. TEN ARE LISTED HERE. YOU CAN GRADE MY EFFORTS ON THE RELEVANCE OF THE SELECTED ITEMS.

Debt Does Not Exist provides a definition of debt, and shows what's missing from policy.

Gresham's Law Redux asks an important question, I think, when it finally gets around to it.

The Business Income Tax offers a suggestion that is more conceptual than practical, perhaps.

Cut wut? is a short one. Makes the distinction between old and new debt.

Creating Slack is an attempt to show what happens when policy incentives turn as I want to turn them. (The example policy is punitive, which is unfortunate; but that is a different matter.)

Financial Reform ties together my ideas on taxes and accelerated repayment of debt.

Four Views contrasts my policy recommendations to three others.

Parsing the Question (Part 2) is an attempt to show how real-world numbers could change if our policy shifts appropriately.

The Great Indebtedness ends with a clear policy recommendation, I think.

The Blind Leading the Blind offers a clear objection to existing policy.

Clarity

There are two different strategies that need to be developed: one to deal with recovery from the crisis and recession; the other to correct the policies that allowed the crisis to develop. I know I don't pay enough attention to the distinction. Sounds like a New Year's Resolution in the works...

Symmetry

I would like our policies to be symmetrical. Symmetry is the "template" I use to design solutions. I want to match the solution to the problem better than existing policy does. For example, in a world of excessive credit-use, the only productive solution is to accelerate the repayment of debt.

Market Pipeline: The Dark Side of Financial Innovation

When I keep going back to a particular post, eventually I have to talk about it.

[LINK to the Market Pipeline post]

Cormick Grimshaw of the Pipeline posts an abstract of a paper by Brian J. Henderson and Neil D. Pearson. I reduced the abstract until it made sense to me:

The offering prices... of a popular... structured equity product were... almost 8% greater than... the products’ fair market values....

Under reasonable assumptions... the mean expected return... is slightly below zero.

The products do not provide tax, liquidity, or other benefits, and it is difficult to rationalize their purchase by informed rational investors.

So, somebody's getting ripped off. I think a lot of people get a lot more upset about that kind of thing than I do. Don't get upset about it. Bear with me.

The last part of the abstract is presented complete, below:

Our findings are, however, consistent with the recent hypothesis that issuing firms might shroud some aspects of innovative securities or introduce complexity to exploit uninformed investors.

In other words, the issuing firms are putting extra nicotine in their cigarettes to get you to keep smoking them.

The best way to get back at those companies is to make people want to stop buying their product. And you know what? People already want to stop buying their product. At least, people want to reduce their debt. When people succeed, finance will become a smaller business in this country. Lenders will have less raw material to work with, from which to create "structured" products and other derivatives.

The best way to get back at those finance companies is to depend less on finance. Just remember, the necessary step is to change economic policy.


Related Links:

• The SSRN page identifies the "structured equity product" as SPARQS.
• What is SPARQS? An interest-paying note built on equity (stocks); a derivative.

Oh, look at the date!

Happy New Year.

Wealth and Income

The golden goose is wealth. The eggs are income. Wealth creates income.

1973

The interesting and well-written Nima provides this graph and the following remark:

It is notable that in post World War 2 America, the poverty rate was declining constantly every year, until in 1973 it hit a level of just below 8.8% from where it has since then bounced back to now around 11% and rising.

How can this be explained?


Nima goes on to say that "major welfare programs... keep the recipients in poverty, rather than motivating them to lift themselves out..."

But it isn't Nima's conclusion that interests me. What interests me is the turning point: 1973. The same year noted by Ross Perot and others. The last year before the 1974 recession.

My conclusion would be that the "golden age" growth (1947-1973) gets the credit for driving down the poverty rate. And that the economic recession which hit like a ton of bricks in 1974 explains the end of that decline.

The fact that poverty has not continued to decline, as the graph shows, would then be evidence that the economy never really recovered from that 1974 recession.


To complete the thought... It is certainly true that the poverty rate could not have fallen much below the 8.8% bottom it did reach. It could not fall below zero. It would have had to start tapering off, well before it hit zero.

Nima's graph shows that the downtrend from 1967-1973 was less rapid than in the years before 1967. This likely was part of that tapering off; but it was interrupted by the 1974 recession, or by major welfare programs or something.


In my view, the growing accumulation of private debt in the post-WWII period reached a breaking point in 1974. It resulted in recession, and the end of a golden age, and the end of the Keynesian consensus, and, among other things, the end of the decline of the poverty rate.

In Nima's view, the end of the decline of the poverty rate was brought on by major welfare programs. But I do not imagine that Nima can attribute our myriad other problems to those same welfare programs.

I wish to point out that my argument -- I don't even know how to say this -- my one central, causal factor is (for me) the cause of everything. By contrast, Nima and others require an endless series of explanations to cover those myriad problems.

Supplyanddemand

The Troublesome Economist has a good summary of the financial crisis. As I read it, the post lays out a good overview of what happened. If you read it, you may find a few things in the post that you disagree with. Good: Remember what those things are, and then compare your reactions to mine, below.

I start with two excerpts from Allan Schmid's post, one from each end of it:

"The too-big-to-fail banks are blaming the financial crisis and the subsequent Great Recession on greedy home buyers..."

"When the big picture is grasped, it is clear that the problem was not greedy home buyers, but super greedy avaricious, (yes, immoral) brokers, banks, and bond raters."

Yeah... I want to leave out the word "greedy," for starters. And if I can reduce the thought to a clear minimum, we have banks blaming home-buyers, and Schmid (along with home-buyers, presumably) blaming banks. Lenders blaming borrowers, and borrowers blaming lenders. Supply blaming demand, and demand blaming supply.

One of the key phrases in all of economics is the phrase supply and demand. Supply and demand. Without supply there is no demand. Without demand there is no supply. This is one of the key concepts in all of economics. And I think it's kinda sad that a hobbyist like me has to remind people of it.

There is no way we can ever solve the economic problem, no less analyze it correctly, if we insist on taking sides on things that are matters of supply-and-demand.

There. Compare that against your reactions to Schmid's post.


I have a couple more points to make. Allan Schmid writes:

"Profits on the difference between home mortgage rates and the lender’s cost of money were too plebian for the high flyers of the financial sector. So the commercial and investment banks packaged mortgages into bonds and resold them to other banks, governments and pensions funds around the world. The market for these derivative bonds was marked by use of absurd levels of leverage, as high as 30 to one."

Yeah, Idunno where the "30 to one" comes from. But I know I've been looking at this graph for a long time -- long before that wiggle there in the early '90s. And I know the line has been climbing for a long time, and policymakers just let it climb. And I know the financial crisis finally caused the trend-line to start dropping in 2008, which created a peak in 2007. In 2007, there was $35 of debt for every dollar of money in circulation.

30-to-one, 35-to-one, close enough. And way, way, way too much debt. But I guess everybody knows that already. But that's not why I'm showinya the graph. I show the graph because I want you to look for some big burst of debt that would have made the trend-line jump up suddenly.

There is no such big burst of debt visible on the graph. There is only a continuous, exponential increase in debt from 1947 to 2007, with some very inconsequential fluctuations in it.

There is one continuous increase in debt lasting 60 years. This graph tells me that the debt of which Allan Schmid writes, above, the debt that created the financial crisis, the debt that was created by the joint efforts of lenders and borrowers and policymakers, this massive and troublesome debt was nothing but the continuation of a process begun at the end of the Second World War.

There is nothing about now that you should focus on. There is nothing about the last two-or-three years -- or the last 10 or 20 years for that matter -- in which you will discover the source of the economic problem. For that matter, you could go back to 1947 and look for the source of the problem, and not find it.

The source of the problem is so deeply embedded in our thinking that we stand on it to look around for the source of the problem. And that, of course, is why we cannot see the source of the problem.

We think we need credit for growth. And the more troubled is our economy, the more we do things to encourage and support access to credit. Well, that was a good plan when our economy had little credit in use. Now that we have so much credit in use -- credit in use being measured as debt, of course -- it is no longer such a good plan.

And yet we have policymakers continuing to do everything in their power to encourage greater use of credit. To some people, this looks like the government favoring the banks. And maybe it is. But I don't think their purpose is to favor the banks. I think their purpose is to get the economy growing again. But they think we need credit for growth. And that is a plan which can no longer succeed.

At the other extreme, we have people starting to say that increasing our output may not be such a good thing after all. But I'm with Milton Friedman on this one:

"Nothing is more important for the long-run economic welfare of a country than to improve productivity."

The solution to the economic problem is to remember that while credit is good for growth, debt is harmful to growth. The one extreme -- excessive accumulation of debt -- kills the economy. The other extreme -- rejection of credit use -- keeps it dead. The solution is to avoid the extremes. It's really not difficult to see.


Final point. In the 12 pages I wrote:

Reliance on credit has driven the growth of the financial sector. It has increased the cost of facilitation relative to the cost of production. It has driven money out of productive work and into finance. "Since 1990, Ford has made more money from financial services, principally automobile loans to consumers and dealers, than from car- and truck-making operations."

The quote about Ford was from a 1994 article in the New York Times. So already by 1994 -- already by 1990 -- we can see that finance was excessive, debt was excessive, credit-use was excessive.

But the policies that promote credit use continued to be enforced and reinforced. And so, in reviewing the events of the last few years, Allan Schmid would write:

"Everyone wanted in on the golden goose as firms like GE and GM, who formerly made real goods, switched to earning a big share of their profit on leveraged financial contracts."

We cannot solve the problems created by excessive reliance on credit, by promoting policies that strengthen the reliance on credit. We need to rely on non-credit money to maintain economic activity in the existing economy, and we need to use credit to expand the economy. We need to use credit for growth, not for everything. It must be obvious by now. And it must be policy.

When you put finance people in charge of policy, they cannot see debt as a problem.

Rock and Hard Place, Smoke and Mirrors

Gene Hayward writes:

Who is more selfish---Senior Citizens who won't take reduced benefits to help young people financially, or young people who won't pay more taxes to help old people financially? Good luck with that question...

Gene's question -- and it's not just Gene's question -- creates a "front" between young and old. As though there is enough money for only one of the two groups. And, well, yeah, that is how it looks.

But if that's how it really is, it's because we've used the wrong economic policies. And by "economic policies" I don't mean just the level of government spending and taxes. That's the only part of policy that gets examined, but it's not where the problem lies.

Not long ago, we were the richest country in the world. If we're no longer on top, we're still close to the top. Therefore, there should be no reason we cannot afford both Social Security benefits and reasonable taxes all around. No reason but bad policy.


Earlier, I covered a MacroMania post that set up a similar "front" -- on the one hand, taxes sufficient to balance the federal budget while expanding stimulus spending. On the other hand, taxes sufficient to eventually balance the budget while expanding stimulus spending.

No. We should not be lining up and taking sides on ridiculous issues like the timing of the tax increases needed to balance the budget.

We should be calling for policies to reduce the private-sector debt that inhibits economic growth. But we'll never even get to the discussion of private-sector debt if we insist on focusing on trivia like "taxing now versus taxing later."

No Solution

Over at MacroMania, David Andolfatto takes a look at Robert Shiller's droll article on the balanced budget multiplier.

"Here is a Christmas gift," Andolfatto writes,

...to those of us who have been primed since youth to be receptive to this sort of message: Stimulus, Without More Debt.

I point out David's remark because I'm just a little too old and anti-social to have got the message regarding the urgent need to avoid government debt.^[1]

I took a course in macro back in 1977, using the 1975 edition of a textbook first published in 1963. There was a world of difference between the economy of the early 1960s and that of the latter 1970s. The Economics 101 I learned was from a time before the solutions arising since the mid-1970s had worked their way into the curriculum.

Our final for the course was to look at the economic problems of the time and write up an analysis and some policy recommendations. I've been doing that ever since.

While economists and policymakers started inventing new stories about rational behavior, and reinterpreting the words of David Ricardo and such, I was in the library, searching through Statistical Abstracts, photocopying data tables at 25 cents a page, calculating ratios with a slide rule, and creating graphs with pencil and paper.

When I read, I read Maynard Keynes and Adam Smith. I was pretty well isolated from the new ideas of the developing horde of new thinkers.


Andolfatto quotes Shiller on the idea of increasing taxes enough to cover enhanced stimulus spending, an idea Shiller supports in his article.

Then Andolfatto rejects a specific part of Shiller's idea, and offers an alternative:

What I have a problem with is in using some silly theory to support the notion, for example, that taxes should be raised to finance a large public capital expenditure...

Now, I'm no expert in finance... But it seems to me that a large capital expenditure should be financed with debt. The debt service could be supported by toll revenue (on bridges and roads) and user fees in general...

Taxes are distortionary and to the extent that they are needed to support public spending, they should be spread out over time.

Shiller defends the idea of using increased government spending as a stimulus, to be paid by increasing taxes enough to keep the budget continuously in balance.

Andolfatto defends the idea of using increased government spending as a stimulus, to be paid by increasing taxes (or "fees") at a more leisurely rate, to bring the budget into balance, but not immediately.

All very nice. However, only six times in the past 50 years have we been able to bring the federal budget into balance, now or later. Both Shiller's idea and Andolfatto's are unrealistic and unattainable, at least to the mind of this isolated thinker.

As it appears to me, the whole notion of solving our economic problems by balancing the federal budget is unrealistic and unattainable. As it appears to me, the whole line of reasoning that first emerged in the 1970s is just bad economics.

To be blunt, I don't think you can develop an economic argument piecemeal, with tiny contributions from dozens or hundreds of individual economists. I think what you get is a piecemeal, patchwork argument held together largely by constant repetition.

What you get is a different argument for every little piece of the problem. There is no overview, no overall coherence, and no viable solution.


NOTES:

1. It's not that I favor expanding government debt, not at all. Rather, I do not let public debt cloud my judgment the way almost everyone else does. [Return]

The Friedman Factor

This is a straightforward version of the roundabout calculation Milton Friedman used to make his graphs show similarity between money and prices.

Milton Friedman's famous graphs seem to show that inflation -- a general increase of prices -- is caused by an increase in the quantity of money, relative to output.

I'll tell ya how he made the graphs look like that.

STEP 1: You take the total amount of money that we actually have in this country, in people's pockets and in their checking accounts, and also in their savings accounts.

STEP 2: You take the total purchase price of all the goods and services we produce in a year, or in other words the total we paid to buy all that stuff.

STEP 3: Then you take the money-number from step one there, and divide it by the GDP number from step two.

STEP 4: And then you take the answer from step three and times it by the Consumer Price Index, and you call this "money relative to output."

When you graph the result from step four, it looks a lot like the price trend, because you factored the price trend into that result.


See also..

• My exchange of comments with the Secret Economist, beginning here
• A refresher on dividing by a fraction
• And my series on Milton Friedman's arithmetic.

"Is the Fed Printing Money?"

Gene,

You write: "Seems to me the banks have a "second" required reserves account that the QE "credits" are going into and do not become a part of the fractional banking system."

I take it you mean an unofficial second RR account... a second account "in effect" as it were. I take it you observe what has happened with bank reserves, and compare it to what would happen if a "second" layer of RR accounts had been set up for the QE funds. If that's not what you mean, I must have missed something!!

Here are excerpts and my initial reactions to the WSJ post that you linked.

Is the Federal Reserve printing money to finance its bond buying? Or isn’t it? Ben Bernanke has given inconsistent answers, at times saying it is and at times saying it isn’t.

It's a sad day when the fate of our economy rests in the hands of people who try to reduce the problem as Bill Clinton did with the line "It depends on what the meaning of the word 'is' is."

On the other hand, maybe Bernanke's doubletalk is the appropriate response to the trivial aggressions phrased as questions, to which he has been subject. I suspect that, even after a lobotomy, Bernanke would be a better economic thinker than all of Congress hooked up in parallel.

In the WSJ post, in the first paragraph after the words "Here is an attempt to sort it out" one finds this little bit of wisdom:

The Fed can do something else. It has the power to electronically credit money to the bank accounts of sellers who in turn sell government securities or mortgage backed securities to the Fed.

I do not understand why that is considered news:

• If you look at a dollar, right across the top there it says FEDERAL RESERVE NOTE. That means the dollar was issued by the Federal Reserve. This has not been news since 1913.
• Whether the money is created "electronically," or by printing, or by stringing shells into wampum, is only a matter of technology. As far as the act itself (creating money) goes, the technology is utterly insignificant.
• Who else would the money be paid to, other than "sellers" ???
• There is nothing else in that excerpt!

So I have to approach the WSJ article with an expectation of disappointment.

//

But as Mr. Bernanke has been trying to emphasize lately — perhaps clumsily — most of the money that the Fed has created isn’t circulating much through the financial system. It’s mostly sitting idly, often in deposits — also known as reserves — that banks keep with the Fed itself.

Definitely clumsily. But I agree with the WSJ, that the money isn't causing prices to rise because the money isn't circulating.

As Milton Friedman tried to emphasize, it is not the existence of money, but the spending that influences prices. Further, the money could circulate without causing prices to rise, if the velocity of money were sufficiently slow. (The abrupt fall of velocity was the reason for the QE in the first place!) However, economic recovery presupposes that velocity will return to some higher level. The money is very likely to cause price increases at that time.

//

Some people say that when new money is created, the people who get it first have an advantage over the rest of us. To me, that's a little petty; but maybe a better word for it would be micro... as opposed to macro.

As things have turned out, the new money is available to people who already have substantial assets, and who are looking to protect their wealth either by getting into or by getting out of dollars. When they get out of dollars, they get into other assets, increasing demand for these, and raising asset prices. If I have my current events right. we can already see that happening.

The new money is not available to those of us already swamped with debt. Fair enough: we'd rather reduce our debt than increase it further. But as a result, at the Consumer-Price-Index level, prices are not rising so much. Yet.

As we see today with the cost of gasoline, rising asset prices will trickle down through the manufacturing process, pushing up costs and prices. I should say, this is just an intuitive analysis. I wouldn't know an asset if I had one.

The Kucinich Bill...

"prohibits the creation of private money through the establishment of lending credit against depository receipts, sometimes referred to as ‘fractional reserve banking’."

Sec. 402 (f) (2)... Page 41 of the PDF.

Unrealistic, I think, to try to prohibit fractional reserve banking.

It is like trying to prohibit gunpowder, or the spread of nuclear weapons, or any technological advance. It is like trying to prohibit the sunrise.

Not Using AutoCAD

We have two policy goals. We want growth, and we want stable prices.

We have two policy tools: We have fiscal policy, and monetary policy.

We have one arrangement of tools-and-goals that we use all the time: We use monetary policy to fight inflation, and fiscal policy to encourage growth.

To fight inflation, monetary policy takes money out of circulation. To encourage growth, fiscal policy encourages spending and credit-use.

Our policies remove money from circulation, but encourage spending and credit-use. Because of these policies, nobody has much money and everybody has a lot of debt.

This problem is about as difficult to solve as the problem I talked about yesterday in the AutoCAD post. That problem was a typo. This one is a failure to notice a conflict in policy. The mistakes are not similar. But neither is difficult to fix.

Emphasis Added

A remark by Jake of EconomPic, from The Story of Income and Outlays:

Slowing growth (not a downturn in growth) is all it takes for a levered financial system to be strained.

Let's make it: Slowing growth is all it takes for an excessively levered financial system to be strained. It is a way, in hindsight, to determine whether our economy was safely or excessively levered.

Finance, fractional reserve banking, risk, debt, capitalism, the use of other people's money -- all these things are essential in any but the most primitive economy. But excessive application of these essentials too often threatens to return our economy to a most primitive state.


UPDATE: 17 JAN 2011

From Steve Keen's Debtwatch, the 16 December 2010 post:

...it was to me (and many other non-neoclassical economists) all too evident that, at some stage, this growth of private debt would have to cease. When it did the mere fact that its rate of growth had slowed would cause a major recession.

Using AutoCAD

So I have in mind to stick a block in my drawing...

A "block" is just another drawing, usually not a very complicated one. It could show a tree or a toilet or a road sign or whatever you need to show often, in the drawings that you do. You can "drag-and-drop" to bring the tree-block or any block into your main drawing. Or you can insert a block using the "insert" command. Or you can do what I like to do, and write a program in VBA to handle the insertion and whatever else I want to do with that block.

I have in mind to stick a block in my drawing, an "info" block that will hold info about the drawing.

My InfoBlock is just some text inside a rectangle, on the "NoPrint" layer because I don't want to see it on the plotted drawing. Told ya, blocks are simple.

It's definitely the kind of thing I want to automate as much as I can: Stick the block in the drawing, automatically... fill out the info as much as I can, automatically... look up that info when I need it, automatically... and make design and drafting decisions based on that info... automatically.

That's the idea. But it starts, as you might expect, with a first step. I put the InfoBlock into my test-drawing by hand -- drag-and-drop -- so the first step then was to be able to find it automatically. That's where the VBA code comes in.

I have a bunch of useful routines already written...

I put 'em in a "CommonProject" file, which is available to any other project I'm working on. (I just use TOOLS:REFERENCES from the VBA menu to select the CommonProject, and the common code is accessible.) Of course, I don't have the InfoBlock code figured out yet, so it's not in my CommonProject... yet.

Among the routines in my CommonProject is ssSelect(). I use it to create "selection sets" of different drawing entities, depending what entities I want to work on.

To find the InfoBlock, I just tell the computer to look for all the blocks named "INFOBLOCK" in the drawing. One minor complication: Internally, AutoCAD calls a block an "INSERT" for some reason. But... I don't really care about the reason; I only need to know what to call the block so that AutoCAD will find it for me.

The screen-capture shown below is as far as I got, when I was fixing an error and decided to write this post. The screen-cap shows two working routines (one "Sub" and one "Function"). The Function returns a value, just like a function in the C language and just like a function in math class.

That's why I needed the "Sub" at this early stage. To test the thing, I run the Sub. The Sub runs the Function for me, and the Function returns a value to the Sub. I needed the Sub so I could display the information returned by the Function.

Anyway, the name of the Function is "getInfoBlock" and you can even see that name used in the Sub, where the Sub runs the Function.

And in the Function you can see my use of "ssSelect" to select all the INSERTs named INFOBLOCK in the drawing. The value returned by "ssSelect" gets put into the variable I call "ss" so I know where it is, so that I can use it.

In the next line after that, I'm already using the "ss" variable. I'm using the built-in "Count" property of the "ss" variable. If you remember, "ss" is a selection-set...

A selection-set is pretty much just what it sounds like: a set of drawing-entities that are selected.

The "ss" is a selection-set, containing all the blocks (or INSERTs) named INFOBLOCK that are in the drawing. Depending what drawing I use it on, there could be zero or more of those INFOBLOCKS. I need to have exactly one of them, before I can proceed.

So, what I had in mind to do was check the count, and if the count is one then I can proceed.

If the count is zero the code will "insert" one. If the count is more than one, the code will delete all but one of 'em. But I didn't get that far yet.

When I ran the Sub to try the code, it was not working. The MsgBox kept telling me that the TypeName was "Empty" when it should have been an "INSERT" or something, but definitely not "Empty."

Why am I looking for the type name "INSERT" instead of the ss.Count value? Because this is the "development" stage. If the code tells me it has an INSERT then I trust that it found the INSERT named INFOBLOCK. That is a lot more feedback than I get from the value of ss.Count.

You can see in the Sub that I started revising my call to "getInfoBlock." The green lines are the first version. (They are green because I made them comments. That way, they don't do anything, but I still have them handy in case I need them again.)

And below the two green lines in the Sub is another attempt to have the thing tell me that an INSERT is an INSERT. Still didn't work. So then, since there was nothing left to look at in the Sub, I started looking for an error in the Function.

Got it!

The code I had in mind to write was

If ss.Count = 1
but what I actually wrote was

If ss.Count - 1

Nice, right? The EQUAL key and the MINUS key are right next to each other on the keyboard, and I hit the wrong one.

For test purposes, I had exactly one INFOBLOCK in my drawing, so the ss.Count value was always one in my tests.

But because I wrote

If ss.Count - 1
the code was subtracting one from the ss.Count, which gave the value zero. So the code was saying If zero, then do stuff.

If zero, on a computer, always comes back false. And because it came back false, my "do stuff" command just didn't get done.

So I changed the MINUS sign to an EQUAL sign, and then it worked okay.


Long story? That's because I'm doing in English something that is more easily done in VBA, and trying to provide some background besides. Forgive me.

And what's the point of this long story?

The whole big, long, seemingly complicated problem was solved by changing a MINUS sign to an EQUAL sign. Finding the problem took some doing, sure. But the problem itself was extremely simple. As was the fix.

Got it?

That's the same level of difficulty as our economic problem.

Relentless

The ground is frozen, but the dandelions don't care. One gone to seed, and one still trying to bloom on 25 December! (upper right)

Not always as obvious as Niagara Falls and often easily overlooked, the relentless forces of nature are not unlike economic forces.

Comment #88

Krugman, The Opinion Pages, 12 December 2010:

The root of our current troubles lies in the debt American families ran up during the Bush-era housing bubble. Twenty years ago, the average American household’s debt was 83 percent of its income; by a decade ago, that had crept up to 92 percent; but by late 2007, debts were 130 percent of income.

SOURCE: CONTRAHOUR AT SEEKING ALPHA

So it's Bush's fault?

Too much politics in Krugman, and too short a timeline of debt growth.

And it's not just the debt of families. It's all debt. But the biggest, fastest increase was in financial sector debt which came out of nowhere and took the lead. That's where the crisis hit the fan, by the way: finance.

Moving on. Comment #88 on Krugman's article (the third comment here) opens thus:

It seems to me that if the problem is lack of demand because household debt is too high and households are going through a process of deleveraging, that we should not try to fix the problem by adding to the debt of our highly indebted public sector.

Comment #88 strikes me as a very popular view, but also quite confused. I applaud the commenter's explicit identification of debt -- household debt here, public sector debt there. Indeed, most people just call it debt, which makes the whole thing a jumble with no solution.

I've done the same, myself. So I know that being explicit about whose debt is whose is very useful. If people were not all so caught up in debt-as-a-bad-bad-thing, it would be easy to see that Comment #88 is quite confused:

We don't want to try to fix the problem of household debt by adding to public debt.

But why not? Is it because public debt is unrelated to household debt, so that adding to public debt is an irrelevant solution?

Is it because public debt is related to household debt, in some way that makes adding to public debt harmful to the household debt problem?

Those are the only choices: unrelated, or related.

Still, public and household debt could be related in some way that makes adding to public debt beneficial to the household debt problem. People just naturally assume that's not the case, because debt-is-a-bad-bad-thing.

I'm not so sure.



To borrow an opening from Comment #88: It seems to me that if the problem is lack of demand because household debt is too high and households are going through a process of deleveraging, that we should fix the problem by reducing household debt as a matter of policy.

The Arthurian solution is not to increase public-sector debt, but to reduce private-sector debt. I don't know why nobody else has picked up on this: Everybody says the problem was created by excessive debt in the private sector. And everybody says private-sector debt must fall before the economy can recover. But nobody says we should use policy to help reduce existing debt.

Policy is still all the other way: We need to get everybody using more credit, because that's what makes the economy grow.

Well, yeah. But the accumulation of debt that results from that strategy is the thing that inhibits growth. So if we cut in half the existing private-sector debt, the private sector will be prepared to grow again. And then it may be time to say we need to get everybody using more credit again.

Merry Christmas

It's from The Hunt for Red October

...checking my numbers... re-creating the Debt-per-Dollar graph... preparing for another post...

oh... Google has added more chart features... playtime... okay...

So, using the same three-source numbers for Total Debt that I've been using for a while now, and a good set of numbers for M1 money, I re-created my DPD graph:

Ah yes... it hits $10 in 1978... $20 in 1998... $30 in 2006... and peaks in 2007 at $35 of debt for every dollar of money in circulation.

...and they couldn't predict the financial crisis. Amazing.

As before, the blue, red, and gold trend-lines indicate the three different data sources, and the mis-match from 1956 to 1970 is still present, and again, the mismatch doesn't bother me, because it's the best data I could find.

I haven't yet figured out how to increase the size of the chart title. Obviously, sticking HTML code in there didn't help at all.

So then I took and edited the graph. All I did, actually, was click the Log Scale checkbox. All the same numbers, just a different view of them. This is the result.

Now we have three really very straight trend-lines: up until about 1932, then down until about 1948, and then a really long, straight-line uptrend for 60 years, to the Paulson Crisis of 2008, the crisis nobody saw coming.

When I first saw the log scale graph, my reaction was immediate:

"Now, that's gotta be man-made."

It Didn't Worry Adam Smith

From mine of 22 December:

Today, cost is divided between wages and profit, with some to rent, and much to a fourth factor that was less significant in Smith's time: the cost of interest.

I am not the first to add a factor to Adam Smith's list. Entrepreneurship is often added as a factor. But as Roger LeRoy Miller notes, entrepreneurship is "actually a subdivision of labor" [Economics Today, seventh edition. Harper Collins. Page 22.]

My view, it's just ego that wants to distinguish the entrepreneur from the riffraff of labor. According to Smith, payment for someone's time and effort, talent and skill is wages paid to labor, plain and simple. Let's keep the ego out of it.

Another item sometimes added to the list is government. This is a more reasonable addition, for a cost is clearly associated with government. Still, to call it a factor of "production" is somehow not right. Anyway, Smith explicitly excluded government from his list of factors:

All taxes, and all the revenue which is founded upon them, all salaries, pensions, and annuities of every kind, are ultimately derived from some one or other of those three original sources of revenue and are paid either immediately or mediately from the wages of labour, the profits of stock, or the rent of land.

Of course, in the same paragraph where Smith rejects taxes as a factor-cost, he also rejects interest:

The interest of money is always a derivative revenue, which, if it is not paid from the profit which is made by the use of the money, must be paid from some other source of revenue...

My view is that interest has become such a large cost in our economy, that it deserves to be broken out as a separate cost factor. This way we can watch it, and compare the growth of interest costs to the growth of profits and wages and rent.

It is not interesting (to me, anyway) to break out entrepreneurship from the body of labor and make this comparison. On second thought... maybe one day I'll do that.

But there is something to be said for breaking out the cost of government as a separate factor-cost, because, like interest, it seems to have grown substantially as a portion of total costs in our economy.

The fact that Adam Smith refused to include government as a separate cost makes one wonder whether that cost, like interest, was significantly lower in Smith's time.

Apparently it was not. I have this picture that shows a mountain of government debt, U.K. government debt, and I stuck an arrow on that picture to identify the year that The Wealth of Nations was published. (The year is easy to remember: 1776. Same year as our Declaration of Independence. Same year that The Decline and Fall of the Roman Empire was published. Peak of the Cycle of Civilization, I say.)

Net Public Debt of the U.K. was over 100% of GDP in 1776, and recently had been over 150%. But Adam Smith didn't think it was even worth noting. And he did not consider the cost of government significant enough to list it as a factor cost.

The economy is composed entirely of transactions.

Any other view is micro-management.

COST

There will be a quiz at the end.

"The Factors of Production"

The following table lists a few textbooks, showing the page number where the factors of production are discussed, and a snippet of discussion.

Date	Title	Author	Page	Excerpt
1958	Economics	Paul A. Samuelson	575	"Our traditional account of capital theory begins with a rather arbitrary division of all productive factors into three categories"
1969	Economics	Richard G. Lipsey & Peter O. Steiner	380	"Producers require land, labor, raw materials, machines, and other factors of production because these are needed to produce the goods and services that the firm sells."
1975	Economics	Campbell R. McConnell	N/A	N/A
1988	Economics	Edwin G. Dolan & David E. Lindsey	698	"Factor markets are important in determining how goods and services are produced"
2000	Macroeconomics	N. Gregory Mankiw	44	"Factors of production are the inputs used to produce goods and services"
2001	Economics	William J. Baumol & Alan S. Blinder	330	"Factors of production are the broad categories ... into which we divide the economy's different productive inputs"

I find it strange that the factors are typically not introduced early in these textbooks. I find it even more odd that none of these textbook authors are inclined to stress the importance of cost as the reason to have factor categories. (I include the 1975 book on the list because that's the book we used in the macro course I took.)

The importance of the factors of production does not arise from the fact that they are "arbitrary divisions," nor because they are "broad categories."

The factors are important because they are used in the production of goods and services, as some of the textbooks note. But they are not important because they "are needed to produce the goods and services that the firm sells." The factors are important because they are the components of cost. Adam Smith writes:

In every society the price of every commodity finally resolves itself into some one or other, or all of those three parts; and in every improved society, all three enter more or less, as component parts, into the price of the far greater part of commodities.

The factors of production are cost categories. Adam Smith identified three categories: land, labor, and capital. With each category he associated a cost: rent, wages, and profits. The factors are important because they allow us to analyze economic performance in terms of cost.

Today, cost is divided between wages and profit, with some to rent, and much to a fourth factor that was less significant in Smith's time: the cost of interest.


The economy is composed entirely of transactions. In every transaction, cost is a consideration; often it is the most important consideration. This is the reason that factor costs are important. And that is why the factors of production are important.

Because the economy consists of transactions, because transactions always occur at the intersection of cost and price, and because cost is always the limiting factor -- we are always willing to accept more in payment, but we are not always willing to pay more -- cost is the most significant of all of economic forces.

I am not satisfied that economists are aware of the significance of cost either in regard to our economy in general, or to the factors in particular. Reviewing the snippets in the above table, it is not clear that any of the textbook authors are even vaguely aware cost is the central concern that gives importance to the factors of production.


QUIZ, as promised:

Q: What is the most significant of all of economic forces?

A: Cost.

Q: What has the most influence on economic performance?

A: Cost.

Q: What is the limiting factor in every transaction?

A: Cost.

Q: What gives importance to the factors of production?

A: Cost.

At the Intersection of Supply and Demand...

Price is what we charge for goods and services...

Cost is what we pay.

Cost is a point on the demand curve. Price is a point on the supply curve. Where the two curves cross, cost and price are equal and a transaction may occur.

cf.

The Fair Labor Standards Act of 1938

From Elementary Economics by Fred Rogers Fairchild, Edgar Stevenson Furniss, and Norman Sydney Buck (of Yale University). The MacMillan Company, New York. Fourth edition; 1939. Pages 448-49.

The United States fair labor standards act of 1938
The latest attempt of the United States federal government to establish minimum wages on a nation-wide scale took the form of a law bearing the above title, which was approved on June 25, 1938... In the industries to which it is applicable the law attempts to establish maximum weekly hours as well as minimum hourly wages... The provisions for maximum hours are as follows: 44 hours per week during the first year; i.e., until November, 1939; 42 hours per week during the second year; 40 hours per week thereafter.

The Invisible Hand? That's Nothin!

Some people say that when times are good, workmen are more idle, and when times are hard they are more industrious than ordinary...

Adam Smith, The Wealth of Nations, Book 1, chapter 8:

In cheap years it is pretended, workmen are generally more idle, and in dear times more industrious than ordinary. A plentiful subsistence, therefore, it has been concluded, relaxes, and a scanty one quickens their industry. That a little more plenty than ordinary may render some workmen idle, cannot be well doubted; but that it should have this effect upon the greater part, or that men in general should work better when they are ill fed, than when they are well fed, when they are disheartened than when they are in good spirits, when they are frequently sick than when they are generally in good health, seems not very probable.


That men in general should work better when they are ill-fed than when they are well-fed, seems not very probable.

He's much easier to read than Marx. And what a nice guy!

Simplicity

Everybody thinks the economic problem must be really difficult, because it's such a big, long-lasting problem. That's not the case. The problem is simple: We confuse money and credit.

We confuse money and credit. Policy removes money from circulation, when really it should be removing credit from circulation, reducing debt, leaving our money alone. The problem is simple.

Someone looking for a complicated explanation won't find the answer. Do not look for complicated explanations. It's a simple problem.

Definitions of Aggregate Demand

9 DECEMBER 2010.. YESTERDAY I RAN ACROSS FLAVIAN'S THOUGHTS ON KARLSSON..
THIS MORNING I WOKE UP WITH PART OF THE FOLLOWING POST IN MY HEAD..

Back in the day when Stefan Karlsson still allowed comments on his blog and I still found him interesting, he opened his post The Logic of Say's Law with a robust claim:

Say's law has come under discussion, so I will now explain what it means and what it doesn't mean and why it is true.

Parts of his post sounded wrong to me, so I commented:

Stefan, I have another question. You write: "Say's law in essence means that there can never be deficient aggregate demand.... The reason for that is we always have unfulfilled desires, and thus always want more.... That is essentially always true, and is if anything even more true during recessions when people are compelled to cut back...."

I am trying to understand your definition of aggregate demand. It seems to be the sum of effective demand or effectual demand as defined by Keynes and Adam Smith, plus some unfulfillable wish list of additional demand. I assume that as usual I am misunderstanding something you have said.

By the way effective demand (for Keynes) is the demand that calls forth supply; and similarly for Adam Smith....

According to Karlsson, "there can never be deficient aggregate demand" because "we always have unfulfilled desires, and thus always want more."

This is nonsense.

"Aggregate" means "added up" or "total." Aggregate demand is total demand. But economists -- apart from Karlsson, evidently -- do not include in aggregate demand everything that anyone could possibly think they might want. Economists mean by it the total of actual demand, accounted as actual purchasing. Not wishes and wants and daydreams.

By "aggregate" demand I mean the thing that Maynard called "effective demand" and Adam Smith called "effectual demand".

"Effective" demand to Keynes is the demand that has an effect. This is not unfulfillable demand of any sort, but actual purchases.

"Effectual" demand for Adam Smith is not unfulfillable demand, but the demand of those who are willing to pay:

"The market price of every particular commodity is regulated by the proportion between the quantity which is actually brought to market, and the demand of those who are willing to pay the natural price of the commodity, or the whole value of the rent, labour, and profit, which must be paid in order to bring it thither. Such people may be called the effectual demanders, and their demand the effectual demand; since it may be sufficient to effectuate the bringing of the commodity to market. It is different from the absolute demand. A very poor man may be said in some sense to have a demand for a coach and six; he might like to have it; but his demand is not an effectual demand, as the commodity can never be brought to market in order to satisfy it."

Karlsson confuses aggregate demand with absolute demand. To Karlsson, "aggregate" demand means the sum total of everything that people may wish for. His reply to my comment confirms this view:

"Arthurian": I may have expressed myself in a way which will appear confusing. What I meant was that deficient aggregate demand can't cause a recession, the reason for this is that demand is determined by what we want and since we can't have all that we want (especially during recessions/depressions!), the underlying cause is that we lack the ability to supply something that the potential producers of what we want also wants, and that the crisis therefore is based on the mismatch between the structure of demand and the structure of supply.

I said to Karlsson: I am trying to understand your definition of aggregate demand. He responded by bringing recession into his explanation, and underlying causes, and mismatched structures. But setting all that aside, it turns out that Karlsson provides the same definition he gave in the original post: "demand is determined by what we want and ... we can't have all that we want." Aggregate demand, for Karlsson, is absolute demand. It includes the poor man's coach and six, and also my Ferrari.

For Karlsson, demand is determined by wants, not by purchases. Since wants are limitless, in Karlsson's view demand is limitless. But this is not a definition of demand. It is part of a definition of economic scarcity.

Demand is measured by what we buy, not by what we would like to have.


Update 30 December 2010:

At the Billy Blog, Billy defines "effective demand" as "spending backed by cash."

Policy in Pictures

After you do this to income...

...and this to demand...

...and allow this to happen to debt...

...for thirty years, and then the economy falls apart, you don't then turn around and say, Well, they had a grand party and now they must pay.

Were you having a grand party? I wasn't. I was working... and complaining about the price of gasoline.

Which Came First?

On the first graph, a change occurs around 1978. After 1978, income starts to concentrate.

On the second graph, a change occurs around 1981, After 1981, the trade imbalance grows significantly.

On the third graph, you can see debt starting to accumulate as far back as 1960.

On the fourth graph, inflation was tapering off until the mid '60s.

Debt accumulation came first. Inflation was the first result.

Nothing About Intrinsic Value

Adam Smith, The Wealth of Nations, Book 1, chapter 4

On the Origin and Use of Money
In all countries, however, men seem at last to have been determined by irresistible reasons to give the preference, for this employment, to metals above every other commodity. Metals can not only be kept with as little loss as any other commodity, scarce anything being less perishable than they are, but they can likewise, without any loss, be divided into any number of parts, as by fusion those parts can easily be reunited again; a quality which no other equally durable commodity possesses, and which more than any other quality renders them fit to be the instruments of commerce and circulation.


Numbers can not only be kept with as little loss as any commodity, as they are not at all perishable, but they can likewise, without any loss, be divided into any number of parts, as by simple addition those parts can easily be reunited again; a quality which no commodity possesses, and which more than any other quality renders them fit to be the instruments of commerce and circulation.

The use of metals in this rude state was attended with two very considerable inconveniences; first, with the trouble of weighing; and, secondly, with that of assaying them...

...we should find it excessively troublesome, if every time a poor man had occasion either to buy or sell a farthing's worth of goods, he was obliged to weigh the farthing.


Numbers have no such inconveniences.

Interest as Factor Cost

Adam Smith, The Wealth of Nations, Book 3, chapter 2:
The farmer, compared with the proprietor, is as a merchant who trades with borrowed money compared with one who trades with his own. The stock of both may improve, but that of the one, with only equal good conduct, must always improve more slowly than that of the other, on account of the large share of the profits which is consumed by the interest of the loan.

Isn't it Obvious?

Adam Smith, The Wealth of Nations, Book 3, chapter 2:
The proprietors of land were anciently the legislators of every part of Europe. The laws relating to land, therefore, were all calculated for what they supposed the interest of the proprietor.


Let wealthy men make law, and the law serves wealthy men.

Put lawyers in Congress, and they make laws no one can read.

No Imagination

I am always quick to admit I have no imagination. When I read the title of Paul Krugman's recent post -- Lawn Guyland Is America’s Future -- I thought he was referring to the rise of landscaping companies as the best "new engine of economic growth" we could hope for.

I had to say the words aloud -- "Lawn Guyland" -- to get PK's reference. Oh, well.

Anyway, in that post Krugman writes

A new Tea Party-backed county executive has taken office, gone ahead and cut taxes — and can’t come up with offsetting spending cuts.

"...can't come up with offsetting spending cuts."

Well, yeah. Because excessive spending is not the problem.

See? I say the same thing, over and over. No imagination at all.

Thoughts on Thoughts

VIC -- I HAVE REMOVED A WORD OR THREE FROM YOUR REMARKS BECAUSE I THINK IT MAKES YOUR THOUGHT STRONGER. DIDN'T ADD "..." BECAUSE THAT WOULD WEAKEN IT. ALSO I BROKE UP YOUR ONE PARAGRAPH INTO THREE, BECAUSE PARAGRAPHS HELP ME THINK. AND I AM CHANGING YOUR WORD "RATES" TO "LEVELS" (...pause...) BECAUSE I HAVE TO.

Responding to my recent post, BigVic writes:

So I turn back to the question that really deserves to be asked in this situation, why? Why allow ourselves to go down this road of credit borrowing and credit spending, why allow private debt to balloon to such astronomical levels, why allow every program to be financed through government debt?

I think that we don't ask these questions because the answer will undermine the system and world that we built. There is no way that most Americans would have been able to keep up with this farce that there is such a thing as the middle class. It is absolutely not possible without such credit policies in place.

If history has taught us anything it is that a strong middle class counters any revolutionary action from occurring in society. It is paramount for the stability of the United States and the system that a middle class is in place...

You write good, kid.

The middle sentence in the middle paragraph there is exactly right, I think. Without the "astronomical" expansion of credit use, There is no way that most Americans would have been able to keep up with this farce that there is such a thing as the middle class.

But if you go back to the 1950s and '60s when the economy was good, we had a strong middle class. Things fell apart then in the '70s, and by the 1980s we had a new kind of economic policy: Reaganomics. With that, the middle class began to wither away.

Reagan was admired like no other President in my lifetime except JFK. Reagan is held in high esteem, still today. And the policies he put in place are still cherished, despite the result we can see all around us.

It is essential to remember that the changes of the past 30 years are the result of the well-received policies of Reaganomics. For many people today there is a disconnect between those policies and the resulting conditions. Current trends of policy are empowered by that disconnect.


You write: a strong middle class counters any revolutionary action from occurring in society. Yes, and a dying middle class gives rise to Tea Parties.

I have to believe that Reagan knew, and every President has known, what you say about a strong middle class. I have to believe Reagan tried to keep the middle class strong with his supply side economics and his policies.

I have to believe, also, that people can see those policies have failed. I think the trouble is that people think there's no alternative to Reaganomics other than pro-debt "Keynesian" policies. But when the problem is excessive debt, one pro-debt policy is no different from another pro-debt policy.


You ask: Why? Why allow ourselves to go down this road of credit borrowing and credit spending, why allow private debt to balloon to such astronomical levels...?

I think you overlook the power of economic policy, Vic. We did not "allow ourselves" to go down that road; we were driven down that road by policy.

There is a whole industry in this country dedicated to helping people get out of debt. That industry would not exist if people were not willing to spend money trying to get out of debt. One might question the logic of such an expense. But the point is, we all of us are doing our best to avoid going down the road of debt accumulation.

Like the weight-reduction industry, the debt-reduction industry has had limited success, but the general trend of the nation is to get fatter, if you get my drift.

People often say we spent too much, we had a party for thirty years, and now we must pay. I say that's nonsense. Maybe some people spent too much. Most people were simply trying to slow the decline in their standard of living.

The problem is not profligate spending. The problem is that we use credit for money. It is difficult to avoid accumulating debt in a society that uses credit for money. And, obviously, one cannot use credit to pay off debt. Even to try would be self-defeating.


Without the astronomical expansion of credit use, as you put it, there is no way that most American would have been able to keep up with this farce that there is such a thing as the middle class.

But it didn't have to be that way. It only is that way, because the Federal Reserve pulled money out of circulation (to fight inflation) while Congress did everything it could think of to get us using more credit (to keep the economy growing). Apparently, they thought using money causes inflation, but using credit doesn't.

Silly boys.

Re-thinking Policy

The only way to fix the economy is to get rid of some debt -- a lot of debt, actually. But remember, it is private-sector debt that holds our economy down. Not public debt. So it is private-sector debt that must be reduced.

When at last we do that, if ever we do, the economy will grow like gangbusters again. With 30 years' of growth incentives in place? There'll be no way to stop the growth!

But when we finally get the economy growing again, we have to do things differently. We have to fight inflation differently. We can no longer expect the Fed to restrict the quantity of money, and curse them when they don't, and curse them when they do.

We must demand from the Fed a quantity of money adequate to support the existing level of economic activity. This will be a much greater quantity than we had, at least greater than we had before the Quantitative Easings.

We must demand from policy that it encourage credit-use for growth, but not for everything. We must expect the Fed to provide sufficient money to support the existing economy, and Congress must understand that credit is only for growth.

And we must invent a policy that uses accelerated repayment of debt to draw money out of circulation when we need to fight inflation, which is always.

The point of these changes is to get monetary stumbling-blocks out of the economy's way, so the economy will perform as we know it can.

Ohm... Ohm... Ohm...

Winterspeak of 25 September 2010 opens thus:
Some U Chicago professor made the impolitic observation that taxes on the "rich" don't actually fall on the rich at all. They fall on professional, college educated, working couples. He's been pilloried, and taken down the post (although I'm sure it lives on). Nevertheless, his central observation is quite correct.


A comment on the post, by Ohm, opens thus:
No matter what income level you increase taxes from, the act *by itself* will sacrifice some aggregate demand for goods, and some for financial assets like stocks. The key is in using the additional tax collected to generate moderate income jobs...


I like Ohm's insight. But his "key" won't unlock the door. Watch while I take his insight and go Arthurian with it:

No matter what income level you increase taxes from, the act *by itself* will sacrifice some aggregate demand for goods, and some for financial assets like stocks. If you take money away from people, people have less money.

But people already don't have any "excess" money. We've been pinching pennies and clipping coupons for years. Meanwhile, massive government debt and deficits show that government also has less money than it seems to need.

(Many people wouldn't agree that government has less money that it needs; but those people can't agree either, on which spending is the excessive spending. This is a clue that that spending may not be excessive and that the problem may lie elsewhere.)

Meanwhile, for the people and the government together, clearly, there is not enough money to meet the need for money. But with all the inflation we had in the last 45 years, everybody knows the Fed has been printing too much money. So, where is the money?

Where is the Money?

Consumers don't have it. Government doesn't have it. If I can use one of economists' favorite lines,

Y = C + I + G + NX

the C doesn't have it, and the G doesn't have it. That leaves only I or NX: Businesses, or Net Exports.

But businesses don't have the money, either. Well, maybe they do now, some of 'em, since the meltdown. But "since the meltdown" is not the normal economy. To see how we got into the melty mess we're in today, we have to go back and look at money in the normal economy.

Businesses didn't have the money. Profits were low, low enough that business was not good. That was the whole problem in a nutshell. Most income of business was tied up in maintaining the business. Restocking shelves. Meeting expenses, just like everybody else. Back in the "old" normal, businesses had cash-flow. But not a lot of money.

Now in the slump, businesses are restocking less; that's why some of them are sitting on cash. But again, we must understand things before the slump. Before the slump, nobody had much money: Not people. Not businesses. Not government.

By the formula, that leaves only NX. Net exports.

Our trade imbalance is certainly a drain of dollars from the U.S. economy. And, yes, the trade imbalance has been getting worse. But all that means is, the farther back you look, the less the trade imbalance is a reason money is in short supply in our economy.

We are left with a dilemma. The answer to our question, Where did the money go? is either
1. We lost it due to foreign trade; or
2. The money wasn't there, even before the trade deficit developed.
My answer: The money wasn't there.

If you look back far enough -- back in the 1970s, before there was a trade imbalance -- that is when our economic troubles started.

Look back to the years when growth was still good: the 1960s. No trade deficit, then, at all. Then in the 1970s, when the "golden age" ended and stagflation arose and the "Keynesian consensus" fell apart, and Nixon took us off gold, even then we had a pretty good balance of trade. It varied, but it varied around zero, the perfect balance of trade. We were not losing dollars to NX, then.

The "golden age" ended and our troubles began in the 1970s. The economy went bad before the trade imbalance developed in the 1980s. Like C and G and I, NX is not where our money went. There must be something else involved. Some other thing in our economy, that can influence the quantity of money.

Hmmm.

The obvious place to look for our money is the Federal Reserve. Everybody says they printed too much. Okay, but where is it?? It's not in any part of our economy that's identified in the economists' formula.

As I see it, they did not print too much money. They restricted too much, encouraging the use of credit instead. Accounts receivable, and credit-cards and such.

That's why business, in the old normal, didn't have money. Businesses had receivables: promises of promises to pay. Consumers had growing debt. And government had budgets that could not be balanced.

The Fed restricted money. And then Congress encouraged spending. And when the spending caused inflation, the Fed restricted more. And when restriction choked off growth, Congress created more incentives for growth and spending and credit-use.

Our use of credit increased faster than our use of money. Before long, we were not only using credit for growth. We were using credit for everything. Policy was replacing money with credit.

And that's when interest costs started contributing to inflation. And when the Fed saw inflation the Fed would raise interest rates, thereby increasing costs and choking off growth. And then, naturally, Congress would create more incentives for growth and spending and credit-use.

The unintended consequence of a conflict in economic policy left us with no money but plenty of spending incentives. Thus we became credit-users. For a long time, the economy got by like that. We thought it "normal." Economists called it the Great Moderation. And debt accumulated.

And then one day, it all fell apart.

This story explains why we have no money. No money, and lots of debt. If you take money away from people, people have less money. If you encourage credit-use, people have more debt. It ain't rocket science. It's policy.

So, Ohm, no matter what income-level you increase taxes from -- or decrease them, for that matter -- you're only moving the empty hole where money ought to be. Changing taxes doesn't solve the problem. We ought to know that by now, having passed that hole around like a hot potato since the 1970s.

Trade Imbalance (Overlay)

If you take the trade deficit relative to GDP...
Multiply by -1, so a growing trade deficit goes up...
Index the series on its average value, as Milton Friedman would do...
Create a graph from the numbers, in a Google Docs spreadsheet...
Add a constant, to shift the trend-line "up" a bit...
Stretch the graph, to make it comparable in size to the Saez graph...
And overlay the Trade Deficit graph on the Saez Income Concentration graph...
This is what you get:

THE BLUE LINE AND GRAY NUMBERS ARE THE TRADE-IMBALANCE OVERLAY

My feeling is, if I had the numbers used in the Saez graph, and I generated both graphs instead of trying to fit the one to the other, the similarity would be greater and the manipulation would be less.

I do not mean to imply that increasing income concentration caused or was caused by the growing trade imbalance. I mean to show that the same trend-change we see in the Saez graph is clearly visible in Trade Imbalance data.

And I do mean to imply that both changes, occurring almost simultaneously, were the result of changes in economic policy.

"tech" notes

I used the (free) PAINT.NET program to do these graphic manipulations.
I opened up the Saez graph and saved it as a PNG file (because PNG allows clear backgrounds).
I opened up the Trade Imbalance PNG. (GoogleDocs saves the graph as PNG by default.)
I used the "Magic Wand" tool to select the white background of the graph, and the DELETE key to erase that background.
I used the "Rectangle Select" tool to select and copy the Trade Imbalance graph.
Back in the Saez graph, I created a new layer and pasted the Trade Imbalance graph there. (Doesn't work if you don't create the new layer first.)
After pasting, I could move and stretch the Trade Imbalance graph, to align the X-Axis years and the Y-value trends.

Full Disclosure... I could have tried to make the one graph look like the other with this manipulation. What I did was try to see how similar they are.

Trade Imbalance (3)

Since 1960, the U.S. trade imbalance looks like this:

SOURCE: ST. LOUIS FED: FRED: TRADE IMBALANCE: BOPBCA

Stability until Nixon went off gold in 1971. Jittery then, but no real change until after the 1981-82 recession. Since that change, the graph shows the trade deficit increasing when the economy grows, and falling during recession, as Bastiat said.

The above graph has no context. To see the trade deficit in context, divide by GDP:

(The first graph shows monthly (BOPBCA) data. The second uses annual (BOPBCAA) data to work with annual GDP data. Annual data makes the second graph less jittery. Dividing by GDP provides context.)

At first glance, the second graph shows a general downward trend. But look closer. In the 1960s, we had a consistent (if small) trade surplus. In the 1970s there was more variation, but it looks to average out about zero for the decade: neither a trade deficit nor surplus. A trade balance, really, from 1969 to 1981.

Since 1981 or '82, the trade deficit grew substantially. (Even during that recession.)

The low point on the second graph occurs around 2005-06. The Y-Axis value there is -0.06, or 6 percent of GDP. That's more than the rough 4% estimate I came up with two or three posts back. (The trade deficit since fell to 4% with the recession.)

Okay, so the trade deficit is bigger than I thought. You could arbitrarily say it becomes a problem at 5% of GDP... and it has been more than 5% of GDP. I say the problem is not the level that has been reached, but the 30-year trend of worsening imbalance.