Friday, December 10, 2010

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.


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.


Jerry said...

It sort of looks like a good chunk of the money went here:

jbpeebles said...

Great post. This is classic Arthurian economics digging out the source of our problems: not an overabundance of money but a lack of it.

To follow these arguments, I think it's vital to get an understanding of the concept of Money As Debt, a Paul Grignon video that I believe just came out in its second version. Not only is the dollar an IOU, an accumulation of someone else's debt, it's also an electronic ledger entry, making it not only debt but synthesized in cyberspace.

Want to get richer in this environment? Wee, go get yourself some digital dollars. Speculate on a real asset like real estate or oil, like they did up to the 2008 crash.

I can't help but ponder the effect of credit money destruction on the derivatives market in 2008-9 (and still unfolding). If money is debt, more is more debt and more debt doesn't mean more assets. As a matter of fact, entire corporations can be created out of nothing overnight (and were), and profit from simply accessing credit, then buying Treasuries, or in the day, CDSs and MBSs.

Want to slow growth? Simply slow the creation of credit, or make existing debt worth that much less. After all a crushing of real estate values (and more significantly, the MBS that were based on them) makes credit and the dollar worth more! If credit shrinks, credit-money is less available meaning each dollar of credit money buys more, not less. Asset devaluation is the perfect compliment to the creation of money from scratch...

At a certain point, the giant money credit creation bubble has to be popped as real assets like gas balloon in cost/value, incurring political risk. Now if the Fed were trying to stop the roaring commodities market back in 2008, it could do so by stopping access to credit, like they did to Lehman. The fallout saw stock and equity values fell close to $20 trillion, which certainly destroyed a lot of dollars/credit money. As Art says, more money needs to be created and it won't be inflationary if asset values decline.

A hyperinflationary event could simultaneously be occurring within a depression, with new dollars--likely existing in credit form only--getting destroyed as quickly as they enter "circulation." Lent by the Fed, the dollars go straight into devaluing debt securities like Treasuries, trying to prop them up in a quid pro quo of access to cheap capital for buying the gov't's debt. As long as the money isn't physically created, or accessible to the economy, like Petrodollars accumulating in some oil rich Mideastern bank, there's no inflationary impact.

I guess we want some inflation, or so Bernanke has said.

Bigvic said...

Great post, but I think you lack one thing here: Why!

This bubble has been created because clearly since the late 70s early 80s China has been rapidly growing. Contrary to what most people think, that China started to grow at a high rate after liberalization in the 1990s, China actually started to grow after 1978. It is very clear that wealth is only relative to the amount of products there are in the world. Now if China starts to grow and we continue to grow, but production is barely higher or instead, we are exporting our production process to china, then that means that this growth here is just artificial since production has not grown in accordance with "real" growth. Then only explanation then for this "real" growth can be temporal, that is we borrow from the future, as your blog highlights so clearly in many posts. I had read a paper this semester discussing the implications of China leaving the periphery and joining the core capitalist countries and the global imbalance of this as the core countries would have to get poorer for China to get richer and the income of these countries become in relative equilibrium. This paper was written over a decade ago, and now we are actually starting to see some of this happen.

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 rates, why allow every program to be financed through government debt? I think that we don't ask these questions because the answer to these questions will undermine the system and world that we built. There is completely 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. 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. Now you could try and finance this through the rich, but it is not going to happen for the purpose of math or the fact that they control policy in this country and would not allow such a thing to happen.

This of course does not get into the obvious argument that without credit it will prove that growth would have been pretty stagnant for years or decades, and completely undermined the notion that the logic of capitalism brings people out of poverty and is good for society. In a "Democracy" you cannot force people to believe such things, you just need to convince in incremental doses at every available opportunity.

You ask the question:
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.

I actually think the answer is both. And that one kept facilitating the other in a dialectical manner. That seem tautological, but then that begs the question if they are not the same thing, or as Socrates would have, the same form. And I think you are neglecting the most important thing of all, the catalyst for this event, the OPEC embargo after the Yom Kippur war which could have sparked this dialectical process.

I really like your posts, and the Y=C+G+I+Xn model, so simple yet always speaks volumes. I think you are on the right track with this, maybe you should write a book or publish something, but I enjoy the direction you are taking economics. I guess issues like this show that economics is very far from being truly understood.

Greg said...

Another great post Art

Hey guys come here and comment on this thread

Not trying to hijack your blog Art but this post has the potential to be a great place for a meeting of some really big minds on money

In the first few comments we have David Andolfatto and Warren Mosler. Plus a few other commenters known to the MMT crowd, Tom Hickey and Ralph Musgrave.

The Arthurian said...

Greg, you pirate!!

Yeah, that is a good post and an impressive collection of wisdom in the comments.

But Mosler spammed the guy.

Greg said...

Yeah, I hope Warren comes back for more commentary.

Its definitely a topic I would like to see him discuss with David Andolfatto and Richard Serlin.

Greg said...

Warren must have his computer set to look for any references to "Printing Money"