Forever More

My son Jerry sends me this Inequality and Crises PDF from Krugman's files -- slides for a presentation. "Sparse but interesting," Jerry says. "I don't know what 'words' were going along with the slides, but I like the graphs." My reaction, of course, is less brief.

The presentation opens with a graph from Piketty and Saez, showing the "top 1% share" of income. The graph is followed by Krugman's comments:

Pre-2008: When I would talk to lay audiences about inequality, I would mention that we were reaching levels not seen since 1929 – and that would inevitably lead to questions about whether we would soon have another Depression. No, I’d say – there really isn’t a clear reason why high inequality should lead to macroeconomic crisis.

And then ....

And then we had the Paulson crisis. Krugman never saw it coming. But that's not what bothers me. Look at Krugman's words: reaching levels on the one hand, and high inequality on the other. "High inequality" suggests stable inequality. "Reaching levels" implies change.

Here, let me re-word the thing. Krugman says income inequality is increasing. People ask if this is a problem. Krugman says high inequality is not a problem.

Krugman does not answer the question. His listeners probably never got to ask the follow-up question: What about when income inequality gets higher? But if Krugman answers, No problem, then ask: And what about when it gets higher?

I prefer a different graph, from Saez. This one I've used before. I added the red lines to show the trends that I see in the numbers.

The trend for most of the 1940s, the '50s, the '60s, and most of the '70s is flat. No change. Income inequality is what it is. End of story.

But it's a different story since the end of the 1970s. Income inequality starts increasing, and it increases relentlessly.

The midsection of the graph shows income inequality stable, and at a low level in comparison to the surrounding numbers. Karl Marx might have called it a high level of inequality. Either way, low or high, it is a stable, unchanging level.

The last 30 years of the graph show income inequality increasing: changing, and continuing to change. And that's the problem, that last bit: continuing to change. Obviously the trend of increasing inequality cannot continue forever. It cannot go beyond what Krugman might call "the upper bound." It cannot increase beyond 100%. And by the last year of the Saez graph it's already at 50%.

Income inequality does not fascinate me. I do not look to it for explanations of our economic troubles. I see income inequality more as a consequence of our economic troubles than a cause. A contributing consequence, if you prefer. But hey, try this on for size:

Suppose things were different. Suppose income inequality increased as shown, but then suddenly stopped increasing at 45% or even 48%. After that the trend would be flat again. We would have "high inequality" but there is no more "reaching" for even higher levels. Maybe then we would avoid the crisis?

If that sudden stop came as the result of policy, it would not be much different than what happened by accident. A few percentage-points less inequality, perhaps, and the crisis anyway. It is the stop that creates the crisis, not the level of inequality achieved.

Perhaps if rising inequality stopped gradually? No, I don't think that would make any difference. I think the wealthy few, like everybody else, want to turn money into "more money." I think they would not be fooled by a gradual decline in the growth of their income. I think we'd have had the crisis anyway.

I think that once the increase of inequality begins, if it lasts for any length of time, faster growth of income at the top becomes the new norm. And like anyone who gets paid, at the top they find getting a raise much easier to take than a pay cut. So once the increase of inequality begins, there may be no way to avoid a crisis when it ends.

I wonder if there are any stats on that.

Ignorance is Bliss

re: "stoking demand" versus "boost[ing] costs"

SIDEBAR:
"Printing money causes inflation." This is a notion associated with Milton Friedman, in my mind at least. But as Friedman pointed out, printing money influences prices via its affect on spending. Spending is the process by which demand is exercised. Demand is the driving force. It is a shortcut to say printing money causes inflation. Sometimes, it is a confusing shortcut. Demand is the driving force. But there is a problem with "demand" theory as well.
Demand has been supposed to cause prices to rise, as Anna Schwartz supposes, and Milton Friedman and, well, everybody. [See sidebar.] But prices are not supposed to start rising as soon as we start growing out of recession, nor while we are still in one.

That's why "stagflation" was such a big deal, way back when. The price increases are only supposed to happen, as Anna Schwartz explains, as capacity limits are approached.

Then again, as Bill Conerly's Capacity Usage graph shows, we've been reaching capacity limits at lower and lower levels since the 1960s.

So I have to say these things:

1. The argument that inflation is "demand-pull" -- that prices are pulled upward by growing demand -- does not explain the circumstances of the greater postwar period. This is important, for it was inflation that undermined the Keynesian consensus.

2. The alternative explanation -- cost-push inflation -- is often immediately rejected. "There's no such thing," I've been told by a very confident fellow. But rejection of ideas is not the same as evaluation or understanding. Anyway, the economy changes. What was true once may be true no more. Not only madmen in authority, but also men mad at authority may be slave to some defunct economist.

3. Inflation arises much sooner than it should, sooner than the standard explanation can explain. But this does not seem to bother anyone. We've settled for "low" inflation as an adequate substitute for "no" inflation. And we ignore inflation: Politicians and the media ignore inflation, until we can no longer ignore it. These are the only reasons the standard demand-pull story seems to hold true.

4. Why do we get inflation before we reach capacity limits? Why does capacity utilization peak at progressively lower levels? These are key questions, questions that if answered might help us solve the inflation problem, and help us understand the economy a little better. But it seems we prefer to ignore such questions, for they endanger our standard explanations of the world we live in.

Bowles Talks Trash

Writing blog posts is like making bread. You have to work the dough and work it, and work it some more. So today I review my posts from yesterday. And don't you know, there's something else I have to say.

Something stuck in my craw yesterday, from the Parade article. It was this remark from Erskine Bowles:

It’s really hard. We could end up walking away with nothing. But we are working together to come up with a commonsense solution. In ‘97, there wasn’t a soul who believed we could balance the budget, but we did.

In ‘97, there wasn’t a soul who believed we could balance the budget, but we did.

Erskine's magic, then, was that after starting with nothing in 1997, the budget was balanced by 1998. But that's not magic. It's trash. It stuck in my craw yesterday, and I did nothing about it. I figured it'd work itself out. But today, just now, I was reviewing my other post from yesterday, the one with federal deficit numbers, and I just started coughing it up.

Here's a brief summary of federal deficits:

The federal deficit hit a bottom at $290 billion in 1992. From that point there was continuous improvement, deficit reduction, until we achieved a budget surplus in 1998. And for two years after that the improvement did not let up.

Let's not talk about policy here, or who gets the credit. Let's look at what Erskine Bowles said. He said that in 1997, nobody had a clue we'd be able to balance the budget. But look at the graph. Look at where we were in 1997, with that very short blue bar indicating a budget very nearly in balance already.

Look at where we were in 1992, and look at the trend from 1992 to 1997, and tell me you agree with Bowles that no one thought we'd be able to balance the budget. I don't agree with Erskine Bowles on that.

Erskine, I gotta tell ya: If you want to fix the economy, ya gotta stop makin' up stories. Ya gotta start being honest about it. That's step one.

And Now for Something Really Weird

From Steve Keen's Debtwatch of 13 June:

A majority of the 16 individuals identified in Bezemer (2009) and (Fullbrook (2010)) as having anticipated the Global Financial Crisis followed non-mainstream approaches to economics, with most of them identifying as Post-Keynesian (Dean Baker, Wynne Godley, Michael Hudson, Steve Keen, Ann Pettifor) or Austrian (Kurt Richelbacher, Peter Schiff).

Apparently they did a study -- two studies -- and found out that 16 people "anticipated the Global Financial Crisis." Only sixteen people? That is just too bizarre.

As long as I'm pointing our weird, let me offend everyone by saying this: The trouble with economists is that they seem to insist -- even the sixteen wisemen among them -- insist on categorizing themselves as "post-Keynesian" or "Austrian" or "mainstream" or in some other group. Everybody wants to be in a slot. That's weird.

By contrast, I (not an economist) consider myself a student of the economy.

But enough with the weirdness. Keen's post is excellent. It comes as close to Arthurian economics, as close to my thinking as anything I have read. First of all, Keen is more concerned with private debt than public. Second, he seems to accept increases in public debt as the solution, or part of the solution to the crisis. Third, he pays little or no attention to M2 money, at least in this article.

The above excerpt is from the introduction of his post. The excerpt below is from his conclusion, here with my interruptions:

The core propositions shared by the Bezemer-Fullbrook group were that the superficially good economic performance during “The Great Moderation” was driven by a debt-financed speculative bubble which would necessarily burst...

The shift from Keynesian economics to Reaganomics was an attempt to fix a problem. That problem was slow growth. (The problem was that we could grow faster only by accepting more inflation. Since we (reasonably) rejected that alternative, the problem was reduced to "slow growth." But perhaps this reduction muddied the analysis from which the solution emerged.)

The cause of the problem was the decline in credit efficiency. (People say printing too much money causes its value to fall. Similarly, I say using too much credit causes its productive potential to fall: It causes credit efficiency to fall.) I refer you to my Credit Efficiency post, where I say that if growth was better in the 1980s than the 1970s, it was because the increase in debt was monstrous in the '80s.

Keen says the "superficially good economic performance" since the mid- to late-80s was "driven by a debt-financed speculative bubble." I say it was driven by the growth of debt. I say the host of Debtwatch has overstated the case.

Keynesian economics died in a morass of inefficient credit. Reaganomics attempted to solve the problem by greatly increasing the quantity of credit in use. It was a brute force technique, moderately and temporarily successful, but doomed to failure because the solution was based on an incorrect understanding of the problem.

... because the debt added to the economy’s servicing costs without increasing its capacity to finance those costs. At some stage, the growth of unproductive debt had to falter, and when it did a serious financial crisis would ensue as aggregate demand collapsed.

That is a beautiful explanation of an ugly problem. But the explanation is wrong. It suggests that if all the debt was productive debt, there would have been no problem. That's blindly optimistic. Accumulating debt would have created the crisis eventually, no matter how you label that debt.

It costs more to use credit than it does to use money. And debt is the measure of credit in use. A large burden of debt means lots of credit in use. It means the cost of credit-in-use is a large component of the costs in our economy.

Costs have consequences.

The policy rescues since that prediction came true have not addressed the fundamental cause of the crisis, which was the excessive level of private debt.

The excessive level of private debt was the fundamental cause of the crisis. Yes.

The deleveraging that the Group predicted has thus been slowed to some degree by government action, but the need for that deleveraging has not been removed.

The need for deleveraging remains. I recommend direct action: Print money and use it to pay off debt. It's a crude solution, but it solves the problem quickly.

As Figure 13 in particular emphasizes, the scale of that potential deleveraging appears certain to exceed that experienced in the Great Depression.

Yeah, I've been thinking about this. There is no reason to assume that the Second Great Depression will last 10 years just because that's how long the First Great Depression lasted. If the modern version of the "Roaring 20s" lasted two or three times as long, then painful aftermath may also last a generation, this time around.

The Blind Leading the Blind

Parade asks Can These Men Fix the Deficit?

Short answer: No.

The plan of these men is to cut spending. "Everything has to be on the table," Alan Simpson says. "We’re looking at how we can reduce discretionary spending," Erskine Bowles says, "... and mandatory spending."

What's wrong with that? Well, it doesn't work. That's what. We've been cutting spending since LBJ. And we had a total of five years with a balanced budget.

I'm not saying we need to spend more. Not at all. But I'm also not saying we need to spend less. Because the problem is not the spending we do. The problem is the stuff we use for money. We use credit for money. That's why we have so much debt.

Debt is not created by excessive spending. Debt is created by the use of credit. We're not a poor country. We're a rich country that uses credit for money. It makes us look poor, and it is making us poor. But this problem cannot be solved with spending cuts.

Another Piece of the Puzzle

While I was gathering numbers for yesterday's post, I ran across this graph:

It's a picture of weekly values of M1, or spending money. Money in circulation. On the right, in the middle of the fat gray bar, you can see Bernanke's trillions.

What I thought was interesting about this graph was the big bump there in the middle, rising until about 1995, then falling. A big bump in the quantity of money. The bump grabbed my attention because of its timing: 1993-4-5. There was a mini-golden age in the U.S. economy from 1995 to 2004. The good years began in 1995, just as the M1 bump was peaking.

Look at the bump from a different perspective. This graph shows annual change values for the M1 numbers:

M1 money growth zig-zags all over the chart. But the low point around 1989 and the high point around 1993 -- there, where it looks like it's giving you the finger -- identify the increasing money-growth that produced the M1 bump. And the upper half of the downtrend after 1993 helped to fill out the bump. After 1995 when the zigzag line drops below zero, the bump curves downward.

So we have a large increase in the quantity of M1 money, from 1989-1995, followed immediately by ten years of good economic performance. But that's not all we have. As the "golden age" link (above) shows, we have a significant drop in debt-per-dollar between 1990 and 1993.

A significant drop in debt-per-dollar at the same time that the number of dollars was rising to create the bump. You could say that the growing quantity of money was the cause in the DPD drop. I say that was part of it, but only part of it. Debt also fell during those years, or grew unusually slowly.

In 1990 and By 1991 the tax code changed. The personal tax deduction for interest expense was eliminated. As a result, people cut back on credit use. That, combined with accelerating M1 growth, created the wiggle in the DPD.

So we have a decline in credit-use, and an increase in the quantity of money. And after 3 or 4 years of that, we get a "golden" decade. Coincidence? Not in my book.

To me, it's Arthurian economics: Reduce the reliance on credit, increase the quantity of money, and accelerate the repayment of debt. In my book the events noted above, leading to a golden decade, are evidence that Arthurian policies work.

Oh -- and look at the effect on the federal deficit:

The deficit maxed out in 1992, then got progressively smaller until we got that first surplus in 1998. And the surpluses increased in size for two years after that, peaking in 2000. That is eight years of continuous improvement in the budget picture.

Clinton? Gingrich? I don't think so. I think the tax-code change of 1990-91 combined with the M1 bump of 1989-95 did the trick. It gave us a golden decade. And it balanced the budget.

Escape from the Planet of the Credit-Users

In yesterday's graph the quantity of spending-money falls to about ten cents per dollar's worth of output. When there are so few dollars circulating, it is hard to buy things, hard to sell things, and hard to put money aside in savings. Money doesn't facilitate well, when there's so little of it. The solution, the Arthurian solution, includes a doubling, more or less, of the quantity of spending money M1.

The obvious panic in your reaction arises from the potential for inflation in my plan. But there is no potential for inflation in my plan, for this reason: The plan also includes a reduction in our reliance on credit. I want to shift from money-that-costs-money-to-use to money-that-doesn't. I am increasing M1 money, but I am not increasing the stuff we use for money. I am changing that from mostly-red to mostly-green: From mostly credit, to mostly not credit. The change will reduce the factor-cost of money, and reduce structural inflation.

Everything that happens in out economy continues to happen, except, oh, say, business interest costs are lower, so that business profits are higher, so that economic growth is better; and business interest costs are lower, so that wages and salaries (and compensation of officers) can be increased, so that customers have more money to save and spend, so that economic growth is better.

This Google Docs graph uses FRED data from the St. Louis Fed. (Find them under THE ECONOMY:DATA in my links.) The St. Louis Fed says M1 "includes funds that are readily accessible for spending." This graph compares the quantity of spending money in our economy to the total purchase price of our GDP.

The graph is an update of yesterday's graph. Yesterday we saw M1/GDP drop fast-and-smooth from 1946 to 1980, the Keynesian half of the postwar period. Then during the Reaganomics half of the period, the M1/GDP trend continued to fall but the path was slow-and-bumpy.

Today's graph picks up at 1959, in the midst of the smooth Keynesian down-trend. And it continues out to January, 2010. Yesterday's graph ends at 2007, before all of the recent excitement.

See that little up-tick at the far right? Well, that's what Bernanke did for us. Bernanke's trillions, and the bailout, and the stimulus and all that. Perhaps you will remember this blue graph, with the big spike at the end that had everybody all upset:

That's the same event, the gigantic spike on the blue graph, and the tiny little upwiggle on my googleDocs graph. Yes, it was a big increase in "the monetary base," from about $0.8 trillion to more than $2 trillion. But the effect of that spike on my Google graph was almost insignificant.

I updated my graph because I was hoping that M1/GDP had climbed much higher. Ten cents is too low. Twelve cents is still too low. It should be about 20 cents. It wants to get there gradually, but it wants to get there.

And don't forget: The extra money in the economy will cause inflation, unless we invent some policies that get us using more money to pay off more debt. If we get those policies in place, our debt goes down. Our reliance on credit goes down. The factor cost of money goes down. And the threat of inflation goes away.

But I doubt Bernanke's plan calls for any reduction in our reliance on credit.

The Credit-Users

We have one abiding principle: Printing money causes inflation.

We have a rule that arises from this principle: Any time there is inflation, the Federal Reserve must restrict the quantity of money. I'd say it is a good rule, except for one thing: It does not work. The rule did work, but the economy gradually changed, and changes made the rule ineffective.

So now consider the rule: Anytime there is inflation, the Federal Reserve must restrict the quantity of money. Look for a flaw in the rule. I know it is hard to see the flaw, because the rule is such a basic part of our thinking. Here is a clue: Milton Friedman wrote something called "The Optimum Quantity of Money."

Here is the flaw: The rule has no lower limit. It only identifies "too much" money. It cannot identify "too little" money. And this flaw skews our thinking.

According to the rule, there is no optimum quantity of money. No matter how much or how little money there is, if there is inflation, there must be too much money.

The rule allows us to drive down the quantity of money below the optimum without any warning or indication at all. There never comes a time when the rule says, Stop! You've gone too far. The rule never says Something else must be wrong.

If printing money is the only thing that can possibly cause inflation, the rule is great. But suppose something else can cause inflation, something like borrowing money, say. Then it becomes possible -- or even likely -- that the Federal Reserve may restrict money, and restrict it more and more (as the Fed has indeed done) without ever extinguishing inflation

We use credit for money. The policy of eliminating money from circulation was the driving force that turned us into credit-users. But our reaction to policy changed the economy. Once we became credit-users, borrowing money became a more significant cause of inflation than printing money.

And after that, the rule didn't work anymore.

Yes, but

Yes, we need credit for growth. We need credit for increases in economic activity. But we should not need much credit to support the existing level of economic activity.