Rest easy

As a follow-up to this morning's review of corporate taxes, just one more graph.
This one shows total corporate income tax paid, relative to GDP.

Since 1980 or so, the corporate tax has been in a holding pattern at 2 percent of GDP.

In other words, for every dollar of income you earn, some corporation somewhere pays about two cents income tax on the money that they earn.

Quick Review & Quiz

Current receipts of the Federal government (blue) and, for comparison, the portion of that which comes from corporate income taxes (red):

Revenue from the corporate income tax as a percent of Federal government receipts:

Next up, the two components of corporate profits: the portion that goes to pay corporate income tax (red) and the portion that remains after taxes (blue):

And the same two components as a ratio: Federal government tax receipts on corporate income as a percent of corporate profits after tax:

Q: At what point did rising corporate taxes begin to interfere with economic growth?

wfhummel.net: The Role of Bank Reserves

A few brief excerpts from William F. Hummel's The Role of Bank Reserves, along with a few brief reactions.

Experience Has Shown...

A minimum level of reserves was once regarded as necessary to ensure that a bank could meet the withdrawal of deposits. However experience has shown that a well-run monetary system can operate successfully with no minimum reserve requirements.

Bill Hummel's article is a child of the Great Moderation. The article is dated 2/17/03. 2003. The same year Robert Lucas wrote that the "central problem of depression-prevention has been solved". Things did go along for quite some time, didn't they, in a way that was considered "Great". But things did not turn out so great in the end.

It may appear that "a well-run monetary system can operate successfully with no minimum reserve requirements". But appearances are sometimes deceiving. Perhaps we should say only that a well-run monetary system can operate successfully with no minimum reserve requirements for a while.

What's That?

Mr. Hummel writes:

Reserves comprise funds on deposit at the Fed plus vault cash.

This is important. It defines which money is counted as reserves. Something I forget all the time. Something worth trying to remember, Art.

• Funds on deposit at the Fed. This is, you know, people's bank balances, except the "people" are banks, and the "bank" that they bank at is the Fed.

• Vault cash. This is money that the banks have, that they have in their vaults, set aside in reserve (so to speak). Not the money in the drawer at the window where the teller might use it to cash a check for you today. Or maybe it is, I don't know. (I read that money in ATM machines is considered "in the vault." So maybe the teller's drawer money is in the vault, too.)

Anyway, the concept of "reserves" is that the money isn't circulating, but is kept aside because, who knows, somebody might need to withdraw their money today. (Hmm. If the teller's drawer money is not considered "in the vault", maybe it should be.) "A minimum level of reserves was once regarded as necessary to ensure that a bank could meet the withdrawal of deposits," as Mr. Hummel says.

Even with no minimum reserve requirement, banks would still have to hold enough reserves at the Fed to cover the checks written by their depositors, and enough vault cash to meet the demand for currency.

Money in reserve includes:
• Funds on deposit at the Fed to cover checks that must be cleared.
• Vault cash to meet the demand for currency.

Now perhaps I will remember what reserves are.

Reserve Money Bears No Credit Risk

The Fed and other clearing banks typically require payment in reserve money which bears no credit risk, rather than direct transfers between private banks which do bear a credit risk.

The Fed and other clearing banks typically require payment in reserve money which bears no credit risk

money which bears no credit risk

rather than direct transfers between private banks which do bear a credit risk.

So, what's that? Payment in reserve money bears no credit risk.

Payment in reserve money bears no credit risk, because it is money. It is not credit and it is not debt. Thank you, Mr. Hummel.

Thank you very much.

Reserves Influence Bank Lending

Mr. Hummel writes:

In the long run, reserve requirements can also influence the level of bank lending, deposit rates, and the quantity of credit and deposits.

It's like pulling teeth to find somebody willing to say that. But it is important.

How do central banks control the interest rate?

Canada imposes no minimum reserve on its banks. Its central bank, the Bank of Canada (BOC), freely lends overnight at its so-called bank rate to ensure that payment orders between banks will clear. That sets an upper limit on overnight rates. It also pays interest on any clearing balances that banks hold at the BOC at a rate 0.5 percentage point below the bank rate. That sets a floor on overnight rates. Volatility in the money market rate is effectively limited to within this operating range.

The BOC target rate is the midpoint of the range. In order to steer the overnight rate toward its target, the BOC conducts open market operations similar to those used by the Fed.

I'm sorry. How do central banks control the interest rate?

In order to steer the overnight rate toward its target, the BOC conducts open market operations similar to those used by the Fed.

Oh, I get it. They buy or sell securities in the open market, changing the quantity of money in the economy in order to influence the interest rate. Got it.

Private Debt 2012 (6): Evaluating the Public Debt

Googling gross interest expense turns up an interesting About.com page -- Interest Income and Expense by Joshua Kennon.

Some income statements report interest income and interest expense separately, while others report interest expense as "net". Net refers to the fact that management has simply subtracted interest income from interest expense to come up with one figure. In other words, if a company paid $20 in interest on its bank loans, and earned $5 in interest from its savings account, the income statement would only show interest expense - net $15.

The amount of interest a company pays in relation to its revenue and earnings is tremendously important. To gauge the relation of interest to earnings, investors can calculate the interest coverage ratio.

I followed the link to Interest Coverage Ratio, also by Joshua Kennon:

The interest coverage ratio is a measure of the number of times a company could make the interest payments on its debt with its earnings before interest and taxes, also known as EBIT. The lower the interest coverage ratio, the higher the company's debt burden and the greater the possibility of bankruptcy or default.

Interest coverage is the equivalent of a person taking the combined interest expense from their mortgage, credit cards, auto and education loans, and calculating the number of times they can pay it with their annual pre-tax income.

Here's something:

General Guidelines for the Interest Coverage Ratio
As a general rule of thumb, investors should not own a stock that has an interest coverage ratio under 1.5. An interest coverage ratio below 1.0 indicates the business is having difficulties generating the cash necessary to pay its interest obligations.

Now we've got guidelines :)

Graph #1: Interest Coverage Ratio for the Federal Government

Graph #1 shows Current Receipts of the Federal Government, divided by Federal Outlays for Interest, or AFRECPT / FYOINT at FRED. The Current Receipts are in billions of dollars, and the Outlays for Interest are in millions, so I divided FYOINT by 1000 to convert to billions.

You can see on the graph a tall, sharp spike before 1945, related to wartime conditions I should think, then a drop, then near two decades of stability with an Interest Coverage Ratio around 15, or ten times the recommended guideline value.

A gradual decline begins in the late 1960s, and we see another decade or so of stability, 1985-1995, with the interest coverage ratio at about 6.0, or still four times the recommended level. Then the coverage ratio rises again and is now in the neighborhood of 12, or eight times the recommended minimum.

For what it's worth, then, if we judge by this business-world standard the Federal government's interest coverage ratio appears to be well out of any danger zone. This graph does not show the Federal debt to be the problem people think it is.

Some things cannot be said often enough. Excessive private debt is the problem.

:(

House Pulls the Plug After Eight Seasons:

After much deliberation, the producers of House M.D. have decided that this season of the show, the 8th, should be the last. By April this year they will have completed 177 episodes, which is about 175 more than anyone expected back in 2004.

Amateurishly done

This:

Professionally done

This.

Just remember -- they're not showing you debt. They're showing you what it would take to make the debt go away.

Sometimes I wonder who the people are that come up with such professional quality presentations, and what their motives really are.

Mitchell 17991 (1): The Least of My Concerns

The opening paragraph from the Billy Blog of 31 January 2012:

I was reading the recently published January 2012 Monthly Bulletin from the ECB yesterday. It provides a massive amount of interesting data about the developments in the Eurozone plus analysis. The descriptive analysis is fine (this went up, this went down) but the conceptual analysis leaves a lot to be desired. This is an institution that still talks about reference values of broad money as a policy target to control inflation. Basically, that idea has no application in our monetary system. But that aside, the release of the latest M3 data tells us how bad things are getting in the Eurozone and do not augur well for the coming year, despite the up-beat forecasts for real GDP that the ECB are still providing. The latest ECB data shows how bad things have become in Euroland.

"Broad money as a policy target to control inflation" is not high on my list of important economic topics. I have already quite thoroughly (I think) demolished the evidence that printing money causes inflation. So I'm not going to focus on that topic, even though it is the focus of Billy's post.

But this post of Bill Mitchell's, like so many of his posts, is extraordinarily dismissive of the economic thoughts and arguments with which he disagrees. Basically, the idea has no application he says. Granted, the topic of his post is to explain his point of view. But now I am stuck having to interpret his explanation in light of what I already know -- and what I know is that Billy simply dismisses arguments he doesn't like.

Graph #1: Some Mostly Parallel Lines on a Log Scale

The two lowest lines on Graph #1 are two measures of inflation, the CPI and the GDP Deflator.

The yellow line that starts at 1947, that's GDP. All the lines below the yellow one (except the lowest two) are money measures -- M1, M2, MZM, M3, and the monetary base. The blue-green line above GDP is total credit market debt owed, TCMDO.

All of these lines are basically parallel to each other and basically parallel to the path of inflation. Any one of them would give you an idea of inflation's path. Not that any of the money measures is a really good indicator of inflation, but they do show the trend.

So if the ECB wants to look at M3 money and use it as an indicator of inflation, well, they're not entirely out of the ballpark. It's a bit of an over-simplified approach but hey, the lines are parallel.

Like the wind

I complained about somebody mistaking observations for causes. The topic was the business cycle. JzB agreed:

This cycle does not cause recessions, the cycle is observable because recessions happen.

Exactly. We can see it, because it happens.

It's a common mistake, I guess, thinking that we see a thing, so it exists, so it must be the cause of [whatever]. I don't understand the logic. Maybe it's the tendency to go immediately to conclusion: I have seen the cycle, therefore the cycle must be the cause of recessions.

I wrinkle up my nose at that and shake my head and am left speechless. But it doesn't stop. Wikipedia does the same thing under the heading Endogenous money:

Proponents deny any practical impact of the money multiplier on lending and reserves.

Why are they even talking about the "impact of the money multiplier"? What is it, like a strong wind? Blowing your neighbor's garbage into your yard...

No. The money multiplier is a ratio of two numbers. It tells how much "money-and-credit" there is for each dollar of non-credit money. (It is sort of like my DPD ratio, actually!) There is in fact some amount of non-credit money in the economy, and some amount of money-and-credit. So you can figure the ratio. You can observe it. It exists.

But does it have an "impact"? No. The money multiplier is not the wind. The money multiplier is how much litter you picked up off your lawn. It is an indication of how strong the wind was. The wind is the economy, or something.

No.

The wind is the reliance on credit.