Versailles Treaty, Marshall Plan, Post-War Japan, MITI, Asian Tigers, Japan Inc., Asset Bubbles, Deflationary Spiral and Lost Decade

Posted by PITHOCRATES - February 21st, 2012

History 101

Douglas MacArthur brought some American Institutions into Japan and unleashed a lot of Human Capital

At the end of World War I the allies really screwed the Germans.  The Treaty of Versailles made for an impossible peace.  In a war that had no innocents the Allies heaped all blame onto Germany in the end.  And the bankrupt Allies wanted Germany to pay.  Placing impossible demands on the Germans.  Which could do nothing but bankrupt Germany.  Because, of course, to the victors go the spoils.  But such a policy doesn’t necessarily lead to a lasting peace.  And the peace following the war to end all wars wasn’t all that long lasting.  Worse, the peace was ended by a war that was worse than the war to end all wars.  World War II.  All because some corporal with delusions of grandeur held a grudge.

The Americans wouldn’t repeat the same mistake the Allies made after World War II.  Instead of another Versailles Treaty there was the Marshal Plan.  Instead of punishing the vanquished the Americans helped rebuild them.  The peace was so easy in Japan that the Japanese grew to admire their conqueror.  General Douglas MacArthur.  The easy peace proved to be a long lasting peace.  In fact the two big enemies of World War II became good friends and allies of the United States.  And strong industrial powers.  Their resulting economic prosperity fostered peace and stability in their countries.  And their surrounding regions.

MacArthur changed Japan.  Where once the people served the military the nation now served the people.  With a strong emphasis on education.  And not just for the boys.  For girls, too.  And men AND women got the right to vote in a representative government.   This was new.  It unleashed a lot of human capital.  Throw in a disciplined work force, low wages and a high domestic savings rate and this country was going places.  It quickly rebuilt its war-torn industries.  And produced a booming export market.  Helped in part by some protectionist policies.  And a lot of U.S. investment.  Especially during the Korean War.  Japan was back.  The Fifties were good.  And the Sixties were even better. 

By the End of the Seventies the Miracle was Over and Japan was just another First World Economy 

Helping along the way was the Ministry of International Trade and Industry (MITI).  The government agency that partnered with business.  Shut out imports.  Except the high-tech stuff.  Played with exchange rates.  Built up the old heavy industries (shipbuilding, electric power, coal, steel, chemicals, etc.).  And built a lot of infrastructure.  Sound familiar?  It’s very similar to the Chinese economic explosion.  All made possible by, of course, a disciplined workforce and low wages.

Things went very well in Japan (and in China) during this emerging-economy phase.  But it is always easy to play catch-up.  For crony capitalism can work when playing catch-up.  When you’re not trying to reinvent the wheel.  But just trying to duplicate what others have already proven to work.  You can post remarkable GDP growth.  Especially when you have low wages for a strong export market.  But wages don’t always stay low, do they?  Because there is always another economy to emerge.  First it was the Japanese who worked for less than American workers.  Then it was the Mexicans.  Then the South Koreans.  The three other Asian Tigers (Hong Kong, Singapore and Taiwan).  China.  India.  Brazil.  Vietnam.  It just doesn’t end.  Which proves to be a problem for crony capitalism.  Which can work when economic systems are frozen in time.  But fails miserably in a dynamic economy.

But, alas, all emerging economies eventually emerge.  And mature.  By the end of the Seventies Japan had added automobiles and electronics to the mix.  But it couldn’t prevent the inevitable.  The miracle was over.  It was just another first world economy.  Competing with other first world economies.  Number two behind the Americans.  Very impressive.  But being more like the Americans meant the record growth days were over.  And it was time to settle for okay growth instead of fantastic growth.  But the Japanese government was tighter with business than it ever was.  In fact, corporate Japan was rather incestuous.  Corporations invested in other corporations.  Creating large vertical and horizontal conglomerates.  And the banks were right there, too.  Making questionable loans to corporations.  To feed Japan Inc.  To prop up this vast government/business machine.  With the government right behind the banks to bail them out if anyone got in trouble.    

Low Interest Rates caused Irrational Exuberance in the Stock and Real Estate Markets

As the Eighties dawned the service-oriented sector (wholesaling, retailing, finance, insurance, real estate, transportation, communications, etc.) grew.  As did government.  With a mature economy and loads of new jobs for highly educated college graduates consumption took off.  And led the economy in the Eighties.  Everyone was buying.  And investing.  Businesses were borrowing money at cheap rates and expanding capacity.  And buying stocks.  As was everyone.  Banks were approving just about any loan regardless of risk.  All that cheap money led to a boom in housing.  Stock and house prices soared.  As did debt.  It was Keynesian economics at its best.  Low interest rates encouraged massive consumption (which Keynesians absolutely love) and high investment.  Government was partnering with business and produced the best of all possible worlds.

But those stock prices were getting way too high.  As were those real estate prices.  And it was all financed with massive amounts of debt.  Massive bubbles financed by massive debt.  A big problem.  For those high prices weren’t based on value.  It was inflation.  Too much money in the economy.  Which raised prices.  And created a lot of irrational exuberance.  Causing people to bid up prices for stocks and real estate into the stratosphere.  Something Alan Greenspan would be saying a decade later during the dot-com boom in the United States.  Bubbles are bombs just waiting to go off.  And this one was a big one.  Before it got too big the government tried to disarm it.  By increasing interest rates. But it was too late.

We call it the business cycle.  The boom-bust cycle between good times and bad.  During the good times prices go up and supply rushes in to fill that demand.  Eventually too many people rush in and supply exceeds demand.  And prices then fall.  The recession part of the business cycle.  All normal and necessary in economics.  And the quicker this happens the less painful the recession will be.  But the higher you inflate prices the farther they must fall.  And the Japanese really inflated those prices.  So they had a long way to fall.  And fall they did.  For a decade.  And counting.  What the Japanese call their Lost Decade.  A deflationary spiral that may still be continuing to this day.

As asset prices fell out of the stratosphere they became worth less than the debt used to buy them.  (Sound familiar?  This is what happened in the Subprime Mortgage Crisis.)  Played hell with balance sheets throughout Japan Inc.  A lot of debt went bad.  And unpaid.  Causing a lot problems for banks.  As they injected capital into businesses too big to fail.  To help them service the debt used for their bad investments.  To keep them from defaulting on their loans.  Consumption fell, too.  Making all that corporate investment nothing but idle excess capacity.  The government tried to stop the deflation by lowering interest rates.  To stimulate some economic activity.  And a lot of inflation.  But the economy was in full freefall.  (Albeit a slow freefall.  Taking two decades and counting.)  Bringing supply and prices back in line with real demand.  Which no amount of cheap money was going to change.  Even loans at zero percent.

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Keynesian Economics

Posted by PITHOCRATES - February 20th, 2012

Economics 101

John Maynard Keynes said if the People aren’t Buying then the Government Should Be

Keynesian economics is pretty complex.  So is the CliffsNotes version.  So this will be the in-a-nutshell version.  Keynesian economics basically says, in a nut shell, that markets are stupid.  Because markets are full of stupid people.  If we leave people to buy and sell as they please we will continue to suffer recession after recession.  Because market failures give us the business cycle.  Which are nice on the boom side.  But suck on the bust side.  The recession side.  So smart people got together and said, “Hey, we’re smart people.  We can save these stupid people from themselves.  Just put a few of us smart people into government and give us control over the economy.  Do that and recessions will be a thing of the past.”

Well, that’s the kind of thing governments love to hear.  “Control over the economy?” they said.  “We would love to take control of the economy.  And we would love to control the stupid people, too.  Just tell us how to do it and our smart people will work with your smart people and we will make the world a better place.”  And John Maynard Keynes told them exactly what to do.  And by exactly I mean exactly.  He transformed economics into mathematical equations.  And they all pretty much centered on doing one thing.  Moving the demand curve.  (A downward sloping graph showing the relationship between prices and demand for stuff; higher the price the lower the demand and vice versa).

In macroeconomics (i.e., the ‘big picture’ of the national economy), Keynes said all our troubles come from people not buying enough stuff.  That they aren’t consuming enough.  And when consumption falls we get recessions.  Because aggregate demand falls.  Aggregate demand being all the people put together in the economy out there demanding stuff to buy.  And this is where government steps in.  By picking up the slack in personal consumption.  Keynes said if the people aren’t buying then the government should be.  We call this spending ‘stimulus’.  Governments pass stimulus bills to shift the demand curve to the right.  A shift to the right means more demand and more economic activity.  Instead of less.  Do this and we avoid a recession.  Which the market would have entered if left to market forces.  But not anymore.  Not with smart people interfering with market forces.  And eliminating the recession side of the business cycle.

Keynesians prefer Deficit Spending and Playing with the Money Supply to Stimulate the Economy

Oh, it all sounds good.  Almost too good to be true.  And, as it turns out, it is too good to be true.  Because economics isn’t mathematical.  It’s not a set of equations.  It’s people entering into trades with each other.  And this is where Keynesian economics goes wrong.  People don’t enter into economic exchanges with each other to exchange money.  They only use money to make their economic exchanges easier.  Money is just a temporary storage of value.  Of their human capital.  Their personal talent that provides them business profits.  Investment profits.  Or a paycheck.  Money makes it easier to go shopping with the proceeds of your human capital.  So we don’t have to barter.  Exchange the things we make for the things we want.  Imagine a shoemaker trying to barter for a TV set.  By trading shoes for a TV.  Which won’t go well if the TV maker doesn’t want any shoes.  So you can see the limitation in the barter system.   But when the shoemaker uses money to buy a TV it doesn’t change the fundamental fact that he is still trading his shoemaking ability for that TV.  He’s just using money as a temporary storage of his shoemaking ability.

We are traders.  And we trade things.  Or services.  We trade value created by our human capital.  From skill we learned in school.  Or through experience.  Like working in a skilled trade under the guidance of a skilled journeyperson or master tradesperson.  This is economic activity.  Real economic activity.  People getting together to trade their human capital.  Or in Keynesian terms, on both sides of the equation for these economic exchanges is human capital.  Which is why demand-side economic stimulus doesn’t work.  Because it mistakes money for human capital.  One has value.  The other doesn’t.  And when you replace one side of the equation with something that doesn’t have value (i.e., money) you cannot exchange it for something that has value (human capital) without a loss somewhere else in the economy.  In other words to engage in economic exchanges you have to bring something to the table to trade.  Skill or ability.  Not just money.  If you bring someone else’s skill or ability (i.e., their earned money) to the table you’re not creating economic activity.  You’re just transferring economic activity to different people.  There is no net gain.  And no economic stimulus.

When government spends money to stimulate economic activity there are no new economic exchanges.  Because government spending is financed by tax revenue.  Wealth they pull out of the private sector so the public sector can spend it.  They take money from some who can’t spend it and give it to others who can now spend it.  The reduction in economic activity of the first group offsets the increase in economic activity in the second group.   So there is no net gain.  Keynesians understand this math.  Which is why they prefer deficit spending (new spending paid by borrowing rather than taxes).  And playing with the money supply.

The End Result of Government Stimulus is Higher Prices for the Same Level of Economic Activity

The reason we have recessions is because of sticky wages.  When the business cycle goes into recession all prices fall.  Except for one.  Wages.  Those sticky wages.  Because it is not easy giving people pay cuts.  Good employees may just leave and work for someone else for better pay.  So when a business can’t sell enough to maintain profitability they cut production.  And lay off workers.  Because they can’t reduce wages for everyone.  So a few people lose all of their wages.  Instead of all of the people losing all of their wages by a business doing nothing to maintain profitability.  And going out of business.

To prevent this unemployment Keynesian economics says to move the aggregate demand curve to the right.  In part by increasing government spending.  But paying for this spending with higher taxes on existing spenders is a problem.  It cancels out any new economic activity created by new spenders.  So this is where deficit spending and playing with the money supply come in.  The idea is if the government borrows money they can create economic activity.  Without causing an equal reduction in economic activity due to higher taxes.  And by playing with the money supply (i.e., interest rates) they can encourage people to borrow money to spend even if they had no prior intentions of doing so.  Hoping that low interest rates will encourage them to buy a house or a car.  (And incur dangerous levels of debt in the process).  But the fatal flaw in this is that it stimulates the money supply.  Not human capital.

This only pumps more money into the economy.  Inflates the money supply.  And depreciates the dollar.  Which increases prices.  Because a depreciated dollar can’t buy as much as it used to.  So whatever boost in economic activity we gain will soon be followed by an increase in prices.  Thus reducing economic activity.  Because of that demand curve.  That says higher prices decreases aggregate demand.  And decreases economic activity.  The end result is higher prices for the same level of economic activity.  Leaving us worse off in the long run.  If you ever heard a parent say when they were a kid you could buy a soda for a nickel this is the reason why.  Soda used to cost only a nickel.  Until all this Keynesian induced inflation shrunk the dollar and raised prices through the years.  Which is why that same soda now costs a dollar.

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FDR, Wage Ceiling, Arsenal of Democracy, Benefits, Big Three, Japanese Competition, Legacy Costs, Business Cycle and Bailouts

Posted by PITHOCRATES - February 14th, 2012

History 101

After the Arsenal of Democracy defeated Hitler the Wage Ceiling was Gone but Generous Benefits were here to Stay

FDR caused the automotive industry crisis of 2008-2010.  With his progressive/liberal New Deal policies.  He placed a ceiling on employee wages during the Great Depression.  The idea was to keep workers’ wages low so employers would hire more workers.  It didn’t work.  And there was an unintended consequence.  As there always is when government interferes with market forces.  The wage ceiling prevented employers from attracting the best workers by offering higher wages.  Forcing employers to think of other ways to attract the best workers.  And they found it.  Benefits.

Adolf Hitler ended the Great Depression.  His bloodlust cut the chains on American industry as they tooled up to defeat him.  The Arsenal of Democracy.  America’s factories hummed 24/7 making tanks, trucks, ships, airplanes, artillery, ammunition, etc.  The Americans out-produced the Axis.  Giving the Allies marching towards Germany everything they needed to wage modern war.  While in the end the Nazis were using horses for transport power.  This wartime production created so many jobs that they even hired women to work in their factories.  Bringing an end to the Great Depression finally after 12 years of FDR.

The Arsenal of Democracy defeated Hitler.  U.S. servicemen came home.  And the women left the factories and returned home to raise families.  With much of the world’s factories in ruins the U.S. economy continued to hum.  Only they were now making things other than the implements of war.  The auto makers returned to making cars and trucks.  The ceiling on wages was gone.  But those benefits were still there.  Greatly increasing labor costs.  But what did they care?  The American auto manufacturers had a captive audience.  If anyone wanted to buy a car or truck there was only one place to buy it.  From them.  No matter the cost.  So they just passed on those high wages and expensive benefit packages on to the consumer.  Times were good.  The Fifties were happy times.  Good jobs.  Good pay.  Free benefits.  Nice life in the suburbs.  All paid for by expensive vehicle prices.

The Big Three could not Sell Cars when there was Competition because of their Legacy Costs

But it wouldn’t last.  Because it couldn’t last.  For those factories destroyed in the war were up and running again.  And someone noticed those high prices on American cars.  The Japanese.  Who rebuilt their factories.  Which were now humming, too.  And they thought why not enter the automotive industry?  And this changed the business model for the Big Three (GM, Ford and Chrysler) as they knew it.  The Big Three had competition for the first time.  Their captive audience was gone.  For the consumer had a choice.  They could demand better value for their money.  And chose not to buy the ‘rust buckets’ they were selling in the Seventies.  Cars that rusted away after a few snowy winters.  Or a few years near the ocean coast.

The new Japanese competition started about 30 years after U.S. workers began to enjoy all those benefits.  So the U.S. car companies paid their union auto workers more and gave them far more benefits than their Japanese competition.  And those early U.S. workers were now retiring.  Giving a great advantage to the Japanese.  Because those generous benefits provided those U.S. retirees very comfortable pensions.  And all the health care they could use.  All paid for by the Big Three.  Via the price of their cars and trucks.

Well, you can see where this led to.  The Big Three could not sell cars when there was competition.  Because of these legacy costs.  Higher union wages.  Generous pension and health care benefits that workers and retirees did not contribute to.  (By the time GM and Chrysler faced bankruptcy in 2010 there were more retirees than active union workers).  The United Automobile Workers (UAW) jobs bank program where unemployed workers (laid off due to declining sales) collected 95% of their pay and benefits.  (You can find many quotes on line from a Detroit News article stating some 12,000 UAW workers were collecting pay and benefits in 2005 but not working.)  The Japanese had none of these costs.  And could easily build a higher quality vehicle for less.  Which they did.  And consumers bought them.  The Big Three conceded car sales to the Japanese (and the Europeans and South Koreans) and focused on the profitable SUV and truck markets.  To pay these high legacy costs.  Until the gas prices soared to $4/gallon.  And then the Subprime Mortgage Crises kicked off the Great Recession.  Leading to the ‘bankruptcy’ of GM and Chrysler.  And their government bailouts.

The U.S. Automotive Government Bailout cut Wage and Benefits once Set in Stone

The Big Three struggled because they operated outside normal market forces.  Thanks at first to a captive audience.  Then later to friends in government (tariffs on imports, import quotas, union-favorable legislation, etc.).  All of this just delayed the day of reckoning, though.  And making it ever more painful when it came.

During economic downturns (when supply and prices fall) their cost structure did not change.  As it should have.  Because that’s what the business cycle does.  It resets prices and supply to match demand.  With recessions.  Painful but necessary.  Just how painful depends on how fast ‘sticky’ wages can adjust down to new market levels.  And herein lies the problem that plagued the Big Three.  Their wages weren’t sticky.  They were set in stone.  So when the market set the new prices for cars and trucks it was below the cost of the Big Three.  Unable to decrease their labor (wage and benefit) costs, profits turned into losses.  Pension funds went underfunded.  And cash stockpiles disappeared.  Leading the Big Three to the brink of bankruptcy.  And begging for a government bailout.

Well, the bailout came.  The government stepped in.  Gave the union pension fund majority control of the bailed out companies.  Screwing the bondholders (and contract law) in the process.  And created a two-tier labor structure.  They grandfathered older employees at the unsustainable wage and benefit packages.  And hired new employees at wage and benefit packages that the market would bear.  Comparable to their Asian and European transplant auto plants in the right-to-work states in the southern U.S. states.  And put the market back in control of the U.S. auto industry.  For awhile, at least.

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Business Cycle

Posted by PITHOCRATES - February 13th, 2012

Economics 101

When you have a Captive Audience you can Charge whatever Prices you Want

Go to a football game lately?  Hockey?  Basketball?  Baseball?  It’s a pretty expensive day out.  Especially if you eat while in the stadium.  Those concession prices are pretty steep.  In fact, people say that stadium food is some of the most expensive food anywhere.  I don’t.  I say it is some of the highest quality and some the most fairly priced food you’ll find anywhere…in the stadium.

Stadium food is convenient food.  And that’s what you’re paying for.  Convenience.  Because it’s too great of an inconvenience to leave the stadium to buy a more reasonably priced hotdog someplace else.  And despite what the critics say of concession pricing, those concessions have long lines.  Because people may say the prices are too high.  But deep down they know what a bargain they are.  Delicious food cooked and sold only steps away from their seat.  It’s better than at home.  And there’s no cleanup.

When you have a captive audience you can pretty much charge what you want.  Because the market is fixed.  Stadiums charge a fortune for those concession spaces.  Because running a big stadium is expensive.  And it’s not really used all that often.  I mean, there are only 8 home games in the regular season in football.  Doesn’t give the stadiums much time to earn revenue to pay for these expensive things.  So they charge high fees wherever they can.  So the concessioners have to pass that cost on to the customer.  As all businesses do.  And when you have a captive audience it’s a whole lot easier to do this.  Because, where else are the people going to go?

Competition Increases Quality and Lowers Prices for Consumers

Let’s look at this in another way.  Say you have a friend who works for a catering company.  He drives a ‘roach coach’.  He stops at the factories and local construction site to sell food to hungry workers.  He sees the money these trucks make.  Considers his paycheck.  And thinks he’s tired of making his boss rich.  So he buys a truck for himself.  And looks for his own territory.

Now let’s say you go on an evening bike ride on weekends.  And you come across your friend.  He’s found some prime real estate to park his roach coach on.  In the median of a boulevard across from an automobile assembly plant gate.  Where he has a captive audience.  Hungry workers working the midnight shift with no place else to buy delicious food.  Business is good.  You stop by on your bike ride and buy a snack and chat.  Then one night you noticed a beat up Ford Pinto pull up in the median not far from your friend’s truck.  He pops the hatch.  And you start smelling something.  Something good.  Fresh pizzas.  And hot fresh subs.  This guy owns a pizzeria.  And just closed for the night.  After filling his car with fresh pizzas, hot fresh subs and soda.  And just like that business wasn’t so good for your friend anymore.  For fresh pizza and hot fresh subs are more delicious than the sandwiches and cans of stew your friend was selling.  But one thing the Pinto didn’t have that your friend did.  Ice.  He was selling warm soda.  Or trying to.  Your friend had cold soda.  And that was just what the doctor ordered on a hot, humid, summer night.  Your friend was now sharing his captive audience.  Selling less than he was.  And at lower prices because of this new competition.  But he was still able to turn a profit and make his truck payment.

Then the Pinto guy took it up a notch.  One night, as the workers headed out into the median on break, he pulled out a tub filled with ice.  And soda.  “Cold soda,” he barked.  “Ice cold soda.”  This squeezed your friend’s sales even more.  He had nothing left to compete with but price.  So he lowered his prices even further.  Barely breaking even.  Then one night someone else pulled up on the median.  A beat up AMC Gremlin.  Some kid just out of high school got out.  Popped the hatch.  And started barking, “Fresh McDonald Big Macs.  French fries.”  And, of course, ice cold soda.  The kid didn’t have a lot.  But what he had he was selling at a nice markup.  Which was enough for him.  Because he had no overhead.  And made enough to by some beer later that night.  A very modest sales goal.  But it split that captive audience three ways.  Soon your friend was losing money.  Then the economy went into recession.  And they discontinued the midnight shift.  Your friend lost his truck.  And went back to driving a truck for his former boss.  The Pinto guy increased his pizzeria’s delivery radius to make up for the loss business.  And hired the Gremlin kid to help with those deliveries.

The Business Cycle is a Natural and Necessary Part of the Economy and is the Only Way Supply adjusts to Demand 

From the perspective of the workers increasing competition made things better.  Competition gave them more variety.  Higher quality.  And lower prices.  Over time that competition gave them more value for their money.  This microcosm of the economy was booming for awhile.  Others jumped in.  Making investments.  Increasing their inventories.  But eventually they expanded too much.  Supply exceeded demand.  Some inventory went unsold.  Prepared food not being something you can return these people had no choice but to cut their prices.  To reduce those burgeoning inventories.  The guy with the highest overhead, your friend with the catering truck, was the first to fail.  Then the market collapsed completely with the elimination of the midnight shift.  So the other two had to shutter their operations there.

We call this the business cycle.  It’s the boom-bust cycle of the economy.  From good economic times (boom) to recessions (bust).  It’s the natural ebb and flow of economic exchange.  When the market presents a demand to be met supply flows into it.  At first prices and profits are high.  Like at a stadium with a captive audience.  Then competition moves in.  Unlike at a stadium.  That demand is now split between the competition.  Each sells less.  And profits less.  To try and increase sales they try to offer better value for the money.  Tastier food.  Colder soda.  Etc.  When that doesn’t work any longer they start lowering prices.  But because supply built up so much as eager competitors joined in get a piece of that action supply grew so much it exceeded demand.  And no amount of price cutting can fix that.  Only a recession.  To reset prices and supply to meet market demand.  Which means some businesses fail.  Those who don’t lay off employees.  To reset their prices and production to levels that meets demand.

Monetary and fiscal policy tries to massage this business cycle.  By softening the recession part of it.  By lowering interest rates.  To encourage businesses to invest and expand production.  And hire more employees.  Or by increasing government spending.  Creating jobs by building roads and bridges.  Or by simply giving more money to consumers (via tax cuts or stimulus checks) to encourage them to buy more.  Thus encouraging businesses to hire more workers.  To meet this ‘higher’ demand.  Of course, in our example, this wouldn’t have helped our three businesses.  None of them would have borrowed cheap money to increase supply.  Not when supply already exceeded demand.  In fact no amount of monetary or fiscal policy action would have helped.  It certainly wouldn’t have added back that midnight shift.  Unless the government started buying cars for people.  Which might have put people back to work on that midnight shift.  But such an expansion of government spending would have increased taxes.  So high that it would have reduced economic activity elsewhere.  As it transferred this money out of the private sector and into the public sector.  Saving a few jobs at the cost of consumers everywhere paying higher taxes.

The business cycle is a natural and necessary part of the economy.  It’s how supply adjusts to demand.  And the only way supply adjusts to demand.  Thanks to prices.  That automatic mechanism that tells businesses exactly where supply should be.  And by interfering with this you make markets operate blindly.  Unable to know when supply exceeds demand.  So supply keeps increasing even after it already exceeds demand.  Creating bubbles.  And when the bubble bursts prices plummet.  To unload those burgeoning inventories.  Making recessions longer and more painful than they need be.

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Fiscal Policy

Posted by PITHOCRATES - February 6th, 2012

Economics 101

The Constitutional Convention in Philadelphia (1787) was about Money and Unity at the National Level 

Once upon a time in America federal taxes were small.  As was federal spending.  The Constitution called for little.  The only big ticket items being an army and a navy.  To protect the new nation.  But Americans didn’t like paying taxes then any more than they do now.  There wasn’t even a federal income tax until the 16th Amendment (1913).  So even maintaining an army and a navy was difficult.  Which led to a lot of problems.  For a nation that couldn’t protect herself got pushed around in the rough and tumble world.  And the U.S. took its share of swirlies and wedgies in her infancy.  Figuratively, of course.

Just as kings needed money to maintain their kingdoms, the Americans needed money to maintain their new nation.  Which was the point of the Constitutional Convention in Philadelphia (1787).  It was about the money.  And unity.  Which the new nation (that just gained its independence from Britain) had little of.  So we got a new constitution.  And a new nation.  And the federal taxing and spending began.  Which was small at first.  Too small for Alexander Hamilton.  But far too much for Thomas Jefferson.  In fact, Jefferson thought any federal spending above zero was too much.  And when he was president he slashed government spending.  To the point that it hurt the safety of the United States.  But he also bought the Louisiana Territory.  And used the Navy and the Marine Corps to protect American interests abroad.  These two items alone required enormous amounts of federal spending.  And borrowing.  Another thing Jefferson was dead set against.  And we’re talking sums of money that not even Alexander Hamilton had proposed.  Yet here was Jefferson, the limited-government president, spending and borrowing unlimited funds. Being more Hamilton than Hamilton himself.

Of course, things change.  Even for Jefferson.  The Louisiana Purchase was a deal that no president should have passed up.  Thankfully, Jefferson took that opportunity to more than double the size of the United States.  Without a war.  Unlike Napoleon who was conquering Europe.   But he was burning through money.  And he needed money more than he needed the Louisiana Territory.  Hence the Louisiana Purchase.  Which turned out to be quite the bargain in the long run for the U.S.  And the antimilitary Jefferson flexed America’s might by teaching the Barbary pirates a lesson.  By deploying the U.S. Navy and Marines to the Shores of Tripoli.  The first U.S. victory on foreign soil.  Giving the U.S. respect.  And a cessation of those swirlies and wedgies.

Keynesian Stimulus Spending may lessen the Severity of Economic Recessions

These things cost money.  And the lion’s share of the federal budget was defense spending.  Per the Constitution.  For that was one of the main things the several states could not do well.  Maintain an army and a navy.  Because they needed unity.  One army.  And one navy.  To protect one nation.  So the states and their people could pursue happiness without foreign aggressors molesting them.  So this is how federal spending began.  But you wouldn’t know it by looking at fiscal policy today.

Fiscal policy is the collection of policies that government uses to tax and spend.  But it’s more than just defense spending these days.  Federal spending had grown to include things from business subsidies to Social Security to Medicare to food stamps to welfare to income redistribution to farm subsidies.  And everything else you can possibly imagine under the sun.  None of which was included in the Constitution.  Because neither Jefferson nor Hamilton would have agreed to these expenditures.  But it doesn’t end with this spending.

Fiscal policy also ‘manages’ the economy.  Or tries to.  By trying to maintain ‘full employment’.  Which means they adjust tax and spend policies so that anyone who wants a full time job can have one.  Based on Keynesian economics.  And the business cycle.  The business cycle is the cyclic economic transitions between economic expansions and contractions.  The inflationary and recessionary boom-bust cycles.  No one likes recessions.  Because people lose their jobs.  And have to get by on less money.  So Keynesian economists say to lessen the severity of recessions the government can take action to stimulate economic activity.  They can cut taxes.  Because when people pay less in taxes they have more disposable income to spend on economic activity.  Which they say will keep people from losing their jobs.  And create new jobs.  Or the government can spend money.  Picking up the slack from consumers who aren’t spending money.  Thus saving and/or creating jobs.  Which stimulus depends on the political party in office.  In general, Republicans favor tax cuts.  And Democrats favor spending.

All Keynesian Stimulus Spending is Deficit Spending

But it’s not as simple as that.  Because during recessions tax revenues fall.  When people earn less they pay less in taxes.  Far less.  Especially if an interruption in their income puts them into a lower tax bracket.  And if you run through all of your unemployment benefits, it will.  So there’s more to economic stimulus than meets the eye.  For to stimulate a government must borrow money.  Or print money.  Because all stimulus spending is deficit spending.

Keynesians say this deficit spending is not a problem.  Because once the stimulus turns the economy around there will be plenty of new tax revenues to pay back the money they borrowed.  But that rarely happens with a tax and spend government.  Because they like to spend.  As is evident by the ever increasing federal debt.  And when they get more tax revenue they spend that tax revenue.  On anything and everything you can possibly imagine under the sun.  Often times cutting defense spending to help pay for all that other spending.  Despite defense spending being one of the few things enumerated in the Constitution.

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FT103: “If General Grant used Keynesian tactics he wouldn’t have given up the attack on Cold Harbor until all of his soldiers were dead.” Old Pithy

Posted by PITHOCRATES - February 3rd, 2012

Fundamental Truth

On the Eve of Cold Harbor Grizzled Union Veterans pinned Scraps of Paper with their Names and Home Cities Inside their Jackets

General Grant has a few reputations.  That he was a drunk.  He wasn’t.  He just couldn’t hold his liquor.  And he hated inactivity.  And being away from his family.  Two things that led him to drink.  They also called him a butcher.  That he cared little for his men.  Which wasn’t true.  The bloodiest single day of battle in the Civil War was the Battle of Antietam.  Grant wasn’t there.  The bloodiest battle was the three days at Gettysburg.  Grant wasn’t there.  One of the greatest Union defeats was at Fredericksburg.  Grant wasn’t there.  So it wasn’t Grant.  It was the tactics used in the Civil War.  Napoleonic tactics.  Massing great ranks of soldiers opposite great ranks of soldiers.  Fire a few shots.  Close in on each other.  Then finish the job with the bayonet.  And plenty of finishing was needed as those Napoleonic weapons weren’t rifled.  Or all that accurate.

The weapons were rifled, though, in the American Civil War.  And far more accurate.  So they killed a lot of soldiers as they massed and fired.  And killed even more as they closed in to finish the job.  They soon learned that massing troops in the open on the field of battle was not a good idea.  Instead they looked for good ground to defend.  At Antietam there was a sunken road in the center of the Confederate line.  One of the first trenches used in warfare.  Lee failed at Gettysburg because General Ewell failed to take the high ground on the eve of the first day of battle.  Over night the Union entrenched strong defensive positions.  That held for days 2 and 3.  At Fredericksburg there was another sunken road.  This one was behind a stone wall.  It was also on the high ground.  And that’s where the Confederates were when the Union attacked.  And lost the battle.

General Lee was a combat engineer in the Mexican War.  Some called him the King of Spades.  So fortifying defensive positions was something he was good at.  And became better at.  Building breastworks.  Which even the odds in battle when a numerically superior force attacks a smaller entrenched force.  Like at Cold Harbor.  Where the breastworks zigzagged for 5 miles.  Allowing the defenders to shoot into the front of the attacking force.  As well as into the side of the attacking force.  Which is why on the eve of battle the grizzled veterans in the Union Army pinned scraps of paper with their names and home cities inside their jackets.  An early dog tag.  So when they attacked those heavily fortified defensive positions in the morning their surviving comrades could identify their bodies and send them home to family for burial.  Which, sadly, proved very useful after the battle.

The Problem with Keynesian Economics is that it interferes with Market Prices causing Inflation and Bubbles

The attack was over in less than an hour.  Seven thousand Union soldiers fell killed or wounded.  Grant regretted his order to attack until his dying day.  And he wouldn’t give such an order again.  Because he learned the folly of attacking entrenched positions.  And began adjusting his tactics to match the technology of the battlefield.

Sometimes it’s easier to identify failed policies in war.  It may have taken some time.  But it eventually became clear.  For when the casualty rates soared people were less willing to send their sons off to war.  Making the cost of those failed policies very real.  And personal.  Not abstract numbers.  Like in economics.  Where few understand what Keynesian economics is.  Or how to identify if these policies work.  Or if they fail.  For if you listen to Keynesian economists they never fail.  And when they do it’s not because they’re wrong.  It’s because those using them weren’t bold enough.  Such as using a Keynesian economic stimulus to pull an economy out of a recession.  It didn’t work in the Seventies.  And it didn’t work in the most recent recession.  The Great Recession.  And how do Keynesians explain this failure?  The economic stimulus wasn’t big enough.

The problem with Keynesian economics is that it interferes with the market forces.  By denying reality.  The business cycle.  The cycle between good economic times and bad economic times.  From periods of expanding economic activity to periods of contracting economic activity.  It’s this second half of the business cycle that Keynesians were especially trying to deny.  Recessions.  Those things that correct prices at the end of a growth cycle.  Before inflation can set in and wreak its havoc.  And when Keynesians interfere with this market mechanism the market doesn’t correct prices before inflation sets in.  So prices keep rising.  And they create asset bubbles.  Like housing bubbles.  Like the one that led up to the Subprime Mortgage Crisis.  And because Keynesians interfered all they did was delay the inevitable.  Allowing prices to rise higher than they normally would have.  Which meant they had further to fall.  Creating a longer and more painful recession than there would have been had they not interfered.

Unlike a Keynesian, General Grant Recognized a Failed Policy and Stopped Using It

Keynesians try to reduce economics down to a set of mathematical equations.  That they accept on faith.  Blinded by their ideology.  And refuse to recognize their failure.  Which is why they continue to interfere with market forces.  And continue to make recessions longer and more painful than they need be.  While strewing a swath of economic destruction in their path.  Like all of those home owners who lost so much value in their houses that their mortgages are now greater than the market price of their house.  Many lost their retirement nest egg in the process.  Some even had to alter their retirement plans because of their losses.  Or go back to work in their retirement.

These aren’t bodies littering a battlefield.  But the Keynesian carnage has destroyed lives just the same.  Impoverishing future generations to pay for their inept policies.  For people not even born today will have a tax bill so great that it will diminish their living standard far below what we enjoy today.  As bad as that is what’s worse is that they don’t change their policies after these failures.  Believing that the only reason they’ve failed is because they didn’t try them on a grand enough scale.  Or the government quit them before they had a chance to work. 

Thankfully General Grant didn’t use such Keynesian thinking at Cold Harbor.  Had he used such reasoning he would have ordered a second assault.  And a third. And kept ordering them as long as he had living men to send in against that entrenched defense.  But he didn’t.  Why?  Because he was smarter than a Keynesian.  He recognized a failed policy.  And stopped using it.

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Inflation and Deflation

Posted by PITHOCRATES - December 26th, 2011

Economics 101

When Demand is Greater than Supply there’s Inflation, when Supply is greater there is Deflation

Agriculture advances gave us food surpluses.  Food surpluses gave us a division of labor.  The division of labor gave us trade.  Money made that trade more efficient.  Religion and the Rule of Law allowed great gatherings of people to live and work together in urban settings.  Free trade let us maximize this economic output and elevated our standard of living.  Free labor sustained economic growth by increasing the number of people making economic exchanges.  Prices automated the process of assigning value and allocating scarce resources (that have alternative uses).  And provided incentive and competition.  The free movement of prices in our economy, then, is very important.  So important that we track extremes in these movements and give them special names.  Inflation.  And deflation.

When the economy is good we typically see prices increase.  Because the greater amount of economic activity is competing for the same scarce resources.  So businesses ‘bid’ up the price of these scarce resources.  To make sure they get what they need before someone else beats them to them.  This more intense competition for these resources causes their prices to rise.  We call this inflation.  Telling other suppliers that demand is greater than the current supply.  This encourages suppliers to bring more supplies to market.  And attracts others into the market.  As this happens the available supply of these scarce resources increases.  And approaches the level of demand.  Where prices then stabilize.

This is the free market correcting prices.  Prices were high because demand was greater than supply.  When supply caught up to demand they stopped rising.  And if supply continues to grow and exceeds demand they will start falling.  Because those scarce resources won’t be so scarce anymore.  Which happens when people bring too much supply to market.  Of course they have no way of knowing this.  Until the prices tell them so.  Falling prices, then, are a signal that supply has exceeded demand.  So suppliers scale back on what they bring to market.  We call this fall in prices deflation.  And when supply drops at or below demand the price correction is complete.  And prices stop falling.

When Government Interferes with Market Prices we can get Bubbles where both Prices and Supply are High

This price-correction deflation goes by another name.  Recession.  And we call this inflation/deflation cycle the business cycle.  Often referred to as a boom-bust cycle.  Times are good on the inflation side.  But not so good on the deflation side.  Because recessions aren’t fun.  Unless you like periods of high unemployment.  But it’s a natural and necessary part of the business cycle.  It’s how the free market corrects prices.  Allocates scarce resources that have alternative uses.  And provides incentive and competition.  Everything that makes free market capitalism function.  Providing the highest standard of living man has ever known.

But some in government like to tinker.  They think why not make the inflation part last longer?  And try to end the deflation part?  So they play with the tools at their disposal.  Monetary policy.  Fiscal policy.  And regulatory policy.  To stimulate demand beyond what the market is demanding.  To keep the good times rolling.  Where we live with permanent but ‘manageable’ inflation.  And avoid deflationary periods all together.  And recessions.  Sounds good.  In theory, at least.  But it rarely ends well when the government interferes with market prices.

When they interfere with market prices they give false information to those in the market.  Continued inflation means continued high prices.  Prices go even higher than they would have if left to market forces.  Indicating a high demand when there is none.  So suppliers rush in to meet this false demand.  Greatly increasing supply beyond demand.  Creating what we call a bubble.  Where both prices and supply are high.  An artificial creation.  And one that cannot last.  And when prices do correct they have a lot farther to fall.  As excess supply is sold off at discount prices.  And employers cut back and shed excess capacity.  Creating high levels of unemployment.  And a long and unpleasant recession until prices finally stabilize once again.  When supply once again matches demand.

The More we try to Eliminate the Deflationary Side of the Business Cycle the More Painful the Recession

Interestingly, government interference into the free market was to eliminate the business cycle.  Especially the unpleasant deflationary side of it.  But their actions only made the deflationary side far more painful.  Because it was their actions that created those inflationary bubbles.  Not the market.  Their actions only delayed the inevitable market correction.  It couldn’t stop it.  Nothing can.  The more they tried the bigger the bubbles they created.  And the bigger the bubble the bigger the correction.  And the more painful the recession.

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LESSONS LEARNED #80: “A nation’s government spends too much when its spending increases at a rate greater than its population growth.” – Old Pithy

Posted by PITHOCRATES - August 25th, 2011

Exchanging Dollars for Gold at $35/ounce was a Strong Incentive not to Depreciate the Dollar

It’s no secret.  Government spending is growing out of control.  It’s producing record deficits.  That caused S&P to downgrade America’s AAA sovereign debt rating.  No one denies that it’s a problem.  This spending.  Those on the Right want to address this via spending cuts.  Those on the Left just want to keep raising taxes.

LBJ exploded government spending with his Great Society in the Sixties.  Back then the U.S. was still on a quasi gold standard.  The U.S. honored an exchange of dollars for gold.  The point of this was to prevent the government from printing too much money.  Print too much and you depreciate the dollar.  So when you promise to exchange dollars for gold at $35/ounce you have an incentive not to depreciate the dollar.  Because as that $35 will buy less and less everywhere else, it will always buy an ounce of U.S. gold.

Well, with the Vietnam War and the Great Society, President Nixon had an unpleasant decision to make.  Unpleasant for a politician.  Either cut spending.  Or print money.  Politicians don’t like cutting spending.  So he printed money.  Which depreciated the dollar.  And countries were taking those cheap dollars and exchanging them for lots and lots of U.S. gold.  There was so much gold flying out of the country that Nixon did something shocking.  We call it the Nixon Shock.  He said the U.S. would no longer honor the dollars for gold exchange.  That was in August of 1971.  And prices have never been the same since.

The Growth of the CPI took off following the Nixon Shock

Keynesian economists were happy to see the end of the gold standard.  Because they like printing money.  And they’ve been advising governments to do just that.  To put an end to the business cycle.  And recessions as we know it.  For when the signs of recession are apparent, the government can pump a lot of dollars into the economy.  Thus avoiding a recession.  This was the policy since the adoption of the Federal Reserve Act in 1913.  Which put the nation’s best and brightest in charge of the American economy.  Who were unable to prevent numerous recessions.  A Great Recession.  And a Great Depression.

So the Keynesians have failed in preventing recessions.  Of all sizes.  Worse, their inflationary policies of freely printing and spending money has increased prices.  Caused a sharp increase in the growth rate of the Consumer Price Index (an inflation indicator).  As you can see in the following chart.  Where we graph government spending (outlays) and the CPI.  Dollar amounts are in billions of constant 2005 dollars.  Data is plotted in 10 year intervals.

 

(Sources:  Outlays, CPI)

You can see that the rate of growth in the CPI took off following the Nixon Shock.  That was the price for government printing money to keep spending beyond its means.  To make everything cost more in real dollars for us.  The consumers.  This shrinking of our paychecks put an end to the single wage-earner as we knew it.  Today the norm is that it takes two incomes to raise a family.  The exception is when one can do it.

Even before the Nixon Shock you could see that government was spending beyond its means.  Increasing its spending greater than the rate of inflation.  That means the size and number of government benefits was growing.  And it continued to grow until the Nineties.  When a Republican House forced a liberal president to the center.  After the Republicans won the 1994 midterm electionsBill Clinton‘s welfare reform decreased the growth rate of government.  For the first time after World War II.  But George W. Bush liked to spend the money.  Barack Obama, too.  Even more so.  Who took government spending to new highs with his $800 billion stimulus.  And his Obamacare.

The Number and Size of Benefits are growing Faster than the Population

Of course, you have to be careful not to let those benefits grow faster than the population.  Because government revenue comes from the taxpayers.  An increasing population means increasing tax revenue.  Because more people are paying taxes.  A decreasing population means declining tax revenue.  Because fewer people are paying taxes.

Likewise, spending that grows less than the population growth rate means a government is spending within its means.  Spending that grows greater than the population growth rate means a government is spending beyond its means.  And most probably running deficits.

We can see this if we graph population with government spending (outlays).  And we do that in the following chart.  Population is in numbers of people.  Outlays are in billions of constant 2005 dollars.  Data is plotted in 10 year intervals (to correspond with the decennial census).

 (Sources:  Population, Outlays)

Up until the Nineties, government spending increased at a greater rate than the population grew.  Clearly indicating that the number and size of benefits was growing relative to the population.  In particular, you can see an upward bend in outlays with the onset of the Great Society. 

This new growth rate remained consistent through the heyday of Keynesian economics.  The Seventies.  And through Reaganomics.  The Eighties.  Democrat Bill Clinton reduced the growth rate of government spending during his two terms in office.  Thanks to a Republican House.   But George W. Bush liked to spend the money.  For a couple of wars.  And a new Medicare prescription drug program.  And then Barack Obama became president.  And made George W. Bush look like a cheapskate when it came to government spending.

We are Spending Money at a Greater Rate than we’re Creating New Taxpayers 

Currently, the rate of government spending is increasing far greater than the population growth rate.  Meaning we are spending money at a greater rate than we’re creating new taxpayers.  Which can only mean one thing.  Record deficits.  Which we have.

We cannot sustain this spending.  It’s not a matter of insufficient tax revenue.  We’re just spending too much.  If we continue to spend at this rate there won’t be enough money to tax away from the private sector to pay for it.  Unless we have another baby boom.   Far greater than the last one.  But babies take time to grow up.  Before they become taxpayers.  Some twenty years or more before they pay any significant taxes.  So that’s a long-term solution at best.

But with the high cost of raising a family that isn’t likely.  Thanks to permanent inflation.  Courtesy of Keynesian economics.  With the way they (Keynesians) bent the CPI graph upward, big families are a thing of the past.  So that’s not an option.  That leaves one thing.  Spending cuts.  Significant spending cuts.  The very thing that would have preserved America’s AAA credit rating.

And you know how politicians love spending cuts.

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Ronald Reagan’s Reaganomics Increased GDP and Tax Revenue, Decreased Unemployment and Tamed Inflation

Posted by PITHOCRATES - August 8th, 2011

Ronald Reagan’s Supply-Side Reaganomics caused an Economic Boom

Politics is a struggle.  Between those on the Left.  And those on the Right.  And nowhere is it more partisan than when it is about one subject.  ReaganomicsRonald Reagan‘s supply-side economics.  Of the Austrian School.  That the Left belittles as trickle-down economics. 

His tax cuts during the Eighties sparked an economic boom.  No one denies this.  In fact, life was very good during the Eighties.  So good that the Left denounce those years as the Decade of Greed.  “Yes, a lot of people got rich,” the Left says.  “But at what cost?”  And then they point to those ‘soaring’ Reagan deficits.  Peaking at about $221.2 billion in 1986.  Or about $358.3 billion adjusted for inflation.  (Pretty tame by today’s standards.  Barack Obama has one in the $1.6 trillion neighborhood.)  But did Reagan cause them with his tax cuts?

To answer this question we look at historical GDP (gross domestic product).  And tax receipts.  From the Seventies and the Eighties.  From the heyday of Keynesian economics.  After the Nixon Shock in 1971. That ended the ‘gold standard‘.  When Nixon said, “I am now a Keynesian in economics.”  And through Reaganomics.  All dollar amounts are constant 2005 dollars (shown in billions).  These are graphed along with the top marginal tax rate, inflation and the unemployment rate.

(Sources: GDP, tax revenue, top marginal tax rate, inflation, unemployment)

Inflation Eroded GDP and Raised Unemployment in the Seventies

There are two relatively flat plateaus on the GDP graph.  Flat or falling GDP growth indicates a recession.  One starting sometime after 1972.  The other one around 1979. 

Both of these correspond to a spike in the inflation rate.  This happens because inflation erodes GDP.  By raising prices.  Higher prices mean we buy less.  Which means less GDP.  And higher prices tend to inflate business profits.  Where profit gains are from inflation.  Not from selling more stuff.  Which means less GDP.

Inflation is one half of the business cycle.  Which is a boom-bust cycle.  A booming economy.  And a busting recession.  Inflation.  And deflation.  Growth.  And recession. 

During growth there’s inflation.  Prices go up as more people want to buy the same things.  Bidding up prices.  The unemployment rate falls.  Because businesses are hiring more people.  To expand.  To meet this demand. 

When they expand too much there’s too much stuff on the market.  People can’t buy it all.  So prices go down.  To encourage people to buy.  And businesses cut back.  Lay people off.  With fewer people working there’s fewer people to buy that excess supply.  So prices fall more.  And businesses lay more people off.  To reflect the falling demand.  Which increases the unemployment rate.

The business cycle, then, corrects prices.  And readjusts supply to demand.  Keynesian economics was going to change this, though.  By removing the recession part.   Through permanent inflation.  At least, that was the plan.  The two plateaus in the GDP graph shows that the business cycle is still here despite their best efforts.   

And the Keynesians only made things worse.  By causing double-digit inflation.  By creating more demand than existed in the market.  People used that easy money.  To buy things they wouldn’t have otherwise bought.  Creating ‘bubbles’ of inflated prices.  Which are corrected by recessions.  And the greater the bubble, the greater the recession.

Easy Monetary Policy (i.e., Printing Money) made Inflation Worse in the Seventies

Government spent a lot during the Seventies.  A lot of that was Keynesian spending paid for with easy monetary policy (i.e., printing money).  Something governments can only do.  They are the only ones that can say, “Use these paper bills as legal tender.  We guarantee it.”

Making fiat money is easy.  But there is a cost.  The more you make the more you devalue your currency.  That’s the cost of inflation.  Money loses some of its purchasing power.  The greater the inflation the greater loss of purchasing power. 

They printed a lot of money during the late Seventies.  So much that the dollar lost a lot of its purchasing power.  Hence the double-digit inflation.

Paul Volcker was a Federal Reserve chairman.  He started in the last year of Jimmy Carter‘s presidency.  And remained chairman for about 8 years.  He raised interest rates severely.  To constrict the money supply.  To pull a lot of those excess dollars out of circulation.  This caused a bad recession for Reagan.  But it killed the double-digit inflation beast.  This sound money policy was a tenet of Reaganomics.  Which was an integral part of the Eighties boom.

Reagan’s Tax Cuts Increased both GDP and Tax Revenue

The hallmark of Reaganomics, of course, is low taxes.  Reagan cut the top marginal tax rate.  He dropped it from 70% to 28% in four cuts.  After the first cut GDP took off.   Because rich people reentered the economy. 

They weren’t parking their money in investments that helped them avoid paying the top marginal tax rate.  They were starting up businesses.  Or buying business.  Creating jobs.  Because the lower tax rates provided an incentive to earn business profits.  And not settle for lower interest income.  Or capital gains. 

For business profits can be far greater than interest earned on ‘income tax avoiding’ investments.  Such as government bonds.  And if we don’t penalize rich people for risk-taking they will take risks.  Create another Microsoft.  Or Apple.  But they are less likely to do that if they know we will penalize them for it.  And that’s what a high marginal tax rate is.  A penalty.  Remove this penalty and they will choose risky profits over safe interest every time.  And make a lot of jobs along the way.

And this is what they did during the Eighties.  Their ‘greed’ created a boom in employment.  A rising GDP.  Accompanied with a falling unemployment rate.  Rich people were pulling their money out of tax shelters.  And putting it into businesses.  Where they could make fat profits.  And making fat profits in business requires employees.  Jobs.  Unlike making money with safe tax-sheltered investments. 

Tax revenue increased.  There were more business profits.  And more business income taxes on those profits.  There were more jobs.  More employees in the workforce.  Paying more payroll taxes.  And more personal income taxes

Successful businesses made more rich people.  And more rich people pay more income taxes than fewer rich people.  A lot more.  The top marginal tax rate was lower.  But there were more businesses and people paying taxes.   Because the lower rates created more taxpayers.  And richer taxpayers to tax.  Which increased overall tax revenue.

Tax Revenue Increased under Reaganomics but Government Spending simply Increased More

So to summarize the data during Reaganomics, GDP grew, tax revenue grew, unemployment fell and inflation was tame.  All the things you want in a healthy economy.  And this all happened when the top marginal tax rate was cut from 70% to 28%. 

So, no, the Reagan deficits were NOT caused by the Reagan tax cuts.  That’s a myth created by the Left to revise history.  To recast the successful policies of Ronald Reagan as failures.  So they can continue in their tax and spend ways.

Those deficits were a spending problem.  Not a revenue problem.  For tax revenue increased after the tax cuts.  So why the deficits?  Because government spending simply increased more.

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Obama Threatens Seniors and Veterans if he doesn’t get his Way in the Budget Debate to Raise the Debt Limit

Posted by PITHOCRATES - July 13th, 2011

Hypocrisy is a Two Way Street

Arguing over debt limits is nothing new.  Neither is the hypocrisy.  It’s not about doing the right thing.  It’s about politics.  Always has been (see Debt Crisis Déjà Vu by Howard Kurtz posted 7/12/2011 on The Daily Beast). 

Democratic Sen. Kent Conrad is losing patience with arguments for raising the debt ceiling.

“The question is: Are we staying on this course to keep running up the debt, debt on top of debt, increasingly financed by foreigners, or are we going to change course?” he asked.

But Republican Sen. Chuck Grassley says there is no alternative, with lawmakers facing “a choice between breaking the law by exceeding the statutory debt limit or, on the other hand, breaking faith with the public by defaulting on our debt…”

“To pay our bills,” said John Kerry, who had just lost his presidential bid, “America now goes cup in hand to nations like China, Korea, Taiwan, and Caribbean banking centers. Those issues didn’t go away on Nov. 3, no matter what the results.”

And always will be.  Parties typically stand by their president.  As the Republicans stood with George W. Bush in 2006.  Who then made the same arguments that the Democrats are making now.  And the Democrats are making the same arguments now that the Republicans made then.  Nothing ever changes.  Just their principles change to suit the politics.

In fact, every Senate Democrat—including Barack Obama and Joe Biden—voted against boosting the debt ceiling, while all but two Senate Republicans voted in favor. It was Bush’s fourth debt-ceiling hike in five years, for a total of $3 trillion.

Eric Cantor and John Boehner voted then to raise the ceiling, and on other occasions during the Bush administration; now they’re leading the opposition. Obama, who warned Tuesday in a CBS interview that he can’t guarantee Social Security checks will go out after the August 2 deadline, has said his 2006 vote was a mistake.

Obama and Biden were against raising the debt limit then because it was fiscally irresponsible.  They’re for it now.  Even though the debt is higher.  And more fiscally irresponsible.

Obama said his 2006 vote was wrong?  I guess we can forgive him being that he was young and inexperienced coming into the U.S. Senate.  Of course, he was even more young and inexperienced as far presidents are concerned.  So perhaps his policy is wrong, too, like that 2006 vote.  The stimulus.  The auto bailout.  The Wall Street bailout.  All that Keynesian tax and spend.  Perhaps when he grows up and learns from experience he will be saying he was ‘wrong’ a lot more often.

Monetary Policy fails to Eliminate the Business Cycle

And speaking of all that Keynesian policy, how has it worked?  (see Bernanke: Fed May Launch New Round of Stimulus by Jeff Cox posted 7/13/2011 on CNBC). 

Federal Reserve Chairman Ben Bernanke told Congress Wednesday that a new stimulus program is in the works that will entail additional asset purchases, the clearest indication yet that the central bank is contemplating another round of monetary easing…

Markets reacted immediately to the remarks, sending stocks up sharply in a matter of minutes. Gold prices continued to surge past record levels, while Treasury yields moved higher as well.

It hasn’t been working.  But never say die.  Just because QE1 and QE2 failed it doesn’t necessarily mean QE3 will fail.  But it will.  And it will further depreciate the U.S. dollar.  Which is why gold prices and Treasury yields are up.  They’re priced in dollars.  So when you make the dollar smaller, you need more of them to buy things priced in dollars.

The Fed recently completed the second leg of its quantitative easing program, buying $600 billion worth of Treasurys in an effort to boost liquidity and get investors to purchase riskier assets…

“The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support,” Bernanke told the House Financial Services Committee on the first of two days of Capitol Hill testimony.

Bernanke also said it was possible that inflationary pressures spurred by higher energy and food prices may end up being more persistent than the Fed anticipates.

So the Fed is looking at policy to fight both inflation and deflation.  Interesting.  Because you use monetary policy to fight one with the other.

This is the Business Cycle that Keynesian economics purportedly did away with.  As inflation starts rising you contract the money supply via higher interest rates.  As deflation reduces asset value you lower interest rates to stimulate borrowing and asset buying.  There’s only one problem to this Keynesian economics theory.  It doesn’t work.

Playing with interest rates to stimulate borrowing does stimulate borrowing.  People take advantage of low rates, take out loans and buy assets.  Like houses.  In fact, there is such a boon in the housing market from all this stimulated borrowing that house prices are bid up.  Into a bubble.  That eventually pops.  And a period of deflation sets in to correct the artificially high housing prices resulting from artificially low interest rates.

The Dollar Loses against the Embattled Euro

So how bad is the depreciation of the dollar (see Bernanke says more support possible if economy weakens posted 7/13/2011 on the BBC)? 

The dollar extended earlier losses against the euro following Mr Bernanke’s comments, with the euro rising more than a cent to $1.4088.

The Eurozone is teetering on collapse with the Greek crisis.  Especially if their problems spread to the larger economies of Italy and Spain.  Further pressuring the Euro.  The Euro had been falling against the dollar.  It’s not anymore.  Not because the Euro is getting stronger.  But because the dollar is getting weaker.

Tax, Borrow, Print and Spend Keynesians love to Spend Money

And the safe haven from a falling dollar?  Gold (see Gold hits record high on Bernanke, euro worries by Frank Tang posted 7/13/2011 on Reuters).

Gold surged to a record above $1,580 an ounce on Wednesday as the possibility of more Federal Reserve stimulus coupled with Europe’s deepening debt crisis gave bullion its longest winning streak in five years…

Gold benefits from additional U.S. monetary easing because such a move would likely weaken the dollar and stir inflation down the road.

“The worst thing for gold would be to have the economy doing well enough that the Federal Reserve starts to normalize monetary policy, or conditions in the European Community begin to settle down,” said Mark Luschini, chief investment strategist at Janney Montgomery Scott, a broker/dealer with $54 billion in assets.

That’s right.  Gold loves bad monetary policy.  And it loves Keynesian economics.  Because the weaker the dollar gets the more expensive gold gets in U.S. dollars.  Gold says, “Print on, Chairman Bernanke.  Keep printing those dollars.  I’ve never felt so alive and powerful.”

Gold is a tangible asset.  Dollars are just pieces of paper.  Gold gets more valuable during periods of inflation because you can’t print gold.  That’s why Keynesian governments refuse to reinstitute the gold standard.  Because having the power to print dollars lets them spend more money than they have.  And tax, borrow, print and spend Keynesians love to spend money.

Democrats Screwing Seniors and Veterans to get their Way

One government advantage of printing money is reducing the value of dollar-priced assets.  Such as government debt.  Economists call it monetizing the debt.  By making the treasuries and bonds people invest their retirement in worth less, it costs less to redeem them.  This is bad for retirees who have to live their retirement on less.  But screwing retirees helps the government to spend more.

Despite this the debt is at a record level.  They still need to borrow more.  Screwing retirees just isn’t paying the bills anymore.  So President Obama, the Democrats and the Republicans have been bitterly arguing about raising the debt limit.  But making little progress (see Obama walks out of tense debt meeting: aide by Andy Sullivan, Reuters, posted 7/13/2011 on the Chicago Tribune).

President Barack Obama abruptly ended a tense budget meeting on Wednesday with Republican leaders by walking out of the room, a Republican aide familiar with the talks said.

The aide said the session, the fourth in a row, was the most tense of the week as House of Representatives Speaker John Boehner, the top Republican in Congress, dismissed spending cuts offered by the White House as “gimmicks and accounting tricks.”

Gimmicks and accounting tricks are all the Democrats want to offer.  Because they just don’t want to cut back on spending.  It’s not who they are.  Big Government tax, borrow, print and spend Keynesians who love to spend money (see Eric Cantor: Obama abruptly walked out of debt meeting by Jonathan Allen posted 7/13/2011 on Politico).

President Barack Obama abruptly walked out of a debt-limit meeting with congressional leaders Wednesday, throwing into serious doubt the already shaky debt limit negotiations, according to House Majority Leader Eric Cantor (R-Va.) and a second GOP source.

Cantor said the president became “agitated” and warned the Virginia Republican not to “call my bluff” when Cantor said he would consider a short-term debt-limit hike. The meeting “ended with the president abruptly walking out of the meeting,” Cantor told reporters in the Capitol.

That bluff would be, off course, not printing Social Security checks or paying the military.  The Education Department will probably get paid.  But seniors will get screwed.  As those serving in the military.  And veterans.  Because when all else fails, take hostages.  Threaten their wellbeing unless you get what you want.

The Democrats believe it’s all their Money

Why is there such a divide between the Republicans and the Democrats?  It’s because of their underlying philosophies.  Republicans believe that this is a nation of ‘we the people’.  Whereas Democrats believe it’s a nation of ‘we the government’ (see We have a taxing problem, not just a spending problem by Ezra Klein posted 7/12/2011 on The Washington Post). 

The Bush tax cuts were not supposed to last forever. Alan Greenspan, whose oracular endorsement was perhaps the single most decisive event in their passage, made it very clear that they were a temporary solution to a temporary surplus. “Recent data significantly raise the probability that sufficient resources will be available to undertake both debt reduction and surplus-lowering policy initiatives,” Greenspan said in 2001.

Okay, so maybe he wasn’t so clear. But everyone knew what he meant. And, broadly speaking, they agreed. We had a big surplus. It was time to do something with it. Brad DeLong, a former Clinton administration official and an economist at the University of California at Berkeley, didn’t want to see the surplus spent on tax cuts. He wanted to see it spent on public investments. “Nevertheless,” he wrote in 2001, “it is hard to disagree with Greenspan’s position that — if our future economic growth is as bright as appears likely— it will be time by the middle of this decade to do something to drastically cut the government’s surpluses.”

The Democrats believe it’s all their money.  Any money they let us keep is ‘government spending’ in their world.  That’s why they call all ‘tax cuts’ government spending.  And not simply returning money to its rightful owners.

But the Republican Party refuses to let any of them expire. And forget admitting that tax cuts meant for surpluses don’t make sense during deficits; they refuse to admit that tax cuts have anything to do with deficits at all.

It’s this belief that stands in the way of a debt deal. “We have a spending problem, not a taxing problem,” Republicans say. If the federal government defaults on Aug. 2, that sentence will be to blame. What a shame, then, that the sentence is entirely, obviously, wrong.

Obviously?  What is obvious is that this person ignores the economic prosperity caused by JFK‘s tax cuts.  Ronald Reagan‘s tax cuts.  And George W. Bush’s tax cuts.  Tax cuts stimulate economic activity.  More economic activity means more tax dollars flowing into Washington.  As history has proven.  And yet the economically naive hang on to Keynesian theories despite their history of failure.  Because they think they are oh so smart.  When in reality they’re not.  Just lemmings unquestioningly following the party line.

The Democrats favor unlimited Taxing, Borrowing and Printing

The budget debate over raising the debt ceiling is not a financial debate.  It’s a political debate.  Currently, the politics have the Republicans opposing the increase.  And the Democrats favoring it.  This is actually more in line with their underlying philosophies.  Democrats believe it’s all their money and they want to keep more.  The Republicans believe the money belongs to the people who earned it and are trying to let them keep more of it.  So you would expect the Democrats to be in favor of unlimited taxing, borrowing and printing.  And Republicans in favor of less taxing, borrowing and printing.  Which is the case in the current budget debate.

The question now is who will blink first?  The Republicans fearing another 1995 government shutdown?  Or the Democrats who are doing the preponderance of bluffing?  (There’s almost $200 billion in cash coming into Washington each month.  If they don’t pay seniors and veterans, people will want to know who they felt was important enough to pay.)

The stakes have never been higher.  What happens in the current debate could very well determine the outcome of the 2012 election.  Oh, and the future of America.

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