Scotland wants to Keep the Pound in a (somewhat) Independent Scotland

Posted by PITHOCRATES - March 8th, 2014

Week in Review

The Greek crisis happened because there was a currency union without a political union.  The Eurozone set some pretty strict limits on deficits and debt to join.  Why?  Because people in the Eurozone would all be using the same Euro.  So they didn’t want one country running up deficits or their debt.  Because if they did they wouldn’t just be messing with their economy.  They would be messing with the entire Eurozone economy.

Well, that’s what Greece did.  They were spending so much money that they had large deficits that added to a large debt.  A euro-denominated debt.  Which meant a default would raise borrowing costs for other euro-denominated debt.  Raising the borrowing costs for the Eurozone.  So to avoid that required other Eurozone nations to help Greece with their debt.  Requiring higher taxes in the more responsible countries of the Eurozone to pay for the irresponsible spending of Greece.  Neither option (default or rescue package) being a popular option.  Especially for the Greek people.  For the rescue package came with strings.  And the big one was austerity.  They had to stop spending so much.  Which meant a lot of people lost some of their government benefits.  Making them very unhappy.  Leading to some rioting in the streets.

Had there been a political union this would not have happened.  For there would have been only one entity borrowing and spending Euros.  One entity taxing the Eurozone nations.  And one entity printing money.  Much like the federal government in the United States.  And London in the United Kingdom (see Scotland’s referendum: Salmond says independence will benefit whole UK posted 3/4/2014 on BBC News Scotland Politics).

An independent Scotland with a strong economy would benefit the whole of the UK, First Minister Alex Salmond has told a gathering in London…

“I believe George Osborne’s speech on sterling three weeks ago – his ‘sermon on the pound’ – will come to be seen as a monumental error.

“It encapsulates the diktats from on high which are not the strength of the Westminster elite, but rather their fundamental weakness.

“In contrast, we will seek to engage with the people of England on the case for progressive reform.”

But Tory MP Mr Mundell said that Mr Salmond was saying that a choice to leave the UK and become independent “means staying exactly the same as we are now”.

He added: “By definition, that simply cannot happen.

“No one should be under any illusion that voting for independence means getting independence, which means becoming a new country outside the UK.

If the Eurozone sovereign debt crisis has taught us anything it’s that a currency union without a political union is not a good thing.  An independent Scotland would eliminate the political union there is now.  And the reason why England does not want a currency union with an independent Scotland is because of what happened in the Eurozone.  It doesn’t work.  At least, it doesn’t work well.  Which begs the question why do they want independence but not complete independence (keeping the pound)?

One can only surmise so they can have more autonomy over their taxing, borrowing and, of course, spending.  Perhaps to spend more.  Creating larger deficits.  And a greater pound-denominated debt.  Which would be of great concern to other holders of pound-denominated debt.  The rest of the United Kingdom.

It is unlikely that independence would lead to a stronger Scottish economy.  Or a stronger UK economy.  If it did then the whole point of the Eurozone would be a lie.  To create a larger economic zone to compete with the large economic zone that is the United States.  Because bigger is better.  At least in terms of GDP.  The British Empire was bigger than the United Kingdom is now.  And the United Kingdom is bigger than a United Kingdom without Scotland.  And an independent Scotland would be smaller than all of the above.  So if you want to maximize GDP you would want to maximize the size of your economy.  Not shrink it.  Which leads one to believe that the reason for independence is something other than economic.  Because the UK is too English?  Perhaps.  Whatever the reason let’s just hope everything works out for the best.  For the United Kingdom did make the world a better place.  With great people like Adam Smith from Scotland.  And John Locke from England.  To name only two of the greats to come from the United Kingdom.

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GDP Growth, Recession, Depression and Recovery

Posted by PITHOCRATES - March 18th, 2013

Economics 101

Gross Domestic Product is basically Consumer Spending and Government Spending

In the 1980 presidential campaign Ronald Reagan said, “A recession is when your neighbor loses his job.  A depression is when you lose yours.  And a recovery is when Jimmy Carter loses his.”  A powerful statement.  And one that proved to be pretty much true.  But don’t look for these definitions in an economics textbook.  For though they connect well to us the actual definitions are a little more complex.  And a bit abstract.

There is a natural ebb and flow to the economy.  We call it the business cycle.  There are good economic times with unemployment falling.  And there are bad economic times with unemployment rising.  The economy expands.  And the economy contracts.  The contraction side of the business cycle is a recession.  And it runs from the peak of the expansion to the trough of the contraction.  A depression is basically a recession that is really, really bad.

But even these definitions are vague.  Because getting an accurate measurement on economic growth isn’t that easy.  There’s gross domestic product (GDP).  Which is the sum total of final goods and services.  Basically consumer spending and government spending.  Which is why the government’s economists (Keynesians) and those in the Democrat Party always say cutting government spending will hurt the economy.  By reducing GDP.  But GDP is not the best measurement of economic activity.

Even though Retail Sales may be Doing Well everyone up the Production Chain may not be Expanding Production

One problem with GDP is that the government is constantly revising the numbers.  So GDP doesn’t really provide real-time feedback on economic activity.  The organization that defines the start and end points of recessions is the National Bureau of Economic Research (NBER).  And they often do so AFTER the end of a recession.  One metric they use is GDP growth.  If it’s negative for two consecutive quarters they call it a recession.  But if there is a significant decline in economic activity that lasts a few months or more they may call that a recession, too.  Even if there aren’t two consecutive quarters of negative GDP growth.  If GDP falls by 10% they’ll call that a depression.

There’s another problem with using GDP data.  It’s incomplete.  It only looks at consumer spending.  It doesn’t count any of the upper stages of
production.  The wholesale stage.  The manufacturing stage.  And the raw commodities stage.  Where the actual bulk of economic activity takes place.  In these upper stages.  Which Keynesian economists ignore.  For they only look at aggregate consumer spending.  Which they try to manipulate with interest rates.  And increasing the money supply.  To encourage more consumer spending.  But there is a problem with Keynesian economics.  It doesn’t work.

When economic activity slows Keynesian economic policies say the government should increase spending to pick up the slack.  So they expand the money supply.  Lower interest rates.  And spend money.  Putting more money into the hands of consumers.  So they can go out and spend that money.  Thus stimulating economic activity.  But expanding the money supply creates inflation.  Which raises prices.  So consumers may be spending that stimulus money but those businesses in the higher stages of production know what’s coming.  Higher prices.  Which means people will soon be buying less.  And they know once these people spend their stimulus money it will be gone.  As will all that stimulated activity.  So even though retail sales may be doing well everyone up the production chain may not be expanding production.  Instead, wholesalers will draw down their inventories.  And not replace them.  So they will buy less from manufacturers.  Who will buy fewer raw commodities.

The continually falling Labor Force Participation Rate suggests the 2007-2009 Recession hasn’t Ended

So retail sales could be doing well during an economic contraction.  For awhile.  But everything above retail sales will already be hunkering down for the coming recession.  Cutting production.  And laying off people. Making unemployment another metric to measure a recession by.  If the unemployment rate rose by, say, 1.5 points during a given period of time the economy may be in a recession.  But there is a problem with using the unemployment rate.  The official unemployment rate (the U-3 number) doesn’t count everyone who can’t find a full-time job.

U-3 only counts those people who are looking for work.  They don’t count those who take a lower-paying part-time job because they can’t find a full-time job.  And they don’t count people who give up looking for work because there just isn’t anything out there.  Getting by on their savings.  Their spouse’s income.  Even cashing in their 401(k).  People doing this are an indication of a horrible economy.  And probably a pretty bad recession.  But they don’t count them.  Making the U-3 unemployment rate understate the true unemployment.  A better metric is the labor force participation rate.  The percentage of those who are able to work who are actually working.  A falling unemployment rate is good.  But if that happens at the same time the labor force participation rate is falling the economy is still probably in recession.  Despite the falling unemployment rate.

The NBER sifts through a lot of data to decide whether the economy is in recession or not.  Do politics enter their decision-making process?  Perhaps.  For they said the 2007-2009 recession ended in 2009.  The U-3 unemployment rate had fallen.  And GDP growth returned to positive territory.  But the labor force participation rate continued to fall.  Meaning people were disappearing from the labor force.  Indicating that the 2007-2009 recession hasn’t really ended.  In fact, one could even say that we have been in a depression.  For not only did a lot of our neighbors lose their jobs.  A lot of us lost our jobs, too.  And because the president who presided over the worst economic recovery since the Great Depression didn’t lose his job in 2012, there has been no recovery.  So given our current economic picture the best metric to use appears to be what Ronald Reagan told us in 1980.  Which means things aren’t going to get better any time soon.

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Disposable Income and GDP Growth

Posted by PITHOCRATES - February 25th, 2013

Economics 101

With less Disposable Income there will be less New Economic Activity Created

The key to economic growth is disposable income.  For when we live from paycheck to paycheck economic growth is flat.  It’s when we have disposable income that we can spend money beyond our basic needs.  Such as on a vacation.  A new car.  A television.  New windows, carpeting, appliances, furniture, etc.  Movies, ball games, dinners, the theater, etc.  New clothes, jewelry, shoes, accessories, etc.  Tennis rackets, skis, baseball gloves, hiking boots, fishing gear, etc.  Smart phones, MP3 players, iPads, laptops, etc.  Jet skis, boats, motorcycles, mountain bikes, etc.  Radio-controlled cars/helicopters/planes, Game Boys, Xboxes, Wiis, PlayStations, multiplayer role-playing computer games, etc.

Buying these things creates a lot of economic activity.  But we can’t buy any of these things unless we have disposable income.  So the only way to increase economic activity is to increase disposable income.  Which means there is a direct relationship between GDP and disposable income.

There’s been a lot of talk about real incomes being flat.  Even falling during the Obama presidency.  Which is bad.  For if median incomes are falling people will have less disposable income.  And with less disposable income they will be buying less of all those things that create new economic activity.  The things we enjoy.  That make our lives more fun.  More enjoyable.  And less miserable.  Those things that increase our standard of living.  And the quality of life.  So a flat and falling median income reduces our standard of living.  And our quality of life.  As we live from paycheck to paycheck.  Making barely enough to meet our living expenses.  And sometimes not even making enough for that.  Having to turn to government assistance to make up the difference.

We add Disposable Income and Discounted Government Spending to get the Net Add to GDP

The key to disposable income and GDP growth is jobs.  And the more jobs the better.  So job creation is very important.  Which means we need a business-friendly environment.  With a minimum of costly regulations.  And low taxes.  To encourage employers to hire more people.  So more people have jobs.  Those who do use their income to meet their living expenses.  And use their disposable income to create new economic activity.  The more disposable income they have the more new economic activity they can create.  So what’s the best way to increase their disposable income?  The same way we encourage employers to hire more people.  Low taxes.  We can illustrate this in the following table which is based on assumptions and approximations.

GDP Discounted Required and Average Calculations

The effective tax rate a person pays includes all taxes he or she will pay.  Property tax, sales tax, gas tax, telecommunication tax, liquor tax, cigarette tax, import tariff, dog license tax, fishing license tax, luxury tax, watercraft registration tax, vehicle sales tax, state income tax, federal income tax, Social Security tax, Medicare tax, capital gains tax, etc.   Median income and living expenses are constants.  We subtract taxes from median income to get net income.  Subtracting living expenses from net income gives us disposable income.  We then calculate these numbers for additional effective tax rates that are multiples of 4%.

We add disposable income and stimulus together to get the net add to GDP.  What we call ‘stimulus’ is a percentage of all those taxes reentering the economy through government spending.  In our example 80% of those taxes find their way back into the economy.  While 20% is lost through waste and inefficiency.  This stimulus can pay for a government worker, a government contractor or a direct government benefit that helps people meet their living expenses.  This redistributed income is money that the income earner would have spent had it not been taxed away.  Instead, someone else will spend it.  But not as efficiently.  As it must first pass through an inefficient government bureaucracy.

Giving People Benefits does not Replace Disposable Income

We extend the table out to an effective tax rate of 52% and graph the results.  We see that as the effective tax rate increases disposable income falls.  As does GDP growth.  Showing that increasing taxation reduces GDP.  That said, average GDP growth has been approximately 3% during the latter half of the 20th Century.  Despite increasing taxation reducing GDP.  So how do we reconcile a falling GDP and a 3% GDP growth?  With aggressive increases in productivity.  And investments in capital equipment.  Allowing business to produce more with less.  Resulting in a rising real GDP growth rate.  As shown in the following graph.

GDP Discounted Required and Average

In order to maintain a 3% growth rate in GDP we need a rising real GDP growth rate (in one America doing very well despite government) to offset the falling discounted GDP growth rate due to falling disposable income (in another America not doing well because of government).  When we add the real and the discounted GDP growth rates together we get the constant 3% of average GDP growth.  Which is why businesses have never been more profitable despite stagnant economic growth during President Obama’s time in office.  They’re doing well because they’re producing more with less by exchanging people for new capital equipment.  Hence the higher profitability along with chronic high unemployment.  With more unemployed workers than available jobs there is a downward pressure on median income.  That combined with higher personal effective taxes has greatly reduced disposable income.  And new economic growth.  Which subtracts a lot away from that real GDP growth.

Giving people benefits does not replace disposable income.  For government assistance helps people meet basic living expenses.  While having a job offers the ability to earn disposable income.  Which is key for new economic growth.  If we bring the effective tax rate down the discounted GDP growth graph will flatten out.  As this happens the gains in productivity would remain.  Leaving real GDP growth unchanged.  With real GDP growth unchanged and discounted GDP growth decreasing the average annual GDP growth would therefore increase.  And approach real GDP growth.  With double digit GDP growth tax revenues would soar even at lower effective tax rates.  Requiring less borrowing.  Which would give us smaller deficits.  While reducing the growth in the federal debt.  Perhaps even reducing the debt.  Solving all of our financial problems.  By simply cutting taxes.  And the spending those taxes fund.

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Economists say Falling Inventories, Steady Unemployment and Shrinking GDP is actually Good News

Posted by PITHOCRATES - February 2nd, 2013

Weekin Review

There is a slew of bad economic news but you wouldn’t know that if you listened to the economists.  Who say that this bad news is some of the best news bad news can be.  Even with unemployment rate ticking up slightly and GDP shrinking they still see the glass is half full.  Eternal Keynesian optimists they are.  But even their explanations are cause for concern (see US economy shrinks 0.1 pct., 1st time in 3 ½ years by Christopher s. Rugaber, Associated Press, posted 1/30/2013 on Yahoo! Finance).

The U.S. economy shrank from October through December for the first time since the recession ended, hurt by the biggest cut in defense spending in 40 years, fewer exports and sluggish growth in company stockpiles. The decline occurred despite faster growth in consumer spending and business investment.

The Commerce Department said Wednesday that the economy contracted at an annual rate of 0.1 percent in the fourth quarter. That’s a sharp slowdown from the 3.1 percent growth rate in the July-September quarter and the first contraction since the second quarter of 2009.

Economists said the surprise decrease in the nation’s gross domestic product wasn’t as bad as it looked. The weakness was primarily the result of one-time factors. Government spending cuts and slower inventory growth subtracted a total of 2.6 percentage points from growth.

Those volatile categories offset a 2.2 percent increase in consumer spending, up from only 1.6 percent in the previous quarter. And business spending on equipment and software rose after shrinking over the summer…

Subpar growth has held back hiring. The economy has created about 150,000 jobs a month, on average, for the past two years. That’s barely enough to reduce the unemployment rate, which has been 7.8 percent for the past two months.

Keynesians focus on consumer spending.  For them an increase in consumer spending equals a healthy economy.  Despite that economy shrinking by 0.1%.  They explain that away as just being a fall in inventories.  As if businesses will go back to increasing their inventories in the next reporting period.  Making everything fine once again.  But if non-Keynesians take all of this data together they arrive at a different conclusion.  The economy is bad.  And will be getting worse.

Consumer spending rose while inventories fell.  And no one is hiring.  What does this mean?  Businesses above the retail level (wholesalers, manufacturers, industrial processors, raw material extraction, etc.) don’t like what they see.  So they’re cutting back production.  They’re not expanding or hiring people.  With these businesses producing less there is less product flowing into inventories.  With less flowing in while there’s more flowing out inventory levels fall.  Which eventually will lead to higher retail prices as goods become scarcer.  Leading to a fall in consumer spending.  And less hiring at the retail level.

So what does this mean?  Businesses above the retail level see a recession coming.  And they’re already hunkering down to limit their losses.

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Microeconomics and Macroeconomics

Posted by PITHOCRATES - September 10th, 2012

Economics 101

Keynesians cannot connect their Macroeconomic Policies to the Microeconomic World

Economics can be confusing.  As there are actually two genres of economics.  There’s microeconomics.  The kind of stuff most people are familiar with.  And is more common sense.  This is more of the family budget variety.  And small business budget.  Where if costs go up (gasoline, commodities, food, insurance, etc.) families and businesses make cuts elsewhere in their budget.  When revenue falls (a decline in sales revenue or a husband/wife loses their job) people cut back on expenses.  They cancel the family vacation.  Or cancel Christmas bonuses.  Straight forward stuff of living within your means.

Then there’s macroeconomics.  The big economic picture.  This is the stuff about the national economy.  GDP, inflation, recession, taxes, etc.  Things that are more abstract.  Unfamiliar.  And often defy common sense.  Where living beyond your means is not only accepted.  But it’s national policy.  And when some policies fail repeatedly those in government keep trying those same policies expecting a different outcome eventually.  Such as using Keynesian economic policies (stimulus packages, deficit spending, printing money, etc.) to get an economy out of recession that never quite works.  And then the supporters of those policies always say the same thing.  Their policies only failed because they didn’t spend enough money to make them work.

Keynesian economics focuses on macroeconomics.  And cannot connect their macro policies to the micro world.  There is a large gap between the two.  Which is why Keynesians fail.  Because they look at the macro picture to try and effect change in the micro world.  To get businesses to create jobs.  To hire people.  And to reduce unemployment.  But the politicians executing Keynesian policy don’t understand things in the micro world.  Or anything about running a business.  All they understand, or all they care to try to understand, are the Keynesian basics.  That focus on the demand side of economics.  While ignoring everything on the supply side.

When the Economy goes into Recession the Fed Expands the Money Supply to Lower Interest Rates

Keynesians have a few fundamental beliefs.  And one of the big ones is the relationship between interest rates and GDP.  In fact, it’s the center of their world.  High interest rates discourage people from borrowing money.  When people don’t borrow money they don’t build things (like factories).  And if they don’t build things they won’t create jobs and hire people.  So the higher the interest rates the lower the economic output of the nation (GDP).

Low interest rates, on the other hand, encourage people to borrow money.  So they can build things and create jobs.  The lower the interest rates the more people will borrow.  And the greater the economic output of the nation will be.  This was the driving factor that caused the Great Recession.  The central bank (the Fed) kept interest rates so low for so long that people bought a lot of houses.  A lot of expensive houses.  The demand for housing was so great that buyers bid up prices.  Because at low interest rates there was no limit to how much house you could buy.  All this building and buying of houses, though, oversupplied the market with houses.  As home builders rushed in to fill that demand.  They built so many houses that there were just so many houses available to buy that buyers had a lot of choice.  Making it a buyers’ market.  So much so that people had to slash their asking price to sell their house.  Which popped the great housing bubble.

The Fed lowers interest rates by increasing the money supply.  They create new money and inject it into the economy.  By giving it to bankers.  Banks have more money to lend.  So more people can borrow money.  This is what lowers interest rates.  Things that are less scarce cost less.  More money to borrow means it’s less scarce.  And the price to borrow it (i.e., the interest rate) falls.  If the Fed wants to increase interest rates they pull money out of the economy.  Which makes it a little harder to borrow money.  Because more people are trying to borrow the limited amount of funds available to borrow.  And this is the basics of monetary policy.  Whenever the country enters a recession and unemployment rises the Fed expands the money supply to encourage businesses to borrow money to expand their businesses and create jobs that will lower unemployment.

Keynesian Economic Policies hurt the Higher Stages of Production where we Create Real Economic Activity

If low interest rates create greater economic activity why in the world would the Fed ever want to raise interest rates?  Because of the dark side of printing money.  Inflation.  Increasing the money supply gives people more money.  And when they have more money they try to buy what everyone else is buying.  As the money supply grows greater than the amount of economic output there is more money trying to buy fewer goods and services.  Which raises prices.  Just like those low interest rates did in the housing market.  The fear is that if this goes on too long there will be an economic crash.  Just like after the housing bubble burst.  From boom to bust.  Higher prices reduce consumer spending.  Because people can’t buy as much when prices are high.  As consumers stop spending businesses stop selling.  Faced with overcapacity in a period of falling demand they start cutting costs.  Laying off people.  People without jobs can buy even less at high prices.  And so on as the economy settles into recession.  This is why central bankers raise interest rates.  Because those good times are temporary.  And the longer they let it go on the more painful the economic correction will be.

This is why Keynesian stimulus spending fails to pull economies out of recession.  Because Keynesians focus only on the demand curve.  Consumption.  Consumer spending.  Not supply.  They ignore all that economic activity in the higher stages of productions.  That activity that precedes retail consumer sales.  The wholesale stage (the stage above retail).  The manufacturing stage (above the wholesale stage).  And the furthest out in time, the raw commodities stage (above the manufacturing stage).  As economic activity slows inventories build up.  Creating a bulge in the middle of the stages of production.  So manufacturing cuts back.  And because they do raw commodities cut back.  These are the first to suffer in an economic downturn.  And they are the last to recover.  Because of all that inventory in the pipeline.  When Keynesians get more money into consumers’ pockets they will increase their consumer spending.  For awhile.  Until that extra money is gone.  Which provided an economic boost at the retail level.  And a little at the wholesale level as they drew down those inventories.  But it did little at the higher stages of production.  Above inventories.  Manufacturing and raw material extraction.  Who don’t expand their production or hire new workers.  Because they know this economic activity is temporary.  And because they know all that new money will eventually create inflation.  Which will increase prices.  Throughout the stages of production.

The Keynesian approach focuses on the macro.  By playing with monetary policy.  Policies that ultimately hurt the higher stages of production.  At the micro level.  Where we create real economic activity.  If they’re not hiring then no amount of stimulus spending at the retail level will get them to hire.  Because giving the same amount of workers (i.e., consumers) more money to chase the same amount of goods and services only causes higher prices in the long run.  And it’s the long run that raw commodities and manufacturing look at.  They are not going to invest to expand their businesses unless they expect improving economic conditions in the long run.  All the way up the stages of production to where they are.  When new economic activity reaches them then they will expand and hire people.  And when they do they will add a lot of new consumers with real wages to go out and spend at the retail level.

One of the most efficient ways to achieve this is with tax cuts.  Because cuts in tax rates shape economic activity in the long run.  Across the board.  Unlike stimulus spending.  Which is short term.  And very selective.  Some benefit.  Typically political cronies.  But most see no benefit.  Just higher prices.  And continued unemployment.  Which is why Keynesian policies fail to pull economies out of recessions.  Because politicians use them for political purposes.  Not economic purposes.

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Jimmy Carter, Malaise, Ronald Reagan, Austrian Economics, Morning in America, Barack Obama, Keynesian Economics and Great Recession

Posted by PITHOCRATES - September 4th, 2012

History 101

It was Morning in America again because Ronald Reagan reduced the Misery Index by 42.7%

Ronald Reagan was a supply-sider when it came to economics.  Of the Austrian school variety.  In fact, one of his campaign promises was to bring back the gold standard.  A very Austrian thing.  The Austrian school predates the Keynesian school.  When the focus was on the stages of production.  Not on consumer spending.  These policies served the nation well.  They (and the gold standard) exploded American ingenuity and economic activity in the 19th century.  Making the U.S. the number one economy in the world.  Surpassing the nation that held the top spot for a century or more.  Perhaps the last great empire.  Great Britain.

Following the stagflation and misery (misery index = inflation rate + unemployment rate) of the Seventies Reagan promised to cut taxes and governmental regulations.  To make it easier for businesses to create economic activity.  Easier to create jobs.  And he did.  Among other things.  Such as rebuilding the military that the Carter administration severely weakened during the Seventies (it was so bad that the Soviet Union put together a first-strike nuclear option.  Because they thought they could win a nuclear war with Jimmy Carter as president).  During the 1980 campaign Reagan asked the people if they were better off after 4 years of Jimmy Carter.  The answer was no.  Four years later, though, they were.  Here’s why.  (Note:  We used so many sources that we didn’t source them here to save space.  The inflation rate and unemployment rates are for August of the respective years.  The dollar amounts are annual totals with some estimates added to take them to the end of 2012.  The debt and GDP are not adjusted for inflation as they are only 4 years apart.  Gas prices and median income are adjusted for inflation.  There may be some error in these numbers.  But overall we believe the information they provide fairly states the economic results of the presidents’ policies.  (This note applies to both tables.))

Reagan entered office with some horrendous numbers.  The Carter administration was printing so much money that inflation was at 12.9% in 1980.  Added to the unemployment rate that brought the misery index to 20.6%.  A huge number.  To be fair Carter tapped Paul Volcker to be Fed Chairman and he began the policy of reigning in inflation.  But Carter did this far too late.  The only way to cure high inflation is with a nasty recession.  Which Volcker gave Ronald Reagan.  But it worked.  By 1984 inflation fell 8.8 points or 66.7%.  Even with this nasty recession the unemployment rate fell 0.2 points or 2.6%.  Which shaved 8.8 points off of the miserable index.  Or reducing it by 42.7%.  This is why it was morning in America again.  The Left to this day say “yeah, but at what cost?” and point to the record deficits of the Reagan administration.  Saying this is the price of tax cuts.  But they’re wrong.  Yes, the debt went up.  But it wasn’t because of the tax cuts.  Because those tax cuts stimulated economic activity.  GDP rose 12.6% by 1984.  And tax receipts even increased with those lower tax rates.  Because of the higher GDP.  By 1984 Reagan’s policies increased tax revenue by 28.9%.  And on a personal level the median income even increased 0.4%.  And this following a very bad recession a few years earlier.  Finally, gas prices fell 22.2%.  And the way Americans feel about rising gas prices this was truly morning in America again.

To Top off the General Malaise of the Obama Economy Gas Prices Soared while Median Income Fell

Barack Obama is a Keynesian through and through.  A believer in pure demand-side economics.  To that end his administration focused everything on increasing consumer spending.  Tax and spend policies.  Income redistribution.  Deficit spending.  Anything to make America ‘more fair.’  Raising taxes on the rich so the poor can spend more money.  With the Keynesian multiplier they believe this is the path to economic prosperity.  Just doing everything within their power to put more spending money into the hands of poorer people.  Increasing government regulation, fees and fines as well as taxes to bring more money in Washington so they can redistribute it.  Or spend it directly on things like roads and bridges.  Or solar power companies.  Even paying people to dig a hole and fill it back in.  Because these people will take their wages and spend them.  Creating economic activity.

So President Obama put Keynesian economics to work.  Beginning with a $787 billion stimulus bill.  Investments into green energy and the jobs of the future.  Like a Department of Energy loan of $528 million to the now bankrupt Solyndra.  Which was only one of many loans.  The bailout of the UAW pension fund (aka the auto bailout).  The government poured $528 million into GM.  And President Obama touted the Chevy Volt, boasting that GM would sell a million each year bringing his green goals to fruition (GM is struggling to sell 10,000 Volts a year).  A lot of malinvestment as the Austrians would say.  But a Keynesian sees any government expenditure as a good investment.  Because if all the people who receive this government money spends at least 80% of it (while saving only 20%) the Keynesian multiplier will be five.  Meaning that the net gain in GDP will be five times whatever the government spends.  So how has that worked for the president?  Well, here are his numbers:

The government spent so much money that the federal debt increased by $5.4 trillion.  Trillion with a ‘T’.  That’s over a trillion dollar deficit each of the president’s 4 years in office.  And his last year isn’t even a whole year.  Unprecedented until President Obama.  And what did all of that federal spending get us after about 4 years?  An unemployment rate 2.1 points higher.  Or 33.9% higher than when he took office.  Inflation fell but it did nothing to spur GDP growth which grew at an anemic 3.1%.  Which is less than a percentage point a year.  Which is why the Great Recession lingers still.  Meanwhile the Chinese are having a bad year with a GDP growth of 7.8%.  So all of that spending didn’t help at all.  In fact, it made things worse.  The economic activity is so bad that even tax receipts fell 2.2% after four years of President Obama.  Which has many in his party saying that we need to raise tax rates.  Contrary to what Ronald Reagan did.  And to top off the general malaise of the Obama economy gas prices soared 107.6% under his presidency.  While the median income fell 7.3%.  One has to look hard to find any positive news from the Obama economy.  And there is one.  Inflation did fall.  But even that really isn’t good.  As it may be an indicator of a looming deflationary spiral.  Giving America a lost decade.  Like Japan’s Lost Decade.

The Flaw in Keynesian Thinking is that it Ignores the Layers of Economic Activity above the Consumer Level

So there you have an Austrian and a Keynesian.  Both entered office during bad economic times.  Although things were much worse when President Reagan took office than when President Obama took office.  The misery index was 20.6% in 1980.  It was only 11.6% in 2008.  About half as bad for President Obama than it was for President Reagan.  It came down 16.4% under Obama.  But it came down 42.7% under Reagan.  Which is why it isn’t morning in America under President Obama.  Reagan increased tax receipts by 28.9 % by the end of his first term.  They fell 2.2% under Obama.  Adjusted for inflation Reagan averaged annual deficits of $348 billion.  That’s billion with a ‘B’.  Obama averaged $1.324 trillion.  That’s trillion with a ‘T’.  Or 280% higher than Ronald Reagan.  Gas prices fell 22.2% under Reagan.  They rose 107.6% under Obama.  Median income barely rose 0.4% under Reagan.  But it fell 7.3% under Obama.  In short there is nothing in the Obama economic record that is better than the Reagan economic record.

And why is this?  Because Obama’s policies are Keynesian.  While Reagan’s policies were Austrian.  Reagan focused on the stages of production to improve economic activity.  Cutting taxes.  Reducing regulatory compliance costs.  Creating a business-friendly environment.  A system that rewarded success.  Whereas Obama focused on consumer spending.  Tax, borrow and print (i.e., quantitative easing).  So the government could spend.  Putting more money into the pockets of consumers.  Which stimulated only the last stage in the stages of production.  So while some consumers had more money it was still a business-unfriendly environment.  Where tax, regulatory and environmental policies (as well as the uncertainty of Obamacare) hindered business growth everywhere upstream from retail sales.  From raw material extraction to industrial processing to construction to manufactured goods.  Where these Obama’s policies punish success.  For the bigger you get the more you pay in taxes and regulatory compliance costs.

The greatest flaw with Keynesian economics is that it looks at aggregate supply and demand.  With a focus on consumer spending.  And ignores the layers of economic activity that happens before the consumer level.  The Austrian school understands this.  As did the British when she became one of the greatest empires of all times.  As did America during the 19th century.  No nation became an economic superpower using Keynesian economics.  Japan grew to be a great economic power during the Fifties and Sixties.  Then went Keynesian in the Eighties and suffered their Lost Decade in the Nineties.  Some Keynesians like to point to China as an example of the success of Keynesian economics.  But they still have a fairly restrictive police state.  And their economic policies are hauntingly similar to Japan’s.  Some have even posited that it is very possible that China could suffer the same fate as Japan.  And suffer a deflationary spiral.  Resulting in a lost decade for China.  Which is very plausible considering the Chinese practice state-capitalism where the state partners closely with businesses.  Which is what the Japanese did in the Eighties.  And it hasn’t been great for them since.  As it hasn’t been great in America economically since the current administration.

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JFK, Tax Cuts, Vietnam, LBJ, Great Society, Hippies, Race Riots, Keynesian Spending, Nixon, Carter and Ronald Reagan

Posted by PITHOCRATES - August 21st, 2012

History 101

Ronald Reagan would follow the Kennedy Example of Cutting Taxes to Grow the Economy

In 1961 West German Chancellor Ludwig Erhard gave John F. Kennedy (JFK) some good advice.  During JFK’s visit he told him not to make the same mistake the British had.  He told Kennedy NOT to follow their policy of high taxation.  Because it killed economic activity.  And economic growth.  England was suffering from her bad tax policy.  He urged the American president not to make the same mistake.

JFK heeded Erhard’s advice.  And cut tax rates.  This did not please liberals in his Democrat Party.  Who were all Keynesians.  And believed in large government interventions into the private sector.  Funded by large government expenditures.  Which in the Keynesian world you got in one of three ways.  Tax, borrow or print money.  You did not cut tax rates.  Which was blasphemous in Keynesian doctrine.  You never, ever, cut tax rates.  But Kennedy did.  Arguing that “an economy hampered by restrictive tax rates will never produce enough revenue to balance the budget—just as it will never produce enough jobs or enough profits.”

A message Ronald Reagan would give time and again some 20 years later.  And would follow the Kennedy example of cutting taxes to grow the economy.  Generating more tax revenue without having to cut spending.  The result of JFK’s ‘trickle-down’ economics were impressive.  He cut the top marginal tax rate from 91% to 70%.  And cut the 20% rate to 14% at the other end of the scale.  What did people do with these tax savings?  They saved.  And invested.  Savings rose from an annual growth rate of 2% to 9%.  Business investment from 2% to 8%.  New jobs grew at a rate of 100%.  And unemployment fell by one third.  With GDP rising some 40% in two years.  And despite cutting tax rates tax revenue rose.  The booming economy generating more tax revenue even at the lower rates.  Even more than the Keynesians said Kennedy was going to cost the government with his tax cuts.

The Social Upheavals of the Sixties, the Race Riots and his Unpopular Vietnam War all took their Toll on LBJ

Liberals love JFK.  But for none of these reasons.  They prefer to wax poetically about his fight to end economic and racial injustice.  Which were in reality low on his priority list.  Addressing civil rights only after trouble was escalating in the south.  But that’s the Left’s cherished memory of him.  And of Camelot.  The American royal family.  They don’t talk about JFK’s trickle-down economics.  His Bay of Pigs fiasco (the plan to oust Fidel Castro from Cuba that he withdrew support from after it met difficulty on the beaches).  His Cuban missile crisis (near nuclear war with the Soviet Union) which his indecision at the Bay of Pigs may have invited.   Or his war in Vietnam.  No.  They stay silent on the best part of his presidency.  As well as the worst parts.  And focus instead on the fairy tale that was Camelot.  Ignoring completely his excellent economic policies and the strong economy they gave us.  And all that tax revenue that poured into the treasury.  Yes, they may have liked having that money.  But they didn’t have to like how it got there.

Following JFK’s assassination Lyndon Baines Johnson (LBJ) ascended to the presidency.  An old school politician that knew how to make deals to advance legislation.  And boy did he.  He declared unconditional war on poverty.  And unleashed the Great Society to spend America out of poverty.  Keynesian to the core.  Pure demand-side economics.  Give poor people money which they will use to buy consumer goods.  That Keynesian consumption that was so crucial to a healthy economy.  So Johnson made good use of all that tax revenue JFK created with his tax cuts.  And LBJ’s Great Society consumed enormous amounts of that tax revenue.  As did JFK’s Vietnam War.  Now LBJ’s war.  Which LBJ escalated.  Government expenditures exploded during the Johnson administration.  And the spending obligations he put into place were only going to escalate future expenditures.  Oh, and we were also trying to land a man on the moon during this time.  All during a time when the world was changing.  When a bunch of filthy hippies began to protest anything that didn’t somehow gratify them (their rallying cry was sex, drugs and rock & roll).  And racial tensions simmered to the boiling point in our crowded cities.

The social upheavals of the Sixties.  The race riots.  The unpopular war on our living room televisions.  They all took their toll on LBJ.  The race riots especially hurt him as he had spent so much money on ending economic and racial injustice.  On a televised address he told the nation that he was through being the president.  He wasn’t going to run for another term.  And he wouldn’t accept a nomination for a second term.  He basically thanked an ungrateful nation.  And planned for his retirement.  Leaving a fiscal mess for the next president.  As well as a mess in Vietnam.  And the job for cleaning up these messes fell to Richard Milhous Nixon.

When Nixon entered the Presidency all those Spending Obligations of the Great Society were Coming Due

Nixon had a lot of liberal tendencies.  He was actually a member of the NAACP since 1950.  Long before JFK or LBJ talked of civil rights.  He believed in New Deal economics.  Of the good government could do.  He was also an environmentalist.  Giving us the Environmental Protection Agency (EPA).  And giving us emissions standards for our cars.  He gave us the Occupational and Safety Health Administration (OSHA).  And a flurry of other regulations.  Not what you would expect from a Republican these days.  Of course, few probably know this.  But they probably do know about Watergate.  At least the word ‘Watergate’.  Which was pretty tame by today’s standards.  Spying on the political opposition.  Then lying about it.

When Nixon entered the presidency all those spending obligations of the Great Society were coming due.  The cost of LBJ’s Great Society really hit the Nixon administration hard.  Enormous amounts of money were flowing out to poor people (so they could spend it and buy consumer goods).  To the war in Vietnam.  To the Cold War.  To the space program.  To the enlarged federal government.  Government spending was going off the chart.  But it wasn’t having the affect on the economy the Keynesians said it would.  They were taxing, borrowing and printing money like good little Keynesians.  But they were devaluing the dollar in the process.  And igniting inflation.  Worse, the U.S. dollar was the reserve currency of the world.  Foreign nations pegged their currency to the U.S. dollar.  The U.S. pegged the dollar to gold.  As the Americans devalued the dollar, though, the foreign countries traded their dollars for gold.  Gold began to fly out of the country.  So Nixon did what any responsible Keynesian would do.  Instead of playing by the rules of the game he changed the rules.  And decoupled the dollar from gold.  The Nixon Shock.  Ushering in the era of unfettered Keynesian economics.  Deficit spending.  Growing debt.  High inflation.  High unemployment.  Stagflation.  And malaise.

Jimmy Carter would see the worse of LBJ’s Great Society.  As it left his economy in a mess.  Despite all of that government spending.  And Carter suffered because he, too, was a Keynesian.  He believed in that GDP formula where GDP equaled the sum of consumption, investment, government expenditures and net exports (exports – Imports).  And the formula clearly states that the way to increase GDP (and increase the number of jobs) was to increase government spending to give money to people so they could buy consumer goods (increasing government spending and consumption in the formula).  It was simple arithmetic.  But the formula left out about half of all economic activity.  The intermediate business spending that takes place before any consumer goods enter our stores.  Think of things consumers don’t buy.  Like railroad track, blast furnaces, construction front-end loaders, etc.  Economic activity that JFK encouraged with his tax cuts.  As Ronald Reagan did so, too, some 20 years later.  Which is why the JFK and the Reagan economies were far better than any Keynesian administration.

Even after more than a decade of unfettered Keynesian spending consumption was only 34% of all economic activity in 1982.  Even though official GDP figures reported it at 65%.  Why the discrepancy?  Intermediate business spending.  The stages of production before consumer goods.  Coming in at 54% of real economic activity in 1982.  Which is why the tax-cut policies of JFK and Ronald Reagan worked.  And the spending policies of JBJ, Nixon and Carter didn’t.  Trickle-down works.  Because it creates jobs.  And those lower tax rates generate higher tax revenues because more people are working and paying taxes.  All things a Keynesian wants.  But they will reject them because they resulted from the ‘wrong’ policies.  Because Keynesians want to tax, borrow and print.  Regardless of their effect on the economy.

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Production vs. Consumption

Posted by PITHOCRATES - August 20th, 2012

Economics 101

To Prevent another Great Depression Keynes said the Key was Government Spending

John Maynard Keynes was a noted economist who analyzed the Great Depression.  And came to the opinion the problem was that there wasn’t enough consumption.  Consumers weren’t buying enough stuff.  That is, they weren’t spending enough money.  Which is key to consumption.  And a healthy economy.  According to Keynes.  And the people who embraced his economic theories.  What we now call Keynesian economics.

It was a whole new way to look at economics.  Consumption.  Or demand-side economics.  Which said demand created supply.  Contrary to Say’s law.  Which basically stated supply creates demand.  Tomáto.  Tomàto.  To most people.  All they understood was that it was better to have a job than to be unemployed.  Because if you had a job you could buy food for your family.  Pay for heat in the winter.  And pay a doctor if your child was sick.

To prevent another Great Depression Keynes said the key was government spending.  To make up for any decline in consumption.  The government could tax, borrow or print money as necessary to get money to spend.  Putting people to work on government projects.  Building things.  Like roads and bridges.  Or digging ditches.  So when businesses lay off people the government can put them back to work.  And pay them with the money they taxed, borrowed or printed.  These people would then take that money and spend it.  A priming of the economic pump as it were.  That, in theory, will provide consumption until the private sector begins hiring again.  Therefore eliminating recessions once and for all.

Economists attribute about 90% of GDP to Consumer Spending and Government Expenditures

There have been about 12 recessions since Keynes figured out how to end them once and for all.  The recent one being the worst since the Great Depression.  Even surpassing the misery of the Jimmy Carter economy.  A time when the impossible happened.  In the world of Keynesian economics, at least.  Government spending designed to decrease unemployment actually increased unemployment.  It turns out there was a downside to printing money.  Massive inflation.  And rational expectations that printing money will lead to massive inflation.  So while the Keynesian way worked in theory it failed in practice.  And not just once.  But a lot.  Yet it is still the model of most governments.  And it’s what colleges teach their students.  Why?  After it’s been so thoroughly debunked?  The answer to that question brings us back to consumption.  And Gross Domestic Product (GDP).

GDP is a measure of a country’s goods and services during a period of time.  That is, it is a measure of economic activity.  The bigger it is the better the economy.  And the more people that have jobs.  The formula for GDP is the sum of consumption, investments, government expenditures and net exports (exports – imports).  It’s this formula that keeps Keynesian economics alive.  Because of consumption.  And government expenditures.  This formula sanctions government spending because, according to the formula, it increases economic activity.  It is the driver of all stimulus spending.  And the welfare state.  Because government spending puts money ultimately into the pockets of consumers who spend it.  That is, government spending creates private consumption.  And consumption creates jobs (demand creates supply).  In the Keynesian world, that it.  There is only one problem.  The formula leaves out a lot of economic activity.

Using this formula economists report that consumption makes up about 70% of GDP.  And government spending about 20%.  These numbers are huge.  That’s about 90% of GDP attributed to consumer spending and government expenditures.  Which is why Keynesians love this formula.   Because it empowers them to tax, borrow and print so they can spend.  All in the name of creating jobs.  And GDP.  But what about the things people make or do that consumers don’t buy?  Like engineering and design services.  Printing presses and ink.  The extraction of raw materials?  Coal mining.  Blast furnaces making steel for use in manufacturing?  Heavy construction equipment?  Machine tools and production equipment?  Assembly lines?  Robots on the assembly line?  Locomotive engines and rolling stock?  Airplanes?  All the people and equipment in the transportation industry?  Etc.  There is a lot of economic activity that makes things or does things that consumers don’t buy.  So where is it in the GDP formula?  Don’t look for it.  Because it’s just not there.

Intermediate Business Spending accounts for about Half of all Economic Activity

Before Keynes the focus was on production.  Not consumption.  Before Keynes we looked at the stages of production.  All of that economic activity that happens before you can buy anything in a store.  Everything between the extraction of raw materials to the final finished good.  Where millions of workers are engaged in economic activity that a consumer knows nothing about when they buy a consumer good.  If you factor in this economic activity into the GDP equation it changes things.  And it changes it in a way that Keynesians and government officials don’t like.

Consumption is the last stage in the stages of production.  The final step in a flurry of economic activity that preceded it.  If you count up this intermediate business spending it comes to about half of all economic activity.  It’s about twice consumer spending.  And about four times government expenditures.  Greatly reducing the roles of consumption and government expenditures in the GDP equation.  And in the economy.  As well as providing the answer to why Keynes didn’t end recessions once and for all with his new economic theory.  Because his new economic theory was wrong.  You don’t create jobs by giving money to people to spend.  You create jobs by making it easy for businesses to hire people.

So demand does NOT create supply like Keynes said.  Supply creates demand.  Like Say said.  And what’s the conclusion we can draw?  Big activist governments do not help a country’s economy.  They just pull money out of the stages of productions.  Where it can create jobs.  And puts it into government.  Where it creates unemployment and inflation.  As demonstrated by all the big Keynesian governments of Europe.  Those social democracies struggling under the weight of their government spending.  Who borrowed money to sustain that spending.  Bringing on the European sovereign debt crisis.  Because of that GDP equation that said they could tax, borrow and print to spend to their heart’s content.  Thanks to a man named Keynes.

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Revolutionary War, Sovereign Debt, Report on Public Credit, Hamilton, Jefferson, Madison, Assumption and Residency Act

Posted by PITHOCRATES - August 16th, 2012

Politics 101

In 1792 the Outstanding Debt at all Levels of Government was 45% of GDP

Wars aren’t cheap.  Especially if they last awhile.  The American Revolutionary War lasted some 8 years until the British and Americans signed the Treaty of Paris (1782) officially ending all hostilities.  So the Revolutionary War was a very costly war.  The ‘national’ government (the Continental Congress) owed about $70 million.  The states owed another $25 million or so.  And the Continental Army had issued about $7 million in IOUs during the war.  Added up that comes to $102 million the new nation owed.  About 45% of GDP.  (Or about 35% without the state debt added in.)

To put that in perspective consider that the Civil War raised the debt to about 32% of GDP.  World War I raised it to about 35%.  World War II raised it to about 122%.  Following the war the debt fell to about 32% at its lowest point until it started rising again.  And quickly.  In large part due to the cost of the Vietnam War and LBJ’s Great Society.  Government spending being so great Nixon turned to printing money.  Depreciating the dollar’s purchasing power in every commodity but one.  Gold.  Which was pegged at $35/ounce.  Losing faith in our currency foreign governments traded their U.S. dollars for gold.  Until Nixon decoupled the dollar from gold in 1971.  Ushering in the era of Keynesian economics, deficit spending and growing national debts.  Because of increased spending for social programs governments everywhere now have debts approaching 100% of GDP.  And higher.  But I digress.

So 45% of GDP was huge in 1792.  And it continued to be huge.  Taking a devastating civil war and a devastating world war to even approach it.  It took an even more devastating world war to exceed it.  And now we’ve blown by that debt level in the era of Keynesian economics.  Without the devastation of another World War II.  This debt level has grown so great that for the first time ever in U.S. history Standard and Poor’s recently lowered the United States’ impeccable sovereign debt rating.  And restoring that debt rating at today’s spending levels will be a daunting task.  But imagine trying to establish a sovereign debt rating after just becoming a nation.  Already with a massive debt of 45% of GDP.

In Hamilton’s Report on Public Credit the New Government would Assume Outstanding Debt at all Levels of Government

There was only one choice for America’s first president.  The indispensible one.  George Washington.  Some delegates at the Philadelphia Convention in 1787 who were skeptical of the new Constitution only supported it because they had someone they could trust to be America’s first president.  George Washington.  Benjamin Franklin, John Adams, Thomas Jefferson and James Madison were indispensible at times.  But not as indispensible as Washington.  For without him the Continental Army would have ceased to exist after that winter at Valley Forge.  That same army would have mutinied (for back pay and promised pensions) after the war if he didn’t step in.  Our experiment in self-government would have ended if he did not relinquish his power after the war.  We wouldn’t have ratified the Constitution without having Washington to be America’s first president.  And our experiment in self-government would have ended if he did not relinquish his power.  Again.  After his second term as president.

With the state of the government’s finances after the war there was another Founding Father that was indispensible.  Not as indispensible as Washington.  But close.  For without him the Washington presidency may have failed.  As well as the new nation.  Because of that convoluted financial mess.  The Continental Congress borrowed money.  The states borrowed money.  Some of which went to the Continental Congress.  The army took stuff they needed to survive in exchange for IOUs.  There were bonds, loans and IOUs at every level of government in every state.  Complicating the matter is that most of the instruments they sold ended up in the hands of speculators who bought them for pennies on the dollar.  As the original holders of these instruments needed money.  And did not believe the Continental Congress would honor any of these obligations.  For before the Constitution the government was weak and had no taxing authority.  And no way to raise the funds to redeem these debt obligations.

A few tried to get their arms around this financial mess.  But couldn’t.  It was too great a task.  Until America’s first secretary of the treasury came along.  Alexander Hamilton.  Who could bring order to the chaos.  As well as fund the new federal government.  He submitted his plan in his Report on Public Credit (January 1790).  And the big thing in it was assumption.  The federal government would assume outstanding debt at all levels of government.  Including those IOUs.  At face value.  One hundred pennies on the dollar.  To whoever held these instruments.  Regardless of who bought them first.  “Unfair!” some said.  But what else could they do?  This was the 1700s.  There weren’t detailed computer records of bondholders.  Besides, this was a nation that, like the British, protected property rights.  These speculators took a risk buying these instruments.  Even if at pennies on the dollar.  They bought them for a price the seller thought was fair or else they wouldn’t have sold them.  So these bonds were now the property of the speculators.

Jefferson and Madison traded Hamilton’s Assumption for the Nation’s Capital

Of course to do this you needed money.  Which Hamilton wanted to raise by issuing new bonds.  To retire the old.  And to service the new.  Thus establishing good credit.  In fact, he wanted a permanent national debt.  For he said, “A national debt, if not excessive, is a national blessing.”  Because good credit would allow a nation to borrow money for economic expansion.  And it would tie the people with the money to the government.  Where the risk of a government default would harm both the nation and their creditors.  Making their interests one and the same.

That’s not how Thomas Jefferson saw it, though.  He had just returned from France where he witnessed the beginning of the French Revolution.  Brought upon by a crushing national debt.  And he didn’t want to tie the people with the money to the government.  For when they do they tend to exert influence over the government.  But Hamilton said debt was a blessing if not excessive.  He did not believe in excessive government debt.  And he wanted to pay that debt off.  As his plan called for a sinking fund to retire that debt.  Still, the Jefferson and Hamilton feud began here.  For Hamilton’s vision of the new federal government was just too big.  And too British.  Madison would join Jefferson to lead an opposition party.  Primarily in opposition to anything Hamilton.  Who used the Constitution to support his other plan.  A national bank.  Just like the British had.  Based on the “necessary and proper” clause in Article I, Section 8.  Setting a precedent that government would use again and again to expand its powers.

At the time the nation’s capital was temporarily in New York.  A final home for it, though, was a contentious issue.  Everyone wanted it in their state so they could greatly influence the national government.  Hamilton’s struggle for assumption was getting nowhere.  Until the horse-trading at the Jefferson dinner party with Hamilton and Madison.  To get the nation’s capital close to Virginia (where it is now) Jefferson offered a deal to Hamilton.  Jefferson and Madison were Virginians.  Give them the capital and they would help pass assumption.  They all agreed to the deal (though Jefferson would later regret it).  Congress passed the Residency Act putting the capital on the Potomac.  And all the good that Hamilton promised happened.  America established good credit.  Allowing it to borrow money at home and abroad.  And a decade of prosperity followed.  Hamilton even paid down the federal debt to about 17.5% of GDP near the end of America’s second president’s (John Adams) term in office (1800).  Making Hamilton indispensible in sustaining this experiment in self-government.  Keeping government small even though it was more powerful than it was ever before.  Of course his using that “necessary and proper” argument really came back to bite him in the ass.  Figuratively, of course.  As government used it time and again to expand its role into areas even Hamilton would have fought to prevent.  While Jefferson no doubt would have said with haughty contempt, “I told you so.  This is what happens when you bring money and government together.  But would you listen to me?  No.  How I hate you, Mr. Hamilton.”

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LESSONS LEARNED #82: “Too much debt is always a bad thing.” – Old Pithy

Posted by PITHOCRATES - September 8th, 2011

Thomas Jefferson hated Alexander Hamilton for his Assumption and Funding Plans 

Thomas Jefferson hated Alexander Hamilton.  For a variety of reasons.  He thought he was too cozy with the British.  And too anti-French.  He also thought Hamilton was too cozy with the merchant class and bankers.  Jefferson hated them, too.  For he thought honest Americans farmed.  Not buy and sell things other people made.  Or loaned money.

But Hamilton was not a bad guy.  And he was right.  George Washington, too.  America’s future was tied to the British.  Trade within their empire benefited the fledging American economy.  And the Royal Navy protected that trade.  For they ruled the seas.  They couldn’t get that from France.  Especially with a France waging war against everyone.

But there was something especially that Jefferson hated Hamilton for.  Assumption.  And funding.  The new nation’s finances were a mess.  No one could figure them out.  There was pre-war debt.  And war debt.  State debt.  And national debt.  The Americans owed their allies.  Neutral nations.  And the former enemy they just won their independence from.  Getting their hands around what they owed was difficult.  But important.  Because they needed to borrow more.  And without getting their finances in order, that wasn’t going to happen.

Thomas Jefferson Understood that a Permanent Debt gave a Government Power 

Hamilton was good with numbers.  And he put America’s financial house in order.  A little too well for Jefferson.  The new federal government assumed the states’ debts (assumption).  And serviced it (funding).  Giving great money and power to the federal government.  Far more than Jefferson believed the Constitution granted.  And this really stuck in his craw.  Because this was the source of all the mischief in the Old World.  Money and power.  The Old World capitals were both the seats of political power.  And the centers of commerce and banking.

Jefferson understood that a permanent debt gave a government a lot of power.  Because debt had to be serviced.  And you serviced debt with taxes.  The bigger the debt the greater the taxes.  Which didn’t sit well with this revolutionary.  I mean, excessive taxation was the cause for rebellion.  Taxes are bad.  And lead to political corruption.  Because the more taxes the government collects the more it can spend on political favors.  Patronage (good paying government jobs for political allies).  Giving rise to a politically-connected ruling class.  Like the Old World aristocracies.  Government grows.  As does their control over the private sector economy.

It’s a process that once started moves in only one direction.  Greater and greater debts.  Paid for by greater and greater taxes.  Until the debt becomes unsustainable.  Like in Revolutionary France.  In present day Greece.  And even in the United States.  Who, in 2011, saw its sovereign debt rating downgraded for the first time in American history.  Because of record deficits.  And record debt.  Caused by excessive spending.  Everything that Jefferson feared would happen.  If government had a permanent debt.

Baseline Budgeting guarantees Permanent Growth in Government Spending

Big Government spending took off in America in the Sixties.  Historically government receipts averaged 17.8% of GDP.  During the Fifties and the Sixties, GDP grew while debt remained flat.  Of course, if GDP grew then so did tax dollars coming into Washington.  For 17.8% of an expanding GDP produced an expanding pile of cash in the government’s coffers.

Liking the taste of this money, government kept spending.  So much so that they adopted baseline budgeting in 1974.  Where current spending is automatically added to for next year’s spending.  Guaranteeing permanent growth in government spending.  To pay for LBJ‘s Great Society.  The Vietnam WarApollo.  And other spending programs.  The spending was so out of control that the debt started to creep up.  And what they didn’t borrow they printed.  Leading to the Nixon Shock.

The Nixon Shock (ending the quasi gold standard) unleashed inflation.  Which Paul Volcker and Ronald Reagan defeated.  With inflation tamed and the Reagan tax cuts, the Eighties saw solid GDP growth.  And record deficits.  The Democrats liked all that cash coming into Washington.  And they spent it faster than it came in.  But to reduce the deficit they made a deal.  For each dollar in new taxes the Democrats would cut three dollars in spending.  Of course they lied.  Because Democrats don’t cut taxes.  They got their new taxes.  But Reagan didn’t get any spending cuts.  In fact, the deal went the other way.  For every dollar in new taxes there were three dollars in new spending.  The deficit grew bigger.  And for the first time the debt grew at a greater rate than GDP.  As shown here:

(Source:  GDP, Debt, Receipts)

The Obama Stimulus gave us Record Deficits and Record Debt

After the 1994 midterm elections, Bill Clinton and the new Republican House compromised.  They reined in spending.  Implemented welfare reform.  And rode the dot-com bubble on the good side.  Before it burst.  It was capital gains galore.  Put all of this together and GDP rose and flooded Washington with tax receipts.  While debt remained flat.  In fact, there were budget surpluses forecast.  But then that dot-com bubble burst.

George W. Bush started his presidency with recession.  A couple of tax cuts later and GDP was tracking up again.  But 9/11 changed things.  And gave us two costly wars (Iraq and Afghanistan).  On top of an expensive Medicare drug program.  Record deficits took debt to new heights.  Then the Housing Bubble burst.  Followed by the subprime mortgage crisis.  And President Obama used this crisis to advance a dormant Democrat agenda.

It was an $800 billion stimulus.  Something he promised would have no pork or earmarks.  Nothing but shovel-ready projects.  Of course, it was nothing but pork and earmarks.  And those shovel-ready projects?  There’s no such thing.  So the stimulus didn’t stimulate anything.  Other than record deficits (surpassing Bush’s).  And record debt.  Debt increasing at a greater rate than GDP.  And equal to or greater than GDP in dollars.  Not seen since World War II.

Hamilton and Jefferson would have United in Opposition against Barack Obama

Debt fell as a percentage of GDP following World War II.  It fell from above 90% to below 40% around the end of the Sixties.  GDP was rising during this period while debt remained flat.  So the flat debt became a smaller and smaller percentage of a growing GDP.  The ‘growing your way out of debt’ phenomenon.  But that process stopped and reversed itself during the Seventies.  When Congress spent with a fury.  As noted above.  Debt grew.  Back to the level of GDP it was during a world war.  Only now there is no world war.  And we’re not spending to save democracy.  We’re spending to end democracy.

(Source:  GDP, Debt $, Debt %)

It is what Jefferson feared most.  Out of control government spending.  Racking up massive debt.  The kind that is impossible to pay off.  And is permanent.  And it was being done not for a war to save democracy from fascism.  But to change America.  To make it a different kind of nation.  No longer one of limited government.  But Big Government.  One with a ruling class.  A ruling class that now has a claim on 100% of GDP.  To pay for everything they gave us.  Where there is no choice but fair-share sacrifice.  Where everyone pays their ‘fair share’ of taxes.  Which is government-speak for raising taxes on everyone.  To flood government coffers with more private sector wealth.

The country is not what it was.  And it will never be what it once was again.  Not with this level of spending.   This is the kind of spending nations see in their decline.  It’s what toppled Louis XVI.  It’s what roiled Greece in riots.  It’s what downgraded U.S. sovereign debt.  For the first time.  Even Alexander Hamilton wouldn’t approve of this.  For his Big Government idea was all about making the nation an economic superpower.  Not bringing back feudalism.

So if you’re not a fan of Barack Obama, here’s something you can credit him for.  His policies would have reconciled two of our most beloved Founding Fathers.  For Hamilton and Jefferson may have hated each other.  But they would have united in opposition against Barack Obama.

 www.PITHOCRATES.com

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