Phillips Curve

Posted by PITHOCRATES - September 17th, 2012

Economics 101

A High Savings Rate provides Abundant Capital for Banks to Loan to Businesses

Time.  It’s what runs our lives.  Well, that, and patience.  Together they run our lives.  For these two things determine the difference between savings.  And consumption.  Whether we have the patience to wait and save our money to buy something in the future.  Like a house.  Or if we are too impatient to wait.  And choose to spend our money now.  On a new car, clothes, jewelry, nice dinners, travel, etc.  Choosing current consumption for pleasure now.  Or choosing savings for pleasure later.

We call this time preference.  And everyone has their own time preference.  Even societies have their own time preferences.  And it’s that time preference that determines the rate of consumption and the rate of savings.  Our parents’ generation had a higher preference to save money.  The current generation has a higher preference for current consumption.  Which is why a lot of the current generation is now living with their parents.  For their parents preference for saving money over consuming money allowed them to buy a house that they own free and clear today.  While having savings to live on during these difficult economic times.  Unlike their children.  Whose consumption of cars, clothes, jewelry, nice dinners, travel, etc., left them with little savings to weather these difficult economic times.  And with a house they no longer can afford to pay the mortgage.

A society’s time preference determines the natural rate of interest.  A higher savings rate provides abundant capital for banks to loan to businesses.  Which lowers the natural rate of interest.  A high rate of consumption results with a lower savings rate.  Providing less capital for banks to loan to businesses.  Which raises the natural interest rate.  High interest rates make it more difficult for businesses to borrow money to expand their business than it is with low interest rates.  Thus higher interest rates reduce the rate of job creation.  Or, restated another way, a low savings rate reduces the rate of job creation.

The Phillips Curve shows the Keynesian Relationship between the Unemployment Rate and the Inflation Rate

Before the era of central banks and fiat money economists understood this relationship between savings and employment very well.  But after the advent of central banking and fiat money economists restated this relationship.  In particular the Keynesian economists.  Who dropped the savings part.  And instead focused only on the relationship between interest rates and employment.  Advising governments in the 20th century that they had the power to control the economy.  If they adopt central banking and fiat money.  For they could print their own money and determine the interest rate.  Making savings a relic of a bygone era.

The theory was that if a high rate of savings lowered interest rates by creating more capital for banks to loan why not lower interest rates further by just printing money and giving it to the banks to loan?  If low interests rates were good lower interest rates must be better.  At least this was Keynesian theory.  And expanding governments everywhere in the 20th century put this theory to the test.  Printing money.  A lot of it.  Based on the belief that if they kept pumping more money into the economy they could stimulate unending economic growth.  Because with a growing amount of money for banks to loan they could keep interest rates low.  Encouraging businesses to keep borrowing money to expand their businesses.  Hire more people to fill newly created jobs.  And expand economic activity.

Economists thought they had found the Holy Grail to ending recessions as we knew them.  Whenever unemployment rose all they had to do was print new money.  For the economic activity businesses created with this new money would create new jobs to replace the jobs lost due to recession.   The Keynesians built on their relationship between interest rates and employment.  And developed a relationship between the expansion of the money supply and employment.  Particularly, the relationship between the inflation rate (the rate at which they expanded the money supply) and the unemployment rate.  What they found was an inverse relationship.  When there was a high unemployment rate there was a low inflation rate.  When there was a low unemployment rate there was a high inflation rate.  They showed this with their Phillips Curve.  That graphed the relationship between the inflation rate (shown rising on the y-axis) and the unemployment rate (shown increasing on the x-axis).  The Phillips Curve was the answer to ending recessions.  For when the unemployment rate went up all the government had to do was create some inflation (i.e., expand the money supply).  And as they increased the inflation rate the unemployment rate would, of course, fall.  Just like the Phillips Curve showed.

The Seventies Inflationary Damage was So Great that neither Technology nor Productivity Gains could Overcome It

But the Phillips Curve blew up in the Keynesians’ faces during the Seventies.  As they tried to reduce the unemployment rate by increasing the inflation rate.  When they did, though, the unemployment did not fall.  But the inflation rate did rise.  In a direct violation of the Phillips Curve.  Which said that was impossible.  To have a high inflation rate AND a high unemployment rate at the same time.  How did this happen?  Because the economic activity they created with their inflationary policies was artificial.  Lowering the interest rate below the natural interest rate encouraged people to borrow money they had no intention of borrowing earlier.  Because they did not see sufficient demand in the market place to expand their businesses to meet.  However, business people are human.  And they can make mistakes.  Such as borrowing money to expand their businesses solely because the money was cheap to borrow.

When you inflate the money supply you depreciate the dollar.  Because there are more dollars in circulation chasing the same amount of goods and services.  And if the money is worth less what does that do to prices?  It increases them.  Because it takes more of the devalued dollars to buy what they once bought.  So you have a general increase of prices that follows any monetary expansion.  Which is what is waiting for those businesses borrowing that new money to expand their businesses.  Typically the capital goods businesses.  Those businesses higher up in the stages of production.  A long way out from retail sales.  Where the people are waiting to buy the new products made from their capital goods.  Which will take a while to filter down to the consumer level.  But by the time they do prices will be rising throughout the economy.  Leaving consumers with less money to spend.  So by the times those new products built from those capital goods reach the retail level there isn’t an increase in consumption to buy them.  Because inflation has by this time raised prices.  Especially gas prices.  So not only are the consumers not buying these new goods they are cutting back from previous purchasing levels.  Leaving all those businesses in the higher stages of production that expanded their businesses (because of the availability of cheap money) with some serious overcapacity.  Forcing them to cut back production and lay off workers.  Often times to a level below that existing before the inflationary monetary expansion intended to decrease the unemployment rate.

Governments have been practicing Keynesian economics throughout the 20th century.  So why did it take until the Seventies for this to happen?  Because in the Seventies they did something that made it very easy to expand the money supply.  President Nixon decoupled the dollar from gold (the Nixon Shock).  Which was the only restraint on the government from expanding the money supply.  Which they did greater during the Seventies than they had at any previous time.  Under the ‘gold standard’ the U.S. had to maintain the value of the dollar by pegging it to gold.  They couldn’t depreciate it much.  Without the ‘gold standard’ they could depreciate it all they wanted to.  So they did. Prior to the Seventies they inflated the money supply by about 5%.  After the Nixon Shock that jumped to about 15-20%.  This was the difference.  The inflationary damage was so bad that no amount of technological advancement or productivity gains could overcome it.  Which exposed the true damage inflationary Keynesian economic policies cause.  As well as discrediting the Phillips Curve.

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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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The Eurozone Contagion Spawned in Spain, Greece and Italy has Infected French Banks

Posted by PITHOCRATES - December 11th, 2011

Week in Review

Here is how a contagion spreads (see Moody’s downgrades top three French banks posted 12/9/2011 on UPI).

Credit rating agency Moody’s Investors Service lowered credit scores for three of the largest banks in France Friday…

The rating service said it was concerned the conditions in Spain, Greece and Italy could deteriorate further, which would mean the French banks would suffer deeper losses on the government bonds they hold.

The whole point of the Eurozone is to replicate the massive free trade economy of the United States.  And it’s been somewhat successful.  The economy of the united states of Europe has matched and even exceeded the economic output of the United States.  But some of the member states cheated to get into the common currency.  The Euro.  By lying about their true debt levels.  And their deficits.  These states are now in trouble.  The costs of their welfare states grow.  Which requires more government borrowing.  And these continuous and growing deficits add to that massive debt.

There comes a point when people doubt whether these states will be able to repay their debt.  And that’s what private investors are now thinking.  So they’re not buying anymore of their debt.  Unless they make it worth their while.  With very high interest rates.  Which increases the cost to service the debt.  In fact their borrowing costs have grown so great that they have to borrow money to pay the interest on the money they borrow.

Of course, this makes it even more doubtful that these countries will be able to repay this debt.  Which scares away more private investors.  Despite those high interest rates.  And threatens the solvency of these countries.  And the common currency itself.  The Euro.  And if the Euro goes so does the Eurozone.  Including the economic powerhouse of the united states of Europe with it.

So other countries of the Eurozone step in and buy these worthless bonds.  To try and save the Euro.  And their own economies.  Now the financial problems of Greece, Spain and Italy are now everyone’s financial problems.  Because of those worthless bonds sitting on the balance sheets of healthier banks.  Which are not quite so healthy anymore.  Because of their exposure to this contagion.

It’s a dangerous game they play.  To save the Eurozone they have to infect themselves with the contagion.  And hope that they are financially immune enough to live through this sickness.  But they are teetering on the brink with their own massive debt.  Their own massive welfare states growing their deficits.  Which will be a problem.  For they refuse to take the same medicine Greece, Spain and Italy are refusing to take.  Austerity.  So the chances are pretty good that they will fall to the contagion, too.  As it continues to spread and infect everyone in the Eurozone.  Until there will be no Eurozone.  Or a united states of Europe.

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FUNDAMENTAL TRUTH #55: “Liberals are all for trickle-down economics as long as the wealth trickles down from those who support liberals.” -Old Pithy

Posted by PITHOCRATES - March 1st, 2011

 Under Carter it was ‘in Government we Trust’

Mention Ronald Reagan in a room full of liberals and no doubt you’ll hear some derisive comment about trickle-down economics.  You see, liberals don’t like Reagan.  They liked Jimmy Carter.  But hated Ronald Reagan.  Because Reagan dared to say the king was wearing no clothes.  Metaphorically, of course.  But not Carter.  He clung onto the illusion of Big Government as the people’s savior.  Though a practicing Baptist, for Carter it was ‘in government we trust’.

Carter was a one term president.  Liberals may have liked him but the rest of the country didn’t.  Granted, he came into office with some pretty bad economic problems.  He can thank LBJ‘s Great Society for that.  The greatest explosion of government spending since FDR‘s New Deal.  And then Nixon decoupling the dollar from gold didn’t help.  The left doesn’t much care for Nixon, either.  Which is funny.  Because he governed as a liberal.  He spent money and grew government.  And when he decoupled the dollar from gold he called himself a Keynesian (i.e., a Big Government guy when it came to economics).  Carter’s misfortune was to follow all of this financial devastation.  Well, that, and the fact he didn’t have a clue about how to fix things.

Reagan did.  “Government isn’t the solution to our problems, government is the problem,” Reagan said in 1981.  And the warning Klaxons went off throughout liberal-land.   There was imminent danger.  And his name was Ronald Reagan.  You see, Carter did all the right things.  For those on the left.  And what did he get?  High inflation.  High interest rates.  And high unemployment.  They measured the economy with the misery index as we wallowed through the stagflation of the Carter years.  During the 1980 presidential campaign, Reagan asked the simple question heard round the world.  Are you better off now than you were 4 years ago?  Reagan went on to win the election.  So the answer was ‘no’.

Reagan Fixed the Economy and Fired Air Traffic Controllers

Reagan cut tax rates.  And the economy eventually exploded.  We said goodbye to stagflation.  And the misery index.  They were relics of the Carter years.  It was a new morning in America.  People had jobs.  They were happy.  Optimistic.  And this infuriated liberals.  Because Reagan’s conservatism flew into the face of everything they held dear.  And then came PATCO

The Professional Air Traffic Controllers Organization.  A federal government union.  They went on strike in 1981.  Which was against the law.  Government unions could not go on strike.  The strike shut down much of air traffic in the U.S.  This was big.  No business travel.  No sports travel.  No vacations.  No mail.  A small group of some 11,000 controllers shut down air travel.  And greatly disrupted the economy.  Reagan ordered them back to work per the law.  They refused.  He fired them.  And the left howled.

So you can see why liberals hate Reagan.  He was a destroyer and debunker of liberalism.  And the people loved him.  He won reelection with 49 states.  The man was more popular than sliced bread.  Worse, people were happy.  Whistling a happy tune while they went on their merry way.  Which is all well and good if you’re one of the ones whistling.  But when you’re part of that tiny 20% of the population that wants to run the other 80%, there was nothing to whistle about.  Reagan had become liberal enemy number one.

Reaganomics Replaces Failed Keynesian Economic Policies

So they attacked.  Then.  And now.  And they zero in on those tax rate cuts.  Sure, they say, the tax cuts stimulated the economy, but at what cost?  Huge deficits and a skyrocketing debt.  This, of course, is not true.  The cuts in the tax rates nearly doubled tax receipts.  The Democrat House (Tip O’Neil and his fellow Democrats had the power of the purse) just went on a spending spree with all that cash pouring into Washington.  Remember, all spending bills originate in the House of Representatives.  Defense.  Entitlements.  And all discretionary spending.  And when tax receipts nearly doubled with cuts in the tax rates, it proved that Reagan was right.  And liberals were wrong.

But they keep repeating the lie.  Hoping that if people hear it enough people will believe it.  Then they move on to trickle-down economics.  Supply-side economics.  Reaganomics.  They love to disparage this term.  Despite the fact that under Reaganomics, the 1980s was one of the most prosperous periods in American history.  So what is supply-side economics?  Well, think of it this way.  When do you live better?  When you have a job?  Or don’t have a job?  It’s pretty hard to pay your bills if you don’t have a job.  You can’t buy gasoline.  Food.  Clothes.  Electronic toys.  Etc.  So I think most will agree that life is better when we have a job.  And where do jobs come from?  From businesses.  That are pursuing a profit.  If they can make a profit they expand their businesses.  And hire more people.  Thus creating more jobs.  And this is supply-side economics in a nutshell.  They’re economic policies that are business-friendly to encourage their growth.  So they will hire more people.

Makes sense.  To the sensible.  But not to a liberal.  Because liberals are Keynesians.  They want to redistribute the wealth.  Take money from the rich.  And give it to the poor.  They believe that is how you create economic activity.  By giving other people’s money to other people so they can spend it.  And we tried it.  Under LBJ, Nixon, Ford and Carter.  Didn’t work.  Liberals will blame everything under the sun why it didn’t work.  But never the ideology itself.  Which is flawed.  Because higher taxes reduce profits.  Which hinders business expansion.  Which hinders job creation.  Which hinders economic activity.  And this is exactly what happened under LBJ, Nixon, Ford and Carter.  Which is why Carter was a one term president.

Trickle-Down is Okay as long as it Fills Union Coffers

The funny thing is that the left often supports trickle-down economics.  Whenever they are supporting the UAW.  They support high pay and benefits for unskilled labor on the assembly line.  Because it stimulates the economy. Yes, we pay these people a lot.  But they go out and spend that money.  And that pumps a lot of money into the local economy.  We’ve all heard these arguments.  Whenever liberals are defending high union wages and benefits.  Of course, liberals got so greedy that they killed the golden goose.  Assembly plants left the country.  Robots replaced workers on the line.  The few jobs remaining have nice wage and benefit packages.  But at what cost?  Hundreds of thousands of jobs were lost in the deal.  A terrible cost as jobs drive the economy.  The more the better.  While fewer higher-paid jobs just don’t help anyone but the few who have those jobs.

It’s the same thing with public sector workers.  No one has a better salary and benefit package.  For many it’s like getting two paychecks for one job.  For every dollar in pay they get something like $0.75 in benefits.  Mostly health care and pensions.  Teachers are often some of the greatest beneficiaries when you factor in all the time off they get.  There’s a reason why these public sector workers strike and never quit these ‘horrible’ jobs.  Because they can’t find a better job.  So when states and cities have trouble balancing their budgets because of out of control health care and pension costs they raise taxes.  Make the rest of us live on less.  To save these jobs.  For these good people.  Sure, we pay them a lot.  But they go out and spend that money.  And that pumps a lot of money into the local economy.

So that kind of trickle-down economics is okay.  But Reaganomics was nothing but tax breaks for the rich paid for by the working poor.  While fat union pay and benefits stimulated local economies.  A double standard?  Yes.  But there is a difference.  Trickle-down from job creators doesn’t generate a lot of union dues.  Trickle-down from union workers and the public sector do.  That’s why the liberals support unions.  Because liberals get a lot of that dues money.  And loyal foot soldiers to advance their agenda.

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