Keynesian Economists are Narcissists who don’t know the First Thing about Economics

Posted by PITHOCRATES - March 2nd, 2014

Week in Review

There was a sketch on the Benny Hill Show that reminds me of Keynesian economists.  Benny was singing a song and they were showing the unrequited love around him.  They showed one woman who loved a man.  But that man loved another woman.  Who loved Benny.  And who did Benny love?  The camera remained on Benny.  Because that’s who he loved.

Keynesian economists are a lot like that.  They like to sound erudite.  They like to write things with impressive economic jargon in it.  The layman can’t understand a thing they say or write.  But that’s okay.  As they are writing to impress their peers.  People who are as narcissistic as they are.  And they tell each other how brilliant they are with all of their demand-side pontificating.  Pinching each other’s cheeks and saying, “Who’s a good economist?  You are.  You’re a good economist.  Yes you are.”  Even though they are always wrong.  Reminding me of another television show.  Hogan’s Heroes.  Where Colonel Hogan and Colonel Klink were disarming a bomb in the compound.  They’re down to two wires.  One disarms the bomb.  The other detonates it.  Colonel Hogan asks Colonel Klink which wire to cut.  He picks one.  And just as he’s about to cut it Colonel Hogan changes his mind and cuts the other wire.  Disarming the bomb.  Colonel Klink asks him if he knew which wire to cut why did he ask him.  And he replied that he wasn’t sure but he knew for sure that Colonel Klink would pick the wrong wire.

This is just like a Keynesian economist.  Ask them what to do to help the economy and you can be sure they’ll pick the wrong thing to do.  Because they love their demand-side economics with all their charts and graphs and equations.  For it feeds into their superiority complex.  As they can baffle people with their bull s***.  Well, the truth is that the economic data doesn’t support demand-side economics.  For all of the stimulus spending Keynesians have encouraged governments to do have never pulled an economy out of a recession.  It has only extended a recession.  And made it more painful.  For if you want to help the economy you have to work on the supply side.  Make it easier for people to be creative and bring things to market.  Things people will buy.  Even if they had no idea that they existed before seeing them in the market (see How Taco Bell’s Lead Innovator Created The Most Successful Menu Item Of All Time by Ashley Lutz posted 2/26/2014 on Business Insider).

The Doritos Locos Taco is one of the most successful fast food innovations of all time.

Taco Bell released the product in 2012 and sold more than a billion units in the first year. The fast food company had to hire an estimated 15,000 workers to keep up with demand…

The team went through more than 40 recipes, and Gomez told Business Insider he sometimes felt like the idea would never come to fruition.

“Execution was so difficult,” he said.

Gomez was eventually able to perfect the shell by using the same corn masa found in Doritos. He also discovered a process that would evenly distribute the seasoning on the shells. And the company found a way to contain the cheese dust in the production process.

Even after Gomez created the ultimate shell, he still had to design production facilities that would make millions of them.

But for Gomez, the years of effort was worth it.

“When we shared the idea with our consumers, they loved it,” Gomez said. “I was blown away with how immediately popular Doritos Locos Tacos became.”

The taco is the most popular menu item in the fast food chain’s 50-year history.

This wasn’t demand-driven.  As Keynesians believe everything is.  Get more money into the hands of consumers and they will demand things.  Thus increasing economic activity.  But not a single consumer was demanding the Doritos Locos Taco.  As there was no such thing to demand.  And giving them more money wasn’t going to bring it to market.  Only creative people with an idea and an indefatigable passion brought this to market.  Spending a lot of years and lots of money to bring to market something people weren’t demanding.  And might not even like.  But they did.  And it was a big success.  This is how you create economic activity.  On the supply side.  Cut tax rates and costly regulations.  Like Obamacare.  So other people are encouraged to be creative and use their indefatigable passion to bring other things to market.  Creating a whole lot more economic activity than just giving people a stimulus check and telling them to go out and create economic activity.  Because once that Keynesian stimulus is spent it cannot create any more economic activity.  Unlike all of the economic activity it takes to sell a billion or more Doritos Locos Tacos a year.


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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 US and UK following Keynesian Policies and Suffering Jobless Recoveries

Posted by PITHOCRATES - April 28th, 2012

Week in Review

The US is not the only country suffering through a ‘jobless’ recovery.  Which is just another way of saying continued recession.  Or double-dip recession.  The UK is having the same problems we’re having.  And using inept government policies to try and fix them.  Just like in the US (see A recession made in Downing Street – but not caused by cuts by ALLISTER HEATH posted 4/26/2012 on City A.M.).

The first problem has been the composition of the austerity package. Much of the tightening has been via tax hikes rather than spending cuts – capital gains, national insurance, stamp duty, value added tax, and now pasties and the rest. That was the wrong choice: lower taxes are good for growth, higher taxes are bad. The trick is to deliver austerity by cutting spending, not by hiking taxes.

The next issue is that the government’s supply-side agenda has failed miserably. By now, developers should have been set free to build new airports and even cities; the labour market should have been liberalised; job-reducing red tape eliminated; the top rate of tax abolished; mad EU rules abolished, and so on and so forth. Britain needed a revolution; it was granted a few over-hyped reforms…

…excessive inflation has slashed real incomes and real wealth; this, rather than cuts, is what has depressed spending the most…

Last but not least, banking rules. It was right to ensure banks held more capital and that credit became priced rationally – but the reforms have spiralled out of control…

What is most depressing is that the double-dip (if that is indeed what it is) will wrongly discredit austerity, even though the state remains incredibly profligate…

President Obama has broken deficit and debt records.  While he chastises the Right for irresponsibly spending beyond their means.  Demanding that they raise taxes to pay for this irresponsible spending.  That somehow higher taxes will fix all of America’s ills.  Or, at the least, address the social injustice of prosperity.  And happiness.

Both the UK and the US are steadfastly following the failed policies of John Maynard Keynes.  Demand-side Keynesian economics.  Tax and spend.  Because they’ve ‘worked so well’ in the past.  Of course they haven’t.  They never have.  And they never will.  What works are supply-side economics.  Those policies embraced by Margaret Thatcher.  And Ronald Reagan.  Who enjoyed real economic recoveries.  The kind that created jobs.

Politics never change.  Politicians dumb down public education so the people never learn the lessons of history.  That all of their policies are tried and failed.  So they make the same arguments every election cycle.  And the young believe in the goodness of these policies.  The fairness of these policies.  Never knowing the lives they have destroyed through the years.  Which is why politicians work so hard to get the youth vote.  Before they learn the truth.  And become conservative.


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Apple Suspends Retail Sales of their iPhone 4S in China due to Crushing Mobs at Retail Stores

Posted by PITHOCRATES - January 14th, 2012

Week in Review

Here is a economics lesson in supply and demand and the role of prices as people in China try to buy the new Apple iPhone 4S (see Apple to halt sales of latest iPhone in China retail stores by Terril Yue Jones and Lucy Hornby posted 1/13/2012 on Reuters).

“We’re suffering from cold and hunger,” a man in his 20s shouted to Reuters Television. “They said they’re not going to sell to us. Why? Why?”

“I got in line around 11 p.m., and beyond the line, the plaza was chock full with people,” said Huang Xiantong, 26, from northeastern Liaoning province.

“Around 5 a.m. the crowds in the plaza broke through and the line disappeared entirely. Everyone was fighting, several people were hurt. The police just started hitting people. They were just brawling.”

Clearly Apple created something that people want.  Which has often been the case with Apple.  Building things people have to have.  Even before the people knew what these things were or that they would one day have to have them.  This is supply-side economics.  This economic activity was generated by supply.  Apple’s new product.  Created by creative human capital and the entrepreneurial spirit.  This is what businesses do.  If we let them.  And not burden them with excessive taxes and regulations.

Of course a Keynesian will point out that Apple did exactly that.  Created their products despite excessive taxes and regulations.  True.  They did that.  But Apple is a giant now.  They can hire lawyers and tax accountants to navigate these excessive taxes and regulations.  The new entrepreneur can’t.  Like other Steve Jobs trying to start out now by creating something new that the people will discover that they must have.  Many of who will not get past the excessive taxes and regulations to get where Steve Jobs did.  Falling along the wayside of ingenuity and possibility because of those excessive taxes and regulations.

Of course, others will point out that if it wasn’t for those excessive taxes and regulations corporations would just put profits before people and charge whatever prices they want.  Selling whatever inferior quality they want.  Well, regarding the quality I refer you to the Reuters article about iPhones going on sale in China.  As regard to prices…

Apple’s latest iPhone, with features including responding to commands with its own voice, was introduced in China and 21 other countries on Friday. Prices ranged from 4,988 to 6,788 yuan ($792 to $1,077).

Apple, in a statement, said its other stores had sold out.

Are prices ranging from $792 to $1,077 fair?  Based on the long lines and stores selling out, I believe the people have spoken.  And they say, yes, these prices are fair.  Perhaps even too fair.  If they were a little more expensive those who truly wanted one and were willing to pay a higher price probably would have been able to buy one before the stores sold out.

This is an example of Say’s law.  Supply creates demand.  These ingenious smartphones were not created in response to demand.  Apple created them and explained why people must have them.  Which they did.  This is how you stimulate economic activity.  Supply-side economics.  You make it as easy as possible for people to bring ingenious things to market.  Not the Keynesian way.  Giving more money to people through tax and spend policies.  Which only allows people to buy what’s on the market now.  It doesn’t stimulate the creativity of entrepreneurs.  Who bring the next great things to market.


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FT96: “The Left uses propaganda more effectively than the Right uses the truth.” -Old Pithy

Posted by PITHOCRATES - December 16th, 2011

Fundamental Truth

Liberals lie because only about 20% of the People are Liberal Democrats

Politicians lie.  On both sides of the aisle.  Democrats lie because they always want to raise our taxes.  And campaigning to raise your taxes just doesn’t win a lot of votes.  So they lie.  Republicans lie, too.  Especially those that want to act like Democrats.  And join the Washington elite where you go to the best of parties and rub shoulders with the best of A-list celebrities.

So that’s why politicians lie.  To fool you into voting for them.  So they can live a far, far better life than you can ever imagine.  Some have grown pretty adept at it.  In particular liberal Democrats.  Who have taken the lie and elevated it to pure party propaganda.   Again, because they have too.  With only about 20% of the people being liberal Democrats, there aren’t enough people out there buying what they’re selling.  So they have to lie about what they’re selling.

And what, exactly, are they selling?  Privilege.  For themselves.  And their friends.  Which they give themselves after winning elections.  Power, control and money.  The usual things a privileged class covets.  Like in the good old days.  In the Old World.  Where a good last name set you apart from the rabble.  And let you live the good life without working.

The more Wretched and Impoverished the Poor get the Better it is for Big Government

Today’s aristocracy is Big Government.  For those in it have power, control and money.  Just like a Baron in medieval Europe.  Except for one thing.  This nobility never has to put on armor and mount his steed and fight for the king.  So it’s even better.  Of course, in the Old World, there were oaths of fealty.  The price of privilege was the possibility of fighting, even dying, for your king.  A liberal Democrat has no such thing to fear.  Hell, they can break the law even and nine times out of ten they’ll get away with it.  Because their kind takes care of their own.  And doesn’t let a little thing like the law get in the way of their good life.

So how does one get to live better than everyone else?  Even being above the law at times?  Simple.  You champion the little guy.  The poor.  The downtrodden.  Those at the bottom of the ladder.  You take care of these people.  At least, you say you are.  By expanding the size of government to, say, alleviate poverty.  Then you raise taxes and expand government again and again.  And again.  And because you do this with the best of intentions no one ever points out that everything you’ve done has failed.  There’s still poverty.  In fact, it seems that every year more people are living below the poverty line.  At least according to government statistics.  Or should I say Big Government statistics?  Convenient, yes?  A little of putting the fox in charge of the henhouse, isn’t it?

Of course, that’s the plan.  Because if you got rid of poverty you’d put Big Government out of a job.  I mean, if everyone was living happily ever what would you need them for?  Happiness is not good for Big Government.  That’s right, the more wretched and impoverished the poor get the better it is for government programs that ‘care’ for them.  And spend more money on them.  Which means more taxes, more control and more positions within the new aristocracy for more of their own.

JFK and Ronald Reagan were both Tax-Cutting Supply-Siders

To keep raising taxes and to keep creating new government programs you have to demonize tax cuts and limited government.  Which is important because history has shown that everyone lives better with lower taxes and a more limited government.  Except, of course, the new aristocracy.

Liberals refer to the Kennedy White House as Camelot.  They absolutely loved JFK.  But they carefully guard his legacy.  Why?  JFK was a tax-cutter.  He believed in supply-side economics.  What the liberal Democrats dismiss snidely as trickle-down economics.  But Kennedy’s tax cuts worked.  They caused an economic boom.  Which the Left is very hush-hush about.  Because they can’t have their hero known as a tax-cutter.  But they have no problem belittling another Kennedy-esque tax-cutter.  Ronald Reagan.

Reagan cut the top marginal tax rate.  The Big Government liberals called him mad.  Out of touch.  Said he hated the poor.  And wanted to starve government programs ‘vital’ for the poor while rewarding rich people.  But like Kennedy, his cut in the tax rates caused an economic boom.  And tax receipts (tax money collected by the IRS) nearly doubled.  None of which was supposed to happen according to the liberals.  So they lied about it.  Said, “yes, there was increased economic activity, but at what cost?  Ronald Reagan’s tax cuts gave us huge deficits that exploded the federal debt.”  Yes, there were huge deficits.  But that’s beside the point.  The cut in the top marginal rate nearly doubled tax receipts.  That’s the key point.  The Reagan tax cuts worked.  The government just spent this new tax revenue faster than they could collect it.

Liberals are such Good Liars that few know the Successful Track Record of Tax Cuts

Cuts in tax rates have a successful track record.  That’s fact.  The Republicans could run on this truth.  But they do such a pathetic job in telling the truth that no one knows about this successful track record.  The liberal democrats, on the other hand, lie through their teeth about this record.  And they’re so good at lying that it’s what most people believe.  Tax cuts explode the deficit.  Grow the debt.  Take money away from the poor.  Gives it to the rich.  While the poor and downtrodden wait for all that wealth to trickle down to them.  But it never comes.  All lies.  But told so well that it’s what most people believe.

JFK was a tax cutter.  A lot like Ronald Reagan.  There were others.  And they all proved that tax cuts increase economic activity.  Which is always good.  Because more economic activity means more jobs.  And more tax receipts.  Which is bad for a caring and nurturing Big Government.  Because if free market capitalism can do this then there is no need for Big Government.  And this is something the new aristocracy just can’t have.


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JFK would have seen a lot of himself in Ronald Reagan

Posted by PITHOCRATES - December 4th, 2011

Week in Review

If you read a speech by JFK without knowing it was a JFK speech something interesting would happen.  You would think you were reading a speech by Ronald Reagan (see By Today’s Standards, JFK Was A Tax-Cutting Supply-Sider posted 11/25/2011 on

Forty-nine years ago, with the economy still recovering from a 10-month recession that ended in 1961, President Kennedy sketched out a bold plan to get the economy moving again. It focused on deep, across-the-board cuts in taxes. Those cuts, made after Kennedy’s tragic death in November 1963, created a boom that lasted through the 1960s and into the 1970s. Contrast his tax-cutting rhetoric of nearly 50 years ago with today’s tax-hiking rhetoric of President Obama and his Democratic colleagues. Following is an abridged version of Kennedy’s remarks to the Economic Club of New York on Dec. 15, 1962.

Yeah, that’s right.  That’s JFK we’re talking about here.  A tax-cutting supply-sider that has more in common with Ronald Reagan than Jimmy Carter, Bill Clinton or Barack Obama.  And he was a Cold War warrior to boot.  Also a lot like Ronald Reagan.

Here are some closing remarks from that JFK speech.

In short, it is a paradoxical truth that tax rates are too high today and tax revenues are too low, and the soundest way to raise the revenues in the long run is to cut the rates now.

The experience of European countries and Japan have borne this out. This country’s own experience with tax reduction in 1954 has borne this out. The reason is that only full employment can balance the budget, and tax reduction can pave the way to that employment. The purpose of cutting taxes now is not to incur a budget deficit, but to achieve the more prosperous, expanding economy that can bring a budget surplus.

Perhaps the Republicans should be quoting this guy.  Run a candidate that is like JFK.  And put him up against Barack Obama.  That would make an interesting campaign.  For the left hates Ronald Reagan.  But they simply adore JFK.  Even though he stood for everything they’re against.

And whenever the Democrats attack the Republican candidate, the Republicans could say that it was an attack on JFK.  Because the Republican candidate believes what JFK believed.  You raised tax revenue by cutting tax rates.  Not by raising tax rates like Barack Obama wants to do.

Unfortunately the Kennedy legacy is not the JFK legacy.  It’s more the liberalism of Teddy Kennedy.  Who stood for everything that JFK did not.


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

Posted by PITHOCRATES - August 8th, 2011

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

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

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

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

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

Inflation Eroded GDP and Raised Unemployment in the Seventies

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

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

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

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

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

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

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

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

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

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

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

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

Reagan’s Tax Cuts Increased both GDP and Tax Revenue

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

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

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

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

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

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

Tax Revenue Increased under Reaganomics but Government Spending simply Increased More

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

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

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


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LESSONS LEARNED #75: “Lower income tax rates generate more tax revenue by making more rich people who pay more income taxes.” -Old Pithy

Posted by PITHOCRATES - July 21st, 2011

Inflation is a Bitch

The top marginal tax rate during the Eisenhower administration peaked at 92%.  When it wasn’t at 92% it was at 91%.  This was post-war America.  A happy time.  They even named a TV series after this time.  Happy Days.  Life was good.  There were jobs aplenty.  And lots of baby making.  Everyone lived happily ever after.  Until the war-devastated economies rebuilt themselves and didn’t need American manufacturing anymore.

Things started to change in the Sixties.  Sure, a top marginal tax rate of 92% was high.  But few paid it.  Creative accounting and useful tax shelters avoided that punishing rate.  But government was still fat and happy with the money it was collecting.  Until the Vietnam War came along.  Johnson‘s Great Society.  And let’s not forget the Apollo moon program.  With renewed competition for American manufacturing, trouble in the oil-rich Middle East and rising inflation, the Seventies weren’t going to be happy.

And they weren’t.  Oil shockNixon shockStagflationMiseryKeynesian economics says to tax and spend to tweak the economy back to health.  When you can’t tax enough, you borrow.  When you can’t borrow, you print.  Nothing is more important than creating demand where no demand exists.  Give consumers more money to spend and ignore the debt, deficit and inflation.  The problem is, inflation is a bitch.

Reaganomics increased GDP 82.9%

Ronald Reagan routed Jimmy Carter in the 1980 presidential election.  Carter’s economic numbers were some of the worst in history.  Double digit interest rates, unemployment and inflation.  All being flamed by an expansionary Keynesian monetary policy.  Until Paul Volcker took over the Fed during Carter’s last year or so in office.  And there really is only one way to cure a bad inflation.  With a bad recession.  And the Reagan recession of the early 1980s was one of the more severe ones.

Reagan was from the Austrian school of economics.  Supply-side.  His Reaganomics embraced the following tenets: cut spending, cut taxes, cut regulation and cut inflation.  In 1980 the top marginal tax rate was 70%.  When he left office it was 28%.  During his 8 years in office he took GDP from $2,788.1 billion to $5,100.4 billion (an increase of 82.9%).

The Reagan critics will note this explosive economic growth and say, “Yeah, but at what cost?  Record deficits.”  True, Reagan had some of the highest deficits up to his time.  But those deficits had nothing to do with his tax cuts.  For Reagan increased tax revenue from $798.7 billion to $1,502.4 billion (an increase of 88.1%).  Those deficits weren’t from a lack of revenue.  They were from an excess of spending.  And, therefore, not the fault of the Reagan tax cuts.

A Downward Trend in Prices is like an Upward Trend in Wages

And the Reagan critic will counter this with, “Sure, the economy grew.  But the rich got richer and the poor got poorer.”  Yes, his income and capital gains tax cuts made a lot of rich people.  But they also transferred the tax burden from the poor to the rich.  In 1980, the top 1% of earners paid 19.1% of all federal income taxes.  By the time he left office that number grew to 27.6% (an increase of 44.8%).  Meanwhile the bottom 50% of earners paid less.  Their share fell from 7.1% to 5.7% (a decrease of 18.9%).

Of course, the Reagan critic will then note that Reagan slashed domestic spending to pay for his military spending.  Well, yes, Reagan did spend a lot.  He increased spending from $846.5 billion to $1,623.6 billion (or an increase of 91.8%).  But he made a tax deal with Congress.  For every new $1 in taxes Congress would cut $3 in spending.  Those spending cuts never came.  Hence Reagan’s monstrous $200 billion deficits.  That’s a lot of money for both guns and butter.

But the greatest thing he did for low-income people was curbing inflation.  High inflation makes everything cost more, leaving low-income people with less to live on.  In 1980, inflation was at 13.5%.  When Reagan left office he had lowered it to 4.1% (a decrease of 69.6%).  No one benefited more from this reduction in inflation than low-income people.  A downward trend in prices is like an upward trend in wages.

The Reagan Economy was Better than the Clinton Economy

The Reagan critic likes to point to the Clinton years as a better economic period with better economic (and fairer) policies.  The Nineties were a period of economic growth.  But even with the dot-com bubble near the end of that period the Clinton GDP growth of 56.9% was less than Reagan’s 82.9%.   

Whereas Reagan achieved spectacular GDP growth while fighting inflation, the Clinton growth did not have to slay the inflation beast.  In fact, inflation rose from 3.0% to 3.4% during his two terms, indicting the GDP growth was not as real as Reagan’s.  Reagan’s was measured with a strengthening dollar.  Clinton’s was measured with a weakening dollar.  Also, real prices fell under Reagan.  While they rose under Clinton.  Making life more expensive for low-income people under Clinton than under Reagan.

Thanks to the dot-com boom, though, Clinton continued to transfer the tax burden to the rich.  He experienced a wind-fall of capital gains tax revenue when all those rich dot-com people cashed in their stock options.  In 1992, the top 1% of earners paid 27.4% of all federal income taxes.  By the time he left office that number grew to 37.4%.  This was an increase of 35.9% (compared to Reagan’s 44.8%).  Meanwhile the bottom 50% of earners paid less, too.  Their share fell from 5.1% to 3.9%.  This was a decrease of 22.7% (compared to Reagan’s 18.9%). 

Over all, though, Clinton’s policies increased tax revenue 69.8% compared to Reagan’s 88.1%.  And this was with the dot-com boom thrown in.  Had there been no dot-com bubble (that burst after he left office) no doubt his GDP and tax revenue would have been less.  Some of this economic dampening perhaps being caused by his increase of the top marginal tax rate from 31% to 39.6%. 

Both Reagan and Clinton made more Rich People

Reagan’s tax cuts led to an economic boom.  He cut inflation making life more affordable for lower-income people.  And he transferred the tax burden to the rich.

Clinton increased taxes.  His economic boom was good but not great.  A big part of his GDP growth and tax revenue was due more to irrational exuberance than real economic growth. 

But both Reagan and Clinton made more rich people.  And these rich people paid more taxes.  And because they did low-income people paid less.  Which would seem to prove that the best way to increase tax revenue (and make the tax system more progressive) would be to create more rich people.  And yet the very people who want to do this advance policies that work against these objectives.  Why?

Politics.  Sure, the Austrian school of economics has a proven track record over the Keynesian school.  But Austrian school economics has a terrible side affect.  It doesn’t grow government.  And all the economic growth and tax revenue doesn’t mean a thing if you lose your comfy federal job.  At least to a Big Government politician.


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Demand-Side Slump or Government caused Supply-Side Recession?

Posted by PITHOCRATES - June 4th, 2011

The Arrogance and Condescension of Liberal Elite Academics

The problem with liberal academics running the country is that they think like liberal academics.  They have no business experience.  But they know how to run businesses better than business owners who’ve been running businesses for years.  It’s the height of arrogance and condescension.  But these liberal elite academics don’t see people.  They see charts and grafts.  Which are religious icons to them.  Holy.  They accept them on faith.  They never question them.  And always make excuses for them when the policies they beget fail.  While pointing at successful policies with successful track records and calling them failures.  Because these policies are heretical.  And conservative.

Here is a liberal academic talking down to the American people with all-knowing condescension.  And if you want to know how the current administration thinks, all you have to do is read this arrogance and condescension (see Fatal Fatalism by Paul Krugman posted 6/4/2011 on The New York Times).

We are not, after all, suffering from supply-side problems…This is a demand-side slump; all we need to do is create more demand.

So why is this slump, like most slumps following financial crises, so protracted? Because the usual tools for pumping up demand have reached their limits. Normally we respond to demand-side slumps by cutting short-term nominal interest rates, which the Fed can move through open-market operations. But we now have severely depressed private demand thanks to the housing bust and the overhang of consumer debt, so even a zero rate isn’t low enough…

The answer seems obvious. We should be using fiscal stimulus; we should be using unconventional monetary policy, including raising the inflation target; we should be pursuing aggressive measures to reduce mortgage debt. Not doing these things means accepting huge waste and hardship.

But, say the serious people, there are risks to doing any of these things. Well, life is full of risks. But it’s simply crazy to put a higher weight on the possibility that the invisible bond vigilantes might manifest themselves, or the inflation monster emerge from its secret cave, over the continuing reality of enormous human and economic damage from doing nothing.

The housing bubble was created by too much unconventional monetary policy.  Money was dirt cheap to borrow.  And people borrowed.  To buy houses they couldn’t afford.  With subprime mortgages.  That they defaulted on when interest rates went up.  Causing the subprime mortgage crisis.  Which happens when you stimulate demand beyond normal market demand.  Why?  Because you don’t create healthy economic growth with easy money.  You create bubbles.

The Fed has done too much.  All their easy monetary policy to stimulate the economy has only devalued the dollar.  Making an important and scarce commodity more costly.  Because the world prices this most important of all commodities in U.S. dollars.  Oil.  Which makes diesel and gasoline.  The energy we use to bring food to market.  Which is why prices are up.  Across the board.  Especially food and energy.  That hit consumers the hardest.  Because of inflation.  Caused by monetary policy.  Which has failed to produce jobs.  Lower the misery index.  Or end the recession.

Their answer?  More of the same.  It’s always more of the same.  Jimmy Carter‘s ‘more of the same’ did not end the malaise of his stagflationRonald Reagan‘s economic policies did.  His conservative, supply-side economic policies.  That created real economic growth.  And doubled tax receipts to boot.  But his policies were heretical.  They went against everything liberals hold sacred.  Their Keynesian charts and graphs.  That look at business activity as an aggregate thing.  And not as people.  So liberals attack the success of Reaganomics.  Despite its soaring success.

You see, Reaganomics created jobs.  It made a favorable business climate.  So business people could do what they know how to do.  Create business. Expand business.  Make more things.  And create jobs.  Which drives all consumer spending.  Which makes up over 70% of the economy.  Because a consumer needs a job to spend.  And this kind of spending will sustain itself.  Unlike Keynesian tweaking.  Which is by definition only temporary.  To fill the gap until the private market restores itself.  Which makes Keynesian economics itself a paradox.  Using policies that hinder the private market to stimulate the private market.

The Inflation Monster is out and Squeezing Consumers

And while some will mock conservatives about letting loose the inflation monster from its secret cave, the inflation monster is already out.  And wreaking consumer havoc (see Tightening our belts: Americans lower income expectations by John Melloy, CNBC, posted 6/4/2011 on USA Today).

With consumers squeezed on both sides by stagnant wages and rising prices, the number who believe they will bring home more money one year from now is at its lowest in 25 years, according to analysis of survey data by Goldman Sachs.

The inflation monster has devalued the dollar.  And when you devalue the dollar you need more of them to buy the same amount of things you did before.  Because, thanks to inflation, those things have higher prices.  Consumers have to pay these higher prices.  Leaving them less money to spend.  And their employers have to pay them.  Leaving them less money to spend on wages.  So few people think they will bring more money home next year.  Because things are so bad this year.

A typical recovery pattern goes like this: stock market bottoms, economic growth bottoms and then hiring and wage increases return. What’s unique and scary about this recovery is that the last piece of the recovery is not there.

For a simple reason.  Intervention.  It’s all that Keynesian tweaking.  Like that trillion dollar stimulus bill.  If it wasn’t for all that government spending the economy may have actually recovered by now.  Now we have recession and inflation.  Thanks, liberal elite academics.

In the 2001 recession, the country lost 2 percent of jobs from peak employment and then made that back in a 48- month cycle, according to data from money management firm Trutina Financial. In 1990, the jobs lost during the recession were recovered in 30 months.

Right now, about 38 months from peak employment during the housing boom, there are still six percent fewer jobs out there. Making up that amount of jobs in 10 months or less would be unprecedented, if not impossible.

“The crawl out of this economic ditch is going to be long and slow,” said Patty Edwards, chief investment officer at Trutina. “Even if they’re employed, many consumers aren’t earnings what they were two years ago, either because they’re in lower-paying jobs or not getting as many hours.”

Jobs are everything.  And to create jobs you have to understand people.  Not look at sacred charts and graphs.  You have to understand what motivates the individual.  Not hypothesize about what will move aggregate curves on a graph.  Of course, liberal elite academics chose not to do this.  Because they are gods.  Infallible.  Who live in a world where paradoxes exist.  And can deny reality at will.

Small Business sees the Government as Adversarial

If jobs are everything, then why won’t there just be more jobs?  You’d think the gods could make them.  And no doubt are wrathful and miffed that their policies haven’t made them.  All because of those dirty, greedy, little business owners.  Heretics.  Sitting on cash instead of using it to hire people. 

Of course, the greatest job creators out there are small business owners.  Who don’t have big legal staffs or legions of tax accountants.  And these Keynesian polices are just overwhelming them.  As related in a conversation on a plane with a Yale law professor.  Who asked point blank why this small business owner didn’t hire more people (see Carter: Economic Stagnation Explained, at 30,000 Feet by Stephen L. Carter posted 5/26/2011 on Bloomberg).

“Because I don’t know how much it will cost,” he explains. “How can I hire new workers today, when I don’t know how much they will cost me tomorrow?”

He’s referring not to wages, but to regulation: He has no way of telling what new rules will go into effect when. His business, although it covers several states, operates on low margins. He can’t afford to take the chance of losing what little profit there is to the next round of regulatory changes. And so he’s hiring nobody until he has some certainty about cost.

It’s interesting listening to a person.  Because you learn something different than you do from moving a curve on a graph.

“I don’t understand why Washington does this to us,” he resumes. By “us,” he means people who run businesses of less- than-Fortune-500 size. He tells me that it doesn’t much matter which party is in office. Every change of power means a whole new set of rules to which he and those like him must respond. ‘‘I don’t understand,” he continues, “why Washington won’t just get out of our way and let us hire.”

Get out of our way?  And let us hire?  You mean they would be hiring more people if it wasn’t for all the policies encouraging them to hire more people?  Interesting.  So what should government do?  How should they be in this business-government relationship?

“Invisible,” he says. “I know there are things the government has to do. But they need to find a way to do them without people like me having to bump into a new regulation every time we turn a corner.” He reflects for a moment, then finds the analogy he seeks. “Government should act like my assistant, not my boss.”

In other words, government shouldn’t tell business owners how to better run their businesses.  Because few in government have ever run a business.  They need to stop acting as the authority on something when those they try to help know more than they do.  This conversation gave this Yale law professor some food for thought.

On the way to my connection, I ponder. As an academic with an interest in policy, I tend to see businesses as abstractions, fitting into a theory or a data set. Most policy makers do the same. We rarely encounter the simple human face of the less- than-giant businesses we constantly extol. And when they refuse to hire, we would often rather go on television and call them greedy than sit and talk to them about their challenges.

Recessions have complex causes, but, as the man on the aisle reminded me, we do nothing to make things better when the companies on which we rely see Washington as adversary rather than partner.

And there it is.  Small business sees the government as adversarial.  And there is only one reason why they do.  Because it’s true.

Fiscal Stimulus is the Problem

This is not a demand-side slump.  It’s a supply-side problem.  Caused by the adversarial relationship between business and government.  Otherwise a trillion dollar in stimulus spending would have done something.  Other than give us inflation. 

Fiscal stimulus isn’t the solution.  It’s the problem.  And we need to stop trying to fix this problem with what gave us the problem.  Because they aren’t gods.  And we are individuals.  Not an aggregate to hypothesize about for fun and games.


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We have a Spending Problem, not a Debt Ceiling Problem

Posted by PITHOCRATES - May 14th, 2011

A Special Bond between the UK and the USA despite a Tea Party

A small group of protestors gathered outside the House of Parliament to protest excessive spending and debt.  It was only a small group that numbered in the hundreds.  A fraction of the thousands that protested the UK’s austerity cuts earlier.  Interestingly, they have been described as ‘Tea Party’ protesters.  Like in the USA.  Interesting because the original Tea Party protests kicked off the American Revolution.  Which ended in American independence from Great Britain. 

A lot has changed since then.  The UK kicked off the Industrial Revolution and created an empire that lasted a hundred years or so.  Then the Americans came into their own and became the world’s greatest economic power.  Took the baton, if you will, from the British Empire.  First the costs of World War I ended the British Empire.  Then the era of Keynesian economics began.  Government grew.  Government spending grew.  First in the UK.  Then in the USA.  And their economies tanked in the Seventies.  High debt.  High inflation.  High unemployment.  Then Margaret Thatcher started fixing things in the UK.  As Ronald Reagan did in the USA.  Things got better.  But old habits are hard to break. 

And here we are in 2011.  Both great nations suffering under unsustainable deficits and debt.  Austerity is now the name of the game.  Some understand this.  Like those few hundred across from the House of Parliament (see ‘Rally against debt’ activists call for more cuts in Westminster protest by David Batty and agencies posted 5/14/2011 on the Guardian).

Hundreds of pro-cuts activists have taken part in a “rally against debt” opposite the Houses of Parliament, in the first Tea Party-style protest to challenge the anti-cuts lobby…

Matthew Sinclair, director of the TaxPayers’ Alliance, said: “There have been lots of chances for other groups to register their protest, and we want to give a voice to people who represent quite a heavy majority who think spending cuts are right and necessary.

The tax consumers protested the austerity cuts.  The taxpayers, on the other hand, are protesting the deficit spending.  For they are thinking long-term.  And know someone eventually has to pay back this debt.  Or someone will at least have to service the debt.  And if it keeps growing, these interest payments are going to become a major budget item.  Requiring cuts in programs today to pay the interest on what they borrowed to pay for programs years ago.

Priti Patel, Conservative MP for Witham, said: “This government is all about deficit reduction. I don’t think enough people realise the extent of the debt facing this country. It is totally unsustainable…

Mark Littlewood, director general of the Institute of Economic Affairs, told the rally: “We won’t put up with this. We are the selfless movement. We’re not asking for money, we’re asking for cuts to make sure our children and grandchildren don’t have to foot the bill.”

It is interesting the use of the term ‘Tea Party’ given our common history.  They don’t recall the Boston Tea Party as fondly in the UK.  No, they don’t celebrate it like they do in the US.  So no doubt it’s the similarities of the movements (protesting out of control government spending) and not the name.  They probably even don’t call themselves a ‘tea party’.

Electoral commission records show that in March, Ukip activists registered the name Tea Party as a political party. It is not yet active, but they said they could field candidates in general elections, byelections and local elections.

Or perhaps they do.  Wow.  They’ve sure come a long way since 1773.  That’s nice.  For as George Bernard Shaw said, England and America are two countries separated by a common language.  There is a special bond between these two nations.  And always will be.  We love each other unconditionally.  Despite the US giving them Madonna.  And the UK giving the world John Maynard Keynes.

The Keynesians versus the Austrians

Governments everywhere love John Maynard Keynes.  Because he empowered governments to spend money.  So ‘borrow and spend’ governments everywhere embrace Keynesian economics.  As do Ivy League intellectuals.  Who tend to have high positions in the US government.  Because they just sound so darn smart.  Who are, at heart, anti-capitalists.   

The Austrian school of economics runs contrary to the Keynesian school.  The only thing the Keynesians learned from the Great Depression was that the Federal Reserve caused bank failures by not printing money soon enough.  And that a selloff of assets started a deflationary spiral.  Austrians, on the other hand, say deflationary spirals are good when they correct bad investment by popping asset bubbles.  Because bubbles have to pop.  Eventually.  And the longer you try to sustain these bubbles the more painful the pop will be.  Whereas Keynesians say double down.  When Wall Street was overvalued they pumped bailout dollars into Wall Street firms buying worthless paper assets to sustain their over-priced values (Fannie Mae, Freddie Mac, Lehman Brothers, etc.).  Didn’t work.  And the nation added a trillion to the debt in the process (see The End of Bernanke’s “End Game” by William L. Anderson posted 5/13/2011 on Ludwig von Mises Institute).

Thus, Bernanke’s minions entered the financial marketplace with a bottomless checkbook, purchasing assets that had lost value (like mortgage securities, AIG stock, and the like) in the marketplace. However, in order to make it look as though the markets were fine, the Fed purchased these securities at prices close to their precollapse worth; Bernanke and company were playing the let’s-pretend-this-worthless-paper-is-valuable game…

In the Keynesian analysis, assets are held to be homogeneous, and the economy is believed to be a bland mixture of those assets that are fully employed when the amount of consumer and investment spending is high enough to continue to give the economy “traction.”

When consumer and investment spending flag, however, Keynesians hold that the government must step in by borrowing and printing money in order to revive the spending circle. If the government spends enough, then the economy can move on its own to the point where consumers and investors keep it going — at least until the next crisis. Keynesians call this movement the “circular flow,” although it is more like circular logic, in which the premise is the conclusion and the conclusion is the premise.

What must never happen is a large-scale liquidation of assets, because that would trigger deflation, which would be accompanied by an endless downward spiral and an economy stuck in a “liquidity trap” with falling prices and high unemployment. Thus, in the Keynesian view, the Fed was justified in purchasing these worthless assets, because it prevented their liquidation and preserved at least their “paper” values.

They spent money like no other administration did and it did nothing.  The unemployment rate went up.  And now inflation is starting to tick up.  Not to mention a trillion dollar deficit adding to an already record debt.  A debt so great that they have to raise the debt ceiling to fund it.

Austrians, however, take a much different view. What Keynesians call idle resources, which need only an injection of spending to be reemployed, Austrians call malinvested resources. The different is crucial, because Keynesians believe that the Fed’s actions prevent an economic downward spiral, while Austrians hold that what the Fed has done furthers the economic downturn.

The difference in opinion centers on causality. Keynesians believe that the downturn is created simply by a reduction in spending, while Austrians hold that the recession is caused by the fact that the series of malinvestments created during the previous boom cannot be sustained. The drop in spending is the result of the downturn, not its cause. The difference in beliefs is crucial: in the Austrian paradigm, trying to sustain the boom conditions by injecting new government spending will always end in disaster.

Keynesian economics are demand-side.  People cause recessions by not spending enough.  So government steps in, borrows (and prints) money and spends in place of consumers.  In the hopes this spending will create jobs.  Austrian economics are supply-side.  Because we are, when it comes down to it, traders.  We trade things.  Or services.  So jobs come first.  Then consumer spending.  So the Austrians would rather create an economic environment that will encourage businesses to create jobs.  And see the market direct resources to the best investments.  Not have the government prop up investments that should fail.

The problem with temporary injections of cash is that they are temporary.  Whereas new jobs will be recurring cash injections.  The Keynesian solution is temporary.  The Austrian solution is sustainable.  It’s sort of like Granny Clampett’s cure for the common cold.  You take it and a week or so later the cold is gone.  Of course, the body just healed itself.  Which is how Keynesian economics works.  If the economy recovers in a year or so the Keynesians will take credit.  When it was just the business cycle finally coming around.  Despite being delayed by Keynesian policies.

The Size of the Debt is a Bigger Problem than a Technical Default

All this Keynesian economics has added greatly to government budgets everywhere.  The UK.  The social democracies of Europe.  And the US.  And it’s reaching critical mass.  Hence the protest outside the House of Parliament.  And the Tea Party protests in the US.  Debts are rising to dangerous levels. 

Now in the US the Keynesians are threatening doom and gloom if we don’t raise the debt limit.  Because that’s the problem.  Not the spending.  Which they don’t see as a problem (see What If the U.S. Treasury Defaults? by James Freeman posted 5/14/2011 on The Wall Street Journal).

Mr. Druckenmiller says that markets know the difference between a default in which a country will not repay its debts and a technical default, in which investors may have to wait a short period for a particular interest payment. Under the second scenario, he doubts that investors such as the Chinese government would sell their Treasury debt and take losses on the way out—”because I’ll guarantee you people like me will buy it immediately.”

Mr. Druckenmiller was once a fund manager for George Soros.  And he helped Soros short the British pound in 1992.  So he knows a thing or two about government finance.  And he’s more worried about the high debt level than a technical default.

Mr. Druckenmiller had already recognized that the government had embarked on a long-term march to financial ruin. So he publicly opposed the hysterical warnings from financial eminences, similar to those we hear today. He recalls that then-Secretary of the Treasury Robert Rubin warned that if the political stand-off forced the government to delay a debt payment, the Treasury bond market would be impaired for 20 years…

Mr. Druckenmiller notes that from the time he started saying that markets would welcome a technical default in exchange for fundamental reform, in September 1995, “the bond market rallied throughout the period of the so-called train wreck . . . and, by the way, continued to rally. Interest rates went down the whole time, past the government-shutdown deadline, and really interest rates never went back up again until the Republicans caved and . . . supposedly the catastrophic problem was solved.”

Back during the government shutdown in 1995, the bond market actually rallied.  Why?  Because investors are worried about being paid back.  High and growing debt levels decrease those chances.  Serious debt reduction talk increases those chances.  Ergo, the technical shutdown lets investors know that someone is serious about the nation’s long term debt paying ability.  Hence the bond market rally. 

He’s particularly puzzled that Mr. Geithner and others keep arguing that spending shouldn’t be cut, and yet the White House has ruled out reform of future entitlement liabilities—the one spending category Mr. Druckenmiller says you can cut without any near-term impact on the economy.

One reason Mr. Druckenmiller says he spoke up in 1995 was his recognition that the first baby boomers would turn 65 in 2010, so taxpayers would soon have to start supporting a much larger population of retirees. “Well,” he says today, “the last time I checked, it’s 2011. We don’t have another 16 years this time. We’re there. I don’t know whether the markets give us three years or four years or five years, but we’re there. We’re not going to be having this conversation in 16 years. We’re either going to solve it or we’re going to find ourselves being Greece somewhere down the road.”

Some have argued that since investors are still willing to lend to the Treasury at very low rates, the government’s financial future can’t really be that bad. “Complete nonsense,” Mr. Druckenmiller responds. “It’s not a free market. It’s not a clean market.” The Federal Reserve is doing much of the buying of Treasury bonds lately through its “quantitative easing” (QE) program, he points out. “The market isn’t saying anything about the future. It’s saying there’s a phony buyer of $19 billion of Treasurys a week.”

It’s all smoke and mirrors.  Once the quantitative easing ends in June, interest rates will go up.  Adding to the interest on the debt.  Which will only get greater should they increase the debt ceiling.  And refuse to cut spending.  As in commit to entitlement reform.  Their future, in a word, is Greece.  Only without anyone being big enough to bail them out.

QE3, Anyone?

Some people get it.  The responsible ones.  The ones paying the taxes.  And the ones buying the bonds.  The debt is the problem.  Which means any deficit is a problem, let alone a trillion dollar deficit.  And there is really only one option that is doable to fix these problems.  Entitlement reform.  There will be no economic repercussions.  Other than a riot or two.  Perhaps.  Which is not that big of a concern for the politicians.  Their greatest fear is the next election.  Because there are so many people collecting these entitlements, cutting them will have an effect in the voting booth in the next election.

So the Keynesians will no doubt say, “QE3, anyone?”  And fiddle while the US economy burns down.  Rather that than admit that they are not important.  Or needed.


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