On October 22, 2020, Paul F. Cwik gave a lecture to the Oxford Hayek Society. The topic is the current state of the Macroeconomy. Some Austrian Business Cycle theory is used to support the analysis. The link to the lecture is here: https://www.facebook.com/BritishConservation/videos/3549109898445519/
In early December, I was asked to present a lecture on the state of the Macroeconomy at the John Locke Foundation in Raleigh, NC. Here is a recording of the presentation:
Our friends at EconStories have produced another hit: "Deck the Halls with Macro Follies." Enjoy!
We kicked off the latest round of the Austrian Economic Forum at North Carolina State University on January 27th, 2012. It was well attended and everyone seemed excited to get the semester under way. This semester is going to be a little different for us in that for each meeting a different Graduate Student will be either presenting his own work or a reading which interests him.
The first session's reading was selected by Alex Gill. He picked chapters 8 and 9 in Philipp Bagus' Tragedy of the Euro (2010).
The European Central Bank (ECB) has powers that are slightly different than those of the US Federal Reserve System. The difference we focused on was the ability of the ECB to expand the money supply.
The system works by the ECB loaning money to banks, which use national governments' bond as collateral. Suppose a national government (e.g., Greece) decides that it must spend more than it takes in from tax revenues; it has a budget deficit. (Hard to imagine I know, but hang in there.) The Greek Government cannot simply create new money to cover its budgetary shortfall. So it borrows the money by selling bonds. The bonds are (either directly or indirectly) purchased by banks. These banks then go to the ECB and ask for a loan. The ECB accepts the Greek government bonds as collateral and credits Euros to the banks' accounts. Where did this money come from? It comes from a big, black hole of nothingness. It is simply brought into existence by the recording of Euros in the banks' accounts.
Bagus also illustrated another difference. The Treaty of Maastricht said that no bail-outs are allowed. If a government overexpands and cannot meet its spending "obligations" then that's its own problem. The national governments were allowed deficits of no more than 3% of GDP and Total Debt to not be greater than 60% of GDP. Clearly, politicians care little about such restrictions.
Today's situation reminds me of the addage that if you borrow $1 million from your banker and cannot pay if back, you are in trouble. However, if you borrow $1 billion from your banker and cannot pay it back, then he is in trouble!
No one who agreed to the treaty should have been under any illusion that these clauses would have been tossed aside in the midst of a crisis. Austrian (or any decent economic) insight into the incentives of a crisis should have led one to this conclusion. Bagus takes a slightly different approach to this analysis.
Bagus argues that the Euro Zone is analagous to the Tragedy of the Commons. Since each country can run a deficit, and then monetize it, they will exploit the "common" value of the currency before others can. Some governments spend more than their revenue and cover the deficit spending with bonds. The governments that run deficits are able to exploit the "commons." The value of the common resource, the Euro, is diminished for the rest of the users of the Euro.
The analogy is a bit of a stretch. The problem with the commons analogy is that "the commons" are unowned resources. When a fisherman catches a fish, he is privatizing it for his own use. The "Tragedy" is that the resource is overused and depleted. The problem with this analogy is that all of the money is always owned by someone. There is not some unowned resource, a pool of value, that then gets exploited when the Greek government runs a deficit. I see what Bagus is trying to do, which is argue that the first to print new money is the winner. But if this is the case, why not just make the standard Austrian non-neutral money argument and be done with it? I think that making the argument on the grounds of non-neutral money is better because it is direct. However, perhaps, Bagus' approach opens Austrian insights and arguments to an audience that otherwise would reject the Austrians out-of-hand.
A conclusion that falls out of this analysis is that Greece will not reduce its deficit. It has no incentive t0 do so. It has been benefitting from the monetary might (stability) of other countries, such as Germany. As a result, the Germans are upset with the Greek. (See Chapter 9) Will it lead to the collapse of the common market, balkanization, or even war? Unfortunately, that is a question that cannot be answered.
***
There is another point on theory that I think needs to be addressed. I think that Bagus is conflating the property rights argument in money production with that of some right to a value of money. In Chapter 8, Bagus contends that money production has external effects, and that the costs and benefits to money production are skewed due to these external effects. So far so good.
However, now he states, "Private gold money with clearly defined property rights was replaced by public fiat money. This money monopoly itself implies a violation of property rights." (p. 79) Hmmm… The problem is that in one sense this is true, but there is a second sense where it is not true. In the first sense, when we switch to a fiat money system, I can no longer demand gold in exchange for my labor services. Thus, this law violates my ability to freely contract on my own terms. However, the negative externality of the loss of value of the gold-in-my-pocket due to demonetization is not a violation of property rights. Nor is it a violation of property rights when there is monetary expansion that leads to a loss in purchasing power for the dollars-in-my-pocket. As my friends who deny intellectual property rights are fond of pointing out, there is no right to the value of anything. All value is subjective.
I think that Bagus is leaning toward the second sense when he says, "By giving fiat money a privileged position and by monopolizing its production, property rights in money are not defended and the costs of money production are partially forced upon other actors." (p. 79)
It would have been better if Bagus stuck to the traditional Hoppean/Rothbardian property rights argument that says that fractional reserve banking assigns the right of the same dollar to two different individuals. but he doesn’t. Instead, Bagus goes after Selgin and White, in footnote #8, for missing the property rights argument. He states that they “do not see any property rights violation in the issuance of fiduciary media.” Then, in addition to citing Hoppe, Hülsmann and Block, he cites entirety of the nearly 900 page book Money, Bank Credit, and Economic Cycles by Jesús Huerta de Soto. Why relegate such an important, and unproven, assertion to a footnote? The way I see it, expanding the money supply, even if it is 100% pure fiat money, is not a violation of my property rights. To claim otherwise means that I have a right to the value of my money, which is simply untrue.
Regardless, I think that the property rights argument is weak and a better case against fiat money and a central bank can be made on pure economic grounds.
Next, I want to address Bagus’ discussion of the "quality" of money, pages 79-80. This line of reasoning makes sense when a country is on a pure commodity standard, but makes little sense when we are talking about fiat money, which is only exchange value. If he simply means seigniorage, then okay, why not just say that? But if he is making a larger assertion, he needs to come out and say what he means and then differentiate it from seigniorage. Especially puzzling are statements like, “In contrast to fiat paper situations, where an increase in the supply of money dilutes the quality of the currency, there is no dilution in the quality of the currency by gold mining.” (p. 80.) He is using “quality” to mean “purchasing power” the first time, but means “percentage of content” in the second. Puzzling and troubling, indeed.
Finally, Bagus misses the big reason there is a check on the overexpansion of the money supply (beyond extent of the money multiplier) in a free banking system. The threat of bankruptcy in a free banking system does not have to come from a bank trying to drive a competitor into the ground. (See pages 83-84.) As Rothbard demonstrates in The Mystery of Banking (Chapter 8, page 114+), we can suppose that all economic actors are fully wanting fractional reserve banking to expand as much as they can. The check on bank expansion comes from the fact that some people have deposits at different banks. Suppose that I bank at Bank A and you bank at Bank B. When I get a check from you, I will deposit that check in my bank so I can access the funds. When I do so, Bank A asks Bank B for the money. That's the check against infinite bank expansion. Bank B had better have the money available for my bank and me or it will go out-of-business. The check is not because a bank might be trying to drive its competitor out of business, instead the check comes from the fact that I want to access my money from my bank.
Overall, it was a good discussion and a good beginning to another semester of thoughtful Austrian Economic Analysis. The next session will cover the idea of using artificial intelligence as an analogue for economic theorizing. The session that follows that will cover The Calculus of Consent by Buchanan and Tullock.
Today there was an article by Derek Kravitz on the AP which was entitled as "Economists Show Support for Obama Job-Growth Plan". Now which economists are those? Well, he quotes Mark Zandi of Moody's Analytics, Allen Sinai, chief economist of Decision Economics, Susan Wachter, a finance professor at the University of Pennsylvania's Wharton School, Michael Mandel, chief economic strategist for the Progressive Policy Institute, Paul Ashworth, chief U.S. economist at Capital Economics and Menzie Chinn, an economist at the University of Wisconsin. (Personally, I have only heard of Zandi before and I think he usually has it wrong.) Amazingly they say that more stimulus is what is needed. Well, maybe not Mandel. (Kravitz is not very clear on this point.) And Ashworth says that people might just save it instead of running out and spend, spend, spending it. (How horrible!) However, as we see by the article's title, the whole point is to show how much economists love Obama's plan. In fact, Chinn says that the plan doesn't go far enough.
Here's the commonality: they are all locked into the formula GDP = C + I + G + (X-M). In other words, the size of the economy is equal to Consumption + Government Spending + Investment + Net Exports. Of these components, they rightly see that consumption is by far the largest.
The only problem with this approach of looking at the macroeconomy is that it is completely wrong.
GDP is defined as the summation of all final goods and services in an economy over a certain period of time, usually a quarter or a year. Only final goods and services are counted because we do not want to double count. In other words, when we make a table, we don't want to count the table when we chop down the tree, and count it again when we turn it into boards, and again when we construct the table and then again when it goes to the wholesalers, and so on. It's one table and we only want to count the one table once. Fine. That makes perfect sense; however most economic activity does not take place at the final stages of production. That's the "Do you want fries with that?" stage. Most people and most economic activity are not there.
So what is a better approach? The Austrian Approach is, by far, better.
We need to disaggregate the Capital Structure--The Structure of Production. Only by viewing the economy as a process of production can we get an idea of how the economy works, and more importantly, how it grows.
The economy does not grow because people simply "demand" stuff. Think about it. Do you demand more than your parents, or grandparents, or people who lived 1,000 years ago? Are we rich in the US because we simply want things more than those who came before us? Ridiculous! So, if it isn't demand that has caused us to be wealthy, then it must be that other thing that economists talk about--supply.
Yes, it is supply that allows us to be wealthy. Now, let's pause as before and think about this point too. Could it possibly be that more stuff is what allows us to have more stuff? Duh! Yes of course it is. Supply has always been the limiting factor, not demand. Thus, we need to focus our attention on production.
In order to get out of these economic doldrums, we need to produce more. It is only through production that we will be able to grow. So how do we grow when starting from a depressed economy? We need to let the costs of production fall. We need to stop propping up prices and let them fall. As input prices (yes, this includes wages) fall, profitability will rise. As profitability rises, there will be more economic activity from both existing companies and new rivals.
The bottom line is that the business sector needs to cut its costs. We could let input prices fall (commodity prices are still fairly high); we could let nominal wage rates fall; and we could reduce the costs of keeping up with rules and regulations. Additionally, imagine how much productive energy would be released if we simply abolished the corporate income tax. All those wasted hours converted into productive activity. A zero corporate income tax would attract capital from all over the world to the US. The first country to do this will be the big winner and then other countries will have to do the same to remain competitive. Instead of implementing Frank-Dodd and ObamaCare, we should repeal these and even more regulatory burdens. What a boon to business and the economy! Production will grow and with it, the economy.
And remember, consumption, jobs and prosperity are a consequence of production, they are not the reason for it.
So I have been tracking the Yield Curve closely this month. The spread between the long and the short rates are closing. In other words, the curve is flattening. Right now this movement is due to the long-rates falling because the short-rates are pinned to the floor by the Fed.
The short rates I have been tracking are the 3-mo and 1-yr T-Bills. I am looking at their spread with the 10-, 20-, and 30-yr bonds. As of today (Aug. 18), the spreads with the 10- and 20-yr bonds are smaller than they were before QE2. The 30-yr spread is 8 and 9 basis points above the low, less than a year ago.
While some may argue that the spread is still fairly wide, and it is, I do not think that this is a stable gap. Some spreads this large took more than a year to close, but sometimes it has taken less than a year.
The key for reading this indicator is whether the short-rates start to rise. If they do, then that is the clear indicator we are looking for. However, this might be disguised by the Fed actively manipulating the yield curve. If it is doing this, then the yield curve is no longer a predictor of the health of the economy.
I know that looking at short-term movements is an imprudent impulse. Nevertheless, I have been watching the Treasury Yields and the spread is dropping quickly. I put the first week of August into my spreadsheet (which is on right hand side of the screen) and the average spread between long- and short-term Treasuries has fallen by more than 56 basis points (more than 0.56%). Okay I have found an error in one of my numbers. And as of today (August 8, 2011) the new number is just above 41 basis points (more than 0.41%).
While this may seem trivial in the face of many other economic problems, it is a clear indicator of the direction of the economy. The current spread is lower than it was before when QE2 began in October 2010. That's not even a full year ago! Is this a sign that the economy is trying to reassert itself over the tampering of the government? I think YES!
As this spread shrinks, we inch closer and closer to the next recession.
As many people know on Friday July 29, the US Dept of Commerce has posted the revised numbers for the US economy. What many people may not know is that the old numbers have also been revised. The Bureau of Economic Analysis posts GDP in real dollars, i.e., they calculate an inflation index and generate the real numbers using chained 2005 dollars. How this is calculated is an interesting topic to very few and so I won’t dwell on that part here.
The interesting part is that the numbers have been revised downward, some of them by quite a bit. In Q3:2007, just before the official start of the recession the old GDP number and the revised numbers were virtually identical. ($13,268.5 billion old vs. $13,269.8 b revised)
Now we see that the drop of the recession was much larger than we originally thought. The old trough was $13,223.5 b in Q3:2008, but now the Q3:2008 number is $13,186.9 b. The old number is 0.28% higher than the new number. Curiously, since Q3:2007, this is the smallest discrepancy. The discrepancy rises to a 1.6% differential by Q4:2009. ($13,019.0 b old vs. $12,813.5 b revised)
The upshot of all of this is that we are in much worse shape than we originally thought. The bottom of the recession was deeper than we thought and we still haven’t reached the pre-recession numbers of Q4:2007 of $13,326.0 b vs. Q3:2011 $13,270.1 b.
After much thought on this topic, I have decided that the best way in which to deal with the $14.3+ trillion national debt is through partial repudiation. Why? It is not an easy story to tell without some context, but I will try my best to be clear.
Each year after my daughter’s birthday in May, the family heads to the beach for a week of sun and sand. Of course one of the best ways to relax is by reading economics! (At least it is for me.) My choice this time was Murray Rothbard’s A History of Money and Banking in the United States (http://mises.org/books/historyofmoney.pdf). I had just finished his four-volume Conceived in Liberty, which details the history of the colonial period through the Revolutionary War, so I thought that this would be a good complement. It was.
In Rothbard’s History, there was a section that has stuck in my mind for the past several weeks. He detailed how, in the late 1830s and ’40s, several states defaulted on their debt. (See pages 102-3.) The upshot is that we do more damage to the economy by trying to pay off the debt.
When the government spends money, it necessarily distorts the economy. When the government buys good X, resources are drawn to the production of good X by the normal market process. The unseen aspect of this governmental action is that resources are drawn away from the production of good Y. In other words, if left alone, the market would produce more Y and less X, but the government distorts the economy. It places its thumb on one side of the scale favoring one market player over another. Most often these political decisions make society worse off.
When government spends that money, the effects are immediate. However, this is only half of the story. The other half is centered on the source of that money. Government only has four ways in which to raise funds: 1) Taxes, 2) Borrowing, 3) Money Creation, and 4) the Sale of Assets. Each of these is bad and further distorts the economy.
Government taxes are never market neutral. They always penalize one behavior and create an incentive to do something else. A sales tax penalizes spending and incentivizes savings. A gas tax penalizes driving and incentivizes telecommuting. An income tax penalizes earning an income and encourages slothfulness. Etc. Each tax imposed hinders the progress of the economy and ultimately reduces living standards. If we had to tax our way out of our national debt, we would have to tax almost 100% of GDP for a year. However, even this action would just barely get us out of today’s hole. It does nothing for next year’s budget deficit.
The second manner in which the government raises funds is through borrowing. It is impossible to borrow our way out of debt. It’s like using a MasterCard to pay your Visa bill and then reversing it next month. Borrowing more is simply not an option.
The third method is money creation. The money that we use today is a fiat money, which is backed by nothing other than the “full faith and credit of the United States Government” (whatever that means). In other words, dollars are backed by nothing. When the Fed creates money, it pulls it out of a big, black hole of nothingness. Where did it come from? Nowhere. How much can it pull out? As much as it wants. There is an infinite supply available. We could, if we wanted, pay off the national debt tomorrow. However, by doing so, $14.3 trillion dollars would be created and dumped into the economy. The dollar might suffer a slight (!) problem of devaluation. [Yes, that was sarcasm.] Prices would, consequently, skyrocket! Furthermore, each newly created dollar has non-neutral effects that jam price signals, redistribute wealth to those with the new money, and sow the seeds of another business cycle. Since this approach is a de facto tax that is hidden from most people, this tends to be the method governments have historically chosen to get themselves out of their debt hole.
The fourth method government uses to raise money is the sale of assets. In the 19th-century, the US government sold western land and used that money to partially finance its activities. Today the US government has reversed its policy of selling assets and is instead acquiring land for various reasons (environmental, military, etc.). While selling assets has the most merit of the four in several aspects, it will not even be considered as a viable option because of this policy reversal. Furthermore, it just isn’t big enough. A one time sale cannot overcome a perpetual expenditure.
So that leaves us with a large dilemma. We have a government that cannot control its spending and we have a national debt that cannot be possibly paid back without wrecking the economy. Even if we used a combination of tax increases, money creation and asset sales, we won’t have enough to fix the mess. At each moment, there is only a finite amount of taxable wealth in the US. If government extracts the wealth through money creation, it can’t extract that same wealth with an additional tax.
The least harmful alternative is partial debt repudiation. In other words, default on some of the debt. Think about what that means for a moment. (Really, take a moment and think about it.) We have spent so much that we cannot pay back our creditors. As I read in Rothbard’s History, we have been in this position before. Here is how Rothbard reports Americans’ reaction to public debt in the 1840s:
“The British noted in wonder that the average American was far more concerned about his personal debts to other individuals and banks than about the debts of his state. In fact, the people were quite willing to have the states repudiate their debts outright. Demonstrating an astute perception of the reckless course the states had taken, the typical American response to the problem, ‘Suppose foreign capitalists did not lend any more to the states?’ was the sharp retort was, ‘Well who cares if they don’t? We are now as a community heels over head in debt and can scarcely pay the interest.’” (page 102)
The same can be said today. Should we really feel bad for those who have purchased government bonds? They are the ones who have been feeding the monstrously, reckless actions of the government. When they get (partially) burned, will they be willing to finance more government debt? Of course not. Suppose the Chinese decide not to lend any more to the US government. Is this really so bad? The government would have to deal with its future overspending.
Fundamentally, there is the issue of justice. Some people loaned the government their money for a return. Why should they have assumed that there was zero risk? When I invest in any other venture, there is always default risk. Why should the creditor to the government get to live under different rules?
Furthermore, why should the average American be punished through higher taxes or a devalued currency for the politicians’ inability to restrain spending? It is like, as Mises once point out, being hit by a truck (the impact of the initial governmental spending) and then to fix the problem, we put the truck into reverse and run the guy back over. All to make it better! The economy was already distorted by the initial spending and then the problem is compounded by funding the spending. Additionally, politicians spend these funds on projects designed to keep themselves in power. Even the programs wrapped in the cloak of magnanimity, like welfare and social security, are designed to make us dependent upon the government and their reelection.
Rothbard’s History demonstrates how the repudiations of the 1830s and ’40s did not cause the sky to fall. In fact, the return to sound money coupled with a liberalization of the economy spurred a tremendous amount of growth. Rothbard:
“It is evident, then, that the 1839–1843 [monetary] contraction was healthful for the economy in liquidating unsound investments, debts, and banks, including the pernicious Bank of the United States. But didn’t the massive deflation have catastrophic effects—on production, trade, and employment, as we have been led to believe? In a fascinating analysis and comparison with the deflation of 1929–1933 a century later, Professor Temin shows that the percentage of deflation over the comparable four years (1839–1843 and 1929–1933) was almost the same. Yet the effects on real production of the two deflations were very different. Whereas in 1929–1933, real gross investment fell catastrophically by 91 percent, real consumption by 19 percent, and real GNP by 30 percent; in 1839–1843, investment fell by 23 percent, but real consumption increased by 21 percent and real GNP by 16 percent.” (page 103)
So how much should we repudiate? I don’t know. The amount should be big enough to scare reality into the investors of US Treasuries (and hopefully politicians), but not too big that it wipes out the retirement funds of those looking for the “safe” investment. Perhaps the Treasury should declare that they will pay 80-cents on the dollar, but that just rolls the clock back a few years (back to only $11.4 trillion!).
The sad reality is that without fundamentally changing the way the government spends, there is no solution. The four largest expenditures made by the government are (from greatest to least) 1) Social Security, 2) Medicare + Medicaid, 3) Defense and 4) Welfare. We can’t really print our way out of the mess, because Social Security payments, etc. are indexed to the CPI. We can’t grow our way out either, because they’re also linked to growth rates.
So repudiation is not a complete solution. It is a part of an overall solution of (real) spending cuts, economic growth and debt repudiation. It is clear that we cannot continue on this path. Politicians are like water—they follow the path of least resistance. Politicians will try to avoid making a decision, and the longer they delay the worse the problem becomes. The reality is that there are no more fixes to be done. We are out of financial gimmicks. The day of financial reckoning is upon us and maybe we can kick the can down the road another election or two, but be prepared for higher taxes, currency devaluation and possibly debt repudiation.
My friend, Harry Veryser, and I wrote a paper for this year's Austrian Scholars Conference. It is hosted each year by the Ludwig von Mises Institute in Auburn, AL. This year's paper is entitled "The Liquidation Phase and Profit Margins: Getting Back to Breakeven." It is now posted by the Cobden Centre in the UK. Here is the link: http://www.cobdencentre.org/2011/06/the-liquidation-phase-and-profit-margins/
And their home page is here: http://www.cobdencentre.org/
Please feel free to leave as many comments as you desire. ;-)
I have been gone for quite some time (hence the lack of new posts), but I am back now. For a week this summer I lectured at FEE's summer seminar--Introduction to Austrian Economics. I presented three lectures: Praxeology, Supply and Demand; Capital and Interest; and Austrian Business Cycle Theory. The last of these lectures is now up on Fee.tv and is found here: http://youtu.be/49rMeA1gyO0.
I don't know how to post the PowerPoints that correspond with the lecture. As soon as I learn how to do that, I will get them up. For now, you can just e-mail me at PCwik@moc.edu and I will send you a copy.
***Update*** I think I have learned how to link to the PowerPoint. Please click HERE.
Or watch it here:
For the first time since May 2010, the Economic Distress Index has crossed above 50 points. Anything above 46 is considered to be economic distress. The US has been above 46 since May 2008. (The NBER dates the recession beginning in December 2007 and lasting through June 2009.) It peaked at 62.8 in June 2009. From there it fell to 48.0 in December 2010, but has been rising steadily since.
On the right side of this page, you will see the Economic Distress Index that I have created. It was suggested by my friends at FEE to create an updated version of the famous Misery Index of the late 1970s. I update it as the data comes in.
As I have been tracking it, I have noticed that the economy tends to be in distress whenever the index is above 46. This has not been scientifically determined. If anyone would like to work on this data set, I am willing to work with you. Just e-mail me at: PCwik@moc.edu.
The point of this post is that the index has been falling from its high of 62.8 in June 2009 to the recent low of 48.0 in December 2010. Since the new year, the Distress Index has been climbing. We are now at 49.6. While this may be an aberration, it may also be the start of the next trend.
Is the economy headed toward another recession? Is the economy worsening?
My training tells me that before an economy can make a solid recovery, we need to liquidate the malinvestments that have been built up in our economy. So far I see little evidence that we have cleaned out much malinvestment. In fact, I think that we have quite a bit more that needs to be liquidated.
While I tend to be optimistic, I don't see the evidence of anything more than a lumbering economy that is burdened down by these malinvestments. The translation is that we cannot have healthy growth until we clear these out. With stimulus bills and government programs designed to prop them up, I think that this anemic growth will be around for a few more years.
The long awaited sequel to the Keynes vs. Hayek rap is out.
Enjoy.
Here is the original first video:
I gave a talk at the John Locke Foundation today, which I thought went rather well. It is called, "Say's Revenge: Living in Keynes' Long Run." Here is a clip from the talk:
Earlier this year a rap video between Hayek and Keynes called "Fear the Boom and Bust" was posted on YouTube. It was wildly successful. You can find it here. With all good things, a sequel is in the works. Here is a sneak peak of a live duel between Hayek and Keynes.
There was an article yesterday on CNBC.com "Fed Will 'Self Destruct,' Policy 'Deeply Flawed': Ron Paul."
Ron Paul is very much in tune with the Austrian perspective of the economy. He argues that the Fed's actions are in the wrong direction and that when he becomes chairman of the committe that oversees Monetary Policy, his approach will be very different. He is in favor of opening up the dollar to domestic competition. Competitive currencies would allow individual citizens the ability to escape from the mismanaged, inflationary policies of the Fed set forth in the post-gold standard era.
To read this article, it is here: http://www.cnbc.com/id/40068994/
The more things change, the more they stay the same.
Today the central bank of the US, the Fed, has announced that it will buy 600 billion dollars worth of “longer-term” Treasuries. By the end of second quarter 2011, they are planning on buying $75 billion in 30-year bonds per month. (I suppose that 20-yr bonds would also fall under the heading of “longer-term” as well.) They again hope that this additional liquidity, “stimulus” will jump start economic growth.
The Fed also announced that they will target Fed Funds rates between 0.00% and 0.25%. This is eerily similar to an announcement they made on March 18, 2009. In that announcement they said that they were going to target Fed Funds rates between 0.00% and 0.25% and inject $850 billion into the economy. $300 billion were to go into the purchasing of longer-term Treasuries. I have already described how such a scheme is pure folly here. In that article, I also pointed out that it didn’t work when they tried it in the Kennedy Administration. Have we started to notice a pattern forming?
It is odd to find that we have tried this before and have not achieved the desired result. The key to impacting the so-called “real economy” by using expansionary monetary policy is by catching people unaware. If businesses see how much is injected and when, then they will adjust in anticipation of the injection. In other words, the only effect that the monetary stimulation will have is the immediate devaluation of the currency.
I just received an e-mail from the good people at the Fundacja Instytut Ludwiga von Misesa (the Polish Mises Institute, http://mises.pl). They tell me that my article "Austrian Business Cycle Theory: Corporate Finance Point of View” is now translated into Polish! How cool is that!? (There is a comments page with a discussion (so far) on time preference and interest rates.)
The new title is “Austriacka teoria cyklu koniunkturalnego z punktu widzenia finansów przedsiębiorstwa,” and it can be found here: http://mises.pl/blog/2010/10/22/p-f-cwik-austriacka-teoria-cyklu-koniunkturalnego-z-punktu-widzenia-finansow-przedsiebiorstwa/
The pdf can be found here: http://mises.pl/wp-content/uploads/2010/10/ATCK-z-punktu-widzenia-finansow-przedsiebiorstwa.pdf
The original can be found here: http://mises.org/journals/qjae/pdf/qjae11_1_4.pdf
There has been a lot of controversy centered on the size of the U.S. National Debt and rightly so, because it has never been a larger number. Today, the national debt is approximately $13,550,000,000,000 dollars. Such a large number needs context. I could say that if we stacked a trillion $1 bills on each other that this stack would stretch around the Earth 2.72 times. Unfortunately, that boggles the mind, especially if I say that our debt is 13.55 times that. Clearly, we need another way to understand the vastness of this number.
Using the Hubble Space Telescope, scientists have a clearer picture of the origin of the universe. Scientists estimate that the universe is approximately 13.7 billion years old. When we compare the age of the universe with the size of our national debt, our national debt is a 1,000 times larger. In other words, if we had spent about $1,000 a year, every year, since the beginning of time, we would have a number about the size of our national debt. Or, suppose you had spent $2.71 a day, every day, since the universe began. You would have spent as much as our current national debt.
How did the debt get so large if there was a surplus in the Clinton years? It is true that the federal government collected more tax revenue than it spent in the late ’90s and national debt shrank, however the debt did not fall to zero. (The last time the national debt was zero was in 1836, under President Andrew Jackson.) We have since had budget deficits—with each borrowed dollar adding to the debt. With the TARP funds, bail-outs, stimulus injections, and other spending programs, there is little wonder that the resulting deficits are so large.
There are three ways that we can get ourselves out of this hole. The first is to monetize the debt. In essence, this means that we can convert the debt into dollars and pay everyone we owe. In fact, this can be done tomorrow. How? Quite simply, allow the central bank of the U.S., the Federal Reserve, to buy up all the existing debt. Let it buy up all the T-Bills, Treasury Notes and Bonds—all of it. Dollars would replace the outstanding debt. Where would the Federal Reserve get all this money? The answer is simply that the Fed would get it out of a big black hole of nothingness. The dollar isn’t backed by anything—not gold, not silver, nothing but the “full faith and credit” of the United States (whatever that is). That means the Federal Reserve can just create money at will. It can create an infinite supply. It doesn’t even need to print new bills. The Fed could simply type numbers into a computer account and it’s done.
What is the problem with monetizing the debt? When $13.55 trillion new dollars hit the economy, the banking system multiplies the new dollars by a factor of a little more than 9. That means the money supply will swell by more than $120 trillion. (The current size of the money supply, as measured by M2, is $8.7 trillion.) If we took this route, we would be well on our way to hyperinflation. There have been several historical instances of hyperinflation, which wipes out life savings and destroys resources that form capital. The most famous instance was the German hyperinflation of 1923. Prices were rising so fast that people had to be paid multiple times a day. When workers were paid mid-morning, the men would run to the gates to give the money to their wives so that they could buy something before the money became worthless. Inflation was so bad that the price of a cup of coffee tripled by the time one finished drinking it. And this was happening for all prices! Germany could not continue with this situation. It had to abandon the Paper Mark and eventually switched to the Reichsmark.
The second way out of this deficit is to increase the amount of tax revenue that flows into the Federal Treasury. This approach has failed miserably for two reasons. The first is that the politicians always seem to find ways to spend all the additional money brought in and leave us no better off. The second reason is that increasing taxes is like having the economy drop an anchor. Taxation slows the economy, stunts business activity and penalizes the behavior of entrepreneurs. As a result, the higher tax rates take a larger percentage from a smaller pie, leaving a small and short-term increase in the revenues flowing into the Treasury followed by a drop-off in tax revenue a year or two down the line leaving a large debt and a stagnant economy.
This leaves the third option: a cut in spending. By a cut in spending, I don’t mean what politicians have been calling a cut, “a reduction in the rate of spending.” I mean, “Stop the car, put it in reverse, and back it up.” We need to cut spending to levels that are below our revenues. This will constitute many broken promises and real pain. The federal government has made very large promises. In fact, the size of the Unfunded Liabilities for the federal government exceeds $110.7 trillion. In other words, just to fulfill the promises already made, another $110.7 trillion are needed in the bank collecting interest right now. (U.S. GDP is only $14.5 trillion.)
So where can we cut our spending? If we look at the amount that we have spent on national defense this year (and I mean all of it), add up the total money spent on all the branches of the military—including equipment, personnel, operations, the wars in Iraq and Afghanistan—we have a year-to-date total of a little more than $527 billion. That is a lot of money and there are certainly areas that could be cut. Yet, if we look at how much we have spent on Social Security over the same period of time, we see the total to be above $534 billion. Furthermore, if we look at Medicare and Medicaid, that number is nearly $604 billion. Unlike defense spending, Social Security, Medicare and Medicaid are currently considered “Non-discretionary” budget items, so radical structural changes are needed to fix this problem, as well as the courage to solve this deficit issue.
I recently heard a good analogy. Imagine that you received some terrible news: your child has an awful, horrible disease. This disease will cause a lot of pain and suffering and could possibly result in the child’s death. Any parent’s natural reaction would be to fall to one’s knees and pray to God, “Give it to me. I will take the pain. I will suffer the burden, but please spare my child.”
Our National Debt is that disease. Why are we so willing to pass on the pain and suffering to the next generation, to our sons and daughters? Why are we so unwilling to bear the burden of our past excesses? The country is already broke. At this point, we are simply piling on. We have to address this issue now; it is getting worse. We have to look in the mirror and ask ourselves, “What kind of a person am I? What am I willing to do? What am I willing to sacrifice?” It has come to the point where the only way to fix this problem is through a sacrifice in today’s comforts. Will we try to spare our children from this disaster or will we impose this debt on them for our own comfort today? What are we willing to sacrifice for our children? What are you willing to sacrifice?
