Which Economists Show Support for Obama's Plan?

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.

Economic Distress Index--Is the Economy Worsening?

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.

Getting Back to Breakeven: ASC 2011 paper

This past weekend, I attended the Austrian Scholars Conference at the Mises Institute in Auburn, AL.  There were many papers presented and I plan on commenting (later) on several of them on this blog.

Many have asked for a copy of the paper I presented with Harry Veryser.  The link to it is here or you can find it here: http://www.moc.edu/images/uploads/tsb_files/The_Liquidation_Phase_and_Profit_Margins_Getting_Back_to_Breakeven.pdf

Recessions and Recoveries

Two weeks ago the National Bureau for Economic Research (NBER) announced that we are out of the recession and have been since June 2009.  So, how does this recession compare to previous recessions?

The earliest date that the NBER uses is 1854.  The average length of a U.S. recession between 1854 and 2010 is 17 months.  If one uses post-WWII data, the average length of a business contraction is 10 months.

If we compare the current recession, which started in December 2007, with that of previous recessions, we see that the duration is longer than either average.  Now that the NBER says we hit bottom in June 2009, we have had 19 official months of recession.

We are now entering the 34th month since the beginning of the recession and many are questioning whether we have truly hit bottom.  While I believe that we have stopped falling, I think that the so-called recovery has started yet.  In fact, there are signs that the recovery is still far off.  For example, private investors are unwilling to make a move until they have a clearer understanding of the government's next regulatory moves.  This situation precisely mirrors investors' sentiments in the 1930s.

The Bush administration reigned over the first 14 months of this recession.  By historical averages, we should have been recovering by inauguration.  What does this tell us?  It says very clearly that the Bush administration made the wrong move by bailing out banks and propping up failing businesses.

It  is now more than 20 months since the Bush administration has left office, and the current government has also done much to hamper any prospect of recovery.  The Obama administration has not unleashed the economy (and reverse the Bush agenda), but instead, it has further shackled it.  By supporting TARP and the Bush bank bail outs and adding to the situation the GM bail out, the ineffective stimulus package, a new health care burden and more financial regulation, the Obama administration has set us on a path towards economic stagnation.  The looming fear is whether the stagnation will be coupled with Jimmy Carter style inflation.

It is time to recognize that taxing, spending and regulating are not the instruments for economic recovery. Money creation, artificially lower interest rates and government accumulation of debt are sending us down the wrong road.

Governments at all levels are stalling the recovery and it seems that no one trusts the market enough to let it do its job.

Perhaps we should listen to our 30th President Calvin Coolidge:

“The people cannot look to legislation generally for success. Industry, thrift, character, are not conferred by act or resolve. Government cannot relieve from toil. It can provide no substitute for the rewards of service. It can, of course, care for the defective and recognize distinguished merit. The normal must care for themselves. Self-government means self-support.”

It's official! The Recession is over...Just in time for the second dip?

The National Bureau of Economic Research (NBER) has long ago deemed itself as the official determiner of recessions--when they begin and when they end.  Today, they have announced--that which I have been saying since at least March 2010 is true--that the recession ended in June 2009.  Here is the link.

So with this incredibly after-the-fact announcement, we find ourselves with national unemployment at 9.6% and North Carolina at 9.7%.  Additionally, we are seeing that the housing market is collapsing (again).  More importantly, we see that firms are expecting the other shoe to fall soon.  The Fed has done more than most thought they would.  The stimulus has now proven to be a failure.  The national debt is sky high.  Social Security, Medicaid and Medicare are unsustainable.  In the face of this, the federal government is burdening the economy with more rules, regulations and taxes.

I am certain that we are in a pause between two painful economic episodes.  Many expect the next election will sort everything out.  I am not quite so hopeful.  The country does need to turn back toward that which works--markets.  However, I do not see that turn any time soon. 

Initially, the Great Depression was merely a bad economic downturn.  In fact, it wasn't even as bad as the initial drop in 1920.  In stepped Hoover and made a bad situation worse.  He turned the country away from markets and sent us down the wrong path.  FDR campaigned against Hoover's crazy spending, but unfortunately not only did he not keep his promise, he increased spending and regulations! 

If we can survive FDR's National Recovery Act, we can survive the current federalization of the economy.  The question is how long will it be until we realize that this path leads us to failure.  How long will it take until we turn back to markets and prosperity?

The Prodigal President (and the rest of us too!)*

*This article appears as an Editorial in July 28th edition of The Garner Citizen News and Times here.

I cannot recall the first time that I heard the story of the prodigal son. I know that I have heard this story at least once a year in church and I am sure it has been more than that. For the longest time I thought that “prodigal” meant that the son returned. So I thought that the title meant that the story was about a returning son. I could not have been more wrong. Recently, the true definition of the word “prodigal” was brought to my attention. According to Dictionary.com, the definition is “wastefully or recklessly extravagant.”

In other words, the story is about the wasteful son, who asks for his fortune upfront and then spends it all in a reckless and extravagant manner. What was known to the people that Jesus was telling the parable to, and unknown to me, was that being prodigal was acting sinfully. Every one knew that spending everything on trifles and then borrowing, spending that, and then trying to spend even more, was just flat-out wrong.

It is amazing how much the world has (and has not) changed. Today, Americans are encouraged to spend, spend, spend. We are encouraged to run up credit card debt and purchase luxury items like new TVs, stylish clothes and nice gadgets. The tax code is designed to discourage savings and thrift. It is designed this way purposefully.

The dominant economic philosophy that governs the writers of our tax codes is the Keynesian economic philosophy. In the Keynesian point of view, GDP and Aggregate Demand are everything. According to economists, Aggregate Demand is defined as the summation of Consumption, Investment, Government Spending, and Net Exports. The largest component in this list is consumption. Therefore, the government “encourages” us, by manipulating the tax code, to spend our money on consumer goods, especially in a recession.

The government wants us to be a “prodigal populace.” (I think that they have been largely successful.)

Continuing along the Keynesian train of thought, since we are in a recession, it can be concluded that there is simply not enough Aggregate Demand. Thus, we need to increase one of the variables to boost our GDP. The variable most easily manipulated is government spending.

The Congress has been more than a willing accomplice to increasing government expenditures. The Federal Budgets have been as follows: $2.7 trillion (2007), $2.9 trillion (2008), $3.5 trillion (2009), $3.7 trillion (FY2010). In less than four years, we have expanded the annual Federal Budget by another trillion dollars. Meanwhile we have increased the national debt to well over $13.1 trillion. Despite these record levels, there are many in Washington that say that this is not enough.

We are clearly living in an age of the “prodigal politician.”

Finally, we come to the piece of news that recently caught my attention. The White House announced that through the $862 billion stimulus package that was passed in 2009, somewhere between 2.5 and 3.6 million jobs have been “saved” or created. I have no idea how one calculates a “saved” job, but let’s assume that these numbers are true. In fact, let’s assume that the larger number of jobs (3.6 million) is the correct number. So, how much did we spend per job? (The math isn’t all that hard.) The answer is $239,444.44 per job!

We can easily see that this is a policy package that was created by a “prodigal President.”

Why? Because, the jobs created by the stimulus package must be some of the nicest jobs in the world. I think that I would like to have a $239,444 job. In fact, with all of this excessive, wasteful and reckless spending I’ve been doing recently, I think that a job that pays $239,444 is the only way I will be able to start to pay my bills. Then again, maybe I should just go ahead and spend it all anyway. But if I did that, would I then become a prodigal Paul?

Hayek vs. Keynes: "Fear the Boom and Bust"

This is a very nicely done video that, while entertaining, covers the key differences between the Austrian and Keynesian business cycle theories.

The Real Bills Doctrine of 2009

In the late 1920s and early 1930s the Federal Reserve System followed a theory called “The Real Bills Doctrine.” While the theory has been totally discredited, it nevertheless emerges in the news and in political circles from time to time. The real bills doctrine makes a distinction between the financial sector of the economy and the “real” economy.

In the late 1920s, the central bank was worried about the amount of money flowing into Wall Street. Many claimed that there was too much speculation, which was creating a false stock market boom. As a result, the central bank stated that it would only loan money to banks and corresponding projects that were “productive.” In others words, the central bank would only loan money to projects that were to be used to produce real goods and services. With the production of real goods and services, the loans would not be inflationary. Or so the theory goes. The reality is that all monetary creation is inflationary regardless of what it is used for.

Today, we are suffering from the real bills doctrine again. It is just dressed up a little differently. The politicians are calling for more economic stimuli to “jump start” the economy. Some politicians are objecting to the direction that Washington is taking not because the theory of increasing government spending to create an economic recovery is flawed (which it is); but rather politicians are objecting to the idea that the money isn’t going toward “real stimulus” projects. They claim that instead of using the money for balancing state budgets, the federal monies should go to “shovel ready” projects. It is in this distinction that the real bills doctrine emerges. When it comes to inflationary pressures, there is no difference between balancing state budgets, shovel ready projects, road construction, stock market speculation, and so on. The more dollars put into the economy devalue each and every dollar, regardless of how it gets into the system.

Furthermore, spending federal dollars will not restart economic growth. The source of economic growth ultimately comes from savings and capital accumulation. Capital accumulation means the production of better tools, better machines, and better equipment. More capital is necessary because it allows each worker to become more productive and raise the standard of living for everyone. This formula has been known and followed by the US since our revolutionary days. Following it has transformed the US from a bunch of small, backwater colonies into the largest economy in human history.

The current stimulus package cannot be funded by using today’s tax receipts. The government will try to get the money to cover these expenditures through borrowing, which will result in the largest deficit ever. Unfortunately, there is simply not enough money to borrow to cover all of the spending. The balance will have to come from money creation. Regardless of what is done with this money, it will cause prices to rise in the near future. Furthermore, since our banks adhere to a fractional reserve system, it means that the newly created base money will be loaned, deposited and reloaned, over and over. This credit creation process will multiply the money supply throughout the economy by a factor of about nine.

We are standing at the edge of a very nasty inflationary period. We can turn back or we can make things worse. If we follow the path of monetary expansion, it will come at a very high cost. Not today, but not too far into the future. It will be at that point when the real bills will have to be paid.

Stop! In the name of the LAW!

Ask any lawyer or police officer and they will tell you that ignorance of the law will not get you off the hook. The same is true when it comes to economic laws and their consequences. Regardless of the intentions behind the legislation, the consequences of economic policies have impacts that follow economic laws.

Today’s government’s strategy is to try to stimulate the economy by increasing aggregate demand by spending more than three-quarters of a trillion dollars on anything and everything. To help put this into perspective, the stimulus package, all by itself, would be the 15th largest economy in the world. So we need to ask, “Where is all of this money going to come from?”

Governments, all governments, have only three options open to them when it comes to raising money: taxation, borrowing, and money creation. Each method not only counteracts the intention of the spending (sustained economic growth), but creates a situation that is ultimately economically worse.

It does not matter whether the law places a new tax on either the consumers or the producers; the burden of the tax is identical. The side that is less price-sensitive will end up carrying the heavier burden of the tax. Furthermore, taxes create what economists call dead-weight losses. These are burdens to all of society because some buyers are willing to buy and some sellers are willing to sell, but because the tax has increased the selling price and lowered the revenue from the sale, they walk away from the exchange undone and frustrated. The bottom line when it comes to taxes is this, it takes before it gives. If the government is hoping that its spending will create “economic stimulus,” it must first take away that economic energy out of the economy if it taxes. The net result is a wealth transfer, but not sustainable economic growth.

The second method of borrowing the money to pay for the spending package has a similar result. The government is not constrained by market forces when it comes to offering interest rates on their securities. Thus to get people to borrow from it, it can keep raising interest rates in order to get the saved dollars. When the government behaves this way, it “Crowds Out” private sector investment. Investors are looking to put their money into a vehicle that will give them a strong return. When the government starts bidding up interest rates, private companies cannot compete and they end up going without. The best possible effect of this crowding-out is a simple wealth transfer, but this is not really the case. The market is looking to put dollars into areas that send resources to their highest valued uses. However, the government does not spend money according to market signals, and as a result, it spends money in areas that do not have the highest valued uses. The net result is that instead of recovery, the economy slows further.

The third method financing the spending is through money creation. Where does the Federal Reserve get this money from? The answer is nowhere. Money is literally created out of nothingness. When this new money is put into the economy it has several effects. The first is that it changes the relationship between debtors and creditors in favor of the debtors. The second implication is that it adds static to the price signal that entrepreneurs follow. Suppose that you are an entrepreneur and you see the prices of your goods are rising by 5%. Is this because there is an increased demand for your goods? Or is it because of inflation? Or is it some combination between the two? What could that ratio be? It makes the already difficult job of the entrepreneur that much harder, thus slowing down the economy.

The most insidious implication that results from monetary expansion is the wealth transfer that occurs. Money is not neutral. When people think of inflation, they think of a price level rising. They think of the water level rising evenly across the surface of a pool. This thinking is, unfortunately, completely wrong. Money affects prices in ways that has real effects on prices and wealth.

Money is never injected into an economy equally across the entire economy. It is injected at specific points. Some people and businesses get the new money first. When they get this new money, they use it. They purchase consumer goods and services and make investments. By making these transactions, they are applying upward pressures to the prices of the items they are buying. They are literally out bidding others to attract goods and services to themselves. The specific pattern of which prices rise and by how much completely depends on who gets the new money first and what their tastes and preferences happen to be at that moment.

There is another group who are witnessing the prices rising, but they have not yet received the new money; it has not filtered to them. An example is those on fixed-incomes. As they see prices rise, their real wealth falls because their incomes have not changed. Thus, there is a real wealth transfer from those that get the new money last to those that get the new money first. The people whose real wealth is declining use their savings to maintain themselves during a recession. Savings are the key to economic growth and recovery, and inflation causes it to dry up. The result is that the economy moves two steps backwards.

Who are the people and businesses that are getting the bail-outs and the government spending? It is those companies that are inefficient and losing money. We are transferring wealth from the healthy part of the economy to the part that is inefficient and needs to be liquidated.

To all of these misguided economic policies, we need to say, “Stop! In the name of the LAW!”