Tag: economics

Actually, it’s about as surprising as seeing Santa at the mall. I suppose you can imagine how shocked I am to be proven correct – again – about downward revisions to the Q309 GDP report that has been keeping the markets afloat for the time being:

Economists React: GDP Revision “Surprisingly Large”
Economists react to the larger-than-expected downward revision to third quarter gross domestic product (GDP), to 2.2% annualized growth from 2.8% previously and 3.5% originally reported.

This isn’t really a surprise, obviously, or I could not have predicted it. And even though this is supposed to be the second and final revision to the third quarter GDP number, (at least until the next comprehensive National Income and Product Accounts revision in 2014), I fully expect that it will be revised downward again in a “surprise” unscheduled revision sometime in 2010. Notice that despite being revised downward itself, the Cash for Clunkers debt-creation program now accounts for 66 percent of the remaining GDP “growth”, up from 47 percent in the initial report.

This is an error of $185 billion, which you will note is both a) larger than the $152 billion Bush stimulus package of 2008 and b) smaller than the average $245 billion variance in quarterly reports. Of course, that latter average takes into account two additional revisions, so as subsequent unscheduled revisions are quietly made, we can expect the Q309 variance to increase. If the first two revisions are a correct indication, it will surpass the average.

There is no growth. There is only debt.

UPDATE: It’s always a little startling to come across references like this when you’re making your daily reading rounds: I sure as heck get more data, which I can view an analyze myself, on individual websites like this one, Mish, Zero Hedge, Vox Popoli, and discussion boards, than I find in the mainstream media. I’ve come to the conclusion that many journalists are not even capable of analyzing the subjects they are meant to be covering. And if they are, they will not be allowed to present their analysis if it conflicts with the agenda of their overlords.

Speaking of that data, here’s a link to the 2007-2009 GDP Variance Chart updated with the most recent revisions.

This article should help explain why “printing” money is not necessarily inflationary in a monetary system where most of the money is created through fractional-reserve lending:

The following chart shows that bank reserves held at the Fed have increased 100-fold over the past 14 months — from around $10B in August of 2008 to around $1000B ($1T) today. It is important to understand that while this explosion in the reserves of US depository institutions has rightfully prompted much discussion and consternation, it hasn’t directly added to the total supply of US dollars (bank reserves are not counted in monetary aggregates such as M1, M2, M3, MZM and TMS). The reason that bank reserves aren’t added to the money supply is that they do not constitute money available to be spent within the economy; rather, they constitute money that could be loaned into the economy or used to support additional bank lending in the future.

If even bank reserves can’t be counted as money, it should be obvious that mere Federal Reserve printed notes can’t be counted either. The money has to go into the system before it can be spent; this is why increased bank reserves are considered to be deflationary. This does not mean, however, that the Fed can simply force the banks to force lending, as some have suggested. Mike Shedlock explains why:

1) Lending comes first and what little reserves there are (if any) come later.
2) There really are no excess reserves.
3) Not only are there no excess reserves, there are essentially no reserves to speak of at all. Indeed, bank reserves are completely “fictional”.
4) Banks are capital constrained not reserve constrained.
5) Banks aren’t lending because there are few credit worthy borrowers worth the risk.

Or, at least, tries to defend himself.

Oy. Rajiv Sethi tries to make sense of the arguments of Bryan Caplan and Tyler Cowen. So I went and looked — and what’s immediately clear is that Caplan, at least, is simply assuming that a rise or fall in nominal wages is equivalent to a rise or fall in real wages.

This was exactly Keynes’s starting point: as he said, by taking it for granted that the bargain over nominal wages sets real wages for the economy as a whole, classical economists had “slipt into an illicit assumption.”

And look: if you work through my little AD/AS exercise it should be immediately clear that in the case I was concerned with, changes in W lead to equal changes in P, so that real wages don’t change. Simple microeconomic logic doesn’t help here at all.

The problem with Dr. Krugman’s defense here is that a) microecnomic logic is not relevant, and b) he has committed his own illicit assumption, for as he stated: “in liquidity trap conditions, the interest rate isn’t affected at the margin by either the supply or the demand for money – it’s hard up against the zero bound.”

But this means that even if one accepts his AS-AD model, it is obvious that he was incorrect to state that economy in the 1930s was hard up against the zero bound. As proof of this, he cites historical interest rates on 3-month Treasury bills as being 0.14%, and forgets that present interest rates on 3-month T-bills are around 0.005%. Moreover, his own calls for quantitative easing indicate that the zero bound cannot be the firm barrier that his model requires them to be.

On a less theoretical level, it is simply not credible to assert that a lower minimum wage is going to magically cause the Fed to raise interest rates. Japan’s highest minimum wage is lower than the U.S. federal minimum and this has obviously not caused Japanese interest rates to increase in 20 years.

I completely understand if some people think I’m attacking strawmen rather than Krugman’s actual arguments. Except I’d create more convincing strawmen:

It seems that more and more Serious People (and Fox News) are rallying around the idea that if Obama really wants to create jobs, he should cut the minimum wage.

So let me repeat a point I made a number of times back when the usual suspects were declaring that FDR prolonged the Depression by raising wages: the belief that lower wages would raise overall employment rests on a fallacy of composition. In reality, reducing wages would at best do nothing for employment; more likely it would actually be contractionary.

Here’s how the fallacy works: if some subset of the work force accepts lower wages, it can gain jobs. If workers in the widget industry take a pay cut, this will lead to lower prices of widgets relative to other things, so people will buy more widgets, hence more employment.

But if everyone takes a pay cut, that logic no longer applies. The only way a general cut in wages can increase employment is if it leads people to buy more across the board. And why should it do that?

First, a reduction in the minimum wage doesn’t mean that EVERYONE’S PAY is going to get cut. There aren’t a lot of surgeons and computer programmers who are suddenly going to face competition from those whose labor is worth less than 7.25 per hour. Second, there are two ways that a general cut in wages could lead people to buy more in the aggregate. If labor costs are reduced, then the price of consumer goods are reduced. The Law of Supply and Demand states that there will be more demand for those lower-priced consumer goods… as well as more demand for the lower-priced labor. Also, it is an established fact that higher-income people save a greater portion of their income and spend less of it than lower-income people. Therefore, creating a larger pool of people making less money on average is going to cause people to buy more across the board.

Please note that I do not agree with the Keynesian aggregate perspective nor do I believe it is the responsibility of government to micromanage the economy, I am merely showing that Krugman is incorrect even from his chosen perspective.

Now, Krugman attempts to evade the obvious criticism in his subsequent post by stating: “the whole point is that reducing all money wages doesn’t necessarily reduce real wages. And for what it’s worth, the little AS-AD analysis I linked to is Econ 101, at least if you use a good textbook.”

This argument against reducing the minimum wage boils down to the possibility that cutting the minimum wage will cause interest rates to rise. That is simply not credible in the current monetary policy environment, as the 20-year example of Japan should suffice to demonstrate. Krugman rests his case on asking us to “suppose that the AD curve is vertical“, but a request for a supposition is a very long way from demonstrating that the AD curve actually is vertical. And even if Krugman’s simplified model had been correct, once one considers the fact that the U.S. Treasury auctioned 3-month bills at 0.005 percent in December 2008, it becomes obvious that America was not liquidity trapped at 0.14 percent in the mid-1930s as Krugman imagines, but actually had room for expansion by an order of magnitude… 28x to be precise.

This is a very informative piece by Paul Krugman which accurately describes how the Keynesians regard budget deficits. I’d intended to post on it prior to the spending/income equivalency discussion, but as it happens, the two are tangentially related so this will make for a nice step into the deeper examination of why Keynesians place such importance on what I assert to be a false simplicity that is the result of them practicing the Ricardian Vice:

Broadly speaking, there are two ways you can get into severe deficits: fundamental irresponsibility, or temporary emergencies. There’s a world of difference between the two.

Consider first the classic temporary emergency — a big war. It’s normal and natural to respond to such an emergency by issuing a lot of debt, then gradually reducing that debt after the emergency is over. And the operative word is “gradually”: it would have been incredibly difficult for the United States to pay off its World War II debt in ten years, which Jim apparently thinks is the right way to view debts incurred more recently; but it was no big deal to stabilize the nominal debt, which is roughly what happened, and as a result gradually reduce debt as a percentage of GDP.

Consider, on the other hand, a government that is running big deficits even though there isn’t an emergency. That’s much more worrisome, because you have to wonder what will change to stop the soaring debt. In such a situation, markets are much more likely to conclude that any given debt is so large that it creates a serious risk of default.

Now, back in 2003 I got very alarmed about the US deficit — wrongly, it turned out — not so much because of its size as because of its origin. We had an administration that was behaving in a deeply irresponsible way. Not only was it cutting taxes in the face of a war, which had never happened before, plus starting up a huge unfunded drug benefit, but it was also clearly following a starve-the-beast budget strategy: tax cuts to reduce the revenue base and force later spending cuts to be determined. In effect, it was a strategy designed to produce a fiscal crisis, so as to provide a reason to dismantle the welfare state. And so I thought the crisis would come.

In fact, it never did. Bond markets figured that America was still America, and that responsibility would eventually return; it’s still not clear whether they were right, but the housing boom also led to a revenue boom, whittling down those Bush deficits.

Compare and contrast the current situation.

Most though not all of our current budget deficit can be viewed as the result of a temporary emergency. Revenue has plunged in the face of the crisis, while there has been an increase in spending largely due to stimulus and bailouts. None of this can be seen as a case of irresponsible policy, nor as a permanent change in policy. It’s more like the financial equivalent of a war — which is why the WWII example is relevant.

So the debt question is what happens when things return to normal: will we be at a level of indebtedness that can’t be handled once the crisis is past?

And the answer is that it depends on the politics. If we have a reasonably responsible government a decade from now, and the bond market believes that we have such a government, the debt burden will be well within the range that can be managed with only modest sacrifice.

Krugman’s reference to the “classic temporary emergency” is a reference to Samuelson’s explanation of the difference between internal and external debt in Chapter 18 of Economics, entitled Fiscal Policy and Full Employment Without Inflation. In creating his example, Samuelson concocts a scenario which posits a) present day munitions are necessary (true), b) there is no outside nation to lend goods (unlikely), c) Congress is unwilling to raise taxes enough to balance the budget (usually true), d) price-control and rationing laws are necessary (irrelevant, as Samuelson himself points out). And Samuelson makes an unintentionally important point when he mentions, offhand, that “Fortunately, the United States has come out of the most costly war in all history with little impairment of capital equipment and internal debt.”

(Sorry, had to do an interview there.)

Now, Krugman begins by posting a somewhat misleading distinction. There is no reason why a temporary emergency cannot be the result of fundamental irresponsibility. In fact, since the present political system is now built on the concept of the permanent campaign and the permanent crisis, one can quite reasonably ask if the idea of a “temporary emergency” is an oxymoron when modern government is taken into account. But if, for the sake of argument, we accept the distinction, it is fairly reasonable to subsequently accept the idea that a big war in which the survival of the nation is at stake would a) trump budgetary concerns, and b) not represent a permanent outlay.

However, it has to be kept in mind that this cannot be applied to all wars or all emergencies. The war has to pose a real threat to the nation’s survival, since losing the war renders future interest payments irrelevant. There is no point in going into massive debt for war if you’re going to have to pay it off regardless of the outcome; losing the war has to represent a worse fate than going into debt. Therefore, the equation varies depending upon whether you are being attacked by killer cannibals from Papua New Guinea or Victoria’s Secret Army. The war has to be short-term, and it also has to favor the odds of not destroying your capital base. Needless to say, this pretty much eliminates every shooting war in which the USA has engaged since, well, WWII.

The next problematic point made by Krugman is that the present crisis is NOT the result of irresponsible policy and that it is temporary. This is, to put it bluntly, incorrect and arguably insane. Numerous books, including RGD, have been written to explain how the present crisis is the direct and predictable result of irresponsible monetary and fiscal policies. Moreover, since total credit market debt grew from $37.8 trillion in 2004 to $52.9 trillion in 2009, there is absolutely no reason to believe that the crisis is temporary either; it will likely take decades of debt-deleveraging and economic contraction to reduce debt/GDP from its present 3.7 to the sustainable long term level of 1.5.

Finally, the Bush tax cuts were not “a strategy designed to produce a fiscal crisis, so as to provide a reason to dismantle the welfare state”. Bush actually expanded Federal entitlements and never made any effort to reduce, let alone dismantle, the welfare state. The tax cuts were actually straight out of the Keynesian playbook, being an expansionary contracyclical policy enacted during the economic slowdown of 2000-2001. Krugman not only fails to support his case here, but provides an argument that is ludicrously easy to disprove.

Therefore, it is downright laughable to attempt to claim that the $450 billion deficit in 2003 was more troublesome than is the $1.8 trillion deficit in 2009. The economic crisis is not the financial equivalent of war because it does not threaten the nation’s survival, it obviously does not represent a fate worse than debt, it is not temporary, and it is the result of fundamentally irresponsible policies.

“The banks also received their share of Hoover’s ire for their unwillingness to expand in those troubled times. The New York Times reported on May 20 that Hoover was “disturbed at the apparent lack of cooperation of the commercial banks of the country in the credit expansion drive.” In short, the “banks have not passed the benefits of these relief measures on to their customers.” The anger of the inflationist authorities at the caution of the banks was typified by the arrogant statement of RFC chairman, Atlee Pomerene: “Now . . . and I measure my words, the bank that is 75 percent liquid or more and refuses to make loans when proper security is offered, under present circumstances, is a parasite on the community.”
– Murray Rothbard, America’s Great Depression, Chapter 11

“My main message in today’s meeting was very simple: that America’s banks received extraordinary assistance from American taxpayers to rebuild their industry and now that they’re back on their feet, we expect an extraordinary commitment from them to help rebuild our economy.”
– Barack Obama, 2009

Plus ca change…. Credit Doug French of the Mises Institute for noticing this play from a 1930s playbook.