« 10,000 B.C. | Main | An educational experiment with higher salaries »
What's going on with the economy?
Paul Krugman runs through some basic scenarios. Remember when Philip Cagan asked why open market operations are performed in terms of money and T-Bills rather than other assets?
The final whammy may be this: the socialist calculation debate (remember that?) is now working against rather than for recovery. Market prices communicate vital information but that assumes a critical mass of market participants is actually trading. When trading dries up, prices go away. When prices go away, the costs of trading rise and fewer people wish to trade.
Felix Salmon notes:
My feeling is that the credit markets are hysterical. They're not clearing, they're not acting efficiently, and spreads, especially on highly-rated debt, are much higher than credit risk alone could ever account for.
Trading in junk bonds hasn't been "right" since the fall. Many of the markets for short-term debt securities are becoming illiquid as well. Why markets are self-destructing in this way remains a puzzle; dump on markets all you want but why here and now?
Loyal MR readers will know that I am usually an economic optimist but at the moment I am worried. I don't see the so-called "real side" of the economy as intolerable by any means. But a weird financial dynamic seems to be feeding on itself in an unusually violent fashion. Steve Waldman has an insightful albeit overstated argument; consider this:
The distinction between debt and equity is much murkier than many people like to believe. Arguably, debt whose timely repayment cannot be enforced should be viewed as equity. (Financial statement analysts perform this sort of reclassification all the time in order to try to tease the true condition of firms out of accounting statements.) If you think, as I do, that the Fed would not force repayment as long as doing so would create hardship for important borrowers, then perhaps these "term loans" are best viewed not as debt, but as very cheap preferred equity.
Is/was the subprime crisis simply a mask for a more general revaluation of the meaning and extent of liquidity? Are such revaluations always so bumpy and so lacking in locally stable iterative processes? As the Chinese would say, we live in interesting times.
Posted by Tyler Cowen on March 8, 2008 at 11:20 PM in Economics | Permalink
Comments
Krugman cites Steve Randy Waldman's Interfluidity blog. In an earlier blog posting of his, Waldman makes a distinction between a panic and a reckoning. Bailouts won't help if we are facing a reckoning.
Similiar, Nouriel Roubini has often made the distinction between a mere liquidity crisis and a solvency crisis.
Posted by: at Mar 9, 2008 12:00:04 AM
Isn't a bubble precisely something where economic calculation goes awry? If prices were giving the correct signals to lenders, borrowers and home-builders, how could a bubble have formed in the first place? It seems to me that the "boom" phase was the one where credit (and house) markets went hysterical. Why else would price signals have gone so screwy?
From what I understand, there is a lot of uncertainty in bond markets, because people are just unsure of how safe of investments their bonds are. Wouldn't illiquidity be a normal, and constructive, response to this sort of uncertainty?
Posted by: Grant at Mar 9, 2008 12:02:26 AM
The system is losing enormous amounts of liquidity. It is coming out of niches that make it very hard to replace through traditional monetary policy actions. The common thread is the withdrawal of liquidity from highly rated but non-transparent funding markets. These are not the subprime markets but were taken down by the collapse of subprime securities and the (justified) loss of reliance on the rating agencies.
1. The asset backed cp market is simply going away. This is taking $1T out of the banking system. The money fund assets that had been in this market are not being reinvested within the banking system, most is going into T-bills. This is an invisible bank run we have been living through since August.
2. Most providers of consumer and commercial credit have come to rely explicitly on securitization as their ultimate source of liquidity. There is practically no access to funds available in this market, and it is the highest rated end where the liquidity is worst. The banks weren't really capable of replacing these markets as a funding source even without their own funding crises to address.
To put this as simply as I can, the main providers of liquidity within the financial system -- money market investors and other providers of liquid cash -- are not built to take credit or liquidity risk. Yet the system developed such that they were, through extendible ABCP, auction rate notes, etc, all backed non-transparently by instruments with all kinds of credit risk and liquidity that was chancy in the best of times. Now that this risk is evident, all these investors can do at this time is to withdraw from the markets. They do not have the financial or operational structures to do otherwise.
So right now there is no liquidity for credit risk securities. The only way to lay off risk is through credit indices like ABX, CDX, CMBX, which are completely irrationally priced at this point. And as a corollary to the point you note of debt turning to equity - this means that these debts must now be capitalized like equity, in terms of leverage and expected return. Until they can be restructured into debt with highly certain performance, the sources of funds to support them will remain insufficient.
This is not an easy problem to solve, and most proposed ideas seem ridiculous on their face. Market participants are more and more just looking for some sort of deus ex machina to bail them out. And losing sleep over it, even on Saturday nights now.
Posted by: misplaced trust co. at Mar 9, 2008 12:13:50 AM
I'm far from an expert, but it looks like the Fed is taking exactly the wrong approach. If there was a speculative bubble, you'd want to force the market to find appropriate prices rather than keep lowering rates and injecting liquidity to re-inflate the bubble. There's so much productive capacity in the economy that it should be strong if they just let the price-discovery mechanism work for all these assets. As I understand it, what's what Paul Volcker did a quarter century ago.
Posted by: Dan at Mar 9, 2008 12:27:57 AM
Dan is right on -- the fed is majorly screwing the pooch. There was a real mis-pricing of in the markets, based on the incorrect assuption that default risks were much lower than they actually were. The fed cannot paper over that mistake, nor is it the fed's job to find the the correct prices -- only large-scale market experimentation can do that. It is the fed's job to keep inflation under control, and the fed could do it, but it is busy doing exactly the opposite in a doomded-to-failure attempt to paper over a real market correction that must occur. Where is Paul Volcker when we need him?
Posted by: David Wright at Mar 9, 2008 1:41:45 AM
Tyler, come on now, you are supposed to know something about economics.
The economy is about to move up the Laffer Curve(bad)with a tax increase in 2010, and if a Obama or Hillery win, another tax increase in 2009. Thats sorry Fiscal news.
And on the Monetary side Bernanke is presiding over a 8% inflation rate(bad).
Posted by: Russ at Mar 9, 2008 1:48:52 AM
James Heckman's recent paper on high school graduation rates implies something that has gotten papered over -- America's median human capital, which grew tremendously for the first 70 years of the 20th Century, has been stagnating for decades. According to Heckman, the high school dropout rate, for example, hit a low of 20% around 1969, and is now up to about 25%.
We're becoming a less middle class country, but the government lured ever more people into buying their own homes, despite declining average human capital below the upper middle class.
And now there's a reckoning.
Posted by: Steve Sailer at Mar 9, 2008 5:02:24 AM
What is the difference between liquidity and solvency? It seems to me that it is on the scale of 'I cannot pay you today' vs. 'I won't pay you ever'. If I have enough saving - or if somebody else has enough saving, which means low interest rate - I can borrow the money today, pay today and bite the lower profit because of the interest rate. However, if I don't have the resources to pay the interest or if there are no resources to 'provide liquidity', I get insolvent.
The whole problem boils down to the difference between lower/zero profit and bankruptcy - small error or huge error. If the company was able to buy inputs for lower price, it would not need to file for bankruptcy. If somebody devised a technology to cheaply produce, the company wouldn't need to wind up. If somebody had resources to lend...the company would have enough liquidity.... Why did occur to anyone that printing money could solve such problems?
I think it was Hayek who described the result of monetary expansion as undertaking projects for which there is not enough savings to get them completed. Sounds familiar? 'I cannot pay you today, I can pay you tomorrow, when the project is completed'...except that the project cannot be completed, because there are no funds to complete it - because there was miscalculation.
It seems to me that austrian economists were right again.... it might be worth looking on what they say about solving problems the way government and Fed tries it. It might happen that they would be right once again...
Posted by: andy at Mar 9, 2008 6:13:54 AM
tyler, you should reread lombard street.
bagheot's description of banking panics in the 1800's uk looks a lot as to what is happening.
on the other hand, the scale and magnitude now is so much vaster that 1) it is order of magnitudes more scary as hell 2) one wonders is difference of scale translates now into different in kind and all we've learned about credit seizures is not as useful or perhaps even useless.
Posted by: DIS at Mar 9, 2008 7:33:31 AM
Nice to see how many posters believe this situation validates their favorite theory.
Add me to those who believe we have solvency, valuation problem. That does not mean we don't also have a liquidity problem.
Posted by: richard at Mar 9, 2008 7:43:06 AM
Politics and Economics are having a head-on collision RIGHT NOW... keep an eye on Mr. Krugman's articles as you watch the collapse. Will we even make it to an election come November? Keep in mind that George Bush has the power to invoke martial law at any time...
Posted by: Dave Lucas at Mar 9, 2008 8:38:35 AM
I echo the comments of Grant and Dan. I know that Prof. Cowen has pooh-poohed the idea that keeping the fed funds rate at 1% from June 2003 - June 2004 had anything to do with the housing boom, so it's consistent that he thinks central banks around the world injecting hundreds of billions at a time into the credit markets has nothing to do with their gyrations.
The basic problem is that financial institutions are holding assets whose values they are not declaring. I.e. they are afraid to just mark them to true market value, and so investors and other institutions are skittish about dealing with them.
A large part of the blame for this is that the government might announce a new bailout plan next month. Every other day, the op eds in the WSJ has some new plan for how to rescue credit markets with taxpayer/printing press help. Why come clean now and admit your institution lost $xx billion in real estate derivatives?
Posted by: Bob Murphy at Mar 9, 2008 9:39:55 AM
Forget the Chinese, how about, "a fool and his money are soon parted." That pretty much sums up what's happening now. The banks weren't careful about who they lent their money to and now they're broke. Doesn't matter how low the fed sets rates, banks have to stick that money in reserve to cover their prior foolishness.
The markets seem to be working just fine. Everyone expects it will be hard to get credit, the banks will have a hard time, and that people who gave banks money (were buying their weird financial instruments) will go broke. (Of course I live in South Florida and "everyone" here is a little jaded when it comes to banks.)
P. S. Some economists should try reading the Calculated Risk blog sometimes. They would be less suprised.
Posted by: jason at Mar 9, 2008 9:43:31 AM
For what it's worth, the Chinese don't actually say that. There's a nice Wikipedia entry that summarizes this myth: http://en.wikipedia.org/wiki/May_you_live_in_interesting_times
Time to go slowly boil a frog (http://jamesfallows.theatlantic.com/archives/boiledfrog/) ...
Posted by: Kevin Miller at Mar 9, 2008 9:44:16 AM
Check out Karl Denninger at Market Ticker. He's been sounding the alarm since April '07.
http://market-ticker.denninger.net/2008/03/open-letter-to-president-and-others.html
Posted by: Sameer Parekh at Mar 9, 2008 11:49:36 AM
You just have to believe, Tyler.
Posted by: mith at Mar 9, 2008 12:22:32 PM
Can someone who knows more about this explain (or give a link) whether this TAF scheme can actually avoid causing inflation?
Posted by: Sarah at Mar 9, 2008 12:30:16 PM
I think Robert Shiller, in Irrational Exuberance, talked about how "this time it's different" or "it's a new paradigm" is a big warning indicator. It's a red flag. (Or was it Taleb in The Black Swan? Maybe both.)
Debt, risk & etc., had a fair amount of that, with capital inflows from overseas.
I don't think I really understand all that, but if frames what I'm struggling with.
Now consider this:
"Consumer spending accounts for about 70 percent of our economy."
Is there any reason that is sustainable in the long term, other than "this time it's different" or "a new paradigm?"
Maybe it is sustainable and all consumption is ultimately done by "consumers" by definition ... but it seems fragile at the same time, fueled by debt and bubble (at least of late).
Posted by: odograph at Mar 9, 2008 12:46:58 PM
What's wrong with our economy? Well apart from the natural business (and life) cycle of ups and downs, I see our lack of PRODUCTION as a real problem.
We are too dependent on consumption of imported goods and do not produce enough "things" for domestic consumption (and export), which keeps money here in our country. Why is this? Because our elites in DC and New York are not really American patroits anymore, they are true internationalists/globalists, who feel compelled to raise the standard of living of every 3rd worlder around the globe.
We need vast tax cuts for businesses to specifically pursue greater production (engineering, manufacturing, high tech, etc.) within our borders (do we have borders anymore, amigo?)
Posted by: Nessus at Mar 9, 2008 1:12:40 PM
I am no financial guru but the problem looks pretty simple from here. We have the United States Government with far mor power over the economy that is proper. We have one of the two main political Parties deeply involved in messing with that economy. First they force lenders to lend money to those that have a rather poor chance of paying it back because to not lend is redlining and racism.
The same Party then prevents any new energy, causing prices to skyrocket. They then cause the ethanol boondoggle, knowingly putting gazillions of taxpayer dollars into a scheme that uses more energy that it creates while using water we don't have and causing food prices to go through the roof. The same Party then attacks the lenders for wanting to get their money back.
Now, of course, that same Party wants taxes to climb. Only economists and politicians wonder what is wrong with the economy.
Posted by: Peter at Mar 9, 2008 2:01:34 PM
Perhaps Keynes and Milto Friedman are right. The Keynes notion that a liquidity trap can prevent markets from correcting and you need fiscal stimulus to spur such an economy. Never was a fan of the theory before but I didn't go through the great depression. And for those on the other side Milton Friedman might warn of trying to apply economic Darwinism to markets. One of the things that contributed to the great depression, according to Milton Friedman, was just letting banks fail. The resulting bank runs should have been forseen and prevented with minimal initial interventions.
Posted by: DanC at Mar 9, 2008 4:09:24 PM
To Hillary and Obama, what we are seeing in part is how an economy responds to a large tax increase. The run up in oil prices has the same impact as the tax increase they support. And BTW, President Clinton was fortunate to have declining oilprices during his terms.
Posted by: DanC at Mar 9, 2008 4:15:18 PM
DanC, what do you think of this idea that we've done the whole Iraq war on forward borrowing, rather than from current tax receipts?
Posted by: odograph at Mar 9, 2008 5:10:21 PM
Why should I care if it was funded out of future or current income. If the investment is worthwhile how I fund it is less important. If future generations will benefit from the investment, why shouldn't they pay some of the costs. These costs are not hidden from the market and they are priced into current economic data.
I would think the spending on the war is small compared to the tax of higher oil prices or even the direct and indirect costs of ethanol subsidies. But I'm not sure how much military expenditures have increased above where they would be if we were not in Iraq (assuming we would be giving financial support even if we had no troops on the ground). The loss in human life and injuries is very high but the dollars spent for direct military action (after you subtract for rebuilding money to the Iraq government, and normal military spending if these troops were sitting in Germany) is often overstated.
Posted by: DanC at Mar 9, 2008 6:33:19 PM
DanC...the liquidity trap is nonsense. If the interest rate is low, then the lenders will not lend. People will try to avoid holding bonds, they will try to sell them...which causes bond prices to fall and interest rates to rise. What prevents interest rates from rising? Central banks, because of the stupid idea that low interest rates 'stimulate' economy. 'Liquidity trap' is simply a problem that is created by central bank and disappears in the moment when central bank stops 'stimulating'(or destroying?) economy.
Keynes and his followers simply had the stupid idea that 'not enough money' is the cause of our problems. This is a classical 'fallacy of aggregation' - what is true for individual is not necessarily true for a society. If an individual is illiquid, he has a problem of 'not enough money' that can be solved by borrowing from somebody who 'has enough money'. Unfortunately, this doesn't mean that if there is nobody with 'enough money' that the problem can be cost-less solved by printing money. When half of the economy is illiquid, the costs involved with printing money gets so visible, that even the post-Keynessian/monetarist economist at the Fed can see that printing money is NOT a solution to 'not enough money' problem - new money simply translates to inflation and solves absolutely nothing.
Posted by: andy at Mar 9, 2008 7:02:32 PM
Which reminds me: being a (small) foreign investor, I am absolutely evading USA simply because of the 'stimulus packages' and Fed easy monetary policy.
No sane investor will put his money into a country with unstable currency. One of the costs associated with monetary/fiscal stimulus is unstable currency. Did you say 'liquidity trap' - investors are afraid to lend because they expect problems? Let's call it 'stimulus trap' - investors are afraid of investing because they expect depreciating currency and falling equity prices. Do you want investors to invest? Let the prices fall and stop depreciating currency. Will it cause huge recession? Sure. If you don't let that happen, the result will be depression that will last until the government let prices fall and stops depreciating the currency.
Posted by: andy at Mar 9, 2008 7:10:24 PM
Misplaced's seems the key comment above. And this is an international crisis, though U.S. (fiscal and monetary) policy, as Steve Sailer points out, surely played a role in encouraging U.S. hhs to overborrow. But I suspect going forward we will find that gov't for good or ill is less powerful than we think.
Here's a question. Some set of assets is gonna get a U.S. gov't bailout. We seem on course to make explicit the implicit guarantee for agency securities. Some banks will need rescuing, maybe big ones. What else?
Posted by: Colin Danby at Mar 9, 2008 7:14:31 PM
I don't think its a matter of "believing" in ABCT. To me it seems like a classic prisoner's dilemma:
-Banks gain unusually large amounts of money via the Fed's purchase of T-bills at above-market rates.
-Banks had very strong incentives to loan out this money.
-The newly-securitized secondary housing market allowed them to sell mortgages (good and bad) and let them become "someone else's problem" (the prisoner's dilemma).
I think we know why the borrowers and lenders committed massive amounts of fraud. But why did the rating agencies do it? Without them, the bad loans could have never been resold. I say an interesting note in the Market Ticker blog, namely that NRSROs enjoyed an oligopoly due to heavy regulation of their industry, and seem to have immunity from fraud prosecution under the label of "free speech". It seems like all parties involved knew they simply wouldn't pay for their fraud at all.
Posted by: Grant at Mar 9, 2008 7:23:37 PM
"generations" Dan? That seems a long time to wait before paying this back.
What exactly does it cost to borrow a trillion dollars in gov debt? And how many median households does it take to cover that interest?
(I think it is harsh enough that returning soldiers will be taxed for it at their new jobs, and that we enjoyed tax cuts in their absence.)
Posted by: odograph at Mar 9, 2008 7:32:41 PM
Ah, I don't know about you Dan, but I trust the Congressional Budget Office (via USA Today), a 2.4 trillion cost:
A previous CBO estimate put the wars' costs at more than $1.6 trillion. This one adds $705 billion in interest, taking into account that the conflicts are being funded with borrowed money.
I don't think this really is OT for this thread, because it impacts what constitutes stimulus & etc. by the government, now that we are in this other sort of trouble.
Posted by: odograph at Mar 9, 2008 7:44:54 PM
Hello,
Does this not mean that people were not as exposed to risk as was feared? That is that the sellers of what is supposed to be distressed assets were only exposed at the margin. So they can ride this out for some time; if the reckoning comes it will come gradually or not at all. At some point buyers will stop waiting and put their money into assets. Put another way, if this sub-prime contagion/recession talk is a "panic," generated by the collapse of a tiny part of a vast world economy, a few discouraging statistics, and bad press eager to ruin the GOP, only a fool would sell. When the panic is gradually over, trades will recur. The only thing I'd sell now is gold and oil.
TOH
Posted by: The Objective Historian at Mar 9, 2008 10:38:08 PM
A very large number of financial intermediaries committed fraud. When the fraud showed up, they were bailed out, because letting them go bust would damage confidence.
So an even larger number of financial intermediaries committed even greater fraud. When the fraud showed up, they were bailed out, because letting them go bust would damage confidence.
So an even larger number ... And now the point has been reached that it is impossible to bail them out. And so, now, confidence is really taking a downer.
We will get a recovery when large numbers of financial intermediaries leave their offices through the windows. Not going to happen, you say? Probably not. There is another possibility: ever more severe financial crises, leading eventually to the abandonment of fiat money.
For fiat money to work, the institutions issuing it need discipline. We are not seeing that discipline.
Posted by: James A. Donald at Mar 9, 2008 11:13:18 PM
I don't want to defend Keynes, but it appears that housing prices can be sticky and may be very slow to respond on the downside. This the Keynes story. Interest rates are dropping but lenders don't seem to have a desire to lend and consumers lack the desire or ability to increase borrowing. Consumers do not yet see good investment opportunities in housing.
Keynes would then argue for fiscal stimulus. Of course giving the government a free hand is a potential problem in the long run. But you seem to argue that there is no multiplier effect from government expenditures. And at this point, government spending in the housing market is unlikely to have any crowding out.
The question is, can low interest rates and a weak dollar increase domestic production without being swamped by an increase in imported commodities.
Posted by: DanC at Mar 9, 2008 11:57:00 PM
Liquidity problem is not the real problem. The real problem is an information one.
Fundamentally, banks' commodity is trust. When that dries up, it shows itself as a liquidity problem.
The information problem is that still, no one knows what they are holding, and no one wants to find out. They'd rather operate with minimal cash flow, keeping their hands tied, than open their books and sell stuff at whatever it is now worth.
Lenders don't want to lend because they don't have the cash. Lenders would rather borrow from the Fed and lend to the government and be done with those pesky annoying customers.
Fiscal stimulus won't do anything until people want to know the truth, and will face the consequences of that truth. All of the Fed's machinations have just wrecked our dollar, making everyone poorer, but doing nothing to solve the information problem.
Posted by: mouse at Mar 10, 2008 12:54:50 AM
Word to mouse! This crisis isn't going away until players in the debt markets are convinced that ratings actually mean something. The markets (and/or regulators) are going to have to work out more reliable methods to assess default risk. The fed lending all the money in the world at subsidized rates isn't going to make that magically happen.
Posted by: David Wright at Mar 10, 2008 2:16:01 AM
Very good points, Mouse.
Posted by: Grant at Mar 10, 2008 3:25:12 AM
DanC, I have never really understood the idea behind "fiscal" or "monetary" stimulus. The idea behind these stimuli is that there are no costs associated with printing money and that economy is somehow affected symmetrically.
You may have have sticky overvalued prices in housing. But: the government is doing everything they can not to let the housing prices to fall. How can you expect the prices not to be slow to respond in such environment?
Second: you may have overvalued prices in housing, but you have undervalued prices in other sectors. You may expect inflation to counter the problem in housing, however how can you expect there won't be any negative effects in the other sectors? Remember: the last monetary stimulus caused the housing bubble. How do you expect the next one not to cause another one?
No, there is absolutely no multiplier effect from government expenditure. The whole Keynes theory simply doesn't work.
Posted by: andy at Mar 10, 2008 4:54:53 AM
Everyone has over-borrowed. Americans and their government carry too much debt. For the little guy it as a 6 year auto loan, for the big guy it was a war.
I agree with sudden debt that debt to income ratios have to come back down to earth.
It's just a tragedy that we ran this debt (at personal and national level) all through a business cycle, and that we must now face a downturn carrying it.
I don't see any stimulus that can make that debt overhand disappear. It has to be worked off (or inflated away).
Posted by: odograph at Mar 10, 2008 9:42:42 AM
This recession has the potential to be the most severe in a long time. The multiplier effect on banks, who are very leveraged, may have a huge negative impact on the economy. Combined with high oil prices, increasing food prices, and the threat of much higher taxes if the Democrats are elected, our future may hold a decade of little or no growth.
How do you take the weight off the banking sector? You could let them go bankrupt or force them into a very conservative shell. The desire of some here to see them suffer because after all they created the mess is self destructive. The Federal government may need to resort to depression era housing sector bailouts. The tax revenues needed to fund such a program pales when compared to the lost economic growth for a decade or the resulting chaos of bank failures.
The moral hazard is small, I think the markets have learned the dangers of subprime lending, and I hope the Federal regulations that encourage high risk loans are revisited. But taking these bad loans off the books may be required
Posted by: DanC at Mar 10, 2008 10:13:39 AM
The entire society is leveraged Dan ... what to you propose, that we elect some Republicans to run some more debt ... and then finally elect some Democrats in "future generations" to pay it off?
Blaming the overhang on the cleanup seems absurd.
Posted by: odograph at Mar 10, 2008 10:24:27 AM
The notion that what this economy needs is a good stiff tax increase is a terrible idea. I would agree that we need simplification of the tax code and a reduction in regulation. We do not need to increase taxes on group X because it plays well in the polls or because it fits your notion of equality, we need to grow the economy and prevent a potential disaster. And make no mistake that we could repeat the Japan mistake and lose a decade of potential prosperity.
And by your comments, do you assume that in addition to immediate troop withdrawals from Iraq, will Hillary or Obama also cut all economic aid to the area so that they can achieve your goal of reduced "war" expenditures.
Posted by: DanC at Mar 10, 2008 11:10:13 AM
DanC.... yes, crashing banks are really, really BAD. What do you consider an alternative? Monetary/fiscal stimulus is inflation. The high oil, food etc. prices are the result of these 'stimulus' policies. You are trying to evade crashing banking sector with inflating and you will end up with: Crashing banks AND higher prices of everything or, if you try really hard, with crashing economy because of inflation AND higher prices of everything.
Crashing banks are bad, but why do you propose even worse solution?
Posted by: andy at Mar 10, 2008 11:12:53 AM
I certainly did not say the economy needed "a good stiff tax increase."
I simply object the implication that future administrations will raise taxes just just because they like 'em.
You've got a long-term mess, and possibly a short-term necessity to add to the mess.
At some point someone will have to pay for it. I think it's a Hail Mary play to think that "simplification" & etc. will give you that for free (let alone "less regulation").
(Your comments about Iraq might also be grouped as "mess clean-up.)
Posted by: odograph at Mar 10, 2008 11:23:05 AM
BTW Dan, you had everything you ask for in the last 8 or so years. We had lower taxes (and low interest rates) during this last recovery.
Why didn't that balance the budget?
(I believe that some of my fellow Republicans, like Greg Mankiw, note that while tax cuts sometimes raise revenues, they don't always. Thus while they are a good policy when they do work ... they are less so when they don't.)
Posted by: odograph at Mar 10, 2008 11:29:27 AM
Andy said: I have never really understood the idea behind "fiscal" or "monetary" stimulus.
Do you know the difference between the two.?????????
Posted by: russ at Mar 10, 2008 11:51:20 AM
russ: Sure. The first one is 'how much money do you print and "lend" to commercial banks' and the second one is 'how much money do you print and "lend" to the government', considering that the central bank fixes the interest rates. If the Fed didn't fix it, 'fiscal stimulus' would lead to higher interest rates and crowding out...
I never really understood the real difference (apart from the fact, that banks have the freedom 'not to borrow' and therefore at least try to force sane behaviour on Fed) and I never really understood how is it supposed to 'help' the economy. I see so many crowding out effects and costs related to printing money that it seems to me impossible for any sych 'stimulus' to have any positive net effect.
Posted by: andy at Mar 10, 2008 12:56:06 PM
First, what is the big advantage of a balanced budget? Why is a budget unbalanced? You are either spending too much or taxing too little. So is the government spending for good projects, in which case borrowing to fund these projects are really investments in the future. If the spending is wasteful, stop spending.
Using the tax code to do social engineering is potentially destructive. If Congress is unable to raise the money they need, they just place regulatory and distorting tax incentives as a back door to greater government control. And when did I claim that tax cuts increase revenues? I think tax simplification, which the Democrats hate and Republicans on occasion mention, will most effectively raise the required revenues without so distorting the market that you help feed things like the subprime loan mess.
For example, Obama and to a lesser degree Hillary want to attack the automotive industry and saddle them with a big increase in CAFE standards. Beating up large corporations plays well in Democratic circles. A more honest, less market distorting approach, would be to impose a carbon tax and let the market find the most effective way to meet the changes. But instead Obama gives speeches about how he is going after the auto industry because that will lower the price of gasoline. But why is he making this claim, because it plays well to the audience. Does it make sense? Not really. But you may be his target market.
We are coming close to a cliff with this economy. The most serious downturn in 50 years is possible. I fear that
Posted by: DanC at Mar 10, 2008 1:50:44 PM
BTW Andy that is the worst explanation for fiscal and monetary policy I have seen
Posted by: DanC at Mar 10, 2008 1:52:26 PM
The argument I've heard Dan is that, if you don't want things to get away from you, you spend at deficit when the economy is weak, and repay that debt when the economy is strong. If I've got my "beginning" and "end" right that means you spend at deficit at the beginning of business cycles (to aid recovery and expansion) and repay that debt at the end (perhaps in part to prevent overheating).
If you try to expand forever, I'm told, it tends to hit the fan.
As an aside, I believe that the CAFE mileage (the actual measure of mileage in the fleet sold) has always exceeded the CAFE requirement (the mandate). That is, Congress has never been so aggressive that they force people beyond the choices they are already making. A wikipedia graph seems to show this (the blue line is above the red line), but you can also just look at today's news. We (weakly) require future SUVs to get better MPG, but people are already fleeing from SUVs.
Posted by: odograph at Mar 10, 2008 2:05:49 PM
OK, I can't stand to be that subtle ;-)
I think things are hitting the fan because we had no guts and forced (with low interest rates, badly leveraged investment, government deficit spending, and individual debt) a bad recovery.
That was NOT a good investment, and did NOT buy the right things.
Posted by: odograph at Mar 10, 2008 2:14:16 PM
andy, try reading this.
http://www.wanniski.com/PrintPage.asp?TextID=2488
Posted by: russ at Mar 10, 2008 2:59:59 PM
DanC: if you don't have central bank, government deficits cause interest rate to rise and crowds out private investment. Can you explain where is the net stimulus?
If you have central bank, it will keep the interest rates down by PRINTING. What's the difference?
russ: I mostly agree with the article, monetary expansion causes only inflation, no net stimulus. High taxes are a problem. So, we are stuck with the 'government borrows from private sources' to finance the 'fiscal stimulus'. I thought this was already solved by Bastiat who saw no net stimulus (the chapter about government-guaranteed credit). Where do you see the net stimulus?
Posted by: andy at Mar 10, 2008 5:26:31 PM
andy: I dont see a net stimulus, its all based off demand side junk thinking. Just like Bush 2001.
Bush 2003 however, was supply side and is the main reason we had the bull market till last fall.
High taxes are THE problem. And do you agree that taxes are going up. In 2010 for sure, and maybe even in 2009 if the right(no pun intended) people win in Nov.
So we have a environment of Bernanke inflation and tax increases coming, you bullish.?????
Posted by: russ at Mar 10, 2008 8:44:01 PM
russ... high taxes are THE problem. Lowering taxes and borrowing the money changes one problem into another one, probably equal. Lowering spending would change the situation, however I was told in another discussion on this blog that 'lower taxes + lower spending' is not called 'fiscal stimulus'... unfortunately, because that is the only thing that would actually work.
Posted by: andy at Mar 11, 2008 3:25:58 AM
andy said:russ... high taxes are THE problem.
WE AGREE
Lowering taxes and borrowing the money changes one problem into another one, probably equal.
NOT QUITE, IF YOU LOWER TAXES TO MOVE DOWN THE PROHIBITIVE SIDE OF THE LAFFER CURVE, WHAT NEEDS TO HAPPEN IS THE ECONOMIC GROWTH CREATED MUST BE ABLE TO PAY THE INTEREST ON THE DEBT, OVER TIME DEBT TO GDP WOULD DECREASE AS THE ECONOMY GROWS.
Lowering spending would change the situation,
OK, SO YOU WANT TO STARVE THE BEAST AH LA MILTON FRIEDMAN, BUT YOU ARE THE BEAST, MOST ON THIS BLOG ARE THE BEAST. YOU WANT TO BE THE LEADER OF THE "STARVE THE BEAST PARTY", A DEAD BANG LOSER.
however I was told in another discussion on this blog that 'lower taxes + lower spending' is not called 'fiscal stimulus'... unfortunately,
LOWER TAXES CAN BE A FISCAL STIMULUS, LOWER SPENDING ALMOST NEVER, TAKE IT TO THE EXTREME ZERO GOV SPENDING, IS THAT A STIMULUS, OR, THE GOV OWENS 100% OF YOUR BUTTOCKS, IF THAT WERE THE CASE THE OLD USSR MUST HAVE BEEN THE MOST STIMULATING PLACE IN THE WORLD.
because that is the only thing that would actually work.
NO, WHAT YOU FAIL TO GRASP IS THAT THE USofA HAS TO RUN A DEFICIT AS LONG AS IT IS THE WORLDS RESERVE CURRENCY.
THAT IS HOWEVER SOMRTHING THAT MR. BERNANKE IS WORKING ON CHANGING.unfortunately.
Posted by: russ at Mar 11, 2008 5:20:10 AM
russ.. The uppercase isn't too readable.
"WHAT NEEDS TO HAPPEN IS THE ECONOMIC GROWTH CREATED MUST BE ABLE TO PAY THE INTEREST ON THE DEBT, OVER TIME DEBT TO GDP WOULD DECREASE AS THE ECONOMY GROWS."
But the higher interest rates because of government borrowing will have roughly the same effect as taxation, don't you think so?
"OK, SO YOU WANT TO STARVE THE BEAST AH LA MILTON FRIEDMAN, BUT YOU ARE THE BEAST, MOST ON THIS BLOG ARE THE BEAST. YOU WANT TO BE THE LEADER OF THE "STARVE THE BEAST PARTY", A DEAD BANG LOSER."
russ, if you stop printing money, the interest rates will rise and cause recession. If you continue printing money you will cause inflation and finally hyperinflation. Do you think that hyperinflation is better then recession?
"NO, WHAT YOU FAIL TO GRASP IS THAT THE USofA HAS TO RUN A DEFICIT AS LONG AS IT IS THE WORLDS RESERVE CURRENCY.
THAT IS HOWEVER SOMRTHING THAT MR. BERNANKE IS WORKING ON CHANGING"
Why does it have to?
Posted by: andy at Mar 11, 2008 7:22:17 AM
andy said: But the higher interest rates because of government borrowing will have roughly the same effect as taxation, don't you think so?
No, I dont agree. If you look at interest rates in the 80's they declined as the deficit increased,as the deficit got bigger interest rates declined. It is really a stretch to equate high interest rates with taxation. The facts do not support the crowding out effect idea.
Gov borrowing is NOT the same as printing money. The treasury borrows money, the Fed prints it. Inflation is always and only a monetary phenomenon, to quote Milton.
Borrowing money does not cause inflation.
If the unit of account were stable, interest rates would rise and fall due to credit conditions.
It is Mr.Bernankes job to supply just the right amount of new money to answer what the market wants, in order to keep prices stable, something which he has failed to do.
But again you verve away from the relation of taxation to economic growth, and go off on a monetary tangent.
Why does it have to?
If someone in the third world wants $1000 US dollars, they have to sell us $1000 worth of goods and services to acquire it, that means we must run a $1000 deficit with them. It goes with the turf.
Britain had the same problem in the 1800's when the pound was the currency in demand.
Posted by: russ at Mar 11, 2008 8:24:20 AM
A few comments.
Interest rates reflect future inflation and have less to do directly with government spending.
If CAFE standards merely reflect market demand, why have them? True that in the past as gasoline prices increase consumers demand for higher MPG cars increase and the market responds. But that does not mean that the government can just push CAFE standards higher and higher without a substantial increase in the cost of the cars. I would let the market balance the issue out. You seem to argue that CAFE don't matter so we can agree that they serve no purpose.
If you have a room full of people and half of the room lends the other half of the room money, did the wealth of the people as a group decline? No.
Is the government more efficient at spending your money then you are? If not, then society loses from higher taxes.
The degree to which the tax code distorts incentives makes the situation worse.
If I borrow the money or pay out of current income, the first questions remains: is this worth spending money on. The Democrats tend to have all kinds of projects that they would spend money on and they set the bar pretty low. Worse they usually tell their supporters, don't worry, I will get somebody else to pay for this.
Posted by: DanC at Mar 11, 2008 9:39:49 AM
BTW, Hillary and Obama both scream about ending tax breaks that encourage the movement of jobs out of the country. First, I wish they would name a company that did this. Second, why don't they mention that high tax burdens and regulatory interference do more to push jobs out of the country then their straw man.
Posted by: DanC at Mar 11, 2008 9:44:27 AM
"No, I dont agree. If you look at interest rates in the 80's they declined as the deficit increased,as the deficit got bigger interest rates declined. It is really a stretch to equate high interest rates with taxation. The facts do not support the crowding out effect idea."
I am not sure which facts. The Fed raised the interest rate, in the beginning of the 80's to >15% and it DID cause recession. Then they let it fail to ~ 10%. When the rate was in the ~ 15% area, the MZM seems somewhat stable (no money printing), the other aggregates not that much. The economy went out of recession when Fed lowered the rates and started printing more money.
It seems to me that the data supports my conclusion: If the Fed doesn't print, the interest rates rise to very high levels, which indeed does cause crowding out (are you suggesting that high interest rates don't cause less lending and less investment?)
"Borrowing money does not cause inflation. "
I never wrote id does. However, it does cause interest rate go up. If Fed fixes interest rate lower then would-be-market-rate, then the more government borrows, the more Fed prints money.
"If the unit of account were stable, interest rates would rise and fall due to credit conditions."
Sure. Can you explain, why Fed just doesn't stop printing money?
"If someone in the third world wants $1000 US dollars, they have to sell us $1000 worth of goods and services to acquire it, that means we must run a $1000 deficit with them."
I meant budget deficits not trade deficits.
Posted by: andy at Mar 11, 2008 10:34:42 AM
The economy went out of recession when Fed lowered the rates and started printing more money.
No the economy went out of recession when the Reagan tax cuts kicked in.
You have interest rates on the brain, your whole world revolves around interest rates, how sad.
Posted by: russ at Mar 11, 2008 12:38:17 PM
Russ, what's the difference when people give their money to the state in form of taxes, or if they give THE SAME money while buing the bonds?
Posted by: russ at Mar 11, 2008 2:35:12 PM
oops, the last one was written by me :)
Posted by: andy at Mar 11, 2008 2:38:24 PM
andy,
when you pay taxes you transfer part of your wealth(cash) to the state.
when you buy a Bond you exchange a liquid asset(cash) for a not so liquid asset(bond), your wealth is not necessary decreased.
Posted by: russ at Mar 11, 2008 8:02:55 PM
andy,
what do you think of this.
http://www.polyconomics.com/searchbase/03-01-01.html
Posted by: russ at Mar 11, 2008 9:01:43 PM
"when you buy a Bond you exchange a liquid asset(cash) for a not so liquid asset(bond), your wealth is not necessary decreased."
The difference is: when I pay taxes, I get nothing in return. When I buy a bond, I get a promise that it will be paid somewhere in the future.
What is the difference NOW? Absolutely nothing - the deficit has exactly the same result as taxes. What is the difference in the future? Financing the government with bonds almost guarantees higher taxes in the future.
Can you explain why deficit financing is preferable?
From you article: "In addition, the cost of financing the debt soared with the highest interest rates in U.S. history."
Still no problem? They DID think it was a problem...
"The way you can tell the income-tax cuts were actually having their supply-side effects is by realizing that INTEREST RATES ON GOVERNMENT BONDS WERE FALLING EVEN AS THE DEFICITS WERE GROWING."
The Fed started printing money and interest rates were falling because tax-cuts? You would surely expect interest rates to fall when Fed started printing money. Why do they relate it to tax cuts??
"This had been the prediction of Robert Mundell, who had made the explicit argument that as long as the tax rate that you are cutting causes the economy to grow fast enough to pay interest on the bonds used to finance the tax cut, you are coming out ahead of the game."
Ahead of which game? That's like saying that if you increased taxes, you come ahead of the game if the economy is fast enough to grow. The interest rate was 20%!!! Have you ever seen an economy grow 20%? Even if he was right (and he is not), this simply does not apply.
Posted by: andy at Mar 12, 2008 5:40:15 PM
andy said:
What is the difference NOW? Absolutely nothing - the deficit has exactly the same result as taxes. What is the difference in the future? Financing the government with bonds almost guarantees higher taxes in the future.
No, there you error if the tax cut increases economic growth, taxes will be lower in the future because the economy will be bigger.
andy said:
From you article: "In addition, the cost of financing the debt soared with the highest interest rates in U.S. history."
Still no problem? They DID think it was a problem...
The problem was solved by the 1982 Reagan tax cuts which increased the DEMAND for dollars, which in turn sopped up the excess liquidity previously created.
andy said:
You would surely expect interest rates to fall when Fed started printing money.
Really, you believe that, you see no inflation premium in interest rates.
andy sai:
Ahead of which game? That's like saying that if you increased taxes, you come ahead of the game if the economy is fast enough to grow.
That does not make sense, I think you are losing it in that last paragraph. you seem to be very confused as to the nature of interest rates, you might want to read Mises, Human Action.
The game is economic growth, and increasing taxes does not create economic growth, but decreasing taxes will.
Posted by: russ at Mar 12, 2008 11:29:48 PM
andy said:
You would surely expect interest rates to fall when Fed started printing money.
"Really, you believe that, you see no inflation premium in interest rates."
russ, the interest rates are driven by supply and demand. Most lenders will require interest rate depending on the rate of inflation. However, Fed is lender and they will not ask for higher interest rate because of inflation. You cannot expect inflation premium in market where one big lender is not influenced by inflation expectations. Fed sets short-term interest rate - however interest-swaps, buying government paper - you bet that it does influence interest rate.
"andy sai:
Ahead of which game? That's like saying that if you increased taxes, you come ahead of the game if the economy is fast enough to grow.
That does not make sense, I think you are losing it in that last paragraph. you seem to be very confused as to the nature of interest rates, you might want to read Mises, Human Action.
The game is economic growth, and increasing taxes does not create economic growth, but decreasing taxes will."
Economic growth spurs from the capital. Less capital (because of government borrowing) means less economic growth. The same with taxes. If you see that it is absurd with taxes, why it is not absurd with capital when the money flows are basically equal? Sure, there are incentives differences - but expecting economy to grow 20+% seems to me insane.
Posted by: andy at Mar 13, 2008 4:00:15 AM
