Tag Archives: policy

It Isn’t Just Our Own Progressives….

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In an interview with Spiegel Online International, ex-Greek Prime Minister Giorgios Papandreou had this to say in response to Spiegel‘s question of where fault lies for the present crisis:

…we need strict budgetary discipline, and we have to reduce expenditures, but we also need growth strategies. And we cannot lose sight of the markets, either. It is unacceptable that they are the ones driving the countries…not giving their governments the time that democratic institutions need. This undermines our democratic foundation. That’s why we need strict regulation of the markets and more transparency, and why we have to contain the rating agencies. We, as socialists, have demanded this again and again, because we cannot do this alone as a single country. This is a mistake being made by the global political class and, in particular, by conservative Europe.

And this brief exchange:

SPIEGEL: They have dictated the strategies for some time now. The primacy of the political class seems to have been suspended.

Papandreou: That’s true, unfortunately. If we decide at 2 a.m. that we have to make a decision because the stock market in Japan is about to open, it’s an acknowledgement of the superior power of the markets.

What a breathtaking lack of understanding of economics, of free markets, even of democratic principles.  With Europe as their role model, it’s no wonder our own Progressives have so damaged our economy and our government.

Papandreou wants growth strategies.  What more powerful growth strategy can there be than to get government out of people’s and business’ way, to let labor go back to being mobile, to let citizens and businesses make their own decisions?  How much more stimulative (to coin a phrase) can government be than to reduce the cost of doing business by reducing taxes on businesses, on citizens, on exchanges between citizens along with that “budget discipline” and those “reduced expenditures?”

A concern, expressed in complete seriousness, is that markets are driving the nations, and not the governments.  Are not the people sovereign in Europe?  Is government truly the Sovereign in the land of John Locke and Jean-Jacques Rousseau?  People, in a free environment, are free to express their will over their government politically, but that’s not all.  To have a truly free environment, they must be free, as well, to instruct their government economically in a free market.  Every citizen in a free country gets two votes: one at the ballot box and one in his economic exchanges with his fellow citizens.

Another concern, expressed with the same lack of understanding, is that people, with their economic decisions, are not giving their governments the time that democratic institutions need in which to act.  But this is to assume that governments must be in the business of governing citizens’ economic decisions in the first place.  Since legitimate government has no such role, legitimate government needs much less time.

As if that’s not enough—or perhaps it’s deliberate (this would be consistent with the European attitude that government must decide for the people)—Papandreou wants to censor the information that people and businesses use in making their economic decisions: “contain the rating agencies.”  Government will make better decisions with its information base than can the citizens for themselves.  Hmm….  How’s that working out today in Greece and in the EU generally?  Do the people or the government, even in Europe, have the better record over the last several decades?

“We cannot do this alone as a single country.”  No closed economy—no economy that has no access to exogenous funding—can “do this alone,” since “this” is government making the decisions, government taxing everyone to pay for the welfare of everyone.  However, expanding this to the euro zone, or all across Europe, begs the question.  The expansion just expands the bounds on what is still a closed economy whose policies depend on outside financing to pay the difference between what the taxes can provide and what the government has promised.  An expansion only ensures that everyone else is dragged into the pit, also.  Making the thing be global changes the situation not a bit.

But in a huge misunderstanding that’s entirely consistent with the European view of “democracy,” of “freedom,” of “markets,” European government Progressives have completely missed the fact that their markets, at bottom, have very little freedom in economies so heavily laden with regulations and government “oversight.”  The polities have only limited freedom in government-controlled societies that limit labor mobility, that limit business choice, and that discourage entrepreneurship (which is entirely consistent with the lack of market freedom).  The Progressives have no understanding whatsoever of the concept of democracy and of individual liberty.  Papandreou’s own government was brought down by the other governments of the EU for the unpardonable sin of asking the Greek people for their opinion of the latest round of bailouts.  The wills of the French and Dutch citizens, when they rejected the European Union Constitution in their plebiscites, were blithely overruled by their governments signing the Treaty of Lisbon, which enacted that Constitution in all but name.  But this failure to understand is not all on the elitists.  In societies where tax evasion is a sport, where the rule of law is a thing of ridicule—this is not the stuff of freedom and democracy, either.

The failure of understanding can be summed up in Papandreou’s own lament: the superior power of the markets.  How terrible it is that government should be subordinate to the will of its people as expressed in a truly free market.

Democracy, free markets, individual liberty demand that the sovereign people make their own decisions, and live with the outcomes and prosper from those outcomes, or recover from the outcomes and then prosper.  These three—free markets, democracy, and individual freedom—are bound up tightly among each other.  None can exist without the others also existing.  Governments must accord citizens the respect of being responsible for their own actions, and the citizens must reassert this right for themselves.

Can We Afford This?

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The International Monetary Fund, reports Belmont Club, is being lined up bail out Italy and Spain to the tune of an $800 billion aid package.  With the US as the IMF’s largest contributor, our “share” of this works out to more than $140 billion.  Can we afford this bailout (I won’t go into “after all the other bailouts” in which our government—we—have participated, both domestically and foreign)?  As an old econ professor of mine used to ask, “Suppose not?”  That is, what are the consequences of our not participating in this new bailout scheme?

Here’s one estimate of those consequences.  The EU’s designated “systemically important” banks hold a lot of European sovereign debt, including, in particular, Greek, Spanish, and Italian (and Portuguese) debt.  So do a lot of the other European banks.  So do a lot of Europe’s national central banks.  On top of this, most of the rest of Europe’s major banks hold the debt (non-sovereign; commercial) debt of those commercial entities that hold all that sovereign debt.

Because of these risks, the EU governing bodies have required those major banks to increase their capital reserves to 9% of their assets in anticipation of a Greek, or other sovereign, default.  But instead of acquiring more capital to reach that 9% threshold, those banks have been busily reducing their asset base to get their existing reserves to 9% of that reduced base—beginning with unloading the sovereign debt they presently hold.  Beyond this, the banks are not buying anymore sovereign debt, in what Spiegel Online International refers to as a “buyers’ strike on euro-zone debt.”  Mutual funds, money market funds, and other financial entities outside the EU have stopped buying European debt, also, even to the point of the US Federal Reserve Bank having to make dollars available to Europe because the commercial entities are even decreasing their willingness to roll over short term debt instruments.  It’s gotten so bad that not even Germany could sell its 10-year bonds in last week’s sale; one-third of their offering was left on the table.

In this environment, suppose Italy defaults (Greece has already defaulted with the agreed 50% write-down of their sovereign debt, but since sufficient government arm-twisting (“Nice banks you got there, Karl, Pierre.  Shame if something happened to them.”) was applied by the other European governments to get private lenders to “volunteer”, a “default” didn’t actually happen).  The banks still holding Italian sovereign debt fail because their assets—those debt instruments—become worthless and are (were) too much of their asset base.  This cascades as banks holding those banks’ own debt fail from the worthlessness of the failed banks’ debt.  And so on.  With the resulting severe economic downturn, the nations of the EU suffer, unemployment rises, output falls; all the things associated with a sharp, steep dislocation occur.  Since Europe is a major trading partner, and so customer, of ours, our economy worsens, our ongoing recession deepens, perhaps sharply, and lengthens.

On the other hand, suppose we go along with this IMF scheme and participate in yet another bailout.  What happens then?  The IMF money, claims La Stampa (via the Belmont Club link above), would give Italy a year to a year-and-a-half to push through reform without actually having to refinance their existing debt.  But, in reality, this just means the string will be pushed down the road.  Politicians, including Italian Prime Minister Mario Monti, won’t use the time to implement real reform, only to pay lip service while continuing to spend.  The rioting in the Italian streets over existing timid spending cuts show this (as they showed in Greece).

Further, with the cost of sovereign—and private—borrowing increasing rapidly as private entities—the only entities, in their aggregate, with the money to continue funding (but even for them, only to a point) national deficit spending, which is sovereign debt, what happens when the money runs out?  Recall that those private entities already are walking away from lending to Europe: they’re not going to lend until they run out of money.

Indeed, Spiegel Online International notes that their sources say that all of the previous bailout attempts have been worthless.  Those sources insist that, as a result, the European Central Bank must finance the debtor nations, even if the EU’s treaties bar it from doing so.  The central bank has enough money, goes the claim, and it can also print money if necessary.  Aside from what blithely ignoring the fundamental law of the land does for binding political entities—and people—together into a coherent polity, such printing of money for the sake of generating dollarseuros is the stuff of very great, if not runaway, inflation, as the Germans know full well.  Sharp inflation represents a devaluation of the currency that is little different from an outright default.

It won’t work, anyway—bailouts cannot work.  The prior bailouts failed, not because there wasn’t enough money transferred, but because the concept of bailouts is a failure: all they do is reward the behaviors that led to the condition by excusing the actors from the consequences of their actions.

In the end, then, Italy (Spain/Portugal) will default anyway.  Only if we’re active participants, we’re out those $140 billion, and a lot more, as all of us, EU and the US, keep trying until the inevitable happens.  Better to cut the cord, stop feeding the habit.  Better if the EU did this, also.  The default will happen sooner, the economic downturn will be extremely sharp, and it will be over.  The defaulting nations will recover, and they’ll be stronger than before for having learned a painful lesson.  For a couple of generations, anyway.  The rest of the nations will be better off, and sooner, for not having ridden this sinking ship down.

Insurance, Bonds, Risk, and Welfare

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Insurance policies and bonds are quite similar in an important respect: they both are instruments used by industries that are founded on the transfer of risk from one person or entity to another in return for a fee of some sort, a fee which most often is characterized by an ongoing transfer payments from the one transferring the risk to the other accepting the risk.  The policies and bonds are the documents that represent these exchanges of risk and fee.

In essence, insurance transfers both the risk—the likelihood—of an undesirable event happening (vis., a person getting sick or dying, or one’s house burning down) and the cost of that event, to another entity, an insurance company.  In return for paying out that cost to an insuree, the insurer receives from the insuree a stream of premiums.  Notice that: the exchange is solely between the two parties; no one else is involved.

It’s quite similar with bonds.  A lender transfers a sum of money to a borrower in return for a stream of payments from the borrower back to the lender.  Here the risk  transferred from the borrower to the lender—the undesirable event—is the risk that the borrower won’t repay the principle transferred at the start.  In return for accepting this risk, the lender charges a premium to the borrower—the interest to be charged that represents an additional amount included in each payment beyond simply a prorated repayment of the principle.  Notice here, too: the exchange is solely between the two parties; no one else is involved.

The insurer makes its money by insuring lots of people so that the cost of having to pay out on any particular policy is covered by the totality of the stream of premium payments from all of the company’s customers, and the expectation that those customers will not suffer their loss simultaneously.  Similarly, the lender makes its money by pooling borrowers so that the cost to the lender due to default of a particular borrower is covered by the totality of the stream of bond repayments from all of the lender’s customers, and the expectation that those borrowers will not all default simultaneously.

The aspects of these two risk transfer industries that are of interest here are the sizes of those premiums and the relationships of the risks from one insuree/borrower to another.  In both cases, the risk transfer fees must be commensurate with the risk being accepted.  If an event—dying, or defaulting on a loan—is highly likely, than the fee must approximate the cost of the event, else the risk acceptor quickly will go bankrupt from routinely paying out more than it receives in return for taking on the risk.  If the event is not very likely at all, than the risk transfer fee similarly can be quite small.

Note, though, that insurance only works if the risks being pooled are similar.  Forcing into a pool people of significantly different risks—mixing a healthy, exercising young women into the same pool as octogenarian, heavily smoking men, for instance—artificially inflates the cost of that insurance to those young women, who won’t benefit from the insurance; it artificially deflates the premiums for those geriatrics who would benefit from the (relatively high risk) insurance; and it distorts the measures of risk for the pool insured, making it difficult for the risk acceptor to accurately price the cost of that risk transfer.

Bonds, also, only work only if the risks being pooled are similar.  Forcing fiscally sound, low borrowing entities to pay the same interest rates as unstable, heavily spending (with little income to cover the spending) borrowers makes such bonds similarly riskier: the risk is pooled on artificial criteria and so the interest required can have nothing to do with the condition of the borrowers in the pool.  This makes it next to impossible for a lender accurately to price this risk transfer.

This arbitrariness also makes it difficult for investors to evaluate the efficacy of a bond or an insurance company investment.

Wealth transfer schema, welfare payment plans, on the other hand, make no pretense of transferring risk, nor should they—that’s not their purpose.  Wealth transfer programs have only one purpose—to subsidize those whom the relevant government has determined should be subsidized.

That’s a long-winded introduction for my briefly stated thesis.  Only when the concepts of risk transfer and welfare are understood to be separate, and kept that way, can we have serious discussions of the utility of providing health cost welfare for some in the form of tax payments from all, or of  the utility of providing debt cost national welfare for some nations (their citizens) in the form of tax payments from all nations (their citizens).  Both Progressives and modern Conservatives (and social philosophies in between) routinely ignore these differences.  Instead, the insurance industry gets treated as a privately funded, government controlled welfare program, and the bond industry (of which the proposed Eurobond is an example) gets treated as a privately funded, meta-government controlled national welfare program.  This conflation invalidates argument on both sides of the question.

Government-Guaranteed Loans and Taxes

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This is a brief tale of taxes and loans as they apply to American education.

In a time when our governments think the answer to correcting our public education system’s decades-long failure to improve our children’s education, as demonstrated by poor and unimproving standard test scores, is to continue their decades-long practice of throwing our taxpayer money at the system (what was it that Albert Einstein said about doing the same thing repeatedly and expecting different results…?), some of our state governments, and the good citizens therein, are rejecting the idea and doing something different.

As  The Daily Caller reports, in the recent special election in Colorado, the voters overwhelmingly rejected a ballot proposal that would have raised, yet again, taxes earmarked for public schools, when no discernable improvements from those increases were expected (by those taxpayers).

Florida, on the other hand, has been doing something different since the turn of the century: it’s lowered taxes by giving tax credits to businesses that donate to a non-profit  K-12 scholarship program that are equal to those donations.  The scholarships then are awarded to low-income families to help pay their costs in sending their children to private schools selected by those parents.  (Notice that phrase, too: “help pay.”  The families have to commit significant funds of their own; by having their own skin in this game, they have incentive to ensure their children do well in the new school.)

The effect of this Florida program is four-fold: the public schools, now having to compete for students, are doing a better job of teaching the children they retain.  The low-income families get better choices in how to get their children educated.  The state saves money: despite losing $1 in education tax revenues, it actually saves nearly $1.50 because despite the stereotype, it’s cheaper to educate a child in a private school in Florida than it is in a public school.  The local communities come out ahead because a dollar taken in taxes is only about six bits actually spent back into the local community due to the internal friction of the various government agencies each taking their taste of that tax dollar, whereas that same dollar left in the taxpayer’s hands is entirely spent in one form or another.

Now let’s look at government-guaranteed student loans for college (those guarantees, don’t forget, are covered by tax dollars from all of us).  What are these loans used for, and what should they be used for?

This table from The Daily Caller is instructive.

Bachelor's Degrees AwardedLook at this table against the backdrop of the global economic competition in which the United States is engaged.  From business, to resource development, to production, to defense, and everything in between, the United States needs well-trained and -qualified scientists and engineers.  What are our students studying?  Visual and Performing Arts.  Education(!?).  Social Science (how are we doing in this field, by the way?).  What are international students, the students of our competitors, studying?  Engineering.  Physical and Life Sciences.

If we’re going to have a government student loan program (I think we should not, but that’s another story), might it not be a little bit beneficial to target those loans in some way?  How about, if we’re going to commit our tax dollars to covering student loans at all, we at least use the program to encourage our students to study—and to stay with through graduation—the engineering and science, technology, and/or mathematics that will actually do our nation and our society some good, instead of just spotting our unformed (and uninformed) high school graduates the bucks they want simply to follow their bliss?

Keynesian Spending vs. Personal Spending

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In this post, I want to talk about two fundamentally different views of spending in an American economy.

One view of spending is Keynesian: any spending is stimulative, and so government’s (stimulative) spending helps a stagnant economy break out of its stagnation.  Further, only government has the resources to provide the size of spending stimulus needed to break a downward cycle.

Thus, if we have a Keynesian stimulus of, say, the $800 billion of an Obama Stimulus bill, or the similar-sized aggregated stimulus spending of a New Deal 80 years, or so, ago, we would expect to see a stagnating, if not sharply contracting, economy break out of its doldrums and return to solid growth.  Yet we did not, in either case.

I won’t get into things like the fact that current government stimulus spending represents future taxes, or government stimulus spending represents a wealth transfer from productive sources to unproductive targets (in the laudable, but unsatisfied, hope that the recipients will become productive), or that government stimulus spending is aimed at a temporary response, while the costs of that spending—those taxes, and debt incurred—are long-term.  The reason government stimulus spending isn’t all that stimulative is that a tax dollar collected from an individual isn’t completely spent in the first place.  Some of that dollar is retained by the government for its own purposes, and some of that dollar is simply lost to intra-government friction.  Less than a dollar makes it out the door as actual spending.

The other view of spending is that personal spending is stimulative, and that were individuals in their aggregate to spend (or resume spending), a stagnating economy would break out of that stagnation.  Associated with this view is the commonly held belief that individual saving, by not being spending, does not contribute to breaking out of that stagnation.

When an individual spends a dollar, though, that whole dollar makes it out the door.  Of course, when the individual also saves that whole dollar is saved.  None of an individual’s dollar, while it’s in his hands, is lost to intra-individual purposes or to friction.

What happens to that individual’s dollar when he spends it, or to the government’s six bits that finally get into the economy as spending?  From here, they follow pretty much the same path: an initial food purchase is made at the local grocery store, some is spent on rent or mortgage, some is spent on the car, and so on.  Each of those recipients then spend some of their parts of that original dollar: on wages, on rent, on supplies, and so on.  All along the way, each individual or business recipient also siphons off a small amount as savings.  Each of those recipients, including the wage earners, repeat this general cycle until finally that original dollar has been consumed.  In general, the original dollar that an individual spends, in all of its spending incarnations through all those recipients’ subsequent spending, turns out to be worth around $1.75 to the local economy.  That government’s six bits, following the same path, though, can only amount to a little over $1.30 for the local economy at that same turnover rate.

Consider the money that’s saved instead of spent, now.  How non-stimulative is that money, really?  In the immediate term of a dollar actually spent, it’s not stimulative.  But it is stimulative in the not too distant future: that dollar saved either is held under the individual’s mattress against a future spending need, or more likely, it’s deposited in a bank or other financial institution.  Once that dollar makes it into the bank, it becomes part of a collection of lots of individuals’ dollars, and that collection is loaned to a number of individuals and businesses—for spending.  Saved money, thus, represents not too very delayed stimulus spending by others who have borrowed the money for the purpose.

But in the end, who is really doing the spending?  Either way, whether government or individual spending, it’s the individual individual’s money that is spent, and so it’s the individual who’s doing the spending.  A critical difference is in the pathway described above that is followed by the individual’s dollar, and this difference determines how much of that dollar actually gets spent and so the final value of that spending.

A dollar taken from an individual in taxes is therefore an expensive dollar.  It represents a loss of a dollar of private saving for future spending or for future private lending for spending, or it represents a loss of $1.75 to the taxed individual’s local economy that would have resulted from his spending that dollar himself.  If that tax dollar—or the roughly three quarters of it suggested above—comes back to that same local economy, it’s only worth $1.30, a reduction in value of 45¢.

Since government spending can only come at the expense of taxing the individual, it cannot be as stimulative as the aggregation of individual spending, even when some of that individual spending is delayed through saving mechanisms, and even if that government spending comes during an economic contraction.