Category Archives: Economics

Miscellaneous economy stuff

The European Union’s Deal

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The European Union agreed, last Friday, to the outlines of an arrangement that might leader to greater unity for the economies of the 17 nations of the euro zone plus six to nine additional members of the EU that are not part of the euro zone.  Only Great Britain has, for certain, demurred.  Leaving aside the question of the legality of the new terms (which arise because Great Britain has refused to go along, preventing the unanimity required by the EU’s governing treaties), what has actually been accomplished?

The EU other than Great Britain has agreed to a financial transactions tax.  This would be a fee that every investor, from an individual to the largest investment bank, would be required to pay on every financial transaction, from brokering a merger of large corporations to any individual buying—or selling—a single share of stock.  Britain couldn’t hack that because the financial industry is 10% of their economy, and they were concerned about the effect of such a large (in the aggregate) tax on their economy.

The biggie, though, was an agreement to more fully integrate the member nations’ economies, to the point of submitting national budgets to EU scrutiny.  Every nation, under this fiscal union, is bound to limit its budget deficit to no more than 3% of that nation’s GDP.  Failure to do so would bring virtually automatic sanctions (the sanctions could be waived on an individual basis, provided 5/6 of the fiscal union members agreed to the waiver).

This raises a critical question, though: what are those sanctions?  As I said, what’s been agreed is an outline, not anything of substance.  The specific sanctions are To Be Determined.  Further, if the negotiations of this (and other) detail hew to the schedule laid out by the fiscal union’s primary proponents, French President Nicolas Sarkozy and German Chancellor Angela Merkel, the deal must be done—and the sanctions identified and agreed—by next March, an ambitious schedule.  Also left unidentified is the or else should the deal not be done by then.  Mr. Market is likely to identify the or else in that eventuality.

There’s another critical question that’s left unanswered, also.  That’s how the fiscal union addresses the present problem of impending rampant sovereign debt insolvency.  The European Financial Stability Facility, the new European Stability Mechanism (which in the end replaces the EFSF; it does not complement it), and the IMF together aren’t enough to bail out Italy and/or Spain (assuming a bailout is appropriate in the first place).  And that’s a problem: the fiscal union sidesteps this question.  The EU is left to hope for the change of heart that will allow the European Central Bank to print euros and/or buy sovereign bonds in quantity and/or sell Euro Bonds.  The wisdom of any of these three ECB options is an open question.  Mr. Market is likely to forcefully express an opinion here, too.

There is yet another question.  How does the fiscal union address lack of homogeneity in the social, economic, and money imperatives of fiscal union members?  It does not; instead, the union attempts a Procrustean chopping and stretching to jam all the nations into a single, ill-shaped bed.

Layered on top of this is the EU leadership’s differing views of the EU’s  and the fiscal union’s role:

  • Merkel sees the EU as a political partner of the United States;
  • Sarkozy (ignoring the likelihood of Sarkozy’s defeat in next year’s elections) sees the EU as an independent power bloc competing with the United States.
  • Merkel sees the fiscal union (I’m reluctant to abbreviate this similarly) as a means of imposing extra-national discipline and control over national budgets;
  • Sarkozy sees the (structure of the) fiscal union as preserving an essential national sovereignty—most especially French sovereignty.
  • The existing EU governance power structures—the ECB, the European Commission, and the European Council—are allying with each other in order to preserve their own turf, power, and prerogatives against the (apparent) supremacy of Sarkozy and Merkel, of Germany and France, in the new fiscal union.  And they’re attempting to use Euro Bonds as their tool of artifice.

I remain not sanguine about the euro’s long-term survival as the common currency of 17 nations, nor am I sanguine about the long-term survival of the 26- or 27-nation European Union.  I’m also not convinced that a breakup of either is necessarily a bad thing.  A collection of four or five groups, each consisting of truly homogeneous nations, with Great Britain and France back in their traditional roles, and all operating in a grand free trade comity, will serve all the nations, and Europe as a whole, better.

Update: Withdrew an editorial note.

Debt and Taxes

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The price of our burgeoning national debt is this.  As our debt grows, more of our national income must be taken out of our economy and spent: at minimum, on the interest payments due; if we’re to actually pay off the loans, even more on principle payments.  But as we make the payments, if we borrow still more, still more money must be taken out of our economy for the additional payments.

In essence (to beat this horse a bit), money taken out of our economy to pay our increasing debt is money not available to our economy for use in productive things: capital investment, R&D, consumption, hiring, and so on.  Our nation’s debt, in the best of times, is a drag on our economy, but when it gets out of hand, it’s worse—it generates a negative feedback loop that actually contributes to shrinking our economy.  The more money taken out to make the payments, the less money for growth; the less growth, the less capacity for absorbing the removal of money, and the more that same removal amount hurts.

It’s true enough that the Federal Reserve Bank can manipulate interest rates, so as to keep those interest payments small and less of a drag, but only to a point.  In the end, Mr. Market overrules all of us, including our government.  As our debt grows (Greece, Italy, and Spain are graciously serving as object lessons here), our ability to repay it becomes more doubtful.  It’s certainly true that the Fed also can print all the dollars it wishes to print with which make those payments.

But there’s a rub here, too.  Our dollars are only worth what they can buy, and as we print more and more of them, they can buy less and less (that’s inflation)—including the “purchases” represented by debt payments.  There will come a time, sooner rather than later, when the interest the Fed is setting on our debt no longer accurately reflects the risks inherent in our debt, both in terms of our ability finally to repay and in terms of the value received from lending to us.  Worse, it will have become impossible to determine an accurate price either of our debt or of the risk in lending to us.  At that point, who will wish to lend to us?  Ask the Greeks, Italians, and Spanish how this is working out for them.

The price of rising taxes, another leg to our government’s efforts to right our economy, is this.  Taxing, at bottom, withdraws money from our economy.  Take everything written above about debt payments subtracting from our economy’s capacity and substitute “tax collections,” and we have the same negative feedback loop.  Increasing those taxes—a need seemingly justified by our stagnating, if not fading, economy—simply exacerbates the problem, with even more money taken out, an even more constricted economy as a result, and even less revenue going to government.  And more importantly, an even less effective economy, with lower production, less investment, fewer jobs, and reduced quality of life.

There is this one additional factor.  Some of the tax revenues do find their way back into our economy, but not all.  Roughly 75-80 cents of every dollar collected in taxes is all that makes it back.  Leaving aside the fraud, waste, and abuse that is a favorite target of our politicians’ perennial “spending cut” moves, the government acts as a middle man in the transactions, and so it keeps a fraction of every tax dollar for itself for the purpose.  Additional fractions of the tax dollar are lost simply to friction.

Further, government spending is money that is significantly misallocated, if only because it’s allocated to purposes we would not have chosen had the money been left in our hands.  It’s also misallocated, though, because so much government spending is allocated to things that inherently wasteful and destructive—overregulation from EPA regulations threaten electricity-generating power plants with closure, at the costs of jobs and of increased instability of our national power grid, for instance—and misguided—subsidies for “green” energy enterprises and for oil and gas production, for instance.  These misallocations reduce the efficiency of our markets so that our economy cannot even use the reduced production effectively.

It’s the Wrong Fight

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Republicans say that any tax cuts must be paid for with spending cuts elsewhere, and this is certainly true.  But what they’re talking about in the present case is payroll tax cuts.  Certainly, these cuts also must be paid for with spending cuts from somewhere else, but the logic ends there.

Senator Dick Durbin (D, IL) even calls out the Republicans on the matter, as I’ve written elsewhere.  But why are the Republicans letting themselves be drawn into this at all?  They’re ceding the terms of the debate and the entire debate to the Progressives.

On what basis do the Republicans—or anyone—agree that funding for Social Security should be cut?  This is a program that is already widely acknowledged to be desperately in need of reform or it’s destined for failure, yet the Progressives refuse to allow any reform.  Cutting funding by cutting payroll taxes that are intended for the Social Security Trust Fund only hastens that collapse.  Instead, we get Senator Jon Kyl’s (R, AZ) lame answer that “The payroll tax doesn’t go into general revenue. It supports Social Security.”  While true, it misses the whole point.  What is the Republican’s plan for reforming Social Security (and Medicare)?  Congressman Paul Ryan (R, WI) put forward ideas for both programs in the budget the House passed in 2010 that are worth serious discussion.  Yet Republicans have barely mentioned those ideas since: were they not serious about these reforms?

More to the point, why didn’t Kyl turn the argument back on Durbin and ask him why he’s opposed to really leaving money in the hands of Americans and our businesses by supporting income tax cuts for everyone?

Senator Durbin has agreed that tax cuts are good for Americans (he said so with the payroll tax cuts); Republicans should be arguing for income tax cuts, and permanent ones, not just via the annual argument over extending the Bush tax cuts, or some subset of them.  Republicans should be challenging the Progressives to offer legislation that provides for permanent income tax cuts for individuals and for businesses; they have a willing ally in Senator Durbin.  Or he’ll be shown by the debate to be disingenuous.  Republican candidates for President have offered real, broad tax reform; Republicans should be discussing these ideas more—in town hall meetings, on the floor of the House and Senate, on the radio and TV talk shows, at every chance they get—and they should make chances to talk about them.  Since they don’t do any of that, I have to ask: of what are they afraid?

The US already has the most progressive individual income tax structure in the developed world.  The President is openly engaging in class warfare as he campaigns for reelection and for his More Taxes More Spending ideology.  The Progressives in the Senate have not allowed the Senate to satisfy its statutory duty to propose an actual budget—of any sort—for nearly three years.  The Progressives nearly blew up the debt ceiling negotiations over their refusal to cut spending and their demand to raise taxes.  The Progressives did succeed in blowing up the Super Committee with their nonnegotiable demand to raise taxes by $1 trillion dollars.  The Republicans need to be calling out the Progressives on all of this.

Instead, Republicans let the Democrats control the argument and limit it to a narrow, doomed to fail path.

On top of this, the only jobs program that gets debated is the Progressives’ tax and spend Jobs Bill, while the Republicans don’t even have a coherent jobs message of their own, much less an actual plan.  Oh, yeah, there’s that Ryan bill from nearly two years ago.  About which they’re absolutely silent.

By letting the Progressives have the debates on their terms—again—and by having no coherent message of their own, the Republicans are in danger of giving control of the House right back to the Progressives in 2012 and of leaving control of the Senate and of the White House in their hands, too.  We’ve seen how well that’s worked for our country.  Four more years will only extend the damage to national disaster proportions.

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.

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.