Current Commentary

Lower unemployment using deflation and the backward bending supply curve of labor

Sequentially, deflation would raise real wages, which would shorten the average work week, which would spur new hiring.  Contrary to the "deflation equals depression" mantra of mainstream economics, evidence suggests that deflation and prosperity can co-exist, and in fact deflation raises real wages. (I wrote about it here:  What's the Cost of an Inflation-Free Bank Bailout?)  The backward bending supply curve of labor argues that as wages increase past a certain point, people work fewer hours.  It has also been estimated that for every 6 minutes the average work week is shortened, 315,000 new employees must be hired to replace the lost output. (See cnbc news.) 

The backward bending supply curve of labor explains the concept that for most people there is a point at which additional leisure time brings more pleasure than an additional car, or house.  It states that, as wages increase, workers will initially work more hours due to the substitution effect making labor more valuable relative to hours not worked. However, past a certain point, the income effect dominates as workers can achieve their desired level of consumption/living standard making leisure time more valuable.  

Essentially it says that money can't buy you happiness past a certain point, but up until that point it does.  A study showed that for most people that point is about $100,000/year. (See Link between income, happiness mainly an illusion.) To quote Nobel Prize winning psychologist Daniel Kahneman, "Money does make a difference when it moves you from abject poverty into the middle class, but it stops making a large difference at about that point. In terms of happiness, the difference between making $5,000 a year and $50,000 a year is dramatic, but the difference between making $100,000 and $100 million is negligible, almost nonexistent."

As wages increase to the backwards bending portion of the curve, hours worked decline. In order for the economy and employers to maintain the same level of output, unemployed workers must become employed workers.  Think of France's 35-hour work week, or Germany's 4-day work week, only instead of coming from a government decree, it arises from free market forces currently being crushed by central planning (banking).  While working less, earning more, and lowering unemployment may sound too good to be true, we must remember that the primary affect of inflation or deflation is not on national output but on national income distribution.

The idea of a shorter work week to reduce unemployment is not new. The idea that those shorter weeks could be achieved through free market banking is.

Tuesday, May 26, 2010

What is the cost of an inflation-free bank bailout?

The banks got two types of bailouts. One was fiscal -- basically anything involving Treasury (TARP, TALF, AIG, Fannie/Freddie); the other was monetary -- basically anything involving the Fed (0% interest rates, TAF, quantitative easing, MBS/Treasuries purchases, and an expanded balance sheet/monetary base).  The general consensus for fiscal policy's trade-off cost was increased deficits, debt and presumably higher taxes or reduced spending in the future.  The general consensus of the monetary policy's trade-off cost was inflation.  At this point there is a real possibility of avoiding inflation, and achieving an inflation-free bailout of the banking system in spite of unprecedented expansionary monetary policy.

How is this possible?  The quantity theory of money states that money supply affects prices.  More money chasing the same amount of stuff leads to inflation.  Most are familiar with MV=PQ where money supply times velocity equals price times quantity.  But you also have to remember how banks create money in our fractional reserve banking system.  M0 (monetary base) times bank lending=M2 (broad money supply), and it is the M2 broad money supply that affects price levels. In other words, if all the money the Fed created through various quantitative easing and debt monetization stays locked up as M0, it won't affect prices, and this leads us to the Fed's crafty exit strategy.

The Fed's exit strategy can be summarized as paying banks not to lend. (See Bernanke's Feb. 10, 2010 statement.)  Through increasing the excess reserve rate (the interest rate paid to banks with excess reserves -- normally banks have to make loans to earn interest, but not anymore), offering term deposits (essentially CDs that pay interest on excess reserves), and reverse repos that trade banks excess reserves created by the Fed for interest-bearing securities, the Fed is engineering an environment where banks can make interest revenue without lending to anyone.  It offers the real possibility of keeping a lid on M2 regardless of what happened to M0 over the least year or so.

Now for the big question:  If we achieve an inflation-free monetary bailout, is there a trade-off cost. And, if so, what is that cost?  The first rule of economics is "there is no free lunch" so logically there must be a cost, but what is it?

The first step to answering that question is to ask what would have happened had there been no bailout?  The most likely scenario is that there would have been a wholesale collapse of the banking system, a huge contraction of M2, and a deflationary spiral.  Cleary the banks would have been losers in that scenario, but there would have been winners.  For one, savers.  For two, consumers.  If you couldn't qualify for a car loan or a mortgage but wanted to buy a house or a car, wouldn't you be much better off if the houses and cars cost less?  The 3rd group that would have been winners were the workers.  While it is true that nominal wages fall in deflation, analyzing price and wage volatility from 1899 to 1933 shows the that ratchet effect works both ways; wages are far more stable than price levels, and in periods of deflation (e.g., the Great Depression) REAL WAGES INCREASED. (See The Relationship Between Wage Rates and Inflation, Emmett H. Welch, 1933).  Examining history from 1820 to 1913 reveals that US real per capita income increased by nearly a factor of 5. When ranked against other developed nations, the US real per capita income went from the middle of the pack to #1 during the same time the general price level fell almost 50% (Deflation Determinants, Risks and Policy Options published by the IMF in 2003, pg 9).  (See History of Standard of Living in the U.S.) The historical record shows that you can have deflation and strong growth.  It also shows that deflation rebalances income distribution in favor of the average worker.

To that end, what was the cost?  The monetary bailouts used central planning to override the free market forces that would have lowered the Gini coefficient and benefited savers, consumers, and workers at the expense of banks, shareholders, and investors.  While the monetary bailouts may not appreciably expand M2, they will serve to appreciably zero sum game the division of it into the hands of bankers and out of the hands of everyone else.

Tuesday, May 25, 2010

Remembering Ross Perot's lesson
of substance over style

Eighteen years ago a big-eared Texan showed the world that Americans prefer substance, ideas, and details, to ambiguity, ideology and platitudes. This 1992 NYT article could be mistaken for today's news if not for the names, yet Perot's main lesson of substance and ideas over vagueness and blind ideology has since been buried and forgotten:  
An Eccentric but no Joke; Perot's Strong Showing

While you may have disagreed with some of Perot's ideas, at least he got specific enough about them so that you could intelligently disagree. Through his use of pie charts, bar graphs, and 30-minute infomercials, Perot gave you enough information that you could debate his ideas and didn't have to resort to ad hominem attacks and call him "socialist" or "radical." He introduced pragmatic ideas to big problems without clinging to the published platform ideology of a particular party often more interested in advancing the party than advancing the country. 

Today we have Barack "Yes We Can/Hope & Change" Obama and Nancy Pelosi's "radical socialist agenda" vs. Glen Beck and Sarah Palin's "radically racist conservative tea party movement," but neither side can really point accurately to specifics of their respective nemesis, certainly not the average voter.  The truth is that healthcare was not socialist; rather, it was corporatist (but it does raise taxes on the "95% of Americans" who were not supposed to get a tax cut).  The bank bailouts were the opposite of socialism, or reverse-socialism.  Proposed cap and trade's regressive pass-through tax certainly isn't going to help the average working man and doesn't qualify as socialist (but it functionally raises taxes on that same 95% group).  Foreign policy has been just as Cheney-hawkish as it was under Bush II.  On the other side, the only specific ideas I'm aware of are "drill baby drill," and let's blame all our problems on Democrats and illegal aliens.  There also are those Greenspanian Freemarkateers who don't believe in any financial regulation reform but certainly believe in all of the bailouts.  According to them, socialism's OK on the way down, but you must leave the markets as free as possible for the way up.  How exactly did they get Dem's to vote for TARP again?

There are two huge looming problems that threaten to hit America with a Greece-style insolvency problem within the next 3-8 years, yet not only does no one have a solution, no one's even talking about working on a solution:

1.  We have converted huge unaffordable private debts into huge unaffordable public debts through the numerous bailouts and functional nationalization of banking. With Fannie Mae and Freddie Mac intravenously hooked up to the American Taxpayer through the Treasury, today's "giant sucking sound" will be the sound of our money being poured down a black hole to save bankers under the pretense of saving homeowners.
2.  We have a huge cresting tidal wave of unaffordable entitlements that no one in a position of power has the guts to address, namely Social Security, and the inequitable, unjust public pension system. For SS, we can raise taxes, cut benefits, or raise the retirement age to 71.  For public pensions, we can raise taxes, cut other services, or eliminate a benefit that 80% of the private sector does without, and the 20% in the private sector who do get pensions get pensions less generous than the government gives.

Getting people to start openly debating these problems is the first step to solving them.

Monday, May 10, 2010

US debt rating downgrade forecast as soon as 2012: America's looming Greek Tragedy

Moody's has run numbers based on CBO budget-deficit projections and their own debt-service risk-tolerances that forecast a US Treasuries ratings downgrade sometime between 2013 and 2018.  Moody's considers debt payments to only be AAA-quality up to 18-20% of tax revenue.  Under CBO numbers, the Obama budget is scheduled to hit that figure by 2018.  Under a more pessimistic assumption that assumes higher interest rates, the hit-the-fan moment happens in 2013.  A ratings downgrade would lead to an interest rate spike resulting in potentially unaffordable payments -- the Greek tragedy.

Article at investors.com.

Tuesday, May 4, 2010

How banks repaid TARP:
The other bailout repayment lie

Too-big-to-fail banks repaid their TARP money with other bailout money. To suggest that TARP was profitable to the taxpayer (as suggested in various recent articles) is to use one-sided accounting that overlooks the 11 TRILLION dollar bailout nation that TARP played only a small part of.   CNNMoney and the NYT have detailed and itemized the GDP-sized totals of the bailouts beyond TARP.  Here's how bailout money poured into some of the less notorious programs was laundered to repay the TARP portion:

While there are a few more moving parts to this scam, the mechanics are much the same as the GM loan repayment lie, essentially moving publicly financed money from one pot to another.  The trick is to identify the pots and understand how they work.

Finally, if TARP has been so "profitable," why is the federal government projected to run deficits equal to or greater than 10% of GDP for as far as the eye can see?  On that question alone, the idea of the bailout being "profitable" falls apart.  Misunderstanding these facts is dangerous.  It increases the probability of a future bank bailout, and it decreases the probability that those responsible for this one get removed from power.

Monday, May 3, 2010

IRS paperwork explosion buried in health reform

Cato Institute looks at a costly IRS mandate that's in the health bill.

Starting in 2012, for the first time ever businesses will be required to issue 1099s to other businesses for purchases over $600.  Spend more than $600 at Office Depot in a year?  Better track down their Taxpayer Identification Number.  More than $600 on FedEx?  Same thing.  Spend more than $600 on gas for business?  Yup, you'll be mailing a 1099 off to either Exxon corporate, or maybe the franchise owner, maybe both. Just pay an accountant a couple hundred dollars an hour to figure it all out for you.  If you can't obtain a TIN, you are required to withhold the taxes from the payment.  Rent, utilities, phones, equipment, inventory, professional services.  Think untangling the mess of wires behind your TV, DVD, cable, video game systems times a hundred.

Now just imagine if you were a big business....all of the inbound 1099s you'll be receiving (in addition to the ones you'll be filing) that you'll need to reconcile with your records and file with your taxes.  Cato estimates it could increase the total number of 1099s filed by over a billion.

Every single B2B (business to business) transaction will have to be recorded, reconciled, and filed with a separate tax form.  Transaction costs will increase.  Accounting costs will increase.  At a time of 10-18% unemployment, barriers to entry and barriers to growth for small business will increase.