Debt ceiling extension:
Chaos vs. order + possible fed maneuver

Civil societies do not solve their differences through violent revolution. On the spectrum of violent chaos vs. orderly transition, failure to extend the debt ceiling would fall far beyond the middle line towards violent chaos.

What exactly would not raising the debt ceiling mean? It would mean an essentially overnight reordering of over 10% of the economy, the proportional size of the deficits that would have to cease. It would not mean a technical default on the full faith and credit guarantee of government issues debt, but it would mean a functional default on many other things, the only question is what other things.

“Mandatory spending” is roughly equal to tax revenue, so it is true that in addition to interest on the debt, you could also pay Social Security, Medicare, Medicaid, unemployment insurance benefits, and food stamps. However, that would require closing every other piece of the federal government, including the military, virtually overnight. File this scenario away under “impossible.”

Defense could be cut in half (a figure that would still leave us at inflation-adjusted end-of-Cold-War levels, and spending four times as much as the number two global spender China), and every other discretionary program could be cut in half. But that would require cutting 40% from the Social Security, Medicare, Medicaid, unemployment insurance, and food stamp category.

You cannot reorder more than 10% of the economy overnight and not have it leading to ketchup sandwiches and homelessness for some people. This point is not to be confused with whether you could cut federal government spending to 15%, or even 10%, without inducing ketchup sandwiches and homelessness. There are strong arguments to be made that roughly 10% of GDP is the optimal size of the federal government, but political brinksmanship where winning means a total chaos transition period is not the way to get there.

Similarly, you absolutely can cut government spending without hurting the economy. One of the many central flaws of Keynesian economics is the false notion that government is exogenous to the economy. Keynesian economics treats the federal government as if it were essentially a group of space aliens from another planet, completely outside the circle of the U.S. economy. According to Keynesian economics, the government has its own separate supply of scarce resources that it can add or subtract from the circle of the U.S. economy. This of course is not true. The private sector and the public sector both draw from the same factors of production of land, labor, and capital. The federal government’s income and demand role in the economy is no different from that of the combined role of an arbitrary group of U.S. corporations whose gross expenses would total up to the same figure as the Fed’s. Of course, if this group cuts back on its expenses, it has a short-term negative effect, but that cutback opens up room for other business to expand. Downwardly flexible prices are necessary for this to best function, but that is a topic for another time.

Americans enjoy a higher standard of living because of the faith the rest of the world puts in us. Part of that faith comes from having a very stable government, where regime change is an orderly process. Even if a technical default on the debt payments is averted (and it should be), the chaos, and even possible civil disorder that could come from this would be confidence eroding. You cannot turn a cruise liner on a dime without wrecking havoc to a lot of what is onboard.

Possible Federal Reserve solution:
Formally printing the debt

There's a theoretical solution that I have mentioned before in passing; I'll write it here to take credit for calling it if indeed it happens.

It is possible that the U.S. could continue spending as much as it does, without taxing anymore, AND without raising the debt ceiling. Such a maneuver would certainly be called “temporary and extraordinary,” but there has been a lot of that lately. All the debt ceiling means is that the Treasury Department cannot issue any new treasury notes to borrow any more money.

The Treasury Department is the country’s checking account. You deposit your paycheck into the checking account (tax revenue), and you pay all of your expenses out of the checking account (SS, Medicare, military, etc.). If your revenue is not covering your expenses, you use your overdraft protection. Now, the Federal Reserve is providing much of that overdraft protection by the fact that the Fed is buying a significant amount of the treasury notes being issued by the Treasury. There are primary dealers (big banks) involved as intermediaries (middlemen rent-seeking off the game, since mercantilist France, rich financiers have been getting richer by financing governments). Because of the intermediaries, it is not technically monetizing the debt. But what if we cut out all the middleman, and just plugged the Federal Reserve directly into the Treasury? In other words, what if Treasury did not have to issue notes, but could still get its money? Treasury and the Fed could work out some sort of internal agreement between the two of them, to not increase the external debt, or issue treasury notes. Functionally, it would be almost no different from what is already happening. The question is how the markets would respond to it. Given the precedent of what is already happening, and the expectations, it likely would be a less negative response than the abrupt reordering that would otherwise come with not raising the debt ceiling.

Such a move would be purely inflationary, and would have a similar welfare effect as a regressive consumption tax, but with less transparency. It is the fact that it is such a smoke and mirrors, paper-over-the-problems ploy that makes me think a switch from unofficially monetizing the debt to officially monetizing government spending is a leading contender for a final outcome of this.

-- Also at my Seeking Alpha blog --

July 6, 2011

Adam Smith says don't vote for Cain or Romney

The “successful businessman” is an idol worshiped by many Republicans, especially those who are active within the primary stage. Adam Smith cautions that these “master manufacturers” are primarily concerned with, and most adept at, advancing their own interests, especially when they conflict with yours, and they often do. While the successful businessman may understand certain things better than the average person, their expertise lies “not so much in their knowledge of the public interest, as in their having a better knowledge of their own interest.” And while they often convince the common man that their interests are inline with the common man’s interests, “they [the successful businessmen] have frequently imposed upon his [the common man’s] generosity, and persuaded him to give up both his own interest and that of the public.” 

Smith really drives the point home with, “The interest of the dealers [the successful businessmen]  is always in some respects different from, and even opposite to, that of the public."

The following quote constitutes the bulk of the final paragraph of Book I. Note that Smith chooses to close out Book I with an explicit castigation of big business. Book I is arguably the most important of the five, where he lays out the entire framework of how a market economy works, and how progress is made, essentially the way the natural world works, and he ends it driving home this one point.

The entire Adam Smith quote, unabridged and uninterrupted:

Merchants and master manufacturers are, in this order, the two classes of people who commonly employ the largest capitals, and who by their wealth draw to themselves the greatest share of the public consideration. As during their whole lives they are engaged in plans and projects, they have frequently more acuteness of understanding than the greater part of country gentlemen. As their thoughts, however, are commonly exercised rather about the interest of their own particular branch of business, than about that of the society, their judgment, even when given with the greatest candour (which it has not been upon every occasion) is much more to be depended upon with regard to the former of those two objects, than with regard to the latter. Their superiority over the country gentleman is, not so much in their knowledge of the public interest, as in their having a better knowledge of their own interest than he has of his. It is by this superior knowledge of their own interest that they have frequently imposed upon his generosity, and persuaded him to give up both his own interest and that of the public, from a very simple but honest conviction, that their interest, and not his, was the interest of the public. The interest of the dealers, however, in any particular branch of trade or manufactures, is always in some respects different from, and even opposite to, that of the public. To widen the market and to narrow the competition, is always the interest of the dealers. To widen the market may frequently be agreeable enough to the interest of the public; but to narrow the competition must always be against it, and can serve only to enable the dealers, by raising their profits above what they naturally would be, to levy, for their own benefit, an absurd tax upon the rest of their fellow-citizens. The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention. It comes from an order of men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it.” 
– The Wealth of Nations, Book I, conclusion of chapter, 11^th paragraph

-- Also at my Seeking Alpha blog --

July 1, 2011

Elizabeth Warren's Baltimore town hall:
A better alternative to bigger government

I attended last night’s town hall meeting with Elijah Cummings and Elizabeth Warren. Warren has been tasked to head the new Consumer Financial Protection Bureau. Its basic goal is to consolidate the functions of 7 existing agencies under the umbrella of one “super-agency” that is tasked with protecting consumers. One prominent and specific goal of the agency is to improve the transparency and understanding of financial disclosures, everything from mortgages, to credit cards. It’s clear that she, her agency, and its main goals have a lot of popular support, based on the raucous, overflow crowd that repeatedly broke into applause.

I agree with the basic diagnosis, but vehemently disagree with the prescription.

It is absolutely true that the financial markets have and continue to suffer from the market failure of information asymmetry. This asymmetry is the deliberate design of banks. Many loan disclosures intentionally obfuscate the true terms and costs of the loan. Most of these practices constitute fraud by the reasonable-man standard, and government has a legitimate purpose in preventing fraud. The question is how best to do this?

Even the most well intentioned and informed government agency (and Warren’s agency very well may be just that) is not the best method of creating market transparency, understanding, and symmetric information between producer and consumer. The best solution is to remove the profit motive to obfuscate and conceal information.

An unsecured loan should always be an unsecured loan, not a loan that is secured against your future wages and any bank account you have. A secured loan should only be secured against the specific asset that is pledged through a security instrument, not the pledged asset plus a bank account, plus future wages for the next 12 years, plus the ability to renew a judgment past 12 years as is the case in MD. Banks should never be bailed out. Eliminate these tools for banks to extract a pound of flesh from those who have defaulted, and you will align the banks' interests for clear, transparent, symmetric information with consumers' interests.

Short of outlawing the practice of effectively turning unsecured debt into secured debt through wage and account garnishments, disclosure, or a separate security instrument is necessary. Current loan agreements read something to the effect of “if you default, we reserve the right to collect to the fullest extent of the law.” The average consumer (the reasonable man) understands that a default on unsecured debt will result in bad credit and the inability to borrow again for a period of time. The average consumer also understands that a default on a loan secured by a car will result in the loss of the car, and a default on a loan secured by a house will result in the loss of the house. He does not understand that he is effectively pledging all of his liquid assets and a third of his future earnings through the garnishment process. Require clear bold disclosure of this term, or even better, a specific security instrument the same as the one that pledged a security interest in the car or the house.

Banks essentially are trying to lend without risk. Make a bad loan? No worries; just forcibly take it. The only thing the lender really has to worry about is the cost effectiveness of the cost to collect, and the possibility of long term unemployment and destitution. Anything short of that and the lender is getting paid through the assistance of the force of government. Lending is inherently risky. To try to eliminate that risk is to allow bankers to print money for themselves. 

The ultimate trump card that consumers have is FU, I’m not paying. To eliminate this option is to shift power away from consumers, and toward banks. Rather than creating a brand new federal agency that will attempt to micromanage the lending process, a much better alternative would be to have the government stop being the strong arm henchman of the banking industry.  Courts are even issuing body attachments and arresting people over unpaid debts, setting bail equal to the amount owed, and turning bail money over to creditors.

-- Also at my Seeking Alpha blog --

July 1, 2011

Baltimore Red Line tunneling
to cost more than the Chunnel

The Chunnel cost approximately $499 million per mile in 2011 U.S. dollars. (The cost was 4.65 billion 1985 British pounds. Converting to 2011 U.S. dollars gives us 15.65 billion; the Chunnel is 31 miles long.)

The underground portion of the Baltimore Red Line will cost $481 million per mile.

Overall Baltimore Red Line cost is $152 million per mile, that’s $28,735 per running foot.

*Math walk through is below. Skip it if you trust me.*

The Baltimore Red Line has a proposed cost of $2.2 billion to run a total of 14.5 miles, an overall average cost of $152 million per mile, which places it among the most expensive ever built. Seattle’s new system opened in 2009 at a per mile cost of $179 million. Plans are for the Red Line to run underground for downtown Baltimore and Fells Point, plus a small stretch in western Baltimore that will dip under a busy intersection. This maps out to 3.9 miles. 10.6 miles will be above ground. Multiplying the average per mile construction cost of above-ground light rail transit (converted from 2002 dollars to 2011 dollars) by the number of miles above ground gives us 30.65 times 10.6 = 325 million. Subtract that from the 2.2 billion total cost gives us a $1.875 billion cost for the remaining 3.9 miles to be tunneled. 1.875B divided by the 3.9 miles gives us a cost per mile of $481 million.

*End of the math walk through*

Note: The Chunnel’s figures are after the fact, actual costs. The Baltimore Red Line’s figures are government estimates. I’d lay good money that the final cost will be more than a rounding error north of its estimate.

Without the tunneling, the cost of the project falls by 80%, from $2.2 billion, to $444 million based on prior above-ground cost-per-mile estimate. Another way to look at it is that putting just one-quarter of the project underground raises the cost of the entire project by a factor of 5.

You could almost afford to put all 14.5 miles of the entire project on a raised monorail, with such a system costing $2.88 billion based on the $166 million per mile that it cost to build that Las Vegas monorail, adjusted to 2011 dollars.

Better yet, you could cut the entire cost of the project in half (and still avoid downtown traffic) by using a raised platform instead of a tunnel. Using Las Vegas’ $166 million per mile figure, you’d be at 166 times 3.9 miles for $647 million, plus 10.6 times 30.65 for $325 million. Total project cost would be $972 million. Is it really worth a billion extra dollars to dig a hole?

Here's another and far cheaper alternative that accomplishes almost the same goal: There is an existing 4000 foot stretch of existing subway tunnel that runs exactly parallel to the proposed Red Line tunnel, exactly 2 blocks north, that would avoid the worst of the downtown traffic. The Red Line website estimates the cost of cutting into and converting this tunnel for sharing to be approximately $200 million, significantly less than the $1.8 billion that digging a new mile-long tunnel will cost.

Questions and points to ponder:

• Why is the federal government considering paying 50% of the cost of a project that is barely even a state level project? Only Baltimore City and Baltimore County will benefit from this. Getting residents of Maryland’s Eastern Shore and the DC suburbs to pay for this is a stretch. Asking Californians and New Yorkers to pay for this is in the realm of "You’ve gotta be kidding me."
• Public infrastructure should be paid for by the lowest level of government that matches its coverage. If it's not crossing state lines, other states shouldn’t pay anything for it.
• Maryland’s prevailing wage laws and the federal Davis Bacon Act drive up the cost of these projects. It is a case of concentrated benefits of those who enjoy above-market wages, against the diffuse costs passed onto tax payers who pay for it. The purpose of government is not to provide an oasis of above-market jobs. It is to provide its customers (taxpayers) as much value as possible. That means getting workers to work for as little as possible, not the other way around.
• Many of these projects have become grab bags for favored contractors, rather than quests to provide value for the taxpayer. Maryland’s State Highway Administration has awarded big contracts to many who used to work in the office.
• Consider all the man hours and brain power that are going towards figuring out how to spend the tax dollars of California residents on a Maryland project, rather than designing and engineering this project.
• Preliminary planning will cost $65 million. That’s $4.5 million per mile, $849 per running foot, to PLAN, not to build. Whose campaign do I have to fund get a piece of that contract?

-- Also at my Seeking Alpha blog --