The Economy

I created this page to allow readers to follow my logic and most Keynsians arguments about what really ails our economy, why what we are focusing on, the debt, won’t solve the problem, and what the way forward is. I don’t pretend to be an expert, but I am detail and data focused and this is what detail, data, and reality are telling me, and what us going nowhere has led me to. It is a four part series which explores:

  • The Economy Part I: The fallacy of the Home Budget Analogy (HBA) when looking at government spending
  • The Economy Part II: Is Debt the problem, do we have a spending problem or a revenue problem, and what is the reasonable level of debt
  • The Economy Part III: What is effective approach to increasing revenue and solving our long term debt problem
  • The Economy Part IV: What is the real way forward and what we need to do

Enjoy.

The Economy Part I

December 17, 2012, 11:31 AM

Debt, deficit, spending problem, fiscal cliff, stimulus, entitlements, tax cuts, taxing the rich, tax reform, and it goes on and on. So I thought for my own sanity and hopefully for a few others, I would clear the air. I have written posts in the past on how the Republicans have just about everything wrong, but the big one is the deficit and what to do about it. They got their noises rubbed in their denial of global warming after Sandy and a few are coming to the realization they are wrong about the 2nd Amendment in the horrible tragedy in Newtown Connecticut. It is not just that we need laws to tightly control gun ownership, but the real deterrent, a change in attitudes about how guns can solve our problems, everybody needs one, and gun violence is somehow macho. Note that in all of these incidents the shooter is white male, the bastion of voter for the Republicans.

But I get distracted. When it comes to about everything, the Republicans have been on the wrong side of effective policy from gays to women’s health issues, to immigration, flow down, energy, not taxing the wealthy, less regulation, and it goes on and on. But on this one, the debt problem, they have many Democrats who buy into their nonsense and is why we can’t seem to solve the problem of our lagging economy and general decline of the middle class. Now if you read Paul Krugman or others who are pointing all this out, you need not read any farther. But if you don’t and still have an open mind about what the right solution is, well, I am going to take you on a trip through critical thinking land.

It all starts with what we know in our gut. No, that does not make it right, just makes us think it is right. When I married my first wife I just knew in my gut this was the right thing to do. I have been questioning my gut ever since. Psychology tells us that most of us don’t take the facts and decide an issue, we have a gut instinct about something and we pick and choose our facts to support that belief. So we are always fighting an uphill battle to see the world as it really is.

Okay what do we know in our gut about economics? We know our own experience, which I like to call the home or small business budget analogy, the home budget analogy for short (HBA). Now this model for managing finances is fairly simple and has four major aspects, earnings, debt, savings, and expenditures. Earnings usually (we are not talking the rich here whose primary income is from investment) come from providing goods and services to someone else, wages or a salary for most of us. Debt is what we have borrowed to own a car, house, maybe education loans, and short term credit cards. Expenses are those loan payments, food, clothing, and entertainment, more or less. Savings is for big purchases and retirement.

So to simplify, the HBA has four distinct parts, income, debt, savings, and expenditures. Now let’s look at how the whole thing works. The whole thing is a long term project to provide a roof over our heads, some amenities, maybe send our kids to college, and down the road have enough left to no longer have to work. Now the success of this enterprise depends on us keeping the thing in balance. Debt cannot be too large or it starts to reduce our savings and expenditures, and more importantly, the end goal is to reduce the debt to the point we can afford to retire and live on our savings.

So if our income gets decreased, something in the balance has to give. Assuming you need your house and car, and you still want to retire, that leaves expenditures like food, clothing, and entertainment, maybe putting off more debt like a new car until later. When we crash is when we try to maintain our spending by using our short term credit, and unless we can generate more income, we finally can no longer afford the minimum payments and we go bankrupt. That is what we know and we apply it to government to solve our economic problems and sadly it is the wrong model. Governments simply don’t work that way and that is why we get into trouble.

So let’s do some comparisons to establish the baseline for our discussion tomorrow. First is debt. Debt whether government or our HBA is our total debt. Deficit is the difference between what we take in in one year and what we spend. Spending for cloths, food, entertainment, that 55″ LCD TV are our expenditures and we tend to relate them to government spending for the military, entitlements, tax cuts (yes that is spending too), education, ect. Governmment income is our tax revenue. Savings in the government sense is a surplus we might build for a rainy day.

So using our HBA, when our tax revenue falls (either because we gave away too much in tax breaks or a faltering economy reduing our tax revenues or payouts in the safet net), we start screaming cut the budget. We can’t afford this stuff and again from the HBA, as our deficits grow and increases our total debt, we see financial doom in our future. This is how just about everyone processes it. It is why you hear “We have a spending problem; Our deficit is 1 Trillion dollars; We are burdening our children with our excesses; Interest rates are going to kill us; and we have to compromise and get a grip on this spending problem.”

There is an element of truth in all of them, but we really have to understand how the macroeconomy works if we we want to solve these “problems”. The HBA describes the micro-economy and if we apply our tried and true solutions from the HBA to the macroeconomy, we will fail miserably. Tomorrow I will explain why the HBA fails us and why working with the Republicans to apply these HBA solutions just makes things worse.

The Economy Part II

December 18, 2012, 1:12 AM

So lets start with debt. How much debt is okay and do we really need to pay it off? Well, in our Home Budget Analogy (HBA) we have some hints. When you go to get a loan, mortgage companies looked at your debt to income ratio. The old rule of thumb used to be that your house payment could not exceed 30% of your monthly income. So first we can say that based upon income there is an acceptable level of debt. We will get to what that is in a minute.

So based upon the above, what is an acceptable level of debt for a government and let’s use what the mortgage companies use, a percent of income. Well a country’s income is its Gross Domestic Product (GDP). And like the home budget (at least we hope) our revenues increase over our life so an absolute number is not useful ($1 Trillion Dollars!). So the measure should be percent of GDP. The larger the GDP, the larger our tax revenue, and the larger the amount of debt we can absorb.

Now there are all kinds of complications here in a macroeconomy like does government borrowing compete with private borrowing and therefore it should be kept at a level that does not in fact depress private investment and the resulting tax revenue. I won’t get into the fact that the government can just print the money to pay off these debts raising the fear of inflation. It suffices to say that when the interest rate combined with inflation is below zero and nobody seems to have a problem lending the government money, this makes this idea moot until the economy really takes off again. The issue we are trying to solve is how to get it going again when lowering interest rates no longer does the trick (fiscal policy) and printing money does not cause inflation.

Okay, what is an acceptable level of debt for a country? Well some would say none and I will get to that in a moment, but that ignores the lesson of history where we need to be able to spend in bad times and have a surplus (or very low debt) in the good times. Paul Krugman has looked at this from a historical perspective and a rule of thumb is about 30% to 40% of GDP (See That Terrible Trillion). Note that we have had much worse debt to GDP ratios in the past (WWII to be precise) than we do now. But since we have a much higher ratio than that now, do we have a spending problem? Short term the answer is no and that is explained in Paul’s post where he shows that our spending during normal times is balanced, but all the extra spending is caused by the falling revenues due to the poor economy and safety net expenditures due to the poor economy. As he puts it:

Putting all this together, it turns out that the trillion-dollar deficit isn’t a sign of unsustainable finances at all. Some of the deficit is in fact sustainable; just about all of the rest would go away if we had an economic recovery.”

Secondly, in our HBA, sooner or later we have to reduce that debt so we can live on a reduced retirement income. The old rule of thumb was to zero out that home mortgage. Now we just get it down to nice level we can sell it with enough profit to move into a smaller retirement home/condo/tent. We need to reduce our debt and payments for debt to be able to live on our retirement income. But governments don’t end. The whole idea of a balanced budget amendment ignores the fact that governments have new children (citizens) they have to provide for in the future. As Paul puts it:

“The first thing we need to ask is what a sustainable budget would look like. The answer is that in a growing economy, budgets don’t have to be balanced to be sustainable. Federal debt was higher at the end of the Clinton years than at the beginning — that is, the deficits of the Clinton administration’s early years outweighed the surpluses at the end. Yet because gross domestic product rose over those eight years, the best measure of our debt position, the ratio of debt to G.D.P., fell dramatically, from 49 to 33 percent.”

The point here is simple. Having debt is not only not necessarily bad, but is necessary and quite acceptable. We don’t have a spending problem, at least not in the short term, we have an income problem. In the HBA example think of it as increased expense payments because you have to have cancer treatments if you are going to be around to keep earning an income in the future. So we have a revenue problem not a spending problem and in the HBA we would need to find a second or third job. But government and its income is a whole other animal which we will discuss in the Economy Part III.

What this blog was all about was pointing out that the HBA of reducing our spending to live within our means was not the answer for our government. Living within our means requires more income because the spending is necessary to our future health. So we have to find a way to get more revenue, not cut expenses we can’t live without. See you tomorrow.

The Economy Part III

December 19, 2012, 1:18 AM

Are you still with me? If you have followed this so far, you are starting to understand that we don’t have a spending problem, we have a revenue problem. In fact we have grossly underspent in critical areas such as infractructure upgrades. In our Home Budget Analogy (The Economy Part I) (HBA) we would have to find a second shift, overtime, or put our kids to work since our expensives are necessary to our future (The Economy Part II). But a government’s revenue is its tax income. It’s tax income is dependent on a growing GDP, so how do we get that going again?

Well now we get to the crux of the issue. To fix the economy we have to understand what ailes it. In my world of engineering we would call that finding the root cause and separating out all the effects so we can fix the real cause. Right now we have a circular argument going on in our political sphere. The argument that is all wrong is that the debt is causing the problem because businesses do not have confidence to invest and hire new employees. So in their minds to solve our problem we must first reduce our debt by reducing expenditures. But as I will show in a minute, when a government reduces it expenditures, it reduces its income, very different from the HBA.

On the issue of whether a lack of confidence in the economy is keeping businesses from creating jobs (the supply argument), we have had much higher debt levels and yet we had a growing economy that solved the problem. And we see some improvement in the economy from the lowering of private debt (having a little more money to spend) and the very slow recovery of the housing industry. That is due to their increased spending, not from any improvement in “confidence”. The real issue here is demand. When people buy things, the economy grows because that is what instills confidence, not some fuzzy idea about government debt. So if spending is the key and people do not have the wherewithal to spend, how do we create it?

Well the whole panic over the fiscal cliff answers that question for you. The panic is over raising taxes (reducing buying power for the majority of Americans) and cutting spending which will result in layoffs. The whole fiscal cliff is reducing the deficit on steroids. If cutting spending cost jobs, then spending that you are cutting creates them. If businesses, who are sitting on massive amounts of cash with interest rates at record lows, won’t invest, government must. Welcome to Keynesian economics. Now this is not a general rule, and when the economy is working normally, a lot of this doesn’t apply. But we are now in a place where this not just a way forward, it is the only way forward.

Okay, so we need more spending by private citizens to buy things and increase the government revenue through a growing GDP. Now in our HBA, increased spending was the last thing you wanted to do. And here is where the HBA really fails. When a government spends in a depressed economy, it results in roughly 1.4 to 1.5 times that amount of spending in the economy. Not only does it allow spending to continue, providing the government an income, but it multiplies it. The same can be said for cutting. When you cut, you reduce federal income by the same multiplication factor. In effect you are creating a vicious cycle where the reduced spending further reduces your income and makes your ability to pay down your debt worse.

So government creates its income by its spending, which in a depressed economy is the primary engine of our economy. If we cut it, we simply reduce our income by more than our cuts were (1.4-1.5 times the cuts), and decrease our ability to pay our debts because we now earn less than we cut. Now these are not normal times. In a normal economy, these effects have very little impact and any loss in jobs can be absorbed in a growing economy. But when the federal government is the only game in town, the spending cuts just make things worse. It is counter-intuitive to the HBA, but there it is.

So the lesson here is that where in the Home Budget Analogy we need to cut our spending and increase our revenue if we can, in the Government model, cutting our spending multiplies our loss in income and hurts the economy on which we depend. That is why even the Republicans agree we need to do something about the fiscal cliff, but they want to cut lifelines in terms of entitlements to solve the debt problem instead of eliminating tax cuts and cutting military spending, just making things worse. Oh, and hanging the costs on the poor and elderly.

If spending helps when our economy is hurt, what spending will be most effective and what do we do about the growing debt in the short term? That is for tomorrow in The Economy Part IV. But think about this. We have shown that the debt in the short term is not the problem and that cutting entitlements and most other spending is counter productive. But the Very Smart People (VSP) as Paul Krugman calls them, which includes many Democrats still tell us we have to come together and both sides give. It’s bullshit because they are still locked into the Home Budget Analogy.

The Economy Part IV

December 20, 2012, 1:18 AM

So where have we been? Well in The Economy Part I we showed that most of us think about our government’s financial problems in a Home Budget Analogy (HBA). This analogy fails us in extremely depressed economic times (lowering interest rates and printing money no longer helps the economy) when we try to solve our problems using this model. This model tells us our debt is growing and our revenues are decreasing so we must cut our spending to solve the problem. But the first thing we found out is that the debt is not really our problem and except for the lost revenue due to our depressed times and safety net spending, our spending is not out of line with a healthy economy and a reasonable debt being used to invest in our future.

So if we can get the economy going, our near term debt problem goes away. We don’t have a spending problem, we have a revenue problem (The Economy Part II). In the Economy Part III we looked at where we can generate income and what ailes the economy. It is not a lack of confidence, but a lack of spending because people have restricted budgets operating under their own HBA which is quite appropriate to their situation. They are restricting spending because their incomes are reduced. And what we arrived at is that government spending does create jobs in a depressed economy, austerity, cutting spending, is counter productive, and we are left to see how we can apply this to get the economy moving again.

This is where things get interesting because we have some real systemic problems with the way our economy is structured based upon policies that go back to the Reagan years. We have cut taxes for the very wealthy which is really government spending, and yet where are the jobs? The tax rates are the lowest in 60 years. The wealthy are sitting on oddles of cash. So where is the thriving economy? Well we all believed in that magic flow down thing and that a high tide lifts all boats. So if the wealthy are getting wealthier, we are all benefiting right? Except it didn’t work. It turns out that low tax rates for the wealthy just transfers our country’s wealth to wealthy with no benefit to the rest of us (See the Congressional Research Services Report). Instead we have a middle class that is loosing ground in wages and benefits. More importantly, if this trend continues, they won’t have the buying power to sustain our economy.

Here is the other counter-intuitive thing we are doing that hurts us. Our states are in a rush to the bottom to lower wages and benefits (Right To Work laws) with the idea that it creates a more competitive atmosphere and creates jobs. But the real impact is to lower wages and benefits for all and reduces the total amount of money to be spent in the economy. Their spending is our income and if it is further deflated, in the macro economy, we all loose. Paul Krugman showed us how more and more of the economic pie is going to those who own things (capital) while labor is getting a smaller and smaller bite. It is just another part of the transfer of wealth to the wealthy and disenfranchising the middle class. There is a tide that lifts all boats, but that tide is the middle class and we must find a way to reinvigorate them. As Chrystia Freeland showed us in her book, Plutocrats: The Rise of the New Global Super-Rich and the Fall of Everyone Else, the lessons of history teach us that as the distribution of wealth becomes more uneven, the economy falters.

So we know stimulus and spending helps and from above we need to realign who gets that help where we will get the most bang for the buck. Well eleminating the tax breaks for the wealthy is a start (revenue). Getting rid of a tax code that favors the wealthy through deductions and incentives to industries that don’t need it would help (revenue). Keeping the tax cuts for the middle class is stimulative because they will spend it. They need it (spending). Investing in infrastructure is an investment in our tomorrow, just like alternate energy, research, education, not to mention bouying up reduce state spending (spending). And it all gets spent creating jobs. So you get the drift. We need to be smart about our economy and stop wasteful spending and spend where it counts.

And that leaves us with one other issue, we will be growing our deficit with this spending. Well maybe. Certainly for the short term. But we are living in extrodinary times where the solution requires creating spending by creating jobs. It is a short term investment in a long term bonanza. Clearly as the economy starts to heat up and private investment starts to increase, government spending can throttle back without hurting the recovery. We can then establish spending levels where we can reduce the deficit and as the GDP grows, the percent of GDP that is debt reduces. When we get near full employment we could do something smart like not cutting taxes (see George Bush for the anti solution) for the rich, maybe raise taxes on the other 98%, and further reduce our debt so that when bad things happen again, we have a pad.

So there is a lot to do and right now our discussion has about everything wrong. Some grand bargain will be about solving the debt problem and austerity will hurt us. We don’t need to cut entitlements, and the real solutions to those growing costs are to implement more efficient systems and approaches utilized around the world instead of our for profit insurance industry, fee for service, and not negotiating drug costs. As the economy grows our Social Security problem is reduced and we can afford to raise taxes to pay for the benefits. Sadly John Maynard Keynes had it right back in the 30s and we have forgotten everything we ever knew. But now you have been reminded of the way forward and have a rational basis for it.

I don’t know what it will take to get people to wake up and recognize this, but I have hope. The horrible massacre in Connecticut has woken most up to the misguided idea that the more guns the better. I can only hope it won’t require that kind of tragedy and suffering to get them to wake up the realities of our economic future. But as a rule of thumb, just assume that if it is Republican, it is wrong headed. Okay, I have done my civic thing, and saved the planet from the evil Republicans. Now I think it is time for maybe a nice Pinot and hold the ones I love close to me, hoping for a better tomorrow.

 

Leave a Reply

You must be logged in to post a comment.