Tax cuts for billionaires will not solve anything

Since the 1980s, Supply Side economics has been a staple of establishment economic thinking. Cut taxes for the wealthy, goes the argument, and the economy will grow.

Here's the problem. Right now there's plenty of supply. The Federal Reserve has been pumping money into the economy at an astonishing rate. The rich have the lowest taxes in modern history. Large corporations are sitting on piles of cash and are making quite respectable profits.

So... why has the economy not recovered? Well, ask why are large corporations sitting on piles of cash? Why are some banks suddenly asking those with savings accounts to pay maintenance fees on those accounts? Why are interest rates at absurd lows?

The answer is that nobody wants to spend the money. That is, corporations don't want to spend what they have, and banks can't find people to borrow what they have to set up new businesses. And nobody wants to do either because the problem right now is not supply, but demand. Demand is flat. People are worried about their underwater mortgages, and 9-16% of the country is looking for work and unable to spend money as a result. We all want to spend money, but we can't.

The argument for giving billionaires (or even the well off) even more tax breaks is that they'll stimulate supply, not demand. "Why tax the job creators" argue those proposing this point of view. Unfortunately, I can't see how the argument stands up in practice. Leaving aside the fact that business expenses can almost always be written off, the reality is that job creation starts with people affording to buy products and services. The more people who wave dollar bills shouting "I want!", the more jobs get created.

At this stage, our political establishment is obsessed with giving cash to those who don't need it, ignoring the problems of those who do, something that leaves us all the worse in the long run.

Deflation and Debt Slavery

Consider the following. You live in a world that is growing every day. With that growth, economies of scale and improvements in technology conspire to bring forward real, practical, improvements in the reward you receive for your labor.

In this world, as in any other, you need to be a part of a society to benefit from the growth, and so you need a roof over your head in a location that allows you to work, to obtain the resources necessary for your survival, and, well, to live.

One option provided to you is to obtain a loan to purchase a house. The terms of the loan are, apparently, quite simple: you pay a fixed amount every month, for thirty years, and at the end of the loan you own the house. Should you stop paying, then you lose the house, and probably a lot of money at the same time, but you can always pay the loan off early, and you should be able to do so simply by selling the house.

Put these together, and you make your decision based upon the reality that your life exists within the growing economy. Unless you make some colossal errors, your income will rise, and based upon this fact, you can reasonably assume that the loan payments will become less burdensome over time. Should you make the colossal errors, you still have Plan B, in that you can sell the house, and use the proceeds to pay off the loan.

Following me so far? Good.

Now, what if I were to tell you that a sizable part of the political establishment right now believes that the value of the loan should be tied to the size of the economy, or worse, should actually grow in weight faster than the economy does. That the burden of debt repayments should always get worse, not better. And that escape routes, such as selling your home, should become more difficult, because the price of your home should never rise, and could even fall.

That's what deflation is. When people are proposing deflation, or claiming it is somehow better than inflation, they're proposing that the value of a dollar should increase. This means that things priced in dollars, such as homes, will reduce in dollar value. It means that someone can take your salary and say "Well, in real terms your salary has increased by 5% over the year, because the dollar now pays for 5% more "stuff", but we only saw a 3% increase in productivity, so we're going to cut your salary by the difference."

So even though you may be more valuable, that you may be working harder than ever before, a loan you took in good faith will become more and more of a burden, and your ability to spend money on other essentials will steadily erode. And realistically, you end up defaulting on your obligations, and the debts pile up, and become more and more burdensome, until you're unable to see a date where you'll pay them off in your own lifetime.

Now the counter argument made by some is "What of it? We need a new economy where people work, save, and then receive the items they need." With respect, this is sheer idiocy.

To begin with, that's not the world now, and to switch to that system without nullifying every loan ever made is unspeakably cruel and unfair.

But moreover, when do you expect people to have the money to buy the things they need? Is it reasonable for someone to be unable to buy a place to live until they're 50? What would be the consequences of a system where people have to wait decades before they can do such a thing, given that new homes are built, unquestionably improving the housing stock, providing good jobs to a sizable portion of the population in the process, because people buy homes when they can afford loan payments?

And this is one example. From someone buying a television on credit, to a business starting up with a business loan, the simple reality is that loans make it possible for commerce to happen that simply wouldn't happen otherwise. And that means growth. And that means we live in 2011, in a society that's pretty close to free from want, from hunger and a lack of shelter, and one in which the vast majority live in unparalleled luxury.

Is inflation, rather then deflation, fair? It's a fair question, but it's also worth noting that inflation hardly has the same effects as deflation. Inflation encourages lending and borrowing, as both sides see it in the best interests to ensure money is "working", that it's in the hands of people who can turn it into more money. Yet, for some reason, ordinary, non-extreme, inflation is seen by many politicians as a terrible thing. Not because of stagflation, or any practical reason like that, but because it's seen as immoral and wrong, a way to steal from those who hoard large piles of green pieces of paper.

I think this is wrong, and I just felt like writing a journal entry to explain why.

A thought about States Rights

My limited understanding of the States Rights argument is that proponents want to switch to a system where each US state has high sovereignty, with only some functions transferred to the Fed, notably the currency, military, etc, and some limited cases where it's useful for the Fed to promote cooperation between the states.

Ignore the military for a moment, let's focus on the economy.

Excluding Britain, isn't that pretty much a description of Europe? Is the economic side of this system working there? If not, why?

(BTW isn't it somewhat ironic that the people who are usually the loudest advocates of this system would be the most offended if they heard the concept described as "European"? Of course, they'd rightly argue Europe was inspired by the US, not the other way around, but I thought I'd throw that out there.)

False economy

Something to bear in mind:

Many who say we need to cut the deficit now are saying we need to because it's too big, and it's better to cut now than have to pay even more later.

Here's a thought though: the likely result of cuts is that the economy will weaken. Now, this immediately creates a problem in that fiscal revenues will drop, and so the deficit isn't going to drop by anything significant. Worse still, in practical terms, it'll become much more difficult to pay off, for the same reason that it's easier to pay a $100,000 mortgage if you have a $75,000/year job, than a $10,000 credit card debt if you don't.

But leave that aside from now. If the economy, as seems all but certain, contracts as a result of cuts in short term spending, what's the next step in terms of what government will do? Will it cut spending even more, with unemployment continuing to get worse?

No, eventually - whether that's in 2012, 2016, or 2020 - will realize it has to spend more to stimulate the economy. And because the economy will, by that point, be considerably worse than it is now, the size of the stimulus the government will inevitably have to provide will be much, much, larger than what it'd need to pay now.

Now if you want you can tell me "Squiggie, stimuli don't work, look at the last one" but frankly, aside from being wrong (we didn't, over-all, actually have a stimulus - the totality of government jobs actually decreased by HALF A MILLION during the last two years), the reality is that a larger stimulus, that's actually in line with what economists were calling for originally is inevitable if the economy doesn't improve. Do you really want to bet, with no serious efforts being made towards job creation in the current government, with likely lower incomes for the retired, government workers (those that remain), and the unemployed, that some how unemployment's going to make drastic drops any time soon?

Making cuts now doesn't make the deficit smaller, except in the very short term. In the medium term, cuts now will result in deficits that make this one look like my credit card bill.

What's the point?

So on Friday it hit me. It wasn't just that I disliked Reid's plan to solve the debt limit crisis, it was that it was clearly going to severely damage the economy and, thus, I started to question whether it even matters if it, or the slightly worse Boehner plan, actually passes or whether we "default".

Here are some random thoughts on the issue, which may or may not answer some of the questions I got after I tweeted the White House the same question.


Macroeconomic models

There are multiple schools of thought on the subject of what severe cuts will do to the economy. Virtually all modern macro-economics is descended from the Keynesian models. A disagreement occurred in the fifties and sixties about the effect of government borrowing and spending, with mainstream Keynesians arguing it has a positive affect during recessions, while a branch, Monetarists, arguing that it has the potential to "crowd out" private borrowing, but actually there's quite a bit of consensus outside of that argument. Both branches and their descendants are adamant that during a recession you have to increase the amount of money in circulation, they just differ on how to do that.


That "crowding-out" argument

Generally speaking, you use market interest rates to determine whether the government is borrowing too much. Interest rates are lower than they've been in a very, very, long time. Maybe that's too simple: the Fed's monetary policies also affect interest rates, so the flooding of the economy with QE/QE2 money might explain this - however, we can determine whether the Fed has pumped too much money into the economy by looking at so-called "Core Inflation". Core inflation is virtually non-existent, ergo the Fed's monetary expansion hasn't put in too much money, and interest rates being low is consistent with the government not crowding out private borrowing.

So it's safe to say that no monetarist is going to make the argument, and remain respected, that spending and borrowing cuts right now would in some way reduce any crowding out, as evidently crowding out just isn't happening. They would argue this in slightly different circumstances, but these aren't times that fit the model, any more than stagflation fits the original Keynesian model.


The affect of less government spending

Quite simply we're looking at contraction. No widely respected macro-economic model right now that applies to the current case - negligible interest rates, negligible core inflation, increasing unemployment - promotes reduced economic activity as a way to increase economic activity.


There's no "deficit crisis"

This is one thing that's annoying the hell out of me. There's a large deficit, and that's not good, but it's certainly manageable - get the economy going again, get some growth going, as unemployment drops start increasing tax rates, and a combination of reduced expenditures on things like unemployment relief programs (which are obviously somewhat less expensive when there's less unemployment) and increased revenues, will give the government a surplus it can use to pay down the deficit.

Unfortunately the media keeps promoting the term, which means we're sleepwalking into making the crisis work. You see, if we go for contractionary policies now, and reduce taxes, then we really will have a deficit crisis because there's not going to be growth, there's not going to be the revenues needed to build a surplus, and vital government support services will become ever more expensive.


The "Debt limit" combined with the current budget is clearly unconstitutional

Forget the 14th amendment, congress is clearly giving the executive conflicting mandates. Unless some extremely clever lawyer can determine a way to resolve both mandates, then one or other mandate is simply not legal.


Things that just don't make sense

The arguments for fixing the deficit now are:

• We don't want to make things more difficult when we do start to pay it off
• The debt causes uncertainty in the markets
• We need to be more fiscally serious and disciplined to prevent this kind of thing from happening.

The people who are making the loudest arguments on this are:

• Promoting contractionary policies
• Demanding regular votes on the debt limit, often with utterly absurd riders or conditions, that'll result in this "crisis" occurring again, increasing "uncertainty" in a way that really is happening.
• Promoting tax cuts at a time of historically already low taxes.

What I don't get is why any of these people are taken seriously.


Should we default?

No, we should raise the debt limit and increase spending for now.


Should we default if the alternative is decreasing spending?

No, we just shouldn't care. The idea that Obama is pushing Reid's plan is utterly ridiculous. Why waste the time? From what I can tell it's a stupid point scoring thing. If the debt limit cannot be raised in time, so be it.


What about the economy makes normal people lay awake at night? High unemployment, or government borrowing?

High unemployment.

Right and wrong approaches to fixing the economy?

I think I came up with a conclusive, unassailable, argument in terms of "What do we do now to fix the economy". That's a fairly arrogant thing to say, especially when it concerns something I already had an opinion on, but here goes:

There are two arguments concerning how we go from here. One is "Shrink the government, hand out more money to the rich."

The other is "Ignore taxes, perhaps even raise them on those who can afford to pay (eg the rich), and increase government spending."

It's actually fairly easy to pick between the two. No, really!

The issue is we have to determine which of these addresses an actual problem.

The first proposed solution is proposed by people who believe that companies are unable to invest money in creating jobs because they don't raise the money to do so. By cutting the taxes of the very rich, they'll have enough money to invest in their businesses, increasing the number of jobs.

The second proposed solution is proposed by people who believe that companies don't invest money in creating jobs because there's businesses don't see enough demand to justify increasing production capacity. Directly create jobs (by increased government spending), and you'll increase demand, resulting in businesses creating jobs to handle the extra capacity they now need.

(I happen to disagree with the basis of the first argument as I've said before - high taxes actually encourage people to leave money in their businesses and invest in them, given the way the tax system is structured, but let's ignore that for a moment and "agree to disagree".)

So which is it? Are major corporations, etc, these days having difficulties raising cash, generally making losses and finding it hard to raise money through the stock market, banks, or anything else; or are they making decent profits, and handing that money out to their shareholders through increased dividends and share buy-backs?

Well, it's pretty much the latter.

The Debt Ceiling

The Debt Ceiling is one of those things that seems entirely reasonable in theory, but in practice is utterly insane. Here's the problem.

The government is required to spend a certain amount of money. How much? That's up to Congress, which sets the budget. The executive can't reduce that amount of money unilaterally.

However, Congress also sets a "Debt limit" which means the executive may run out of money, be unable to borrow more, and find it cannot spend the money congress has told it to.

So what's the point? In practice, the only purpose the ceiling serves is to allow congress to create an artificial crisis whenever it wants. If Congress actually wants to reduce the amount of debt, or put a ceiling on it, it has always had the power to do so. The only purpose of the ceiling is to create a crisis and make it appear to be the executive's fault.

What's Obama doing about this? Answer: I don't know. Obama has ruled out taking the "constitutional option" by all accounts - basically saying "Screw you guys, you're telling me to break the law whatever happens, which by definition means your laws are unconstitutional, so I'm going to ignore the limit which appears to be the law that's the problem". Obama has a habit - public option, DADT, etc - of pretending his hands are tied when, in fact, he actually supports the outcome anyway, and his recent claim that this was a historic opportunity to cut social security makes me think that he, ultimately, wants to cut government spending.

Recently I read an article in the Washington Post which included a quote from Obama, in 2006, saying he was going to vote against an increase in the debt ceiling as a senator, which he and the democratic caucus ultimately did. While some protested this was a typical case of the MSM trying to be "balanced" using a "both sides do it" argument, the WP got this right. Yes, Obama was right that in 2006, when the economy was doing well, paying down the debt was the right approach. Virtually every mainstream, sane, economics system teaches you that in Econ 101. However, the only method to achieve this is to reduce the government's spending mandates. Obama didn't try to do that, he simply voted for something that would create a crisis.

The debt ceiling is not an effective method to reduce the debt. It does create uncertainty in the markets, and will cause lenders to demand higher interest rates for government borrowing in future, and it'll cause chaos if it's actually hit. It's a stupid idea, and it has to go.

Why we tax the rich

It's extremely odd listening to the rhetoric at the moment where even the suggestion that a subsidy ("tax break") on what's ultimately very much a luxury item (corporate jets) might be closed is considered "class warfare". It doesn't make much sense on any level that this is "class warfare", but the label is repeated so often by many on the right that you have to wonder why they think that.

Virtually every modern democracy has a progressive tax rate. The term "progressive" here could be defined as having two meanings - on a technical level, it's progressive in that the more you earn, the progressively large a portion of your earnings you're supposed to pay back to society. And it's progressive in that it's considered a progressive ideal, a step towards a utopian society where a leveling of the playing field is a necessary goal to bring peace, prosperity, and freedom from want for all.

But let's forget about the latter aspect, and concentrate on whether a healthy society is better off with progressive tax systems. The arguments for and against can be summarized as follows:

For

• The rich, pretty much by definition, benefit more from society than the poor, and therefore should pay more towards its upkeep.
• The rich can afford higher taxes. If I take away a person who's earning $1000 a month half his salary, the chances are he'll not be able to pay for food, shelter, and necessary resources. If I take away half the salary of someone earning $1,000,000 a month, well, that person's still going to be living an extremely comfortable lifestyle.
• Higher taxes generally fall upon wealthy businessmen. If wage rises have diminishing returns, then those same people will be encouraged to evaluate whether an increasingly minor rise in personal income is worth it if it has a disproportionate effect on the businesses they run.

Against

• It's frequently argued that higher taxes are unfair, because richer people have earned every penny of their income.
• It's sometimes argued that richer people are going to spend their money anyway, so it'll trickle down to the not so rich.
  
• It's frequently argued that if those with high wages have more money, they'll invest more of it in their businesses.

I agree with all of the points in the "for" section, and none of those in the "Against". I'll explain why for each point.

The rich, pretty much by definition, benefit more from society than the poor, and therefore should pay more towards its upkeep.

I tend to think the above point is so self-evident that it barely deserves explanation, but it does have arguments against. The key word above is "society". The argument against is that taxes don't go to "society", they go to "government", and government spends disproportionately - through welfare, unemployment, social security, medicare, etc - on the poor. This ignores the fact though that the taxes that are collected to support those specific programs are taxes being raised to fund society, not government. It happens that we use the power of government to administer those social programs, but that doesn't change where the money is flowing.

Now, obviously, it's easy to see government programs that aren't social, such as the military, but even there, it's pretty obvious that the military is defending something of more value to someone when it's defending a large amount of property and/or an infrastructure to bring in a huge amount of income than it is when it's defending little infrastructure and a small house.

There's also a practical side to contributing one's fair share to the society one lives within: the rich also benefit from a stable society free of serious want. Nobody in their right mind wants to live in a country where a significant proportion of their neighbors are desperate. How many would argue that those self same people who want a stable society to live in, to protect the infrastructure that keeps them wealthy, shouldn't pay what needs to be paid to bring that stability into place?


The rich can afford higher taxes

Again, this is an argument that should be seen as self evident, and I suspect actually it is. Most arguments against this are usually by accident when a critic of higher taxes is actually arguing something else. As in "Oh yeah, let's have higher taxes, then rich people will be forced to send their money to Barbados."

That's not really a counter argument. Nobody's being forced to send their money to an off shore tax shelter - people who do so are trying to "protect" a class of living, not preventing themselves from going into bankruptcy - and, besides, tax shelters aren't as attractive as frequently claimed. The money that's sent into a tax shelter isn't easily accessible, and unless taxes are obscenely high (like the 90% rates we saw in Britain during the 1970s), the principle of diminishing returns certainly applies here.

There's a simple, unavoidable, practical argument here. If we take two people, one earning $20,000 a year, the other earning $250,000 a year (to use a figure many on the right claim is not a high wage), if I lose half my earnings (in taxes), will it cause immense hardship? For the person on $20k, the answer is "almost certainly". For the person on $250,000, the answer is "no way."

Now, there is one thing I'd like to add here. Obviously if someone has been taxed at 30% on their income all of their lives, and has entirely legitimately made long term financial decisions based upon an assumption they'll continue to have a similar net income for a while, then raising their taxes to, say, 50%, overnight, is obviously going to cause hardship. It might mean that a mortgage suddenly becomes difficult to pay, for example. But a small increase, or a series of small increases over a decade, are not going to cause that kind of problem. And I hear no-one arguing for a sudden doubling of income taxes for the very wealthy.


People will be encouraged to evaluate whether an increasingly minor rise in personal income is worth it if it has a disproportionate effect on the businesses they run.

This is one of the strongest arguments to be made in favor of higher taxes and yet I rarely hear anyone express it. Indeed, the exact opposite argument - that raising taxes will mean business people will have less money to invest - is more often the one that people hear.

One little bit of evidence of this can be seen in the disproportionate wage rises since the 1970s. As taxes on upper incomes were reduced, the gap between wage earners has massively increased. With no incentive to put their companies first, those with the power to set their own salaries have raced to the bottom to get as much money out of their companies, and into their bank accounts.

Was this wrong? It's hard to say, but it's also true that we're in the rather odd situation where we see people running companies into the ground - from the .com excesses during the 1990s to the banks in the last decade - being rewarded with ever higher salaries, with most outsides, quite legitimately, wondering if there are any incentives whatsoever to run a business for the benefit of its shareholders, customers, and employees.

What about the counter arguments?

Higher taxes are fair, even ignoring the fact they made their money within the society they're paying taxes for, because richer people are rarely worth what they're paid

This one's controversial in some quarters, but really large salaries come down to luck and not a lot else. I'm not arguing that everyone should be paid the same as everyone else, but there's clearly something wrong when someone's working six days a week, ten hours a day, and barely making minimum wage, while someone else, through a series of accidents that started at birth, gets to work a few days a week and earn millions. I'm not arguing that millionaires aren't hard workers, most are, but it's frequently underestimated what the work differential is between those on the highest incomes, and those on lower incomes.


Money doesn't trickle down, it trickles up

The argument that money trickles down is generally based on the idea that a wealthy person will buy a much bigger home, a private yacht, and that as they spend their money, everyone they spend money on will get richer.

Unfortunately this argument doesn't actually make a lot of sense. Let's go through the problems with the whole "rising tide" thing:

• The amount of "stuff" someone with wealth needs isn't generally that exceptional, or much larger than what someone without it needs. So the number of jobs created is actually somewhat small.
  
• The industries those jobs create are subject to the same constraints. A tiny group of people take huge amounts of money out of the businesses, everyone else gets whatever's left.
• The rich have more money to spend on non-productive property. For example, the rich could spend a large amount of money on land. This doesn't in any way increase jobs, indeed, by removing resources from the economy that could be put to work, it reduces the ability of an economy to create and sustain jobs.
  

There are additional problems. With demand being limited to small numbers of big ticket items, rather than large numbers of smaller items, prices rise for everything that's not an absolute necessity (ie not something everyone's going to buy anyway.) To put it another way, imagine if the only people who would ever be able to afford plasma TVs, whether you make them in factories pumping out a million a year, or hand craft each from the finest oak and the love of a master craftsman, are the extremely wealthy. Would there be an industry of any size making plasma TVs? Without that large industry, would there be the jobs created by that industry? Without the jobs, would wages ever rise to levels that make mass produced plasma TVs become affordable?

Arguing that money should be concentrated in the hands of the wealthy because it'll eventually make its way to everyone else is arguing for an end to the gains made since the industrial revolution, as a world where money is widespread is a world where economies of scale make economies grow. Money never trickles down, it trickles up.

Raising taxes encourages people to spend money on their own businesses

I posited a related argument above, but here's the thing. How do I know that investing in a business you own is a great thing to do if you have higher taxes?

Well, because that's how the tax system is set up. I own a business. When I spend money I earn on my business, it becomes tax deductible, and it doesn't matter if I'm earning a billion dollars a year, or $100,000. And thanks to a progressive tax system, the more I spend on my business, the less of a proportion of what's left gets taxed!

Class warfare? It'd be class warfare if, y'know, this was about class, not income, and if it involved warfare, not taxes. This is about an economy that needs a few less moral hazards, and a society that supports itself.

When people assume good ideas are bad

Once upon a time there was an economist called John Maynard Keynes. Keynes looked at the consequences of World War I, and the economic aftermath, and determined that things might possibly be bad. A decade and a half later, another crisis was engulfing the world, this time economic, and Keynes reasoned that the issue was that there was a lack of people buying things, and that this needed to be dealt with if the crisis was to be dealt with.

In the meantime, governments did what they always do, and prevaricated, going back and forth between constructive ideas and destructive ideas. The US government, for example, would spend money on public works in an attempt to revitalize the economy, and it would work. Then when unemployment started to fall, the government, concerned about the whole "People might think we're communists" crap, would cut back, and the economy would collapse again. This went on again and again, and was only broken after another war broke out, and the government was able - nay, required - to spend money like it was going out of fashion.

Keynes became a giant amongst economists after WW-II. He was proven right, again, and again, and again, about the links between unemployment, inflation, and fiscal policy, and governments began to seriously embrace Keynesian ideas concerning their own economies. But there was an asterisk to be put against the embracement. Keynes advocated massive government spending during bad times, and massive government saving during good times. But some governments used Keynes to justify spending at all times, and this caused an already skeptical group of economists to want to get away from Keynes, who was seen as encouraging too much government intervention in markets.

After much debate, most started to rally behind the ideas of Milton Friedman. Friedman adapted the Keynesian models, but addressed the underlying causes of poorly performing economies using what's arguably a similar but more generic set of concepts. Friedman argued that the cause of the great depression was a lack of money.

The amount of money in a modern economy is generally decided upon by a so-called central bank, a bank that acts as the manager of the country's currency. The bank has a number of tools available to it to allow it to expand the amount of money in the economy. It can, for example, adjust reserve rates, allowing banks to "lend" considerably more money than they "borrow" (from savers.) It can make loans of money cheaper, making it cheaper for banks to obtain more cash to put against their reserves.

When the Great Depression started a large number of banks collapsed because a lack of confidence in them caused numerous runs. The banks failed because they were unable to borrow enough to pay their savers. Friedman argued this was fundamentally the cause of the Great Depression, and that the Federal Reserve, the US's central bank, didn't do enough to increase the money supply to take care of the problem.

The arguments of Friedman and Keynes are often portrayed as polar opposites, but in reality they're similar, they just propose different groups of people as having the responsibilities involved. Both argue for an increase in the money supply, but Keynes proposes a "hard money" solution whereby the government borrows (or, preferably, spends savings) to inject more money into the economy via spending on commerce and business, while Friedman proposes a "soft money" solution where money is literally created to inject into the economy via banks.

Unmodified Keynesian economics was generally the default until the mid seventies. We have President Carter to thank for a switch over to Friedman's Monetarist economics in the US, and Margaret Thatcher for the switch to Monetarism in the UK. Both countries were suffering stagflation, which seemed to be caused by inflexible adherence to Keynesian economics. In particular, mainstream Keynesian opinion seemed to be that inflation and unemployment were negatively correlated. If measures were taken to deal with inflation (by tightening government spending), unemployment would likely rise, and if measures were taken to deal with unemployment, inflation may rise. Unfortunately, both countries were suffering both inflation and unemployment, and Keynesian economists were largely considered to be at a loss on how to deal with both happening at the same time.

OK, recap time.

• From the 1950s to the 1970s, Keynesian economics had been dominant
• The interventionist nature of Keynesian economics, and its use to justify heavily interventionist policies, made free market advocates eager to find alternatives, regardless of how effective Keynesian economics really were.
• During this 20-30 year period, one possible crisis was identified that most generally consider both unsolvable by classic Keynesian models, and caused by them, notably stagflation.

So, what happened here? Well, monetarism was tried, and it didn't work out as well as people hoped it would. The economies of both the UK and US significantly worsened, with unemployment rocketing. Indeed, this was by design - monetarists argued that if inflation was controlled, the other problems with the economy would eventually sort themselves out.

Growth in the US and UK slowed down. Both countries have had rates of growth since the 1980s that was positive, but nothing like as strong as the post war period that preceded it. And just to make matters worse, the Japanese had their own economic crisis after having what's considered the most healthy economy in the world. Upon collapse, the Japanese chose to let their Central Bank deal with the crisis, and only made minimal use of fiscal policies to deal with the issues, just like the Monetarists said they should.

The Japanese banks were suddenly awash with money, which they invested in countries whose economies were healthy, finding it almost impossible to lend money at home. Oops. Monetarism suddenly had its equivalent of stagflation, in this case a situation where unemployment remained high, while the Central Bank was running out of ways to inject more currency into the economy without devaluing it significantly in the process.

OK, recap time (2):

• Monetarism was tried, and appeared to have even worse problems than ordinary Keynesian economics. Keynesian economics at least took two or three decades to show any flaws, while Monetarism barely lasted half that time, and seemed to cause a lot of misery even when it was "working".
• Monetarism was clearly less effective than Keynesian economics at keeping an economy growing.

Now, here's where it gets interesting.

Recall the basic Keynesian principle: spend when your economy is having problems to get out of those problems, save when it isn't. It's not exactly rocket science, if you've ever taken out a student loan, you probably understand the concept.

Well, here's the problem. During the nineties, several things happened.

First, in the US, nobody wanted to admit that Monetarist economics were, well, just awful. And if they didn't want to admit that, they certainly didn't want to admit that Keynesian economics, flawed though it might be, was better, that it generally worked, and that Keynesian economists might have found ways to deal with the whole stagflation part. Why? Well, because Monetarism was a "free market" solution, at least in the sense that it didn't involve the government directly. Nice, free market, banks got to choose where to spend the money.

The second part was that the guy who came after Carter, Reagan, was an utter imbecile who decided to win elections by using a new lowest common denominator tactic - simply claim it was OK to reduce taxes. And it became gradually impossible for anyone to get elected who thought raising taxes was a good idea.

And so we got to the a state where by the early part of this century, US governments basically started to do things because they weren't Keynesian. Bush Jr, for example, used the fact the country was running a surplus as a reason to cut taxes. Keynesians would argue (and did) that given the economy was healthy (at that precise point) and the fact we had a large deficit, we should be keeping taxes where they are, using the surplus to pay off the deficit.

Do you know now where I'm going with this?

Keynes was never "discredited", any more than Isaac Newton was when Einstein said those fateful words "Wait a moment, I think there's more to it than that*". Keynesian economics turned out to be astonishingly effective, and one flaw in the classic Keynesian system shouldn't be used as a reason to switch permanently to a system that's clearly inferior. We've seen some absolutely awful economic policies since the abandonment of Keynesian economics within the US.

• The promotion of bubbles
• A refusal to pay off deficits when we can afford to do so
• A complete unwillingness to raise taxes when clearly they need to be raised.
• A refusal to spend when we clearly need to.
  

The doors to this path opened when Carter and Thatcher decided to try monetarism, the situation was made considerably worse when Reagan essentially promoted having your cake and eating it policies, and a lack of integrity in economics, and when nobody in power on this side of the Atlantic proved willing to admit that any of this was wrong.

We now have a government and establishment that:

• Probably knows that only government spending will fix the crisis
• Knows that monetarist solutions like lowering interest rates and quantitive easing can only go so far.
• But has decided the deficit is more important, like an idiot deciding they should put $5 towards their credit card debt rather than towards a bus ticket to a sure thing job interview.
• Are treating the deficit as a problem caused by overspending, rather than undersaving.
• Have so much invested in looking at the big deficit number, they've forgotten that the real problem with the economy is the lack of jobs. People with jobs can support themselves, and pay taxes towards paying things off.

Until our politicians accept the last thirty year's fiscal policies might have been utterly stupid, we can expect to have an economy that's just as bad as Japan's.



* OK, I don't think Einstein ever said that.

Well, actually, I think it's a good idea

A bizarre allegation has surfaced. Obama plans to install a device in every car in the country, that'll measure the number of miles you drive. Then you'll have to pay per mile. What an evil genius!

It's bollocks, of course, Obama has no intention of doing anything of the sort. It's too unpopular, of course.

But, here's a question. Is it reasonable to charge road users by something related to the number of miles they drive? Is there a cost to each mile driven, and if so, is the way we raise the revenue needed to pay that cost fair?

Right now, roads are massively subsidized. Absurdly subsidized. Part of the reason why people live in the middle of nowhere, by default, in most parts of the country is because taxpayers pay a fortune to have roads built to the middle of nowhere, so that homes can be built in those locations and people can live there.

In the US, there's a small amount of revenue collected at the pump that in theory is related to the number of miles driven, but it doesn't cover the full costs of road building, which generally comes out of a basket of local, state, and federal taxes, and while anything that reduces oil usage is a positive thing, the costs of road usage aren't lower simply because you drive a Prius. What are the costs? More than you might think. Railroads are worth mentioning here: they're privately owned in the US, and so we can look at the costs involved and ask what equivalents there are with ordinary roads.

Railroad operators, at least today, need to buy land to build their tracks upon. They have to pay property taxes to compensate communities for the land they continue to use. They also have to build and maintain the right of way. And each decision about where to build a line to has to be taken using a full cost benefit analysis, they can't build lines to the middle of nowhere on a whim that the road might be useful one day.

For governments building roads, very few equivalent costs exist. Governments don't pay property taxes, they collect them, leading to the absurdity that railroads in the US actually subsidize normal roads. Generally, governmental entities will measure the cost of a road simply in terms of the cost of building it, and the cost of maintaining it. And if nobody uses that road, well, the road will be undamaged, and so it'll be assumed that the "cost" of keeping the road around is negligible.

Now, suppose you want a sane transportation policy. Wouldn't a "users-pay" philosophy make the most amount of sense, with the "cost" associated with each transportation system being measured in a consistent way? You'd limit the road budget, forcing road builders to actually weigh the costs of building out roads when doing so. You'd prevent one form of transportation system dominating others for any reason other than superiority.

Now, before I go any further, I want to emphasize I'm not talking about Obamodometers. Leaving aside privacy concerns, I don't think such a system would necessarily produce the fairest outcome. What I'd like to see, instead, is a system based upon a combination of private and community road ownership. Essentially, roads would either be owned by their users (usually in the form of communities owning their local roads), or owned by private entities who'd use whatever revenue generation method they wish.

I'm not talking about raising taxes, rather redistributing how we collect them. Making road users responsible for roads reduces the need to make local, state, and Federal governments involved in them, which means other taxes can be cut. In the medium term, you'd see, over-all, a lower tax burden, because the stupidity of building bad roads, and penalizing companies that take traffic off of roads, would be drastically curtailed.

These kinds of reforms can't be done in isolation. They have to be accompanied with planning reform so that the absurdity of requiring businesses be housed in buildings built miles away from the employees and customers they serve can be finally ended. You can't simply require road users pay the costs, you also have to ensure they can escape high road costs by reducing their cost burden.

That's what I think anyway.

Good and bad bubbles

So, continuing the economics theme...

Went through a little thought experiment today. Let's imagine two alternate universes. Both have companies called Squigglerail, whose purposes is to build and run a high speed railway line from Miami to New York City.

(Why a railway? Because it's my fantasy, OK? Insert whatever you want here, but make sure it's similar.)

In Universe One, Squigglerail raises billions from investors, and plans to start by running a free passenger service while it determines the best way to monetize the system. The system is built, and the first services run for a few years, with Squigglerail gradually introducing systems based upon advertising, and premium services.

Needless to say, Squigglerail is amazing popular, but hemorrhages cash, and finally goes bankrupt three years later. With the principle proven, Slashco buys Squigglerail's assets for a song, and starts, you know, charging customers, and closing down unprofitable services. Ten years later, there's a functioning railway system that didn't exist before, it's delivering billions in value every year, and everyone's glad it exists, although there are some very upset investors.

Now, let's go to Universe Two. Squigglerail raises billions from investors, and carefully choses a business model that involves selling transit services to passengers, who buy these things called "tickets" and then are allowed to ride the train. The system is slow to start, but becomes profitable after three years, and a decade later, there's a functioning railway system that didn't exist before, it's delivering billions in value every year, and everyone's glad it exists, especially the Squigglerail investors.

Universe Two is obviously better than Universe One. But is Universe One worse than Universe Zero, where there was no Squigglerail?

Obviously, in one and two, there's something that's worth far more than was paid to make it. The only difference is that in one scenario, a bad monetization model leads one particular group of people to lose money (the investors), while delivering massive value to an even larger group of people (the riders.) In the other, the riders benefit less than they did in U1 (which is OK, because they still benefit - if they didn't, they wouldn't see the tickets as worth spending money on), and the investors don't lose anything.

I posit this rather contrived scenario because I was thinking of the two bubbles I've seen in the last decade and a half. Both caused large numbers of people to lose ridiculous amounts of money. The thing is though, that despite the problems investors had, I think - overall - the country was better off during and after the .com bubble than it would have been had the .com bubble not happened.

This isn't true of the housing bubble. That just swallowed money.

The difference? In the .com boom, as with Squigglerail, something was actually made, of enormous value, that caused growth, it's just bad monetization meant that investors had no way to share in the growth they funded.

The housing boom generally involved something that already existed, with only a superficial rise in value, and it existed largely because of supply and demand, not economic growth. So the housing bubble was actually damaging to the economy, and those who promoted it, seeing the .com collapse as no big deal, didn't bother to ask why the .com collapse didn't have a massively depressive effect on the economy, and whether inflating the price of homes had anything in common.

BTW, don't buy gold.