government

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Wealth Inequality in America

Plenty of talk has gone into the rising income inequality that America has experienced since the early 1970s. But income is merely a wealth flow, and the truer measure of equality is the distribution of net worth and financial wealth (the wealth stock).

The historical change is clear: the bottom 80% have gotten considerably poorer both in financial wealth and in terms of total net worth:

This widening gap between the rich and everyone else is not a case of people being rewarded for their talents. Some income and wealth disparity is an inevitable effect of the market process. But the reality of today is more of a case of oligarchs harnessing the power of government bailouts, monetary policy, corporate subsidies, pork, quantitative easing, barriers to entry, favourable regulation, SuperPACs, Citizens United, lobbyists, market-rigging (etc, etc, etc) to get whatever they want.

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Spending Problem? Paul Ryan is the Spending Problem

Paul Ryan talks like a small government conservative:

Too much government inevitably leads to bad government. When government grows too much and extends beyond its limits, it usually does things poorly.

And the WSJ is pumping up Ryan as an antidote to the growth of government:

Ryan represents the GOP’s new generation of reformers. More than any other politician, the House Budget Chairman has defined those stakes well as a generational choice about the role of government and whether America will once again become a growth economy or sink into interest-group dominated decline.

But Ryan himself has been responsible for a lot of that government growth. He loyally voted for all the big government programs George W. Bush ensconced into law — Medicare Part D, often described as the largest expansion of the welfare state since Lyndon Johnson’s Great Society; the Department of Homeland Security and the TSA; the wars in Iraq and Afghanistan; the PATRIOT Act and the NDAA; the TARP bailout of Wall Street; the bailout of General Motors. So long as it was debt-fuelled spending authorised by a Republican (and during the Bush years, there was an awful lot of debt-fuelled spending authorised by Republicans) Ryan was out voting for it. 

Ryan’s voting record establishes firmly that Ryan is as much for bailouts and the expansion of government as Obama. He talks like a small government conservative on the deficit, too, but dig into the details and he promises to balance the budget on the back of closing loopholes in the tax code that he refuses to specify, while completely ignoring the severe problem of excessive total debt that is keeping the economy depressed today.

Does Ryan have an explanation for his voting record? Why did he put party loyalty above loyalty to the principles he now claims to espouse? Or did he forget his small government principles during the Bush years? Did he only discover Ayn Rand in 2008?

Ryan was forced to try and explain. Here’s the exchange between Ryan and ABC News’ Christiane Amanpour.

AMANPOUR: Congressman Ryan, you actually voted for the Wall Street bailout, and indeed the auto bailout as well.RYAN: Right. The auto bailout in order to prevent TARP from going to the auto companies, because we already put $25 billion aside in an energy bill, which I disapproved of, to go to auto companies.

What? Ryan later tried to clarify his remarks in an interview with the Daily Caller:

The president’s chief of staff made it extremely clear to me before the vote, which is either the auto companies get the money that was put in the Energy Department for them already — a bill that I voted against because I didn’t want to give them that money, which was only within the $25 billion, money that was already expended but not obligated — or the president was going to give them TARP, with no limit. That’s what they told me. That’s what the president’s chief of staff explained to me. I said, ‘Well, I don’t want them to get TARP. We want to keep TARP on a leash. We don’t want to expand it. So give them that Energy Department money that at least puts them out of TARP, and is limited.’ Well, where are we now? What I feared would happen did happen. The bill failed, and now they’ve got $87 billion from TARP, money we’re not going to get back. And now TARP, as a precedent established by the Bush administration, whereby the Obama administration now has turned this thing into its latest slush fund. And so I voted for that to prevent precisely what has happened, which I feared would happen.

Ryan should take a leaf out of Mr T.’s book and quit his jibber-jabber. He voted for TARP, as well as the auto bailout, and he has no reasonable explanation beyond fierce loyalty.

Republicans had two choices — Ron Paul and Gary Johnson — who are both consistent fiscal conservatives with no record of supporting bailouts or expansions of government, and no record of supporting costly pre-emptive wars. The Republican Party rejected both candidates, and instead went with two defenders of bailouts, two expanders of government, two believers in pre-emptive war and a large, powerful security state. That decision says an awful lot about the Republican Party.

People who want to see government play a smaller role in the economy and society should look elsewhere; outside of rhetoric both of the two major tickets have a track record of increasing the size and scope of government, increasing debt levels and bailing out favoured corporations.

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Is China a Currency Manipulator?

Mitt Romney thinks so:

China has an interest in trade. China wants to, as they have 20 million people coming out of the farms and coming into the cities every year, they want to be able to put them to work. They want to have access to global markets. And so we have right now something they need very badly, which is access to our market and our friends around the world, have that same– power over China. To make sure that we let them understand that in order for them to continue to have free and open access to the thing they want so badly, our markets, they have to play by the rules.

They’re a currency manipulator. And on that basis, we go before the W.T.O. and bring an action against them as a currency manipulator. And that allows us to apply tariffs where we believe they are stealing our intellectual property, hacking into our computers, or artificially lowering their prices and killing American jobs. We can’t just sit back and let China run all over us. People say, “Well, you’ll start a trade war.” There’s one going on right now, folks. They’re stealing our jobs. And we’re gonna stand up to China.”

The theory goes that by buying U.S. currency (so far they have accumulated around $3 trillion) and treasuries (around $1 trillion) on the open market, China keeps demand for the US dollar high.  They can afford to buy and hold so much US currency due to their huge trade surplus with America, and they buy US currency roughly equal to this surplus.  To keep this pile of dollars from increasing the Chinese money supply, China sterilises the dollar purchases by selling a proportionate amount of bonds to Chinese investors.  Supposedly by boosting the dollar, yuan-denominated Chinese goods look cheap to the American (and global) consumer.

First, I don’t really think we can conclusively say that the yuan is necessarily undervalued. That is like assuming that there is some natural rate of exchange beyond prices in the real world. For every dollar that China takes out of the open market, America could print one more — something which, lest we forget — Bernanke has been very busily doing; the American monetary base has tripled since 2008. Actions have consequences; if China’s currency peg was so unsustainable, the status quo would have collapsed long ago. Until it does, we cannot conclusively say to what extent the yuan is undervalued.

What Romney is forgetting is that every nation with a fiat currency is to some degree or other a currency manipulator. That’s what fiat is all about: the ability of the state to manipulate markets through monetary policy. When Ben Bernanke engages in quantitative easing, or twisting, or any kind of monetary policy or open market operation, the Federal Reserve is engaging in currency manipulation. Every new dollar that is printed devalues every dollar out in the wild, and just as importantly all dollar-denominated debt. So just as Romney can look China in the face and accuse them of being a currency manipulator for trying to peg the yuan to the dollar, China can look at past U.S. administrations and level exactly the same claim — currency manipulation in the national interest.

While China’s currency policy in the past 40 years has been to attract manufacturing, technology, resources and investment into China (and build up a manufacturing base to provide employment to its low-skilled population) by keeping its produce cheap, America’s currency policy has sought to enjoy a free lunch made up of everyone else’s labour and resources. This has been allowed to develop because of America’s reserve currency status — everyone has needed dollars to access global markets, and so America has rested on her laurels and allowed her productive industries to decline. Why manufacture the bulk of your consumption when China can do it cheaper, and Wal Mart has no problem with slave labour? Why manufacture your military hardware when China can do it cheaper? Why produce your own energy when you can instead consume Arab and Latin American oil?

Former U.S. ambassador Jon Huntsman raised this issue in an article from China Business News in a cable that was eventually leaked via Wikileaks:

The U.S. has almost used all deterring means, besides military means, against China.  China must be clear on discovering what the U.S. goals are behind its tough stances against China. In fact, a fierce competition between the currencies of big countries has just started.  A crucial move for the U.S. is to shift its crisis to other countries – by coercing China to buy U.S. treasury bonds with foreign exchange reserves and doing everything possible to prevent China’s foreign reserve from buying gold.

If we use all of our foreign exchange reserves to buy U.S. Treasury bonds, then when someday the U.S. Federal Reserve suddenly announces that the original ten old U.S. dollars are now worth only one new U.S. dollar, and the new U.S. dollar is pegged to the gold – we will be dumbfounded.

Today when the United States is determined to beggar thy neighbor, shifting its crisis to China, the Chinese must be very clear what the key to victory is.  It is by no means to use new foreign exchange reserves to buy U.S. Treasury bonds.  The issues of Taiwan, Tibet, Xinjiang, trade and so on are all false tricks, while forcing China to buy U.S. bonds is the U.S.’s real intention.”

Romney and others of his ilk might brush this off, believing that China’s $3 trillion dollar reserve hoard was gained through unfair means — slave labour, cutting corners in quality, the aforementioned “currency manipulation”, etc, and that that somehow gives America the right to inflate away its debts and screw its creditors. To some degree, they have a point. If China had a problem with America inflating away its debts, it should never have put itself so deep into dollar-denominated paper. If China recognised that America’s debt position was unsustainable, it should never have put so much into something so unsustainable, irrespective of supposed American pressure.

In the short term, though, I think escalating the trade war through the imposition of tariffs is a very bad idea. America is a consumption-led economy, and with middle class incomes already squeezed, a constriction of the supply of cheap and readily available goods is likely to put a lot of downward pressure on consumption. And it’s not just consumption — in today’s hyper-globalised world, a huge proportion of manufacturing — including military hardware — at some stage flows through China.

As Vincent Fernando noted:

Most of America’s key military technologies require rare earth elements, whose production China holds a near-monopoly over.

It’s thus perhaps no surprise that China has made the threat of rare earth export restrictions a new political bargaining chip.

American corporations could gradually pull out of China and shift to manufacturing and extracting resources elsewhere including America (which has large rare earth deposits), but it would be a challenging process. Rebuilding an industrial base is hard: skilled and experienced labour takes time to develop (American labour is rusty and increasingly unemployed and disabled), and supply chains and webs have all agglomerated in China. Building up domestic supply chains takes time, expertise and entrepreneurial zeal. And any destabilisation could spook global markets.

So let’s make no mistake: in the short term America needs China far, far, far more than China needs America. The notion that China needs America as a consumer is totally false; anyone can consume given the dollars or gold, and China holds $3 trillion, and continues to increase its imports of gold.

Peter Schiff summarises:

The big problem for countries like China and India is that they still subsidize the U.S. They buy our Treasury bonds and lend us all this money so we can keep consuming. That’s a big subsidy and a heavy burden.

They can use their money to develop their own economy, produce better and more abundant products for their own citizens. It’s a farce to think that the only thing China can do with its output and savings is lend it to the U.S. government, especially when we can’t pay it back.

Mitt Romney seems intent on destabilising this fragile relationship. American policy that incentivised globalisation and the service economy has very foolishly drawn America into this fragile position where its economy is increasingly fuelled not only by energy coming out of the politically and economically unstable middle east, but also by goods coming from a hostile and increasingly politically and economically unstable power.

And make no mistake — although China has done well to successfully transform itself into the world’s pre-eminent industrial base and biggest creditor, it has a lot of bubbles waiting to burst (particularly housing), stemming from the misallocation of resources under its semi-planned regime. Which makes this entire scenario doubly dangerous. Any shock in China would surely be transmitted to America, simply because it is becoming increasingly pointless for China to continue subsidising American consumption (through buying treasuries) when they could instead spend the money raising the Chinese standard of living. That could mean a painful rate-spike.

The real problem is that Romney is trying to address a problem that is very much in the past. If Romney was elected as President on this platform in 2000, things might be different. But China got what it wanted: by keeping its currency cheap and its labour force impoverished it became the world’s pre-eminent industrial base, the spider at the heart of the web of global trade, and a monopoly on important industrial components and resources. China used American demand, technology and investment during the 00s to develop. Now the imperative is not to grab a bigger share of global manufacturing, or a bigger hoard of dollars, it’s to leverage that position toward the ultimate aim of returning China to its multi-millennial superpower status. The promise of Chinese primacy is quite simply the strongest tool for the CPC to retain its (increasingly shaky) grip on China.

However we should not discount the possibility that bursting economic bubbles may stoke up some kind of popular rebellion against the Communist authorities in some kind of Chinese Spring. A new more pro-Western regime is surely America’s best hope of containing China, while gradually manoeuvring itself out of dependency on Arab oil and Chinese goods. But that may just be wishful thinking; it is possible that a new Chinese regime may be vehemently anti-Western; the Opium War and China’s 20th century humiliation still ring deeply in the Chinese psyche.

So it is unclear what is next for China, and the relationship between China and America. But having the world’s biggest manufacturing base and a monopoly over rare earths is a strong position to be in if your ultimate aim is to manufacture huge quantities of armaments in the pursuit of an aggressive, expansionist foreign policy…

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Austerity & Extremism

I noted yesterday that anything the government gives you, the government can take away, and that dependency on government services — which might be withdrawn — leaves citizens weak and unfree.

One cause for the withdrawal of government that I neglected to mention (intentionally, as I hoped someone would pick it up in comments) was the matter of austerity. While the example I was bouncing my ideas off — of denying treatment to smokers or the obese — remains theoretical, the withdrawal of government services and spending as a result of austerity is very much a reality, especially in Europe.

To wit:

That more austerity produces less GDP (and very often bigger deficits due to falling tax revenues — as exemplified by Portugal) is self-evident. That society is — for lack of a better word — pissed with this outcome is the clear reality on the ground. Made dependent upon government largesse, society now finds the crutch of services, spending and government jobs withdrawn. And of course, this has political blowback.

As Tyler recently put it “nationalism is back with a bang”. But it’s not just the nationalists who are doing well, so too are the far left. Just as in the 1930s many people who have been failed by the mainstream parties are angry, and their instinctual reaction is to reject the political mainstream and look to the fringes.

Let’s look at Greece.

From the WSJ:

Two political mavericks—one a soft-spoken former Communist, the other a firebrand nationalist—are tapping into public anger at incumbents and the harsh austerity measures Greece must adopt to stay in the euro, as support for mainstream parties withers ahead of May 6 elections.

Right-wing economist Panos Kammenos and left-wing lawyer Fotis Kouvelis are poles apart ideologically. But they are currently among the most popular party leaders in Greece, and their parties have sprung from nowhere to challenge Greece’s political establishment and the austerity policies that many Greeks blame for deepening their country’s economic crisis.

Between them, Mr. Kammenos’s Independent Greeks and Mr. Kouvelis’s Democratic Left could win around 20% of the vote. Their rise is cutting deeply into support for Greece’s two mainstream parties — the conservative New Democracy party and the center-left Socialists, known as Pasok — that share power in a fractious coalition government.

Given the utter train wreck that the Greek economy is, it is shocking that these figures are not significantly higher. In the recent first round of the French Presidential election, the far left and far right polled over 30%, a post-WW2 high.

All over Europe, the unemployed and dispossessed are becoming increasingly frustrated with the status quo.

From Bloomberg:

Europe’s front against austerity has expanded in recent weeks after Spain struggled to meet European Union-imposed deficit targets, election campaigns in Greece faced anti- austerity rumblings and a revolt against extra spending cuts in the traditionally budget-conscious Netherlands propelled Prime Minister Mark Rutte’s coalition toward an early breakup.

Europe has been here before. Hitler came to power, lest we forget, on the back of a devastating period of German austerity.

As I noted in November:

After just two years of “austerity” measures, Germany’s economy had completely collapsed: unemployment doubled from 15 percent in 1930 to 30 percent in 1932, protests spread, and Bruning was finally forced out. Just two years of austerity, and Germany was willing to be ruled by anyone or anything except for the kinds of democratic politicians that administered “austerity” pain. In Germany’s 1932 elections, the Nazis and the Communists came out on top — and by early 1933, with Hitler in charge, Germany’s fledgling democracy was shut down for good.

It’s the same story; more austerity means more misery, means more political and social rumbling, means a greater support for radical political parties. We haven’t gotten anywhere near the scope or magnitude of the 1930s (yet), but the present European contraction has not dampened the technocratic fervour for deeper and faster cuts and tax hikes (which, quite obviously lead to bigger deficits, which trigger more austerity, ad infinitum). Could this at some point mean revolutions that put radicals into power? It becomes increasingly plausible.

And the initial problem in my view is excessive dependency on the state and centralisation. If the state makes up 50% of GDP, cutting spending in the interests of paying down debt will cause a severe contraction throughout the entire economy. If the state makes up 15% of GDP, less so. If the state is only a small fragment, austerity in the interests of paying down debt — even during a recession or depression — is feasible. If the state is a goliath, it will lead to a crippling economic contraction (and of course, the attendant realities of public fury and politcal extremism).

Centralised systems are always and by definition fragile to shocks and mismanagement, because the activities at the centre are transmitted throughout the entire system; poor decisions at the centre metastasise throughout the system. In a robust decentralised system, mismanagement only hurts at the local level, because there is less of a mechanism for the transmission of shocks.

The lesson sticks: anything the government gives you, the government can take away (sometimes deliberately, sometimes not). That could be healthcare, that could be security, that could be economic growth. If it’s delivered by central fiat, it’s fragile.

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Krugman’s Inflation Target

The Keynesian blogosphere is up in arms at Ben Bernanke’s response to Krugman’s view that he should pursue a higher inflation target as a debt erasure mechanism.

According to Chairman Bernanke:

We, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable in that we’ve been able to take strong accommodative actions in the last four, five years to support the economy without leading to an unanchoring of inflation expectations or a destabilization of inflation. To risk that asset for what I think would be quite tentative and perhaps doubtful gains on the real side would be, I think, an unwise thing to do.

Krugman responded:

This is not at all the tone of Bernanke’s Japan analysis; remember, Japan had nowhere near as high unemployment as we do, and his analysis back then was not simply focused on ending deflation.

Disappointing stuff.

The basic Keynesian logic is as follows:

The economy is performing far below its potential, due to an ongoing slump in aggregate demand caused by a contraction of confidence. Simply, there is plenty of money, but far too many people are risk averse and thus are not spending (and thus creating economic activity) but instead just holding onto their money. The Fed should ease some more, so as to create inflation that turns holding cash into a risk, and so encourage investment and consumption. What’s more, residual debt overhang is a burden on the economy, and additional inflation would decrease the relative value of  debts, giving some relief to debtors.

Matthew O’Brien presented this chart to make the case that output is far below its potential:


I am deeply sceptical that GDP is a sufficient measure of output, and I am even more sceptical that the algorithmic jiggerypokery involved in calculating what the Federal Reserve calls “Potential Nominal GDP” has anything whatever to do with the economy’s real potential output. But I will accept that — based on the heightened unemployment, as well as industrial output being roughly where it was ten years ago — that potential output is far below where it could be, and that the total debt overhang at above 300% of GDP is excessive.

The presupposition I really have a problem with, though, is the notion that this is a problem with hoarding:

Simply, the United States is a consumption-driven economy. And that isn’t so much of a fact as it is a problem. More and more money is going toward consumption, and less and less is going toward investment in companies, in ideas and in businesses. Exemplifying this, less and less money — even in spite of the Fed’s “pro-risk” policies (QE, QE2, ZIRP, etc) is going into domestic equities:

The fundamental problem at the heart of this is that the Fed is trying to encourage risk taking by making it difficult to allow small-scale market participants from amassing the capital necessary to take risk. That’s why we’re seeing domestic equity outflows. And so the only people with the apparatus to invest and create jobs are large institutions, banks and corporations, which they are patently not doing.

Would more easing convince them to do that? Probably not. If you’re a multinational corporation with access to foreign markets where input costs are significantly cheaper, why would you invest in the expensive, over-regulated American market other than to offload the products you’ve manufactured abroad?

As Zero Hedge noted:

In the period 2009-2011, America’s largest multinational companies: those who benefit the most from the public sector increasing its debt/GDP to the most since WWII, or just over 100% and rapidly rising, and thus those who should return the favor by hiring American workers, have instead hired three times as many foreigners as they have hired US workers.

So will (even deeper) negative real rates cause money to start flowing? Probably — but probably mostly abroad — so probably without the benefits of domestic investment and job creation.

Then there is the notion that inflation will effect debt erasure. This chart tends to suggest that at least for government debt it may not make much difference:

There’s no real correlation between government debt erasure and high inflation.

Paul Donovan of UBS explains:

The fundamental obstacle to governments eroding their debt through inflation is the duration of the government debt portfolio. If all outstanding debt had ten years before it matured, then governments could inflate their way out of the debt burden. Inflation would ravage bond holders, and governments (with no need to roll over existing debt for a decade) could create inflation with impunity, secure in the knowledge that existing bond holders could do nothing to punish them. In the real world, of course, governments roll over their debt on a very frequent basis.

Consumer debt may also not experience significant erasure.

From Naked Capitalism:

Inflation only reduces debt overhang in a significant way for households who are fortunate enough to see their nominal wages rise along with the general rise in prices. In today’s economy, workers are frequently not so fortunate.

The deeper reality though, is that even if my concerns are unfounded and Krugman is correct, and that a higher inflation target would achieve precisely what Krugman desires, I don’t think it would solve the broader problems in the economy.

As I wrote in November:

The problem is that most of the problems inherent in America and the West are non-monetary. For a start, America is dependent on oil, much of which is imported — oil necessary for agriculture, industry, transport, etc, and America is therefore highly vulnerable to oil shocks and oil price fluctuations. Second, America destroys huge chunks of its productive capital policing the world, and engaging in war and “liberal interventionism”. Third, America ships even more capital overseas, into the dollar hoards of Arab oil-mongers, and Chinese manufacturers who supply America with a heck of a lot. Fourth, as Krugman and DeLong would readily admit, American infrastructure, education, and basic research has been weakened by decades of under-investment (in my view, the capital lost to military adventurism, etc, has had a lot to do with this).

In light of these real world problems, at best all that monetary policy can do is kick the can, in the hope of giving society and governments more time to address the underlying challenges of the 21st Century. When a central bank pumps, metrics (e.g. GDP and unemployment) can recover, but with the huge underlying challenges like the ones we face, a transitory money-printing-driven spike will in no way be enough to address the structural and systemic problems, which most likely will soon rear their ugly heads again, triggering yet more monetary and financial woe.

On the other hand, it would be interesting to see Bernanke go the whole hog and adopt a fully-blown Krugmanite monetary policy, just to see Krugman’s ideas get blown out of the water by the cold, dark hand of falsification.

Of course, there was an opportunity to achieve debt erasure in 2008, when the world faced a default cascade and a credit collapse. Had economists and planners let the system liquidate, a huge portion of bad debt and bad companies and systems would have been erased, and — after a period of pain — we might well be well into a new phase of organic self-sustaining growth. But we live in a different world; where zombie systems, companies and their assets are preserved by government bailouts and interference, and very serious people like Paul Krugman earnestly push dubious solutions to problems that their very interventionist worldview created.

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More Evidence That Austerity During Depressions Works

Sorry, no. I am being sarcastic.

From Bloomberg:

The U.K. economy shrank in the first quarter as construction output slumped, pushing Britain into its first double-dip recession since the 1970s and raising pressure on officials to salvage the recovery.

Gross domestic product contracted 0.2 percent from the fourth quarter of 2011, when it shrank 0.3 percent, the Office for National Statistics said today in London.

Last month I described Britain’s problems: GDP levels have never recovered to pre-crisis levels, the unemployment rate continues to climb from post-crisis levels, government debt level continue to climb, inflation levels are elevated, and all of these metrics are somehow worse than the situation in America. 

And now Britain is back in recession.

The bottom line here is that trying to conduct an austerity program during the depths of a recession is dangerous. Less government spending and higher taxation translates into falling incomes for many, which often translates into falling tax revenues (as is the case here), which means that “deficit reduction” just produces larger deficits. Greece is the extreme example.

Nations in the Eurozone that have seen the most growth have conducted the least austerity:


So what would a successful conservative economic program look like today?

Well, until the nation is out of the slump and consistently growing, it should begin and end with slashing regulation and barriers to entry so that more unemployed people can become self-employed. It could include some form of program to encourage taxpayer-funded banks to lend to people who want to start businesses, for the same reason.

While not throwing around stimulus slush money (for that tends to end up in the pockets of well-connected corporations) it would maintain spending levels, and look to redirect some spending toward more productive endeavours for instance giving small businesses tax breaks for every job they create, or every factory they open.

The welfare cuts must wait until there is a strong and self-sustaining recovery, for when the economy is creating lots of jobs, for when there is a demand for labour. Slashing welfare when there are no jobs to go to is totally self-defeating.

The deficit reduction must wait until tax revenues are consistently rising due to a strong and self-sustaining recovery.

It frightens me that conservative voices have gotten this so hideously wrong. We had a decade of fiscally reckless government, where governments, consumers and businesses totally forgot the imperative to save in the fat times to spend in the lean, and joined the leverage mania and the derivatives casino. That was dangerous and foolish. And now policymakers have chosen to focus on deficits at precisely the wrong time. It is absolutely the worst of both worlds.

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Economics for the Muppet Generation

Mark McHugh of Across the Street provides a succinct summation of the problem America faces:

McHugh continues:

  • From 1947 to 1974 US income per capita grew more than National debt per capita 25 times.
  • In the last 30 years, National debt per capita has grown more than income per capita 24 times.
  • The last time income per capita grew more than national debt per capita was 2001.
  • Ben Bernanke arrived at the Federal Reserve in 2002.

So simple, even a muppet can understand what the problem is, right?

Not exactly. We know what the problem is: national incomes aren’t rising, even while we get deeper and deeper into hock trying to maintain our standard of living. We know that this pattern is totally unsustainable; unless incomes rise, that debt will become increasingly impossible to service. What is less clear is the cause of this stagnation.

So what changed between 1990 and 2005 that led the nation debt per capita to so quickly overtake national incomes per capita?

While I am mindful that correlation does not necessarily imply causation, that data fits pretty beautifully. The explanation for this trend would be that as America has become more and more consumptive, and less and less productive that more and more capital went offshore to pay for consumption, and thus less and less contributed to the national income, even as Bernanke ponied up trillions in new reserves, and even as the shadow banking system created trillions in pseudo-money.

So where’s America’s money?

Here:


So is this a criticism of free trade? Should America have been more protectionist of her industries and her domestic manufacturing? Not necessarily; what the Washingtonian elites refer to as “free trade” is heavily subsidised. The status quo that Washington has made seems to heavily favour China and disfavour America. Imports from China are subsidised by American military largesse; every dollar America pushes into its military-industrial complex pushes shipping costs like insurance a little lower. So while labour costs in the Orient are naturally cheaper (due to population density, and development level), that doesn’t necessarily mean that Chinese goods are naturally cheaper in the American market. Under a genuinely free system — where America was not subsidising shipping costs — would made-in-America be more competitive compared to Chinese goods? Would China have built up a less  mountainous supply of American cash? I think so.

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Angela Merkel Still Doesn’t Understand Capitalism


Last December I took the time to explain capitalism for Angela Merkel:

Capitalism means both successes and failures. It is a fundamentally experimental system, with a continuous feedback mechanism — the market, and ultimately profit and loss. Ideas that work are rewarded with financial success, and ideas that don’t are punished with failure. With capitalism, systems, ideas and firms that fail to produce what the market wants fail. They go bankrupt. Their assets, and their debt is liquidated.

When that mechanism is suspended by a government or central bank that thinks it knows best — and that a system that is too interconnected to fail is worth saving at any cost — the result is almost always stagnation. This is for a number of reasons — most obviously that bailouts sustain crippling debt levels, and are paid for through contractionary austerity. But it is larger than just that.

In nature, ideas and schemes that work are rewarded — and ideas and schemes that don’t work are punished. Our ancestors who correctly judged the climate, soil and rainfall and planted crops that flourished were rewarded with a bumper harvest. Those who planted the wrong crops did not get a bailout — they got a lean harvest, and were forced to either learn from their mistakes, or perish.

These bailouts and interventions have tried to turn nature on its head — bailed out bankers and institutions have not been forced by failure to learn from their mistakes, because governments and regulators protected them from failure.

Obviously she did not read my advice.

Reuters reports:

Angela Merkel is not happy that financial markets have not made any contribution to resolving the financial crisis.

Right; financial markets need to contribute to resolving the financial crisis?

What financial markets? The markets have just become another manipulated manifestation of central planning. The more dollars, euros and yen that central banks pump into markets the less traders will be trading fundamentals  — i.e. basing their trading on the inherent value of securities, and allowing the needs and wants of society to determine economic output — and the more they will be trading the prospects for more central bank and government intervention, more QE, more hopium.

Central planning always and inevitably has unsolicited side-effects (in this case, that markets would be corrupted and junkiefied), and usually side-effects which are not necessarily visible or detectable to the person doing the planning no matter how sophisticated their pseudo-scientific simulations appear to be. Central planners are always making decisions with incomplete information, and the missing information very often has a large and appreciable effect on outcomes. In a small and decentralised system, this is not a problem; decision-makers can usually locally adjust their behaviour to a new trajectory as they get new information. But for central planners, operating from the centre of a system, policy is always centralised and generalised, slow to adapt to local information, slow to adjust to local trends and patterns, broad and sweeping rather than subtle and local.

Very simply: the only way that financial markets could ever have solved the financial crisis is if government had left them alone enough for them to adapt to the new post-bubble reality. At the very most, this meant providing a safety net for the poor and the jobless while the market worked out its problems. Instead, our leaders chose to preserve and thus crystallise possibly the most-deranged and malinvestment-fuelled bubble economy in human history, full of greedy and parasitic companies of no real value to society, and which in a market economy would have gone bust long ago.

And now central planners (and Nixon was right — they’re all central planners now) want to whine about the markets not doing what they desire?

The great delusion of Western governments in this era has been that everything appears to them to be a problem for them to fix. If they identify a problem, they will find a way (usually with our tax money) to address it. They almost never realise or even consider that sometimes the problems that they identify are best addressed by being left alone (with at most the provision of a safety net for the poor and vulnerable). If you’re holding a hammer, every problem will look like a nail. And government keeps bashing society with the hammer of centralisation and central control. And society is not a nail.

Lao Tzu understood this in stating:

The wisest course is to keep the government simple and inactive, for then the world stabilises itself.

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The Disaster of Youth Unemployment

This is a demographic disaster.

From the Guardian:

Unemployment among Europe‘s young people has soared by 50% since the financial crisis of 2008. It is rising faster than overall jobless rates, and almost half of young people in work across the EU do not have permanent jobs, according to the European commission.

There are 5.5 million 15- to 24-year-olds without a job in the EU, a rate of 22.4%, up from 15% in early 2008. But the overall figures mask huge national and regional disparities. While half of young people in Spain and Greece are out of work, in Germany, Austria and the Netherlands it is only one in 10. In a further six EU countries, youth unemployment is around 30%. Of those in work, 44% are on temporary contracts.

The same phenomenon exists in the United States:

And why is this such a staggering  problem?

Firstly, the psychological impact: a whole lot of young people have never become integrated with the workforce. Many will become angry and disillusioned, and more likely to riot and rob than they are to seek productive employment. There is a significant amount of evidence for this:

Thornberry and Christensen (1984) find evidence that a cycle develops whereby involvement in crime reduces subsequent employment prospects which then raises the likelihood of participating in crime. Fougere (2006) find that increases in youth unemployment causes increases in burglaries, thefts and drug offences. Hansen and Machin (2002) find a statistically significant negative relationship between the number of offences reported by the police over a two year period for property and vehicle crime and the proportion of workers paid beneath the minimum before its introduction. Hence, there are more crime reductions in areas that initially, had more low-wage workers. Carmichael and Ward (2001) found in Great Britain that youth unemployment and adult unemployment are both significantly and positively related to burglary, theft, fraud and forgery and total crime rates.

Additionally unemployment is correlated with higher rates of suicide and mental illnesses like depression. And of course, the longer the unemployment, the rustier workers become, and the more skills they lose. Frighteningly, the numbers of long-term unemployed are rising:


Second, the economic impact: people sitting at home doing nothing don’t contribute productivity to society. In a society faced with falling or stagnant productivity, that is frustrating; there are lots of people sitting there who could be contributing to a real organic recovery, but they are not, because nobody is hiring, and (perhaps more importantly) barriers to entry and the welfare trap are crowding out the young, and preventing the unemployed from becoming self-employed. It also means higher welfare costs:


That leads to higher deficits, and greater government debt.

So it is not just a demographic disaster; it is also a fiscal one.

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There is No Such Thing as a Service Economy

It is often said that prostitution is the oldest profession. This is not true, and I know this with a very high degree of certainty. For a prostitute to subsist, there must be  a medium of exchange, and for a medium of exchange to exist — even in terms of barter — there must be a surplus of production (i.e. a person is producing more than they can consume). Thus, there must be pre-existing productivity, for example food that has been hunted, or gathered or grown, tools that have been created, etc.

The truth is that prostitution (or perhaps soldiery) is probably the oldest service profession.

What is a service profession? Well broadly there are two kinds of professions: goods-producing, and services-producing. Goods-producing professions produce things. Services-producing professions do things without producing any definable goods. Prostitution is a very good example. So is legal work, consulting, lobbying, graphic design, sales work, soldiery, musicianship, acting, etc. And yes — while I feel that writing creates a good — it too is widely considered a service.

At present, the Western economies are dominated by services.

From the World Bank:

Joe Sitglitz’s article in Vanity Fair late last year argued that we need to move even further into a service-led economy:

What we need to do instead is embark on a massive investment program—as we did, virtually by accident, 80 years ago—that will increase our productivity for years to come, and will also increase employment now. This public investment, and the resultant restoration in G.D.P., increases the returns to private investment. Public investments could be directed at improving the quality of life and real productivity—unlike the private-sector investments in financial innovations, which turned out to be more akin to financial weapons of mass destruction.

The private sector by itself won’t, and can’t, undertake structural transformation of the magnitude needed—even if the Fed were to keep interest rates at zero for years to come. The only way it will happen is through a government stimulus designed not to preserve the old economy but to focus instead on creating a new one. We have to transition out of manufacturing and into services that people want—into productive activities that increase living standards, not those that increase risk and inequality.

Now I’m not accusing Stiglitz of anything other than a misplaced zeal for fixing the American economy. His suggestion is merely emblematic of a wider misconception.

Service jobs come into existence as there are bigger surpluses of production. In an isolated national economy, the services sector will only grow if the productive sector grows in proportion. But in a global economy, with flows of trade and goods, illusions are possible.

The truth is that there is no such thing as a service economy. Our economy today (other than in places like, say, North Korea) is truly global. All of those service workers — and every cent of “services” GDP — is supported by real-world productivity, much of which takes place outside the West — the productivity of the transport system, the productivity of manufacturers, the productivity of agriculture.

The continued prosperity of the West is dependent on the continued flow of goods and services into the West.

This is an intentionally zany example (but certainly no less zany than Krugman’s babysitting co-op) of how moving to a “service-based” (pun-intended, you’ll see) economy can prove detrimental:

Imagine the centrally-planned society of War-is-Peace-Land, occupying one half of a large island, and led by an absolute King. The kingdom is very successful in warfare, and maintains a great advantage over its sole neighbour. 50% of its working subjects are conscripted into the military, in various roles — soldiery, tactics, smithing, horsemanship, etc. Of the other half of the population 30% work in collective agriculture, 10% work in light industry (e.g. making candles) and 10% are personal servants to the King (or in the case of females part of his large harem). Now, the King does not like the fact that his harem is not as large as it could be; he does not like that there are women and girls toiling the fields when they could be in his harem. Nor does he like that there are men toiling in the fields when they could instead be conscripted into the military.

Fortunately in the neighbouring kingdom of Productivity Land, they have huge surpluses of agriculture and productivity, as only 30% of their population is conscripted into the military, while 40% work in agriculture, and 20% in light industry. As they make such huge surpluses, they are willing to make up for any shortfall in War-is-Peace-Land. As a result of this, more and more workers in War-is-Peace-Land can be moved from agriculture to serving the King, either as a manservant (carrying his Royal chair, beating up anyone who insults him, tending to his elaborate gardens) or as a member of his harem. In return for this, the King sends promissory notes — which are often promptly lent back —  from Productivity Land to pay for their products. Productivity Land uses this money to acquire natural resources from other islands.

Eventually, the King decides that his pleasure gardens need to be greatly expanded, and so he moves the entire non-military workforce out of agriculture, and into manufacture terra cotta and bronze statues, to decorate his pleasure gardens. Of course, War-is-Peace Land has built up a humungous debt over the years, and Productivity Land feels short-changed in sending its productive output across to the other half of the island in exchange for increasingly-devalued pieces of fiat paper that buy increasingly less and less resources. But the King of Productivity Land is very smart. He recognises that winning a military confrontation with War-is-Peace Land will still be difficult, so he agrees to continue this arrangement so as to make War-is-Peace Land even more deeply dependent upon the produce of Productivity Land. 

One day, the King of War-is-Peace Land was out frolicking gaily in his pleasure gardens, smoking his pipe and contemplating a lazy afternoon molesting his harem. Alas, no. A messenger from Productivity Land arrived at the Palace to inform him that Productivity Land was sick of his devalued fiat currency, and so would no longer send agricultural products or other produce. That was it — War-is-Peace Land had no intent to pay back their debt, so they were out in the cold.

“Nonsense!” cried the King, and promptly had the messenger arrested, tortured and killed. He rallied his generals, and declared war against Productivity Land. Alas, they did not get very far. It took three days for the army to be rallied together into a fighting force, and by that time War-is-Peace Land was running low on food and fuel. Armies — no matter how well-equipped — cannot march on an empty stomach. The tired and weary soldiers of War-is-Peace Land were more numerous and better equipped, but their hunger and subsequent tiredness got the better of them and they were massacred and beaten back. The King tried to escape, but was captured by Productivity Land’s forces and promptly executed.

Readers can read whatever they like into the above story; it is purely fictitious, and of course massively simplified. But I think it captures the essence of the problem of  outsourcing your productivity to foreign lands who might not always be as friendly as they appear to be today.

The bottom line here is that any proposals regarding transitioning to an economy even more dependent on services assumes that goods and productivity will keep flowing into the West, even though there is no guarantee of such a thing.

Governments in the West would do better to worry about the West’s (lack of) energy and resource independence.