japanisation

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How saving endangers the economy — and what to do about it

An impressive video featuring former Treasury Secretary Larry Summers has been making the rounds.

Summers makes the case that the United States and other Western nations may have reached a state of permanent stagnation in growth and employment. In Japan, per capita incomes grew strongly until the 1990s, and since then they have been growing very weakly and intermittently. Summers cites Japan as an early example of what might occur elsewhere.

Japan’s stagnation is shocking — today, the Japanese economy is only half the size economists in the 1990s predicted it would be if it had continued on its pre-1990s growth trend. As Summers notes, in the U.S., growth is also well below its pre-crisis trend, and unemployment remains persistently high. More than 12 million people who want work and are actively looking cannot find it. That’s a very ugly situation.

Under normal conditions, central banks can lower interest rates on lending to banks as a way to encourage activity and fight unemployment. Lower rates make business projects easier to afford, and more business projects should mean more jobs. If an economic shock pushes the unemployment rate up, central banks can lower lending rates to ease conditions. And conversely, if economic conditions are overheating and inflation is pushing up above the Federal Reserve’s target of 2 percent, interest rates can be hiked to encourage saving and discourage spending.

Yet in the current slump, unemployment has remained elevated even while interest rates have been at close to zero for four years while inflation has remained contained. This suggests that the interest rate level required to bring employment down significantly is actually below zero. Summers agrees:

Suppose that the short-term real interest rate that was consistent with full employment had fallen to negative 2 percent or negative 3 percent sometime in the middle of the last decade.

But central banks can’t lower interest rates below zero percent because people can just hold cash instead. Why invest if you’re going to lose money doing so?

Read More At TheWeek.com

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George Osborne’s Misconceptions About Countercyclical Fiscal Policy

Britain's Chancellor of the Exchequer George Osborne attends the Lord Mayor's Dinner For The Bankers And Merchants Of The City of London

George Osborne just came out in favour of counter-cyclical policy — saving more in the boom, and spending more during a “rainy day”. This is consistent with John Maynard Keynes’ notion that “the time for austerity at the Treasury is the boom, not the slump”.

The thing is, George Osborne seems to believe that right now we are moving toward a boom and need to adopt the policies of the boom:

Chancellor George Osborne has said he wants the government to be running a surplus in the next Parliament and can get there without raising taxes.

He told the Conservative conference the public finances should be in the black when the economy was strong as insurance against a “rainy day”.

His comments were taken as suggesting more years of spending restraint.

Business welcomed the goal but Labour said Mr Osborne had missed targets before and could not be trusted.

The BBC News Channel’s chief political correspondent Norman Smith said Mr Osborne’s underlying message was that austerity would continue after the next election despite the return to growth.

If 7.8% unemployment and a smaller real economy than 5 years ago doesn’t constitute a rainy day, I’d like to know what does. To me, and to many economists this kind of thing doesn’t just constitute a rainy day, it constitutes a full blown great depression. Eventually, sooner or later, someday the economy will return to growth and full employment. With the right luck — technology breakthroughs and other exogenous shocks etc — that could be two or five years from now. The experience of Japan, however, who have endured a 20 year depression suggests that it could be much later rather than sooner.

The safer alternative is to use fiscal policy — as Osborne himself implies — during the rainy day to directly bring back full employment sooner, rather than later by engaging in infrastructure projects and the like. Even if a government hasn’t saved money during the boom, interest rates are so low during the slump that it is cheap to do so, even in the context of soaring national debt levels as is the case in Japan today.

Getting the economy to a point where the government can run a budget surplus, of course, is still a noble ambition. But Osborne has shown no awareness whatever of the steps that need to be taken to get to that position. Infrastructure and housing investment and a jobs program would be a start. So too would liberalising planning laws and lending to and deregulating business startups so that more houses can get built and more businesses can get started. For now, Osborne is preaching responsibility while doing something deeply irresponsible — prolonging a depression with unnecessary demand-sucking job-killing austerity. The boom, not the slump, is the time for austerity at the Treasury and this (for the love of God) is not the boom.

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Why Modern Monetary Theory is Wrong About Government Debt

I’ve taken some criticism — particularly from advocates of modern monetary theory and sectoral balances and all that — for using total debt rather than just private debt in my work.

The modern monetary theory line (in one sentence, and also in video form) is that government debt levels are nothing to worry about, because governments are the issuer of the currency, and can always print more.

This evokes the words of Alan Greenspan:

The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default.

Of course, the point I am trying to make in worrying about total debt levels is not the danger of mass default (although certainly default cascades a la Lehman are a concern in any interconnective financial system), but that large debt loads can lead to painful spells of deleveraging and economic depression as has occurred in Japan for most of the last twenty years:

Japan-Debt-Hoisington-27

Of course, before the crisis in America (as was the case in Japan at the beginning of their crisis) government debt was not really a great contributor to the total debt level, meaning that the total debt graph looks far more similar to the private debt line than the public debt line, which means that when I talk about the dangers of growing total debt I am talking much more about private debt than public debt:

010212_2140_TheDebtwatc1

But what Japan empirically illustrates is the fact that all debt matters. Japan’s private debt levels have reset to below the pre-crisis norm, yet the economy remains depressed while public debt continues to climb (both in absolute terms, and as a percentage of GDP). If excessive private debt was the sole factor in Japan’s depression, Japan would have recovered long ago. What we have seen in Japan has been the transfer of the debt load from the private sector to the public, with only a relative small level of net deleveraging.

And high and growing public sector deficits often lead to contractionary tax hikes and spending cuts. This happened time and again during Japan’s lost decades. Peter Tasker of the Financial Times writes:

When Japan’s bubble economy imploded in the early 1990s, public finances were in surplus and government debt was a mere 20 per cent of gross domestic product. Twenty years on, the government is running a yawning deficit and gross public debt has swollen to a sumo-sized 200 per cent of GDP.

How did it get from there to here? Not by lavish public spending, as is sometimes assumed. Japan’s experiment with Keynesian-style public works programmes ended in 1997. True, they had failed to trigger durable economic recovery. But the alternative hypothesis – that fiscal and monetary virtue would be enough – proved woefully mistaken. Economic growth had been positive in the first half of the “lost decade”, but after the government raised consumption tax in 1998 any momentum vanished. Today Japan’s nominal GDP is lower than in 1992.

The real cause of fiscal deterioration was the damage done to tax revenues by this protracted slump. Central government outlays as a percentage of GDP are no higher now than in the early 1980s, but the tax take has fallen by 5 per cent of GDP since 1989, the year that consumption taxes were introduced.

A rise in debt relative to income has historically tended to lead to contractionary deleveraging irrespective of whether the debt is public or private.

The notion at the heart of modern monetary theory that governments that control their own currency do not have to engage in contractionary deleveraging remains largely ignored. Just because nations can (in a worst case scenario) always print money to pay their debt, doesn’t mean that they will always print money to pay their debt. They will often choose to adopt an austerity program (as is often mandated by the IMF), or default outright instead (as happened in Russia in the 1990s).

And what governments cannot guarantee is that the money they print will have value. This is determined by market participants. In the real economy people in general and creditors (and Germans) in particular are very afraid of inflation and increases in the money supply. History is littered with currency collapses, where citizens have lost confidence in the currency (although in truth most hyperinflations have occurred after some great shock to the real economy like a war or famine, and not solely as a result of excessive money printing).

And there has always been a significant danger of currency, trade and political retaliations by creditors and creditor nations, as a result of the perception of “money printing”. Many, many wars have been fought over national debts, and over currencies and their devaluation. One only has to look at China’s frustrated rhetoric regarding America’s various monetary expansions, the fact that many Eurasian creditor nations are moving away from the dollar as a reserve currency, as well as the growth of American-Chinese trade measures and retaliations, to see how policy of a far lesser order than the sort of thing advocated in modern monetary theory can exacerbate frictions in the global currency system (although nothing bad has come to pass yet).

Governments controlling their own currencies are likely to continue to defy the prescriptions of the modern monetary theorists for years to come. And that means that expansionary increases in government debt relative to the underlying economy will continue to be a prelude to contractionary deleveraging, just as is the case with the private sector. All debt matters.

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Japan’s Adult Diaper Boom

Japan’s population has gotten so old that diaper manufacturers are selling more adult diapers for incontinent seniors than they are baby diapers. According to Bloomberg:

Unicharm Corp’s sales of adult diapers in Japan exceeded those for babies for the first time last year.

This is because Japan’s population is getting older and older:

This is a pronounced trend all over the developed world. As people live longer and as fertility rates fall, there is a proportionately a larger and larger population of elderly retirees being supported by a proportionately smaller and smaller population of young workers paying taxes and interest on debt.

Governments of countries with ageing populations have a few choices. First, they could relax immigration laws so that working-age immigrants can enter the country, work and pay taxes to support the domestic elderly population (Japan has some of the tightest immigration laws in the world). Second, they could change the tax code or legal framework to incentivise a higher birthrate (for instance, tax breaks per child). Third, they could raise the retirement age (or at least provide incentives to keep an ageing population in work).

Another option is to hope for a miracle. But that doesn’t have a history of working out very well.

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Negative Nominal Interest Rates?

A number of economists and economics writers have considered the possibility of allowing the Federal Reserve to drop interest rates below zero in order to make holding onto money costlier and encouraging individuals and firms to spend, spend, spend.

Miles Kimball details one such plan:

The US Federal Reserve’s new determination to keep buying mortgage-backed securities until the economy gets better, better known as quantitative easing, is controversial. Although a few commentators don’t think the economy needs any more stimulus, many others are unnerved because the Fed is using untested tools. (For example, see Michael Snyder’s collection of “10 Shocking Quotes About What QE3 Is Going To Do To America.”) Normally the Fed simply lowers short-term interest rates (and in particular the federal funds rate at which banks lend to each other overnight) by purchasing three-month Treasury bills. But it has basically hit the floor on the federal funds rate. If the Fed could lower the federal funds rate as far as chairman Ben Bernanke and his colleagues wanted, it would be much less controversial. The monetary policy cognoscenti would be comfortable with a tool they know well, and those who don’t understand monetary policy as well would be more likely to trust that the Fed knew what it was doing. By contrast, buying large quantities of long-term government bonds or mortgage-backed securities is seen as exotic and threatening by monetary policy outsiders; and it gives monetary policy insiders the uneasy feeling that they don’t know their footing and could fall into some unexpected crevasse at any time.

So why can’t the Fed just lower the federal funds rate further? The problem may surprise you: it is those green pieces of paper in your wallet. Because they earn an interest rate of zero, no one is willing to lend at an interest rate more than a hair below zero. In Denmark, the central bank actually set the interest rate to negative -.2 % per year toward the end of August this year, which people might be willing to accept for the convenience of a certificate of deposit instead of a pile of currency, but it would be hard to go much lower before people did prefer a pile of currency. Let me make this concrete. In an economic situation like the one we are now in, we would like to encourage a company thinking about building a factory in a couple of years to build that factory now instead. If someone would lend to them at an interest rate of -3.33% per year, the company could borrow $1 million to build the factory now, and pay back something like $900,000 on the loan three years later. (Despite the negative interest rate, compounding makes the amount to be paid back a bit bigger, but not by much.) That would be a good enough deal that the company might move up its schedule for building the factory.  But everything runs aground on the fact that any potential lender, just by putting $1 million worth of green pieces of paper in a vault could get back $1 million three years later, which is a lot better than getting back a little over $900,000 three years later.  The fact that people could store paper money and get an interest rate of zero, minus storage costs, has deterred the Fed from bothering to lower the interest rate a bit more and forcing them to store paper money to get the best rate (as Denmark’s central bank may cause people to do).

The bottom line is that all we have to do to give the Fed (and other central banks) unlimited power to lower short-term interest rates is to demote paper currency from its role as a yardstick for prices and other economic values—what economists call the “unit of account” function of money. Paper currency could still continue to exist, but prices would be set in terms of electronic dollars (or abroad, electronic euros or yen), with paper dollars potentially being exchanged at a discount compared to electronic dollars. More and more, people use some form of electronic payment already, with debit cards and credit cards, so this wouldn’t be such a big change. It would be a little less convenient for those who insisted on continuing to use currency, but even there, it would just be a matter of figuring out with a pocket calculator how many extra paper dollars it would take to make up for the fact that each one was worth less than an electronic dollar. That’s it, and we wouldn’t have to worry about the Fed or any other central bank ever again seeming relatively powerless in the face of a long slump.

First of all, I question the feasibility of even producing a negative rate of interest, even via electronic currency. Electronic currency has practically zero storage costs. What is to stop offshore or black market banking entities offering a non-negative interest rate? After all, it is not hard to offer a higher-than-negative rate of interest for the privilege of holding (and leveraging) currency. A true negative interest rate environment may prove as unattainable as division by zero.

But assuming that such a thing is achievable, I think that a negative rate of interest will completely undermine the entire economic system in clear and visible ways that I shall discuss below (“white swans”), and probably also — because such a system has never been tried, and it is a radical departure from the present norms — in unpredictable and emergent ways (“black swans”).

Money has historically had multiple functions; a medium of exchange, a unit of account, a store of purchasing power. To institute a zero interest rate policy is to disable money’s role as a store of purchasing power. But to institute a negative interest rate policy is to reverse money’s role as a store of purchasing power, and turn money into a drain on purchasing power.

Money evolved organically to possess all three of these characteristics, because all three characteristics have been economically important and useful. To try to strip currency of one of its essential functions is to risk the rejection of that currency.

How would I react in the case of negative nominal interest rates? I’d convert into a liquid medium that was not subject to a negative rate of interest. That could be a nonmonetary asset, a foreign currency, a digital currency or a precious metal. I would actively seek ways to opt out of using the negative-yielding currency at all — if I could get by using alternative currencies, digital currencies, barter, then I would.  I would only ever possess a negative-yielding currency for transactions (e.g. taxes) in which the other party insisted upon the negative-yielding currency, and would then only hold it for a minimal period of time. It seems only reasonable that other individuals — seeking to avoid a draining asset — would maximise their utility by rejecting the draining currency whenever and wherever possible.

In Kimball’s theory, this unwillingness to hold currency is supposed to stimulate the economy by encouraging productive economic activity and investment. But is that necessarily true? I don’t think so. So long as there are alternative stores of purchasing power, there is no guarantee that this policy would result in a higher rate of  economic activity.

And it will drive economic activity underground. While governments may relish the prospect of higher tax revenues (due to more economic activity becoming electronic, and therefore trackable and traceable), in the present depressionary environment recorded and taxable economic activity could even fall as more economic activity goes underground to avoid negative rates. Increasingly authoritarian measures might be taken — probably at great cost — to encourage citizens into using the negative-yielding legal tender.

Banking would be turned upside down. Lending at a negative rate of interest — and suffering from the likely reality that negative rates discourages deposits — banks would be forced to look to riskier or offshore or black market activities to achieve profits. Even if banks continued to lend at low positive rates, the negative rates of interest offered to depositors would surely lead to a mass depositor exodus (perhaps to offshore or black market banks offering higher rates), probably leading to liquidity crises and banking panics.

As Izabella Kaminska wrote in July:

The simple fact of the matter is that in a negative carry world – or a flat yield environment for that matter – there is no role or purpose for banks because banks are forced into economically destructive practices in order to stay profitable.

Additionally, a negative-yielding environment will result in reduced income for those on a fixed income. One interesting effect of the present zero-interest rate environment is that more elderly people — presumably starved of sufficient retirement income — are returning to the labour force, which is in turn crowding out younger inexperienced workers, who are suffering from very high rates of unemployment and underemployment. A negative-yielding environment would probably exacerbate this effect.

So on the surface, the possibility of negative nominal rates seems deeply problematic.

Japan has spent almost twenty years at the zero bound, in spite of multiple rounds of quantitative easing and stimulus. Yet Japan remains mired in depression. The fact remains that both conventional and unconventional monetary policy has proven ineffective in resuscitating Japanese growth. My hypothesis remains that the real issue is the weight of excessive total debt (Japan’s total debt load remains as precipitously high as ever) and that no amount of rate cuts, quantitative easing or unconventional monetary intervention will prove effective. I hypothesise that a return to growth for a depressionary post-bubble economy requires a substantial chunk of the debt load (and thus future debt service costs) being either liquidated, forgiven or (often very difficult and slow) paid down.

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The Data That Won It For Obama

I wondered during the final debate whether Mitt Romney might steal a phrase from Ronald Reagan and ask Americans if they were better off than they were four years ago. It has worked for the Republicans before, and all the polling data pointed to the idea that voters were looking at the economy as the top issue.

Yet Romney did no such thing. Perhaps that was because by a number of significant measures, many Americans are better off than they were three or four years ago when America was mired in the epicentre of a global economic crisis. While America is in many cases just catching up to ground lost in the 2008 crash, and while many significant and real doubts remain about the underlying fundamentals of the American and global economies, the American economy has reinflated since early 2009.

Real GDP growth has been sustained:

The S&P500 has gone upward:

So has industrial production:

And total wages and salaries:

And here’s corporate profits:

And although total employment remains significantly depressed, headline unemployment has fallen (and those who have dropped out of the labour force have been entitled to expanded welfare programs):

It seems — although this was a very divided election — that these data provided enough juice to give just enough Americans the sense that although they may not be better off than they were at the turn of the millennium, under Obama things are improving just enough.

Certainly, some groups who have not fared well due to low interest rates such as seniors rejected Obama, too. Other groups, like women, deserted the Republicans on social issues. Yet Republicans looking for reasons why Romney ultimately lost probably need look no further than slow but steady reinflation.

Beneath the surface, this tepid reinflation is very much akin to the economy that got Bush re-elected in 2004. That recovery ended in mania and a bubble and finally a crash when subprime imploded in 2008. It is more than possible that this recovery is equally unsustainable and will end the same way, in crushing disappointment and grinding deflation.

Debt — the fuel of bubbles — is slowly growing again, from a perilously high starting point:

Deleveraging in the new quantitatively-eased environment has been very, very slow. This is a delicate and dangerous balancing act. Total debt levels as a percentage of the economy remain humungous and are a grinding weight on the underlying economy:

The Obama-Bernanke reinflation may well be an illusion built on the shakiest of foundations. And it may end more painfully than even the disastrous Bush-Greenspan reinflation. Yet it was enough to guarantee Obama re-election.

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The Burden of Government Debt

There has been an awful lot of discussion in recent months about whether government debt is a burden for future generations. The discussion has gone something like this: those who believe government debt is a burden claim that it is a burden because future generations have to repay taxes for present spending, those who believe that it is not claim that every debt is also credit, and so because the next generation will inherit not only the debt but also the credit, that government debt is not in itself a burden to future generations, unless it is largely owed to foreign creditors.

It is relatively easy to calculate what the monetary burden of government debt is. Credit inheritance and debt inheritance are not distributed uniformly. The credit inheritance is assumed strictly by bondholders, and the debt inheritance is assumed strictly by taxpayers. Each individual has a different burden, equalling their tax outlays, minus their income from government spending (the net tax position).

For an entire nation, everyone’s individual position is summed together. In a closed economy where the only lenders are domestic, the intergenerational monetary burden is zero. But that is by no means the entire story.

First, debts to foreign lenders are a real monetary burden, because the interest payments constitute a real transfer of money out of the nation. Second, while there may be little or no debt burden for the nation as a whole, interest constitutes a transfer of wealth between citizens of the nation, specifically as a transfer payment from future taxpayers to creditors. This adds up, at current levels, to nearly half a trillion of transfer payments per year from taxpayers to creditors. So while the intergenerational burden may technically add up to zero for the nation, it will not for individuals. The real burden is huge transfers from those who pay the tax to those who receive the spending, and those who receive the interest. So who loses out?

Here are the figures for 2009 showing net tax position for each income quintile:

Bottom quintile: -301 percent
Second quintile: -42 percent
Middle quintile: -5 percent
Fourth quintile: 10 percent
Highest quintile: 22 percent

Top one percent: 28 percent

The negative 301 percent means that a typical family in the bottom quintile receives about $3 in transfer payments for every dollar earned.

What this data does not show are the reverse transfers via interest payments. There is no data (that I can find) on treasury interest payments received by income quintile, but assuming that the top quintile dominates income from interest (as they dominate ownership of financial assets, owning over 95% of all financial assets) this leaves the lower income quintiles benefiting from transfer payments, the top quintile benefiting from interest (as well as policies like bank bailouts, corporate subsidies, and quantitative easing, whose benefits overwhelmingly benefit the top quintile), and squeezing the taxpaying middle quintiles who receive neither the benefits of interest payments, nor significant welfare transfers.

To misquote George Orwell, when it comes to the national debt and who takes its burden, some pigs are definitely more equal than others.

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Debt & Obesity

The waistline bubble began to expand at just about the same time as the debt bubble:

First, it’s important emphasise that correlation is not causation — more than 99% of murderers have consumed water in the twenty four hour period preceding a murder. But it is clear that the effects of globalisation are at play in both cases (simply because globalisation has transformed the American economy) – far fewer Americans have to do physically demanding manufacturing work, and thanks to the mechanisation of agriculture and food production there are far more calories-per-American available to consume.

The interesting difference between debt and obesity is that while it is possible from historical evidence to construct a fairly coherent model linking excess outgrowth in debt with recession and depression — for example, I conjecture that a depression becomes inevitable when debt service cost growth consistently outpaces income growth  — there is no such historical evidence available for obesity, because there has never in known world history been an obesity epidemic of such proportion, so there is no way to know how the obesity bubble may burst.

To what extent do the healthcare overheads of an obesity epidemic act as a drag on economic growth? According to an estimate by the CDC, $147 billion.

How much of a drag on the real economy is supporting those who have dropped out of the labour force due to obesity-related illness like diabetes, fatigue, depression and cardiovascular illness?

Well, we know that in the years that obesity has been exploding, that the disabled proportion of the workforce has almost tripled:

That’s almost 9 million individuals receiving Federal disability — almost six million more than we would have if the number of those receiving Federal disability was proportionate to the numbers at the beginning of the Ford administration. And if each disabled worker was contributing the per-capita average of $46,546 to GDP, the US would be producing roughly $279 billion more output. Even if only half of the increase is associated with obesity (a very, very, very conservative estimate) that equates to around $140 billion of  lost output. That — especially when considered next to the healthcare costs — is a pretty big gap, and that does not even begin to consider that the obese workers not on disability tend to be associated with lowered productivity.

So to what extent has the debt acquisition been an attempt to paper over the cracks of an economy increasingly losing productivity due to obesity and obesity-related illness, and to what extent is obesity linked to the current American employment and growth weakness?

Well, we know that it is possible to blow up a huge debt bubble without a high level of obesity, because Japan has been mired in a debt-fuelled depression for the last twenty years without any associated obesity epidemic, and because the Great Depression was preceded by a huge outgrowth in debt, but no such outgrowth in obesity. And certainly, the United States lives with far greater burdens than the effects of obesity — for example, the quantifiable burden of invading and occupying Iraq and Afghanistan has been greater in the past decade than the quantifiable burden of growing national obesity. This is not to mention the effects of job migration, maintaining a global empire with bases in over 150 countries, and bailing out Wall Street banks. Debt has been a means to paper over the cracks of lost productivity and an American empire living far beyond the means of its productivity — but there is far more to that than just the outgrowth in obesity.

But obesity is causing a significant output loss, which by definition contributes to the wider problems.

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Krugman, Newton & Zombie Banks

Paul Krugman:

Mitt Romney – supposedly advised by Mankiw among others – is outraged:

[T]he American economy doesn’t need more artificial and ineffective measures. We should be creating wealth, not printing dollars.

That word “artificial” caught my eye, because it’s the same word liquidationists used to denounce any efforts to fight the Great Depression with monetary policy. Schumpeter declared that

Any revival which is merely due to artificial stimulus leaves part of the work of depressions undone

Hayek similarly decried any recovery led by the “creation of artificial demand”.

Milton Friedman – who thought he had liberated conservatism from this kind of nonsense –must be spinning in his grave.

The Romney/liquidationist view only makes sense if you believe that the problem with our economy lies on the supply side – that workers lack the incentive to work, or are stuck with the wrong skills, or something.

Perhaps Krugman ought to consider more seriously the reality that since both Japan and now America have gone down the path of continually bailing out a corrupt, dysfunctional and parasitic financial system that neither nation has truly recovered.

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. While some surely perished from misfortune, and some surely survived from luck, this basic antifragile mechanism ensured the survival of the fittest agriculturalists and the transmission of their methods, ideas and genes to further generations. In the financial sector today the Darwinian mechanism has been turned on its head; in both Japan and the West, financiers have not been forced by failure to learn from their mistakes, because governments and regulators protected them from failure with injections of liquidity. Markets have become hypnotised and junkified, trading the possibility of the next injection of central banking liquidity instead of market fundamentals.

So it should be no surprise that financial institutions have continued making exactly the same mistakes that created the crisis in 2008. That crisis was caused by excessive financial debt. Many Wall Street banks in 2008 had forty or fifty times as much leverage as they had equity. The problem with leverage is that while successful bets can very quickly lead to massive profits, bad bets can very quickly lead to insolvency, liquidity panics and default cascades.

Following 2008, many on Wall Street promised they had learned their lesson, and that the days of excessive leverage and risk-taking with borrowed money were over. But, in October 2011, another Wall Street bank was taken down by bad bets financed by excessive leverage: MF Global. Their leverage ratio? 40:1.

So why was the banking system bailed out in the first place? Defenders of the bailouts have correctly pointed out that not bailing out certain banks would have caused the entire system to collapse. This is because the global financial system is an interconnected web. If a particularly interconnected bank disappears from the system, and cannot repay its creditors, the creditors themselves become threatened with insolvency. Without state intervention, a single massive bankruptcy can quickly snowball into systemic destruction. The system itself is fundamentally unsound, fundamentally fragile, and prone to collapse.

Government life-support has given Wall Street failures the resources to continue their dangerous and risky business practices which caused the last crisis. Effectively, Wall Street and the international financial system has become a government-funded zombie — unable to sustain itself in times of crisis through its own means, dependent on suckling the taxpayer’s teat, alive but yet failing to invest in small business and entrepreneurs.

My theory is this: our depression is not a problem of insufficient demand. It is systemic; most prominently and immediately financial fragility, financial zombification, moral hazard, and excessive private debt, alongside a huge number of other long-term systemic problems.

The new policy of unlimited quantitative easing is an experiment. If those theorists of insufficient aggregate demand are right, then the problem will soon be solved, and we will return to strong long-term organic growth, low unemployment and prosperity. I would be overjoyed at such a prospect, and would gladly admit that I was wrong in my claim that depressed aggregate demand has merely been a symptom and not a cause. On the other hand, if economies remain depressed, or quickly return to elevated unemployment and weak growth, or if the new policy has severe adverse side effects, it is a signal that those who proposed this experiment were wrong.

Certainty is something that economists in particular should be particularly guarded against, even as a public relations strategy. Isaac Newton famously noted in the aftermath of the South Sea bubble that “I can calculate the motion of heavenly bodies but not the madness of people.” In the sphere of human action, there are no clear and definitive mathematical principles as there are in astronomy or thermodynamics; there have always been oddities, exceptions and quirks. There has always been wildness, even if it is at times hidden.

So we shall see who is right. I lean toward the idea— as Schumpeter did — that the work of depressions and crises is clearing out unsustainable debt, unsustainable business models, unsustainable companies, unsustainable banks and — as much as anything else — unsustainable economic theories.

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Forget Broccoli

Americans are either celebrating or damning the Supreme Court’s 5-4 ruling that the individual mandate is constitutional.

I find it hard to believe that anyone believed that the Supreme Court would rule any other way. Precedent dictates that the Federal powers of taxation are unimpeachable, and have been so since the New Deal. That’s the state of reality, and I found it puzzling that the individual mandate to purchase healthcare might be deemed unconstitutional when the collective mandate to collect taxes to purchase next-to-everything (including both healthcare and broccoli) has been considered constitutional for the best part of a century.

If America wants to overturn current legal norms America needs to elect different politicians. But with a greater and greater welfare-bound population, it seems inevitable that more and more Americans will vote themselves greater and greater quantities of free stuff.

Yet there is a bigger point to all of this, and it’s nothing to do with broccoli.

If Congress can constitutionally create a mandate for individuals to purchase healthcare, then Congress can create a mandate for individuals to purchase financial securities. Which — given the fiscal cliff that we are about to run off, and the reality that more and more sovereigns are dumping dollars and treasuries — could well be a useful weapon in keeping the Treasury’s borrowing costs low and the bread and circuses flowing.

Here are the GAO’s own figures:

With such a humungous load, it will take a lot of (shall we say) financial engineering to keep borrowing costs low.

The purchase of treasury securities is of course something Japan already mandates of financial institutions. Sure — the Fed and the primary dealers can do a lot of the heavy lifting — but what’s stopping Congress from mandating that patriotic Americans with any spare cash dump it into government securities (or even flagging equities)?

One day, Atlas may shrug. Until that day, Congress just acquired a powerful new funding tool.