paul krugman for budget director!

So Peter Orszag recently resigned as director of the Office of Management and Budget.  I figure that he wants to get out before the fiscal train wreck comes to a head, and I'm sure the director of the budget's job isn't any easier when Congress refuses to even pass a budget (as they have done this year).  There has been some speculation regarding who Obama will nominate to replace Orszag, but I recently found this article by Simon Johnson, the former chief economist at the International Monetary Fund.  It had the laughable premise of suggesting Paul Krugman as Orszag's replacement.  Right now Krugman is getting a lot of heat for his recent op-ed which suggested, if not promised, that the U.S. was doomed to slip into another great depression if the U.S. did not spend billions and billions of deficit dollars to stimulate the economy (article here).  Really?  A depression is inevitable without massive increases in government spending?  Now although I don't agree with the premise that government spending alone will turn the economy around, I don't think that anyone other than Krugman believes that it is the only way to avoid a depression.

Unfortunately this is a tough hypothesis to test; however, we do know that for the past two years almost everything that has been suggested by Mr. Krugman has been implemented as policy by Mr. Obama.  As has been outlined by The Wall Street Journal and others, Obama has followed Krugman's advice to spend, spend, spend in order to counteract the negative aspects of a lack of demand; Mr Krugman has stated numerous times that he believes that depressed demand is the main culprit for our current economic troubles.  In order to stimulate demand, the government needs to spend because private industry will not.  That is the Krugman economic fix.

President Obama has heeded his warning.  First there was Mr. Obama's first budget, in which overall federal spending rose 18%, or $536 billion.  And this doesn't even reflect the true increase in spending.  Thanks to low interest rates the feds were able to save about $65 billion on debt servicing, so the true increase in federal outlays was closer to 22%.  And that was only in ONE YEAR.  Throw in the $800 billion dollar stimulus (which was not included in the budget) and total spending increased by roughly $1.4 trillion.  This increased spending meant that total federal expenditures reached over 24% of GDP, a post-war record.  How much more spending does Mr. Krugman want?  Under Obama we already now have one in every four dollars earned by American redistributed by 535 people sitting in Washington, D.C.  And lest we forget, that spending will increase even more when the the trillion dollar plus health care entitlement begins running huge deficits. 

Despite all this spending and the promise of economic recovery that came with it, the results have not materialized.  And this isn't the only reason to question Mr. Krugman's credentials to run the Budget Office.  Check out this Krugman Article from 2003 when he blasted the Bush administration for increasing deficit spending.  According to Krugman, he refinanced to fixed rate mortgage because he was sure that interest rates were sure to rise.  The Bush administration's reckless spending and tax cuts — which increased the deficit to about 3% of GDP — would have to cause interest rates to sky rocket.  Here he is in his own words:

But what's really scary — what makes a fixed-rate mortgage seem like such a good idea — is the looming threat to the federal government's solvency.

That may sound alarmist: right now the deficit, while huge in absolute terms, is only 2 — make that 3, O.K., maybe 4 — percent of G.D.P. But that misses the point. "Think of the federal government as a gigantic insurance company (with a sideline business in national defense and homeland security), which does its accounting on a cash basis, only counting premiums and payouts as they go in and out the door. An insurance company with cash accounting . . . is an accident waiting to happen." So says the Treasury under secretary Peter Fisher; his point is that because of the future liabilities of Social Security and Medicare, the true budget picture is much worse than the conventional deficit numbers suggest.

Oh wait I'm sorry.  I guess Mr. Krugman does understand that budget deficits can be a problem, although it is only when the party in power is one he does not agree with. He was worried when deficits were 3% of GDP, but now that it is almost 10% he insists on more spending.  Demand-siders (my new name for those insisting on government spending as the best way for economic recovery) will counter by saying the spending is needed now to avoid a recession, but regardless whether it is needed or not will not change the effects of those deficits.  Even if the spending is desperately needed, higher deficit levels coupled with the looming social security/medicare insolvency (which Mr. Krugman did rightly point out) can lead to tremendously bad consequences.  Most likely these will be soaring interest rates and the inflation that accompanies the monetizing of the debt.  Mr. Krugman can't have it both ways, and unfortunately I think his 2003 analysis was closer to correct.

All of this is just further evidence that Krugman isn't much of an economist anymore and is more just a liberal columnist.  He simply uses his economic background to attempt to justify typical liberal policies: increase spending and redistribution of wealth.  He loves to bash business and blames excessive risk as the major cause of the recession.  He has called long term unemployment a "slow-motion human and social disaster" that must be counteracted at almost any cost; however, he also called the Waxman-Markey Cap-and-trade bill "well short of what the planet really needs."  You don't have to be a economics professor at Princeton to recognize that increasing the cost of energy and more environmental regulation will slow economic growth, making it even harder for the unemployed to find work. When he attacked Senator Jim Bunning's block of the extension of unemployment benefits for people that have been out of work for up to two years, he claimed that it was "bizarre" that anyone would think that providing employment benefits in continuum would disincentivize people to work.  However, a textbook authored by Paul Krugman called "Macroeconomics" contains the following passage:

Public policy designed to help workers who lose their jobs can lead to structural unemployment as an unintended side effect. . . .  In other countries, particularly in Europe, benefits are more generous and last longer.  The drawback to this generosity is that it reduces a worker’s incentive to quickly find a new job .  Generous unemployment benefits in some European countries are widely believed to be one of the main causes of “Eurosclerosis,” the persistent high unemployment that affects a number of European Countries.

 Like I stated Krugman seems less and less like a economist and more and more like a typical political columnist.  This in and of itself is not a bad thing, however, when people try to defend Obama's economic policies they often point to Mr. Krugman for justification.  I refuse to defer to his diminishing authority.

corporations are bad, mmmkay?

That's common knowledge today, correct?  Corporations are evil, greedy entities that steal from the poor and give to the rich.  They don't care about anything but profits.  This type of greed is inherently evil, and money is the source of that evil.  For generations progressives and socialists have made that argument.  According to them, profit seeking is not a good thing, and without Big Brother there to keep them under control, they will eventually plunder the nation.  Look at the bashing BP is getting right now.  Obviously, they deserve a lot of blame of the spill itself.  However, criticism of BP is hardly limited to the spill.  Often the criticism has been aimed directly at allowing the profit seeking motive itself.  According to many of these commentators, the profit seeking motive is flawed, as companies will not consider the public interest in making decisions leading to less desirable social outcomes.  Instead, they believe that that the government should exercise huge amounts of control over these corporations in order to coax them into doing what they consider is "right thing to do."

As I mentioned in an earlier post, I am currently reading Atlas Shrugged by Ayn Rand.  Although I am only about half way done, a recent rant by one of the characters really caught my attention.  His name is Fransisco d'Anconia, and this rant was aimed to be a defense of the profit seeking motive.  He said it better than I could say it myself, so here it is in his entirety.  I know it is really long, but I think it is right on point.  (Note: Also, I just want to say that although Ms. Rand's estate obviously owns the copyright to the following excerpt, I am reprinting with the intention to comment on its meaning, so as to explain its significance and relevance today.  I believe this is consistent with the fair use doctrine codified under 17 U.S.C. § 106.  I encourage any and all, if they find the following passage interesting or through provoking to purchase the entire book and read it for themselves.  A link is provided at the end of this post.)

"So you think that money is the root of all evil?" said Francisco d'Anconia. "Have you ever asked what is the root of money? Money is a tool of exchange, which can't exist unless there are goods produced and men able to produce them. Money is the material shape of the principle that men who wish to deal with one another must deal by trade and give value for value.   Money is not the tool of the moochers, who claim your product by tears, or of the looters, who take it from you by force. Money is made possible only by the men who produce. Is this what you consider evil?

"When you accept money in payment for your effort, you do so only on the conviction that you will exchange it for the product of the effort of others. It is not the moochers or the looters who give value to money. Not an ocean of tears not all the guns in the world can transform those pieces of paper in your wallet into the bread you will need to survive tomorrow. Those pieces of paper, which should have been gold, are a token of honor--your claim upon the energy of the men who produce. Your wallet is your statement of hope that somewhere in the world around you there are men who will not default on that moral principle which is the root of money, Is this what you consider evil?

"Have you ever looked for the root of production? Take a look at an electric generator and dare tell yourself that it was created by the muscular effort of unthinking brutes. Try to grow a seed of wheat without the knowledge left to you by men who had to discover it for the first time. Try to obtain your food by means of nothing but physical motions--and you'll learn that man's mind is the root of all the goods produced and of all the wealth that has ever existed on earth.

"But you say that money is made by the strong at the expense of the weak? What strength do you mean? It is not the strength of guns or muscles. Wealth is the product of man's capacity to think. Then is money made by the man who invents a motor at the expense of those who did not invent it? Is money made by the intelligent at the expense of the fools? By the able at the expense of the incompetent? By the ambitious at the expense of the lazy? Money is made--before it can be looted or mooched--made by the effort of every honest man, each to the extent of his ability. An honest man is one who knows that he can't consume more than he has produced.'

"To trade by means of money is the code of the men of good will. Money rests on the axiom that every man is the owner of his mind and his effort. Money allows no power to prescribe the value of your effort except the voluntary choice of the man who is willing to trade you his effort in return. Money permits you to obtain for your goods and your labor that which they are worth to the men who buy them, but no more. Money permits no deals except those to mutual benefit by the unforced judgment of the traders. Money demands of you the recognition that men must work for their own benefit, not for their own injury, for their gain, not their loss--the recognition that they are not beasts of burden, born to carry the weight of your misery--that you must offer them values, not wounds--that the common bond among men is not the exchange of suffering, but the exchange of goods. Money demands that you sell, not your weakness to men's stupidity, but your talent to their reason; it demands that you buy, not the shoddiest they offer, but the best that your money can find. And when men live by trade--with reason, not force, as their final arbiter--it is the best product that wins, the best performance, the man of best judgment and highest ability--and the degree of a man's productiveness is the degree of his reward. This is the code of existence whose tool and symbol is money. Is this what you consider evil?

"But money is only a tool. It will take you wherever you wish, but it will not replace you as the driver. It will give you the means for the satisfaction of your desires, but it will not provide you with desires. Money is the scourge of the men who attempt to reverse the law of causality--the men who seek to replace the mind by seizing the products of the mind.

"Money will not purchase happiness for the man who has no concept of what he wants: money will not give him a code of values, if he's evaded the knowledge of what to value, and it will not provide him with a purpose, if he's evaded the choice of what to seek. Money will not buy intelligence for the fool, or admiration for the coward, or respect for the incompetent. The man who attempts to purchase the brains of his superiors to serve him, with his money replacing his judgment, ends up by becoming the victim of his inferiors. The men of intelligence desert him, but the cheats and the frauds come flocking to him, drawn by a law which he has not discovered: that no man may be smaller than his money. Is this the reason why you call it evil?

"Only the man who does not need it, is fit to inherit wealth--the man who would make his own fortune no matter where he started. If an heir is equal to his money, it serves him; if not, it destroys him. But you look on and you cry that money corrupted him. Did it? Or did he corrupt his money? Do not envy a worthless heir; his wealth is not yours and you would have done no better with it. Do not think that it should have been distributed among you; loading the world with fifty parasites instead of one, would not bring back the dead virtue which was the fortune. Money is a living power that dies without its root. Money will not serve the mind that cannot match it. Is this the reason why you call it evil?

"Money is your means of survival. The verdict you pronounce upon the source of your livelihood is the verdict you pronounce upon your life. If the source is corrupt, you have damned your own existence. Did you get your money by fraud? By pandering to men's vices or men's stupidity? By catering to fools, in the hope of getting more than your ability deserves? By lowering your standards? By doing work you despise for purchasers you scorn? If so, then your money will not give you a moment's or a penny's worth of joy. Then all the things you buy will become, not a tribute to you, but a reproach; not an achievement, but a reminder of shame. Then you'll scream that money is evil. Evil, because it would not pinch-hit for your self-respect? Evil, because it would not let you enjoy your depravity? Is this the root of your hatred of money?

"Money will always remain an effect and refuse to replace you as the cause. Money is the product of virtue, but it will not give you virtue and it will not redeem your vices. Money will not give you the unearned, neither in matter nor in spirit. Is this the root of your hatred of money?

"Or did you say it's the love of money that's the root of all evil? To love a thing is to know and love its nature. To love money is to know and love the fact that money is the creation of the best power within you, and your passkey to trade your effort for the effort of the best among men. It's the person who would sell his soul for a nickel, who is loudest in proclaiming his hatred of money--and he has good reason to hate it. The lovers of money are willing to work for it. They know they are able to deserve it.

"Let me give you a tip on a clue to men's characters: the man who damns money has obtained it dishonorably; the man who respects it has earned it.

"Run for your life from any man who tells you that money is evil. That sentence is the leper's bell of an approaching looter. So long as men live together on earth and need means to deal with one another--their only substitute, if they abandon money, is the muzzle of a gun.

"But money demands of you the highest virtues, if you wish to make it or to keep it. Men who have no courage, pride or self-esteem, men who have no moral sense of their right to their money and are not willing to defend it as they defend their life, men who apologize for being rich--will not remain rich for long. They are the natural bait for the swarms of looters that stay under rocks for centuries, but come crawling out at the first smell of a man who begs to be forgiven for the guilt of owning wealth. They will hasten to relieve him of the guilt--and of his life, as he deserves.

"Then you will see the rise of the men of the double standard--the men who live by force, yet count on those who live by trade to create the value of their looted money--the men who are the hitchhikers of virtue. In a moral society, these are the criminals, and the statutes are written to protect you against them. But when a society establishes criminals-by-right and looters-by-law--men who use force to seize the wealth of disarmed victims--then money becomes its creators' avenger. Such looters believe it safe to rob defenseless men, once they've passed a law to disarm them. But their loot becomes the magnet for other looters, who get it from them as they got it. Then the race goes, not to the ablest at production, but to those most ruthless at brutality. When force is the standard, the murderer wins over the pickpocket. And then that society vanishes, in a spread of ruins and slaughter.

"Do you wish to know whether that day is coming? Watch money. Money is the barometer of a society's virtue. When you see that trading is done, not by consent, but by compulsion--when you see that in order to produce, you need to obtain permission from men who produce nothing--when you see that money is flowing to those who deal, not in goods, but in favors--when you see that men get richer by graft and by pull than by work, and your laws don't protect you against them, but protect them against you--when you see corruption being rewarded and honesty becoming a self-sacrifice--you may know that your society is doomed. Money is so noble a medium that is does not compete with guns and it does not make terms with brutality. It will not permit a country to survive as half-property, half-loot.

"Whenever destroyers appear among men, they start by destroying money, for money is men's protection and the base of a moral existence. Destroyers seize gold and leave to its owners a counterfeit pile of paper. This kills all objective standards and delivers men into the arbitrary power of an arbitrary setter of values. Gold was an objective value, an equivalent of wealth produced. Paper is a mortgage on wealth that does not exist, backed by a gun aimed at those who are expected to produce it. Paper is a check drawn by legal looters upon an account which is not theirs: upon the virtue of the victims. Watch for the day when it bounces, marked, 'Account overdrawn.'

"When you have made evil the means of survival, do not expect men to remain good. Do not expect them to stay moral and lose their lives for the purpose of becoming the fodder of the immoral. Do not expect them to produce, when production is punished and looting rewarded. Do not ask, 'Who is destroying the world? You are.

"You stand in the midst of the greatest achievements of the greatest productive civilization and you wonder why it's crumbling around you, while you're damning its life-blood--money. You look upon money as the savages did before you, and you wonder why the jungle is creeping back to the edge of your cities. Throughout men's history, money was always seized by looters of one brand or another, whose names changed, but whose method remained the same: to seize wealth by force and to keep the producers bound, demeaned, defamed, deprived of honor. That phrase about the evil of money, which you mouth with such righteous recklessness, comes from a time when wealth was produced by the labor of slaves--slaves who repeated the motions once discovered by somebody's mind and left unimproved for centuries. So long as production was ruled by force, and wealth was obtained by conquest, there was little to conquer, Yet through all the centuries of stagnation and starvation, men exalted the looters, as aristocrats of the sword, as aristocrats of birth, as aristocrats of the bureau, and despised the producers, as slaves, as traders, as shopkeepers--as industrialists.

"To the glory of mankind, there was, for the first and only time in history, a country of money--and I have no higher, more reverent tribute to pay to America, for this means: a country of reason, justice, freedom, production, achievement. For the first time, man's mind and money were set free, and there were no fortunes-by-conquest, but only fortunes-by-work, and instead of swordsmen and slaves, there appeared the real maker of wealth, the greatest worker, the highest type of human being--the self-made man--the American industrialist.

"If you ask me to name the proudest distinction of Americans, I would choose--because it contains all the others--the fact that they were the people who created the phrase 'to make money.' No other language or nation had ever used these words before; men had always thought of wealth as a static quantity--to be seized, begged, inherited, shared, looted or obtained as a favor. Americans were the first to understand that wealth has to be created. The words 'to make money' hold the essence of human morality.

"Yet these were the words for which Americans were denounced by the rotted cultures of the looters' continents. Now the looters' credo has brought you to regard your proudest achievements as a hallmark of shame, your prosperity as guilt, your greatest men, the industrialists, as blackguards, and your magnificent factories as the product and property of muscular labor, the labor of whip-driven slaves, like the pyramids of Egypt. The rotter who simpers that he sees no difference between the power of the dollar and the power of the whip, ought to learn the difference on his own hide-- as, I think, he will.

"Until and unless you discover that money is the root of all good, you ask for your own destruction. When money ceases to be the tool by which men deal with one another, then men become the tools of men. Blood, whips and guns--or dollars. Take your choice--there is no other--and your time is running out." (My emphasis added)

 Like I said, I am only about half way done, but this passage struck me as one of the most succinct, well-reasoned defense and applications of the principles first put forward by Adam Smith when he described the invisible hand of capitalism those hundreds of years ago.  With the America turning 234 on Sunday, it is important to keep in mind what made America great.  It was not those who wish to spend other peoples money for the "public good" but those who freely did what was in their best interest and along the way made a lot of money and just so happened to raise the rest of us up with them.

free lunches and the rule of law

"Nothing is free in this world."  That is one of the quotes I heard growing up on almost a daily basis.  Usually it was from my father, once again reminding me of something that I needed to do.  However, there may be no more of an apt quote to describe wealth creation in our society.  Contracts and business relationships are based on a symbiotic relationship between two parties: each offers something the other desires, and the parties offer to provide something the counter-party desires in return.  At the end of the day, each side is better off as they receive a benefit that they could not provide to themselves, and in order for the transaction to occur that benefit must at least be equal to the value of the payment in the mind of each party.  Hence, these transactions are often wealth generating, as each party is in a position they think that they are better off, and therefore more wealthy, than they were prior to the transaction.

In my opinion the Obama Administration does not recognize the market as a wealth creation mechanism or at the very least underestimates its importance.  Private transactions are the engines of economic growth, and if Obama were truly interested in turning around the job market and reinvigorating the economy he would put into place polices that further increase the incentives to do business such as lowering marginal tax rates, reorganizing and simplifying federal agencies in order to decrease complexity in industry and lower the barriers to entry, and begin addressing long term budgetary issues no so that markets will be reaffirmed in their belief of the long term solvency of the federal government (keeping low the cost of credit).

However, all of these policies have tradeoffs, be it decreased federal revenue, loss of some services or decreased payouts to those receiving entitlement payments (although it is worth to note that most of these savings would be at the expense of future benefits, not those currently on social security and medicare).  Many countries are already taking such measures, and they aren't your traditional list of unfettered capitalists: the United Kingdom, Germany and even partially France.  However, back in the good old U.S. Obama has made federal government spending in the form of jobless benefits, stimulus, and other spending programs the key to his economic development strategy.  According to Obama and the neo-Kenyesians who push this strategy, the U.S. economy's main problem is lack of demand, and that by pouring money into the system in the form of government contacts and welfare, demand will be boosted and the economy will grow.  This is partly the policy justification for the stimulus back in 2009, the continued extensions of jobless benefits and the current push to provide bailouts to that state governments so that they are not forced to make tough political decisions such as whether to fire teachers or raise taxes.  Obama continually dismisses the negative effect this spending has on the budget (which is completely financed through borrowing as the deficit is in the trillions of dollars) claiming that the extra debt is hardly a drop in the bucket compared to our total liabilities.  Therefore Obama is basically selling the position that the spending is all gain and no pain: we will experience growth now and the cost will be little more than interest payments down the road.

This brings me back to the adage, "Nothing in this world is free." Obama's policies seem to run afoul of this rule, and luckily more and more people are beginning to notice it.  Despite the administrations claim that the stimulus has created around 2.5 million jobs, which it has no way of supporting or justifying, there is little sign that it has had an overall positive effect on he economy.  The administration prefers these types of policy choices, whereby they can tout benefits immediately and push any potential liability down the road.  Well by this logic, why do we ever stop stimulating the economy? If wealth can be created simply by government spending, we should have government spend as much money as possible.  It's the elusive free lunch! The truth is that this type of spending dose little to encourage long term investment - the engine of wealth creation - and its adverse effects are simply kicked down the road.  This is endemic in many of Obama's policy choices: the healthcare bill, extension of jobless benefits, and all the other debt financed spending.  You know the day of reckoning for this debt is coming when even Western Europe is getting serious about fiscal restraint. Mr. Obama, there is a reason your European colleagues have rejected you calls for a new round of stimulus: even they no longer buy the hype that you can spend your way to growth.

On a slightly unrelated note, I also wanted to briefly discuss an issue that has become more and more troubling.  Since coming into office President Obama has done more to circumvent the rule of law there perhaps any president since FDR.  First, there was the Chrysler and GM bailouts, where Mr. Obama first "put his boot on the heel"of secured creditors in order to appease his union constituency (I documented it at the time here, here, here, here and here).  The bankruptcy system in this country is the envy of the world, and although it may sound counter-intuitive that is a very good thing.  Banks freely lend to businesses and homeowners because they have a mechanism to have that loan repaid even if the borrower defaults.  Usually this insurance takes the form of a security interest in property, whereby the bank will legally be allowed to take title upon default.  However, the system will only work if security priority rules are objective, straightforward and made prospectively.  Without this type of certainty, the lenders will not have faith in the system, and lending will dry up.  Just ask any entrepreneurs in Africa or Eastern Europe about their access to credit in countries that don't have such rules.  The economic growth of these countries suffers enormously as a result.

The GM and Chrysler bailouts were one example were the rule of law in credit allocation was eroded, and the BP shakedown for a cool $20 billion is another.  First, and let me make clear, it is completely BP's liability to compensate those who were adversely affected by this oil spill.  No one challenges this point.  In order for capitalism to properly function, an negligent or intentionally injured third party must be compensated when another party's actions have caused it economic damage.  This forces companies engaged in risky enterprises to take risk into consideration and price it into any business plan.  Just making BP pay these damages will incentivize other oil companies to either beef up their safety and security measures, purchase more insurance or a combination of both.  This is a good thing and example of the market's ability to absorb new information and price assets accordingly.  However, I absolutely do not agree with the President's choice to force BP to set aside $20 billion for claims to be distributed by a third party.  Although this may have been a smart business decision by BP (showing the public it s serious about its obligations, providing a low overhead way of distributing damages and otherwise forgoing at least part of what will be millions in legal fees by settling with some people quickly), BP's original announcement came after a meeting between its Chairman, Mr. Obama and Attorney General Holder.  I'm sure the threat of criminal investigations didn't come up in that meeting.  No I bet there was no quid pro quo at all.  Why would the Justice Department want to investigate the BP Chairman of the Board at all? How could a swedish director have any type of criminal liability for an explosion that happen in the Middle of the Gulf of Mexico?  The reality is there is no possible way to impose criminal liability on a director for this type of accident, although the threat of such an investigation is one hell of a bargaining tool...


What's more is the fact that Mr. Obama is once again rewriting the rules for creditors in an attempt to put politics ahead of the rule of law.  BP could not possibly come up with $20 billion cash without severely affecting its liquidity and cash flow.  Therefore it is making payment in roughly $1.5 billion quarterly installments.  However, until the total is paid, BP was forced to allow the federal government to put a lien on approximately $20 billion of BP's assets.  This may sound fair, but in reality this is giving the Feds first crack at BP's assets should a bankruptcy occur.  This secured interest is now on par with other secured creditors and I have no doubt that in the event of a bankruptcy the feds would be fully repaid at the expense of older creditors.  Although it may sound innocuous and just for the claims of those who have been damaged by the spill to be given a higher priority than creditors, this is simply not how our system works.  Congress designed the secured credit system as a way to ensure the adequate allocation of credit and it has worked exquisitely over time.  Capital from all over the world flows to the U.S. because of the protections it is provided and the impartiality of the courts that uphold the rules.  By turning the law on its head and giving the damages of tort victims higher priority than creditors, some faith and belief in the system is lost, and the rule of law eroded away.  Although innocuous in the short term, over time this trend will have devastating effects on our financial system.  Creditors will begin to price this uncertainty into the price of credit, making it more expensive.  Politically risky activities will begin to find it harder and harder to find credit at all.  This culture of ignoring the dictates of the rule of law, coupled with our increasing debt will, if let unchecked, eventually destroy credit allocation as we know it in this country.  Don't think the U.S. will be a financial powerhouse for ever, as money is the most fungible of all assets, and the flow in to the U.S. is surely vulnerable if the risk of loss is too high.  To protect against this, we must maintain the rule of law and not succumb to the political allocation of capital and economic rights that is more akin to Iran or Venezuela.

immigration

So pretty much out of nowhere immigration has become the hot topic in Washington.  Before Arizona passed its own version of immigration control, no one in Washington was really talking about the issue.  My own cynical opinion is that the Democrats saw immigration as a way to steer the debate away from their unpopular policy debacles (stimulus, auto bailouts, health care, and what is slowly becoming a handout for big banks - financial reform).  With the so-called "jobless economic recovery" and voters pissed as hell at government in general, the Democrats looked poised to suffer monumental losses in November.  In this environment I'd probably want to change the subject as well.  Whether changing the issue to immigration is a smart political move is yet to be seen.

Very few issues are as divisive as immigration.  This has almost always been the case throughout the history of American politics.  Historically, many Americans born here have always felt an aversion to allowing more people to enter "their" country.  This was true in the nineteenth century - Irish, Italian, Asian and Eastern European immigrants were treated extremely harshly by traditional Protestant white majorities that dominated the country at the time.  Not much has changed today other than the fact that many of the people's whose ancestors once belonged to these oppressed groups now wish to limit immigration, themselves, while the majority of the anti-immigration sentiment is now focused on Mexicans.  This idea that we shouldn't allow anymore immigrants into the country when we have so many other problems of our own is what I like to refer to as the "Labor Union View of Population." 

I don't mean to say that labor unions around the U.S. espouse a policy view that we should close our borders.  In fact the opposite is true.  Many influential unions see a large amnesty as a tremendous opportunity to expand their ranks.  Currently many illegal immigrants compete directly with union labor in a variety of industries such as farming, construction and other day-laborer jobs.  Part of the reason some of these workers do not join unions themselves is because of their undocumented status.  Amnesty could change all of that.  But I regress.  The reason I term the anti-immigration view the "Labor Union View" is because in my opinion most Americans who hold anti-immigrant views do so for the same basic reason why a worker joins a labor union: to restrict the size and diversity of the labor pool.  Labor unions operate by restricting the supply of workers an employer has to choose from.  By imposing rules that only union members can be eligible for a job, the price of such labor rises.  Many anti-immigration components feel the same way.  By limiting the amount of immigrants into the country, the total supply of labor will decrease, thereby increasing the price of labor.  Remember the old South Park adage, "THEY TIRK ERRR JEEERBBBSSS?!?" (see clip below)



Now first of all I do not want to make you think that this is the only reason why some anti-immigration view holders do not support a comprehensive immigration reform bill.  I think there is a lot of merit to the argument that the control of our own borders is an urgent national security issue.  Unfortunately we live in an age where thousands of people around the world wish to do innocent, American civilians harm simply because of the way we live our lives.  We have an obligation as a people to stand up to these people that challenge our free and open society.  This means that we must do everything in our power to prevent attacks within our border against our fellow citizens.  However, in my opinion this national security issue is often used by as a smokescreen by politicians whose ultimate goal is to simply close the border. I also believe the argument that we should not reward those people who break our laws by granting them amnesty is deserving of merit.

There is also no doubt that some prejudice is involved as well.  These prejudicial views combined with the idea the immigrants will come in here and take away good well-paying, all-american jobs leads to a political culture that simply demonizes any type of comprehensive immigration reform.  This view point is simply wrong on the policy and wrong on the facts.  Immigration can be a tremendous source of growth in our economy, but only if it is coupled with other pro-growth initiatives along the way.  We must move away from the idea of "Zero-Sum" economics that dominates the immigration debate.  Just because an immigrant comes here and takes a low paying manual labor job does NOT mean that there is one less job for an native born American.  When an employer hires an immigrant for less money than he would have to pay native american to do the same work, the companies overall efficiency has increased.  These savings are eventually reinvested either in the business itself, or passed on to shareholders who can use the money to fund other productive ventures elsewhere in the economy.  This creates real job growth, not the artificial spikes in demand that are the dominant effect of short-term government "stimulus."

 So what would effective reform look like?  First, the emphasis of any policy must incentivize well-educated, hard-working immigrants to come to America.  These are keystone innovators of any society, and technology driven economy like the United States needs these types of thinkers in greater numbers in order to prosper.  The most important proposal I could make in this category would be to be institute a rule that any foreign graduate from a U.S. university with a science or engineering background should be offered a permanent green card and the opportunity to work towards citizenship.  By increasing the number of innovators we can harness the economic growth associated with these individuals over the course of their lives.  I don't think many people could make a strong argument why such a policy is against U.S. interests.

Secondly, I believe that some type of amnesty is necessary.  As I have written many times before, inherent economic realities often provide very strong incentives to break laws that limit the individual's ability to economically prosper.  Take for instance the market for illegal drugs.  The penalties associated with the traffic of these substances is very harsh, in fact much harsher than any anti-immigration laws, but every year millions of Americans take risks anyway to sell and purchase the drugs.  Regardless of the basis for such demand, the economic incentives provided by its mere existence almost forces many poor Americans into entering drug trade.  When the rewards of success are so high, even the chance of criminal punishment does not substantially decrease the average expected value of engaging in such an enterprise.  This is also the case regarding illegal immigration.  The incentives provided by the good working conditions and economic opportunities available in the U.S. make it economically rational to break U.S. immigration laws even taking into account the chance of apprehension.  Therefore illegal immigration will continue regardless of any attempt to truly secure the border because the incentive to break the law is too high.

In this situation, I believe that the prudent and cost-effective strategy would be for the government to attempt to facilitate the actions of economically rational actors in a way that still protects vital national interests such as preventing terrorists from coming into the country.  It makes no sense for government to attempt to completely eliminate a segment of a natural market (in this case outlawing a section of the natural labor market), as it is impossible.  As long as the underlying economic rational remains (which in this case will remain as long as the U.S. economy is prosperous) , people are going to pursue their economic best interests regardless of the penalties that are put into place.  Even the strict criminal penalties instituted in Arizona do not provide enough incentive to overcome the rational economic decision making that immigrants have made in my opinion.  As long as the worse the U.S. government can do is to send them back home, there is little incentive not to try to enter the country.

Therefore I believe the best immigration policy the U.S. can establish would be one that liberalizes the rules for permanent residency.  However, in a country with as many government "social safety net" programs as the U.S., allowing this sort of unfettered immigration could easily lead to abuses.  Obviously I am for the reduction, if not the complete elimination, of many of these wasteful programs that incentivize people to be unproductive.  However, I am in the minority so many of these programs are unfortunately here to stay.  Therefore I would propose that in exchange from dramatically liberalizing and increasing the immigration quotas, the new immigrants would be required to waive any right to participate in a list of certain government programs.  This would include medicaid, the new health care entitlement, and other types of welfare subsidies.  In exchange for giving up access to these handouts, we should end the cap on the number of new immigrants we allow into the country.  If someone does not have a criminal history and wishes to enter the U.S. to work, then we should allow it provided that he or she agrees to give up his ability to simply live off the state.  It is a fair compromise, but I doubt anyone in Congress, especially the Democrats who are simply trying to liberalize immigration so that there will be more wards of the state, would even consider this proposal. 

In conclusion, my basic premise is that illegal immigration is mainly caused by rational economic decision making of these immigrants.  When something is a rational economic decision even in circumstance where the government is attempting to completely ban it (undocumented immigration, drugs, prohibition) then it is nothing more than a tremendous waste of government resources to enforce such a policy.  If there is one thing I firmly believe it is that if a market for some good or service naturally exists (in the case of immigration it is a strong market for labor in the U.S.), then government prohibition of such a market does nothing but push it underground where the rule of law no longer applies.  This gives economic power to those who openly disobey the law and should not be the policy of our government.  Instead we should recognize that we cannot unilaterally eliminate a natural market in our free society, so instead we should attempt to structure the market in such a way that maximizes the benefits to everyone involved.  In the case of immigration I would argue that the best way to do this would be to encourage people who want to work hard to come here and do just that, while still instituting important checks regarding their background.  Are some people that have broke the law in the past or potential terrorists going to slip through the cracks in this type of liberalized system?  Most definitely yes.  However, I believe that is part of the price you must pay in a free and open society.  The economic benefits of liberalization outweigh these risks by an order of magnitude, and I believe that terrorists will get around even the most stringent rules if they really wanted to.  Remember that we have thousands of miles of open border with Canada.  Instead, by eliminating the possibility that immigrants are coming here for a handout, these immigrants could be a tremendous source of growth for years to come.  That would be good for all Americans.

book club

So from time to time I actually do read an occasional book. Although I would have to say over half of what I read is non-fiction, I do enjoy a good novel from time to time. Unfortunately, it has been over a year (since Christmas 2008) that I have read a book cover to cover. So I have decided that I am going to read a book.

As I said, I enjoy non-fiction books. The subject matter that these books come in are in two basic categories: economics/philosophy and golf. However, I really want to read a fictional novel that seems to be a least somewhat related to these two categories. As you may have guessed, this combination does not tend to lead to many dramatic tales of heroism, especially since the political philosophies I enjoy reading about are more libertarian in nature. Nobody seems to want to make their protagonist a golf pro or a champion of laissez faire economics. However, after reading an article in Fortune about Wisconsin Republican Congressman Paul Ryan (btw great article link here), one of his favorite authors caught my eye: Ayn Rand.

Now I have heard of Rand numerous times before, and I knew that her books had been very influential on people like Ronald Reagan, Alan Greenspan, Jack Kemp and Newt Gingrich; however, I have never personally read any of her work.  Obviously, anything that is read by conservative leaders like those mentioned above has never been anywhere near a public high school reading list (where most of the novels I have read have come from).  So I am going to check it out.  And I encourage you to do the same.  Listed below is a link to Rand's masterpiece Atlas Shrugged on Amazon.  From what I have heard, Rand is an excellent writer who champions the idea of free markets and individualism, while still keeping the reader actually engaged in a riveting story.  We shall see.  I am buying the book today, and I will review it on this site when I am finished, although I have no idea when that will be.  Until then, here's to a reading experiemnt.  Hopefully I won't get lazy and try to find a movie version...

lions recap and a look back at cash for clunkers

Penn State easily played their best half of football yet this season when they thoroughly dominated Illinois in the second half on Saturday, en route to a 35-17 win in Champaign. Despite a disappointing first half (PSU led 7-3 at the break), the running game allowed Penn State to control the clock and the ball in the second half, and the offensive line finally learned how to run block. Both Evan Royster and Stephfon Green (pictured below) eclipsed the 100-yard mark, helping PSU out gain Illinois 208-8 in the third quarter. This is exactly the recipe that PSU needs to repeat if they hope to remain competitive in the Big Ten title race. By running the ball and controlling the clock, PSU can keep there defense off the field and fresh, allowing them to do what they do best: simply dominate Big Ten opposing offenses. This also takes some pressure off QB Dayrll Clark, who by the way responded very well after having the worse game of his career against Iowa. If Penn State can run the ball effectively, they will be a force to be reckoned with in the Big Ten and against whoever they end up facing in a bowl game.


On a completely unrelated note, I want to say a few words about the federal government's recent cash for clunkers program. Over the Summer, the program was hailed as the most successful of all the stimulus programs. Over the lifetime of the program (including when it was extended in late august) approximately 700,000 car buyers took advantage of the program where they traded in an old "clunker" for credit towards a new, more fuel efficient vehicle. Sounds great right? Old gas guzzlers off the roads, and it's a boost to American automakers at a time they really need it. Well guess what? Looking back it seems like the plan was all that environmentally beneficial, and in the long run it probably did more to hurt the U.S. economy than it did to help it.

U.S. auto sales plummeted in September, down 25% from 2008 (GM was down 45% and Chrysler 42%). And this is compared to September 2008, right when the banking meltdown was becoming apparent. Critics predicted that the cash for clunkers program would do little than cannibalize future auto sales that would have occurred anyway, and that seems to be the case. September sales are down because many people who would have bought in September simply bought while the program was in effect. Although the automakers may have gained a marginal amount of sales that would not have occurred, there is no way the boost was enough to justify the $3 billion cost of the program. Not to mention that dealers were forced to destroy all the cars traded in during the program. Instead of recycling perfectly capable vehicles, most likely at lower costs that middle and lower class Americans could afford, the feds mandated that we destroy these economic resources.

Additionally, the environmental benefits have been overstated. One study by Hudson Institute economist Irwin Stelzer found that at best the program would reduce oil consumption by 0.2% per year, which amounts to less than one days use of gasoline. Even despite future savings in fuel costs, the program still is very unstimulating. Two University of Delaware economists recently attempted to sum all the benefits and costs of the program (increased auto sales, reduced gas consumption, environmental improvements vs. cost of the program) and found that the benefits do not outweigh the costs, and the true cost to GDP is -$1.4 billion. So much for helping the tanking economy.

In short, the cash for clunkers program is nothing more than the federal government once again attempting to redistribute wealth. The fat cats in Washington spent over $3 billion of our money (adding to the national debt) in order to subsidize new car buyers, and attempt to subsidize car manufacturers. The sad part is that it seems as if they didn't even succeed in reaching their second goal. The editorial board of the Wall Street Journal said it best in their editorial Clunkers in Practice (*please also note that this article was the basis for my post and I used many of their statistics*):

The basic fallacy of cash for clunkers is that you can somehow create wealth by destroying existing assets that are still productive, in this case cars that still work. Under the program, auto dealers were required to destroy the car engines of trade-ins with a sodium silicate solution, then smash them and send them to the junk yard. As the journalist Henry Hazlitt wrote in his classic, "Economics in One Lesson," you can't raise living standards by breaking windows so some people can get jobs repairing them.

Too bad in Washington, having a simple and catchy slogan, regardless of whether the program itself has huge hidden costs, is the goal. Politicians make a living off misleading an uneducated and uniformed electorate, and nothing will change until we vote them ALL out of office.

paul krugman and the austrian business cycle

A lot of people read Paul Krugman's op-ed's each week in the New York Times. He is perhaps the most read economist in the United States. In fact, when it comes to his research areas, such as location theory and economic geography, he was able to win a Nobel Prize in economics. However, the it is a complete fallacy to equate this award with Krugman's ability to make macroeconomic predictions based on Keynesian theories. Krugman won the 2008 Nobel Prize due to of his research relating to economies of scale and and their effects on urbanization in developed nations. This empirical research and the associated theories have almost nothing to do with the political rhetoric that he spews in his column on a weekly basis.

For instance in his column this week entitled Reagan Did It, Krugman postulates that Reagan's deregulation of the the banking and financial markets caused Americans to abandon fiscal thrift and take on too much debt, which caused the current economic downturn. Here a a few illustrative quotes from the article:

The increase in public debt was, however, dwarfed by the rise in private debt, made possible by financial deregulation. The change in America’s financial rules was Reagan’s biggest legacy. And it’s the gift that keeps on taking . . . It was only after the Reagan deregulation that thrift gradually disappeared from the American way of life, culminating in the near-zero savings rate that prevailed on the eve of the great crisis . . . These defaults in turn wreaked havoc with a financial system that — also mainly thanks to Reagan-era deregulation — took on too much risk with too little capital.

First, I am not even going to address the individual freedom and personal liberty issue that government should not be in the business of telling its citizens how much debt they are allowed to take on. According to Krugman, an all-knowing financial regulator/bureaucrat knows how much debt an individual should be allowed to accumulate, rather than allowing the market let a variety of creditors determine the proper amount for each individual on a person-by-person basis based on a multitude of risk related factors. Instead I want to address why Krugman is completely off-point when he claims the "deregulation" and the associated increase in private debt (and by the way he does not point out any specific provisions of the Garn-St. Germain Depository Institutions Act that would provide incentives for individuals to take on too much debt) caused the recession we face today. In fact, Krugman does little more in the article than assert that a lack of governmental regulation of the credit markets was the reason that consumers took on large amounts of debt.

Krugman is correct when he points out that excessive private debt had a role to play in the economic downturn. However, the reason for this increase in American indebtedness cannot be attributed to the abstract theory of "Reagan Deregulation." Perhaps the reason that Krugman attributes this increase in debt to deregulation is because he does not accept the Austrian theory of the business cycle. Krugman has received much acclaim for this 1998 article entitled The Hangover Theory, in which he dismissed the Austrian business cycle theory. However, as many commentators have been quick to point out, Krugman at best misapplied the theory and at worst he deliberately misrepresented it in order to make a political point. For instance, he claimed that the theory can be described in the following way:

In the beginning, an investment boom gets out of hand. Maybe excessive money creation or reckless bank lending drives it. Maybe it is simply a matter of irrational exuberance on the part of entrepreneurs. Whatever the reason, all that investment leads to the creation of too much capacity. . . Eventually, however, reality strikes investors go bust and investment spending collapses. The result is a slump whose depth is in proportion to the previous excesses . . . Here's the problem . . . [a]s a matter of simple arithmetic, total spending in the economy is necessarily equal to total income. Every sale is also a purchase, and vice-versa. So if people decide to spend less on investment goods, doesn't that mean that they must be deciding to spend more on consumption goods implying that an investment slump should always be accompanied by a corresponding consumption boom? And if so why should there be a rise in unemployment?

However, Krugman's characterization oversimplifies the theory. He claims that theory postulates that for "whatever the reason" for the malinvestment, there must be an economic downturn proportional to that malinvestment. However, the theory states that the control of the monetary supply by a central bank, which can artificially lower interest rates by directly injecting newly created money directly into the credit markets, causes unsustainable booms and busts because investors, who under normal market conditions would more highly value present capital over future investments with too much risk to justify the necessary debt are induced to malinvest because of the artificially lower interest rate. Krugman ignores the central bank's critical role in causing the boom by distorting the risk analysis and eliminating an interest rate that accurately reflects market conditions. Additionally, the theory does not necessarily require high unemployment during the "bust" part of the cycle. Instead, the theory claims that unemployment during the recession results from rigidity in real wages and that if wages were allowed to decrease, a increase in unemployment might not necessarily occur during the liquidation of the bad investments.

The Austrian theory very accurately describes the causes of the current economic downturn and even the traditionally leery media has begun to accept the fed's role in the recession. By keeping interest rates lower than they would have been absent monetary expansion that exceeded the accompanying increase in economic output, the fed created the conditions necessary for the housing bubble and other malinvestments of capital. If interest rates had been determined by market conditions, many of the homeowners who are currently defaulting would not have been approved for such large loans, and financial institutions would not have taken on such a large share of high risk sub-prime and option-ARM loans. Krugman would have you believe that greedy businessmen were trying to game the system absent proper regulation and things like mortgage backed securities were a way they could quickly profit from this excessive risk. Now I am not saying that the fact that these loans were securitized and spread to all sectors of the financial industry were not also major contributing factors to harshness of the downturn, by they would not have been created in the first place (at least not on such a large scale) but for the fed's loose money policies throughout the first half of the decade.

the gm deal and paying for universal healthcare

The bailout to save a second troubled automaker, this time its GM, is all but finished. Although it is still likely that GM will file for bankruptcy protection on Monday, the details of the deal that were advanced by Geithner and the Treasury Department, are pretty much set, pending final approval by the UAW workers. The UAW and their retirees are the big winners in the deal. The union and the trust tasked with safeguarding the UAW retiree's pension benefits holds approximately $20 billion in claims against GM. In exchange for settling the claims, the UAW will receive $10 billion in cash money, a 17.5% stake in the restructured GM, an option to purchase another 2.5% down the line (but to be fair, it is not likely they will exercise that option because of unfavorable terms in the warrant, so let's just assume it will stay at 17.5%), $6.5 billion in dividend preferred stock paying an astronomical 9% dividend, AND about $2.5 billion in promissory notes. Wow, that is a mouthful. Contrast that deal with the one received by GM's secured creditors, which are owed approximately $27 billion. They will receive a 10% stake in the restructured company and warrants to purchase another 15% in about a decade. So the secured creditors are receiving less equity and no cash for more total claims than a group that is on-par with other unsecured creditors.

Now I understand that this is not a bankruptcy proceeding, but a voluntary agreement, but let's get this straight: it is voluntary in the same sense as the situation where one of the parties threatens to physically harm the other party in negotiations, inducing the party that is threatened to agree to terms. In this sense almost any action can be considered voluntary because the party is voluntarily acquiescing, albeit due to threats of violence. In the case of GM, the large majority of the secured creditors are the major banks, including Citi, Bank of America and the old Wells Fargo (not sure what they are now, Wacovia maybe?). The arbiter is the Treasury Department; the same treasury department that controls many of the decisions that the banks are allowed to make as a condition of their receiving TARP money last year. In other words, since the banks have not yet repayed the TARP money, the Treasury can make their lives very difficult if they do not like what the bank is doing. Therefore, the banks, fearful of retribution by Geithner by way of terms associated with TARP funds, are almost forced to accept less than they could achieve through bankruptcy. If this isn't strong arming I don't know what is. And the Obama administration is playing politics by playing softball with the UAW, giving them a larger ownership share AND CASH FOR HALF THEIR CLAIMS. This supposed to make up for further concessions by the union in their collective bargaining agreement, but a UAW press released claimed, "[f]or our active members these tentative changes mean no loss in your base hourly pay, no reduction in your healthcare and no reduction in pensions." (Link here to read the actual memo released just a few days ago.) So much for concessions that make GM profitable.

So if the UAW is getting 17.5% of the equity, bondholders another 10%, who is going to get the rest of the company? The answer is... you guessed it! The federal government! Does anyone really believe that GM is going to be profitable anytime in the immediate future? Just because they have received a ton of taxpayer money (all told the total amount is projected to be $100 billion) doesn't mean that they are magically going to start making cars people are going to want to buy. A partnership between the federal government and the UAW doesn't seem like the type of ownership that will focus on the cost cutting and efficiencies necessary to get GM out of the red and into the black, once again making it a profitable company. The UAW is going to continue business as usual, sacrificing profitability for more benefits for workers. But don't worry, the unlimited cash cow, the federal government, is their partner so I'm sure there will be plenty of money to go around, regardless of how much the company is losing. Nobody will complain when the tax payer foots the bill, will they? Mark my words, unfortunately the U.S. government is now a majority owner of the largest automanufacturer in the world and they are not going to relinquish that hold anytime soon. For the next few years, GM will bleed money and the federal government will finance the losses. The only bright side is that this may be an issue Republicans will be able to use against Obama and the democrats in 2010 and beyond.

Lastly, although there is more I want to say regarding Obama's recent proposals to finance universal healthcare, I just want to comment one of the ideas. For a breakdown of a few of Obama's proposals check out this Wall Street Journal article. Even Obama admits that the costs of such a program will be huge, and that the feds will have to increase revenue to pay for it. One of the proposals is to make it so that contributions to health savings accounts would no longer be tax deductible. Currently there is very little incentive for insured individuals to curtail their healthcare expenditures. Typically low deductibles and the co-pay amounts do not reflect the actual cost of the services rendered. Therefore the price payed by the consumer does not serve its critical function of relaying the information regarding the costs of the services to downstream users. Since the price is distorted, there is no incentive to only use the service when it is marginally beneficial. Therefore, the services are overused, imposing larger costs on the system as whole. Health savings accounts go a long way in fixing this problem. Typically, they will be employed in combination with traditional catastrophic insurance coverage with a high deductible. Instead of comprehensive coverage, the patient will contribute part of his paycheck into the health savings account for use for future medical services that are below the price of the high deductible. Typically the contributions are partially matched by the employer and are tax deductible, just like other contributions to health insurance.

Under such a system, the patient would have to pay the full amount of any treatments received up to the deductible amount. They will make these payments from their health savings account. Since the patient is allowed to keep contributions to the savings account that are not used, he has a strong incentive to save as much of it as possible. Therefore, in cases where he may or may not have to go to the doctor (like when he has a head cold), he will probably choose not to go if the price of the visit is more valuable to him than the benefits of the visit. There is no such incentive in a system where a doctor visit only costs a $15 co-pay. By allowing the price system to function effectively, costs on the system as a whole are reduced because only transactions that both sides consider necessary and beneficial will occur. However, by eliminating the tax deduction associated with health savings accounts, the Obama administration is attempting to provide fewer incentives for more people to adopt such a system. He would like to replace this capitalist solution with his socialist system where everyone buys insurance from the federal government.

what are the u.s.'s employment goals?

Everyday there are new reports about further economic contraction and rising unemployment. A conservative estimate puts the current national unemployment rate is 8.6%. President Obama has made fighting employment one of his most important goals. The recent $787 billion stimulus bill, along with the $3.5 trillion budget, have attempted to create jobs by spending tremendous amounts of money - money that we get from taxation, borrowing and increasing the money supply (i.e. creating it at the federal reserve and buying U.S. treasury bonds). Now these may be very necessary initiatives; an unemployment rate that is near 10% is unproductive and causes many inefficiencies, decreasing the GDP and average standard of living. But what is the ultimate employment goal of the federal government? Is it an unemployment rate of 5%? 2%? Full employment?

I am sure that most of you would recognize full employment as an admirable, but unachievable goal. But does the fact that full unemployment is probably unachievable make a policy goal of full employment any less desirable? According to the Obama administration, the answer is no. His policies are designed to save millions of unproductive, over-paid UAW jobs at Chrysler and GM, while attempting to create millions of "green" jobs, betting the future of the U.S. energy sector on the belief that biofuels, solar and wind energy are going to be economically feasible and efficient with the next few years. Regardless of the merit of saving/creating these jobs, if the Obama administration's goal is to create jobs and lower the unemployment level to something more akin to bullish economic times, then there are several other policies that it has proposed which have the exact opposite effect.

First, Obama has consistently supported and voted to raise the federal minimum wage. However, economists have all recognized that raising the minimum wage will raise unemployment. Generally, raising the minimum wage will cause a decrease in the number of entry-level and low-skill jobs available. By decreasing the number of entry-level jobs, the government prevents the poorest and most uneducated people from joining the workforce. Although the wages for these jobs are low, employers are forced to train these workers who have very few skills that make them attractive to employers. Instead of giving these working poor the chance to enter the work force and learn skills that could help make them more marketable to future employers with higher paying jobs, the minimum wage eliminates their chance to learn through experience. Instead, these people often rely on the crutch of welfare since now jobs for which they are qualified are unavailable. For a detailed U.S. House of Representatives report on the minimum wage and its effect on unemployment, see this link.

Similarly, Obama's strong support for labor unions also has the effect of decreasing employment opportunities. Inherently, labor unions operate to limit the number of possible applicants for a given job. The gains that a strong union achieves for its workers come primarily at the expense of other workers. This is inherent in the law of demand. By increasing the price associated with a given product (in this case labor), the demand for that product will decrease. A successful union will decrease the number of jobs available in which it controls. It can thereby increase the price of its labor force without fear of losing jobs. However, the results of this process are decreasing opportunities for employment in the unionized industry and flooding non-unionized industries with the excess labor, thereby lowering the price that could be charged by these laborers. The effect is that fewer laborers are hired than would have been employed in unionized industry absent the union, and the non-unionized labors have fewer opportunities to find employment and are only able to demand lower wages than they would absent the union.

In addition to supporting many measures that actually decrease employment levels, the Obama administration (as well as the Bush administration before that) continued policies that have the effect of lowering effective wages of all workers. By supporting a full employment policy through government spending financed through deficits, Obama is fueling inflation and chipping away at the spending power of the average worker. Government spending can be represented to the public as adding to employment, while taxes are represented as decreasing employment. Therefore there is a strong incentive for officials to spend in the guise of creating jobs, but not to increase taxes to finance the spending. However, the spending that is not financed through taxation must be paid for either through borrowing (either domestically or internationally) or through increasing the money supply. Excessive borrowing is also not politically expedient, however, there is little public outrage aimed at increasing the monetary supply. As a result, politicians have found it relatively easy to spend, spend, spend, and finance it all by printing more federal reserve notes. As I have repeatedly emphasized in previous posts, increasing the money supply faster than economic output will cause inflation. Although many wages will be forced up by this inflation, over the past half century the wages will not grow as fast as inflation. Below is a plot of real wages and nominal wages over that time period.


As you can see, although wages have increased with inflation, despite productivity growth real wages have remained relatively stagnant. One thing that should be considered is that the federal income tax rates do not change with inflation. So the government actually benefits as consumers are making more money (although the money is not worth as much) so they will move into higher tax brackets in our progressive tax system, even though they have no more spending power than before. It has the effects of a tax increase without having to pass a tax increase. Talk about taxation without representation! But no one ever questions how the federal government is the complete and only cause of inflation, and only they can cure it from occurring.

In conclusion, the Obama administration needs to be upfront about their employment goals. If its main goal is full employment, then it should be upfront with the American people about how its minimum wage and union policies counteract other efforts to achieve those goals. Additionally, it should take efforts to eliminate the deficit spending that is financed by the federal reserve. If not it should acknowledge is role in the inflationary boom and bust cycle, and let workers know the effects that this inflationary policies have on their wages and tax burden.

the consumer nation

Often a lot is made over the large, sometimes described as excessive, consumption of the American public.  Officials from both parties decry that the U.S. cannot continue to consume at the rate it does, importing products from all over the world, and only exporting a few select products to the international community.  According to these officials this consumption is unsustainable and will eventually cost America its status as the economic leader of the free world.  But what causes these officials to make these accusations?  And are they right in their hypotheses?

The answer to the first question is almost always the same, regardless of the product or industry.   When American consumers buy cheap international products, the artificially low wages of foreign workers and subsidies of foreign governments make competition between the international producers and domestic producers fundamentally unfair.  American producers, with higher labor costs and large costs associated with complying with both state and federal industrial standards, cannot produce the products as cheaply as 3rd world labor.  In order to insulate American industries, the federal government should impose high tariffs on imports from these countries, thereby protecting the domestic industry.  Therefore the American industry will be able to compete with the international competitors, and the American workers will not lose their jobs because of cheap labor overseas.  

Now this all this sounds great, and its easy to make soundbites that can convince people that this is the right policy.  However, in reality this practice does more to harm the American people than it does to protect them.  First, we must understand that if another country can produce a good cheaper than we can domestically, it is the best interest of the large percentage of the American people to buy at this lower price.  As I stated above, the U.S. is a nation of consumers, and by allowing the consumer to purchase a product at the lowest possible cost, the maximum amount of people will see a benefit.  

Additionally, if Americans choose to buy strictly foreign products at the expense of purchasing domestic products, there is a market mechanism to counteract this balance.  The reason international labor is cheaper is because foreign workers are willing to accept less for the same work that American workers in the same industry will accept for the job.  Now these international workers are not paid in U.S. dollars, but in their home country's currency.  However, American consumers purchase their products using U.S. dollars.  In order to pay their workers, international producers must change the U.S. dollars paid into their own country's currency.  When Americans are buying large amounts of international products and few international consumers are buying American products, instead buying from their own domestic industry or another nation other than the U.S., the result is that more people will attempt to change dollars into the international currency than the international currency into dollars.  As a result the exchange rate between the international currency and the dollar will change, with the dollar becoming relative less valuable than it was in relation to the international currency.  In turn, this means that the international labors will become more expensive in terms of the amount of U.S. dollars it takes to pay for their labor.  Additionally, U.S. exports will drop in price in the international market, making U.S. exports more competitive abroad.  In the long term, if the market is allowed to function properly, an equilibrium will be struck, and the U.S. consumer will be able to buy the cheapest products, and products that the U.S. can produce most cheaply will be purchased both domestically and abroad.  

Now many are quick to point out that this equilibrium point may occur at a price where many industries that are currently being subsidized would no longer be able to operate profitably (easy example is the domestic auto industry) and thousands of people would lose their jobs.  Well this is probably true, but in the grand scheme of things it will maximize the country's benefit to let these industries fail.  The benefits to the consumer of lower prices for goods far outweigh the benefits to workers of a government subsidized industry.  In most any industry, the amount of workers is small relative to the amount of consumers of the product.  Even if some workers lose their jobs, a much larger number of people will see the benefit of lower prices.  And the people that do lose their jobs can either get a new job in a similar industry that has a business model that can compete with the international  producers, or they can get jobs in a different industry where American producers can create the cheapest products.  

Opponents of free trade like to portray economic problems as a winner/loser dichotomy.  According to their arguments, when U.S. consumers buy international products at the expense of domestic producers, the foreign country wins and the U.S. loses.  But in reality economic transactions are win/win situations.  The transaction would not take place if both producer and consumer saw a benefit.  In this case, the international producer benefits from sales of its product, and the American consumer benefits by receiving a product that he desires at the lowest price he can find.  If the U.S. is importing more value than it is exporting, than exchange rates will change until the equilibrium is reached.  If the U.S. is truly a nation of consumers, which it surely is, than it is the free market, and not the tyranny of government controls that will provide the maximum benefit to the American people. 

A couple of random things

I want to address three main issues in this post:
1) What happened on last night's episode of I Love Money 2;
2) President Obama and Sec. Geithner's plan for dealing with toxic bank assets; and
3) A few of the reasons I don't buy 95% of what comes out of Paul Krugman's mouth.

Now numbers two and three deserve their own posts, but unfortunately I don't have the time to write three separate posts right now. So instead I am going to introduce my arguments and hopefully come back to the issue at a later time. Let's see how it goes.

First, it finally happened. Frank "The Entertainer" was kicked off of I Love Money 2 last night. I have been waiting for this to happen for weeks. Frank was a stupid person who yelled so loud that he could manipulate many of the people with feeble minds (cough, cough, 20 Pack, Onyx, Frenchie, Heat) who were on the show. Finally enough dumb people were gone so that an alliance led by Tailor Made finally was able to stand up to him. After winning the episode's challenge, Tailor Made convinced It to join his alliance. It was then able to convince Saphari that if she didn't vote Frank into the box, she would be the one put in the box herself, along with Myamee and It. She would then be the person went home, which is all most likely true. Instead Myamee, It, and Saphari's votes for Frank were enough to stalemate the vote, allowing the paymaster, Tailor Made, to choose who was put in the box. He obviously chose Frank, and after making Saphari sweat for a little while, sent him home. I couldn't be happier, and I can't wait to see where the show goes now that the individual challenges are starting.

Secondly, I have read a few reports on the Obama administration's new bank asset relief plan, and as you may have guessed, I am not impressed. As I understand it, and I may be wrong because I am not particularly well educated on these types of securities, first the banks will auction off the assets, often taking losses just so that the bad investments are off their books. Next, the treasury will use the remaining $100 billion or so in unused TARP funds to go in as a 50/50 partner with the private investor who wins the auction. However, instead of requiring full payment for the asset, the private investor and the treasury will only be required to put up 1/14 of the purchase price each. The rest of the price will be paid for from a FDIC in the form of a non-recourse loan which would be lent to the new public-private partnership at a 6-to-1 debt-to-equity ratio.

This is simpler to understand using the example given by the treasury department. Say a bad bank asset is really worth $1, but it is sold at the auction for $0.84. In this case the private buyer and the treasury would each put up $0.06, while the remaining $0.72 would be financed buy a loan by the FDIC. Basically the tax payer is on the hook for 90% of the investment.

The first problem I have with the plan is the pairing of private investors with the treasury, each sharing profits. After seeing how the house acted last week when AIG used federal funds to pay their top executives, why would anyone in their right mind want to accept federal funds to buy a troubled asset. Imagine, for example, that some lucky investor ends up purchasing a tremendously undervalued asset (not out of the realm of possibility), and sees tremendous profits. I can just see Nancy Pelosi now, yelling on the house floor about "windfall profits" and attempting to implement a 90% tax retroactively on private investor despite the fact that the federal government will also see similar profits.

Secondly, tax payers bear way to much of the risk. As I stated, the treasury will match the private investors capital investment while the rest will be financed through FDIC and federal reserve loans. Although the toxic bank assets may turn out to be undervalued, there will undoubtedly be a large number that will fail, and the federal government, well actually tax payers, will be forced to front the bill.

Lastly, although this system may work for banks that are not in terrible shape, there is almost no chance it will work for someone like CitiBank. There assets will most likely be sold at such a low price at auction that they will be unlikely to accept the price and the loss associated with it. Executives who accept short term losses like that see stock prices tumble even farther, destroying their compensation and most likely costing them their job. A more likely scenario is that the will refuse the sale price, and in order to keep them on their books continue to hoard funds and refuse to lend. Basically it will be exactly the opposite of the desired goal of the plan, as the markets will fail to be recapitalized.

Now like I said, I will continue to follow the proposal and will comment as new ideas and issues emerge. Hopefully, this will work, but I have a sneaking suspicion that it won't, and that Congress will step in a few months with now with actual legislation that will only further exacerbate the problem or cause brand new ones. For a better alternative check out the blog that I follow (Link in the box to the right) entitled The Road from Serfdom. Although it isn't written yet, I am going to force my roommate to write it tonight because I don't want to take credit for what I think is a very good idea. So get writing Andy Maran.

Finally, I just want to write a paragraph or two on a few of the reasons I don't think Paul Krugman really knows what he's talking about when he attempts to predict the future of the economy. Now Krugman is an excellent research economist, and his work won him a noble prize in 2008. However, he has a history of being a very poor forecaster, based mainly on his reliance on Keynesian models. For one example, see this link which outlines how he wrongly predicted massive inflation in the 1980's while working for the the Council of Economic Advisers for the Reagan administration.

Now I can't base my entire dislike for his theories one one prediction, but when he doesn't believe one the the most fundamental issues of my economic beliefs, that inflation is a pure monetary phenomenom, then how can I accept anything he says. In his memo Krugman uses indicators such as oil and commodity prices as well as exchange rates to predict further inflation. However, these indices are not inflation causing, they are only inflation spotters. Inflation is caused by nothing more than in an increase in monetary supply relative to output. If output and monetary supply remain the same, then there is little or no inflation. When the monetary supply increases faster than a nation's output, that nation will experience inflation.

Krugman also uses misrepresentations to make political points as well. For example, Krugman's attack on Milton Friedman's theory that the federal reserve's failure to end its tight money policy prior to the great depression may have been a contributing factor to the extent of the economic downturn (Link to the article here). Krugman claimed that since the monetary base (i.e. currency and central bank deposits within the federal reserve) had risen rapidly prior to the current downturn and has failed to curb the current economic fall, so the federal reserve could have done nothing to soften the great depression. However, the truth is that Friedman's argument was that the fed's failure to increase the true money supply (i.e. money contained in deposit accounts and currency in circulation) made the great depression worse. And that also explains why an increase in the monetary base has not helped soften the current downturn. Banks are currently hoarding money with deposits at the Federal Reserve. This explains the increased monetary base and in reality the true money supply has not increased recently, perhaps exacerbating the current downturn.

Anyway I'm tired of typing. I'm sure I'll complain more later.