Thursday, August 12, 2010

"Forgive Us Our Debts...."

One of the central working assumptions in Keynesian theory is the homogeneity of all assets. As economist Robert Higgs notes:
This way of compressing diverse, economy-wide transactions into single variables has the effect of suppressing recognition of the complex relationships and differences within each of the aggregates. Thus, in this framework, the effect of adding a million dollars of investment spending for teddy-bear inventories is the same as the effect of adding a million dollars of investment spending for digging a new copper mine. Likewise, the effect of adding a million dollars of consumption spending for movie tickets is the same as the effect of adding a million dollars of consumption spending for gasoline. Likewise, the effect of adding a million dollars of government spending for children’s inoculations against polio is the same as the effect of adding a million dollars of government spending for 7.62 mm ammunition. It does not take much thought to conceive of ways in which suppression of the differences within each of the aggregates might cause our thinking about the economy to go seriously awry.

In fact, “the economy” does not produce an undifferentiated mass we call “output.” Instead, the millions of producers who bring forth “aggregate supply” provide an almost infinite variety of specific goods and services that differ in countless ways. Moreover, an immense amount of what goes on in a market economy consists of dealings among producers who supply no “final” goods and services at all, but instead supply raw materials, components, intermediate products, and services to one another. Because these producers are connected in an intricate pattern of relations, which must assume certain proportions if the entire arrangement is to work effectively, critical consequences turn on what in particular gets produced, when, where, and how.

These extraordinarily complex micro-relationships are what we are really referring to when we speak of “the economy.” It is definitely not a single, simple process for producing a uniform, aggregate glop. (Emphasis mine)
I quote Prof. Higgs to answer Krugman's recent blog post on debt and GDP in which he points out that during the 1930s the debt/GDP ratio fell. In commenting on graphs he has in his post (which you can see on his link -- I'm not reproducing them here), he writes:
Debt actually fell as the economy slumped, through a combination of deleveraging and default. The ratio to GDP spiked only because GDP collapsed. Conversely, as the economy began to recover under the New Deal (before the big mistake of 1937), the debt ratio improved thanks to rising GDP, even though the nominal level of debt also rose.

What all this tells you is how important it is, in dealing with debt, to get the economy moving — and how devastating it is, even if you’re deeply frugal, if contraction and deflation rule.
The problem is that Krugman is operating on the assumption that private and government debt are homogeneous in nature when, in fact, they are not. Most private debt, and especially private debt of that era, is for capital formation and business expansion. Government debt (and especially the federal debt), on the other hand, mostly exists for present spending purposes and it not investment by any stretch of the imagination. (The one exception on the local and state levels is the issuance of capital bonds which are used for roads, bridges, and other physical infrastructure improvements. These bonds usually have pretty specific fees designed for repayment, as opposed to having a general obligation for taxpayers.)

In the Krugman-Keynesian view, however, there is only spending, and debt is useful to the economy ONLY in the fact that it permits more present spending, which supposedly is the grease that gives the economy "traction" and allows there to be future development. As Krugman has noted elsewhere, public debt might be rising, but it only is helping to replace the drop in private debt.

However, it is important to note that the mechanism for repaying private debt (which is undertaken for capital or business expansion) is the sale of goods and services in the future. The debt ultimately is repaid because real wealth is expanded, as opposed to the debt payments coming from the pockets of future taxpayers.

Krugman would argue that government borrowing today simply helps keep spending alive, and that will give the economy some "traction" so that the economy in the future will be stronger. What is lacking in that train of thought, however, is the mechanism for economic growth. In his view, economic growth occurs because people spend more money. End of discussion.

This view, I believe, is extremely shortsighted. In Austrian (and the old standard) views of economics, economic growth occurred because over time, people found ways to create more goods and services by using fewer resources, thus permitting those now-unused resources to be applied to other uses. That seems to be counter-intuitive to today's thinking in which we assume that growth occurs only because we are using more and more scarce resources (and that one day those resources will run out and we will be reduced to poverty via increased scarcity).

Again, this demonstrates a huge misunderstanding of what resources are and how we use them. Many products we now use are made from factors that at one time were not seen as resources at all. Crude oil once was seen as a nuisance product, and the modern silicon for computers is nothing more than something derived from sand.

Capital is useful because it serves as a tool for permitting us to make more goods from fewer factors of production, and especially labor. Contrary to the atavistic belief that capital creates mass unemployment, capital allows labor to be applied to uses to which labor before was too scarce to be used in this way.

Thus, to say that the only economic use of capital is the spending generated to create it (which I doubt even Krugman believes, although his analysis does not permit any other interpretation) is to misunderstand capital and to misunderstand the use and importance of debt. In other words, the guy simply does not "get it."

11 comments:

Edward said...

to A.P. Lerner,
"
You assume the banking system is reserved constrained. It is not. The banking system is capital constrained, not reserve constrained. Reserve requirements do not dictate how much a bank lends out, since they can always meet reserve requirements in the fed funds market. This is basic operational fact, not theory."

My apologies, You are right of course, but that only proves my point. Reserves that accumulate in the banking system back to the central bank through Quantitative easing, like the Japan experience, only demonstrate the fact that money that is not lent out does get create either inflation or economic growth.

" '"if either of you had $50,000, either in greenbacks, gold, silver or palladium coins buried in your backyard. how is that a deficit on me or anyone else?"

I'll simplify things for you. If the government decides to raise taxes on you, and you need to take that $50k out of the ground, and use it for taxes, what happens to your surpluses? (hint, they go down). And what happens to the public deficit (hint, it goes down). What if you get a tax cut? You have more money to bury in the ground, and guess what, the deficit goes up as well. Is that simple enough for you? See the relationship? See the chart above.
I already did. i grant that its a powerful correlation But Correlation doesn't prove causation.Also if I was earning 100,000 and paying 40,000 net-net net in taxes and the feds raised their take from 40% to 42%, i'd have to pay $2000 more from MY income stream, YOUR savings have zero to do with the situation. What's mine is mine and what's your's is yours. Now we're talking basic law not accounting And please A.P. If you consider your surpluses, (if you have some) to be a deficit of mine, give some money to me. I'm afraid of the government raising taxes, and i'm afraid of being cut short for next year :-)

""I suppose one could pay the irs the prevailing dollar value of one's tax liabilities in gold or silver"

"Go ahead, try paying your taxes in silver. See where it gets you."

So you're saying that the IRS doesn't deal with foreign currency tax liabilities? now who's overlooking something?

"Best wishes living in 1810"
Ha Ha Ha cute.
And by the way, you never answered my question. How do you determine when private sector demand for savings has been reached? When bond auctions fail? When stagflation comes? And don't interest rates reflect the demand for money not loanable funds. At least that is what Paul Krugman said in his blog post on niall Ferguson, liquidity preference and loanable funds. And by the way, what happens when the government just meets its expenditures, it neither runs a surplus or a deficit?

Edward said...

Another Anonymous

"Edward, what you are saying is hard to understand. The deader the money is, the clearer it is that everyone's revenues must balance to zero. Just think of the no banks, no credit, just paper dollar bills moving around. Those paper dollar bills had to be printed and spent at one time, that's when they contributed to that year's government deficit. In a game of Monopoly, no matter how the money moves around, the total is always the same, and how much leaves the Bank at any period is the same as the total of the players' net savings. It is possible for the revenue of everyone in a private economy to exceed their outflows, if the government deficit equals that total. In theory, if prices are flexible, indeed it WOULD be possible for all sectors to run surpluses with each other if the cash surplus of one entity were not counted as the deficit of another I don't see what price flexibility has to do with anything . "if the cash surplus of one entity were not counted as the deficit of another" Huh, well, if you count incorrectly and uses new rules of addition and subtraction, well you won't get the same results as everyone else. In the real world, when the government gives me a dollar, it counts as a dollar of income to me, and a dollar of spending of the government, contributing to that year's deficit. All these identities boil down to is : If I give one dollar to you, then I am down one dollar -1 on my books, you are up one dollar , +1 on your books, and the total -1 + +1 = 0. I hope you agree with this.


I do because A TRANSACTION HAS TAKEN PLACE! BUT before you give me a dollar, BEFORE THE GOVERNMENT RAISES TAXES, that dollar counts as a piece of equity for you, and it isn't a liability on anyone. (This isn't the gold standard era, the government doesn't have to redeem all its dollars in gold, and it costs virtually nothing for the Fed to 'print" new money.
I mention price flexibility because the Keynesians always say it is difficult to save all at the same time when short rates are zero without causing a depression and a general glut because prices are well, sticky.

AP Lerner said...

“Reserves that accumulate in the banking system back to the central bank through Quantitative easing, like the Japan experience, only demonstrate the fact that money that is not lent out does get create either inflation or economic growth”

Agreed. I have never said otherwise. Prof. Anderson would have you believe we are headed for hyperinflation because of all the ‘money printing’ and excess reserves. He, like most Austrains, are wrong and do not understand the monetary system, and do not understand quantitative easing. In fact, I have explained in other posts how QE is deflationary, not inflationary. Quantitative easing is the biggest non event in the history of monetary policy. It’s a useless policy.

“I already did. i grant that its a powerful correlation But Correlation doesn't prove causation.”

It’s not correlation. It’s algebra. The chart is a graphical version of this:

(I – S) + (G – T) + (X – M) = 0

And all the data to recreate this identity can be found here:

http://www.bea.gov/

“Also if I was earning 100,000 and paying 40,000 net-net net in taxes and the feds raised their take from 40% to 42%, i'd have to pay $2000 more from MY income stream, YOUR savings have zero to do with the situation”

Who said anything about my savings if private taxes go higher? The public deficit shrinks if taxes go up. See the math above. Or the chart.

“If you consider your surpluses, (if you have some) to be a deficit of mine, give some money to me”

This is gibberish

“So you're saying that the IRS doesn't deal with foreign currency tax liabilities? “

Try paying your income taxes in Euro then. Same result as silver.

“How do you determine when private sector demand for savings has been reached?”

Inflation. If the public sector stayed out of the way and let the private sector determine its level of savings via the market, output would be maximized and inflation would not be an issue. But because the public sector insists on targeting inflation, and foolish economists that follow Austrian theory are hell bent on balanced budgets because they think the US government represents some sort of credit risk, the private sector will never reach its full potential. As the algebra and a basic understanding of financial balances show, public deficits are required for the private sector create wealth. Now way around it (note, I did not comment on the composition of the deficit. I never have. It’s a separate, political decision)

It’s funny, Austrians claim to be supportive of free markets, yet their ridiculous claims that we are heading for bankruptcy and the deficit must be cut, now, now, now just further distort the market.

“BUT before you give me a dollar, BEFORE THE GOVERNMENT RAISES TAXES, that dollar counts as a piece of equity for you, and it isn't a liability on anyone.”

The flaw with your logic is you assume the government must tax first, then spend. This is not true. The government spends first, then makes tax/debt decisions. The government such as the United States is NEVER revenue constrained. Think about his, if we started a brand new economy from the beginning, where does the first dollar come from? Government spending, of course.

As an aside, why is Prof. Anderson criticizing a macro economist with micro economics? Does he not know the difference? He should find a micro economist to criticize with these kind of post (which of course if fraught with bad economics, but that’s another post for another day..)

This is yet, another, silly post.

Anonymous said...

AP Lerner: "Think about his, if we started a brand new economy from the beginning, where does the first dollar come from? Government spending, of course."

This, from the man who calls the posts of others "silly."

jason h said...

I wonder how many people it takes to magically transform from micro to macro and suddenly change the laws of economics.

A person generates wealth by producing more than he consumers, but a nation and her government generates wealth by consuming more than it produces. How strange.

burkll13 said...

AP Lerner: "Think about his, if we started a brand new economy from the beginning, where does the first dollar come from? Government spending, of course."

I Posted This link last week sometime. money happens naturally whether you or any government acknowledges it or not.

AP Lerner said...

@ burkll13 - try paying your taxes with bottled water and cigarettes. Your post is irrelevant

burkll13 said...

wow, seriously? do you think everyone would just sit around waiting for the government to issue new currency? why would a system that rejects government issued currency NOT be considered an economy? you are lost in your strange little logic circle.

Edward said...

A.P. Lerner,

"Who said anything about my savings if private taxes go higher?"
YOU did in response to my original hypothetical scenario:

""if either of you had $50,000, either in greenbacks, gold, silver or palladium coins buried in your backyard. how is that a deficit on me or anyone else?"

'"I'll simplify things for you. If the government decides to raise taxes on you, and you need to take that $50k out of the ground..."

"“If you consider your surpluses, (if you have some) to be a deficit of mine, give some money to me”

"This is gibberish"

Sigh. Clearly you have a humor deficit as this is known in some quarters as a joke, a snark etc..

"Try paying your income taxes in Euro then. Same result as silver."

Not my point, my point is that exchange range issues ARE relevant to issues of tax liabilities

“BUT before you give me a dollar, BEFORE THE GOVERNMENT RAISES TAXES, that dollar counts as a piece of equity for you, and it isn't a liability on anyone.”

"The flaw with your logic is you assume the government must tax first, then spend. This is not true. The government spends first, then makes tax/debt decisions. The government such as the United States is NEVER revenue constrained. "

Are you bloody serious!? Even within the framework of your assumptions of the government as an issuer of its own currency, the u.s. can't take advantage of that status too much. it is inflation constrained, (By the way, what's the ideal rate of inflation, in your theory 2%, 3, 4%,8%?)If the demand for private savings HAS BEEN REACHED, public deficits and private savings are high, and inflation rate is accelerating from 5 to 7% and unemployment from 5 to 7%, and assuming a responsible government that isn't Argentina, the government MUST contract the money supply raise taxes, slash spending. The government IS revenue constrained IF it decides to live within the private sector inflation constraint, I guess i just assume a responsible government, whereas you don't therefore, your objection that modern governments are not revenue constrained is utterly trivial, because the upper inflation constraint is in ITSELF an upper boundary of spending power on responsible governments."


"Think about his, if we started a brand new economy from the beginning, where does the first dollar come from? Government spending, of course."

Gold and silver evolved as currencies naturally long before any printing presses

Bob Roddis said...

Let the charlatans, I mean Chartalists yammer on.

It is clear that they a) don't understand where money comes from, b) they employ homogeneous aggregates (and are oblivious to the problem that creates; c) they have no clue about subjective value and economic calculation which would be totally disrupted under their Keynes-on-steroids funny money regime; and d) they have no theory of capital structure and how their funny money routine would devastate it.

For the fifteenth time, please explain why government debt is essential to the existence of private savings.

Also, explain "The banking system is capital constrained, not reserve constrained."

Don't use accounting identities and don't point to some alleged statistical proof.

AP Lerner said...

@ Edward:

“YOU did in response to my original hypothetical scenario”

No, I did not. You mis-interpreted, or I mis-typed. As I have stated before, as public deficits shrink, private savings must contract. See the chart. Or the math. Or go to bea.gov. It all adds up. It’s not theory. It’s reality.

“Not my point, my point is that exchange range issues ARE relevant to issues of tax liabilities”

What are exchange range issues? Do you mean exchange rates? There are no exchange rate issues. The US government only accepts US currency for payment of taxes. End of story.

“Are you bloody serious!? “

Just think about the operations of government spending. It’s not a household. It’s not a business. FYI – we left the gold standard 40 years ago, and the US currency is non convertible, and the government has an unlimited supply. Who says they have to tax first, spend second? The government is not a household. Of course, policy makers do not even realize this, so I guess it’s hard to expect neo liberal economist to understand this as well. Read some Wray, or Mosler. Or this speech by Beardsley Ruml, a true genius well ahead of his time.

http://hiwaay.net/~becraft/RUMLTAXES.html

“the u.s. can't take advantage of that status too much. it is inflation constrained”

YES. EXACTLY. There is hope for you yet. As I have argued many, many, many, many times, and shown with ample data, charts graphs, and reality (not theory) the US government is not a credit risk, so the fools that believe we are headed for eminent bankruptcy because of the deficit are just that, fools. Watch out, the 10 yr. note is at 2.7%. We are doomed. Nonsense! Inflation is the only constrain, so criticism of tax and spend policy’s should be focused on inflation, not baseless fears of becoming Greece.

“By the way, what's the ideal rate of inflation, in your theory “

There is no ideal inflation rate. The market can figure that out. If the public sector ceases to target inflation and ceases to target deficits, the market will take care of the rest.

“the government MUST contract the money supply raise taxes, slash spending”

Exactly. This will happen automatically as tax revenues increase, and the automatic stabilizers decrease. The deficit shrinks to a more appropriate level. This was the problem with the Clinton surpluses. He let the deficit turn to a surplus; the private sector had to borrow to maintain its financial equity, thus, credit bubble formed. Clinton taxed too much.

“The government IS revenue constrained IF it decides to live within the private sector inflation constraint”

No, deficits dictate inflation. Not revenue. A more appropriate way to phrase you sentence is the government is deficit constrained.

“your objection that modern governments are not revenue constrained is utterly trivial”

No, I never said modern governments are not revenue constrained, I said the US government is. As is Canada, Australia, the UK. All these countries (and some others) have a free floating, non convertible currency where the sovereign is the monopoly supplier of that currency. They are never revenue constrained. Germany, Italy, China, Greece. All revenue constrained. Not all monetary systems are the same.

“Gold and silver evolved as currencies naturally long before any printing presses “

So what. They are not currencies today in the US.

As an aside, thanks for the intelligent banter.

@ Bob Roddis:

“For the fifteenth time, please explain why government debt is essential to the existence of private savings”

I never said debt. Deficits, not debt. Huge difference. All government debt does is change reserve balances. It’s all in the simple math above. If you have no interest in algebra, then I can’t help you.

“Also, explain "The banking system is capital constrained, not reserve constrained."”

I already have. See above.