About that Social Security "Trust Fund"

In his column today, Paul Krugman defends Social Security and (of course) demonizes anyone who might raise any objections. As he writes, people who raise questions (he claims that would be "Conservatives"): "...hate Social Security for ideological reasons: its success undermines their claim that government is always the problem, never the solution."

Now, my sense is that we are dealing with a non sequitur, but Krugman uses those a lot. However, I'm not going to debate the merits of SS today, but rather deal with one statement that Krugman has made regarding the "trust fund." He writes:

About that math: Legally, Social Security has its own, dedicated funding, via the payroll tax (“FICA” on your pay statement). But it’s also part of the broader federal budget. This dual accounting means that there are two ways Social Security could face financial problems. First, that dedicated funding could prove inadequate, forcing the program either to cut benefits or to turn to Congress for aid. Second, Social Security costs could prove unsupportable for the federal budget as a whole.

But neither of these potential problems is a clear and present danger. Social Security has been running surpluses for the last quarter-century, banking those surpluses in a special account, the so-called trust fund. The program won’t have to turn to Congress for help or cut benefits until or unless the trust fund is exhausted, which the program’s actuaries don’t expect to happen until 2037 — and there’s a significant chance, according to their estimates, that that day will never come. (Emphasis mine)

Here is the problem: the "special account" is nothing more than short-term government paper that matures every six months. At the present time, most government debt is paid via...more government debt -- plus interest. Now, this looks nice, officially-speaking, but the problem is that the mechanism for turning this bond-laden "trust fund" into cash is for the government to sell the bonds.

Now, if I know Krugman, he would say (as would James K. Galbraith) that this is no problem, because the Federal Reserve System can buy the bonds. (He has not said this, I know, but I suspect that would be in his arsenal of answers.) In other words, the ultimate "backing" for Social Security is a glorified and "sophisticated" mechanism of printing money.

So, I would not exactly call this a sound system of "investment." My sense is that Krugman is trying to score ideological points, not promote good finance.

What Can the Fed Do?

In his column today, Paul Krugman excoriates the Federal Reserve System, and especially Ben Bernanke, for "inventing reasons to dither in the face of mass unemployment." Why? Because the Fed is not creating enough inflation, which Krugman claims will give the economy "traction."

Krugman writes:

America’s current economic troubles aren’t exactly identical to those of Japan in 1999-2000: Japan was experiencing outright deflation, while we aren’t — yet. But inflation is well below the Fed’s target of around 2 percent, and it is continuing to slide. And Americans face a level of unemployment, and sheer human misery, far worse than anything Japan went through.

Yet the Fed is doing almost nothing to confront these troubles.

However, Krugman also suggests a "solution," and it is here that I think we need a discussion. He says:

What could the Fed be doing? Back when, Mr. Bernanke suggested, among other things, that the Bank of Japan could get traction by buying large quantities of “nonstandard” assets — that is, assets other than the short-term government debt central banks normally hold. The Fed actually put that idea into practice during the most acute phase of the financial crisis, acquiring, in particular, large amounts of mortgage-backed securities. However, it stopped those purchases in March.

Since then, the economic news has grown steadily worse. And earlier this week, the Fed changed course — but barely. It now says that it will reinvest the proceeds from maturing securities in long-term government bonds. That’s a trivial change, basically the least the Fed could get away with without facing a firestorm of criticism — and far short of the major asset-purchase program the Fed should be undertaking.

So, once again we see the post hoc ergo propter hoc fallacy at work. Why is the economy now in the tank? The Fed isn't buying enough assets, as though the economy was doing well in March.

Not surprisingly, Krugman blames those dastardly regional Fed chairmen for this plight, declaring:

What’s going on here? Has Mr. Bernanke been intellectually assimilated by the Fed Borg? I prefer to believe that he’s being political, unwilling to engage in open confrontation with other Fed officials — especially those regional Fed presidents who fear inflation, even with deflation the clear and present danger, and are evidently unmoved by the plight of the unemployed.

And in fairness to Mr. Bernanke, discord among senior officials also makes it difficult for policy to change expectations: it would be hard to credibly commit to higher inflation if this commitment were constantly being undercut by speeches out of the Richmond or Dallas Feds. In fact, I’d argue that loose talk by some Fed officials is already having a negative economic impact. But while Mr. Bernanke doesn’t have the authority to stop that loose talk, he could make it clear that it doesn’t represent overall Fed policy.

Yeah, its the rhetoric. If only we had all members of the Fed declaring that what this country needs is a good bout of inflation, then everything would be fine and the economy would be gaining "traction" toward recovery. However, there is a problem here, and it is NOT that President Obama waited until recently to fill 16 Fed slots, regardless of what Krugman claims.

No, the problem is that Krugman confuses the paper purchase of assets deemed worthless in the markets with the creation of real wealth. I have said before that Krugman really does confuse paper money with wealth, a fallacy that Adam Smith and others exploded more than two centuries ago, yet lives on in the hallowed halls of Ivy League institutions.

Like the Supply-Siders that claim that the real problem is that the government has not cut tax rates low enough (although that does help), Krugman's answer always is that there is not enough inflation. In Krugman's view, there really is no "real" economy; instead, it is a combination of paper and rhetoric, as though capital and other factors of production are simple putty to be molded in the hands of the "experts" in Washington.

The economy is not tanking because of any alleged "dithering" at the Fed. It is tanking because the government insists upon strangling those firms that still are healthy ("wicked profiteers") and propping up the politically-connected firms (i.e. Government Motors) or forcing taxpayers to ante up to pay for assets that cannot ever be profitable in a real economy (i.e. "Green Energy"). The Keynesian prescription - inflate, inflate, inflate - is what is intellectually and morally bankrupt, and as long as that mentality rules, we will have a moribund and depressed economy.

"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."

Krugman: The State is Light

[Update, Thursday, August 12, 2010, 9:20 AM]: I have deleted Wednesday's post on scientific fraud because I am not sure that the false temperature listing was deliberate. There may have been an error by the satellite readings that people did not pick up until later. I do try to make sure that what I put on my website is reasonably accurate, and I am not sure that what I have alleged is true, given the information I have now. [End Update]

On August 3, 1914, British Foreign Secretary Edward Grey looked out of the window of the Foreign Office and watched as workers lit the street lamps for the approaching nightfall. Germany had just invaded Belgium, Europe was at war, and Parliament the next day would declare war on Germany and Austria-Hungary, and much of the world would be plunged into the horror of World War I.

Grey then made his famous and prophetic statement: "The lamps are going out all over Europe. We shall not see them lit again in our time," and the slaughter of 10 million soldiers and countless civilians in the next four years would prove his point.

In his column today, Paul Krugman plays off that statement, but puts things in a different context. The lamps are going out, but they are going out because the state does not seize enough property and resources from Americans:

The lights are going out all over America — literally. Colorado Springs has made headlines with its desperate attempt to save money by turning off a third of its streetlights, but similar things are either happening or being contemplated across the nation, from Philadelphia to Fresno.

Meanwhile, a country that once amazed the world with its visionary investments in transportation, from the Erie Canal to the Interstate Highway System, is now in the process of unpaving itself: in a number of states, local governments are breaking up roads they can no longer afford to maintain, and returning them to gravel.

And a nation that once prized education — that was among the first to provide basic schooling to all its children — is now cutting back. Teachers are being laid off; programs are being canceled; in Hawaii, the school year itself is being drastically shortened. And all signs point to even more cuts ahead.

We’re told that we have no choice, that basic government functions — essential services that have been provided for generations — are no longer affordable. And it’s true that state and local governments, hit hard by the recession, are cash-strapped. But they wouldn’t be quite as cash-strapped if their politicians were willing to consider at least some tax increases. (Emphasis mine)

Why are we in this terrible, terrible state? It is because Goldstein's legions, er, the few Republicans left in Congress, have not properly worshiped the Greatness of the State. (Of course, this assumes that Republicans actually shrink government, but I have seen no evidence of that claim in the past 30 years, when the Republican Party was at its strongest since before the Great Depression.)

Krugman goes on:

...the federal government, which can sell inflation-protected long-term bonds at an interest rate of only 1.04 percent, isn’t cash-strapped at all. It could and should be offering aid to local governments, to protect the future of our infrastructure and our children.

But Washington is providing only a trickle of help, and even that grudgingly. We must place priority on reducing the deficit, say Republicans and “centrist” Democrats. And then, virtually in the next breath, they declare that we must preserve tax cuts for the very affluent, at a budget cost of $700 billion over the next decade.

In effect, a large part of our political class is showing its priorities: given the choice between asking the richest 2 percent or so of Americans to go back to paying the tax rates they paid during the Clinton-era boom, or allowing the nation’s foundations to crumble — literally in the case of roads, figuratively in the case of education — they’re choosing the latter.

It’s a disastrous choice in both the short run and the long run.

In the short run, those state and local cutbacks are a major drag on the economy, perpetuating devastatingly high unemployment.

It’s crucial to keep state and local government in mind when you hear people ranting about runaway government spending under President Obama. Yes, the federal government is spending more, although not as much as you might think. But state and local governments are cutting back. And if you add them together, it turns out that the only big spending increases have been in safety-net programs like unemployment insurance, which have soared in cost thanks to the severity of the slump.

That is, for all the talk of a failed stimulus, if you look at government spending as a whole you see hardly any stimulus at all. And with federal spending now trailing off, while big state and local cutbacks continue, we’re going into reverse.

So, we are to assume that the U.S. Government is just wallowing in money when, in fact, it is borrowed money, money that U.S. taxpayers ultimately must repay. (Of course, what will happen is that the government will repudiate the debt via inflation, which also is a tax, albeit a more hidden tax.)

But that is not all. We are supposed to think that the government is sitting on piles and piles of cash, but Goldstein selfishly is letting rich people keep some of their income, and then those evil rich people also are sitting on that cash. So the problem is that those who have the money are not spending it, and that is why we are in recession. And why are they not spending the money? Krugman explains with this non sequitur:

How did we get to this point? It’s the logical consequence of three decades of antigovernment rhetoric, rhetoric that has convinced many voters that a dollar collected in taxes is always a dollar wasted, that the public sector can’t do anything right.

The antigovernment campaign has always been phrased in terms of opposition to waste and fraud — to checks sent to welfare queens driving Cadillacs, to vast armies of bureaucrats uselessly pushing paper around. But those were myths, of course; there was never remotely as much waste and fraud as the right claimed. And now that the campaign has reached fruition, we’re seeing what was actually in the firing line: services that everyone except the very rich need, services that government must provide or nobody will, like lighted streets, drivable roads and decent schooling for the public as a whole.

So the end result of the long campaign against government is that we’ve taken a disastrously wrong turn. America is now on the unlit, unpaved road to nowhere.

Now, the last time I ever heard anything about "Welfare Cadillacs" was in the 1960s, more than four decades ago. Since then, the American State at all levels has grown fantastically, and while I have heard some rhetoric from Republicans about "big government," nonetheless the reality of governmental expansion belies whatever politicians might say.

Yet, according to Krugman, the problem is that the state does not swallow enough wealth. I suppose that he believes that perhaps had his hero FDR been successful in his attempt to levy a 100 percent tax on all incomes above $25,000 (he tried to do this with an executive order in 1942, but Congress struck down his attempt and the courts did the rest), then we would be a rich, happy country right now.

Furthermore, states and localities are cutting back spending just like the rest of us because the U.S. economy is in a serious recession, and, contrary to what Krugman tells us, the recession did not happen because of anti-government rhetoric or rich people or the lack of high tax rates. There is this problem of causality, and, unfortunately, Krugman confuses cause with effect.

Krugman: Higher Taxes Are A Net Plus

As I have noted before, Paul Krugman told me during a Q&A in a session at the 2004 Southern Economic Association meetings (Dr. Joseph Salerno was sitting next to me and he can verify what I am writing) that the 70 percent tax rates that existed before 1981 were "insane." Given what Krugman has written in a recent blog post, my sense is that he has repudiated his 2004 statement.

He writes:

If we could wave away political reality, I’d let all the Bush tax cuts expire, and use the improvement in the budget outlook to justify a large, temporary increase in public spending.

However, he notes, so he goes to the next best thing: raising only the top marginal rates. His justification is pure Keynesian and it leads to asking the following question: If government spending always is better than private spending, then why not have a 100 percent tax rate on ALL income? Let me explain.

Krugman declares that wealthy people might not spend all of the income that accrues to them (they save it, and everyone knows that Keynesians believe that saving is bad, bad, bad), so government must confiscate as much as possible, since government always spends what it gets (and more). As for lower-income people, they are not so willing to save, so they spend their money, which is good for the economy:

It comes down to the dual fiscal problem the U.S. economy faces: short-term, the government needs to do all it can to prop up spending; long-term, it needs to reduce the deficit. The latter concern means that it would be a terrible idea to make the high-end tax cuts permanent; that would be a huge drain on the public finances, serving no good purpose. But why not a temporary extension? Because it would do very little to promote spending.

The basic framework we have for thinking about consumer spending goes back to none other than Milton Friedman, whose “permanent income” hypothesis says that people will save most of any income change they see as merely transitory. Telling rich people that we’ll keep their taxes low for a couple more years is, for them, a transitory income gain; they’ll save the bulk of it.

Isn’t the same true for lower-income people? Not to the same extent. Permanent-income reasoning doesn’t fully apply when some people are “liquidity-constrained” — they have depressed income, which would make them want to spend more than they earn right now, but they’re out of assets and unable to borrow, or unable to borrow except at relatively high interest rates. People in that situation will spend much or all of any temporary windfall.

So if we give money to people likely to be liquidity-constrained, they are likely to spend it. That’s why aid to the unemployed is an effective stimulus; it also suggests that tax cuts for lower-income workers will be relatively effective at raising demand. But the affluent, who typically have lots of assets and good access to borrowing, are much less likely to be in that situation. So tax cuts for the lower 60 or 80 percent of the population are an OK, not great but OK, form of stimulus; tax cuts for the top 2 percent, not at all.

Notice that Krugman says that letting lower-income people keep some of their money is "OK," but not "great." What is "great," obviously, is government spending.

So, I ask the question again: Given Krugman's logic, is it not better for government to confiscate ALL earnings from everyone and spend the money on what the Political Classes believe to be important? After all, Krugman clearly states in this post that government spending is better for the economy than private spending, so it seems to me that logic should prevail and all of us work for the government for free.

Paul Krugman and Comment Policies

A lot of fuss has been stirred up this past week with Paul Krugman's announcement that he was changing the comment policies on his blog to limiting the comments to three inches. After the hostile response by some, Krugman basically said: "Hey, it's my blog and if you don't like it, you can lump it."

A number of people have sent me the recent American Thinker piece on this change in policy, although I must say that I am reluctant to embrace the claim that Krugman is doing this out of sheer paranoia. I don't know, and, frankly, since I rarely write in his comments section, I don't care what his comment policies might be.

On a number of occasions, my own comments section has featured duels between people who agree with Krugman and those who disagree, and once in a while I join in the discussion, although I usually limit my comments to the actual blog post. I figure that the comments section is for people to express their own views and, frankly, to have fun.

So, unless a comment is obscene or potentially libelous, I tend to let it stand, as I am not wounded by disagreements nor do I worry that some people think I am an idiot. When one makes public statements, as I have done, people will disagree and that is OK.

I do think that Krugman has seemed angrier on his blog lately, and certainly has been even more partisan. As an academic economist, I tend to believe that economists should be above political rhetoric, even if we can support political candidates. My hope is that my blog or other articles do not degenerate into political talking points, and all too often, I believe Krugman does just that.

Economists have a lot of intellectual weapons, and I don't believe that we have to let our analysis degenerate into ______ good and _______ bad. Unfortunately, I believe that is just what Krugman has done, and his constant blame of all our current problems on Goldstein, er, Republicans, is just silly and beneath his stature as a Nobel laureate.

Bob Murphy Takes on Krugman's History and Krugman's Curious Definition of Prosperity

Paul Krugman is fond of claiming that Herbert Hoover was a "liquidationist" (he was not) and that the Hoover administration responded to the downturn by having the Federal Reserve System raise interest rates and by cutting spending.

Bob Murphy, who in my view is a real economist (not a Keynesian), takes on the Krugman version of American economic history in this article, which I believe is worth reading. He not only debunks the Krugman-Robin Wells (Krugman's wife) thesis, but also anticipates the counter-criticisms.

In his column today, Krugman continues his theme that the Fed and the government are not doing enough borrowing and spending to prop up the economy. I guess that trillion-plus-dollar deficits still are not enough for him.

However, I do wish to take on one element of his analysis, that being the definition of "prosperity" as being associated only with the rate of unemployment. Now, he only has the word in the title, but it is clear that he is saying that the rate of unemployment (or employment) is the key to prosperity.

I would like to argue that it is the other way around: a prosperous economy will provide employment opportunities. But there also is another point that Keynesians seem to forget: employment is a MEANS to an end, not an end in itself.

During the Cold War, I remember hearing a Marxist (card-carrying Marxist) "economist" claiming that Romania had a better economy than that of the USA because there was "no unemployment there." Now, he said this during the recession of 1982, when the rate of unemployment then was close to what it is today. Indeed, I remember hearing the critics claim (including men like John Kenneth Galbraith) that not only was the supposed "full employment" of the U.S.S.R. and its satellites "proof" of a "superior" economy, but THEY HAVE FREE MEDICAL CARE.

Now, what they did not point out was that the real standard of living for people in those countries was dismal, and medical care for the mundanes (those that were not part of the Communist Party ruling class) was pretty bad, to put it mildly. Furthermore, as James Bovard points out in this recent article, Romania, for all the lovefest showered upon it from different quarters, in reality was a most miserable place.

I bring up these points to note that full employment in itself is NOT an appropriate "goal" for an economy. Furthermore, I would say that "economies" do not have "goals." Instead, individuals have goals. An economy is a mechanism by which individuals produce and distribute things that help to meet their needs, in which individuals participate as part of their own means-ends frameworks.

The question we should ask is this: Why are there impediments to individuals being able to engage in those things which help us to meet our goals? If you are wondering why this is so, try starting your own business to make goods or provide services that others might want, and you will find that government provides a large number of barriers.

In some cases, such as delivering documents from one person to another, one might find that it is against the law, given the legal monopoly held by the U.S. Postal Service. Places like Cleveland, Ohio, which has been losing population for years, make it very difficult for entrepreneurs to get started, as Nick Gillespie notes in this recent article on the Reason website.

To the Keynesian, however, all of this is gibberish. An economy to them is nothing but a series of numbers to be stacked into GDP figures. In that view, assets are homogeneous and all that is needed is a little bit of inflation and -- Presto! -- we have an "economy."

There is a "great gulf fixed" between how Paul Krugman and I view an economy. Krugman despairs because the government is not spending enough money and the Fed is not printing enough to create high rates of inflation. I despair because the government is doing everything it can to destroy what still is relatively healthy in the economy in order to help its sick friends, like corn-based ethanol, "alternative" energy, and firms on Wall Street that are politically-connected.