Wednesday, June 24, 2009

Yahoo! Finance promotes economic misinformation



Charles Wheelan writes a column on Yahoo! Finance called the "Naked Economist." This guy is not only naked, he's clueless. Here is his most recent column. I put my comments below his.

Ben Franklin supposedly said that it's better to skip supper and go to bed hungry than it is to wake up in debt. Ben would be quite disappointed in us. We Americans didn't skip dinner; instead, we opted over the past decade to gorge at the buffet and then charge it.

You skip enough meals and you will become malnourished. There is no reason to pursue a life of privation when you live in a nation of abundance.

We woke up as the world's largest debtor -- so deeply in debt that our global creditors are getting nervous, and rightfully so.

This author doesn't seem to understand that there are two sides to a balance sheet: liabilities AND assets. He forgets the asset side and in so doing, ignores the fact that the U.S. has a hugely positive net worth and that the U.S. economy produces high returns on capital. Donald Trump has huge debts, too, but his assets are greater and that makes him rich. Every savvy businessman knows that you get rich by using OPM (other people's money), yet this guy seems to think that the way to become rich is to be a lender. Benjamin Franklin also said, "Neither a debtor OR LENDER be!" He forgot that one, too!

Here are some economic realities associated with our deepening fiscal hole.

It's bad. As in, $11 trillion bad. That number alone doesn't mean much, at least without context. So here is some context. First, that's roughly $40,000 for every man, woman, and child in the country. Second, our debt is projected to grow to roughly 100 percent of GDP by 2010, meaning that, if we were to devote everything we produce as a nation to paying down debt, it would take us an entire year to pay off what we owe.

Here's some context: People routinely take 15 years or more to pay off a mortgage and he's telling us that the whole entire national debt could be paid off in 10 months. It would take the average household five years to pay off a mortgate if it devoted everything in earned to paying. He's wringing his hands and getting hysterical for a debt that is proportionally, five times smaller. Finally, the $11 trillion that he is talking about is roughly 78% of our GDP. Sound bad? Well, consider the fact that Japan has a debt-to-gdp ratio of 200%! And Japan still pays near-zero on its debt.

Furthermore, the debt of the U.S. government equates to part of the holdings of financial assets of the public, BY DEFINITION! What kind of economist is this guy??

Eating Up the Global Capital Pool

Other countries have become more indebted as a percentage of GDP, but they were small countries, so they sucked up less of the global capital pool. There is only so much money in the world, and we have borrowed a shocking proportion of it. The only other time the U.S. has been so indebted was at the end of World War II.

Yes, and it didn't destroy us. It made us rich! Furthermore, there is no, "sucking up of the global capital pool." That statement is simply, ridiculous!! The U.S. government spends by crediting bank accounts, which ADDS to the global capital pool. The money to buy Treasury securities (which are simply interest bearing accounts of the U.S. government) comes from government spending itself!

Big debt means big interest payments. The Chinese haven't loaned us a trillion dollars because we're good-looking; they've loaned us a trillion dollars because we pay for the privilege of using that capital. Interest payments now make up more than 8 percent of the federal budget -- meaning that nearly one of every 10 of your tax dollars gets you absolutely nothing in return. No schools, no bridges, no domestic wiretaps. That's just the cost of servicing the debt we've run up.

"Big debt means big interst payments." Not if the Fed keeps interest payments low. Interest payments by governmet actually FELL year-over-year even as the deficit has more than doubled. Hello!!!! He can look these numbers up. Moreover, even if the government DID pay more in interest, that comprises part of the income to the private sector, which means it enriches the public; it doesn't impoverish it. He has it completely backwards!!

And we've done nothing terribly productive with all that borrowed money. Debt, after all, is not inherently bad. If you borrow $100,000 to go to medical school, then you've probably done a very smart thing. When you graduate, your earning potential will be higher, enabling you to live better even after you pay off the loans (with interest). In this case, you used borrowed money to invest in something that made you more productive.

Debt incurred in the process of sustaining aggregate demand is good. It's pretty much irrelevant what it is spent on because it "trickles" through the economy in the same fashion that tax cuts for the rich "trickle" through.

Now suppose that you borrowed $100,000 to sustain a lifestyle that you could not otherwise afford: to pay the rent, to buy nice clothes, and to make the payments on your luxury car. When that bill comes due (with interest), you're no more productive than you were when you started borrowing. You borrowed used money for consumption, not investment.

The consumption he's talking about (paying rent, buying clothes, a car) equates to income to homebuilders, auto dealers, clothing stores. Is he saying that these vendors do not DESERVE to earn a living? Then he is making a value judgement about what kind of businesses should exist and what kinds shouldn't. (That's central planning--something he's against.) I guess he believes that we should have a society where there are only medical schools (he deems these "valuable). We can all be naked, without food, shelter and nice things, but we'll have plenty of doctors.

Unfortunately, America's borrowing resembles the latter more than the former. We haven't upgraded our transportation infrastructure or made major investments in alternative energy or financed education for those who could not otherwise afford it.

Yes, there are many worthwhile investments and we can make them anytime we want, but are hindered by a belief system very much in line with what this guy believes. That's precisely why we aren't making these investments!

Stop the Bickering

We need to stop bickering about who got us here. Was it the Bush tax cuts (yes) or the Obama stimulus (yes) or profligate Congressional spending (yes) or voters who continually reward pork more than parsimony (yes)? But analyzing just overcomplicates things. We are deeply in debt because we have routinely spent more than we collect in taxes. That's just a mathematical reality that has become needlessly confounded with politics.

Government exists for the public purpose. The preamble of the Constitution states, "...establish Justice, insure domestic Tranquility, provide for the common defense, promote the general Welfare..." Sustaining output and employment are fundamental to promoting the general welfare and possibly even fundamental to insuring domestic tranquility.

He's again misinformed when it comes to taxes and believes that taxes "fund" the government. If that were true then why does the government only accept payment in its OWN MONEY!. You can't even argue that it is your labor that you are paying to the government, because your labor goes to earn the government's money (at least in part) in order to satisfy whatever tax liability there is. The government can spend whatever it wants if it spends in its own money and is not constrained by tax collections. Taxes are used to regulate demand and impart value to the currency, among other things.

If you're a small government conservative, that's great. But let's say enough of the tax cuts without corresponding spending cuts. Those aren't tax cuts; they are tax postponements. You've just left the bill for future taxpayers, with interest.

Not at all. Tax cuts restore income and savings to the private sector. what's wrong with that? If gov't reduces fiscal drag to the point where we are using all our available resources and capital--but not beyond--then we are living at our highest level of utility and prosperity. What's wrong with that??

And if you believe that government can and should build a stronger America, terrific. I'm sympathetic: I like early childhood education and the high-speed rail and Army sharpshooters who kill pirates. If you want those things, then pay for them.

Big government or small government, the revenues need to equal the expenditures. It really is that simple.

That simple? Maybe to a simpleton like him, however, over our 220 year history revenues have hardly ever equaled expenditures and when they have, they have preceded major economic downturns, like in the late 1920s, 2000 and most recently, in 2007, when the deficit was less than 1% of GDP and we were fighting 2 wars!

When the Big Bills Come Due

The big bills haven't even come due yet. If the U.S. were a family, we'd be crouched over the kitchen table trying to figure out how to pay the Amex and Visa bills -- and the gigantic Mastercard bill would still be in the mail.

The bills are always coming due. Every single day the government pays interest on debt and even redeems debt. Then guess what? It issues some more. This guy ought to look at the daily Treasury Statement. He's clueless. So far this month the bill came due for $485 billion. That's how much debt was redeemed (gov't paid back principal to holders). So far this fiscal year, $5.2 TRILLION has been redeemed--half of all outstanding debt. Did the world come to an end??

The big bill still in the mail for the United States is for our entitlement programs -- primarily Social Security and Medicare. We've made huge commitments to these programs that are not adequately funded. That Social Security check you're counting on when you turn 65 doesn't show up in the debt figures, but it's still money that we will owe. Lots and lots of money.

This is a joke. Even David Walker--Deficit Terrorist in Chief--admitted on my radio show that there is no solvency issue.

And the Chinese are worried U.S. debt, as they should be. All debtors have creditors; ours are all over the world. The biggest one is the Chinese government, which has been buying up U.S. Treasury bonds with all the vigor and foresight of a 1990s Las Vegas real estate developer.

Chinese are laughing at us as they enact stimulus programs and deficit spend in magnitudes three times as big as what we are doing. They can do that, because they don't have journalists running around shouting nonsensical things such as, "Taxpayer on the hook," or misinformed guys like Whelan who are given platforms to spew their misinformation. It's outrageous.

The Chinese buy Treasuries because that is a safe, interest-bearing way to store the dollar wealth they have accumulated from selling us real goods. It is their desire to "net save" in dollar-denominated financial assets, otherwise they would be saving in another currency or buying goods from us and THEY would be running a trade deficit instead of the other way around. The only way for the Chinese to buy dollar-denominated financial assets is to acquire dollars and the only way they can do that is to sell us merchandise on the cheap.

If we don't honor our bonds, China doesn't get to repossess the White House or the national parks; they don't get to carve their own leaders on Mt. Rushmore. Treasury debt is secured by the "full faith and credit of the U.S. government" -- which won't command much at auction, if it comes to a foreclosure type situation.

No nation that issues debt denominated in its own currency and where that currency is not backed by gold or tied to some fixed exchange rate can EVER default on its debt. He doesn't understand this, but neither do the ratings agencies and many U.S. lawmakers.

Chinese officials aren't worried about bankruptcy because the U.S. has an easier and more insidious option -- we can print our way out of the problem. Our debt is denominated in dollars, and the U.S. government has the authority to print those dollars. We could take a page from the Zimbabwe policy manual and just print money to pay our bills -- thereby debasing the currency, creating inflation, and devaluing the real value of what we owe.

Japan's debt tripled in the past 10 years and it was downgraded by the ratings agencies to the level of Botswana, but it still pays almost zero percent interest on its debt. I hear this Zimbabwe example a lot. Zimbabwe is a corrupt country, run basically by a thug, Robert Mugabe. It has little infrastructure and scant capital. It's economy is one seven-thousandth the size of the United States. Most important, however, is the fact that its debts are denominated in other currencies, primarily in dollars. This comparison is SOOOOO inapplicable it is not even funny. This guy calls himself an economist??? He might as well just say that the whole Apollo mission to moon was staged.

Is that a sensible solution? No, as it imposes the costs of inflation on all of us. I don't know anyone eager to revisit the 1970s (in terms of economic performance or fashion).

Can anyone prove that the amount of entitlement debt that will have to be "covered" by the government actually just crediting bank accounts, will be inflationary? No one has.

Is it a possibility? You bet. In fact, I'm surprised that long-term interest rates haven't climbed more than they have. (When long-term lenders fear inflation, they demand higher interest rates to protect against that contingency.)

Long-term interest rates haven't climbed because the Fed has been setting them lower. No wonder he's, "surprised." He doesn't see the connection.

The solution to all this is straightforward: Spend less than we take in, and use the surplus to pay down debt. At the risk of lapsing into economics jargon, yes, this is going to suck. Think about it: Americans don't like their current tax bills -- which aren't even high enough to pay for our current spending, let alone the bills we've run up from the past. In the future, we will have to pay more and get less.

What he calls a "solution" is a path of economic ruin. By "spending less than it takes in" the government would, in short order, deplete all the private savings and private wealth of the nation. Since government debt (Treasuries) are an asset, by "paying them off" the government effectivley reduces the amount of assets held by the public with no concomittant decrease in the public's liabilities, thus resulting in lower net worth of households. This is his, "solution."

But we've done it before. We paid off the debt accumulated during World War II. In fact, the ensuing decades saw some of the most impressive gains in wealth and productivity in American history. But it will require a radical change from what we're doing now.

Yes, it was the gains in wealth that reduced the size of the debt. The debt didn't go away, it just became smaller relative to the overall economy as the economy grew. That's the real solution: get the economy growing again.

An economic recovery will help. But we can't pretend that will be enough. We need to raise taxes, cut spending, and/or reform our entitlement programs. Probably all three, and in a serious way.

Can't pretend? Is this guy serious? Economic growth is the ONLY way to reduce the deficit without impoverishing the private sector.

Will that dampen economic growth in the short run? Yes. Will it jeopardize important social programs? Yes. Will it compromise our ability to make important public investments? Yes. Does it limit what we can spend on healthcare reform? Yes.

Will it reduce output and incomes? Yes. Will it impoverish more people? Yes. Will it reduce our standard of living relative to the rest of the world? Yes. Will only a small percentage of Americans even have health care if we follow him? Yes.

But as Ben Franklin would have pointed out, we should have thought about that before ordering room service and then charging it to a credit card.

As Ben Franklin said, "Neither a borrower nor LENDER be."

2 comments:

Matt Franko said...

Mike,
Excellent!
At my work I pay about $5000 per year to my local utility (Gas & Electric).
I plan on being in business for another 20 years, according to the DDC, I'M IN DEBT TO MY UTILITY CO. FOR $100K! I didnt even realize! Oh well.
Keep it up I see some cracks lately in the DDC armor.
Matt

PS I dont know if you were following over at WMs, but the ECB did a 1% one year repo last night for equiv. $620B! In one day! Where is the "printing money" and "debasing" crowd on this one? the Fed has taken over 6 months to expand the Fed balance sheet by an amount that is less. It has hardly been mentioned in the media.

Mike Norman said...

Yes, I saw Warren's email. If the media had any brains I'd call them hypocrites, but I can't...they're just clueless!