The most profound comment in the news yesterday was, in my mind, this quote:
“The highest tax bracket income earners, when compared with those people in lower tax brackets, are far more capable of changing their taxable income by hiring lawyers, accountants, deferred income specialists and the like. They can change the location, timing, composition and volume of income to avoid taxation.”
This comes from the keyboard of Arthur Laffer of Supply-side economics fame. (See, http://professional.wsj.com/article/SB10001424052748703977004575393882112674598.html.) Laffer then gives several examples of such avoidance behavior: Senator John Kerry of Massachusetts, former Senator Howard Metzenbaum, and former Chairman of the House Ways and Means Chairman Charles Rangel.
I totally agree with Laffer on his major point.
This avoidance behavior also exists in the presence of an “inflation” tax. Whereas inflation has been touted as benefitting the “less well-to-do”, this is just a short-run help. Over the longer run, the “less well-to-do” cannot protect themselves very well against rising prices and so end up with lower real wages, real wealth, and fewer job opportunities.
As in the case of government assessed taxes, those individuals in the highest tax brackets or who have accumulated the greatest amounts of wealth are more capable of protecting their real income and real assets from an inflationary depreciation “by hiring lawyers, accountants, deferred income specialists and the like.” They can find many ways to avoid inflation that are not available to the “less well-to-do.”
There are three points that I would like to make relative to the above comments. First, many policies that attempt to help one class of people in a democratic society at the expense of another class of people may succeed in the short run. However, in the longer run, these policies tend to rebound on the former class of people, making them worse off, while achieving little or nothing in terms of the latter class.
In some cases these efforts produce a “negative-sum game” result in which everyone loses something. And, this leads me to the second point. By facing off “one class” of society versus “another class” of society, antagonisms are created, suspicions are raised, and society tends to be worse off. This is not what is supposed to happen in a liberal, democratic nation.
A liberal society works where people cooperate with one another and build community. To quote Ludwig von Mises on a liberal society: “It is important to remember that everything that is done, everything that man has done, everything that society does, is the result of such voluntary cooperation and agreements.”
I am not arguing in this post for or against renewing the “Bush tax cuts”. What I am arguing for
is a change in the rhetoric surrounding discussions about the federal budget, the rhetoric surrounding discussion about the financial reform bill, and the rhetoric surrounding many other issues in front of the American public these days.
Yes, arguing for one class against another may seem like good politics, but in America this really doesn’t win elections. Arguing for one class against another is a form of populism and the very politically astute Bill and Hilary Clinton have stated that elections cannot be won on a populist platform. (One reference on this point to Hilary Clinton can be found in Robert Rubin’s book “In An Uncertain World”.) I still remember watching Al Gore, in the 2000 election campaign, speaking in Mark Twain’s home town on the Mississippi River, Hannibal, Missouri, re-framing his campaign in populist terms. My immediate reaction was…Gore has just lost the election! And, he was well ahead of dubya in the polls at the time.
My third point is that very often people (and especially politicians) get caught up in the consequences of actions, which are current, and fail to see the causes of the these outcomes. This is a big problem in economics: many economic causes occur long before the consequences of the cause are recorded. For example, rent controls on apartments may lower housing costs for renters in the short run. However, if the owners of the apartments fail to maintain the units over time because of the reduced cash flows from the lower rental revenues, many will blame the “owner” and not the rent controls, for the now shoddy apartments .
An important example of this is the government caused inflation over the past fifty years or so. The gross federal debt increased by a compound rate of more than 7% per year from 1961 through 2008. A lot of this debt was monetized so that inflation increased at a compound rate of more than 4% per year during this time period accompanied by numerous asset bubbles which resulted from the excessive creation of credit. Financial innovation prospered in such an environment leading to greater and greater use of financial leverage, the taking on of greater amounts of risk, and the growth of “creative” accounting practices. Ponzi schemes also thrived in such an environment.
Why did businesses succumb to the taking on of excessive risk? The answer: in an inflationary environment, that is where the incentives are. If a company is out-performing its competitor by ten basis points then the competitor may assume more risk or take on greater financial leverage to pump up returns to match the competitor. The environment is cumulative in that more risk begets even more: or, as Chuck Prince, the CEO of Citigroup stated, “If the music keeps on playing, you have to keep on dancing.”
And who gets blamed? The greedy bankers…and not the government that created the inflationary environment. This point was made by the economist Irving Fisher in 1933: “If it is inflation and the one who profits is the business man, the workman calls the profiter a ‘profiteer.’ The underdog reasons as follows: ‘How did I get poor while you got rich? You did it, you dirty thief. I don’t know just how you did it; your ways are too subtle, sinister, dark and underground for simple me; but you did it all the same’
But, none of us—neither the farmer, nor the workman, nor the bondholder, nor the stockholder—thinks of blaming the dollar. So the real culprit stands on the curbstone watching us poor mortals as we beat out each other’s brains, and has the last laugh.”
Working together can result in a “positive-sum game”. The wealthy and those earning high incomes, at least most of them, believe that they should pay taxes. Maybe a new approach needs to be tried rather than attacking them and then trying to penalize them by enacting highly restrictive rules or excessive tax structures which they will spend great amounts of money to avoid.
The old methods don’t seem to work. Maybe we need to work to balance the tax laws so as to maximize tax revenues rather than punish one group of people over another. Maybe we need to think about creating a more open and transparent financial system that allows the economic process to work rather than saddle the economy with rules that dictate “outcomes”.
However, the old methods are built into the political system and will not change before this November. Guess we will just keep on shooting ourselves in the foot!
Showing posts with label federal taxes. Show all posts
Showing posts with label federal taxes. Show all posts
Tuesday, August 3, 2010
Thursday, March 11, 2010
"Sharing the Pain: Dealing with Fiscal Deficits"
Over the past week or so, I have spent a lot of time on sovereign debt and the problems being faced by various nations across this planet with respect to their budget deficits. I suggest the article “Sharing the Pain” in the March 4, 2010 edition of The Economist as a good compilation of issues relating to the situation many countries are now facing. This piece is contained in the briefing, “Dealing with Fiscal Deficits,” http://www.economist.com/business-finance/PrinterFriendly.cfm?story_id=15604130.
We can separate the discussion into three categories: the problem, the pain, and the pragmatic response.
First, the problem. History shows us that when economies slow down, budget deficits appear or widen. Revenue growth declines as the needs to increase outlays rises. Put this general movement on top of decades of undisciplined management of government budgets and you can get “one hell of a problem”
The Economist article states that “deficits in several countries have increased so much and so fast during the economic crisis of the past 18 months or so that it is generally agreed that remedial action will be needed in the medium term. Deficits of 10% or more of GDP cannot be sustained for long, especially when nervous markets drive up the cost of servicing the growing debt.” It continues, “when markets do lose confidence in a government’s fiscal rectitude, a crisis can arise quite quickly, forcing countries into painful political decisions.”
Second, the pain. History shows, according to Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard, that it is highly unlikely that the “rich countries” of the world will experience a burst of rapid and prolonged growth. “Sluggish growth is more likely” and “the evidence offers little support for the view that countries simply grow out of their debts.”
“So, short of debt default or implicit default via inflation, that leaves just two other ways of closing the deficit. Spending must be cut or taxpayers must pay more.” Hence the pain!
Here we can point to the situation in Greece where much of the effort to return some fiscal discipline to the country is falling on cuts in government wages and in social benefits. This has resulted in substantial personal retrenchment and civil unrest. Today we read of a second general strike in the nation that closed all public services. See, “New Strike Paralyzes Greece,” http://www.nytimes.com/2010/03/12/world/europe/12greece.html?ref=business.
The deficits are so large in most of the affected countries that minor adjustments to spending or taxes will have little or no impact. The budget adjustments that must be made are quite substantial: hence the depth and breadth of the pain.
In recessions that are relatively minor, government monetary and fiscal stimulus seems to restore economic growth, thereby rectifying the situation and minimizing the pain. But, in a recession of the magnitude of the Great Recession the government does not seem to be able to “buy” itself out of the trouble. Hence, the spread of the pain.
Furthermore, there is an added difficulty that enters the picture in the more extreme cases. Those that are more affected by the recession and by the adjustments that need to be made in government budgets may come to see the changes as a break in the “social contract” of the country. This government that saw to their welfare, put them to work, and sustained them through the minor crises of the past, now seems to be abandoning them. And, for whom? The international financial community!
Obviously, if we get into this state of affairs, the emotions can become quite high, as in Greece.
This leads us into the third category which has to do with what government can do in such situations. The problem with the situation brought on by large budget deficits and a growing national debt is that there are no good solutions. Anything the government does in an attempt to get the budget under control while encouraging the economy to recover hurts someone.
This is why governments must be very pragmatic in what they propose. Doctrinaire approaches just do not seem to work. There are only two suggestions from the historical perspective that seem to have borne some fruit in the past. The first is that there needs to be some “social cohesion” in the country to achieve some success in the effort to get the country’s budget under control. The second is that governments “should focus on spending cuts rather than tax increases.”
The article in The Economist points to two instances where successful government tightening has taken place in recent memory: Sweden and Canada. In both cases the crisis in the country became acute enough and the ruling governments acted in a sufficiently pragmatic way so that voters finally got behind the efforts. However, this social cohesion was not always achieved on the first attempt.
Some of the social cohesion can be gained by raising some taxes, especially on the “better off”. This may be the “quid pro quo” for the less well off to accept the other things that need to be done. The downside to this is always that the “better off” have more escape hatches that will allow them to avoid any imposition of taxes they feel are excessive. And, many countries in the past twenty years or so have built up reputations as “low tax havens” to attract business. Ireland, for example, lowered its corporate tax rate to just 12.5% and is very reluctant to increase this and harm the climate they benefitted so much from. If taxes go up on these people and businesses, they can be very mobile and move to less oppression environments. Also, tax evasion can be a huge problem especially against sales or value-added taxes.
So, the burden of fiscal tightening falls on the spending side but this is not an easy road either. And, when one looks at the “big” targets for cuts, good arguments for not making cuts abound. Military spending is not a major item in many countries needing budget cuts, but it is in the United States. Here, there are two wars being fought and the need to maintain the world’s “top” military machine and keep it current through research and development makes the budget almost non-touchable.
The next major item that comes up on the list to consider is government employment. Over the last 50-60 years, governments throughout the world have exploded in terms of providing employment. Over the last several years the rate of government hiring has gone up, especially in the United States, in an effort to deal with the financial crisis and the Great Recession. Is it realistic to think that governments will shrink in size or in terms of payroll expenses? This is where Greece and Ireland and Portugal and Spain have promised to do something. And, of course, this is where much of the civil unrest has come from.
Next, social programs, a huge item in many government budgets and the primary cause of the expansion of government budgets in the post World War II period. (For more on this see Niall Ferguson’s book “The Ascent of Money: A Financial History of the World.) The Economist suggests that one area that can be rationalized here is the pension system in these countries.
And, there are other ideas available.
The thing the article (implicitly) points out is that the way out of the fiscal dilemma is not easy. But, I suggest three further things that need to be considered. First, leadership. The countries facing the problems discussed here need to have someone out in front that is understood and trusted. The only way out of this situation is pragmatic: not progressive, not conservative, not liberal, not socialist, or any other dogmatic approach. But, to achieve the “social cohesion” necessary for success, there must be leaders that draw people together.
Second, the proposed solutions cannot just force people back into the way things were. One reason for the depth and breadth of the Great Recession is the changing structure of the society and culture. (For more on this see my post, http://seekingalpha.com/article/192713-the-trouble-with-recovery.) If this is true, then the leadership must be forward-looking rather than serving just entrenched interests.
Finally, this will not be easy. As The Economist article closes: “There are many battles over deficits to come. Well chosen policies that foster growth may make them less fierce. They may be bloody even so.” Amen.
We can separate the discussion into three categories: the problem, the pain, and the pragmatic response.
First, the problem. History shows us that when economies slow down, budget deficits appear or widen. Revenue growth declines as the needs to increase outlays rises. Put this general movement on top of decades of undisciplined management of government budgets and you can get “one hell of a problem”
The Economist article states that “deficits in several countries have increased so much and so fast during the economic crisis of the past 18 months or so that it is generally agreed that remedial action will be needed in the medium term. Deficits of 10% or more of GDP cannot be sustained for long, especially when nervous markets drive up the cost of servicing the growing debt.” It continues, “when markets do lose confidence in a government’s fiscal rectitude, a crisis can arise quite quickly, forcing countries into painful political decisions.”
Second, the pain. History shows, according to Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard, that it is highly unlikely that the “rich countries” of the world will experience a burst of rapid and prolonged growth. “Sluggish growth is more likely” and “the evidence offers little support for the view that countries simply grow out of their debts.”
“So, short of debt default or implicit default via inflation, that leaves just two other ways of closing the deficit. Spending must be cut or taxpayers must pay more.” Hence the pain!
Here we can point to the situation in Greece where much of the effort to return some fiscal discipline to the country is falling on cuts in government wages and in social benefits. This has resulted in substantial personal retrenchment and civil unrest. Today we read of a second general strike in the nation that closed all public services. See, “New Strike Paralyzes Greece,” http://www.nytimes.com/2010/03/12/world/europe/12greece.html?ref=business.
The deficits are so large in most of the affected countries that minor adjustments to spending or taxes will have little or no impact. The budget adjustments that must be made are quite substantial: hence the depth and breadth of the pain.
In recessions that are relatively minor, government monetary and fiscal stimulus seems to restore economic growth, thereby rectifying the situation and minimizing the pain. But, in a recession of the magnitude of the Great Recession the government does not seem to be able to “buy” itself out of the trouble. Hence, the spread of the pain.
Furthermore, there is an added difficulty that enters the picture in the more extreme cases. Those that are more affected by the recession and by the adjustments that need to be made in government budgets may come to see the changes as a break in the “social contract” of the country. This government that saw to their welfare, put them to work, and sustained them through the minor crises of the past, now seems to be abandoning them. And, for whom? The international financial community!
Obviously, if we get into this state of affairs, the emotions can become quite high, as in Greece.
This leads us into the third category which has to do with what government can do in such situations. The problem with the situation brought on by large budget deficits and a growing national debt is that there are no good solutions. Anything the government does in an attempt to get the budget under control while encouraging the economy to recover hurts someone.
This is why governments must be very pragmatic in what they propose. Doctrinaire approaches just do not seem to work. There are only two suggestions from the historical perspective that seem to have borne some fruit in the past. The first is that there needs to be some “social cohesion” in the country to achieve some success in the effort to get the country’s budget under control. The second is that governments “should focus on spending cuts rather than tax increases.”
The article in The Economist points to two instances where successful government tightening has taken place in recent memory: Sweden and Canada. In both cases the crisis in the country became acute enough and the ruling governments acted in a sufficiently pragmatic way so that voters finally got behind the efforts. However, this social cohesion was not always achieved on the first attempt.
Some of the social cohesion can be gained by raising some taxes, especially on the “better off”. This may be the “quid pro quo” for the less well off to accept the other things that need to be done. The downside to this is always that the “better off” have more escape hatches that will allow them to avoid any imposition of taxes they feel are excessive. And, many countries in the past twenty years or so have built up reputations as “low tax havens” to attract business. Ireland, for example, lowered its corporate tax rate to just 12.5% and is very reluctant to increase this and harm the climate they benefitted so much from. If taxes go up on these people and businesses, they can be very mobile and move to less oppression environments. Also, tax evasion can be a huge problem especially against sales or value-added taxes.
So, the burden of fiscal tightening falls on the spending side but this is not an easy road either. And, when one looks at the “big” targets for cuts, good arguments for not making cuts abound. Military spending is not a major item in many countries needing budget cuts, but it is in the United States. Here, there are two wars being fought and the need to maintain the world’s “top” military machine and keep it current through research and development makes the budget almost non-touchable.
The next major item that comes up on the list to consider is government employment. Over the last 50-60 years, governments throughout the world have exploded in terms of providing employment. Over the last several years the rate of government hiring has gone up, especially in the United States, in an effort to deal with the financial crisis and the Great Recession. Is it realistic to think that governments will shrink in size or in terms of payroll expenses? This is where Greece and Ireland and Portugal and Spain have promised to do something. And, of course, this is where much of the civil unrest has come from.
Next, social programs, a huge item in many government budgets and the primary cause of the expansion of government budgets in the post World War II period. (For more on this see Niall Ferguson’s book “The Ascent of Money: A Financial History of the World.) The Economist suggests that one area that can be rationalized here is the pension system in these countries.
And, there are other ideas available.
The thing the article (implicitly) points out is that the way out of the fiscal dilemma is not easy. But, I suggest three further things that need to be considered. First, leadership. The countries facing the problems discussed here need to have someone out in front that is understood and trusted. The only way out of this situation is pragmatic: not progressive, not conservative, not liberal, not socialist, or any other dogmatic approach. But, to achieve the “social cohesion” necessary for success, there must be leaders that draw people together.
Second, the proposed solutions cannot just force people back into the way things were. One reason for the depth and breadth of the Great Recession is the changing structure of the society and culture. (For more on this see my post, http://seekingalpha.com/article/192713-the-trouble-with-recovery.) If this is true, then the leadership must be forward-looking rather than serving just entrenched interests.
Finally, this will not be easy. As The Economist article closes: “There are many battles over deficits to come. Well chosen policies that foster growth may make them less fierce. They may be bloody even so.” Amen.
Friday, January 15, 2010
Tax Evasion?
In the last few days we have seen a ton of headlines and articles talking about how President Obama is going to tax the major banks of the country (including US branches of foreign banks) in order to recoup the bailout funds paid to the banks that went to save them.
The President pledged to “recover every single dime the American people are owed.”
Remember that Mr. Obama is the protector of the dime since he vowed that the health care plan would not cost the American public “one dime”!
The estimated bottom-line cost to the banking system is about $100 billion over a ten-year period.
The banking system is, of course, lobbying as hard as it can to prevent such a tax from being levied. And, lobbyists are earning a lot of money off of this.
But, the President has heard the voice of the little people who are angry at the bankers.
Oh, and then there is the need for new bank regulation.
The estimated cost of this new regulation is in the billions of dollars.
The banking system is, of course, lobbying as hard as it can to prevent such regulation from being inacted. And, lobbyists are earning a lot of money off of this.
But, the President has heard the voice of the little people who are angry at the bankers.
What can we bet on?
My experience in running banks and in studying banks and the banking industry is that the big banks will not, ultimately, pay much of the bill at all.
The reason for this is that the banks will find many, many ways to get around any new laws, regulations, and taxes or will pass the cost of the new laws, regulations, and taxes on to others.
Let me just say here that I don’t mean to single out just the banks in this area. In this Age of Information and with a global network of business and finance almost everyone that has wealth or financial clout or is big can find ways to avoid laws, regulations, and taxes. And, if you don’t believe this it just shows how good these people and organizations are at evading them.
And, the people and organizations that can evade or avoid these new laws, regulations, and taxes the best are the ones that the President and the “populists” are after. The people and businesses that are the least able to avoid the new laws, regulations, and taxes are those that can least afford the consequences of the new laws, regulations, and taxes. This will include the small- and medium-sized banks and people from Main Street. This has happened over and over again throughout history.
Just an example: in the 1960s it was almost the mantra of a certain brand of economist that a little inflation (an inflation tax, if you will) would help the “little people” because it would result in more employment. This was captured in something called “the Phillips Curve.”
The result? In the short run employment was a little higher but people found that inflationary expectations adjusted and over a longer period of time it took more and more inflation to sustain the small rise in employment associated with the higher inflation. By the end of the 1970s we had a real crisis!
Furthermore, those with more wealth or who were better connected could protect themselves from inflation. They could purchase assets, like homes, and art, and securities that appreciated in value with increases in prices. The less well-to-do or the less well-connected could not do this and so the wealth distribution in the country became more skewed.
Thirdly, higher and higher inflation affects productivity and this impacted the use of existing capital and the hiring of the less educated and less trained worker. Unused capacity in manufacturing and under-employment rose over time again hurting those that were the least able to protect themselves.
The purchasing power of the dollar declined from 1961 to the present: where one dollar could buy one dollar’s worth of goods at the former time, it could only buy 17 cents worth of goods now. And, who has suffered the most? Main Street and not Wall Street!
There are two forces dominating the banking scene right now and neither one of them can lead to the construction of sound banking regulations and banking practices. The first is the emotion of the present. People may be upset about what has happened and are particularly incensed at the profits that the large banks are posting. However, an emotional response to current events cannot lead to a rational result. Basing laws, regulations, and taxes on a populist outburst will only produce consequences that are regretted in the future.
Second, it has been my observation that politicians only fight the last war. This is popular because the “last war” is discussed in the press and it is what the constituents of the politicians are responding to. Furthermore, the issues are so complex that the politicians don’t even understand what happened in the “last war”. If you don’t believe this take a look at the initial work the Financial Crisis Inquiry Commission.
Finally, the big banks that the politicians are going after have already moved on “light years” ahead of what happened in the “last war”. I have written several posts on this very fact. Thus, the politicians are firing at the wake of a rapidly moving boat and will miss their target by a lot!
Oh, well, politicians have to get their 15 minutes of fame and try and get re-elected: Seems like we could spend our time concentrating of more productive efforts.
BIG BANK PROFITS
If anyone should be congratulated for the massive profits that have been posted by the “big banks” over the past nine months it should be Ben Bernanke and the Federal Reserve System. Since the real strength of the earnings, especially in banks like JPMorgan Chase, have been in investment banking and trading, one can argue that the Federal Reserve policy of keeping short-term interest rates near zero has subsidized the pockets of the big bankers. Thus one could ask if any of the huge bonuses being paid out by the “big banks” are going to the Chairman and his officers in the Federal Reserve System. They certainly deserve them!
The President pledged to “recover every single dime the American people are owed.”
Remember that Mr. Obama is the protector of the dime since he vowed that the health care plan would not cost the American public “one dime”!
The estimated bottom-line cost to the banking system is about $100 billion over a ten-year period.
The banking system is, of course, lobbying as hard as it can to prevent such a tax from being levied. And, lobbyists are earning a lot of money off of this.
But, the President has heard the voice of the little people who are angry at the bankers.
Oh, and then there is the need for new bank regulation.
The estimated cost of this new regulation is in the billions of dollars.
The banking system is, of course, lobbying as hard as it can to prevent such regulation from being inacted. And, lobbyists are earning a lot of money off of this.
But, the President has heard the voice of the little people who are angry at the bankers.
What can we bet on?
My experience in running banks and in studying banks and the banking industry is that the big banks will not, ultimately, pay much of the bill at all.
The reason for this is that the banks will find many, many ways to get around any new laws, regulations, and taxes or will pass the cost of the new laws, regulations, and taxes on to others.
Let me just say here that I don’t mean to single out just the banks in this area. In this Age of Information and with a global network of business and finance almost everyone that has wealth or financial clout or is big can find ways to avoid laws, regulations, and taxes. And, if you don’t believe this it just shows how good these people and organizations are at evading them.
And, the people and organizations that can evade or avoid these new laws, regulations, and taxes the best are the ones that the President and the “populists” are after. The people and businesses that are the least able to avoid the new laws, regulations, and taxes are those that can least afford the consequences of the new laws, regulations, and taxes. This will include the small- and medium-sized banks and people from Main Street. This has happened over and over again throughout history.
Just an example: in the 1960s it was almost the mantra of a certain brand of economist that a little inflation (an inflation tax, if you will) would help the “little people” because it would result in more employment. This was captured in something called “the Phillips Curve.”
The result? In the short run employment was a little higher but people found that inflationary expectations adjusted and over a longer period of time it took more and more inflation to sustain the small rise in employment associated with the higher inflation. By the end of the 1970s we had a real crisis!
Furthermore, those with more wealth or who were better connected could protect themselves from inflation. They could purchase assets, like homes, and art, and securities that appreciated in value with increases in prices. The less well-to-do or the less well-connected could not do this and so the wealth distribution in the country became more skewed.
Thirdly, higher and higher inflation affects productivity and this impacted the use of existing capital and the hiring of the less educated and less trained worker. Unused capacity in manufacturing and under-employment rose over time again hurting those that were the least able to protect themselves.
The purchasing power of the dollar declined from 1961 to the present: where one dollar could buy one dollar’s worth of goods at the former time, it could only buy 17 cents worth of goods now. And, who has suffered the most? Main Street and not Wall Street!
There are two forces dominating the banking scene right now and neither one of them can lead to the construction of sound banking regulations and banking practices. The first is the emotion of the present. People may be upset about what has happened and are particularly incensed at the profits that the large banks are posting. However, an emotional response to current events cannot lead to a rational result. Basing laws, regulations, and taxes on a populist outburst will only produce consequences that are regretted in the future.
Second, it has been my observation that politicians only fight the last war. This is popular because the “last war” is discussed in the press and it is what the constituents of the politicians are responding to. Furthermore, the issues are so complex that the politicians don’t even understand what happened in the “last war”. If you don’t believe this take a look at the initial work the Financial Crisis Inquiry Commission.
Finally, the big banks that the politicians are going after have already moved on “light years” ahead of what happened in the “last war”. I have written several posts on this very fact. Thus, the politicians are firing at the wake of a rapidly moving boat and will miss their target by a lot!
Oh, well, politicians have to get their 15 minutes of fame and try and get re-elected: Seems like we could spend our time concentrating of more productive efforts.
BIG BANK PROFITS
If anyone should be congratulated for the massive profits that have been posted by the “big banks” over the past nine months it should be Ben Bernanke and the Federal Reserve System. Since the real strength of the earnings, especially in banks like JPMorgan Chase, have been in investment banking and trading, one can argue that the Federal Reserve policy of keeping short-term interest rates near zero has subsidized the pockets of the big bankers. Thus one could ask if any of the huge bonuses being paid out by the “big banks” are going to the Chairman and his officers in the Federal Reserve System. They certainly deserve them!
Thursday, July 9, 2009
Explaining the Drop in the Weekly Money Stock Measures
Thursday afternoon the Wall Street Journal came out with a startling headline: “US M1 Fell $16.2 B In June 29 Week; M2 Fell $36.2 B.” (See http://online.wsj.com/article/BT-CO-20090709-714875.html#mod=rss_Bonds.)
Looking at the H.6 release that comes out at 4:30 PM on Thursday afternoon the Journal reported correctly. The H.6 release is titled Money Stock Measures. The seasonally adjusted M1 money stock measure averaged $1,669.1 billion in the week ending June 22, 2009 and averaged $1,652.9 billion in the week ending June 29, 2009, a drop of $16.2 billion. Please note that in the two weeks previous to June 22, the M1 Money Stock measured $1,630.9 billion and $1,656.5 billion, respectively.
Thus, M1 rose by $7.0 billion in the week ending June 15 and by $26.5 billion in the week ending June 22.
In terms of the seasonally adjusted M2 series, the weekly average for the week ending June 22 was $8,385.4 billion and for the week ending June 29 the M2 Money Stock averaged $8,349.2 billion, indicating a $36.2 billion drop. We can note that for the two previous weeks M2 averaged $8370.0 billion and $8,385.2 billion, respectively.
M2 rose by $15.2 billion in the week ending June 15 and by $0.2 billion in the week ending June 22.
Now let’s see what happened to the non-seasonally adjusted data. The M1 money stock rose $29.5 billion in the week ending June 15, by $52.0 billion in the week ending June 22 and rose another $47.9 billion in the week ending June 29. These figures are significantly different than the seasonally adjusted series.
In terms of M2, this series rose by $16.4 billion in the week ending June 15 but it dropped by $74.4 billion in the week ended June 22 and dropped again by $49.0 billion in the week ending June 29. Again there are serious differences.
There are two points to make here. Formerly the Fed did not put out weekly data on the Money Stock Measures because they jumped around so much. Such volatility can be unnerving to people watching the money stock. Obviously, people at the Wall Street Journal reacted very strongly to the weekly release.
Second, trying to seasonally adjust weekly data is only for the foolhardy or for the very brave. The only conclusion I can draw from the behavior of both the seasonally adjusted series and the non-seasonally adjusted series is that a lot of “stuff” is going on and the seasonal adjustment process is doing very little to capture what is going on. That is, what we are seeing here is white noise!
Is there any clue to what might be happening to banking accounts?
The answer to this is yes, there have been things happening that might help to account for some of the swings and because of the uncertainty of exactly when these things happen from year-to-year their movements can “screw up” the seasonal adjustment of the raw series.
To see what might be happening in the banking system, I go to the Federal Reserve release H.4.1, “Factors Affecting Reserve Balances.” This release also comes out at 4:40 PM on Thursdays. The account I am particularly interested in on the Fed statement is the line item called U. S. Treasury General Account. This is the account that the Treasury Department pulls in tax money from the private sector and then pays it out to the private sector. It is the “transaction” account of the Treasury Department, the one in which the Treasury deposits tax money and the one which the Treasury Department writes checks against.
This account is a “Factor that is absorbing reserves.” That is, when the Treasury draws funds in from the private sector it removes reserves from the banking system. When the Treasury writes checks to the private sector and these balances at the Fed decline, reserves are put back into the banking system.
The Fed and the Treasury work hard to coordinate their actions because they don’t want to incur large swings in the bank reserves. So, what happens is that tax payments and such are kept in the banking system until the Treasury is about to write some checks. When it draws funds from the banks, private deposits go down and the Treasury balances at the Fed go up. When the Treasury turns around and sends out checks to the private sector, bank deposits go up and the Treasury balances at the Fed go down. The Fed then manages bank reserves so that there are few if any dislocations caused in the banking system due to these transaction.
What we have here in June is a buildup in balances at the U. S. Treasury General Account and then a draw down as the Treasury writes out checks. What the Wall Street Journal caught was the building up deposits in the Treasury account. This comes out in the releases up to June 29.
However, we have not yet see the affect of the Treasury checks going out because we don’t have more current data on the Money Stock measures. We do have data for the Treasury’s General Account for the banking weeks ending July 1 and July 8.
And what do we see?
In the banking week ending June 10, the Treasury account averaged $31.4 billion. The next week the account averaged on $42.3 billion, but the account AT THE CLOSE OF BUSINESS on June 17 was a whopping $132.8 billion. Most of the money was drawn from the banking system at the end of the banking week so that the average did not move much.
But, for the banking week ending June 24, the Treasury General Account balance averaged $118.7 billion reflecting the growth in deposits, but the account AT THE CLOSE OF BUSINESS on June 24 stood at $78.8 billion. A lot of money passed though this account in a very few days.
The U. S. Treasury General Account then continued its decline. The average balance for the banking week ending July 1 was $72.0 billion and the average balance for the banking week ended July 8 was $34.2. This latter figure was right at the level of the average balances in the account in the first two weeks of June.
So, as the Wall Street Journal reported, we saw a massive decline in both measures of the Money Stock in the week ending June 29. However, the swings were caused by operational transactions within the government and should be reversed out in the data that are released for the weeks ending July 6 and July 13. But we won’t see those data for another two weeks.
Bottom line: the money stock is not collapsing! Whew!
Looking at the H.6 release that comes out at 4:30 PM on Thursday afternoon the Journal reported correctly. The H.6 release is titled Money Stock Measures. The seasonally adjusted M1 money stock measure averaged $1,669.1 billion in the week ending June 22, 2009 and averaged $1,652.9 billion in the week ending June 29, 2009, a drop of $16.2 billion. Please note that in the two weeks previous to June 22, the M1 Money Stock measured $1,630.9 billion and $1,656.5 billion, respectively.
Thus, M1 rose by $7.0 billion in the week ending June 15 and by $26.5 billion in the week ending June 22.
In terms of the seasonally adjusted M2 series, the weekly average for the week ending June 22 was $8,385.4 billion and for the week ending June 29 the M2 Money Stock averaged $8,349.2 billion, indicating a $36.2 billion drop. We can note that for the two previous weeks M2 averaged $8370.0 billion and $8,385.2 billion, respectively.
M2 rose by $15.2 billion in the week ending June 15 and by $0.2 billion in the week ending June 22.
Now let’s see what happened to the non-seasonally adjusted data. The M1 money stock rose $29.5 billion in the week ending June 15, by $52.0 billion in the week ending June 22 and rose another $47.9 billion in the week ending June 29. These figures are significantly different than the seasonally adjusted series.
In terms of M2, this series rose by $16.4 billion in the week ending June 15 but it dropped by $74.4 billion in the week ended June 22 and dropped again by $49.0 billion in the week ending June 29. Again there are serious differences.
There are two points to make here. Formerly the Fed did not put out weekly data on the Money Stock Measures because they jumped around so much. Such volatility can be unnerving to people watching the money stock. Obviously, people at the Wall Street Journal reacted very strongly to the weekly release.
Second, trying to seasonally adjust weekly data is only for the foolhardy or for the very brave. The only conclusion I can draw from the behavior of both the seasonally adjusted series and the non-seasonally adjusted series is that a lot of “stuff” is going on and the seasonal adjustment process is doing very little to capture what is going on. That is, what we are seeing here is white noise!
Is there any clue to what might be happening to banking accounts?
The answer to this is yes, there have been things happening that might help to account for some of the swings and because of the uncertainty of exactly when these things happen from year-to-year their movements can “screw up” the seasonal adjustment of the raw series.
To see what might be happening in the banking system, I go to the Federal Reserve release H.4.1, “Factors Affecting Reserve Balances.” This release also comes out at 4:40 PM on Thursdays. The account I am particularly interested in on the Fed statement is the line item called U. S. Treasury General Account. This is the account that the Treasury Department pulls in tax money from the private sector and then pays it out to the private sector. It is the “transaction” account of the Treasury Department, the one in which the Treasury deposits tax money and the one which the Treasury Department writes checks against.
This account is a “Factor that is absorbing reserves.” That is, when the Treasury draws funds in from the private sector it removes reserves from the banking system. When the Treasury writes checks to the private sector and these balances at the Fed decline, reserves are put back into the banking system.
The Fed and the Treasury work hard to coordinate their actions because they don’t want to incur large swings in the bank reserves. So, what happens is that tax payments and such are kept in the banking system until the Treasury is about to write some checks. When it draws funds from the banks, private deposits go down and the Treasury balances at the Fed go up. When the Treasury turns around and sends out checks to the private sector, bank deposits go up and the Treasury balances at the Fed go down. The Fed then manages bank reserves so that there are few if any dislocations caused in the banking system due to these transaction.
What we have here in June is a buildup in balances at the U. S. Treasury General Account and then a draw down as the Treasury writes out checks. What the Wall Street Journal caught was the building up deposits in the Treasury account. This comes out in the releases up to June 29.
However, we have not yet see the affect of the Treasury checks going out because we don’t have more current data on the Money Stock measures. We do have data for the Treasury’s General Account for the banking weeks ending July 1 and July 8.
And what do we see?
In the banking week ending June 10, the Treasury account averaged $31.4 billion. The next week the account averaged on $42.3 billion, but the account AT THE CLOSE OF BUSINESS on June 17 was a whopping $132.8 billion. Most of the money was drawn from the banking system at the end of the banking week so that the average did not move much.
But, for the banking week ending June 24, the Treasury General Account balance averaged $118.7 billion reflecting the growth in deposits, but the account AT THE CLOSE OF BUSINESS on June 24 stood at $78.8 billion. A lot of money passed though this account in a very few days.
The U. S. Treasury General Account then continued its decline. The average balance for the banking week ending July 1 was $72.0 billion and the average balance for the banking week ended July 8 was $34.2. This latter figure was right at the level of the average balances in the account in the first two weeks of June.
So, as the Wall Street Journal reported, we saw a massive decline in both measures of the Money Stock in the week ending June 29. However, the swings were caused by operational transactions within the government and should be reversed out in the data that are released for the weeks ending July 6 and July 13. But we won’t see those data for another two weeks.
Bottom line: the money stock is not collapsing! Whew!
Sunday, January 25, 2009
How Effective Might the Stimulus Plan Be?
The Obama stimulus plan totals $825 billion. This plan is a combination of spending plans and tax relief. The dollar amount needed to be large, we are told, because the American economy is tanking and a lot of effort needs to be exerted to stop the decline and re-establish positive growth once again. Of course, we were told similar things when the legislation relating to the TARP was introduced. We have also been told that the number needs to be large because we don’t really know how much stimulus will be needed to jump-start the economy so we need to throw a lot of cash at the problem in hopes that the effort will be large enough to do the job.
The problem is…how much extra spending will $825 billion of stimulus create in the economy. In the simple Keynesian model this $825 billion will generate something more than $825 billion as new investment and new spending is created from the initial stimulus. The word going around is that the Obama economists are using a “multiplier” of 1.5. Thus, $825 billion in new spending and tax cuts will actually result in another $412.5 billion in spending raising the total affect on the economy to $1.2375 trillion…a hefty sum.
On Thursday, the Wall Street Journal printed an opinion piece by Harvard economics professor Bob Barro (http://online.wsj.com/article/SB123258618204604599.html?mod=todays_us_opinion)
who argued that the “multiplier” might be something different from 1.5 and might even be as low as zero! Barro contended, supported by his research, that even in times that are most favorable for the multiplier to be toward the higher end of this range, war times, the multiplier comes out to be no higher than 0.8. That is a stimulus plan that totaled $825 billion, could only expect to produce about $660 of real Gross Domestic Product not $1.2375 trillion. But, he adds, this estimate of 0.8 is probably optimistic.
Why would the final impact of the stimulus package be less than the amount of the stimulus package itself? There are several reasons. For one, the government expenditures could be expected to be a substitute for private investment or other private expenditures. Furthermore, whether or not the tax cuts are spent is another question. In the recent Bush43 tax rebate program much of the rebate money either went into savings or it went to pay off existing debt. In a poll released in the middle of last week, pollsters found that, on average, people would apply 70% to 75% of any tax relief from the stimulus plan to savings or to paying off existing debt. So there are arguments…and empirical support…for the contention that the “multiplier” may not be as high as 1.5 and might realistically be below 1.0.
The threat to save or pay back debt is real…not only for consumers…but also for businesses. Some economists who have studied recessions and depressions talk about a period of time called a debt/deflation. In periods like these the future looks bleak…and economic units…consumers and businesses…try to pull back and restructure themselves on a sounder financial basis. That is, they want to reduce the leverage that is on their balance sheet and get away from owing money. The first concern has to do with being unemployed or faced with going out of business…economic units want cash or, at least, near-cash items so as to be able to bridge a period when cash inflows might be low. And, if there is a possibility of deflation, people want to reduce the amount of debt on their balance sheets because the real value of debt and debt payments increase when prices are falling.
Some “Keynesians” have tried to incorporate these ideas about debt/deflation into their economic models. Hyman Minsky was one of the most prominent economists to explicitly discuss the impact of the capital markets on economic expansions and contractions. However, most of the empirical models used by policy makers do not take account of capital market effects on economic activity. (For a discussion of the economic model used for policy forecasting in the Federal Reserve see “Ben Bernanke’s Fed: The Federal Reserve After Greenspan” by Ethan S. Harris, Harvard Business School Press.) It is hard to contemplate “multipliers” as high as 1.5 if one considers these capital market issues.
For people to spend or borrow (if they could borrow) they need to have at least a somewhat optimistic view of the future (even for the possibility of inflation) to maintain or increase spending by either reducing savings or by borrowing. The obvious psychological impact hoped for from the stimulus package is that economic units will have enough confidence in the future or will even be willing to borrow and pay back loans with cheaper real dollars to keep spending or even increase spending. The Obama team is intending to use the rest of the TARP funds released by the Congress ($350 billion) to get people borrowing again.
Of course the concern about achieving this latter effect is the concern over the creation or the re-enforcement of moral hazard in the economy. If the government continues to “bail out” not only financial institutions but businesses, families, and other economic units, these economic units will continue to take on more and more risk in the future because they know that the government will supply a safety net to protect people from their foolish bets. The economists who argue from the viewpoint of the debt/deflation hypothesis contend that sooner or later the economy will take on so much debt that the debt/deflation cannot stop until people finally work off their extreme financial imbalances and return to more normal debt loads and positive amounts of saving. Some of these economists believe that this time has arrived and the economy cannot be turned around until economic units have worked off their excessive debt burdens and taken on a more conservative view of their economic future.
To get a zero multiplier (see the Barro article and Barro’s textbook “Macroeconomics: A Modern Approach” published by Thomson South-Western) one must argue that economic units will anticipate the increased real economic costs, real future taxes, or inflation that result from the way in which the stimulus package is financed and re-arrange their economic and financial activities to be able to cover the future government levies. A zero multiplier means that for every $1.00 the government puts into the stimulus plan, economic units will remove $1.00 from the spending stream. Thus, the $825 billion stimulus plan would increase real Gross Domestic Product by…ZERO DOLLARS!
What is the alternative to the type of stimulus plan proposed by the Obama administration? Barro argues that things must be done to encourage business commitment and innovation. His favorite idea is to eliminate the federal corporate income tax. If people are to be put back to work again…businesses must be hiring. In order to do this the energy and the foresight of the American business community must be put back to work again. The concern with massive public-works programs is that they will just substitute for the innovation and entrepreneurial leadership that still exists in the country and could produce real growth but needs to have the appropriate incentives.
So, what will be the impact of the Obama stimulus plan? You take your guess…I’ll take mine. My guess is that the multiplier is less than 1.0 and is maybe as low as 0.4. A reason for this pessimistic view of the multiplier is that we are at the stage where people/families and businesses finally have to fully restructure their finances to get balance sheets back into some form of conservative position. After many, many years of chasing dreams through betting on rising inflation with increased leverage and new financial instruments…the economy finally needs a break…needs to catch its breath and settle down for awhile.
I could be wrong. The American government could throw so much money at the economy that rising inflation and increased leverage becomes “the thing” again. If such is the case…then we are just postponing for another time, dealing with the monster that the government has created in the first place.
The problem is…how much extra spending will $825 billion of stimulus create in the economy. In the simple Keynesian model this $825 billion will generate something more than $825 billion as new investment and new spending is created from the initial stimulus. The word going around is that the Obama economists are using a “multiplier” of 1.5. Thus, $825 billion in new spending and tax cuts will actually result in another $412.5 billion in spending raising the total affect on the economy to $1.2375 trillion…a hefty sum.
On Thursday, the Wall Street Journal printed an opinion piece by Harvard economics professor Bob Barro (http://online.wsj.com/article/SB123258618204604599.html?mod=todays_us_opinion)
who argued that the “multiplier” might be something different from 1.5 and might even be as low as zero! Barro contended, supported by his research, that even in times that are most favorable for the multiplier to be toward the higher end of this range, war times, the multiplier comes out to be no higher than 0.8. That is a stimulus plan that totaled $825 billion, could only expect to produce about $660 of real Gross Domestic Product not $1.2375 trillion. But, he adds, this estimate of 0.8 is probably optimistic.
Why would the final impact of the stimulus package be less than the amount of the stimulus package itself? There are several reasons. For one, the government expenditures could be expected to be a substitute for private investment or other private expenditures. Furthermore, whether or not the tax cuts are spent is another question. In the recent Bush43 tax rebate program much of the rebate money either went into savings or it went to pay off existing debt. In a poll released in the middle of last week, pollsters found that, on average, people would apply 70% to 75% of any tax relief from the stimulus plan to savings or to paying off existing debt. So there are arguments…and empirical support…for the contention that the “multiplier” may not be as high as 1.5 and might realistically be below 1.0.
The threat to save or pay back debt is real…not only for consumers…but also for businesses. Some economists who have studied recessions and depressions talk about a period of time called a debt/deflation. In periods like these the future looks bleak…and economic units…consumers and businesses…try to pull back and restructure themselves on a sounder financial basis. That is, they want to reduce the leverage that is on their balance sheet and get away from owing money. The first concern has to do with being unemployed or faced with going out of business…economic units want cash or, at least, near-cash items so as to be able to bridge a period when cash inflows might be low. And, if there is a possibility of deflation, people want to reduce the amount of debt on their balance sheets because the real value of debt and debt payments increase when prices are falling.
Some “Keynesians” have tried to incorporate these ideas about debt/deflation into their economic models. Hyman Minsky was one of the most prominent economists to explicitly discuss the impact of the capital markets on economic expansions and contractions. However, most of the empirical models used by policy makers do not take account of capital market effects on economic activity. (For a discussion of the economic model used for policy forecasting in the Federal Reserve see “Ben Bernanke’s Fed: The Federal Reserve After Greenspan” by Ethan S. Harris, Harvard Business School Press.) It is hard to contemplate “multipliers” as high as 1.5 if one considers these capital market issues.
For people to spend or borrow (if they could borrow) they need to have at least a somewhat optimistic view of the future (even for the possibility of inflation) to maintain or increase spending by either reducing savings or by borrowing. The obvious psychological impact hoped for from the stimulus package is that economic units will have enough confidence in the future or will even be willing to borrow and pay back loans with cheaper real dollars to keep spending or even increase spending. The Obama team is intending to use the rest of the TARP funds released by the Congress ($350 billion) to get people borrowing again.
Of course the concern about achieving this latter effect is the concern over the creation or the re-enforcement of moral hazard in the economy. If the government continues to “bail out” not only financial institutions but businesses, families, and other economic units, these economic units will continue to take on more and more risk in the future because they know that the government will supply a safety net to protect people from their foolish bets. The economists who argue from the viewpoint of the debt/deflation hypothesis contend that sooner or later the economy will take on so much debt that the debt/deflation cannot stop until people finally work off their extreme financial imbalances and return to more normal debt loads and positive amounts of saving. Some of these economists believe that this time has arrived and the economy cannot be turned around until economic units have worked off their excessive debt burdens and taken on a more conservative view of their economic future.
To get a zero multiplier (see the Barro article and Barro’s textbook “Macroeconomics: A Modern Approach” published by Thomson South-Western) one must argue that economic units will anticipate the increased real economic costs, real future taxes, or inflation that result from the way in which the stimulus package is financed and re-arrange their economic and financial activities to be able to cover the future government levies. A zero multiplier means that for every $1.00 the government puts into the stimulus plan, economic units will remove $1.00 from the spending stream. Thus, the $825 billion stimulus plan would increase real Gross Domestic Product by…ZERO DOLLARS!
What is the alternative to the type of stimulus plan proposed by the Obama administration? Barro argues that things must be done to encourage business commitment and innovation. His favorite idea is to eliminate the federal corporate income tax. If people are to be put back to work again…businesses must be hiring. In order to do this the energy and the foresight of the American business community must be put back to work again. The concern with massive public-works programs is that they will just substitute for the innovation and entrepreneurial leadership that still exists in the country and could produce real growth but needs to have the appropriate incentives.
So, what will be the impact of the Obama stimulus plan? You take your guess…I’ll take mine. My guess is that the multiplier is less than 1.0 and is maybe as low as 0.4. A reason for this pessimistic view of the multiplier is that we are at the stage where people/families and businesses finally have to fully restructure their finances to get balance sheets back into some form of conservative position. After many, many years of chasing dreams through betting on rising inflation with increased leverage and new financial instruments…the economy finally needs a break…needs to catch its breath and settle down for awhile.
I could be wrong. The American government could throw so much money at the economy that rising inflation and increased leverage becomes “the thing” again. If such is the case…then we are just postponing for another time, dealing with the monster that the government has created in the first place.
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