Posts Tagged ‘federal reserve’

Mandated spending is pushing on thread.

August 31, 2010 8 comments

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The folks over at Econ Stories made history in January of this year when they released Fear the Boom and Bust, the first popular, Ke$ha-endorsed rap video about economics. The video depicts world-renowned economists John Maynard Keynes and Friedrich August Hayek arguing about how the federal government’s fiscal and monetary policies affect the “Boom and Bust” business cycle, focusing on the parallels between the Great Depression and the housing and lending collapse which began near the end of the Bush administration and has continued throughout the Obama administration.

As with any rap, the main feature of the video is its lyrics, which contain the topic of today’s discussion: “Your focus on spending is pushing on thread.” This line is a rather esoteric reference, by way of clever metaphor, to monetary asymmetry. These are daunting words, but they actually refer to a very intuitive concept which has eluded policy-makers and even many economists for over a century. The aim of this post is to help the average observer understand just what is meant by the phrase “pushing on thread,” as well as to provide a conceptual base for further investigation of how ignorance of economics has had grave consequences for nations around the world.

The best way to discover economic principles is through thought experiments that investigate cause-and-effect relationships. Suppose, for example, that the average individual eats out at restaurants or bars about twice a week. If the government were to impose a law mandating that no person may eat out more than once a week, it would obviously have a negative impact on economic activity. In fact just about everyone can guess this if asked. Unfortunately, not so many of us can really explain precisely what is meant by “economic activity” or how the government’s new rule reduces it. Nevertheless, we understand instinctively that economic activity must be depressed by forbidding people from eating at restaurants.

What actually happens in a situation like this is as follows: Consumers, who at any given time have only a certain amount of liquid assets (money) they can spend, are willing to spend some of their assets at restaurants. However it may be that they decided to eat out twice a week, that’s what they’re willing to do. When the government declares that they may not do this, it prevents economic transactions from occurring. This is “bad” for one simple reason – people wanted those transactions to occur. Specifically, restaurant owners and restaurant customers wanted to make an exchange of money for food. They wanted to do this because each of them valued what the other had more than what they were giving. The customer would rather have a meal, and the owner would rather have cash. If the transaction occurs (the customers eat at the restaurant), everyone feels better off than before. If the government prevents this, economic activity – specifically, the exchange of assets in a beneficial way – is diminished.

Such a law won’t cause all of the consumers’ wealth to go to waste, of course. By preventing people from patronizing restaurants, the government induces them to do something else with their money. However, whatever it is that they decide to do, it is important to remember that it will always be their second choice. They would rather have spent their money on eating at a restaurant than whatever they spend it on instead. Therefore, the value of what they buy with the money they would have used at restaurants will be less to them. They will be worse off. Similarly, the restaurant owners will be worse off, even if they leave the restaurant industry and take up another profession. This is their second choice profession – it was not the most appealing and profitable venture for them. The transactions that people wanted to make to increase their lot in life have been prevented by the government, and whatever is substituted is by definition less beneficial.

Thus it is now clear precisely how a government mandate against eating out more than once per week reduces economic activity, in the sense of forcing a real reduction in beneficial transactions. The concept of pushing on thread enters if the government attempts to employ the reverse idea. Suppose, now, that a law is passed which requires each person to eat out at least three times per week. Remember the assumption that the average individual eats out twice per week. If limiting the amount that people can eat out has the effect of reducing economic activity, perhaps mandating that people eat out more often will increase economic activity. Certainly, restaurant owners might tend to think so. As there will be more transactions in the restaurant industry, revenue will go up for restaurant owners, some of which will be passed on to their employees. Indeed, more restaurants will be built, and that will create jobs in construction, cooking, and waiting. Consumers will have more meals, and probably better ones, too.

It would be great – right? Not at all. Mandating more consumption of products and services does not have the opposite effect as mandating less. If anything, it actually has the same effect, as total per-capita product still declines. This is the essence of the “pushing on thread” metaphor. If the government’s policies impacted the economy in a manner that were so easily manipulable and reversible as, say, a door – pull to open, push to close – then it is doubtful such highly educated experts would be hired to determine the government’s policies. Instead, though, the effects of policy are complicated, and the more they are analyzed, the more depressing the conclusions become. Mandates and regulations pull down, but can not push up, on the health of the economy.

To see how this is so, recall that consumers have only a certain amount of money to spend at a time. They must budget this money somehow; spending infinitely is not an option. Therefore, as people are forced to spend more and more at restaurants, they must by definition make sacrifices elsewhere. Perhaps before a person went out to eat twice a week and went to the theater once. Now he goes out to eat three times, but stops going to the theater to compensate. This, again, is not an even trade-off. He is actually worse than before, because he has stopped doing something he wanted to do – going to the theater – in favor of a second choice option. He didn’t want to spend all that money at a restaurant, so he is by definition worse off if he is required to do so.

Similarly, the business owners also take a hit in productivity. Obviously the owners of pre-existing restaurants will see a rise in profits if a law were passed requiring more visits to restaurants. Yet what is also true is that the owners of theaters must see a decline in profits, as well. As restaurants are built in the weeks and months after the law is passed, so also theaters are closed. Small business owners and their employees will shift industry. People will quit their jobs as theater directors and go to work in food service. Again, this is a second choice. Again, it is by definition worse than what was in place before. The converts from other industries to the food industry are taking jobs they weren’t trained to do in order to satisfy a fabricated demand that doesn’t really exist except that the government requires that it does.

Economists and politicians may preach about the stimulus effects of increased spending in the restaurant business. The newspapers scream headlines about the new jobs created by constructing more restaurants to meet the growing demand. Yet all of this is in the spirit of the broken window fallacy, commenting on the visible benefits of a transaction while ignoring the unseen opportunity costs. The idea put forth is that any economic transaction is by definition a good one, when in fact only a voluntary exchange benefits both parties involved. When praising the activity generated from a mandate to consume, it is necessary to ignore or dismiss the activity which would have occurred in the absence of the mandate – and that activity would have been preferable to both consumers and producers.

One might imagine that policymakers and politicians had by now come to understand the lesson in this simple parable of restaurants. At the very least, they certainly have hired economists and analysts who are too educated to fall for the basic fallacy of pushing on thread – of assuming that the opposite of an action which produces a result will produce the opposite result. Since elected officials tend to be of above average intelligence and education level, and since the federal government has many panels of experts with decades of experience in economics, it is to be expected that, although government policies may not always be perfect, they aren’t as utterly naive as requiring people to eat at restaurants and then declaring an improvement in the economy.

Aren’t they? It seems not, as the past three years have revealed an ever-increasing role of government spending and government-supported consumer spending in the name of “stimulating” the economy, without much consideration for the fact that it is impossible for such policies to increase total productivity at all. Remember the Bush package, when you and your significant other got mailed a check for six hundred dollars in order to stimulate the economy? The stated goal of this policy decision was to prevent an economic collapse and help boost GDP in the face of an expected moderate decline.

Well, it didn’t work at all. GDP ended up dropping far more than predicted, not in spite of the stimulus, but because of it. In fact, Bush’s idea failed so completely that Obama expanded upon it and extended it to affect more people. At every turn, with every new stimulus program, of which there have been about a half dozen since the housing crisis began three years ago, the federal government has sworn that there would be a demonstrable increase in GDP as a result, and every time real GDP (adjusted for inflation) has actually fallen.

This is by no means the extent of the damage – examples of government destruction rationalized as construction abound. It turns out that Barack Obama actually pulled the “mandate that people eat out” trick, only he did so with cars. The infamous Cash for Clunkers program, which one might argue is better termed “the General Motors bailout,” required Americans to buy new cars – with their own money, funneled through the federal government by taxes. Essentially, Obama offered a subsidy, funded out of tax-payer money, for people to scrap old cars and buy new ones. The program was sold on the claim that the act of buying new cars would spur economic growth.

It did not accomplish this, and it could not have under even the most generous interpretation. The philosophy of the program was flawed at its core, because it presumed that the activity generated by purchasing new cars must be good activity – ignoring the fact that, if it were beneficial to buy a new car, people would simply do that on their own. By taking tax dollars, which are of course collected by force, and demanding that they be applied to the purchase of automobiles, the government incentivized allocating resources to one particular sector of the economy, but by definition took resources away from other sectors where consumers would rather have used them. Requiring that people spend their money on a new car is no different from requiring that they spend it at a restaurant, and the damage done is exactly the same. Whatever else people would have spent their money on instead if given the choice, that was better for them than the purchase they were forced into. Ultimately, though, this was lost on policymakers, because they rationalized their decisions by observing the economic activity of buying cars and ignored everything else that money could have been used for.

When the government gets worried by how much of people’s money it is taking to fund purchases they didn’t choose to make, it has another card to play, which is monetary inflation and deficit spending. For a hundred years, Keynesian economists and federal-level politicians have struggled to convince the world – both the people in it and physics itself – that monetary policy allows the government to spend money it doesn’t actually have, if it’s careful enough. All manner of nuanced methods have arisen towards this aim. From the esoteric quantitative easing to tried-and-true manipulation of bonds and printing presses, an academic field and a sector of industry has grown up around selling the notion of the free lunch. The government, it is claimed, can fund programs with other methods besides simply taking money from individuals.

This, unfortunately, is not true. The government cannot create wealth out of thin air, no matter what elaborate practices its banks may employ. Whatever government money is not taken from individuals expressly through taxation is ultimately taken through inflation, the devaluation of savings accounts. When the government bails out banks with trillions of dollars of unofficial spending, this money is taken from the savings accounts of all Americans, especially the middle class, whose combined liquid assets represent the bulk of non-industrial capital. Literally, dollar bills and other written representations of money are created by the government, which the elites call “injecting money into the economy,” and the result is that the value of the dollar declines.

As the dollar is weakened, the ability of savings to buy real products and services decreases proportionally. That means that a person who used to be within a month of having enough money saved up to buy a boat, or who had savings to support his family for a year in case he lost his job, or who was preparing to send his children off to college, is now able to buy less than he otherwise would have with the same amount of dollars. This, then, is the cost of the bailout, and fits the exact same model as the fabled restaurant mandate. The government forces individuals to forgo purchases they otherwise would have made voluntarily in order to pay for a mandated bailout of corporations whose unwanted products and services failed to produce profits – all in the name of stimulating the economy.

The economic crisis has lead to the government fully doubling the monetary base in just a few short years. The long-term consequences of this will be the establishment of recession conditions as the “new normal.” The economy will not improve – it cannot improve – so long as the government continues its policy of mandating spending at levels above what would naturally occur. The American middle class individuals do not want to dig into their savings to bail out enormous banking corporations that have mismanaged their money. They do not want to buy new cars at a time when their income level is uncertain and the bare necessities are of immediate concern. When the government disrespects their decisions in managing their finances, it is only destroying any hope of recovery. Policies that focus on spending are pushing on thread, trying to create a stimulus but ultimately just allocating precious resources where they don’t belong. If Americans want a better future for themselves, the only option is less spending, less mandating, and less government.

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I will buy a billboard for Ron Paul

August 13, 2010 3 comments

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It’s simple, really. Ron Paul philosophically opposes the expanding American empire because it is killing our troops, wasting our taxpayer money, and destroying our reputation around the world. He knew that Barack Obama lied about wanting to end the war in Iraq and gave America an opportunity for a fundamentally different foreign policy.

Ron Paul knows that the War on Drugs is constitutionally unauthorized, morally obscene, and pragmatically a complete failure, and that is why he completely opposes all drug legislation and has voted against it every time.

Ron Paul also understands that the Federal Reserve has caused the boom and bust cycle and must be stopped so that the market can heal before the middle class is wiped out entirely. He stood staunchly against the Obamacare bill and was one of the few Congressmen who demonstrated philosophical justification for his belief that the market, not the government, could provide people with healthcare most effectively. He knows that Barack Obama is allied with corporations just as Bush was, and fears that government interference in trade inherently favors monopolies and corporate bullying instead of fair competition and prosperity.

At a time when even the allegedly anti-war Democrats were screaming for more government control, Ron Paul knew that the Department of Homeland Security was dangerous and evil at its outset, not years later when it was exposed for the damage that it has caused. In fact, Ron Paul was one of the very few Congressmen who attacked the PATRIOT Act upon its inception.

Ron Paul knows that the United States Constitution is the best defense of freedom that has ever been implemented in recorded history. He has always performed his Congressional duties with absolute respect for the Constitution and is one of the last remaining Congressmen who still believe that the Constitution was meant to radically limit the power of government to interfere in people’s lives.

Ron Paul predicted and understood the financial collapse years before it occurred and tried his best to prevent it, but was overwhelmed by a huge majority in Congress who favored more government control and blindness to economic realities over freedom and sensible policies. For many years he has been telling this country that the federal banks and their lobbying potential are dangerous and destructive to the economy and the freedoms of the American people. He stands alone as a stalwart voice of reason and liberty in a sea of Orwellian anti-humanism on Capitol Hill.

It is for this reason that I am proud to announce my personal commitment.

If Ron Paul runs in 2012, I will buy a billboard out of pocket.

I am, of course, willing to accept help. If you are interested in making a donation when the time comes, subscribe to my blog by clicking on the button in the upper right, or reply below. If you plan to donate or, even better, if you plan to buy your own billboard, feel free to save this image and upload it as your profile picture on Facebook. The more visibility this image gets, the more hope we have for America.

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Congressional Candidate BJ Lawson is a master of economics, fears censorship of the internet.

July 19, 2010 8 comments

I got a chance to interview BJ Lawson again at the Carrboro Famers’ Market on Tomato Day. He was there to talk to consumers about the value of consuming organic produce instead of industrial and processed foods whose only assurance of “safety” is the FDA. Thanks to the Triangle Conservatives for informing me of this opportunity. I encourage all of you to check out their group for information regarding local politics, even if you don’t agree with their opinions.

Click to watch the video, or scroll down to read the transcript of the interview.

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JC: Do you think you can beat David Price in a policy debate? Can you, you know, show that you’re better than any opposing candidate on serious economic issues? Can you out-talk him? Do you know more economics than he does?

BJ: Well, I do think David Price is limited by what he’s allowed to say, frankly, and I think one of the frustrations most Americans have is that our government is lying to us and continues to lie to us. So … my offer to the voters: an honest conversation on the issues that are affecting us. So for example in economics, it’s clear that we’re in a crisis that was caused by and is caused by too much debt, yet the only solution that Washington wants to give us involves more debt. You can’t cure an alcoholic with another drink, so just to even be honest about recognizing the cause of our economic problems and then talking about how we transition to a freer economy where we create wealth in our communities is a discussion we desperately need to be having. Mr. Price, unfortunately, is limited by what he’s allowed to say and what his Congressional leadership will let him say, so he’s gonna be in a tough position in a policy debate because he’s not allowed to be honest.

JC: All right, so you talk about debt, and I’ve heard you talk about before reducing government spending, so what I want to know is, you’re in a debate, and David Price says this: “All economists agree that it takes money to make money. Capital gets reinvested into new industries and ventures to generate more wealth and turn the world’s motor. However, during a recession, individuals and banks reduce spending, keeping their capital saved rather than invested and lent. While saving has personal prudence, it is macroeconomically unwise. The decreased consumer spending and bank investment causes factories to slow or shut down resulting in unemployment and rising prices. The government can utilize the multiplier effect by taxing income and savings to fund construction and production projects. These projects aren’t always managed perfectly, but they reinvest capital which would otherwise be stored and not producing output. There’s no advantage to having wealth that isn’t being employed, but funding projects generates new jobs and ensures a cyclic flow of wealth. Shouldn’t we build up our projects when capital lies dormant in a recession?”

BJ: Ah yes, the paradox of thrift. So, were David Price to quote the paradox of thrift by Keynes, we’d also have to remind him that Keynes’s other philosophy was, “In the long run, we’re all dead.” And what we’ve reached in our debt – in our economy – is a point of debt saturation where, effectively, if we try to have the government continue to take on more and more debt beyond our ability to service it, we’re compounding the problem. So, at a very real level, what we need is not more capital in government hands to be mal-invested and given out through crony-capitalism, but we need to get more capital that can be put to work in our local communities. That means freeing up the market to create our own jobs, our own businesses, and not relying on the government as a source of debt finance stimulus, which is simply tying more weights to our ankles and ultimately slowing us down.

JC: But what you’ve just given me is a whole bunch of fiscal policy that assumes completely constant monetary policy. You talk about the federal debt, and you ignore the fact that the Federal Reserve has the ability to reduce the real value of the federal debt by modifying the currency. Can’t we fund projects and modify the value of the currency? Yes, it will reduce the value of savings, and I recognize that that’s disadvantageous to the individual, but we are in a recession. There are disadvantages to the individual. Reducing the value of the currency would increase economic flow if combined with a good fiscal policy.

BJ: So here’s the problem with our monetary policy is that we’re reaching the mathematically constrained end-game for our faith-based currency. What we’ve got is a system of debt-based fiat money that, as you know, can be expanded at will by the Federal Reserve and given out through crony-capitalism, as we’ve all experienced. That system, however, is mathematically limited because, when you’ve got a system of money where your money itself is based upon debt, and new money coming into circulation comes with a burden of interest to pay it back, you need, over time, an exponentially-increasing amount of new money to service the existing debt.

JC: What you’re talking about is when the federal debt becomes so large that the real interest, disregarding what the Federal Reserve claims the interest is, the real interest on the federal debt exceeds the maximum power of taxation at the peak of the Laffer Curve. It becomes impossible even if government spending goes to zero to ever pay off the debt because the interest on the debt exceeds the power of taxation.

BJ: Exactly. And I don’t know if David Price understands that.

JC: Do you think we are at that point?

BJ: Well, we’re clearly at the point where we have tipped over into the diminishing marginal utility of debt, where more debt added into the economy is actually reducing our GDP instead of increasing it. That’s the beginning of the end-game. So until we’re willing to have an honest conversation about the reality of dealing with the crisis of too much debt, and the need to purge mal-investments, to get that back into the economy down to a sustainable level, all we’re gonna be doing is stimulating ourselves off a cliff.

JC: All right, you’ve convinced me on your fiscal policy. Then David Price comes back with a statement about monetary policy again. He says: “During a recession, many companies, especially small businesses, experience a reduction in profits. Because they are businesses, they must scale back their operations to compensate. Yet long-standing social custom coupled with union negotiation makes it almost impossible to reduce wages and hours. Thus the only way a company can scale back operations is through layoffs. In layoffs, not only are some individuals punished for lack of productivity out of proportion to their actual decrease in productivity, but there’s a decrease in specialization of labor, which results in higher prices for consumers. This reduces total economic output, creates an unemployment panic, and compounds the recession. But there is another way. The Federal Reserve can inflate the currency, lowering real wages without lowering nominal wages. The recession is still there, but there are fewer layoffs, the burden of lost productivity is shared instead of focused in certain individuals that didn’t necessarily actually have their productivity go to zero even though they became unemployed and their income went to zero, and there’s no unemployment panic. So shouldn’t the Federal Reserve combat sticky wages by loosening the money supply?”

BJ: Theoretically one might be able to make that argument, but again we’ve reached the point where that process no longer works. How can we lower-

JC: But did it work before? I mean- … it works in some cases?

BJ:  Well, I mean it depends on your definition of “work”. If by “work” you mean, “Can we steal from savers and investors and encourage crony-capitalism that benefits the politically well-connected at the expense of everybody?” Yeah, you could argue that it works.

JC: But why does it benefit the politically well-connected at the expense of everybody if I take a real paycut, but everybody in my company stays employed, and a few individuals whose productivity only went down by ten percent don’t lose all their income?

BJ: Right, but people are on the treadmill of trying to compete to maintain a standard of living against a currency that’s declining in purchasing power. The crony-capitalism and the politically-connected gets into who has access to the first dollars off the printing press if you will, the electronic printing press. The people who have access to the money first when it’s created in an easy-money regime – they’re the ones that benefit, because they’re getting the first fruits of the harvest before prices go up. Unfortunately, though, as we’ve talked about, we’re at the point of debt saturation where we’re already seeing interest rates at zero percent. What is left? The Fed is out of bullets, and to say that we can continue to reduce interest rates or be any easier with easy money ignores the fact that there’s too much debt in the system. For every lender, there’s got to be a borrower, and there aren’t a whole lot of credit-worthy borrowers who are interested in levering up in the current environment. So we’re at the point where the tried-and-true forms of Keynesianism, so-called “Keynesianism”, are no longer effective when you reach the point of debt saturation.

JC: Okay, now the federal government is trying to control the internet. Are people like me the target of the federal government’s attempts to control the internet? Are they mad that I don’t have to buy big books to understand what’s happening in the world? And would you fight tooth-and-nail, not just – I don’t want to say, you know, “Vote ‘No’!” on the bill; you can vote ‘No’ on the bill; the bill’s gonna pass anyway. Would you talk to Ron Paul, and talk to Barney Frank if you have to, and stop the federal government from having any – any- regulatory control over the internet.

BJ: It’s a – that is a critical issue. Yes, I will, and you can get a pretty good picture as to how dangerous the current situation is when you consider that the Department of Homeland Security just this past month over the July 4th weekend put out a very short, like fifteen-day request for comment on a proposal for a policy to provide universal internet user identification. So you can see how the screws are going to be clamped down, and it isn’t even going to require additional acts of Congress to happen. The bureaucratic processes are already in motion to start clamping things down, and we need to fight it.

JC: Is it unconstitutional that the Department of Homeland Security even has the authority to make any kind of regulation? Shouldn’t Congress be in charge of all that?

BJ: Indeed, and you get to another important topic which I call the “Write the Laws!” act, where we look at Congress essentially delegating its Constitutional authority to write legislation to unelected bureaucrats and lobbyists. So you end up with regulatory capture and rules that are written by the politically connected with no legislative recourse for we the people, for us the people.

JC: Cool. Thank you.

BJ: Thanks for coming out.

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The Raleigh Tax Day Tea Party Rally in Five Minutes; One-on-One Interviews

May 20, 2010 4 comments

A summary video of the Tax Day rally in Raleigh, North Carolina, including one-on-one, issue-by-issue interviews with the 4th District Congressional candidates.