Thursday, October 16, 2014

How to fix the economy

This post, written by Duane and me, was submitted to the Albuquerque Journal in response to an article by two mainstream conservative economists. It doesn't look like the Journal is interested, but we keep trying.

In an article published in the Journal on October 6 Micha Gisser and Kenneth Brown offered five policies they claim could fix the economy. While some of their ideas are on the right track they are really repetitions of old, ineffective, conservative policies. 

Our economic solution takes issue with conservatives and liberals alike. Both Democrats and Republicans are obsessed with deficit reduction. Democrats think the government has a revenue problem, while Republicans think government has a spending problem. They are both wrong. Our real problem is unemployment caused by a lack of demand for consumer goods and services. Until we conquer unemployment by increasing demand our economy will continue to struggle.

Employment ratio is not recovering after recent recession as in the past.

The symptoms of our economic woes are that national production (GDP) has been running approximately $800 billion per year below its potential capacity, and year after year the wealthy gain more of the national income than the workers. To fix this, we need to reduce corporate welfare and initiate policies that put more money into workers’ pockets.

Certainly, we should decrease corporate taxes. They are just production costs passed on to consumers. And, we should simultaneously increase minimum wages so that the money saved from taxes goes to workers, not to corporate executives and stockholders. We should also revive the successful FICA tax holidays on both businesses and workers.

Keeping wages low only works to improve profits for a single company. To think that it works for all companies in the aggregate is a fallacy of composition well known to most economists. If wages are low in the aggregate, it hurts demand, sales and profits for business in general. 

We must invest in the future. Because demand is not growing, businesses in the aggregate are not investing. A recent Bloomberg report says S&P 500 companies are using 95% of profits for share buybacks. That is good for stockholders but not for workers and is a large contributor to the increasing wealth gap. In our credit-driven economy there must be borrowing to invest and expand the economy. If not business, the federal government must invest.

According to the American Society of Civil Engineers we need $3.6 trillion by 2020 to renovate  our infrastructure in energy, water, transportation, and health. Instead of #FixTheDebt we need to #FixTheInfrastructure. Only the federal government can make the necessary investments.

Recently the International Monetary Fund, a hard-nosed enforcer of austerity, has done an about face and recommends government deficit investment in infrastructure for the US and other countries. By including benefits as well as costs, the IMF calculates that 1 dollar invested yields 3 dollars in production. It concludes that infrastructure investment pays for itself.

While making government investments, we should look to the future. Currently, we need fossil fuels for baseline energy complemented with the green-energy alternatives of nuclear, solar and wind. Our investments should reduce our continued dependence on fossil fuels in the future by expanding our technologies in zero-carbon producing energy sources. 

To reduce regulations is to say we don’t care much about health, safety or our environment. We need clean air and water, and infrastructure investment can assure them along with jobs. We don’t need dirty energy for jobs.

While the health-for-profit lobby threatens that healthcare costs will increase from 14% to 20% of the economy, we know that other advanced countries get better care for 10% or less. Also, we know that health care costs are falling, and more people are leading healthier lives as they get health care previously denied. Nevertheless, both political parties have failed to bring healthcare to all at a reasonable cost.

It is appropriate for government to sustain deficits for investment in national security and for investment in our infrastructure. At the same time, it reduces unemployment, which is our biggest problem, and assures that our grandchildren are well positioned to excel in a competitive global market place.

Deficits do not harm our grandchildren. The national debt is the sum of all deficits since the formation of the republic and represents net financial savings of the non-government sector. We pass those savings on to our grandchildren along with the renovated infrastructure.

Both authors are retired PhD physical scientists and follow Modern Money Theory, which describes monetary operations for a sovereign fiat currency.

Wednesday, September 24, 2014

Federal Deficits are Necessary

 A 600-word version of this was submitted to the Santa Fe New Mexican in early September and this version to the Albuquerque Journal by Duane and I as co-authors. Figure was not submitted. Neither has been published. I suspect that the title/subject matter is too radical for editorial staffs. We will have to keep trying.

Our economy is struggling under high unemployment and slow growth because of widespread, irrational fear of deficits and public debt. Candidates for the upcoming election promise to increase austerity and repay the “national debt.” Even the White House is bragging about small and decreasing deficits. But, deficits are necessary, more so for a languishing economy. This discussion illuminates how federal deficits reduce unemployment and result in private savings.

Most of our money is created in the private sector by bank loans driven by business investment activity in response to consumer demand. Contrary to common understanding banks do not simply lend out deposits. A quote from a recent Bank of England report says it succinctly:

    “Whenever a bank makes a loan, it simultaneously creates a matching deposit in the
    borrower’s bank account, thereby creating new money.”

Because money created by bank loans must be repaid, there can be no net savings from loan activity. It is a zero-sum game in which prosperity is experienced only if loans are made faster than they are repaid. The domestic private sector deflates unless continually boosted by new loans.

The economic risk is that unrestrained bank credit can lead to unsustainable private debt, as in the recent housing bubble. Unable to service their debt, borrowers reduce consumption, which leads to unemployment as firms cut back production due to reduced consumer demand.

Private loans drive our economy, but when the economy falters, either the federal government must intervene or export trade must increase to restore employment and stabilize the economy.

Like bank loans the federal government creates new money when it makes deposits into bank accounts to pay for purchases from the private sector. Unlike bank loans there is no corresponding private liability created, and the deposit remains in the private sector unless removed by taxes. Federal spending increases both net private savings and consumer demand while taxation decreases them.

Exports to foreign nations can also provide income to our domestic private sector. However, the US has been a net importer since the 1970s. Consequently, our foreign trade deficits reduce our domestic financial assets and cause unemployment as jobs go overseas.

In good times businesses borrow to invest, consumers borrow to consume, and government tax revenue is high. But, if federal fiscal policies result in low deficits or surpluses while imports are high, financial assets decrease in the private sector, consumer demand decreases, and businesses slow production causing increased unemployment.

Businesses focus on profits and have no incentive to maintain high employment. Our slow economic recovery and continued high unemployment over the past six years have shown that the monetary operations of the Fed have failed. However, Congress can always increase deficit spending or reduce taxes to restore both demand and employment without inducing inflation. Unfortunately, irrational fear of deficits led to austerity instead of the needed government investment to generate a faster economic recovery.

Historically, low deficits precede economic downturns, and surpluses precede depressions. 

Stacked bar chart from BEA data shows dollar flows to/from government, private and foreign sectors quarterly from 1960 Q1 to 2014 Q1. Note government deficit always equals sum of private surplus and net imports.

During five periods in the 19th century the government had budget surpluses, and each was followed immediately by an economic depression. In the 20th century, surpluses in the 1920s immediately preceded the 1929 Great Depression, and the “Clinton” surpluses in the late 1990’s preceded a recession in 2001 and the Great Recession in 2008. Throughout the decade leading up to the 2008 crisis, the combination of surpluses, low deficits, and high imports sucked $1.6 trillion out of the private sector.

Invested in research, education, and infrastructure government expenditures provide the real assets to modernize our public structures and institutions so necessary to assure our children’s future productivity. The “national debt,” which is the sum of deficits since the formation of the republic, unlike a bank loan, is never repaid, and provides financial assets that help secure our financial future. In our economy, only federal deficits result in both net private savings and reduced unemployment.

Both authors are retired PhD physical scientists and students of Modern Money Theory, which describes monetary operations for a sovereign fiat currency.
Bank of England
"Money creation in the modern economy"

History of surpluses and depressions

BEA Data to compute private savings loss FY1998QI through FY2008QI

Tuesday, August 19, 2014

It’s time to change federal fiscal policy

Today I submitted this to the Albuquerque Journal. My tendency to try to say too much with too few words has made me a bit hesitant, but I decided to give it a shot. It seemed timely after I read Milbank's column. 

My heart sank Sunday, August 17 as I read Dana Milbank’s column in the Journal entitled “American optimism is a thing of the past.” Surveys show that most Americans think the next generation will not do as well as we have.

No doubt, our current economic policies have harmed the future of our grandkids. Mainstream economists blame it on “secular stagnation,” and suggest we will have to live with slow growth and high unemployment.

As we have observed, the Fed has been unable to stimulate the economy with its purchases of privately held securities. The-Powers-That-Be tell us that government must tighten its belt just as households must. So, the White House brags about lower and decreasing deficits. TPTB tell us there is no alternative. Well, there is an alternative; the die is not yet cast.

For years TPTB have told us that our high public debt and deficits would cause interest rates to rise, and we would be unable to service our debt. That didn’t happen, because the Fed sets interest rates. TPTB didn't know that.

Also, TPTB told us that “money printing” by the Fed to purchase private securities would cause inflation, even hyperinflation. That didn’t happen, because those purchases were just asset swaps. Nobody ended up with more money in their pockets. TPTB didn't know that.

Additionally, TPTB said that the excess reserves caused by Fed security purchases would lead to a lending binge by banks and debase the dollar. That didn’t happen, because banks don’t lend reserves. TPTB didn’t know that reserves stay in the banking system.

TPTB still believe we have a trickle-down economy, but we know now that it’s really a trickle-up economy. TPTB shut down government last year over debt ceiling negotiations because of a wrong-headed aversion to deficits and debt, not knowing there is little to fear from either.

Why do we continue to listen to TPTB when they are consistently wrong.

We live in a demand-driven economy where my spending is your income. Workers are paid to produce goods and services. If all workers spent all their income, demand would be such that all products would be consumed. But, there are inevitable “leakages” in total demand. 

We need to renew infrastructure. It's a matter of available resources not money.

Some elect to save part of their earnings. Unless others spend more than they earn not all goods and services are consumed. Then producers cut back production causing unemployment.

Another leakage is spending on foreign imports. While imports have many benefits, they result in reduced demand and unemployment here at home.

Taxes are also a leakage, if they are greater than government spending. But, if taxes are less than government spending, the resulting deficit increases demand and reduces unemployment. High unemployment means that federal deficits are too low to make up for leakages.

Federal spending and taxation are fiscal operations that we always have available to stimulate the economy, especially when the Fed’s monetary operations fail as they have these past seven years. We are prevented from employing fiscal policies by the deficit and debt scare tactics of TPTB, of course.

Deficits reduce unemployment, the costs of unemployment benefits, and the human suffering caused by involuntary unemployment. For our economy, there is nothing closer to a free lunch than putting the unemployed to work.

A household’s debt represents a financial asset for their bank and has to be repaid. The “national debt” is completely different as it represents financial assets for the whole private sector and never has to be repaid. Rather than a burden on our grandchildren those assets will be passed on to them.

It really boils down to this. Whether we rely on Social Security, pensions, or private portfolios we need a highly educated, productive work force to support us in our old age. With well constructed fiscal policies, we can assure that our kids and grandkids will have the knowledge, education, and infrastructure to provide for themselves and us.

Now is the time. Let’s get people, who understand basic monetary operations, into Congress and newsrooms.

Related Reading

Demand Leakages: The 800lb Economist in the Room

American optimism thing of the past

Sunday, May 4, 2014

The federal budget process: What did Leon Panetta mean?

Duane and I worked together on this to submit as a letter to the Helena, MT Independent Record. We hope to make the point that the US Budget, unlike households, is about resources instead of money. Duane submitted it today. It was published here and received some nice kudos here and here and here.

Leon Panetta was recently the guest lecturer at the University of Montana’s annual Jones-Tamm Judicial Lecture.  Mr. Panetta is a true patriot, having served with distinction for over 20 years under two presidents. Under President Clinton he directed the Office of Management and Budget and later served as Clinton's Chief of Staff. Under President Obama he served as Secretary of Defense and later as Director of the CIA. 

Leon Panetta
 Mr. Panetta stated that “the nation's biggest security issue was its inability to deal with the budget.”  Although many will interpret his statement as a call to cut the deficit, what he was really criticizing was the Congress’ inability to produce and pass a spending budget that would put some certainty into the ability of the nation to do strategic long term planning.

Like most Washington public servants, Mr. Panetta holds the old-fashioned view that federal budgets should be balanced and the magnitude of deficits is an important metric for the economy. This view is appropriate for households and businesses that have limited financial resources. However, the federal government issues the nation's currency and is not constrained by financial resources. It has all the financial resources it needs and is constrained only by the nation's productive resources.

Both political parties are dominated by the false view that the federal budget must be balanced. The only difference is that conservatives think the government has a spending problem and liberals think it is a revenue problem. Both are wrong and it is hurting America's competitive global advantages.

In the modern world of fiat currency the federal government must focus on real resources (available materials, factories, infrastructure, labor, knowledge) instead of financial resources (money and bonds) in managing the economy. Money is the vehicle that allows the smooth movement of goods and services from sellers to buyers in the economy. The federal government as the sole issuer of the U.S. dollar can issue all the money it needs to move any resources of the nation. 

The US and most other nations of the world have used a fiat monetary system since President Nixon defaulted on the gold standard in 1971. Under a gold standard the quantity of money available to the nation is determined by its store of gold, which limits economic growth. Under a fiat system the available money varies with the growth of the economy, and depends on bank loans and federal spending. In the absence of adequate bank loans to make investments in our main-street economy, Congressional budget decisions are responsible for reviving a depressed economy.

The Congressional budget exercise should not be about achieving a balanced federal budget. The budget should be developed to assure that all available resources of the nation are put to good use. There is plenty of work to be done, and we can avoid high unemployment. The federal government can employ all the resources not employed by private industry. If unemployment is high, as it is now, federal deficits are too small. 

Many will denounce deficits as causing inflation or adding to a gigantic national debt. They forget to mention that inflation results from demand greater than our productive capacity. But, government purchases of either goods or services from labor, which are readily available because of high unemployment, increase total production along with demand and that benefits businesses.  Such purchases are not inflationary. 

They also fail to mention that the huge national debt is in reality a huge private asset.  The national debt is nothing more than government bonds that individuals, banks, and pension funds hold in their accounts as secure savings instruments.

Mr. Panetta is correct that the nation is weakened when it fails to deal with the budget. But, forcing the federal budget to be balanced either by reducing spending or increasing taxes only hurts our main-street economy by preventing it from growing. Such austerity measures are appropriate only on the rare occasion when the economy is overheated and threatening inflation. A depressed economy, which is what we have today, requires higher spending and lower taxes. 

The threat to our future generations is not from a gigantic national debt, which is in reality a gigantic collection of safe and secure savings instruments that will be held by our future generations. The real threat results from the U.S. Congress’ failure to responsibly spend money into circulation to fix our failing bridges, highways, waterways, sanitation systems, public schools, state universities and other public services that we citizens rely on in our daily lives.

Duane Catlett Bio: Duane lives in Clancy, MT.  He is a retired career PhD chemist and materials technology manager.  He is a student of Modern Money Theory and the role of government in our economy. 

Dan Metzger Bio: Dan lives in Santa Fe, NM.  He is a retired PhD physicist and engineering manager.  He is a serious student of Modern Money Theory.

Tuesday, April 8, 2014

Federal employment policy exploits labor

This has been submitted to the ABQ Journal as a Letter to the Editor. We'll see if it flies.

Recently, people like to find fault with the Federal Reserve Bank (Fed) for Quantitative Easing and related issues. Of the actions the Fed takes, none is more startling than its exploitation of labor.

In a growing economy, it is possible for a shortage of labor to occur and for employers to bid up the price of labor, which might lead to inflation. In response to the threat of inflation, the Fed will take action to increase unemployment to a rate usually above 5%.

Thats right, our government has a policy to increase unemployment to forestall inflation. As this policy also preserves the value of the US dollar, it is considered a reasonable price to pay. This is just another way that people get the shaft when they don’t understand the game.

There is always work to be done. There is no need for unemployment

To initiate this policy the Fed increases the cost of borrowing to cool the economic expansion and increase unemployment. When unemployment is too high, the Fed lowers the interest rate to encourage borrowing that normally stimulates the economy to employ more people.

Currently, this policy is not working well. The Fed has lowered rates to almost zero and many businesses still can't or won't borrow to invest and hire, which is necessary for economic growth when Congress limits federal deficits.

Even though unemployment is high and decreasing very slowly, investors are anticipating increased interest rates that will keep unemployment at a noninflationary level. These unemployed, whom the Fed use to guard against inflation and maintain the value of the dollar, suffer like all the unemployed. Children go hungry; crime, including domestic violence, increases; and opportunities for education are lost. 

Such is the price of this policy. Adding insult to injury, some members of our Congress will denigrate the involuntarily unemployed as lazy ne’er-do-wells.

There is an alternative to this terrible policy. Instead of a labor pool of the unemployed to manage inflation, we can have a labor pool of the employed. The pool will naturally expand or contract as private industry fires or hires, respectively. 

Every unemployed person, who is willing and able to work, can be employed by the federal government at a minimum living wage. Such a program is often called a Job Guarantee (JG).

The JG would set the minimum wage at which employers could find employees from the labor pool of people, who are already working every day. It would minimize unemployment and continue to allow employers to reduce staff when necessary. The negative social consequences of unemployment would be greatly reduced, and the Fed would be able to meet its dual mandate. While the productivity of JG employees might be less than optimal, it would be much greater than for unemployed people.

The cost of such a program would be offset by reductions in unemployment insurance, food stamps, and minimal loss to the economy of reduced consumption by households. Most importantly, it makes good sense for the government to minimize the ravages of unemployment on good people when there is a viable alternative to existing policy.

Fundamentally the JG, which requires real production, seems to be superior to the Swiss idea of an Unconditional Basic Income that was featured on PBS recently.

Friday, March 14, 2014

Neither Bitcoin nor dirty socks are money

Today, I submitted this to the Albuquerque Journal. They didn't publish my last one. I thought this one might be more fun. It was published on March 20 under the title "Bitcoins may be bartered, but they are not money."
In recent, interesting, Journal articles Winthrop Quigley has pointed out that any things can be used as currency (money) if people accept those things. Dirty socks were used as an example. Hyman Minsky has pointed out that anyone can issue money, the problem is getting it accepted. So, what is money? And, why should we accept it?

Bitcoin and old socks are just things. In order to be money things, they must represent debt. Debt is just an IOU (I owe you), and for thousands of years money has been IOUs. For Joe's old socks to be money things, Joe must be willing to redeem them for something of value say, a dollar bill, a bit of gold, or a cup of sugar. Otherwise, if Joe gives Mary a pair of old socks for an old toaster it is just a straightforward barter agreement. But, if Joe is willing to redeem the socks for something of value, Mary can give the socks in trade for something else and Joe will be in debt to that third person.

So it is with Bitcoin, which is just a thing even though it is only a number on a spreadsheet in a computer somewhere. Indeed, the dollars we generally use are mostly entries on spreadsheets at our banks. As Bitcoin is not an IOU, it is not a money thing, and any exchange of it for something is just a barter agreement. Consistent with this argument, the governments of Japan and Canada have declared that Bitcoin is not money.

A grocery store coupon is money. It is an IOU issued by a company for a limited time and is a credit against our bill at the checkout counter.

Even though an IOU is money, it may not be generally accepted. If Joe's socks represent cups of sugar, there may not be many takers, but there may be more takers for gold. Then there is the US dollar. Why is it generally accepted? After all, it offers less than a cup of sugar. 

The dollar is an IOU of the government, and it offers only itself in redemption. A ten-dollar bill will get you ten one-dollar bills. Big deal, what's the attraction in that? 

What drives our need to acquire dollar IOUs? It might be that the government has declared dollars to be legal tender or that we generally agree to use them. Actually, we all need dollars, because we must pay our taxes with them. As a grocery store coupon is a credit at the checkout counter, so a dollar is a credit against your tax bill. Even a child with no tax liability, must pay for candy with dollars, because the candy maker needs them.

A sovereign money thing is issued by a sovereign government and is a tax credit. Bitcoin was invented supposedly to bypass government money. Money in any form can not compete with state money for acceptance.

Wednesday, February 19, 2014

Economists and politicians need to step into the light.

Today, I submitted this to the Albuquerque Journal as a Letter to the Editor. 

The Journal editorial page on Tuesday, February, 18 included a column by Robert Samuelson that concluded correctly, “To regain relevancy, economists are searching for a new light bulb - or better use of the old. Meanwhile, most are still sitting in the dark.” And, that includes Mr. Samuelson.

That new light bulb is shining brightly in those who recognize that our economic system changed fundamentally when President Nixon took us off the gold standard and introduced modern fiat money with a floating exchange rate. 

Modern Money Theory is a new light for a better economy.

Those who understand and embrace the insights of Modern Money Theory that anticipated the Great Financial Recession, foresaw the Eurozone crisis, and explains how federal deficits help a listless economy know full well that our economy need not struggle as it has. 

Samuelson fears federal deficits and supports austerity while searching hopelessly with the OECD for answers to why austerity has not worked out well. He need look no farther than the new lightbulb shining in his face. Deficits are the source of net savings in the private sector. They stimulate consumption and reduce unemployment.

He and other economists sitting in the dark are bewildered that the trillions of dollars the Federal Reserve has poured into the economy have not caused the expected inflation. They still refer to Quantitative easing (QE) as stimulus when obviously it is not.

The answer is simple. When the Fed buys Treasuries (or other financial assets) from Jane, the total financial assets of Jane remain the same. It’s a straight up asset swap. It only changes Jane's preferences for assets (cash or something riskier). However, fiscal stimulus, government buying goods and services from Jane, actually increases Jane’s financial assets.

It’s quite clear, QE fails to stimulate the economy, because it tries to increase one's spending out of existing income. Fiscal stimulus works, because it increases one's spending out of increased income.

To the delight of many including Republicans, Democrats, progressives, and conservatives the deficit is falling fast and according to the Congressional Budget Office will be at or below 3% of GDP this year and the next two. Alleluia, our economy will be saved! Or, will it crash like other economies around the world that have followed the same policy of austerity? We are fortunate to have been on austerity-lite. 

As the deficit has fallen unemployment has remained high, capacity utilization has declined and with it industrial production, which has been declining overall since mid 2010. Year over year retail sales and mortgage applications are falling. 

The weak stimulus of the 2009 American Asset and Recovery Act has disappeared and our economy languishes unnecessarily. Inflation is too low while unemployment is too high. That likely will continue until economists and politicians realize that deficits and national debts are terrible metrics for steering the economy. Inflation and unemployment would be much better in an enlightened economy.