Class Warfare

Republicans huff and puff about Democrats’ assault on richer people. Democrats retort that they are not interested in class warfare – they just want to be fair. Finger pointing. Hateful words. My mother is bigger than your mother.

Is there a way to prove who is right or wrong about class warfare? I doubt it but we sure have fun slugging it out. As my Mom used to say, I don’t care who did it. You are both going to your room.

Instead of debating which came first the chicken or the egg let’s try another approach. Let’s just focus in on the question of taxing the rich more.  Taxing the rich is being discussed today as part of a program to reduce future debt and/or find a way to stimulate employment. Taxing the rich, according to some Democrats is a way to generate tax revenue so that future government deficits will be smaller. It seems fair to them since the rich, after all, are rich. Less of their income is devoted to buying goods and so there is less potential to harm spending in an already weak economy.  So the basic intuition of taxing the rich is that this is a way to reduce future deficits without overly slowing the recovery. In terms of fairness, it is believed that the rich have done well in the last 20 years and if anyone can take the load of higher taxes right now, it would/should be them.

Like any proposition, this one needs to be objectively evaluated. I don’t care if you are a Democrat or a Republican, you might not favor taxing the rich more if (1) it did not raise revenue, (2) it did not reduce future deficits, and/or (3) higher taxes for the rich had a negative implication for economic growth and employment

As is usual, I will not prove anything below, but I do hope to show that in 2011 there are many good reasons to believe that higher taxes on the rich will not be a good thing for the country. I’d rather take this approach than argue endlessly about whether or not this is class warfare. Let’s take one thing at a time.

First, what exactly do we mean when we say we are taxing the rich more? As I understand the current proposal it means reducing income tax deductions for persons having taxable income of $200,000+ and imposing a higher tax rate for people who earn a million dollars or more. So to begin with we could have a discussion about whether or not income tax returns of $200,000 imply that people are rich. While a Midwestern college professor living in small town who makes that amount might feel pretty wealthy I am told by people who live on the coasts of the USA that $200,000 per year does not indicate a lifestyle that involves high priced call girls and large shiny cars. And many entrepreneurs who file individual tax returns might quibble about whether such an income level would suggest even medium priced call girls or a Kia Soul.

This question of defining who is rich and who really has the capability to pay the tax and not reduce consumption has some relevance. This is not just a game of defining what rich means.  Is it possible that the current plan hits people who will make real spending cutbacks? Is it possible that entrepreneurs faced with such a tax will compensate by reducing wages or hours of employees? Thus, while it might be plausible to tax the rich for the purposes expressed above, it might be useful to do some serious homework about at what level you might be able to define rich and succeed. But even if this level can be found there is another issue that relates to how the rich will react when they are singled for punishment. Without significant changes in the overall tax code, is it not predictable that very rich people will feel singled out and work extra hard to find ways to exploit the existing code to reduce their tax liability?

Second, speaking of the rich and very rich, let’s talk about saving. Saving is boring. Except for a few exceptional people, most of us would rather have dinner with the in-laws than save. But consider the fact that saving greases the wheels of the economy. Thankfully in most countries there is plenty of saving going into the banks and other financial institutions each month so that entrepreneurs who want to invest have a source of funds. Consider, however the USA right now. The government is not saving. In fact the government is basically running down its saving to the tune of almost $1.5 trillion per year. That is, instead of that amount of money going to private borrowers it is being diverted to the government. The Fed has done its part to replace those savings but that is not a permanent solution. Every country needs for its businesses and households to save. And guess who does most or nearly all of the saving in the USA? That’s right – it is the richer people and the companies. If we aim a bigger tax bite at these richer folks and the small businesses who earn more than $200,000 per year, then this will mostly be seen by a reduction in US saving. Some might continue to save but they will use every loophole still available to park their money in places where they can get a decent after tax return. As a result we will see our preciously small savings going abroad and making our country even more financially dependent on China and other countries. You might call that a very significant unintended effect of taxing the rich more.

So the upshot is that while higher taxes on the rich looks like a nice way to improve the country’s debt problems, mostly what it will do is make them worse. As wealthier people save less or move their saving off shore, it just makes it harder for our banks and financial institutions to survive and make good loans for investments and houses. It also makes it harder for the country to grow. Remember that a country’s aggregate demand is composed of household spending AND spending by business firms for plant, equipment, office buildings, software, etc. Taxing the rich might seem to protect household consumption, but it does very little to similarly shield the rest of the spending. Higher taxes on the rich could very well mean more problems in banking and finance – and less spending and employment.

Let’s get back to the fairness issue. Measuring changes in fairness is to look at how the low, middle, and high income people have prospered over the last 10 years. It is absolutely true that of these groups, the wealthier ones have done the best. But does that mean that a policy to redirect money from the pockets of the wealthy to the pockets of others will improve things? I doubt it. Do we really think that the issues that plague the very poorest will be solved through another government poverty program? If you are concerned about wasting society’s money, do you really trust government to use these dollars to make a real dent in poverty? I doubt it. And the proof of this is the very fact that in the face of rising poverty we have not one single clearly espoused and forcefully lobbied analysis of poverty. Name one politician who is pushing a clear program to reduce poverty in the USA. You can’t because instead of one good program we have a mess of individual programs that are rife with inefficiency and corruption. That’s the way these politicians want it.  They make it look like they advocate for the poor every day and every way and the end result is all talk and no action. The rich are an easy target. But will taking from the richest really help the people who might benefit the most?  Give me a real poverty program to replace the current mess and I think the rich would be happy to vote for it and pay for it.

The same basic story relates to the middle class – a group that has suffered because of industrialization, globalization, reduced power of unions, bunions, and more. In the name of helping the middle class we have a myriad of conflicting and wasteful programs not to mention an almost constant outcry for business regulation and against any program that appears to assist business. We come back over and over and over to this silly notion that prosperous business comes out of the hide of the middle class. Some people honestly believe that for business succeed they must injure or take advantage of their workers.  It is so simple and wrong that most people forget the notion that it is a healthy business that hires more people. Imagine a time in the last 100 years when it wasn’t true that employment rose rapidly because businesses were thriving. How can one argue against creating a better climate for business flexibility, creativity, and competitiveness?

The present proposals to extract more income taxes from the rich won’t work and they won’t improve fairness. Class warfare or not, they simply miss the point. They won’t help the poor or the middleclass and will only be one more attempt to dupe the nation into supporting an inefficient government. If our policy makers really cared about the poor and the middle class then we should have seen a real program aimed at specific problems.

I have one last point. I took the high road here. But one has to wonder why it is that the President can believe that it is fair when half the country’s citizens don’t pay any income taxes. I suspect he would have a lot more luck in raising taxes from those who can afford to pay the extra taxes if he would just stop repeating his mantra about millionaires and billionaires and just get to the hard business of a comprehensive tax reform. It is silly to think that the country’s debt and other issues can be solved by taxing rich people more.  He could end up soaking the rich if he would just elucidate a program that examines the whole tax system and treats all people with dignity and respect. 

When the Lender of Last Resort Fails

Charlie only had one life jacket on his pontoon boat. Pete fell overboard and Charlie thought about throwing it to him but then realized that if he did, he would no longer have one for himself.  Being a true friend he threw it to him but unfortunately Pete went over the falls anyway – life jacket and all. Then Charlie noticed the leak in the boat.

I studied a lot of macro but I never got to the chapter that says what happens when the lender of last resort fails.  It is a widely shared view that the Fed has the right and the privilege to be the lender of last resort. So if the US economy is sinking and sinking badly, the Fed is supposed to use monetary policy to keep us all from drowning. We saw the lender of last resort activity in the last couple of years. Now the Fed has announced that it will be the lender of last resort for French and other European banks.

It all sounds pretty rational. Economic systems are prone to boom and bust cycles. We think we learned from the Great Depression and from other financial crises that monetary policy should play a stabilizing role. But one thing we didn’t learn is what happens when the central bank plays the role of lender of last resort and they fail. That is, Pete goes over the waterfall and there are no life jackets left. What now?

If there will be a lesson to be learned from the present global financial crisis it will be that central banks really did play their lender as last resort roles. Europeans often bemoan the fact that the European Central Bank did not bail out Greece and other countries fast enough or with enough gusto, but even the ECB has come forth with plenty of cash. Now the FED, ECB, and a few other central banks are printing money to help key European banks get enough dollars. There is enough money out there to sink a very large boat.

What is reassuring to some folks and frightening to others is that the lender of last resort role has no finite amount of ammunition. Unlike Charlie’s life jacket, the Fed has plenty of bullets. Why? Because modern central banks can print money whenever they want.  It is virtually costless to pump out another $100 billion. The problem is not so much the number of bullets – it is their impact. Maybe we should be using pharma as our example. Mike has a headache. Give him a couple of aspirins. Mike still has a headache. Give him a few more aspirins. The truth is that Mike has a headache because is wearing the wrong size undershorts. Aspirin isn’t going to help. Mike needs a bigger thong.

When the Fed was doling out all that dough last year did it ever wonder what would be left for them to do in a double dip? I don’t know what goes on behind those gold laden walls, but I didn’t hear much on this topic. And their seeming unflagging duty to pour in even more money recently suggests that the thought has not even entered their minds.  If one tranche wasn’t enough try two. If two wasn’t enough try three. It’s just math. It’s math at least until you realize that more and more aspirin in going to give Mike a bad stomach problem to complicate his undershorts issue. 

So there are two points to cover. First, why didn’t the earlier money expansions work? Second, why are they creating even worst problems as a result of the monetary addiction? The first part is easy. Monetary stimulus (and fiscal stimulus) do not address the most pressing problems. The causes of the Wall and Main Street problems were financial – too much leverage on top of two much leverage.  Very little has been done to solve those problems because politicians don’t have the guts to tell people there is no easy way out of that dilemma. So they prefer to drag us through a decade of horrible economic malaise instead. Don’t rip off the band-aid. Pull it off a little at a time. Only a politician would do this. Doctors don’t get paid for being popular. They rip off band-aids with fervor and sometimes glee. Our politicians use money as a drug to counter some of the negative side-effects of the slow band-aid pull.

So the answer to question 1 is simple – politicians give us money instead of real solutions. The second question is more interesting. Okay – so we slowly bleed for a while. Isn’t that better than the intense pain of a quick solution? I think the answer is no. Here are five why.

Reason #1. Weakening the economy for a long time makes it very sensitive to every economic virus that goes around. A strong patient bounces back from the flu quickly. The weak one may not survive. What economic shocks are around the corner? Clearly whether it is a jolt in energy prices or a spike in food prices after flooding, the economy will adjust more slowly and with less elasticity. This is very risky behavior!

Reason #2. Keynes was very specific in his book the General Theory that when credit markets lack confidence, the impact of monetary policy on output and employment all but disappears. There may still be a few people around who trust Bernanke, but as more and more money seems to work less and less, we are getting closer and closer to Keynes’ liquidity trap wherein money is totally useless to stimulate the economy.

Reason #3. The low interest rate environment just compounds our problems. So long as people cannot get decent returns on assets they will pressure financial institutions to innovate and create ways for them to take higher risk and get high returns. Banks would rather facilitate this madness than loan money to entrepreneurs. Isn’t it interesting that the Fed says they are saving us yet what they are really doing is engineering a repeat of the past financial crisis! Why does the Fed want to perpetuate leverage and risky investments? This could mean more downgrades and another financial crisis

Reason #4. All this focus on monetary policy diverts our attention away from reforms that would regulate the most egregious factors in the housing and financial markets. It is true that the positive effects of these kinds of policies will be slow in coming. But the longer you wait, the more the problems fester. The more the problem festers the more we raise the probability that a new shock will throw us for a loop.  

Reason# 5.The Fed has discounted an increase in inflation despite the fact that most indicators and expectations measures show it is bubbling below the surface. Despite all this economic sluggishness and large and persistent excess capacity, the psychological link between money and inflation remains as strong as ever. Inflation will not simply rise gradually. At some point it will explode. When it does it will be too late for the Fed to reverse engines. Bernanke stares at the cameras and solemnly says for us to trust him. The Fed is a very modern and scientific institution. When the economy recovers and inflation begins to be a larger threat, the Fed with utmost precision will remove money in the perfect amounts that will guarantee growth in output with stable inflation. Woowee. And if you believe that have I got a bridge to sell you!

In short, the Fed is entering uncharted waters. They seem to see no end and no risk to their policy of lender of last resort. They REALLY need to think about this some more. It is a very dangerous game they are playing with our jobs and welfare.  

Macroeconomic Policy and Fooling the Public

As policy leaders dispense with logic and grab at policy straws aimed at further demand stimulation, it is good to review the essential assumptions underlying the Keynesian model’s optimism about aggregate demand policy. The key assumption is something called Wage Illusion. A second one has gotten less notice but is something we might call Business Optimism illusion. I was going to call it Snake Oil but I had another JD and calmed down a bit.

While there are some who believe that economics and especially macroeconomic can be reduced to the terms hocus pocus (ie total nonsense) I cling to the notion that macro and macro policy have a basis in logic. When President Obama or one of his policy advisors recommends a stimulus package, the recommendation does not come out of the blue – it comes from a well spelled-out analytic framework. I keep resisting the urge to use this word – but I really should admit that our real world policy is based on THEORY. Whew, I went ahead and said theory. I feel a bunch better now.

One theory says that you might want to try stimulating demand as a way to exit a recession or improve the growth of the economy? Most of us learned something called Neo-Keynesian theory.  It turns out that Monetarists and Supply-Siders also pay homage to the Neo-Keynesian Model (NKM). While these groups of economists may disagree on policies and various technical aspects of the NKM, they tend to use the NKM to support their recommended policies. You might call the NKM an agreed common battleground. Monetarists and Neo-Keynesians do not usually agree about policy but they use the NKM to duke-it-out.

So let’s get back to stimulating the economy with a policy to increase spending or aggregate demand. It all sounds so reasonable. Give people tax cuts and they will spend. Give people bigger subsidies and they will spend. Have the government build roads and bridges and the people that build these roads and bridges will receive income from the government and they will spend. You have to admit, it sounds pretty straight forward and easy. Woowee!

I see that some of you are getting red in the face and are ready to inhale large quantities of funny cigarettes. So let me agree that the above oversimplified. Some of those people who receive the new incomes have big debts to pay and do not spend all of the money. And we know that at some point some tax payer will have to pay for the government handouts – and those who pay the extra taxes will spend less. So you can understand why some people might be doubtful that the government can create as much spending as I alluded (deluded?) to above. But that argument has already been made widely and loudly and I don’t want to get into that in my remaining three million pages below.

Let’s take a really big breath and just ASSUME that the government policy I described above does lead to more spending. So now we can imagine shops with more customers and companies enjoying higher sales and possibly higher profits. What does the NKM say happens next? First, business firms work down some of their inventories and given sanguine expectations about future sales they begin to hire more workers.  Workers are pleased as punch to take the job offers and are quite willing to accept the employment.  

According to the NKM, the firms have excellent foresight but the workers are a little dim. The workers are afflicted with a macro-disease called wage illusion. That is, they are willing to work at a very low wage simply because they are asked. It is sort of like the plain girl at the dance who agrees to have her feet tromped on by any hayseed who requests a quick belly rub (that means dance for you people with dirty minds). Firms are assumed by the NKM to fully appreciate the fact that a stronger economy will bring about higher prices and make the worker worth the bargain. The worker, however, is assumed to not anticipate or not care about the higher prices that will further erode their buying power.

Upshot – Wage illusion is the key and critical assumption of NKM that translates an increase in spending into an increase in employment. From there it is all (Four) roses and JD – once employment increases this facilitates even more spending and we are on the Staten Island Ferry bound for glory.

So what about this wage illusion thing? My guess is that if this psychological/informational disparity ever existed between workers and managers, it does not have a pot to piss in today. I use words like piss in a pot so that economists like Paul Krugman will understand what I am saying. And when I say today, I mean anytime after about 1969. After 1969, when inflation was beginning its notorious charge into the upper atmosphere, very few workers were not paying attention to the myriad ways that inflation eroded the buying power of their incomes. I recall when the coal miners went on strike at the end of the 1970s and were demanding a three-year wage hike of something like 39%. That doesn’t sound like dim workers to me. Today’s papers show Greek workers smashing pumpkins and otherwise displaying their displeasures with Greek austerity programs that would diminish their incomes.  Wage illusion simply has no relevance to today’s situation. Without wage elusion, you have more resistance of workers to job offers. It is not as easy as the NKM assumes to find and hire workers at wages that are favorable to firms, given the state of the economy.

And this brings me to the second part of the NKM illusions – the one about the firms having optimistic views about future prices and profits as a result of the government’s new program and the ensuing first round of spending.  Note that in the NKM once the spending starts flowing the firms soon decide they need more goods and to get the extra goods they need more workers.  So we might ask the following question. What makes the firms so sure that this new spending is going to be permanent? After all, the avowed stimulation policies of the government are meant to be temporary. By design they will be removed soon in the future. So maybe the NKM was assuming something we might call OPTIMISM ILLUSION when it automatically assumed that firms would place their stamp of approval on the fiscal stimulus and fall over each other trying to hire a bunch of workers.

So there we are. Our fellow macro policy activists assume: (1) labor wage illusion and (2) Business Optimism Illusion. What happens if neither of these illusion assumptions really hold today? What happens if workers acknowledge that prices will rise in the future? What happens if firms are somewhat skeptical that government has addressed underlying factors that caused the recession in the first place? I wrote a blog post in the past where I likened recent monetary and fiscal stimulus to pushing the blood back into the patient. We want the doctors to address what caused the blood to flow out – not push the blood back in.  What if business firms worry that the government has not adequately addressed housing, finance, too big to fail, excessive and corrupt leverage, excessive government regulation of business, and other factors that caused the recent recession?

Wouldn’t it be nice to use a version of the NKM that assumes that both workers and managers are rational enough to take care of themselves properly? Do we really want our policies based on assumptions about illusions and people who do not know how to take care of themselves? I doubt it.

So if you agree with me you understand that liberal macro activists are misleading our poor government leaders into doing things to the economy that will either have little effect or will make things much worse. Also, if you agree with me, you can quote me on this new concept called Business Optimism Illusion and support my nomination for the Nobel Prize (for excessive creativity)) or at least for the Guinness Book of Records. Or you could just send money. 

The Scorpion and the Turtle make Friends and Fiscal Balance

A scorpion asked a turtle to take him across the stream. The turtle said no because he knows scorpions are mean and will sting him. The scorpion explains he REALLY needs to get across the stream and that he is really a different kind of scorpion. He promises to be good. Mid-stream the scorpion stings the turtle. As they are both going under the turtle asks him why he stung him ensuring sure death for both of them. The scorpion replies – I am a scorpion. That is what scorpions do.

So is the scorpion/turtle a democrat or a republican? To me it doesn’t matter. They are playing a dangerous game. The question is why. It seems to me that politicians are more polarized than ever. It is a normal state of affairs to have difference of opinion and heated arguments. After all there are strong ideologies separating the parties here and everywhere. But both parties are using extreme tactics that get us nowhere. Republicans shout that liberals are ruining the country with too much government spending. Democrats respond that conservatives are destroying the country by hurting the poor and middleclass. These charges are typical. But the Democrats ran roughshod during Obama’s first two years and the Tea Party is playing dangerous games now. How does an objective person explain why things are so bad today? I don’t think one can blame it totally on one party or the other. What changed such that there is so much animosity and intransigence on both sides?

I don’t pretend to have the answers. But I do think that if we knew more about the causes of this political mess, then maybe we might have a hope of ending it. Finger pointing from both sides does little to create the healing and it appears to be making things worse. Thanks to conversation with some of my friends, I have come up with 5 trends that explain current political radicalism in the US and elsewhere. What do you think? Did I miss something?

First, it might be that problems are worse now. They may also be more complicated or different from past problems. As a result there is a real lack of consensus about what to do. Mike, there are little green men eating your Hosta leaves! Maybe I should use deer repellent? No, you better call in the B52s. Jerk! Butthead!

Second, we are now much closer to the day when the aging of the population finally has arrived – we can’t keep putting off financing solutions. So long as the baby boom generation was not yet 65, we could be nice to each other and talk about solutions. Well the baby boom is defined as starting with people born in 1946. Count it out – they are now 65 years old. Many started on Social Security as early as 62 and most of them are joining Medicare as soon as we hit 65. While the problems will surface only gradually the reality of not imposing a real plan hit home when S&P downgraded our debt. It is real and large and now we have to do something about looming debt. Politicians call these programs entitlements but many people see these programs more like a pension that was earned through a lifetime of work. It is NOT hard to see why such different views could inspire heated discussion.

Third, the social state has grown for 50+ years and Obama Care provided one more example of expansion. Perhaps that was the proverbial straw that energized support/attack of the whole social state. Many of us watch things grow and change and despite some displeasure we optimistically hope that things will work out okay. But then all of a sudden we reached a limit and years of concern turn into rage.  Ds are sick and tired of Rs moaning about the welfare state. Rs are fed up with increasing scope and size of government. Why the cork popped in the last few years I don’t know, but it ain’t champagne that is flowing.

Fourth, maybe we have too much TV/electronic news/entertainment. Is there a shred of news left? There is some notion that stuff happens every day and someone dispassionately decides what is important enough to inform and attract viewers – who then run out and buy large quantities of vacuum cleaners, soap, and heavily discounted car insurance. In the good old days when Walter Cronkite gave the news we had great confidence that it was unbiased. We also thought the earth was flat. Anyway, there used to be a time in a news program when the OPINION light went on and we all knew that was not news. It was an opinion. Well, despite Fox’s claim to be fair and balanced, there ain’t no opinion light and we are all pretty sure that news is chosen to fit the conservative agenda. Of course, all the other outlets are the same serving carious other agendas.

Finally, there is the idea that the public either doesn’t care or are simply easier to fool. None of the four above suggested causes makes any sense if you have an informed, educated, and energized public. For example, thoughtful voters know when the press is biased and can find ways to get better information. Or just because macro problems are more severe or more complicated, it doesn’t follow that an intelligent public can be duped into accepting untried and risky political policies. But if we have grown intellectually lazy then it is easy to see how and why our politicians have taken the low road. It is not effective to use logic about complicated economic and financial trends if the public just wants pretty, leggy newscasters and outrageous politicians who scream at each other in high definition, blue ray, 3D, 4G amazing colors.

So what do you think? What is behind all this nonsense? What makes today’s politicians take the low road? If I am right the best way to return to some normalcy is an energized and informed public. One way to get that result is a calamity. It seems wasteful to go through another financial collapse and a double-dip economy  to get citizens more focused. It would be much better if a leader stepped up who could deliver the right message. He or she would definitely occupy a grand place in our future history books.The President gets a chance to do that this week. Somehow I am not too optimistic.