The Skeptical Optimist

Our incomplete healthcare wish

Just a quick observation about the healthcare debate that will soon heat up in the wake of President Obama's speech to Congress...

The politicians getting all the attention are missing three-fourths of the healthcare issue. (Might that be intentional?) Healthcare is a four-legged stool, but they're only talking about one of those four legs:

"Health care costs too much; we must make it affordable for all Americans."

Remember six months ago, when almost all of us were wishing for the price of gasoline to drop? Well, it dropped — but I haven't seen any dancing in the streets as a result. Reason: A global depression is what made it drop.

Lesson: Let's be careful what we wish for.

Now we get a do-over regarding what we're wishing for. This time it's health care. And, based on the lesson we learned the hard way on gasoline prices, I'd like to submit a "clarification" of our wish regarding healthcare. Why? Because, as I said, the current mantra is about cost, cost, cost -- and in my judgment, cost is one-fourth of the issue. The other three legs of the four-legged healthcare stool are quality, availability, and innovation.

So, here's a comparison: First is our current wish, as the politicians have constrained it. Second is how I'd amend our wish.

1. Our healthcare wish, as it stands:

"Healthcare should be affordable for all Americans."

2. How I would amend our healthcare wish:

"Healthcare should be:
(a) affordable for all Americans, with...
(b) no increase in waiting lines, and...
(c) no decrease in the quality of care, and...
(d) no decrease in the pace of innovation."

We got burned on our gasoline wish. Fool me once, shame on you; fool me twice, shame on me.

To Senator Dodd: Let's privatize social security.

Today, during Fed Chairman Bernanke's testimony before the Senate Banking Committee, Senator Chris Dodd used the opportunity to twist the knife, one more time, in the Republicans' old idea of privatizing social security. Bernanke reluctantly confirmed that the stock market would not have been a good place for private citizens to have parked their social security assets. Duh.

Senator Dodd seemed pleased with himself for getting that on the record; Republicans seemed impatient to get off that subject and on to the next question.

I have three takeaways: (1) Republicans deserve extreme embarrassment; (2) Democrats should try to curb their smug grins; and (3) it's time to consider privatizing social security — the correct way.

To Republicans
You botched the privatization message; social security has never been about investing, it has been about a government-guaranteed safety net. You deserve to be embarrassed. Privatization is not about investing in the stock market; privatization is about private property.

To Democrats
Congratulations on your political victory. Turning the Republicans' mistake into a club you can use against them time and again was skillful, top-notch politics. They deserve every bit of the beating you're giving them. What's more, your victory delivered the added benefit of masking the real issue you'd much rather not expose to the public's attention. (It would be advisable to consider how long you can keep the real issue buried, however.) 

To Senator Dodd: How about this idea?
Today, social security's old-age benefits are promises by the federal government to everyone who has accumulated credits within the system. Those benefits, as you know, can be changed at any time by politicians such as yourself. Those of us who have earned SS credits hear politicians talk a lot about the sanctity of the social security system—but frankly, sir, we remain unsure as to what you and future politicians might someday decide about those benefits we've earned and you've promised. [Our experience has taught us that any changes you might make would probably be bad news for us.]

In short, although we agree with you that the stock market is no place for SS funds, we disagree with your assertion that privatization is a bad idea. We'd feel much better about the safety of our SS benefits if those political promises were turned into our own private property.

What form might that private property take? Well, how about a new form of Treasury bond — say, "Social Security Retirement Bonds" — backed by the full faith and credit of the US government? They would become our own personal property, not redeemable until retirement age, not transferrable, void upon the death of the holder, and structured such that the timing of redemptions wouldn't change the projected cost of the social security system by a single dollar. The stock market wouldn't be an option; SS funds would be fixed in the form of new, nontransferrable government bonds with our names on them. 

With a properly-designed SS bond program, the only difference would be this: the promises politicians have made would merely become our personal property, backed by the full faith and credit of the US government. Like the Treasury bonds now held by the Chinese, they would be secure from the whims of future US politicians.

Would you support that, Senator Dodd?  If not, please explain.

The Lehman evidence

Commenter Bob asked a good question: Where's the evidence that Lehman was the first domino?

Well, the Lehman failure may not have been the first domino, but I'd say it was the first really big bomb, and it put a really big crack in the system's foundation. If we could somehow pick a single event to do over, now that we have the benefit of hindsight, I'd bet a lot of money that the Fed and Treasury would pick keeping Lehman afloat — especially since that just might have prevented the more-costly AIG rescue a day later. Just my guess, though.

What follows is a sequence of charts I selected from a presentation I attended at the Dallas Fed on November 21, 2008. They are key measures of the credit markets, and they all show clearly how the credit markets reacted to the Lehman event. (The reaction was sudden, very large, and negative.)

Click any chart to enlarge it.

Again, these are the ones I selected; the title of the presentation was "Reopening America's Financial Arteries: Addressing the Recent Financial Crisis."

Nationalize the banks, or euthanize them?

Either of those mutually-exclusive choices would likely lead to system collapse, according to Jim Cramer. He has been advocating a third alternative, which he describes starting 4 minutes into the video clip of the first portion of his show; click the following link and listen to the whole thing.

Jim Cramer video clip, Feb 20, 2009

Here's a quick summary of his suggested alternative, for anyone interested in the arcane detail: The government offers 40-year, 4% fixed rate mortgages to everybody, not just deadbeats and knuckleheads, for their home's appraised value, and protects the lenders by issuing them equity participation certificates for the difference, which the lenders use for regulatory capital.

Another observation he made that's food for thought: Hoover accelerated the fall into the Great Depression by being more concerned with not rewarding the undeserving than with saving the system from collapse.

In other words, it wasn't a choice between status quo versus bailing out the incompetent — because status quo was off the table. Is history repeating itself?

"Inside the Meltdown": Another must watch

This documentary by PBS is a good supplement to the CNBC show ("House of Cards") I mentioned in a previous post. This one is on the web; here's the link:

Inside the Meltdown.

 

Moral dilemma: What if we had a do-over on Lehman?

I asked the "do-over" question of some senior officials at the Dallas Fed a few months ago, and got the talking-points answer that it would have been "illegal." In other words, rescue wasn't an option, because the "rule of law" (...or, perhaps more precisely, "rule of the letter of the law") prevented it, which probably would have prevented many of the subsequent dominoes from toppling.

Today's Wall Street Journal suggests an answer to the Lehman do-over question: keeping the politicians out of the process in the beginning could have avoided most of the subsequent bumbling, grandstanding, gridlock, and economic nosedive.

But that answer raises an even bigger question I'll address below. First, an excerpt from the article (read the whole thing at this link.) Here's the excerpt:

How Democracy Ruined the Bailout (Wall Street Journal, Feb. 18, 2009, page A15):

Ben Bernanke and Henry Paulson, in a phone call last Sept. 17, decided to involve political actors in the bailout following the Lehman debacle. They had good, legal, democratic and constitutional reasons for doing so, but it was a terrible mistake.

With perfect foresight, Mr. Paulson might have put his foot down and said, "No. We will solve this ourselves, even if it means stretching our powers beyond every precedent." . . .

Harry Truman "scared hell" out of the country to get it ready to support a multigenerational facing-down of the Soviets. Scaring hell out of the economy, begun by President Bush and continued by President Obama, has produced only the runaway crisis it was advertised to prevent.

What if Paulson and Bernanke had just kept the politicians out of it -- in order to prevent the "rule of law" system from (nearly) committing suicide? If that's what could have happened, should they have done it?

I cautiously say yes. There are precedents in emergency situations -- one of the first being Thomas Jefferson's sidestepping of the Consitution to close the Louisiana Purchase before that opportunity evaporated. The danger is that, in such situations, we are temporarily relinquishing power to the "rule of men" (or women), and suspending the rule of law. Does our system permit our leaders to save the "rule of law" from itself? [Goedel's theorem could be at work here...]

It's an interesting dilemma; comments are welcome.

"House of Cards": A Must Watch

If you have any interest at all in the root causes of the financial meltdown, CNBC's "House of Cards" is a must watch. I just finished it, and I highly recommend it. (At this blog, I've condensed the root cause down to "crooks and idiots" -- but this documentary fills in almost, but not quite, all the details.)

Here's a link to CNBC's synopsis; the upcoming schedule is as follows:

"CNBC's "House of Cards" will re-air on Sunday, February 15th at 9PM ET and Monday, February 16th (President's Day) at 8AM, 8PM and 12AM ET."

Fixing Friedman's famous proverb

It's unanimous: "Deficits today will cause higher taxes in the future." Milton Friedman said it, and he was absolutely correct. It's no wonder we hear it from ideologues, of all stripes, trying to score some kind of political point about the other party's deficits.

But my pet peeve is this: Even though Friedman's statement is true, I just wish people would try thinking a little harder—just a little, teeny-tiny bit harder—before employing that glib throw-away line and reminding us who said it. Deficits mean future tax increases. Yada, yada, yada. I've been hearing it even more frequently, now that everyone realizes just how sizable the next few federal deficits will be. So frequently that four days ago, my patience ran out. I got so sick of hearing it, I made myself the following promise:

The very next time I hear someone utter that sentence, it's no more Mr. Nice Guy: I'm going to stomp that trite, overused platitude into the ground once and for all, where it deserves to stay. No offense, Mr. Friedman, but everybody has oversimplified your truism, and I won't stand for it any longer.

Three days ago
The morning after I made myself that promise, someone said it again, in a Wall Street Journal op-ed (Feb 10): an article titled "There's No Stimulus Free Lunch." Here's how the author chose to say it:

The increased federal debt caused by this stimulus package has to be paid for eventually by higher taxes on households and businesses.

The author was... Gary S. Becker, professor of economics at the University of Chicago, and Winner of the 1992 Nobel Prize in economics. [I visit his blog a lot.]

Gulp. Did I make that promise to myself a little too hastily?

Today
Well, I've double- and triple-checked my numbers, and everything still checks out. So I've decided to keep that promise I made to myself. Here goes...

"Taxes will be higher in the future because of deficits today": Years ago, that made me picture a huge tax rate on our grandkids' pay stubs — maybe a 60% or 80% bite taken by Uncle Sam, shrinking their take-home pay down to a sum barely big enough to pay the rent and buy a few tomatoes for dinner. All because we, their grandparents, ran deficit after deficit during what our grandkids would subsequently dub "The Decadent Decades." Wow, did I feel guilty.

But I don't any more. Reason: I started thinking about it just a little harder. For example, over a period of years, I saw Uncle Sam take a bigger and bigger tally of dollars out of my paycheck, even when my tax rate didn't change; but I also noticed two other things on those same paychecks: both the "gross pay" and the "net take-home pay" kept getting bigger and bigger, too. I watched all three numbers keep increasing, even when the tax rate didn't change, and even during the Reagan years when the tax rate went down. Gross pay, taxes, and take-home pay kept getting bigger. Sure, in some years, some of it was inflation — but in most years, most of it was real growth. Especially during the Reagan years.

How to increase taxes and take-home pay at the same time
I set up a hypothetical example to demonstrate that it's possible to increase taxes without increasing the tax rate structure, while simultaneously increasing everyone's take-home pay. It's a simple economy with 20 taxpayers, spread across three tax brackets. They get more productive (and therefore get real pay raises) at a rate of 1% per year, and they are upwardly mobile (i.e., they get promoted occasionally).

Also in this economy, it is virtually impossible for the politicians to increase tax rates (the constitution requires a 99% majority). Consequently, to increase their tax "take" from the private economy, the politicians have no choice but to spend their time making laws that enhance the economy's real growth rate.

The two charts below show what happens over a ten-year period. First is the taxable income per person in this three-bracket economy. Remember, everybody got 1% more productive each year, and got a matching (real) raise in their wages and salaries.

Over ten years, that increased each bracket's taxable income per person by 11%. But that's not all; the next chart shows the total tax dollars each bracket paid into the government.

In total, the taxpayers were paying 29% more tax dollars after ten years. That 29% "tax increase" was the equivalent of a 2.6% tax hike each year — but the politicians didn't have to increase anybody's tax rate to achieve that!

Obviously, the increasing productivity helped, but that's not all. One lower-bracket taxpayer got promoted into the middle bracket, and one middle-bracket taxpayer started a new business and got rich. Upward mobility of the workforce helped, too.

See? We don't have to raise tax rates to raise taxes. Real growth works even better. It's called "growing the tax base."

Think about the lawmakers in this hypothetical economy: they've achieved politician nirvana, because their tax take keeps growing and growing, but they never have to raise ANYBODY'S tax rates (...nor are they allowed to). They enjoy sky-high approval ratings, and are perpetually returned to office by the happy, prospering populace. All because these politicians understand the overwhelming importance of economic growth, and the folly of anything that detracts from it. It is the most highly-evolved system of political economy in the history of civilization. [Sorry, I guess I got carried away dreaming about that faraway fantasyland. Back to reality...]

How I'd fix Friedman's proverb
So, it's about time someone clarified Milton Friedman's indisputable truism, "Deficits today will cause higher taxes in the future" — don't you agree? I'll volunteer. Here's how I'd improve on it:

"Deficits today will cause higher taxes in the future — but not higher tax rates, if we focus on enhancing real economic growth."

Capitol Hill debates the stimulus bill

On Capitol Hill, it's those damn deck chairs again: nobody can agree how they should be arranged. Partisanship continues to trump statesmanship. Even though the $800 billion package is called "stimulus," everyone seems to be paralyzed by old, worn-out talking points. Democrats still can't stand tax cuts, Republicans still can't stand government spending. To Democrats, the danger is that tax cuts might get saved instead of spent... and besides, the left-wing base still despises "corporations," and god knows they don't deserve a tax cut. To Republicans, the danger is that so-called stimulus spending just might become permanent, instead of stopping after the stimulus has stimulated... and besides, the right-wing base despises anything that smells like "big government" or "spending our grandchildren's money."

Speaking of money, I've been wondering if anyone besides a handful of people understand what almost happened five months ago, in mid September. Jim Cramer warned about it on his CNBC show: it was an electronic run on the money market, and he spotted it as it was happening. A "run on the bank" causes the bank to collapse; a "run on the money market" causes the entire financial system to collapse — and that's what nearly happened in mid September (one money market fund "broke the buck" -- a rare occurrence, and a very bad omen).  We came within a few hours of financial collapse, which would have been followed quickly by the collapse of our political system. If more than just a handful of politicians understood that they were almost fired en masse five months ago, I bet today's conversation would not be about the Titanic's deck chairs. But that's just my educated guess; I have a history of overestimating politicians.

Fortunately, the truth is at last being articulated in terms that are easier to understand than all the jargon we've been hearing. A reader sent me a link to a video everyone should listen to (...thank you, Denise). It's Congressman Paul Kanjorski on C-SPAN explaining what happened back in September. The important part starts at the two-minute mark; be sure to catch it, then send the link to your friends and ask them to pay attention. Here's the link.

The ingredients of a good stimulus bill
Here are the three major ingredients I think a good stimulus bill would include. It has everything to do with getting the credit system flowing again in the short run, then trusting the private sector with our standard of living in the long run. I'll admit right up front that it's a pipe dream, because it would actually require bipartisan support—which implies that both sides would have to retreat from several of their talking points, which of course is why it's a pipe dream. But here goes:

1. Start spending money and cutting taxes as soon as possible. Contrary to what some Republicans claim, the money the government spends will not be offset by a reduction in private spending, it will be sourced from money that would otherwise have sat idle (the "money at rest" that's causing such low velocity today). Contrary to what some Democrats claim, the tax cuts, even if saved, would get spent by private sector borrowers, because the whole idea is to get the credit system flowing again. Spending is what we need; spending by government until the private sector gets going again, spending by consumers who regain their confidence, and spending by borrowers who are willing and able to get loans again.

2. Sunset provisions on government stimulus spending. When the stimulus has stimulated, stop stimulating. A healthy private sector is the most effective engine for increasing our standard of living; but a permanent takeover of too large a portion of GDP by government is the surest way to retard the growth of our standard of living.

3. Infrastructure spending should be on projects that will benefit future generations, not on dig-a-hole-fill-it-up fiascos. Lacking enough such investments, the stimulus money should be spent a different way, such as tax cuts.

Conclusion
Keynesians are right: preventing a deflationary collapse takes big action in the short run by government. Hayekians are right: in the long run, the private sector is the best engine for prosperity. But tired, worn-out lists of political talking points are getting in the way of both of those truths. In other words, there are a lot of icebergs in our path; we need a crew that's paying attention, instead of arguing about deck chairs.

Pushing on a string

The Fed has been "printing money" (purchasing assets from the public with money it has the power to create from so-called thin air) at an unprecedented pace in recent months, as we've discussed before. The objective is to stimulate lending and borrowing, which is the heartbeat of the economy. But all that new (base) money hasn't been doing much stimulating so far.

Below is a chart from the St. Louis Fed showing what the banks are doing with all that new base money: they aren't lending it out [...more precisely, they aren't using it to back new loans]; they're sitting on it, in the form of "excess reserves."

Click to enlarge:

[For clarity, I made the line a little fatter.]

Investopedia explains Excess Reserves as follows:

Financial firms that carry excess reserves have an extra measure of safety in the event of sudden loan losses or cash withdrawals by customers. This may increase the attractiveness of the company that holds excess reserves to investors, especially in times of economic uncertainty. Boosting the level of excess reserves can also improve an entity's credit rating, as measured by ratings agencies like Standard & Poor's.

That explains why all that "money printing" by the Fed isn't causing price/wage inflation. Here's the nearly-unperturbed chart of the money supply. [Source data here].

Click to enlarge:

If and when this chart starts to ramp up, the Fed will need to start selling securities back to the public, to keep a lid on inflation. Until then, avoiding deflation will remain the Fed's big challenge.