Okay, so those aren't big surprises to anyone who has visited this blog in past seven years. But I expect they will surprise many readers at American.com, the online magazine of the American Enterprise Institute. Here's a link to my latest article there:
Why Growth Matters More than Debt
In the article, I used our familiar pie chart; I also thought of a more public-friendly name for the "debt burden"--specifically, I called it the "Interest Bite." [You may recall that I've tried its inverse, "Times Interest Taxed," at this blog before--but that most certainly does not compress down into a convenient acronym.]
How the Democrats and the Tea Party botch Reagan's legacy
On the one hand, getting nostalgic about Reagan is easy for Republican presidential candidates (with the unfortunate exception of Ron Paul, who has publicly advocated condemnation of Reagan). On the other hand, actually understanding what Reagan did, and how he did it, seems to be significantly more difficult for quite a few Republicans, and for an even larger portion of Democrats.
It's time we started thinking just a little harder about Reagan's tenure; there might be a clue or two that could help us out today.
My latest article about this topic is now available at the American Enterprise Institute.
Bernanke’s response
Ben Bernanke is doing a good job, so far, in carrying out Alexander Hamilton’s sage advice: keep politicians at a safe distance from monetary policy. He’s doing that by the simple act of ignoring a letter he received. I hope he continues using that approach.
However, I have been having a little fun imagining a parallel universe—one in which Bernanke patiently responds to the politicians, in an honest attempt to explain what the Fed is trying to do.
Imagine we are now in Parallel Universe Number Two. Here is Bernanke’s response.
-------------------------------------
Dear Sirs:
Thank you very much for your letter. Past Chairmen would have ignored it under the guiding principle of keeping politics at arm’s length from monetary policy. However, I’ve decided break tradition by responding—particularly if my response helps to clear up any misconceptions.
I’d like to explain, as simply as I can, what the Fed is trying to do, in hopes that you will see that we are not on the path of creating Weimar USA; in reality we are trying to help achieve the goal of getting the economy moving again. “Jobs, jobs, jobs” is how everyone likes to put it these days. Please understand that, just as Congress sometimes has difficulty acting in unison, so does the Fed... occasionally. We all know these are difficult times; but we all have responsibilities to act, even if it cannot always be with unanimity.
Please bear with me. My explanation requires four steps and one simple algebraic equation; no calculus, I promise. I sincerely hope you will follow along as I take it one step at a time.
[As an aside, I have read Atlas Shrugged as I presume you have; but one aspect of the plot has always bugged me greatly. It has to do with the part about those little gold coins in John Galt’s intermountain utopia. I’ll get to that later, after covering the four-step explanation I feel I owe you.]
First is the equation that helps us envision how the real economy and the money supply interact with each other. It’s the simple “equation of exchange” we see in economics books. Here it is, below:
Next is a simple, color-coded explanation of each element. I’m sure you’ll all recognize the “P” (price level) component, because when a country makes the horrible mistake of hyperinflating its currency, “P” takes off like a rocket. But there are three other things in the equation of exchange: the money supply, the money velocity, and the quantity of real goods and services exchanged, as shown below:
Most people consider “T” to be the most important element—the total amount of production and exchange in the real economy. It is affected by virtually everything we do in monetary, fiscal, and regulatory policy.
The next logical step: how the Fed can try to help whenever fiscal, regulatory, and past monetary policies have failed to get the real economy (T) moving and growing again at a robust pace. (Whether the Fed should try is a different question; currently the Fed's mandate is to do something about both "P" and "T"; you can change that, of course, but that's the way it is now.)
The explanations use the scenario of an undesirable slowdown in real economic activity—today’s situation, including the effect of dormant excess reserves. In the alternate scenario of undesirable inflation, the Fed would reverse its action by “unprinting” money (i.e., by raising its target rate and selling assets as necessary), to keep the price level in line with what we all hope is robust activity in the real economy.
Lastly, we have the equation to which I believe those who advocate the gold standard are mistakenly committed. Note the conspicuous absence of “T” and “V.”
It says that any increase whatsoever in the money supply is the very definition of inflation. (Never mind that we cannot actually measure the money supply, as the Volcker Fed discovered, after which the Fed began targeting the interest rate instead of the money supply.) The simplified equation says, to understand inflation, there’s no need to think about idle money sitting in excess reserves, and no need to think monetary policy can do anything about any sluggishness in the real economy. No, all we need is a known quantity of money, like the gold coins in John Galt’s intermountain utopia; monetary policy is as simple as that. [My view, and that of many others: it's an oversimplification.]
And that brings me back to the irritating flaw in the Atlas Shrugged plot—one that the economist in me couldn’t help but notice. Presumably, John Galt’s economy would attract many other high-integrity producer-consumers, and the utopian economy would grow due to increases in population, physical capital, human capital, and productivity. But with a known quantity of little gold coins (M) in a growing economy (T), the prices (P) would be forced to fall (deflation)—which in turn would require smaller and smaller gold coins as the economy flourished. Either that, or the economy would surely taper off, stagnating at a constant level of activity in a short period of time. How small could a gold coin get before the economy leveled off and everyone started demanding some new, better way to grow the money supply so that the real economy could start growing again? How much deflationary pain would it take for the citizenry to start demanding the innovation of fiat money, and the controlled, purposeful printing of same, in Galt’s intermountain utopia? Certainly the need for fiat money would cause an entrepreneur to invent it, at least by the time the gold coins got tiny enough to start leaking out of everyone’s pockets from between the stitches, if not long before, wouldn’t it? If not, Galt’s economy would be doomed--definitely NOT what Ayn Rand had in mind.
As I said, it’s an angle only an economist could conjure up.
In any case, sirs, I hope this response will help to reassure you that the Fed understands the problem, and is trying to do what it can to alleviate it, even though it is not always possible to act unanimously.
Sincerely,
Ben Bernanke
Chairman of the Federal Reserve Bank
United States of America, Parallel Universe Number Two
ps –
Effective fiscal and regulatory reforms would have the potential of eliminating the need for dramatic actioin in monetary policy.
----------------------------
Grow or Die
[President Obama correctly says that robust growth is the only way to fix our current situation without raising taxes. That's what he says, anyway. Below is a condensed version of what my career taught me about growth, followed by how that microeconomic truth applies to our macro economy.]
There are only two kinds of problems in business: (1) growth problems; and (2) liquidation problems. I read that a quarter century ago, and ever since then, I’ve never found a single exception to that truism. Every problem I’ve encountered in business falls under one of those two headings. And I can now add another tidbit of wisdom: Without exception, solving the growth problems is a lot more fun.
Grow or die. Expand or liquidate. Or, as Red reminded himself (after leaving Shawshank):
Get busy livin’—or get busy dyin’.
Early in my career, I was extremely fortunate to have joined a company that, as the leader in its industry, was growing its market share in a market that was growing rapidly. A growing share of a growing market; you know, it doesn’t get much better than that. We had growth problems galore; we were profitable, we were working hard to keep up with the growth, and we were having hectic fun.
Costs were growing rapidly—but that was good news, because revenues were growing even more rapidly — and it takes money to make money. Sure, we found ways to improve the cost structure, but that, too, was a lot more fun because of the growth problem. Bottom line: The stockholders loved the revenue-driven profit growth we delivered, year in and year out.
There’s one thing about stockholders, though: they keep demanding profit growth, whether or not revenue is growing. Stockholders have a funny thing about that. And guess how profit growth is delivered when revenue is stagnant (or worse, shrinking): cost-cutting, that’s how. In a no-growth environment, cost-cutting problems tend to become more than “productivity” programs; they tend to be liquidation problems. Cutting fat is always a good idea; cutting meat and bone is hardly ever a good idea. In a no-growth environment, though, it’s easy for management to mistake investments in the future for discretionary costs—and sometimes the "solution" to the liquidation problem only accelerates the downward spiral. Liquidation problems must be solved, but that doesn’t make them as fun as growth problems.
In any case, stockholders demand growing profits no matter what; it’s management’s job to deliver it; and, of the two ways to deliver profit growth—growing revenues or cutting costs—the only sustainable strategy in the long run is to grow revenues. Here are two charts that illustrate the difference. Profit growth through revenue growth is open-ended; profit growth through cost-cutting eventually runs into a dead end. (That’s why most successful companies place significant emphasis on developing new products and services.)
I hope those are self-explanatory. They are my condensed summary of hundreds of individual experiences on both the “growth problem” and “liquidation problem” sides of the business management coin. They are the microeconomic examples illustrating the principle of “Grow or Die.”
I have one last chart depicting how the “growth problem” scenario works for our economy as a whole. As I’ve said before, a growing economy causes federal tax revenues to grow; the green and blue lines below show that relationship. Another thing I’ve said before is that a measured, prudently managed deficit is also sustainable indefinitely. (See this article, in which I suggest how to define “fiscal responsibility”—something the doom peddlers consistently shy away from doing.)
Growth solves a lot of problems. Not only is it the seldom-mentioned third alternative to the false-dilemma of cutting spending or raising tax rates, growth is an imperative for our macroeconomy, too.
Wouldn't it be nice to hear some growth ideas from our politicians and doom peddlers for once? Wouldn't it be nice if the need for "robust growth" turned out to be more than just eloquent talk from President Obama?
Red said it best: Get busy livin’—or get busy dyin’.
--------------
Austrians vs Keynesians: The Scoreboard
[After submitting this to a discussion group as my synopsis of the difference between those two schools of thought on monetary theory and policy, I decided to tweak it a little and post it here. If nothing else, it might clarify my stance on a few key issues for newer visitors to this blog.]
Keynesians 1, Austrians 0
The fundamental debate about monetary policy boils down to fiat money vs commodity money — and the question, "Which of those is a better system for ensuring a stable value of money?"
Before we can answer that, we need to agree on the definition of "stable money." In many minds, it means "money that does not suffer unanticipated inflation higher than 2-3%." In my opinion, that is only half of the proper definition; it should also include "money that also does not suffer deflation of any level." In short: Stable money is money that does not inflate or deflate.
Now, if you agree with my proposed definition, the flaw I see in the Austrian side of the monetary argument becomes easier to detect. As an experiment, try this: search any of their essays or texts on the subject, and count the number of occurrences of the word "inflation"; then count the number of occurrences of the word "deflation." I predict the ratio will be at least 100:1, if not 100:0 (infinite). Deflation is at best an afterthought in that ideology, even though it can produce worse consequences than inflation -- such as a downward-spiraling implosion of the real economy, which in the past has tended to end in the violent overthrow of governments.
An even harder-to-detect flaw in the commodity-money dogma (besides the "deflation? who cares?" attitude) is its shaky track record of actually preventing inflation itself, in spite of how plausible the theory sounds. As with any type of money, commodity money (eg, gold or silver) is inflationary whenever an increase in its supply outstrips the economy's ability to increase its production of real goods and services. The California gold rush produced inflation (arguably with excellent results for the real economy); on the other hand, Spain's obsession with bringing in silver from the new world caused a domestic inflation that removed Spain from the industrial revolution. In both cases, sudden increases in the supply of commodity money were inflationary — the same thing that happens to fiat money when its supply increases too quickly.
Moreover, some in the Austrian school define "inflation" differently from the way most people think of it these days. The (archaic, in my opinion,) definition is "any increase in the money supply." Contrast that with the way most people define inflation: "any increase in the general price level." To achieve stable prices, the money supply must increase roughly at the same rate as the supply of real goods and services. But to achieve the Austrians' version of "no inflation" the money supply must not increase -- which means prices and wages must fall as the real economy grows -- IF it grows *in spite* of the stagnant pool of money available to the economic participants. I have yet to see an essay proposing a politically-viable way of convincing the general public that falling nominal wages are no problem at all, because falling nominal wages are in fact constant or rising real wages in a real economy that's growing. And, as Lincoln said, "With public sentiment, nothing can fail; without it, nothing can succeed."
The Keynesians, in my judgment, have the upper hand in monetary theory: the proper goal is to prevent BOTH inflation AND deflation in the general price level. Deflation is partially-disguised as rising unemployment, but it is deflation nonetheless. (Reason it's disguised: When prices fall, businesses must reduce costs in order to survive. But hourly wage rates tend to be more rigid than prices; therefore, to reduce the cost of wages and salaries, businesses must reduce labor hours instead of labor $/hr. One full-time employee equals 2000 hrs/yr; you know the rest.) The Keynesians and neo-Keynesians seem to be the only ones genuinely concerned about preventing a deflationary spiral in unusual times like the ones we have been experiencing; the opposing viewpoint isn't much more than "Deflation? So what, who cares?" — and amounts to a hands-off policy of letting unemployment rise to whatever level we supposedly deserve because of prior excesses. I think that is an unacceptable mistake of ignoring money that's unstable in the downward direction.
Unanticipated inflation gives debtors an unfair advantage. Unanticipated deflation gives creditors an unfair advantage — that is, up until the debtors default, at which time everybody loses because of an accelerating downward spiral to oblivion. A "stable value of money" means preventing both inflation and deflation. The Keynesians have articulated both sides; the Austrian school has been vocal about inflation, but inexplicably silent about deflation. Makes me wonder if the Austrians could only see monetary theory from the creditors' viewpoint. In any case, on monetary theory, you can count me with the Keynesians, until something better comes along.
Keynesians 1, Austrians 1
That said, I must qualify my objections to the Austrian school of thought: My objections are strictly limited to their 19th century thinking regarding monetary theory and money mechanics. I am an enthusiastic advocate of Hayekian ideas regarding the growth and vitality of the real economy in a free society. The Hayekian model for the real economy (as oppposed to the monetary side) is market- and rule-of-law driven, analogous to the biological model of natural selection and adaptation. By contrast, the central planning, government-knows-best model is analogous to Intelligent Design in biology. I most definitely do not subscribe to Intelligent Design in biology, nor do I subscribe to it in economics; the evidence in both cases is overwhelmingly in favor of the evolution model employing selection and adaptation. Hayek's brilliant essay, The Use of Knowledge in Society, explains why the market-driven model of selection and adaptation creates growing prosperity, and why Intelligent Design (a.k.a. central planning) fails.
So, I keep the money side of the economy well separated from the real goods and services side in my thinking. Money flows the opposite direction from real goods and services. Stable money is one of government's responsibilities, according to Adam Smith and most subsequent thinkers (...the other responsibilities being defense, justice, education, and infrastructure). After providing those, the government is NOT responsible for the real goods and services side of the economy. [That's why I support the Fed's monetary initiatives, but oppose the GM bailout and life-support programs. Stable money is the government's responsibility; automobile manufacturing is not.]
In short: It's all tied up: Keynesians 1, Austrians 1.
That's my interpretation, anyway, after a couple decades of research into the subject. And it's the reason I think Reaganomics is far from "dead," in spite of the wishful thinking on the left these days. Reaganomics is growth economics; what we've had to switch to is stop-the-bleeding economics. It's not an either-or choice, as I explained in more detail in this article a few months ago.
That's it. Happy Independence day, and have a safe and fun weekend.
The Fed vs the Politicians
Last Friday, the top story in the Wall Street Journal was all about how our esteemed politicians on Capitol Hill jumped all over Fed chairman Ben Bernanke the day before.
It was the harshest public grilling for a central bank chief since the late 1990s... The mounting controversy over the Fed's involvement risks subjecting the central bank to the kind of political pressure it has managed for decades to resist.
As usual, our esteemed politicians seem to disagree amongst themselves as to exactly what is so upsetting about the Fed's actions.
Critics on the right, especially House Republicans who have long been suspicious of the Fed's power, say the central bank intervened too aggressively into the private sector. Critics on the left say it has been too opaque in its actions and too easy on big banks.
Publicly, the politicians are split as to why the Fed irritates them. But I suspect a hidden agenda: politicians wish they had more control over the Fed -- but they don't, and that's why they were acting like spoiled kids last Thursday. Bernanke handled his grilling with admirable composure, and as I watched a recording of the session, I thanked my lucky stars that our country is, so far, still following Alexander Hamilton's advice to be sure that control of the central bank is kept AWAY from the politicians. If that condition changed and our esteemed politicians somehow gained a much larger measure of control over monetary policy, I'd have to triple or quadruple the odds of a deflationary depression or of high inflation — or both of those disasters taking turns in a perpetual cycle.
Obama should reappoint Chairman Bernanke in January, period. Bernanke knows how monetary policy should be handled in unusual times like these, he's doing it, he openly explains it to us in terms we can understand (unlike any past Fed chairmen), and he somehow maintains his composure when being grilled by grandstanding half-wit politicians. Those are valuable skills, especially the last one.
Inflation/Deflation watch
For now, the Fed continues its success at preventing both deflation and inflation. Here's the latest Inflation/Deflation chart.
[If the politicians ever gain direct control of monetary policy, I'll have to expand the Y-axis scale significantly upwards and downwards.]
Obama gets it: “Robust” growth is the solution
At last! We have a political leader who has found a way to say “Deficits don’t matter under the right conditions” without becoming the target of ridicule and partisan barbs as happened to Dick Cheney. I consider that a huge and important step in the right direction.
Obama said the following in a recent interview with Bloomberg (...and thanks to William B. for the tip):
One of the biggest variables in this whole thing is economic growth.
And, most importantly…
If we are growing at a robust rate, then we can pay for the government that we need without having to raise taxes.
I give that sentence an A-minus. That puts Obama way, way ahead of all other politicians, who deserve D-minuses and F’s in the category of understanding and communicating the overwhelming importance of “robust economic growth.”
Mind you, I’m not complaining, but if I could have tweaked that sentence just a little, it would have read as follows (my tweaks are in boldface):
If the private sector is growing at a robust rate, then we can pay for the government that we need without having to raise anybody’s tax rates.
Presumably, we can all agree that "growing" means "creating new jobs, products, and services"; I hope at least that is nearly unanimous. But tweaks aside, this is very encouraging; we’re making important headway, at least rhetorically. Now all we have to do is make “robust growth” happen in reality—which requires a lengthy and important debate, to which I will be happy to contribute.
For now, however, I’d like to enjoy the moment. “Robust growth” is at last out there for us to think about and talk about with our family, friends, and neighbors, thanks to President Obama's communications skills. He's a great talker, and that's an indispensable first step.
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