Professor Bainbridge...on law, politics, religion, culture & food

I agree with this analysis that the ‘stimulus’
packages are reflexive and not justified by history. Worst of all, the stimulus never aims
at the origins of the crisis: housing, debt, energy, trade, and above all the dollar.

Few would disagree with the notion of rate cuts now. But all rate cut, in a vacuum, by themselves
are sterilized by losses in the currency, given this market. Dollar value losses over the last few years trace the same lines with interest, downward. When you start to hear a throrough-going analysis of all of the elements of the crisis, we will know we are getting closer to answers.

I think the nature of the ‘stimulus’ matters. I think its silly to dismiss ANY tax or spending cuts as ‘unnecessary’. Are you suggesting that the elimination of the dividend, capital gains and estate taxes would be bad for the economy?

Capitalism takes… capital. Double and triple taxing earnings is bad for the economy in both the best and worst of times.

On the other hand, monetary ‘stimulus’ through inflating the dollar by lowering short term interest rates, or by increased govt borrowing from the Fed is BAD in any circumstance - why on earth would it ever be a good thing to deplete your savings?

With all due respect professor, I don’t believe your point is very well thought out.

As much as I’d like our economy to weather this storm in a healthy way, I have to shudder to think how this “stimulus” may play out. I consider myself a fiscally conservative Independent, but I can’t help be especially suspicious of the Democratic Party side of the aisle, who will find this an excuse to fill every rattling can of scamming neediness whether it works for the economy or not.
Please, Lord of our Forefathers, let them not do too much damage!

Decades ago, Miltion Friedman explained that “found money” does not alter people’s spending habits significantly. A tax rebate does not make people wealthier, so they either pay down debt with it (which is “stimulus” neutral) or put it into savings (also neutral).

For people to spend more, Friedman explained, they have to increase their regular income. They have to make more money over time, not just once.

The central fact to remember when assessing any government monetary policy is this: The government has no money of its own. Therefore, the government has no money to stimulate the economy. All it can do is return money that it took away from the economy to begin with.

More here.

Some of the objections to current stimulus proposals relate to the idea that what is paid out must be taken from somebody else, or the increase of deficit means the future generations is saddled with additional liabilities.

This perspective represents macroeconomics as “closed system.” I would like to suggest the viewpoint that macroeconomics is in fact “open system.”

Value is fundamental to all things economic.  In economics, value is the sub-atomic particle without mass, upon which everything in economics is built. Value exists only in the imagination. It can be easily created or destroyed. It is value that defines assets. Assets are only carriers of value and do not define value.

The historical development of economic thought includes the hidden, instinctive and automatic assumption that value is inherent in assets.  This always leads to “closed system” thinking because the quantity of value is limited to the quantity of so-called “real” assets. This is erroneous.

Value is an ephemeral thin air essence.  It’s all the same regardless of which asset it is ascribed to.  If value is ascribed to newly created money, it adds real value to the economy, just the same as when value is ascribed to gold after it is made available to the market as the result of mining.

Our traditional monetary policy through fractional reserve banking multiplies money during credit expansion, but will annihilate money during credit contraction.  Through this process massive amounts of value can appear and then disappear within an economy.  During the disappearing phase, it leaves behind a lot of non-performing debt that can seriously threaten the financial system and subsequent economic performance. 

The solution is quite simple for problems associated with disappearance of value during credit contraction.  It is quite possible to tap the vast pool of value that exists in the imagination of the mind, from whence all value is derived, by straightforwardly creating dollars and introducing this cash flow into the economy through fiscal policy.  This cash flow can replace debt in the balance sheet of the private economy while simultaneously maintaining proper discipline with monetary policy--- raising reserve requirements to limit the amount of money that can be created through credit expansion.

The combination of of using fiscal policy to manage money supply in combination with tight monetary policy will help maintain the value of the dollar without damaging the prospects of real economic growth.

And now, for the real heresies!  The near total reliance of managing money supply on the credit system is becoming unmanageable.  It is the old Model T, unsuitable for high-speed technologically advanced economies.  ( The more that is discovered and invented, the more that can be discovered and invented----with the rate of innovation rising, which is responsible for rising productivity) The money from credit expansion due to the housing bubble, stimulated widespread global economic growth.  But note this carefully; with very little inflation.  What this means is that a higher rate of stimulative economic policies is possible then previously assumed, but you can’t do it by causing bubbles with the credit system.

You do it with created money----no you don’t borrow it, you literally create it, and use it as part of the national budget.  This does not add to the deficit and it’s no different than if the US treasury owned a mine with a shaft of solid gold, which it accesses to use as part of the national budget.  Management of liquidity should be shifted away from traditional monetary policy to fiscal policy--- and, no, no, no, this will not cause inflation if the fractional reserve credit system is correspondingly restricted in the money supply it produces.

Jake Peachey

One big reason why this fiscal stimulus might be different from past attempts is that it seems like the politicians are willing to move quickly rather than delay.  A rebate on 2007 taxes would be a great way of quickly putting additional spending power in the hands of consumers or simply help their balance sheets.

We’ve had a bubble in investment in housing and the rate cut will help ease the transition to a more appropriate level of investment but consumer debt levels are high and I hate to see more liquidity driven wealth effects driving spending.

Then again, I never understood why Greenspan/Clinton were so anxious to cut the Federal deficit.

The other reason why politicians love the idea is that the bill will be larded with all kinds of earmarks and nonsensical pork. An ‘emergency’ gives them just the cover they want.

With which ever pols face on it, an excellent T-shirt:  “Don’t just sit there. Do something foolish!”

Jake,

In plain English, are you suggesting that the government should print more money?

Rob

Jake,

Isn’t that what the Fed does when it “injects” money into the banking system? They just “print” it and hand it to banks. I’ve always assumed they “burn” it when the loans are repaid, but I could be wrong.

Jake is obviously a smart guy but has never taken an economics course.  The Fed impacts money by buying/selling treasuries.  In other words when they said they were cutting the target Fed Funds rate they are saying we will buy bonds (or perhaps sell) in a fashion designed to result in a Fed Funds rate of 3.5%

Assuming it is buying bonds (they are trying to drive the rate down by buying) that puts more dollars in the hands of the financial system to loan/spend etc.  More money in the system equals higher demand for goods and services.

The problem arises if everyone just sits on the additional cash and doesn’t spend it.  That can mean that they are purchasing bonds (reducing the number of bonds the fed is purchasing) or has happened in the last few years buy assets such as houses or invest in the stock market.  The Greenspan Fed created so much liquidity in an effort to keep the economy going that it created an asset price bubble.

What Professor Bainbridge is suggesting is that we allow the Fed to pump additional liquidity into the system but we don’t honestly know where that liquidity is going.  It might be spent on goods and services that will keep the economy going or they might buy assets which will help support asset prices and create the feeling of people that they have wealth and therefore can spend it on goods.

My personal belief is that the fiscal/fed policies since the early 90s have been misplaced.  When the government stopped borrowing so much it resulted in interest rates plunging which resulted in an asset price bubble and speculative investments (dot-com).  Yes there are benefits from the investments but in my view the extremely low interest rates created a casino style economy.

Clinton should not have raised taxes and probably should have cut them to reflect the fact that there was too much savings in the world (not in US; I’m talking world savings much of which is making its way to the US).  By keeping interest rates at a reasonable level asset price bubbles would not have formed (or would have been less likely) and individuals balance sheets would be stronger because they would not have gone on the speculative binge that they did when interest rates declined.

In the early 2000s the government began to run larger deficits but demand was so slack that the Fed had to continue to pump liquidity into the system continuing to inflate the bubble.

I think massive government deficits are called for until the excessive world-wide savings are sopped up. 

What can you do?  Imbalances are an economic fact of life but you take steps to try and prevent them from growing too large and policy over the last 15 years has been misguided in my opinion.

Hey when was the last time you heard someone say the Fed deficit wasn’t large enough!!!

are reducing short-term interest rates by buying bonds.  This is a simple/supply demand thing.  If If the Federal government prints/creates liquidiyt

Jeff Boyd said, “What Professor Bainbridge is suggesting is that we allow the Fed to pump additional liquidity into the system...”

Let’s not confuse fiscal policy with monetary policy.  I won’t go into the whole explanation because I don’t have the time or energy, but suffice it to say, the above is NOT what Prof. Bainbridge is talking about.

The elephant in the room now is the ongoing, Republican-sponsored federal deficit.  I say Republican because the entire deficit was generated under Reagan, Bush 1 and Bush 2.  This would be the ideal time for fiscal stimulus.  Running a deficit now is the correct policy in order to stimulate the economy.  The problem (as the Prof stated above) is that we have an approx. $10 trillion debt, thus, generating a large budget deficit in this fiscal year becomes problematic. Had we balanced the budget in the past, running a one-time, or even two- or three-year deficit would be no big deal. 

Running big budget deficits on top of $10 trillion of already existing debt could raise inflation or solvency issues and is not as easy a fix.

gab,
Did you read Professor Bainbridge’s post?

Some quotes follow:
“By the time Congress has finished negotiating who gets what, and puts the new law into effect, the recession is usually past — and the fiscal stimulus arrives just when it is least needed.”

“Peter Orszag, director of the Congressional Budget Office, told The Wall Street Journal, “Most of the stimulus options under consideration would be difficult to actually get out the door in the first half of 2008.” By the time a program spreads its healing balm, we may find the recession has died a natural death—or was never born.”

Greenspan made the above arguments in his recent book as well.  I don’t know everything but Mr. Gab know less.

Mr. Boyd, I wasn’t the one who confused monetary policy and fiscal policy, so saying that I know less than you is a clear mistake.  As I tell my children, the inability to admit error is a sign of immaturity.

I also said, “this would be the ideal time for fiscal stimulus.” I’ll translate into English for you, “this would be the ideal time” means right now. 

And most of the above quotes assume a garden-variety US recession - my bet is that this one is gonna be different, thus requiring more and longer stimulus than past recessions.

Oh, and don’t assume Bainbridge knows anything more about the US economy than anybody else, simply because he can cut and paste…

With the continuing deterioration in the dollar and the inflating of the money supply,the sensible action to take is to buy gold,or its equivalent.The gold stock index is a good choice.

You brilliant analysis clearly shows I do not know the difference between fiscal and monetary policies and I bow down before your obvious intellect.  Perhaps when you are less busy you can come back and explain it all.

With regard to deficits, the strange thing is you are touting the same line as Ronald Reagan in 1976 before he discovered “supply-side economics.” 1976; the first year I heard the Ramones.

Gabba gabba hey!

Asked about whether there would be new spending in the stimulus package, Rangel said, “You can bet your life that they’ll [sic]be an increase on the amount of money given for unemployment compensation…. There will be funds there for food stamps.”

Right there that tells you what not to do.

to Rob, mrsizer,Jeff Boyd

My main objection is the monetary system based on fractional reserve banking, which is inherently unstable.  It produces money by credit expansion ---- building from a base money supply which the Fed controls.  The system forms a huge inverted pyramid of debt during economic expansion and really gets out of hand with manic speculative frenzies. The psychology of herd behavior is destabilizing.

This historic system is the tail that wags the dog (the real economy) and is responsible for the economic cycles of history.

I would like to see a system of steady irrigation instead of liquidity floods and droughts.  This would be done by keeping real interest rates at the upper end of historic levels and raise the reserve requirements substantially.  This would greatly reduce the amount of money the fractional reserve system could create through credit expansion.

And then, a good portion of the federal budget (200 to 400 billion) would be financed by creating money when the treasury sells bonds to the Federal Reserve which is the ritualistic act of creating money, because the Federal Reserve simply shows an increase in the account of the US treasury when it buys the treasury bonds which the US treasury draws upon.  The treasury never needs to redeems those bonds because it is not real debt as if the Federal Reserve had gotten that money from someplace else that needs to be repaid.  That 200 to 400 billion part of the budget supplied by the Federal Reserve should not be counted as a real debt.

The US treasury can meet the maturity of those bonds by rolling it over with more paper.  If the Fed storage area for US bonds fills up they can buy a big paper shredder and this can go on till the sun burns out.

There is still another heresy I entertained which may be even more “outrageous”!  There would be occasional times that proper management of money supply could be facilitated by the Federal Reserve if it had to authority to utilize the US treasury, within a designated framework, to adjust tax rates and authorized rebates quickly and expeditiously, as is needed now, under guidance of professionals rather than politicians.  Imagine if it took an act of Congress every time interest rates due to be changed!  In fact I would rather see cuts in tax rate and rebates that additional interest rate cuts henceforth --- to maintain the value of the dollar. 

The importance of maintaining the value the dollar (still another heresy) is that when trading partners trade for the specific purpose of acquiring the dollar, which many do, (mercantilist tendencies) there is no trade deficit with that import.  We traded that import for a an exclusively manufactured US asset: the dollar.  I could never understand why anyone would want to devalue one of our more important exports.

When you think in terms of value being the beginning and end of everything economic, a whole new perspective arises.

Jake Peachey

Jake,
Those are some very good points. 

You are obviously right that the debt can drive speculative excess that have plagued developed economies for centuries.  I just don’t think there is an alternative short of a government directed economy and that yields problems much worse than the imbalances that arise from time to time.

Milton Friedman always said the Fed should grow the money supply steadily rather than the liquidity floods that we seem to have.  Many supporters of the gold standard make the same arguments.  The problem is that the economy has become more complex and to my knowledge no one has really created any index or measurement to indicate what steady growth is. 

http://www.newyorkfed.org/aboutthefed/fedpoint/fed49.html

If people all of the sudden decide to stop spending money (like in the depression) government has to take action to prop up demand.  It can be through liquidity injections or fiscal policy.  The point is that there just isn’t any way to get around the problem of human nature and without the ability to act there is little doubt we would be heading into a serious recession.  Now with the Fed creating money and perhaps with fiscal stimulus yea we might have a recession but it won’t be the on-going sort of thing that we had in the depression where the Fed didn’t inject liquidity and the Federal Government (contrary to popular belief) did not take stimulatory action.

The Federal Government selling bonds to the Fed is called “monetization.” It has been years since I’ve seen the figures but when someone says the US government’s debt is $9 trillion it is an exaggeration because the Fed holds a good chunk of that.
http://economistsview.typepad.com/economistsview/2005/09/what_is_debt_mo.html

As much as I hate the idea of moving government out from under the responsibility of elected officials I like your idea of making fiscal policy more flexible.  If it was set up properly I think it is a wonderful idea. 

In the end though I think of it this way.  The US economy is what $14 trillion (close enough) and the US ran a trade deficit of $700-$800 billion.  The worst that can happen, ASSUMING THE ECONOMY ADJUSTS to its productive capacity is that the US takes maybe a 6% real hit to spending.  That is a big hit but if it simply means that we are now exporting more goods and consuming fewer Chinese manufactures is it really so bad???

The hard part is the adjustment.  If the Asians and Oil-producing countries are going to stop loaning us money (I don’t think they will; at least the Arabs won’t) let’s hope our economy can make the transition quickly.