The Skeptical Optimist

"Protecting jobs": good politics, but...

...it always backfires, and ends up costing jobs. Trade wars tend to break out. But what do politicians care? "Protecting jobs" gets them elected, and that's what it's all about, isn't it?

Supposedly, someone in the administration is keeping track of the number of jobs being "created" -- no doubt for use in the next political campaign. Do you think they'll be properly tracking and deducting the jobs destroyed by the Buy American mantra? Probably not. But I'm confident that objective journalists such as Lou Dobbs will call them on it.

Just kidding. Replace "confident" with "not holding my breath" in the sentence above, and scratch the word "objective."

Read about the "outrage in Canada" in today's Washington Post.

[Many thanks to commenter Harun for pointing this out. I lifted this from the comments under the previous article.]

Fiscal responsibility, and the Obamanomics Report for May 2009

"Fiscal responsibility" is a term nobody ever defines — until today.

I gave it a shot a couple years ago, in an article titled “'Fiscal Responsibility' defined at last" -- but even that definition turned out to be too mushy for my taste. If I had it to do over again, I'd add two words to the end of the title: "...sort of."

If you've read more than a few articles at this blog, you already know my position: Growing debt is nothing to fear as long as the economy is growing at or near the same pace as the debt. The proper measure for that was the debt-to-GDP ratio. Recently, I've had to amend that position: It is ALSO nothing to fear as long as we are using it in the short term to get the economy back on the growth track.

But the problem with using the debt/GDP ratio as the measure is that nobody can say how much is too much (or too little); consequently, nobody knows how much runway we have left. Debt/GDP was 120% after WW2, but would that be too much now? Or would we still have some slack even at that level? Who knows? (Not economists, I can tell you that with a lot of confidence.)

I found a measure I like better than debt/GDP. It's the "Net Interest share of Federal Spending." If our monetary policy is successfully controlling inflation, but we are not being fiscally responsible, the interest share of spending will grow in the long run, crowding out things like defense, justice, social security, and health care.

Some things that put upward pressure on the interest share of spending are:

• increasing federal debt
• increasing interest rates on the debt
• "investments" that don't boost the economy

Some things that relieve the pressure are:

• increasing GDP (by far, the best way)
• decreasing interest rates on the debt
• "investments" that succeed in boosting the economy

[I intentionally left "running surpluses" off the second list; for an explanation why, see this article from four years ago.] 

How much is "too much"? I think we have a better indicator with this new statistic. Interest required 15% of federal outlays in the Clinton years, which are loudly touted as a good example of fiscal responsibility. Because of falling interest rates and growing tax receipts during the Bush years, it fell to an even more fiscally-responsible range of 7%-9%. Now the Obama budget calls for a combination of spending, growth, deficits, and interest rates that will take it back up to the Clinton-era level of 14%. No sweat, in my judgment, IF the budget comes true. (Big if, huh?)

So, here's the new chart. I plan to update this one monthly.

Pay no attention to the huge drop in the last six months; it's temporary, and it's due to the huge spending increase that will soon cause the interest payments on the debt to rise, just as the budget predicts. We need to watch how the red line tracks against the budget line.

I will say that if it does level off at 14% in a few years, that will be sustainable, and it will match the level achieved in the Clinton years. But it will require most of the "investments" in the Obama budget to pay off in enhanced growth. We'll see it unfold fairly soon, in any case.

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Data sources:
Monthly Treasury Report

Treasury Debt Position Report

Obama budget[*]

[*] The only assumption I had to make was this: The avg interest rate "budgeted" for paying net interest on the publicly held debt will be the midpoint between the budget's forecasted rates for 3-mo T-bills and 10-yr T-notes. 

Mis-remembering Jack Kemp

Jack Kemp’s decades-long message is still being bastardized by partisans on the left. Bob Herbert of the New York Times chose the occasion of Kemp’s untimely death to take a few more whacks at the false piñata of (so-called) “Trickle-down economics.” Here's how he chose to insult Jack's economic message just a few days after Kemp died:

As every scheme imaginable was developed to bolster the fortunes of the rich, ordinary people were left in the humiliating position of waiting for some of the goodies to trickle down to them.

I’m certain of one thing: Bob Herbert is committed to the anti-trickle-down message because of its political effectiveness. And I strongly suspect another thing: Bob Herbert’s commitment to that political message is solidified by financial and entrepreneurial ignorance. (Just an educated guess, though.)

Jack Kemp’s economic message was not only simple, it was unarguable (and always will be):

“People respond to incentives.”

That simple truism is the foundation of supply-side economics. (I wish it had picked up a different name such as incentive economics, growth economics, job-creation economics, or innovation economics—but that’s 20-20 hindsight.) I met with Jack a few times nine years ago, after he had been kind enough to mention my old website in his newspaper column, and that was his message. Simple and unarguable. It was not that “tax cuts are always the solution to every problem.” Nor was it that “tax cuts always pay for themselves,” or “tax cuts will yield greater tax revenue before the next election.” It was simply that “people respond to incentives”: the economy will grow more effectively if we trust the people to make good things happen, given the right incentives.

Nobody could dispute what he really said and really meant, so the left had to put their message-crafters to work. The result was the most successful and formidable redefining of a political opponent’s idea that I have ever witnessed: Jack’s idea, thanks to his crafty opponents, became “trickle-down economics” instead of “people respond to incentives.”

Trickle-down has become the crowd-inflaming piñata the left drags out every election season. Never mind that trickle-down asks us to believe the impossible: that risk-reward happens in reverse order, i.e., that entrepreneurs who’d like to get rich by starting new businesses do it as follows:

(1) they get rich; then...
(2) they start new businesses.

The financially ignorant might fall for that message, but the rest of us understand that entrepreneurs first risk a lot of money (hiring workers, paying suppliers, etc.), with the hope of subsequently attracting enough customers to get rich. The entrepreneur who fails to get rich has paid out all the money to others, and ends up with nothing to keep. The one who succeeds in getting rich (or at least in not failing) is the last to get his or her share of the money success generates. That’s where the phrase “risk-reward” comes from—and they do happen in that order.

But that doesn’t matter to politicians and partisans. Votes do. Almost all voters consider themselves “non-rich,” and their votes accrue handsomely to any politician who can make them feel “trickled upon” by “the rich.” It’s called class warfare rhetoric, it’s employed in every campaign season, and it works far more often than not.

The Trickle-down piñata gets dragged out for every election; that’s no surprise. But when Bob Herbert drags that bastardization out for the occasion of Jack Kemp’s death, it’s a tasteless insult.

Is that kind of insult-journalism one of the reasons the nearly-bankrupt New York Times has lost so many subscribers and advertisers? (I wouldn’t know firsthand; I’m not a subscriber or advertiser.)

I miss Jack Kemp because of his economic ideas, not in spite of them. Growing the economy is overwhelmingly important. Jack knew that, and he knew something else few others, including members of his own party, seem to know: growth doesn’t just happen; growth isn’t an exogenous variable (...as Paul Romer would put it). Growth happens as a result of activities undertaken by people. And people respond to incentives.

Do deficits cause higher interest rates? You decide.

We're running huge deficits these days — just in case any of your friends haven't noticed yet. A lot of my friends have noticed, and they don't like those deficits one bit, because they've made up their minds that deficits, especially big ones, cause interest rates to rise.

It's become conventional wisdom, and for good reason. It's based on a common-sense theory: After the government borrows money in the bond markets, there's less money left over for businesses and entrepreneurs to borrow. When borrowable money is scarcer, the interest rates rise.

Who could possibly argue with that logic? Economists call it the "Crowding Out" theory. Alan Reynolds has called it the "fixed supply of bonds" theory. At any given risk level, there's only a fixed amount of bonds that lenders will buy. US Treasuries are as close to risk-free as bonds get, so the government goes to the front of the line, and gets first dibs on the lenders' money. When the supply of near-risk-free bonds runs out, the lenders not only move to higher-risk bonds, but also have fewer dollars to lend; that means interest rates go up.

It's just plain common sense. That's why I was a believer for a long, long time, and that's why it's "conventional wisdom" to this day.

But in 1994, I hit a snag. I decided to research the Crowding Out theory to see if anyone had tested it against our track record of deficits and interest rates. (Why? Because I'd read Dr. Rick Boettger's book, The Deficit Lie, in which he pointed out that the Crowding Out theory was bunk—and I wasn't sure I believed him.)

After a few months of research, I realized that—as plausible as the theory sounds—sure enough, there's a problem: Turns out, it really is a myth. In fact, from the several studies that economists had done, trying their best to find the relationship between deficits and interest rates, the bottom line was this: If there's any correlation at all, it is a weak negative correlation. In other words, whenever deficits got bigger, interest rates got smaller, and vice-versa.

Well, with the huge deficits we're running these days, I thought it would be wise to reopen the question. So I retrieved the monthly deficit and interest rate data from the Fed and the US Treasury, going back to September 1981.

[By the way, there are all sorts of ways to analyze the historical data: nominal interest rates vs nominal deficits, real rates vs nominal deficits, nominal first differences, deficits vs lagged interest rates, and on and on. But I chose to begin by keeping it simple, by just comparing the trailing-12-month deficit to the same month's key interest rates (Prime rate, 10yr Treasuries, and 1yr Treasuries).]

All I was looking for was a correlation indicating a significant positive relationship between deficits and interest rates. But all I could find was more of the same: a weak, negative relationship that merely confirmed what I'd discovered (for myself) fifteen years ago.

Below is a chart of the data. My conclusion is in the caption, but please decide for yourself whether you think bigger deficits cause interest rates to rise, and vice-versa:

I've run every correlation I had time for, and they all indicate a weak negative relationship — including the recent huge deficits we've incurred. I've been hearing for decades that skyrocketing interest rates, driven by deficit spending, are just around the corner. I'm still waiting.

Someone observed once that it's extremely difficult to watch a beautiful theory get murdered by ugly facts. But that's what I've been watching happen to the Crowding Out theory for fifteen years and counting. I guess I'll just have to accept the similar explanations that both Alan Reynolds and Ben Bernanke have given to explain those ugly facts:

The world bond market is a hundred trillion dollars in size—far too large (even now, apparently) for US deficits to have a discernible adverse effect on interest rates.

I'll keep the popular Crowding Out theory in its proper place in the "Plausible-sounding Theories" section of my bookshelf. I like to keep that section in alphabetical order, so I'll put it between the Blue Cheese Moon theory and the Flat Earth theory.

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ps-
I revisit this analysis every couple years. Here's a link to the last time I took a look:

Pay no attention to the man behind the curtain

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Also, here are the data sources...

Prime rate.

10yr Treasuries.

1yr Treasuries.

Trailing-12-month deficits: derived from the Monthly Treasury Statement.

Free trade wins a silent victory

Two presidents in a row have demonstrated the dichotomy between the economics versus the politics of free trade. Bush and Obama took opposite approaches in demonstrating it, but the message is the same.

Even though economists are virtually unanimous that free trade yields extra jobs, not fewer, they have a reputation for being less than expert in politics. That's where the politicians take over; most of them (I think) do understand that free trade is better overall, but they also understand that supporting it might not be the best strategy for securing votes in the next election.

Bush talked up free trade and got elected to his first term. But he wandered away from that commitment when he signed steel import tariffs into law. Why? Because lots of union votes were at stake, and he needed them for the next election. 

Obama talked down NAFTA during the campaign, and promised to reopen the treaty.  Why? Because lots of union votes were at stake, and he needed them for the next election. He got elected... but last week he wandered away from that commitment with the announcement that he would not reopen it to press for new environmental and labor regulations.

Here are two links:

1: the campaign promise; and
2: last week's decision to kill the promise. 

I had been hoping all along that Obama's campaign talk was just obligatory pandering to swing-state voters' emotions (...as his economics advisor, Austan Goolsbee, had assured the alarmed Canadians behind the scenes back then). Bingo, I got my wish. Chalk it up as a victory for free trade and more jobs (...although possibly not union jobs). 

Next wish
I also wish politicians would just tell the truth in the first place, even if it takes a little more explaining. But we all know that will never happen, so I'll settle for one out of two.

Where economists say the economy is going

Larry Summers (Obama's economics advisor) said a few weeks ago that, when it comes to forecasting the economy, there are only two categories of economists:

Category 1: Those who know they don't know;
                        and...
Category 2: Those who don't know they don't know.

I thought that was worth a chuckle. Then, yesterday, a Wall Street Journal article about economists' forecasts reminded me of a brief exchange from about fifty years ago ...between Curly and Moe, as I remember:

Q: "What kind of an idiot do you take me for?"
A: "Why, is there more than one kind?"

Turns out, there is more than one kind. The Category 2 economists break out into four different groups, according to this article by David Wessel. [I counted four scenarios, notwithstanding the title they chose for the article.]

Here's a pie chart of the chances our economy will go in each of four possible directions, according to the data Wessel collected from those who don't know they don't know:

Definitions (my summaries):

V: Very steep recovery. The way the business cycle always bounces back—as will this one. Due largely to fiscal and monetary stimulus prodding the "natural dynamism of capitalism" into reasserting itself.

U: Unimpressive, slower recovery. Takes longer, but at least it's an eventual recovery. "Less painful than a Lost Decade."

L: Lengthy stagnation. Not a recovery, at least for a long, long time (2-10 years). Financial markets stabilize, but don't improve.

Big-D: Depression, double-digit unemployment, social unrest, and who knows what else. Possible triggers: "virulent deflation that pulls down prices and incomes"; "political gridlock that stops governments in the U.S. or Europe from spending enough to fix the banks before a big one fails"; and higher interest rates due to a collapse of the dollar.

Anyway, please read the article. David Wessel did an excellent job compiling the details he obtained from the Category 2 economists.

Best Lead Guitarist Ever

[It's time for a breather from economics.]

Who deserves the title "Best Lead Guitarist Ever"?

Some of my friends and family members hold different opinions from mine, but they're wrong. Some of the names they've come up with are Buddy Guy, Slash, Eddie Van Halen, John Petrucci, Eric Clapton, Jimmy Page, Keith Richards, Jimi Hendrix, and Steve Vai. [One friend even picked Chet Atkins, believe it or not... but even though I admit Chet Atkins was pretty good, this is coming from the same guy who flunked art appreciation back in junior high school, and today cannot understand why Hollywood refuses to colorize the first and last ten minutes of The Wizard of Oz.]

Anyway, I'll end the suspense; the correct answer is:

Stevie Ray Vaughan.

Instead of trying to explain in words why SRV gets the title, I'll just post some evidence. The video below is a 2-fer, and the whole thing is great, but the first 2:36 will prove my point.

Strongly recommended before pressing the "play" button: Put on a good set of headphones.

There. That should take care of any lingering doubts. [With the probable exception of the guy who picked Chet Atkins.]

How to increase taxes without increasing taxes

It's April 15, and that's as good a day as any to make another attempt at undermining the scaremongers who keep warning us that...

"future taxes WILL increase, because of deficits we run today."

That's a mathematical certainty, so there's no way to disagree with that statement -- as far as it goes. But there's an important consideration our scaremongers never tell us about.

Below are two pictures depicting the two ways to increase the taxes flowing into the federal government; note that taxes increase dramatically, in both cases, across several generations. The first way of increasing taxes is the one we always think about. The second one takes just a little more brainpower — which is why I think the scaremongers avoid it. (They either don't understand it, or they don't want to try to explain it to us. In either case, we have a problem that needs to be solved.)

Increases in gross pay happen when we get promotions, when somebody starts up a new company that creates better, more productive jobs, and when existing companies replace crummy jobs with better, more productive ones.

Our politicians have a direct impact on that process. They can hinder it, for example, by "protecting" jobs that would soon become obsolete in a more competitive market environment. They can help it, for example, by making it easier and more attractive for entrepreneurs to try to get rich by creating new jobs that provide consumers with new products and services.

But you and I aren't forcing our politicians to explain in better detail how their policy proposals would help or hinder the growth process. I think it's because the word "growth" is too abstract, too easy to skip over in spite of its overwhelming importance. As a result, we're letting our politicians off the hook.

When ex-Comptroller General David Walker tells us our "taxes WILL increase" — thereby setting Glenn Beck's eyes rolling backward towards the ceiling — we shouldn't let the conversation stop there. Glenn Beck (...or at least somebody) should be asking what growth rate assumption is behind Walker's projections, what growth rate it would take to obviate tax-rate increases, why the Financial Report of the US Government ignores the present value of future tax receipts on the asset side of its balance sheet, what growth rate it would take to neutralize the present value of future liabilities, and other growth-related questions like those.

"Growth" means "higher take-home pay" resulting from higher productivity. Maybe if we started thinking of it that way, we'd be better-equipped to ask policymakers better, tougher questions than they've had to answer so far.

Or, maybe I'm being too optimistic. Maybe I'd better just start preparing for method #1 above: higher tax rates.

Glenn Beck versus Big Brother Ben

[Recently I've been forcing myself to watch Glenn Beck's popular show on Fox News. His sarcastic, condescending style makes my task more difficult each day... but he has been misleading his fast-growing audience on the important topic of "money printing" by the Fed, and I promised myself I'd keep tabs on exactly how he mangles and twists the message whenever he brings it up. Here's my first report...]
--------------------------------------

Glenn Beck recently showed us what a trillion dollars would look like. Why? Because the Fed is "printing it up" — and as Glenn Beck and the rest of the Ron Paul crowd know for sure, printing money is an inflationary disaster that makes our currency worthless. It's just that simple to them, because "inflation" doesn't mean rising prices and wages, it means "more money, period."

Here's a link to one of Beck's segments, where he tried to impress his audience with a graphic that showed just how huge a warehouse it would take to store one trillion dollars. (He starts counting to a trillion at 3:15 into the video; I strongly recommend muting it until you get to that point.)

The problem with Beck's quasi-argument: it ignores a few important questions — questions I never, ever expect him to address on his show. Reason: He's irrevocably committed to the scare story, and his audience is snowballing; for him, there's no going back now. But here they are anyway...

First question Beck will never address:

What if the one trillion new dollars in that warehouse just sat there, static and immobile... what if nobody spent any of it on anything... what effect would THAT have on inflation?

Answer: It would have no effect whatsoever on inflation. Even if it were ten trillion new dollars, or a hundred trillion, and it just sat there collecting dust, it would not, and could not, cause prices or wages to rise one penny.

And guess what: That's exactly what's been happening. Here's a chart from the St. Louis Fed titled "Excess Reserves" — bankerspeak for "money just sitting there doing nothing":

Click to enlarge:

Again, don't expect to see that on Glenn Beck's show. Reason: It runs counter to his dogma, and that's a no-no when one is firmly entrenched in belief-preservation mode.

Second question:

If that new money is supposed to make the dollar worth less, then why is the rest of the world fleeing to the safety of the dollar, instead of fleeing away from what you say is the soon-to-be-worthless dollar?

Third question:

What if the Fed started to see the public getting more and more interested in using that new money to start or expand their small businesses, hire people, and get each one of their small pieces of the economy moving again? 

Answer: Well, that is PRECISELY what the Fed would LIKE to see happen. Duh.

Fourth question:

What if, after the economy did get moving again, the Fed started MAKING THAT TRILLION DOLLARS DISAPPEAR?

Answer: Well, that is ALSO what the Fed says it is going to do. Reason: The Fed is COMMITTED to (a) helping the economy get moving again, then (b) keeping inflation down after it recovers — in that order. At 8:20 into this 60 Minutes interview, Fed Chairman Ben Bernanke explains it himself, like this:

"...we need to [be printing money] because our economy is very weak and inflation is very low. When the economy begins to recover, that'll be the time that we need to unwind those programs, raise interest rates, reduce the money supply, and make sure that we have a recovery that does not involve inflation."

But there's no doubt in my mind that Glenn Beck will ignore those questions, and plow right ahead with his annoying schtick on the air. Instead of listening intently to the Bernanke interview above, he'll opt for displaying a gigantic, Orwellian head shot of Big Brother Ben as a scary backdrop on his set (alternating, of course, with gigantic shots of goose-stepping Nazis).

But maybe some concerned citizens will bring those questions up at one or more of Beck's upcoming "tea parties." Maybe. But maybe not; maybe it's just easier for us to let Glenn do our thinking for us, as we stare at that scary picture of Big Brother Ben Bernanke. [... And if that turns out to be the case, I'll have to start thinking of a different name for this blog.]

Denmark's humorous socialist

Denmark Socialist P. N. Rasmussen's unintentionally humorous tirade against capitalism (WSJ, "The Socialist Solution to the Crisis") was good comic relief for me last week.

Unsurprisingly, he blamed Reagan-Thatcher ideology for all the world's problems. The real knee-slapper for me was his insistence on "the strongest possible international agreement on climate change" that would be impossible for conservatives to resist. The best part was this:

"We must show that the costs of doing nothing far outweigh the costs of switching to a carbon-free economy..."

I can't wait to see the responses from the governments of China and India to Rasmussen's insistence on the "carbon-free" economy, because (presumably) those carbon-belching economies are Rasmussen's first targets. No doubt he knows that China "supplies" California with 25% of its air pollution, and that China is building coal-fired power plants at a breakneck pace. No doubt.

I love a good, long laugh, I really do. It helps blow out the pipes.