The Skeptical Optimist

Money-printing for dummies

News flash:

Ben Bernanke and the Fed
have been "printing money."

That’s supposed to be counterfeiting, according to politician Ron Paul. It’s supposedly treasonous, according to politician Rick Perry (...yes, he actually said that; see this link). But I disagree; I think it’s a laudable, praiseworthy effort in monetary policy by non-politician Ben Bernanke to protect main street from the hardships of stagnation and deflation – in the absence of any help in the way of growth-friendly fiscal leadership from our politicians.  

If you have any friends who think printing money is always inflationary, this post is for them. They are only hearing half of the real story from our politicians, and I bet they’d like to hear the other half.

Here are several several facts grouped under the two headings “common knowledge” and “well-kept secrets.”

Common knowledge:

• The Fed can print money rapidly.

• Inflation is too much money chasing too few goods and services. [Keyword: “chasing.”]

• Unanticipated inflation is bad; it hurts lenders by forcing them to accept money of lower value as payback for previous loans.

Well-kept secrets:

• Printing money is the Fed’s tool to fight deflation.

• The Fed can also “unprint” money rapidly.

• Unprinting money is the Fed’s tool to fight inflation.

• Deflation can be triggered or fueled by insufficient money to support the potential production of goods and services.

• When newly-printed money is just sitting there not “chasing” anything, it doesn’t cause inflation or cure deflation.

• Deflation is bad; it hurts borrowers, frequently forcing them to default on their loans – which in turn hurts lenders as well.

 How the Fed prints and unprints money

The Fed “prints money” by purchasing U.S. Treasury securities from the public (i.e., from banks) – but instead of printing paper money to buy them, it simply bumps up the balances in the banks’ checking accounts at the Fed. Conversely, it “unprints” money by doing the reverse. The money isn’t “printed” or “unprinted”; the Fed simply changes numbers on a spreadsheet. That’s why “unprinting” money is just as fast and easy as “printing” money.

Wishful thinking

Wouldn’t it be a big step forward if our politicians started revealing some of the well-kept secrets above? For example, wouldn’t it be nice to hear one of them admit that the Fed’s job is not only to protect bankers from inflation, but also to protect main streeters from deflation? It would lead to a less-dogmatic, more substantive debate about what the Federal Reserve is doing. Hint: The Fed isn’t counterfeiting, it isn’t playing politics, it isn’t committing treason, and (for anyone who defines inflation in terms of the general price level, as opposed to the price of gold) it isn’t inflating the currency.

And if our politicians can’t find the courage to open up the debate like that, our journalists should call them on it instead of continuing to let them get away with it.

Pie chart of who owns the national debt: mid-2011

My pie chart has been copied all over the web for several years, so I guess that means it's a hit. But the data got stale since the last time I published it, so it's time for an update.

Here's who owns the U.S. national debt as of mid-2011.




Data sources:

• Foreign holdings

• Treasury debt reports

China loves U.S. debt; never mind the bluster

I enjoy a good laugh, and the New York Times provided one a few days ago in the article titled "China Tells U.S. It Must ‘Cure Its Addiction to Debt’" at this link.

Here's an excerpt:

“The U.S. government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone,” read the commentary, which was published in Chinese newspapers.

What's so funny about that is the irony: For many years, China has been selling their goods and services into our market in order to obtain US dollars; they want our dollars, we want their goods and services at bargain prices. Why do they want U.S. dollars? So they can give them back to us in return for U.S. Treasury securities. We get the dollars back, they get Treasury securities. What do we use the dollars for? Among other things, we use them to buy spy satellites and other national security assets to keep better tabs on ... China.

Here's the (ironic) sequence of events in the cycle:

1. China decides that exporting to the USA is how they want to keep many of their workers employed;
2. China's workers make things, then China sells them to us to obtain our dollars;
3. We get the goods and services, China gets non-interest-bearing U.S. dollars that sit in their checking account at the U.S. Federal Reserve;
4. China pays those dollars back to the USA, in return for interest-bearing U.S. Treasury securities that sit in their savings account at the U.S. Federal Reserve;
5. The U.S. Treasury uses a portion of those returned dollars to buy spy satellites, Aegis cruisers, and other national security assets to help us keep tabs on China.

Bottom line: China gets the U.S. Treasury securities they want as a reward for their nineteenth-century mercantilist economic policies, and the USA gets beefed-up capabilities in intelligence-gathering and other military assets, financed at rock-bottom interest rates. Everyone is happy.

How will we ever "pay China back"?

That question is irrelevant. The real question is, Why does China keep refusing to let us "pay them back" no matter how hard we try? Whether or not we "pay China back" is completely under China's control; they can choose to get "paid back" every time any one of their T-securities matures -- but instead of keeping the dollars we try to pay them back with, they choose to exchange those dollars for new T-bonds, T-bills, and T-notes.

The answer is obvious. China doesn't want their U.S. dollars back; they'd rather have U.S. Treasury securities, and it's their choice. Why should they want non-interest bearing dollars instead of interest-bearing T-notes?

As long as China chooses to have an economy based on exports, the US market will be their biggest opportunity for selling their stuff -- and the U.S. dollar will be currency they'll receive for the stuff they sell us. What they buy with those dollars is their choice, and their track record is telling us they prefer to save those dollars by investing in U.S. Treasury securities. If China, all of a sudden, has some kind of problem with U.S. Treasury securities -- why don't they just sit on all those non-interest-bearing U.S. dollars we keep trying to give them?

Doesn't make much sense, does it? Unless, of course, it's simply nationalistic political bluster designed to impress Chinese workers who make things for us instead of for themselves.

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End note:
This topic is perennial. See my previous article from two years ago, Poker with China.

Two choices for balancing the budget: pro-Reagan, and anti-Reagan

Take a look at the graphic below depicting two different ways of balancing the budget, then decide which of those two methods you prefer. (Full disclosure: My strong preference is for method 2, the pro-Reagan balanced budget.)




Note the big difference between the anti- and pro-Reagan methods of balancing the budget. The first one indiscriminately labels everything "government spending"; the budget it balances with tax receipts is the unified budget. The second one discriminates between two types of spending, just as Reagan did, and just as most state governments do: (a) immediate expenses, versus (b) investments in the future; the budget it balances  with tax receipts is the operating budget. The first one insists that no more money should be borrowed to fund any type of "government spending" whatsoever; the second one confirms the financial truth that it is perfectly sound financial practice to borrow money for good investments such as defense, infrastructure, and, as many argue, education. The first method fingers "borrowing" in general as the evil demon to be exorcised; the second fingers bad spending and bad investments as the culprits -- which are quite distinct from borrowing for good investments.

Reagan knew the difference between expenses versus investments. For example, he knew that beefing-up our defense and intelligence capabilities (backed by a stronger economy) would generate benefits not immediately, but in the future. That's why he steadfastly and unequivocally exempted national defense from budget-cutting, in spite of objections from all sides (including his own green-eyeshade employee, David Stockman). Exempting defense contributed immediately to the Reagan deficits; the benefits were not immediate, but  accrued a few years later with the end of the Cold War -- which ended the threat of a thermonuclear war between superpowers. It was a good investment, and borrowing money to fund it was sound financial practice. [And to those who are fond of saying "investment" is just a code word for "spending" I ask, Is there really no such thing as an "investment" by our government? Really?)

Unfortunately, the pro-Reagan method has apparently been forgotten by the very people who should be keeping it alive. One example is the ex-governors who tend to brag about having balanced their state budgets when they run for president: they also tend to omit the important detail that it was the operating budget they balanced while they were simultaneously utilizing debt financing to help fund their capital budgets. Another example: The Republicans, of all people, should understand the long-established private sector business lesson that debt is frequently the preferred way to help finance good investments in growth and security -- so why are those Republicans now acting as if that same truth does not apply to government?

In short, the anti-Reagan method (an indiscriminate ban on borrowing) has been gaining a lot of support, driven by, but not limited to, conservative freshmen in the House of Representatives. It's ironic that the message is being amplified by supposedly pro-Reagan voices such as Rush Limbaugh and Sarah Palin. All of them are making a mistake best articulated by Einstein: "Everything should be made as simple as possible, but not simpler."

Keeping the budget under control

The oversimplified, anti-Reagan method supposedly keeps the budget "under control" by way of a constitutional amendment that forbids borrowing for any kind of spending, except during a declared war; see the proposed wording at this link. (Oh well, at least the proposed wording acknowledges that winning a war is a good investment for the future, for which borrowing is permissible. But that begs the question, Why shouldn't it be permissible to borrow money to prevent a war? For example, was having a surplus in the late-90s that much more important than investing at least that much in the intelligence and counterforce capabilities it would have taken to prevent 911, Afghanistan, and Iraq?) Seems to me the anti-Reagan way of balancing the budget can end up saddling us with a heavier debt burden instead of a lighter one.

But the pro-Reagan method would need a control mechanism, too. Capital budgeting isn't a panacea; it is full of potential pitfalls, one of the first of which would be that politicians would scramble to get their pet spending programs labeled "capital investments." The pros and cons were analyzed in this excellent CBO paper in 2008.

The control mechanism

I favor a results-oriented control: the ratio of debt to GDP, because the longer-term results are what count more than the shorter-term debates about the definition of capital. Because good investments tend to foster real growth of the economy (...or to prevent destruction that would damage our economy), the size of our economy (GDP) should play a role in the measure. Higher GDP means higher tax receipts, which in turn mean increased ability to afford the debt it took to fund the investments. (Although other measures may be more to the point, such as Times Interest Taxed, the debt/GDP ratio is more widely recognized and therefore an easier sell.)

Bottom line: Controlling to a specified "ceiling" ratio of debt/GDP permits borrowing for good investments in defense, infrastructure (and education?), and would therefore be far superior to the anti-Reagan method of an outright ban on any type of borrowing. Why the anti-Reagan balanced budget has so much support is beyond me.

National Debt Meter

I'm back, and it's the same old subject: the national debt (...more precisely, the federal debt).

Instead of the same boring debt clock we see everyplace else, I decided to display a debt meter, showing the debt as a percentage of the economy.




Notice where it is today compared with where it stood at the beginning of 2009; not good, to say the least. Also shown on the meter are the high- and low-water marks for the USA (1946 and 1835 respectively), as helpful benchmarks.

I presume we can all agree that the ratio has been growing much too fast. It grew from 45% in January 2009 to 64% today. That's not sustainable, and it begs the question, what should we do about it? Most of our politicians and pundits are talking about it, but almost all of them are trapped in a false dilemma: should we cut spending only, or should we cut spending and simultaneously increase some people's tax rates?

A false dilemma. It reminds me of something George Carlin said a while back: "Some people think the glass is half full, some think it's half empty. Not me; I think the glass is too big."

In reality, economic growth is the only way out. Robust growth rates of the Reagan-Clinton era are what we need, far more urgently than we need tax-rate hikes or generic cuts in infrastructure and national security "spending." (For a clue about where I'm coming from, check my 'about' page.) The best way to increase taxes is to leave tax rates where they are, and increase the number of people paying taxes (aka "job creation"). The best way to defend the country and to build the infrastructure our kids and grandkids will need is to grow tax revenues by fostering what Schumpeter dubbed "creative destruction."

Economic growth increases the denominator (GDP) over the long haul, which improves the debt/GDP ratio. Anemic growth as we have today is bad news; robust growth as we had in the '80s and '90s eliminates a lot of problems. Unfortunately, I hear almost nothing from either side's politicians about how any given generic "spending cut" or targeted "tax hike" will enhance private sector growth. I've become convinced that most of them don't understand growth -- just like they don't understand the arithmetic that explains why the ratio of debt to GDP improves when the denominator gets larger. And because they don't understand that, they have no hope of understanding the mathematical truth that the USA could continuously improve its debt-to-GDP ratio while running permanent deficits forever, as long as the economy grew faster than the debt. (Try that brain teaser out on one of the tea party politicians; I predict it will induce cognitive dissonance.)

In any case, I'll be posting here periodically again, and I suspect the national debt issue will be a central topic as it was before.

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End note: links to data sources for the National Debt Meter:

GDP - Bureau of Economic Analysis, Table 1.1.5

Debt - US Treasury Debt Position Reports

A solution to the idiotic "debt ceiling"

[Update: Here's what The Economist has to say about the debt ceiling.]

Here we go again with the political grandstanding around the idiotic "debt ceiling" -- idiotic because it's defined in a fixed number of dollars instead of a percentage of GDP.

I sound like a broken record on this, but I'm not giving up on it. Instead of reinventing the wheel, I'll simply quote what I wrote five years ago...

The fixed-dollar-amount "debt ceiling" is a platform for political grandstanding, not a ceiling  that carries any meaningful financial significance.  Ten years ago, it was the Republicans who played political chicken with the president  by placing our nation’s creditworthiness at risk.  This year, will it be the Democrats . . . or possibly a few Republicans who covet the political label "fiscally responsible"?

I don’t know about you, but this particular political game is one of the few I cannot stomach.  It doesn’t matter which political party is threatening to force the USA into default on its Treasury securities. I do not find it funny, cunning, or cute; I find it infuriating.  (How ironic it is when politicians force our nation to the brink of bankruptcy—to earn the label "fiscally responsible."  I bet Alexander Hamilton spins in his grave every time this comes up.)

(Here's the link to that article ...and please don't get hung up on my 80% number, because that stake-in-the-ground is five years old; we have a bit more information available to us now.)

I've watched this political game play out for the better part of four decades, and you know what: it's way past time for the headline-seekers, on both sides, to stop playing chicken with our nation's creditworthiness -- and start spending more time doing things that would help GROW THE ECONOMY.

[Hmmm, that triggers a related thought... I wonder what percentage of the 535 Capitol Hill politicians are sufficiently proficient in grammar-school arithmetic to understand that a brand new way to stay under any given ratio of debt-to-GDP is to grow the DENOMINATOR faster than the NUMERATOR?  My guess: of the 30% who understand what a "denominator" is, half of them get it; what's your guess?]

For the left, for the tea party, and for everyone: Four questions

I’ve noticed that one of the most difficult questions anyone can face is this:

“Seriously, what would it take for you to change your mind?” 

Reason: it forces one to think past the talking points one’s chosen ideology has laid out; rote memorization is little help in coming up with an answer. That’s why I ask that question a lot – frequently of myself, but definitely not limited to that.

I have plenty of them, but decided to choose just four of them, to get the ball rolling.  Here they are -- one for you lefties, one for you tea-partiers, and two for everyone.

1. For the left, re: Tax cuts for the rich.
For nine years, all I’ve been hearing from you is that the Bush tax cuts benefitted only the rich. “Tax cuts for the rich” is the phrase that sums up the “failed policies of the past” mantra, the one that succeeded in rallying middle-class anger, largely helping to get Obama elected two years ago. Fine. Now, here’s my question:

If the Bush tax cuts benefitted only the rich, as you’ve been saying for nine years, why are you now saying that letting all the tax cuts expire will hurt the middle class? Which is it: Did the Bush tax cuts help the middle class, or didn’t they?

2. For the tea party, re: The debt.
You say the big problem is the debt (...I heard Rand Paul say it on ABC today). In my opinion, the big problem is not the debt per se, but that the debt is growing faster than the economy is – however, you have more votes than I do, so here’s my question: 

If you had a choice between a tax policy that would increase tax revenues by increasing the number of job creators and taxpayers, versus a policy that would decrease the total debt level by whatever means, which one would you favor? Would you settle for a debt level that is shrinking relative to the size of the economy (an expanding economy with a falling debt/GDP ratio), or would you insist on surpluses that reduced the total debt, regardless of the impact on jobs and job creation? 

3. For everyone: “Cut” versus “Grow.”
The best path to prosperity has always been through private sector job creation that increases the number of taxpayers, as well as the wages and salaries of those taxpayers. Everybody wins. So:

Why do we hear so much about where and how to “cut” – but so little about where and how to “grow”?

4. For everyone: The “balanced budget.”
It’s virtually unanimous: The debt is growing too fast -- and coincidentally, the debt ceiling vote in Congress is coming up soon. Moreover, it’s common knowledge that a vote to default on our debt would destroy the dollar and create a near-instantaneous worldwide financial collapse (...hint: not conducive to job creation) – so here’s my question:

How about we redefine the term “balanced budget” as follows: A fiscal budget that causes, or at least coincides with, job creation and economic growth that exceeds debt growth, such that the ratio of debt to GDP is decreasing?

Not one of those would fit on a bumpersticker, though. Probably a bad sign.

Bill O'Reilly won't answer this...

...I predict with confidence. In any case, here's a letter I sent to him at Fox News, just for fun.

subject:
Far-left loons, and far-right _____?

Bill,

As a political independent, I prefer fair-and-balanced commentary as an aid in making my own informed decisions. I need some help to decide whether I should start recording your show.

By my rough estimate, the small percentage of people at the far left of the political spectrum is about the same size as that on the far right; both of those factions already have their minds made up on every issue. New information bounces off them like bullets off Superman. Pathetic, isn't it?

In any case, I've heard you refer frequently to those on the left as "far-left loons"; that's okay with me, because name-calling can sometimes make a valid point, and I enjoy a person with a fair-and-balanced sense of humor.

But I was wondering what you call their counterparts on the right -- "far right [what?]." I haven't yet heard the nickname you've picked for them. No doubt you have one, and no doubt you've used it just as frequently as "far-left loons" on your fair-and-balanced show.

Just curious. I have a strong preference for fairness and balance in reporting and commentary, and look forward to being able to add your show to my DVR list after I get your answer.

Best wishes,
Steve

My priorities, and my hope for our Talker-In-Chief

My priorities have changed, suddenly and unexpectedly. (You may have inferred that already from the recent lack of activity at this blog.) Posting here needs to drop down on my priority list for a while.

Remaining high on my list, however, will be paying attention as the presidency of our Talker-In-Chief unfolds. I hope to begin seeing some substance developing in the wake of all the eloquent talk, specifically regarding his unarguable statement about the topic that is my hot-button issue:

If we are growing at a robust rate, then we can pay for the government that we need without having to raise taxes.

President Obama is eloquent, no doubt about that. What's scary to me is the increasing evidence that maybe that's all there is: eloquent talk. In my mind, that nagging possibility started becoming a probability when I read what a few people close to him had to say about his eloquence, and matched that with what's been happening so far in his presidency. Here are a few excerpts from Dan Heninger's article (WSJ, 4/30/09):

Harvard Law Prof. Charles Ogletree told how Mr. Obama spoke on one contentious issue at the law school, and each side thought he was endorsing their view. Mr. Ogletree said: "Everyone was nodding, Oh, he agrees with me."

The reason I have never forgotten this article is its last sentence, in which Al Gore's former chief of staff Ron Klain, also of Harvard Law, reflects on the Obama sensation: "The interesting caveat is that is a style of leadership more effective running a law review than running a country."

Obama, of course, has known about his biggest asset for a long time:

Senate Majority Leader Harry Reid... tells of congratulating freshman Sen. Obama on a phenomenal speech. Without a hint of conceit, Mr. Obama replied, "Harry, I have a gift."

I hope to see some follow-through on his eloquent "robust growth" statement — such as raising the effect-on-growth question for key policy proposals. I hope to see the executive branch begin defining policy specifics, instead of outsourcing them to the legislative branch; after all, the voters chose President Obama, not President Pelosi. I hope to see the ongoing campaign rhetoric come to an end, because talk is cheap. I hope to see governing begin, because policymaking is supposedly what the campaign rhetoric was all about. I hope Obama starts getting up the learning curve more quickly.

I have hoped for a lot of things from politicians... but (with the exception of the interval from 1981-1989) have almost always been disappointed. If disappointment is once again the result, then all we'll have at the helm for the next three-plus years is a Talker-In-Chief.

Not a pleasant prospect.

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End notes:

1. For what it's worth, I'll also be keeping my eye on a promising young guy from Wisconsin: Paul Ryan. Not only is he sharp on the key economic issues, he's demonstrating some excellent communication skills. For example, here's a clip in which he politely handles two hostile MSNBC interviewers. (I strongly suspect I'll be sending him a campaign contribution or two as time unfolds.)

2. As I said, posting will be less frequent for a while, so I decided to reprint one post from the past that pretty much summarizes my major theme for this blog. See the article immediately below: Grow or Die.

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’.

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