Incentives for Destruction

by Luke Muehlhauser on April 14, 2011 in Ethics,Guest Post

Today’s post on ethics is written by Alonzo Fyfe of Atheist Ethicist. (Keep in mind that questions of applied ethics are complicated and I do not necessarily agree with Fyfe’s moral calculations.)

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In what I consider to be an under-reported news story of the week, Bill Gross, the famous (in financial circles) manager of the narly $250 billion PIMCO bond fund, has given up hope that our government can get its budget under control. He is betting his fund’s assets that America will fail, and that interest rates will sharply rise in the near future.

A growing number of investors are growing increasingly confident that the United States will go the route of Greece, Portugal, and Ireland with respect to acquiring an unmanageable debt. But in our case, there will be no larger organization capable of stepping in and bailing us out.

The American political system and culture seem ill-suited for financial responsibility. Specifically, their aversion to debt has been far too weak – and its population far too willing to embrace irrational blindness to reality – to motivate effective change.

I drew this conclusion in part from the population’s excessive willingness to embrace other irrational and indefensible claims ranging from religious fundamentalism, global warming denial, and creationism on the right, to new-age medicine and subjectivism on the left. Far too many people have proven themselves adept at denying reality to expect them to generate realistic responses to real-world problems.

However, reality has a bad habit of asserting itself without regard to people’s beliefs. Unfortunately, that fact has proven to be a poor deterrent against adopting irrational and unfounded beliefs.

We must add in support of this current datum that, with a deficit of $1.6 trillion, the government was nearly brought to its knees in a dispute over less than 2.5 percent of that amount – $38 billion. Our politicians will have to find hundreds of billions of dollars to cut, and the recipients of those hundreds if billions simply will not tolerate the burden.

Through their political activism, they will create a situation what requires government failure to address this issue.

For these reasons, I expect that America will eventually default on its debt, and those who hold a significant amount of that debt at that time will suffer as a result.

Now, I have the testimony of investing experts confident enough that this opinion is accurate that they are moving hundreds of billions of investment dollars based on that belief.

In short, investors are now seeing the US Government as a poor risk.

We can further expect that those who do not think so are grounding their opinion more on sentiment that on reason – more on faith in the US Government than on an objective evaluation of the facts.

However, Bill Gross is not just refusing to purchase US debt (perhaps out of fear the government will default on those loans). It is short-selling US treasuries.

Without going into details of how this works, suffice it to say that this is an active bet that the price of treasuries will drop – that people are buying treasury bonds today that will be cheaper to buy tomorrow.

In making this move, Gross is creating an incentive, on the part of his investors, to help to bring about this political failure. To the degree that the government fails to address its debt problem, these investors will profit.

This means that those who are invested in the PIMCO bond fund now have a stake in helping to make sure that this prediction comes true – helping to bring about a state of affairs in which future investors are unwilling to buy – and willing to unload at bargain prices – the government bonds they hold.

Many of these people vote and contribute to political candidates.

In fact, many are the type of people who can arrange for personal and private meetings with political senators, representatives, and presidents (unlike the rest of us).

Granted, many people do not know that they now have a stake in bringing about government fiscal failure. They belong to pension plans that have these investments, or they are paying insurance premiums to companies that are now betting on the US government’s financial failure. We cannot expect this fact to affect their decisions, given their ignorance.

However, the most heavily invested will not be ignorant of what conditions must exist for their investments to profit.

It’s a dangerous game to be playing – setting oneself up to have a motivating interest in realizing a state that will be so destructive in its ability to thwart the desires of others. In fact, I think I can argue that no good person would do such a thing.

Certainly, those who give others a reason to act so as to make things better are to be prized more as neighbors and community citizens than those who create incentives to make things worse.

- Alonzo Fyfe

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{ 39 comments… read them below or add one }

jimrandomh April 14, 2011 at 4:54 am

This doesn’t seem very well-connected to the reality of how currencies work. The US government cannot default on its debt, because it has the unlimited, exclusive right to issue US dollars, and all of its debts are measured in dollars. Now, the dollar may drop relative to other currencies like euros, yen and gold, and it may suffer inflation which lowers the value of long-term investments that pay out in US dollars such as treasury bonds.

There is a limit, of course – there’s some amount of deficit spending which would raise the inflation rate so high, people would abandon dollars in favor of other currencies, causing the dollar to collapse entirely. But we’re nowhere near that point. As it stands, deficit spending is just another form of tax, one that affects all assets tied to USD. Like all other taxes, whether it’s good or bad depends solely on a cost-benefit analysis that compares the effects of the tax to the value of the marginal next thing that would be cut from the government’s budget.

As a sanity check, I would encourage you to write down (just for yourself) some estimates of what the inflation rate has been recently, what it’s been over the last 20 years or so, and which way and how much the dollar has moved relative to other currencies. Then go look these up. This data is easy to find, and it’s much more closely connected to reality than the Congressional budget and news articles are.

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mister k April 14, 2011 at 5:11 am

Spending encourages growth. This is particularly true during a recession, where private companies are on a decline. Govt spending during a recession protects against said recession getting worse. If the economy grows again, then suddenly the govts finances don’t look too bad- their income is growing after all.

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Celestial Teapot April 14, 2011 at 5:36 am

I have to second what jim said. This post seems to be coming from a place of ignorance of the subject matter.

Let’s start with this: “United States will go the route of Greece, Portugal, and Ireland.” The United States cannot go the route of those countries. The difference is that we control our own currency. They are on the Euro which is controlled by the European Central Bank. If they need to raise money they need to find people to give them Euros; they can’t create them themselves. In our case, even if no one would buy newly issued debt the Fed can buy it instead.

Are we anywhere near a situation where the Fed would be the buyer of last resort for treasury debt? No. Interest rates are and have been well below the average rate during any of the last presidential administrations (Bush, Clinton, Reagan).

Isn’t “printing” money really bad? Only if the economy starts doing really well. If the Fed were to buy more treasury debt then it ends up in the reserve accounts of banks at the Fed. You can think of it as swapping less liquid assets (treasuries) for more liquid assets (money, electronic money to be exact). But, this only causes inflation if it makes it out of those reserve accounts into the economy at large, usually in the form of loans. Those loans only happen if economy picks up! The Fed has many tools at its disposal to slowing that down if the economy heats up too fast (we can only wish it would!). They can raise the reserve requirements and raise the interest they pay on reserves for example.

The United States should be running a deficit right now. The recovery is very anemic. Pulling money out of the economy makes that worse not better. Japan has a debt to GDP ratio of over 2 and they can still borrow at one of the lowest rates in the world?

So why would people be shorting treasuries? For one thing it would be harder for treasury rates to go much lower. They are at historic lows! Second, the Fed will be winding down its quantitative easing program soon and rates will be expect to rise. Finally, the economy is projected to start growing somewhat faster, inflation will rise temporarily, and investing in other things like businesses (stocks) will be more profitable. That is a good thing. It is what we want.

If someone is telling you they are betting on the US government defaulting my advice would be: don’t give them your money!!

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thepowerofmeow April 14, 2011 at 5:41 am

jim is on the right track here. The US cannot have a financial collapse like Greece or Ireland or Portugal. The fact that there is no larger institution to bail us out is a good thing. It means we have sovereign control over our currency. The US can always print more money (every time it spends that is exactly what it does) to cover its debts.

The problem to me is the accepted paradigm that the federal debt is something that has to be repaid. China (and whoever else we “owe”) already has dollars, they just invest them in Treasuries instead of spending them. The federal government does not need that money for revenue as every time the government spends it creates dollars out of nothing. Taxation and bond sales serve as liquidity drains (getting rid of excess dollars to prevent inflation) rather than revenue generators. So what happens when China wants to cash in their bonds? Well, then they have cash instead of bonds. They will either buy more bonds, keeping their dollars completely inert, or they will spend their money on American products (the only place they can actually redeem their dollars) which would stimulate the economy. A huge reason we have such a deficit is that the world wants our dollars instead of our products. They sell us stuff and instead of buying our stuff, they just sit on the dollars as a reserve currency. Therefore the federal government must spend more than it takes in, or else all the dollars would slowly drain out of the economy into inert accounts full of Treasuries held by other countries and institutions. In short, the federal debt and deficit are not analogous to a household debt and deficit. A household needs an income to spend. The federal government does not. The real problem we face is a weak economy. The deficit should be whatever it needs to be to keep our workforce fully employed. Then if inflation becomes a problem, the Fed and the government can instigate another liquidity drain through bond sales and raising taxes.

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Rufus April 14, 2011 at 7:17 am

Alonzo Fyfe,

I drew this conclusion in part from the population’s excessive willingness to embrace other irrational and indefensible claims ranging from religious fundamentalism, global warming denial, and creationism on the right, to new-age medicine and subjectivism on the left. Far too many people have proven themselves adept at denying reality to expect them to generate realistic responses to real-world problems.

I wonder how the language of virtue might fit into your moral schema. Do you think there are intellectual and moral habits that need to be cultivated? For instance, would developing rational habits help one the avoid “reality-denial”? What do you think of akrasis? Is it possible that many know that living in debt is wrong, the consumerist life-style is shallow and short-sighted, but they just can’t help themselves?

Best,

Rufus

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RA April 14, 2011 at 9:15 am

There is probably no limit to the amount of stuff you could write about the morals of Bill Gross. Usually when Gross speaks, he wants you to buy what he is selling and vice versa. In a few months, you will read an article about how Gross has gone long treasuries after he has managed to get people to sell and give him the prices he wants.

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Bret April 14, 2011 at 9:20 am

I think the real danger to the U.S. is that we have “all our eggs in one basket”. The richest 400 Americans have more wealth than the bottom 155,000,000. And many of the bottom 50% have their wealth in banks owned by the top 400! From an economic distribution standpoint, we seem to be creeping towards feudalism.

When you consider that America’s total Net worth is around 50 Trillion, give or take tens of trillions(this is a hard number to determine), a 1.6 trillion dollar deficit seems very managable. That is, if we are willing to take drastic measures.

There may be something to Mr. Fyfe’s analysis but a collapse or default is entirely avoidable. A one time utilitarian act of taking 50% of the top 400 American’s wealth(or some similar number) could completely erase our debt, though not solve our spending problem. But if we were facing down a nationwide financial crisis it seems to me, that this would be the right thing to do, though it would be very contraversial. Really, we would be reducing billionaires to, well, billionaires, or at the least multi-millionaires. One of the issues of American attitude is so many people would rather have the richest Americans stay rich and the government collapse, than take from the richest to save the government.

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Peter Hurford April 14, 2011 at 11:17 am

It seems unreasonable to declare that a belief is being made “more on faith in the US Government than on an objective evaluation of the facts” without providing even a link to some semblance of an objective evaluation of the facts…

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antiplastic April 14, 2011 at 11:44 am

Is this a guest post in ethics or a guest post in “ethics”? I thought there was going to be a more concerted effort to distinguish the two.

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David April 14, 2011 at 2:44 pm

This doesn’t seem very well-connected to the reality of how currencies work. The US government cannot default on its debt, because it has the unlimited, exclusive right to issue US dollars, and all of its debts are measured in dollars.

Except that many of our debts are, at this point, indexed to inflation (TIPS, for instance). We cannot inflate our way out of these.

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Alonzo Fyfe April 14, 2011 at 3:31 pm

jimrandomh

It is true that inflation is another way that the government can deal with debt. It is not a costless alteranative. Defaulting on the debt and agreeing to pay $900 out of $1000 in debt, and inflating the currency so that $1000 is only worth $900, are not substantially different.

Both options will bring profits under Gross’ strategy since they both drive down the price of bonds. One drives it down because the holder does not expect to be paid back a smaller amount of cash, the other drives prices down because the owner expects to be paid back in inflacted (value-decreased) currency.

mister k

Spending encourages growth.

Celestial Teapot

The United States should be running a deficit right now. The recovery is very anemic. Pulling money out of the economy makes that worse not better. Japan has a debt to GDP ratio of over 2 and they can still borrow at one of the lowest rates in the world?

This is the Keyesian view. The monetarists disagree.

However, even if true, this does not address the concern of this post. Deficits for the sake of fiscal stimulus is supposed to be temporary. They are supposed to be paid back – the government is supposed to run a surplus to counter-balance the deficit.

There’s no sign of a surplus on the horizon. Even under the assumption of an economic recovery, the expectation is that the deficits will drop to approximately $500 billion per year. There is no hope of the types of huge surpluses in the future that would be necessary to counter-balance the deficits of the past.

The “we are in a recession and need deficits” are looking only at the short term. Those deficits are supposed to end when the current economic conditions that require them end. But we have deficits that have no realistic prospect of ending, let alone generate the types of surpluses that will leave us capable of handling the next economic downturn.

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Reginald Selkirk April 14, 2011 at 4:08 pm

The ones who really scare me are the lunatics who think we can eliminate the deficit by lowering taxes.

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Daniel Martin April 14, 2011 at 4:56 pm

I’d recommend zerohedge, marketticker, and national inflation agency as resources to read on this stuff. The US is going down.

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Luke Muehlhauser April 14, 2011 at 5:51 pm

antiplastic,

Huh?

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Spork April 14, 2011 at 6:11 pm

As someone else recently said, “Never believe what Bill Gross says, watch what Bill Gross does.” As an exercise, compare and contrast what Bill Gross says with what Warren Buffett says. Who are you going to believe?

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thepowerofmeow April 14, 2011 at 7:45 pm

Alonzo,

Why must the US pay down it’s debt? Think about what that actually means. It means trading China’s bonds for dollars (which are both forms of IOU’s). Then what happens? Nothing. Nothing until those dollars are spent. And what happens when those dollars are spent? It stimulates the economy. People buy our products and since spending equals income, it would help our employment rate.

People think that China (and other US “lendors”) have the better of us. But the opposite is true. China sends us real products, real resources, and yet they refuse to exchange the dollars they receive for products. So we are getting all the stuff. So “paying back” our debt means China buying our products instead of sitting on dollars or bonds. Which they are free to do at anytime.

The US only issues Treasuries (debt) because it is required by law. We don’t even really need to. Deficit spending introduces new dollars out of nothing and the fact that we have 9% unemployment is a sure sign that demand is too low right now. We need more money, we need more deficit spending. And that deficit spending should be in science, infrastructure, all manner of education, things that will make us a real economic powerhouse. Supposedly saving paper dollars instead of investing in the future is the way to the back of the line for us.

Just think of what it actually means to “pay back” our debt. Turning one set of IOU’s into another.

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Supernova April 14, 2011 at 10:27 pm

I agree wholeheartedly with your assessment of the “American spirit”, Luke.

On Facebook, when a government shutdown seemed imminent, my friends were arguing that a cut in pay to members of congress (as well as less foreign aid spending) would be all it took to balance the budget. I responded with actual figures, and not a single person was convinced. They all struck me as selfish, and not a single one of them would be willing to take a cut to government benefits that they actual drew from… because they “needed” it. Everything the government spends money on is “needed” by somebody, but we have to be willing to sacrifice (a lot) in order to balance the budget.

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A-man Atheist April 15, 2011 at 12:46 am

Did you ever elaborate on that critique of Kris you mentioned during your blog on Kris’ book?

-> Christian Cadre critiques Kris.

They sure directed a lot of personal attacks at you. Especially in the comments. One guy claimed that you and John Loftus were just shameless merchandizers who were trying to promote Carrier and Price’s work. It’s a very mean comment, but one wuld be stupid not to ask why they think that.

BTW their views- not mine.

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andyman409 April 15, 2011 at 1:50 am

This was one of the comments left for you Luke. Many people are now accusing us of being unknowledgeable of simple history. Is this true. Is the entire atheist community run by people that have no idea about what they are talking about?

“I think the point of the post at Luke’s site is similar to the one he did at Loftus’ site awhile back, and that is basically media publicity for selling his book. The average reader of those blogs are the people who will buy this book. They are largely uninformed and want a somewhat intellectual sounding argument against the resurrection. That’s why the book carries endorsements from Price and Carrier. The only reason to have those guys endorse a book is to cash in on their cult-following among internet atheists…as the average reader of this site knows…they hold virtually no respect in the field of biblical studies and their endorsements would actually hinder some scholars from reading the book, ya know?

As you make clear in this post, most of us who have studied the topics would find the posts at DC and CSA wanting and thus skip even considering to buy the book…but your typical internet infidel buys up things like this and thinks they are serious scholarly interactions.”

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Polymeron April 15, 2011 at 2:51 am

I am shocked and appalled by the various “dollars out of nothing” responses above.

Not only do they betray a lack of moral qualms (“why should we pay the debt?” Um… Maybe because taking things and not paying for them is WRONG?), but they also betray a misunderstanding of the implications of debt monetizing.

There is a good reason why the US keeps saying it will not monetize its debt. Precisely what incentive would other countries have for sticking to a dollar standard if this were the case? What incentive would anyone have to lend the US more money if that money was becoming worthless?

“What do we care,” you say. “We’ll just print more money!”. Yes, borrow more from yourselves. Because that really works in the real world.

See, when the Fed prints money, it does so by loaning it out – not just by fiat. If the debt is repaid, then you have slight inflation (the interest remains after the original debt is settled), which is matched by a corresponding economic growth (presumably, the profit that allowed the loan to be repaid in the first place).
But the Fed can loan to anyone. A way for the US to monetize its debt would be to buy whichever junk it can, loaning money that will never be repaid. When these loans are defaulted on – say, because the money went overseas – you get a large inflationary force that is NOT, repeated not matched by matching corresponding goods and services. Essentially, everyone’s dollars are suddenly worth less.

This is equivalent of a hidden tax on anyone holding dollars.

Now, what happens if the US government keeps issuing more treasury bonds than it ever repays? The bonds become the very same junk we were just talking about. Money keeps flowing into the economy – from the Fed through the government and into the market – with no corresponding goods or services being created.

That way lies hyperinflation.
You’re right on a minor point – the US won’t go the way of Greece so long as it controls its currency. Rather, it would go the way of Iceland. That is SO much better!

Think these things through, people. At best, borrowing money then making it worth half that much before repaying is immoral. At worst, it’s not just immoral but will also not be tolerated by US debtors – who would demand debts repaid in real goods and services rather than fake electronic money. Though even if they snooze through this and lose that value, with the dollar being very weak there would be nothing stopping foreigners from buying US real estate for pittance.

If Americans are expecting to hog this planet’s resources indefinitely, they’re in for a very rude awakening.

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thepowerofmeow April 15, 2011 at 9:16 am

Once again, we will never really have a balanced budget as long as dollars are the preferred reserve currency of the world. This is because countries effectively buy our dollars from us when they sell us products, then they sit on the dollars or put them in Treasuries.

As to the moral issue – this is the type of reasoning used by conservatives to get us to give up Social Security and programs for the poor for “moral” reasons. The real moral outrage is to stop investing in infrastructure, science and education while 9% of us are sitting around doing nothing. It’s like not planting crops because we can’t afford it. It makes no sense. We will only experience hyper-inflation when production and money completely lose touch with each other. We are not even close to this, rather the opposite is true as deflation has only been narrowly avoided in recent years. We are purposefully not putting people to work creating real resources because of misunderstandings about balance sheets.

Just remember, this US prints money out of nothing every single time it spends and it destroys money every time it taxes. The US HAS no money, not REALLY, as it creates it at will by spending it into existence. Inflation is something to by worried about, but only when production is at full capacity and our economy is well under capacity right now.

Also remember, what exactly does it mean to “pay back” our debt? See my earlier comment.

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thepowerofmeow April 15, 2011 at 9:21 am

“Now, what happens if the US government keeps issuing more treasury bonds than it ever repays? The bonds become the very same junk we were just talking about. Money keeps flowing into the economy – from the Fed through the government and into the market – with no corresponding goods or services being created.”

This is not true as a bond is a liquidity drain on the economy. Bonds are still fairly liquid but not as much as Treasury notes (cash). Dollars and bonds only contribute to inflation when they are actually spent. Otherwise they sit around as in inert hoard, which is exactly what the US debt is. And if people starting spending the money they are “owed” (dollars and bonds are both IOU’s remember) then it would stimulate our economy, putting people to work. And if inflation started to take hold as our economy began to chug along at full capacity, then raising taxes or selling more bonds could drain the extra liquidity right back out. Taxes are even better because they destroy all financial assets rather than even leaving a bond sitting around.

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thepowerofmeow April 15, 2011 at 9:42 am

The big problem is that people still view our federal fiscal policy under the paradigm of the gold standard which we have been off for 40 years. Here is a great description of how things actually work, as opposed to how we say they work. Our common sense cannot be trusted on this stuff without understanding how it really works.

http://moslereconomics.com/wp-content/powerpoints/7DIF.pdf

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polymeron April 15, 2011 at 11:34 am

thepowerofmeow,

There’s no way to gild the lily here: What you are saying is simply false.
You are spreading the misconception that because modern money is handled in spreadsheets as numbers on a computer, then more can be made without consequence. This is simply not true.

Money represents debt; having it represents a right to draw on collective resources. Every time the government borrows from the Fed and spends that money, it essentially lets itself draw on everyone’s collective wealth. It is assumed that this debt would be repaid. Without this assumption, there is no legitimacy to printing money.

You haven’t given any real answer to why the moral issue isn’t real, except to say that it’s used by your political opponents. Arguments are not soldiers; bunching a moral argument into an opposing camp does not invalidate it.

I am under no obligation to read a 100 page document just because you link to it. If it makes any relevant point, quote it. In any case, judging by the first few pages it’s a load of crock.

That deflation was looming close does not mean hyperinflation is less likely; on the contrary, historically attempts to combat deflation led to just that. Just look at the amount the Fed is pouring into the economy; the dollar already weakened considerably (about 20% since the crisis started), and it would have weakened further if countries like Israel were not buying dollars in huge bulk. As soon as countries stop taking it, your precious currency is going to spin out of control.

Lastly, taxes do not destroy money. Repaying debt to the Fed does.

When I get back to a computer I will be happy to provide sources for all of this. What are yours, except for some nameless would-be economist? Not that you were making many factual claims to begin with, mind. But your arguments do not hold water because tney are based on faulty assumptions. And, I suspect, a predetermined conclusion (deficit spending = good).

Face it – you HAVE to borrow to keep running these deficits. And monetizing said debt is as immoral as any con – assuming you manage to pull it off.

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cd April 15, 2011 at 11:58 am

Bill Gross is hoping to profit off a market panic. He sees the opportunity for generating or occurrence of a market panic due to the irrational political arena behavior of political demographics with substantial overlap with American investor class demographics.

It takes a lengthy study of American politics, demographics, and history to come up with anything like a decent model, i.e. accurate narrative and analysis of causes, for what we are all watching happen. Perhaps no one can do so in real time. But there are several obvious pieces. Here’s a shot: white conservative Middle America is profoundly demoralized after so many years of struggling, and failing, to recover prosperity and a share of preeminence. It has now given up the fight and agreed to its own downsizing and a substantial degree of social, economic, and political self-liquidation at the ballot box in cheerful resignation. When it claims “America is Bankrupt” it is declaring itself as a lost cause that will never be able to pay back what credit it takes. Other elements/demographics of the American project worry about the consequences of this suicidal outlook but don’t share it. The commissions and proceeds of the liquidation are being directed to WCMA’s elites and diehards- select politicians, developers, CEOs, megachurch pastors, the religious-industrial complex. Absolutely not The Government, which obviously wastes all on The Unworthy.

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thepowerofmeow April 15, 2011 at 12:43 pm

polymeron,

The point of view I am putting forth is often called Modern Monetary Theory. It is supported by the economics school at University of Missouri at Kansas City and James Galbraith, an economist at UT (who wrote one of the introductions to the book I linked to), and many others. I put the link up for anyone who may be interested in understanding these issues more deeply.

You have misrepresented my position badly. I never said that more money can be made without consequence. Too much government spending can lead to inflation. However money, or bonds for that matter (debt), that is not spent does not contribute to inflation. How can it? What does cause inflation is too much demand (the actual expenditure of money) and not enough production to go along with it. But our economy is not even close to full production with this level of unemployment.

Of course there is another source of inflation and this is the price of food and oil, which is rising because of speculation and because interests can control the supply so effectively (like OPEC). This probably will cause some inflation, but that is unrelated to the potential inflation caused by too much demand (a more accurate description of things than “too much money”). Plus the Fed can sell bonds and control interest rates to control inflation.

Net financial assets are only created by government deficit spending. Where else would they come from? It is simply incoherent to say the government needs taxes to spend. Where did the money it is taxing come from? Rather, despite the outdated paradigm still in use around us, it is more accurate to see the government as creating money when it spends and destroying it when it taxes.

Also, it may not be such a bad thing for the dollar to cease to be the reserve currency of the world. It has led to the decimation of our manufacturing base, because no one buys are products with the dollars they receive when we buy their products. Many people fret about the dollar losing value and then complain the China is keeping the Yuan too low. China allowing the Yuan to rise is the equivalent of the dollar losing value.

If countries start getting rid of their dollars, then are just trading it amongst themselves. If they actually redeem their dollars for products, it must come back into the US economy. If there is too much liquidity (or more accurately, too much “demand”), it can be drained through bond sales (to raise interest rates) or taxation.

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Zeb April 15, 2011 at 12:46 pm

thepowerofmeow, you are blowing my mind. What little economics I have studied was all Austrian, and while I knew there were wildly opposing but equally intelligent theories out there, I never bothered reading them because I lost interest in the subject. I have to say, what you’re saying makes sense, and that I can tell Polymeron has not effectively rebutted your points yet. But if even scholars who have spent lifetimes studying economics diagree so wildly about these theories, what hope is there for a layman to make a good choice, and why should he endeavor to try? And yet we’re asked to vote on politicians advocating one or another of these theories. Well, thanks for the interesting read anyway!

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stamati April 15, 2011 at 1:13 pm

Zeb:
But if even scholars who have spent lifetimes studying economics diagree so wildly about these theories, what hope is there for a layman to make a good choice, and why should he endeavor to try? And yet we’re asked to vote on politicians advocating one or another of these theories.

Which is why I am going to relocate to a subsistence community somewhere in Alaska.

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thepowerofmeow April 15, 2011 at 1:31 pm

Zeb,

Thanks, friend! I am struggling to understand this stuff myself. But it all makes so much sense, and yet it is different than our preconceptions. Of course, this makes sense as we are accustomed to managing our own finances – but we need an income to spend and the federal government does not.

Warren Mosler’s book is an easy (relatively!) read that will continue to blow your mind, like it did mine. all the best, POM

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thepowerofmeow April 16, 2011 at 5:38 pm

One last point about government spending and the idea that the government is drawing on the public’s resources when it spends. Rather the opposite is true. Every single dollar spent by the government ends up in private hands. Money for building bridges, medicine for the elderly, military campaigns, etc. etc. becomes resources in the private sector. It pays people money who then have it to spend.

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Alonzo Fyfe April 18, 2011 at 8:56 am

US Credit Outlook Cut by S&P on Deficit Concerns.”

(Reuters) – Standard & Poor’s on Monday downgraded its credit outlook for the United States, citing a risk that policymakers may not reach agreement on a plan to slash the huge federal budget deficit.

While the credit rating agency maintained the country’s top AAA credit rating, it said authorities have not made clear how they will tackle long-term fiscal pressures.

S&P said the move signals at least a one-in-three chance that it could cut its long-term rating on the United States within two years.

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thepowerofmeow April 18, 2011 at 9:23 am

The credit rating of the US is meaningless. It is based on the assessed risk of default and there is no chance that the US could ever default on debts owed in its own currency, which it prints out of nothing. Even money itself is a debt remember, an IOU. The only way our country could ever default is if policymakers decided to do so, which would be idiotic and nonsensical, though you never know what might happen when people don’t understand the system very well.

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thepowerofmeow April 18, 2011 at 9:29 am

S&P cut Japan’s credit rating in 2003 and nothing happened. Interest rates are virtually the same now as then. Interest rates on government bonds will tend to follow what the economy is doing rather than a meaningless credit rating.

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Alonzo Fyfe April 18, 2011 at 12:47 pm

You are going to have to explain to me the relevant difference between, “I can’t pay you what I owe you so I am going to pay you 50 cents on the dollar”, and “I can’t pay you what I owe you so I am going to pay you in dollars that are only worth 50 cents.”

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thepowerofmeow April 18, 2011 at 1:29 pm

You are right to see that the only real danger is inflation. Inflation occurs when a country’s productivity is outstripped by its aggregate demand (there is another type, driven by a scarce resource, like oil or some sort of monopoly on price/wage setting, but that’s different).

We are not even close to this scenario as we are well under our potential productivity as evidenced by the long unemployment line. And inflation has not been a danger at all in recent years, nor has it been a danger in Japan whose debt to GDP ratio is waaaay bigger than ours.

When the government spends it introduces new financial assets into the economy. That’s it. Right now, it is just not destroying as much money through taxation as it is spending. The government will always have to run a deficit on average, because the economy will need more dollars as it expands (a surplus destroys more dollars than is being created and is therefore deflationary to the economy). On the other hand, if it runs too big of a deficit, inflation is the danger, as you rightly say. But the days of counting how many dollars are “out there” are over. It all boils down to demand and productivity being in the right balance. The deficit should be whatever it needs to be to keep full employment. Future inflation can be offset by higher taxation and/or interest rate hikes by the Fed.

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thepowerofmeow April 18, 2011 at 4:41 pm

Another thing to consider – A 1.5 trillion dollar deficit this year may seem inflationary, but since 2006, American households have lost over 15 trillion dollars in net worth, mostly because of falling housing prices. That is 15 trillion in potential purchasing power that has completely evaporated. No wonder deflation has been the bigger danger in recent years.

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Alonzo Fyfe April 19, 2011 at 5:34 am

thepowerofmeow

Right now, it is just not destroying as much money through taxation as it is spending.

I am not talking about “right now”. It would not even be possible for the government to make such a rapid change in policy that anything I am writing about has any chance of taking place “right now”

You are writing as if the current economic situation is permanent. While I am writing as if the debt and deficit are at risk of continuing as the current economic situation changes over time. Admittedly, as I wrote this post, the idea that somebody would interpret it as something that even has a chance of happening “right now” (rather than over years or decades) was too absurd to contemplate.

When you turn the wheel of a car to round a corner, you had better be prepared to straighten the wheel again and even turn it the other direction as the road curves or you are going to end up in the ditch, or, worse, driving off a cliff.

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Zeb April 19, 2011 at 11:20 am

One last point about government spending and the idea that the government is drawing on the public’s resources when it spends. Rather the opposite is true.

Now here I think you must be wrong, though you are more educated than me, so please correct me. But the government is not just spending money, it is purchasing and disposing of real goods. When the DoD builds a $1billion bomber, it is taking $1billion worth of labor, expertise, and materials. That not only deprives us of what those resources would have otherwise be used for, but it also drives up the price of the remaining resources. I think you are saying that there is still a benefit, beyond that of what was purchased, in that government spending injects liquidity which will spur productivity at times when it is slack, like now. But I do think we should remember that while “wasting money” might not be bad, wasting real goods is stupid and if the government is going to inject liquidity by purchasing goods it should be investing wisely. Otherwise, why not just send everyone a big check and let the people decide how to spur productivity?

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thepowerofmeow April 19, 2011 at 1:30 pm

Alonzo,

Don’t take the “right now” too seriously, I was just talking about what deficit spending is, which is adding financial assets into the system. If our economy is going full strength with full employment and inflation starts to rise to an undesirable level, then yes, the deficit and debt can be reduced. But it is not a problem until that point. I should add that it SHOULD not be a problem. Economics is based on humans, however, so if everyone believes the sky is falling, even if it is not, it could have consequences. But I doubt even that. The greatest danger is that the government will enact austerity measures and we can see how that has helped Ireland, for instance. Ugh. Bleeding the patient is not a good plan.

Even a little inflation wouldn’t be so bad, as it would be evidence of a strong economy (provided it’s not caused by oil scarcity or other “cost push” factors) and it would encourage investment. Companies sitting on 2 trillion dollars that are not being invested would have incentive to spend if the value of those dollars is dropping a bit.

Zeb,

Bingo, man. War is complete destruction of actual, real resources. It’s building things with lots of real investment and then blowing them up. However, WWII is widely considered what finally ended the Great Depression and it was a massive government stimulus program that blew stuff up. Yet it mobilized the country’s labor force, trained it and got our infrastructure up and running. So it still set us up for decades of economic success. But yes, viewing what is happening with REAL resources, instead of paper money whose only purpose is to organize the creation and distribution of those resources, is a great way to think.

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