boneyard bill, step inside

[NobleSavage]

Can you give all your evidence for 2nd economic slide in one post? I'm not looking to attack, I just like considering this kind of thing.

 

[boneyard bill]

Can you give all your evidence for 2nd economic slide in one post? I'm not looking to attack, I just like considering this kind of thing.

Wow. That's a tall order. Let me give it a try.

The primary issue is economic bubbles, and the most obvious of these bubbles is in the bond market. Through quantitative easing the Fed has kept interest rates extraordinarily low. Short term rates are within a rounding error of zero. Long-term rates for the benchmark 10-year treasury bonds have been at or about 2.5% for years. The historical average 10-year treasury yield is 6.8%. Now it is important to understand that when we talk about bond interest rates, we are talking about the yield, not the rate posted on the bond. So, in other words, if I have a $10,000 bond that pays an interest rate of 5%, and current yields are 2.5%, the value of the bond could have increased to as much as $20,000 because an investor could pay $20,000 and still realize a yield of 2.5%. Now it really isn't that simple because the redemption is for only $10,000 so the buyer would have to amortize the premium, the extra $10,000 or whatever, that he paid so the actual purchase price would considerably less than $20,000 but it would also be quite a bit higher than the $10,000 face value. The point is that when I purchase a bond, if bond yields go down I can expect to sell at a profit and if they go up, I can expect to have to take a loss if I sell.

One more important point. When people talk about "long-term rates," they are not talking about the rate of issue of the bond, they are talking about bond yields. Remember, we're talking about the bond market here, the place where people buy and sell bonds to each other. We are not talking about bonds bought at auction from the Treasury Department. However, it should be obvious that when Treasury sells bonds at auction, the interest rate of issue is going to pretty close to the bond yields in the bond market.

This process in the bond market is automatic. When bond prices go up, bond yields go down and vice-versa. So if I say, "the bond market went up," I am saying exactly the same thing as when I say, "bond yields when down." This isn't a cause and effect situation. The two sentences actually refer to the same event. The increase bond prices is how the yield goes down. So,in the bond market, we can say that an increase in interest rates (i.e. the bond yield) leads to a reduction in asset prices.

The situation works the same way in the rest of the economy but we have to add the qualifier ceterus paribus, "other factors equal." It is possible for stock prices and real estate prices to rise, for example, even as interest rates are also rising. In fact, this is quite common during an economic boom. But without such exogenous factors an increase in interest rates would lead stocks, real estate, and similar assets to fall in value.

Now what has been happening for years now, is that the Fed has been buying treasury bonds in the bond market. This buying has pushed bond prices up and therefore reduced long-term interest rates. It had been argued that the low interest rates would stimulate the economy but that hasn't happened for a variety of reasons which would lead us off track. (This argument is probably more a justification for Fed policy than the actual reason for Fed policy which is to keep insolvent Wall Street banks afloat).

So interest rates are about as low as they can get and lower than ever before anywhere in history with the possible exception of Japan and, very recently, in Europe where a policy of "negative interest rates" has recently been introduced but I don't think that policy applies to the bond market but only to banks.

Since interest rates are unprecedentedly low, it should be obvious that the only place they can go is up. And when interest rates go up ceterus paribus, asset prices fall. So we should be headed for a big jump in interest rates and when that happens, we would see a big decrease in bond, stock, and real estate prices. And there is no evidence that exogenous factors will rescue any of these markets. In other words, the Fed's bubble will burst. The only question is how long the Fed can keep interest rates this low.

When the Fed buys treasuries from the banks, it doesn't pay for them. It simply adds the purchase price to the banks reserves and this increases the monetary base. But new money doesn't get created until banks lend the money, and so far there has been little interest in borrowing money by either investors or consumers. In other words, the Fed policy has worked so far precisely because it HASN'T stimulated the economy.

If the money created actually gets into the economy we would then see a big increase in inflation which would lead to increased interest rates which would collapse asset prices, but exogenous factors (a growing economy) could mitigate that collapse. Unfortunately, no one really knows how to thread that needle.

How do you stimulate the economy? In current economic thinking, one way is low interest rates. We see that that is not working. The other way is through deficit spending, but our current deficits are already exacerbating the situation.

We've been borrowing a trillion dollars a year or more just to finance the deficit. If interest rates went up, it would increase the deficit even more due to the higher interest rates needed to finance the deficit as well as old debt that needed to be rolled over. So reducing the deficit or (when pigs fly) balancing the budget could reduce the pressure of this situation somewhat. But while it might lead to a softer hard landing, it still wouldn't lead to a soft landing.

Interest rate will eventually go up, the Fed can't keep them down forever. That means asset prices will have to fall. That means many businesses and individuals will become insolvent. They won't be able to borrow money and they won't be able to pay bills, and the economy will crash.

This is what we call "bad fundamentals." There is simply too much debt out there, and instead of letting people and businesses pay off that debt (which would admittedly have produced a longer recession), the Obama Administration and the Fed decided to double down on bubble economics by urging more borrowing through low interest rates, bailing out insolvent banks and businesses, cash for clunkers and other gimmicks. As a result, private debt is even worse and when asset prices collapse, the defaults and bankruptcies will ensue. What I am talking about is like the bursting of the real estate bubble in 2007 only on steroids.

And that isn't even the worst of it. That is just the easiest to understand. We also have the problem of our huge foreign exchange deficit and the strength of the dollar which is tied to the fact that it is the reserve currency. That, however, is another issue. We could have a severe economic downturn without collapsing the dollar. (In fact, the dollar could strengthen by such an event). But we could also have a collapse of the dollar which would certainly lead to a severe economic downturn.

Our problems could also be triggered by foreign events. The big banks are so interconnected that the collapse of a foreign bank could trigger a downturn here. So could a recession in China. Our sanctions on Russia could help to trigger a trade war. That could also be catastrophic.

Details are impossible to predict because we can't predict what event will trigger the collapse nor can we predict how policy makers will respond. So we could have depression in our future or we could have high inflation. My guess is for stagflation.

Is there a cure or a preventative? Probably not. It's just too late for that. We've got too many insolvent banks. But if there is any chance, this is what we need.

1. Reduce the budget deficit and put balanced budget plan into effect that would include entitlement reform to reduce entitlement spending. (i.e. social security, medicare, Medicaid).

2. Dramatically slash our overseas commitments. We need drastic cuts in defense spending anyway, but reducing troops levels and spending overseas saves doubly because it also reduces our foreign exchange deficit. The pay, support and maintenance of troops overseas sends money overseas and weakens the dollar's status as the reserve currency. We also need to resolve outstanding issues in Ukraine and in the Middle East. We cannot afford to escalate these areas of conflict or get more deeply involved in them.

3. Reduce taxes on capital. Begin with reducing the corporate income taxes to competitive levels and/or allow companies to bring back foreign earnings without having to pay high domestic rates.

4. Reduce regulations. The number of new regulations that have been promulgated just since Obama took office is enormous. What have these regulations accomplished? The vast majority are just political payoffs. They protect one private interest group or groups against competition from others while increasing costs for everyone. The public suffers.

 

[NobleSavage]

^^^Thanks. I'll do a little research and come back with questions. What I do know off the top of my head is that Krugman does not believe there is a bond bubble. I've kinda lost interest in Krugman as he seems more interested in politics than economics. I know that the hedge fund types HATE Bernanke. When there is that much hate there is often a blind spot. The long term credit market is 20 Trillion(?) or about equal to the stock market or the housing market. How much of a loss do you see in bonds? The stock market lost half of it's value peak to trough and the housing market about 1/3.

 

[Togo]

Interesting account. Can I poke at it?

This process in the bond market is automatic. When bond prices go up, bond yields go down and vice-versa. So if I say, "the bond market went up," I am saying exactly the same thing as when I say, "bond yields when down." This isn't a cause and effect situation. The two sentences actually refer to the same event. The increase bond prices is how the yield goes down. So,in the bond market, we can say that an increase in interest rates (i.e. the bond yield) leads to a reduction in asset prices.

The situation works the same way in the rest of the economy but we have to add the qualifier ceterus paribus, "other factors equal." It is possible for stock prices and real estate prices to rise, for example, even as interest rates are also rising. In fact, this is quite common during an economic boom. But without such exogenous factors an increase in interest rates would lead stocks, real estate, and similar assets to fall in value.

It may work in the same way, but here it clearly is a cause and effect relationship...

Since interest rates are unprecedentedly low, it should be obvious that the only place they can go is up. And when interest rates go up ceterus paribus, asset prices fall. So we should be headed for a big jump in interest rates and when that happens, we would see a big decrease in bond, stock, and real estate prices. And there is no evidence that exogenous factors will rescue any of these markets. In other words, the Fed's bubble will burst. The only question is how long the Fed can keep interest rates this low.

Hang on though... The market price of assets falls, but why is that a bad thing?

Interest rate will eventually go up, the Fed can't keep them down forever. That means asset prices will have to fall. That means many businesses and individuals will become insolvent. They won't be able to borrow money and they won't be able to pay bills, and the economy will crash.

Why would they go insolvent? I'm possibly just displaying ignorance here, but we're assuming that these individuals are businesses are heavily indebted, right? And the reason why we're seeing sluggish growth and little appetite for borrowing or lending is because people/businesses are hoarding cash building up their cash assets or paying off debt, and because rival investments, such a shares, are performing comparatively poorly. Surely the point at which interest rates rise is the point at which this stops happening?

But if there is any chance, this is what we need.

1. Reduce the budget deficit and put balanced budget plan into effect that would include entitlement reform to reduce entitlement spending. (i.e. social security, medicare, Medicaid).

Why entitlement spending in particular? Wouldn't that just increase the indebtedness of such groups? I don't see how transferring wealth from one group to another (ie reducing taxes for all by reducing spending on a particular segment of society) fits in to your argument.

3. Reduce taxes on capital. Begin with reducing the corporate income taxes to competitive levels and/or allow companies to bring back foreign earnings without having to pay high domestic rates.

??? Why would that help? Again, obviously any tax reduction is a good thing in isolation, but the tax reduction has to be paid for, which means any tax reduction is a transfer from one area to another. Why is corporate income a better place to have wealth than anywhere else in the economy?

4. Reduce regulations. The number of new regulations that have been promulgated just since Obama took office is enormous. What have these regulations accomplished? The vast majority are just political payoffs. They protect one private interest group or groups against competition from others while increasing costs for everyone. The public suffers.

The effect of the regulations is supposed to be to increase foreign investment in the US, by making it clear that the financial crisis that cost so many foreign investors their savings is unlikely to be repeated. It's also supposed to reduce the systemic risk of the banking industry. I can see that, for example, banks knowing exactly what risks they are taking and being able to track how and when those risks increase, is a burden. But I'm not sure why that would be a bad thing. Banks make money by taking risks. Reducing the amount of risk they can take does reduce their profitability, and increase the amount of capital they need, but a stable financial market is more valuable than a shaky one.

 

[SimpleDon]

Bill is hampered by a faulty understanding of economics. His politics controls his economics, not the other way around. He is almost completely wrong about everything except his conclusion. We are headed for a recession. Europe is already in one.

The reason that we are headed for a recession is that we are approaching the effective demand limit to growth in the economy. Bill ignores the one factor that will cause the recession, demand. Austrian and to a large degree, neoclassical economics are supply side economics, That supply will create its own demand, Say's law. They assume that the demand for products in the economy is virtually infinite. They confuse desire with demand. Economic demand requires not only the desire to purchase something, it also requires that the consumer has the money to buy it. Consumers depend on their wages for money to buy products. Thirty five years of suppressing wages to boost supply has left us with excess money available as financial capital and low demand because wages have been suppressed.

It is the excess capital that builds the real asset bubbles. We need higher wages. To reduce the excess capital and to boost demand.

I have to go to the pool. More later.

 

[boneyard bill]

^^^Thanks. I'll do a little research and come back with questions. What I do know off the top of my head is that Krugman does not believe there is a bond bubble. I've kinda lost interest in Krugman as he seems more interested in politics than economics. I know that the hedge fund types HATE Bernanke. When there is that much hate there is often a blind spot. The long term credit market is 20 Trillion(?) or about equal to the stock market or the housing market. How much of a loss do you see in bonds? The stock market lost half of it's value peak to trough and the housing market about 1/3.

I agree with you about Krugman. He should be taken with a grain of salt as should Larry Summers and all those other politically connected "economists."

I'm not sure how hedge funds operate, but I can surely see why pension fund managers would hate Bernanke. Their job is to invest for yield and take few risks. But yields are extremely low I the bond market, and the risks are high because interest rates can only go up. So their bond portfolios are in jeopardy of losing value. They're forced into the stock market to gain higher yield, but the risk there is probably even higher. I assume hedge fund managers face a similar dilemma.

That depends upon how policy makers react, so I don't really know how to guess in this area. If the Fed floods the market with money, you're going to get a different result than if they let the big banks collapse. So I would guess we're looking at about half but there are a great variety of scenarios.

 

[boneyard bill]

Togo writes:

Interesting account. Can I poke at it?



It may work in the same way, but here it clearly is a cause and effect relationship...

I agree.

Since interest rates are unprecedentedly low, it should be obvious that the only place they can go is up. And when interest rates go up ceterus paribus, asset prices fall. So we should be headed for a big jump in interest rates and when that happens, we would see a big decrease in bond, stock, and real estate prices. And there is no evidence that exogenous factors will rescue any of these markets. In other words, the Fed's bubble will burst. The only question is how long the Fed can keep interest rates this low.

Hang on though... The market price of assets falls, but why is that a bad thing?

It isn't necessarily, if you're free of debt. But if you have a lot of debt, the decline in asset prices reduces your ability to borrow money. So many businesses can face a liquidity problem that can tank the entire company. Then there's the added problem of being unable to raise money in the stock market.

Individuals can also be affected as stockholders and this is especially true if they are speculative investors who have lots of cash invested in options that go the wrong way. Of course, that can include some financial firms as well.

Interest rate will eventually go up, the Fed can't keep them down forever. That means asset prices will have to fall. That means many businesses and individuals will become insolvent. They won't be able to borrow money and they won't be able to pay bills, and the economy will crash.

Why would they go insolvent? I'm possibly just displaying ignorance here, but we're assuming that these individuals are businesses are heavily indebted, right? And the reason why we're seeing sluggish growth and little appetite for borrowing or lending is because people/businesses are hoarding cash building up their cash assets or paying off debt, and because rival investments, such a shares, are performing comparatively poorly. Surely the point at which interest rates rise is the point at which this stops happening?

Well you just explained why they would go insolvent. Because of debt. But these affects are cumulative so that business that isn't heavily indebted may suffer from a serious decline in sales for example.

Another problem is that capital gets liquidated. Some investors see the economy doing rather well because of the low interest rates. They mistake liquidity for growth and undertake investments that are not sustainable in the long run. The great example of this is the real estate bubble. Lots and lots of contractors built houses because there appeared to be such a great demand for it. But in the end, the demand collapsed because it wasn't based on people getting richer. It was based on people having easier access to credit. So many of those houses remained unsold and some projects were simply abandoned without ever even being finished. Obviously many construction companies also went under.

But if there is any chance, this is what we need.

1. Reduce the budget deficit and put balanced budget plan into effect that would include entitlement reform to reduce entitlement spending. (i.e. social security, medicare, Medicaid).

Why entitlement spending in particular? Wouldn't that just increase the indebtedness of such groups? I don't see how transferring wealth from one group to another (ie reducing taxes for all by reducing spending on a particular segment of society) fits in to your argument.

The problem with entitlements is their exponential growth. The aging of the baby boomers and the rising costs of health care lead these programs to grow in expense far faster than tax revenue grows. Raising taxes would solve that problem for only the year in which the taxes were increased. The increased tax revenue would then increase in subsequent years only in line with economic growth. Likewise, cuts in defense or other discretionary items only represent a one-time reduction. Entitlement reform doesn't necessarily require immediate cuts. Cuts for future retirees could bring those programs back to solvency. Obviously, it would help if we could find ways to reduce health care costs across the board. Obamacare certainly won't do that, however. Likely it will produce the reverse effect. How do you cut costs without savaging service? You need market reforms. Give people, consumers and providers alike, more options to tailor the service to their needs and personal financial situation.

3. Reduce taxes on capital. Begin with reducing the corporate income taxes to competitive levels and/or allow companies to bring back foreign earnings without having to pay high domestic rates.

??? Why would that help? Again, obviously any tax reduction is a good thing in isolation, but the tax reduction has to be paid for, which means any tax reduction is a transfer from one area to another. Why is corporate income a better place to have wealth than anywhere else in the economy?

I could go into why the corporate income tax is probably the dumbest of all taxes, but that's a different discussion. I said "reduce taxes on capital." That needn't be limited to a corporate tax reduction. It's simple. If you reduce taxes on capital, then after tax profits will go up. That means that some investments that weren't viable before, now become viable. That means you get more investment, and that means more income including more income taxes. So a 50% tax reduction wouldn't mean a 50% reduction in revenue. In some cases, it could be completely self-financing. This is especially true with the corporate tax because the stockholders would still get taxed. So the increased after tax revenue, insofar as it gets passed on in dividends, is taxed at the personal level and that is added to the increased revenue from more jobs, etc. Ultimately, the only way out of our dilemma is to increase endogenous factors so the increased interest rates don't result in reduced asset prices and the best, probably the only, endogenous factor is economic growth.

4. Reduce regulations. The number of new regulations that have been promulgated just since Obama took office is enormous. What have these regulations accomplished? The vast majority are just political payoffs. They protect one private interest group or groups against competition from others while increasing costs for everyone. The public suffers.

The effect of the regulations is supposed to be to increase foreign investment in the US, by making it clear that the financial crisis that cost so many foreign investors their savings is unlikely to be repeated. It's also supposed to reduce the systemic risk of the banking industry. I can see that, for example, banks knowing exactly what risks they are taking and being able to track how and when those risks increase, is a burden. But I'm not sure why that would be a bad thing. Banks make money by taking risks. Reducing the amount of risk they can take does reduce their profitability, and increase the amount of capital they need, but a stable financial market is more valuable than a shaky one.

There are far more regulations than what you have mentioned. But in the current situation, the Fed did not reduce the systemic risk. It took it over so the Fed itself is, for practical purposes, insolvent. Meanwhile, the Wall Street banks are still in deep, deep trouble. This is obvious from the simple fact that we have yet to restore the "mark to market" rule. Banks can value their assets at pretty much anything they like. That's because mark to market was suspended during the financial crisis. If the banks were solvent, they could reinstate that rule and market confidence would increase. So we've really funneled trillions of dollars into the banks merely to keep them afloat. They needed to have been allowed to fail in 2008. It would have been a much worse recession, I'll admit. But by now we'd be done with it. We'd have solvent banks that didn't need zero interest rates to survive.

Keep in mind, that when a company goes bankrupt, the creditors own the company. And when the creditors own the company, that company is debt-free. The creditors probably won't be able to recover their investment dollar for dollar, but the enterprise often is still quite viable. It's market value just happens to be a fraction of the debt it had been holding.

 

[boneyard bill]

Simple Don writes:

The reason that we are headed for a recession is that we are approaching the effective demand limit to growth in the economy. Bill ignores the one factor that will cause the recession, demand. Austrian and to a large degree, neoclassical economics are supply side economics, That supply will create its own demand, Say's law. They assume that the demand for products in the economy is virtually infinite. They confuse desire with demand. Economic demand requires not only the desire to purchase something, it also requires that the consumer has the money to buy it. Consumers depend on their wages for money to buy products. Thirty five years of suppressing wages to boost supply has left us with excess money available as financial capital and low demand because wages have been suppressed

As a statement of Austrian or free market economics, the above quote is almost entirely wrong. Say's Law does not say that supply will create its own demand. That is a Keynesian mis-statement. They certainly do not assume that demand is infinite or that it is nothing more than desire. Workers do depend on their wages to acquire the money to purchase products, but the important point here are the products that are produced by those wages, not the products that are purchased from them. Simply giving higher wages to workers for making the same amount of products will not produce prosperity. It will produce inflation and distortions in the economy that will ultimately lead to recession or much worse.

That is why I have said that demand is a product or service. The wages represent goods and service produced. I an increase paper money wages is not accompanied by an increase in products or services produced, you haven't actually increased demand.

Why would investors accumulate capital that doesn't produce a return? If they want a return, they have to invest it. And investment spending on factories, mines, research, etc. Is ALSO demand. I fail to see where demand has been suppressed unless you can show that the fat cats are using $1,000 bills as wallpaper. If you quit worrying about wages and encourage more investment, real wages will go up automatically as prices fall for new products or as the result of new production methods for old products.

 

[Togo]

Since interest rates are unprecedentedly low, it should be obvious that the only place they can go is up. And when interest rates go up ceterus paribus, asset prices fall. So we should be headed for a big jump in interest rates and when that happens, we would see a big decrease in bond, stock, and real estate prices. And there is no evidence that exogenous factors will rescue any of these markets. In other words, the Fed's bubble will burst. The only question is how long the Fed can keep interest rates this low.

Hang on though... The market price of assets falls, but why is that a bad thing?

It isn't necessarily, if you're free of debt. But if you have a lot of debt, the decline in asset prices reduces your ability to borrow money. So many businesses can face a liquidity problem that can tank the entire company. Then there's the added problem of being unable to raise money in the stock market.

Which again, would be a problem if you're an expanding company desperately looking for investment. But that's not the situation we're in. We're in a sluggish economy, where people are trying to pay off debt, not increase it. A company that can only survive by ever-increasing amounts of debt is unlikely to survive whether rates go up or not, so we're really looking at companies rolling over or servicing debt. But rates aren't going to go up unless there is a shortage of cash - because that's what the borrowing rate actually represents. The condition we're in, with high levels of debt, are the same conditions that are holding interest rates down.

What we have at the moment is sluggish lending because risks are high, returns are low, and many companies that would otherwise invest are instead paying off their liabilities. This is particularly the case with financial lenders, who have a larger obligation to hold cash than they did before the crash. So we have potential lenders building up their balance sheets, and potential borrowers clearing their liabilities. The reason why investment isn't taking place is because of the risks involved, not because of a shortage of cheap liquidity. In order to move back to growth we need stability (i.e. less risk), which means clearing debt, or at least moving back to a level of indebtedness that would survive interest rates going up.

e will eventually go up, the Fed can't keep them down forever. That means asset prices will have to fall. That means many businesses and individuals will become insolvent. They won't be able to borrow money and they won't be able to pay bills, and the economy will crash.

Why would they go insolvent? I'm possibly just displaying ignorance here, but we're assuming that these individuals are businesses are heavily indebted, right? And the reason why we're seeing sluggish growth and little appetite for borrowing or lending is because people/businesses are hoarding cash building up their cash assets or paying off debt, and because rival investments, such a shares, are performing comparatively poorly. Surely the point at which interest rates rise is the point at which this stops happening?

Well you just explained why they would go insolvent. Because of debt.

That's not enough. You're suggesting that we get a sharp rise in the scarcity of cash at the same time that vast numbers of people are paying out debt payments. The very conditions that create low interest rates are the one's you're concerned about should interest rates rise.

The only way I can see this coming about is if there is an uneven recovery. If, hypothetically, you moved all the wealth into a small sub-segment of the population, and they then all invested abroad, then you could get a headline rise in the interest rate (borrowing rate) in the US at the same time that everyone else ran out of cash. You'd still need some kind of active recessionary force, such as a shift in the tax burden in favour of the small sub-segment and against the indebted majority. But otherwise you're saying that everyone runs out of cash while they're paying so much of it to each other, which is a bit like saying interest rates and asset prices go up at the same time.

But if there is any chance, this is what we need.

1. Reduce the budget deficit and put balanced budget plan into effect that would include entitlement reform to reduce entitlement spending. (i.e. social security, medicare, Medicaid).

Why entitlement spending in particular? Wouldn't that just increase the indebtedness of such groups? I don't see how transferring wealth from one group to another (ie reducing taxes for all by reducing spending on a particular segment of society) fits in to your argument.

The problem with entitlements is their exponential growth.

That is a problem, yes, in that the figure we need in X years time is higher than it is now. But that's not connected to anything else you've presented so far.

The aging of the baby boomers and the rising costs of health care lead these programs to grow in expense far faster than tax revenue grows. Raising taxes would solve that problem for only the year in which the taxes were increased. The increased tax revenue would then increase in subsequent years only in line with economic growth. Likewise, cuts in defense or other discretionary items only represent a one-time reduction.

But defence spending also grows every year, and the amount we'll need in X years time is higher than it is now. Surely the same argument applies? Weapons increase in cost and sophistication every year in the same way as medical care. Indeed it's the same process driving both effects. So why entitlement cuts rather than defence cuts? Obviously you can prefer one to the other, but I'm not seeing an economic driver here.

Entitlement reform doesn't necessarily require immediate cuts.

If you don't have immediate cuts, you're not effecting the immediate economy.

An even future projected cuts still have an immediate chilling effect on investment. Pension funds are a very large and constant source of investment capital. However, they have to tailor their programs to the projected retirement income of the beneficiary. The more you cut future entitlements, the less risk they can afford to take because the future income is less certain. The less risk they can take, the more they have to put into low-risk bonds, rather than real investment.

Obviously, it would help if we could find ways to reduce health care costs across the board.

Yes, you'd be better off with a UHC system like ours, which covers more people at a lower cost. However, that's a separate topic in itself.

3. Reduce taxes on capital. Begin with reducing the corporate income taxes to competitive levels and/or allow companies to bring back foreign earnings without having to pay high domestic rates.

??? Why would that help? Again, obviously any tax reduction is a good thing in isolation, but the tax reduction has to be paid for, which means any tax reduction is a transfer from one area to another. Why is corporate income a better place to have wealth than anywhere else in the economy?

I could go into why the corporate income tax is probably the dumbest of all taxes, but that's a different discussion. I said "reduce taxes on capital." That needn't be limited to a corporate tax reduction. It's simple. If you reduce taxes on capital, then after tax profits will go up. That means that some investments that weren't viable before, now become viable.

eh? If the tax is on profits (i.e. capital increase), then the investments only become more viable if they make the investment a better return than lending the money at the prevailing interest rate. And the prevailing interest rate is near zero. In times of high interest rates, this might be good advice, but in the present climate, it's just throwing a subsidy money at the problem. The economy is already awash with cash - that's what a low interest rate means - that money is cheap to borrow. The problem is find someone safe to lend it to or invest it in, which means the issue is the riskiness of lending. Rather than making already profitable activity more profitable, you're better off dealing with the risks involved.

So a 50% tax reduction wouldn't mean a 50% reduction in revenue.

That's true of any tax reduction. It's also true of any tax increase.

This is especially true with the corporate tax because the stockholders would still get taxed.

Only if they're people. It's entirely possible to work out a company structure whereby the money never gets passed through an individual's hands at all, and thus never gets taxed at the full rate. Most pension funds, trust funds, and family tax shelters work in this way.

Ultimately, the only way out of our dilemma is to increase endogenous factors so the increased interest rates don't result in reduced asset prices and the best, probably the only, endogenous factor is economic growth.

Eh, you've still not said why reduced asset prices are bad. You've said they're bad because they increase interest rates, but if rates are going up, then why is it an advantage to prevent them from depressing asset prices?

4. Reduce regulations. The number of new regulations that have been promulgated just since Obama took office is enormous. What have these regulations accomplished? The vast majority are just political payoffs. They protect one private interest group or groups against competition from others while increasing costs for everyone. The public suffers.

The effect of the regulations is supposed to be to increase foreign investment in the US, by making it clear that the financial crisis that cost so many foreign investors their savings is unlikely to be repeated. It's also supposed to reduce the systemic risk of the banking industry. I can see that, for example, banks knowing exactly what risks they are taking and being able to track how and when those risks increase, is a burden. But I'm not sure why that would be a bad thing. Banks make money by taking risks. Reducing the amount of risk they can take does reduce their profitability, and increase the amount of capital they need, but a stable financial market is more valuable than a shaky one.

There are far more regulations than what you have mentioned.

<shrug> The biggest increase has been in the area I described. You want to take as fact the idea that regulations have no purpose, then I'll need evidence, because it's clearly a political belief, rather than an economic one.

But in the current situation, the Fed did not reduce the systemic risk. It took it over so the Fed itself is, for practical purposes, insolvent.

That's how risk transfer works. You spread the risk around to make it easier to bear. The way banks make money is by taking on risks that would bankrupt smaller investors, which they can weather by virtue of their size, their ability to match investors to risks, and their ability to hedge risks on the international markets. In doing so they remove risk from the system, making borrowing and investing safer. That's how they justify their charges and make their profits. The recent crisis showed the extent to which banks in practice rely on the Federal government as a backstop, so the Fed has more formally taken on some of those risks, and is taking their cut by requiring banks to actually track their own activities more closely.

Meanwhile, the Wall Street banks are still in deep, deep trouble. This is obvious from the simple fact that we have yet to restore the "mark to market" rule.

They may never restore it. It's always been a fairly odd rule in any case, because it assumes efficient markets. At the moment, they aren't, and at any point where you'd care about the market value of the bank's assets, they wouldn't be. That's why the latest financial crisis saw assets being priced at less than their coupon payments (less than the cash they were producing).

Banks can value their assets at pretty much anything they like.

Well, they can't, because of all those pesky regulations you're complaining about. The ones where you have to disclose what assets you're holding and how they're valued.

Keep in mind, that when a company goes bankrupt, the creditors own the company. And when the creditors own the company, that company is debt-free.

No it isn't. As a creditor to a bankrupt bank, I can tell you that the company has to be run to the benefit of the creditors, first and foremost. That means if you want the business to keep going, you have to use money that would otherwise be going to creditors to keep it afloat and running. The trick is to present a plan that you can convince the majority of creditors will get them more money than just stripping the assets. That typically involves taking some small part of the business that has minimal assets but makes cash and keeping it afloat. Just as bailing out a bank involves taking the entire business and keeping it afloat. I'm not seeing much of a distinction between the two, here. The advantage of a bankruptcy is that the creditors can be convinced to slash the size of the liabilities in return for control over the company, while the advantage of a government bailout is that the creditors may not be capable of running the company. Certainly, in the case of Lehman Brothers Europe, the amount of the business they could keep running was tiny, and simply unwinding all the positions and chasing all the various counterparties for payment is likely to take 15 years or so. After you've paid for 15 years of accountants and lawyers, there won't be much left.

But we're drifting off the point.

I'm not seeing the advantage of propping up asset prices independently of their effect on interest rates. I feel like I'm missing something obvious there.

I'm not seeing the advantage of cutting military spending rather than entitlements, since both liabilities grow over time.

I'm not seeing why lowering taxes on profits would help in an economy where the baseline return on capital is close to zero in any case.

And I'm certainly not seeing why trying to transfer wealth to investors would help, when we have lots of cheap money but a great reluctance to spend or invest due to the level of indebtedness. Surely transferring money in this way would simply increase the chances of the nightmare you describe - interest rates going up (i.e. money becomes more in demand) without a reduction in the risk or debt embedded in the economy?

 

[funinspace]

3. Reduce taxes on capital. Begin with reducing the corporate income taxes to competitive levels and/or allow companies to bring back foreign earnings without having to pay high domestic rates.

A minor comment w/o jumping into the whole show here. Corporate income taxes now only bring in about 10% of total federal tax revenue, well below the percentage from decades ago. The tax code is insanely complex. Personally, I think it would be better to just dump corporate taxes all together and just tax capital gains and dividends as regular income in whatever tax bracket the person is in.

Of course Congress likes it the way it is, as this provides them a gravy train of paying corporations for their campaigns.

 

[boneyard bill]

3. Reduce taxes on capital. Begin with reducing the corporate income taxes to competitive levels and/or allow companies to bring back foreign earnings without having to pay high domestic rates.

A minor comment w/o jumping into the whole show here. Corporate income taxes now only bring in about 10% of total federal tax revenue, well below the percentage from decades ago. The tax code is insanely complex. Personally, I think it would be better to just dump corporate taxes all together and just tax capital gains and dividends as regular income in whatever tax bracket the person is in.

Of course Congress likes it the way it is, as this provides them a gravy train of paying corporations for their campaigns.

I agree. The corporate tax is stupid. Corporations can't pay taxes. People pay taxes. So it's really a hidden tax which is why politicians like it. I think it is the consumer who probably pays the bulk of the corporate tax anyway.

 

[boneyard bill]

Togo writes:

Since interest rates are unprecedentedly low, it should be obvious that the only place they can go is up. And when interest rates go up ceterus paribus, asset prices fall. So we should be headed for a big jump in interest rates and when that happens, we would see a big decrease in bond, stock, and real estate prices. And there is no evidence that exogenous factors will rescue any of these markets. In other words, the Fed's bubble will burst. The only question is how long the Fed can keep interest rates this low.

Hang on though... The market price of assets falls, but why is that a bad thing?

It isn't necessarily, if you're free of debt. But if you have a lot of debt, the decline in asset prices reduces your ability to borrow money. So many businesses can face a liquidity problem that can tank the entire company. Then there's the added problem of being unable to raise money in the stock market.

Which again, would be a problem if you're an expanding company desperately looking for investment. But that's not the situation we're in. We're in a sluggish economy, where people are trying to pay off debt, not increase it. A company that can only survive by ever-increasing amounts of debt is unlikely to survive whether rates go up or not, so we're really looking at companies rolling over or servicing debt. But rates aren't going to go up unless there is a shortage of cash - because that's what the borrowing rate actually represents. The condition we're in, with high levels of debt, are the same conditions that are holding interest rates down.

No. Interest rates are being held down by deliberate action of the Fed through the purchase of US Treasuries. The Fed purchases treasuries which drives the price up and drives interest rates down. High levels of debt produce higher interest rates, not lower. If the Fed were not purchasing treasuries, interest rates would go much higher. This is what we need as it would encourage people to save more.

What we have at the moment is sluggish lending because risks are high, returns are low, and many companies that would otherwise invest are instead paying off their liabilities. This is particularly the case with financial lenders, who have a larger obligation to hold cash than they did before the crash. So we have potential lenders building up their balance sheets, and potential borrowers clearing their liabilities. The reason why investment isn't taking place is because of the risks involved, not because of a shortage of cheap liquidity. In order to move back to growth we need stability (i.e. less risk), which means clearing debt, or at least moving back to a level of indebtedness that would survive interest rates going up.

I agree with the general idea you express here. But I disagree that companies are not investing because they need to pay down debt. In general that is not the case at the moment. Many companies are taking advantage of the low interest rates to buy back their own stock. This increases earnings per share even if total earnings are not going up and that increases the stock price and executive's bonuses. Companies are not investing because there is a shortage of demand. On that point I don't disagree with Simple Don. I disagree with Simple Don on what constitutes demand. An increase in the money supply does not increase demand. Demand derives from production, not from currency increases. So what we need is NOT to encourage more borrowing which has been the focus of government policy. We need people to pay down debt and to save.

e will eventually go up, the Fed can't keep them down forever. That means asset prices will have to fall. That means many businesses and individuals will become insolvent. They won't be able to borrow money and they won't be able to pay bills, and the economy will crash.

Why would they go insolvent? I'm possibly just displaying ignorance here, but we're assuming that these individuals are businesses are heavily indebted, right? And the reason why we're seeing sluggish growth and little appetite for borrowing or lending is because people/businesses are hoarding cash building up their cash assets or paying off debt, and because rival investments, such a shares, are performing comparatively poorly. Surely the point at which interest rates rise is the point at which this stops happening?

The problem is that the Fed has kept interest rates artificially very low for a very long time. So assets are overpriced. If assets fell by a normal amount as interest rates rose from 5% to 6%, which would be a normal situation, we are looking at interest rate rising from 2.5% to 6%. So the decline is asset prices will be much worse than normal. Where the first scenario might impact a few companies severely, the second scenario impacts a whole lot of companies.

Well you just explained why they would go insolvent. Because of debt.

That's not enough. You're suggesting that we get a sharp rise in the scarcity of cash at the same time that vast numbers of people are paying out debt payments. The very conditions that create low interest rates are the one's you're concerned about should interest rates rise.

The only way I can see this coming about is if there is an uneven recovery. If, hypothetically, you moved all the wealth into a small sub-segment of the population, and they then all invested abroad, then you could get a headline rise in the interest rate (borrowing rate) in the US at the same time that everyone else ran out of cash. You'd still need some kind of active recessionary force, such as a shift in the tax burden in favour of the small sub-segment and against the indebted majority. But otherwise you're saying that everyone runs out of cash while they're paying so much of it to each other, which is a bit like saying interest rates and asset prices go up at the same time.

Debt retirement destroys cash. When a bank makes a loan, it creates cash. When that loan is paid off, the cash disappears. It also disappears when debts are liquidated through bankruptcy. That is what is going to happen. The trillions that the Fed has created will disappear and the economy will crash as the money supply settles back to where it was. The policies that I have advocated will trigger this sooner rather than later, and therefore reduce the severity. But, as I have said, it's really too late. We should have let the banks collapse in 2008. That would have created a more severe recession, but it would have left us with banks and businesses that are solvent and well-financed once the re-organization has occurred which is usually a couple of years.

But if there is any chance, this is what we need.

1. Reduce the budget deficit and put balanced budget plan into effect that would include entitlement reform to reduce entitlement spending. (i.e. social security, medicare, Medicaid).

Why entitlement spending in particular? Wouldn't that just increase the indebtedness of such groups? I don't see how transferring wealth from one group to another (ie reducing taxes for all by reducing spending on a particular segment of society) fits in to your argument.

The problem with entitlements is their exponential growth.

That is a problem, yes, in that the figure we need in X years time is higher than it is now. But that's not connected to anything else you've presented so far.

The aging of the baby boomers and the rising costs of health care lead these programs to grow in expense far faster than tax revenue grows. Raising taxes would solve that problem for only the year in which the taxes were increased. The increased tax revenue would then increase in subsequent years only in line with economic growth. Likewise, cuts in defense or other discretionary items only represent a one-time reduction.

But defence spending also grows every year, and the amount we'll need in X years time is higher than it is now. Surely the same argument applies? Weapons increase in cost and sophistication every year in the same way as medical care. Indeed it's the same process driving both effects. So why entitlement cuts rather than defence cuts? Obviously you can prefer one to the other, but I'm not seeing an economic driver here.

No. Defense spending is subject to the appropriation process. Entitlements are not. Suppose the economy is growing at 4% per year and tax revenue is growing at the same rate. But now suppose that entitlements are growing at 7% per year. It should be clear that you are going to be running deficits in this area for as long as those rates continue. A tax increase will only close the gap for one year because the increase taxes will only grow at 4% rate while expenditures grew at a 7% rate. The same is true for cuts elsewhere in the budget. They could close the gap for only one year.

Entitlements are part of the law. I am entitled to so much social security every year because that is what the law says. The only way you can cut the growth in entitlements is to change the law to say that people are not entitled to what they once were. That's what "entitlement reform" is all about. But entitlement reform at this point wouldn't necessarily have to cut benefits for current recipients. Social security and Medicare are still above water but they won't be for long. Especially Medicare. Most entitlement reform proposals suggest cutting future benefits to bring the costs in line with revenue growth.

Defense spending, in contrast, can be reduced in the next budget simply through the appropriation process, and I don't believe that defense spending has been growing faster than revenue growth anyway. This doesn't mean that defense spending shouldn't be cut. It should and it will, one way or another. But defense cuts alone won't solve the problem.

Entitlement reform doesn't necessarily require immediate cuts.

If you don't have immediate cuts, you're not effecting the immediate economy.

An even future projected cuts still have an immediate chilling effect on investment. Pension funds are a very large and constant source of investment capital. However, they have to tailor their programs to the projected retirement income of the beneficiary. The more you cut future entitlements, the less risk they can afford to take because the future income is less certain. The less risk they can take, the more they have to put into low-risk bonds, rather than real investment.

Pension funds typically invest in low-risk bonds. If they are investing heavily in stocks (as they are these days) something is wrong. But I don't see where entitlement cuts would influence pension funds very much. Pension funds are private.

Obviously, it would help if we could find ways to reduce health care costs across the board.

Yes, you'd be better off with a UHC system like ours, which covers more people at a lower cost. However, that's a separate topic in itself.

Single player plans eliminate the market therefore depriving you of the values of those services. With no price guidelines, you get shortages and eventually the rationing of health care.

However, you could simply subsidize health care for low income people (or for everyone) and people with pre-existing conditions (which Obamacare does) without adding all the bureaucracy and red tape that Obamacare also produces.

US health care is more expensive than other countries because of all our regulations on health care insurance. Our actual health care delivery regulations aren't much different from other countries, but our insurance regulation is.

3. Reduce taxes on capital. Begin with reducing the corporate income taxes to competitive levels and/or allow companies to bring back foreign earnings without having to pay high domestic rates.

??? Why would that help? Again, obviously any tax reduction is a good thing in isolation, but the tax reduction has to be paid for, which means any tax reduction is a transfer from one area to another. Why is corporate income a better place to have wealth than anywhere else in the economy?

I could go into why the corporate income tax is probably the dumbest of all taxes, but that's a different discussion. I said "reduce taxes on capital." That needn't be limited to a corporate tax reduction. It's simple. If you reduce taxes on capital, then after tax profits will go up. That means that some investments that weren't viable before, now become viable.

eh? If the tax is on profits (i.e. capital increase), then the investments only become more viable if they make the investment a better return than lending the money at the prevailing interest rate. And the prevailing interest rate is near zero. In times of high interest rates, this might be good advice, but in the present climate, it's just throwing a subsidy money at the problem. The economy is already awash with cash - that's what a low interest rate means - that money is cheap to borrow. The problem is find someone safe to lend it to or invest it in, which means the issue is the riskiness of lending. Rather than making already profitable activity more profitable, you're better off dealing with the risks involved.

But the low interest rate policy isn't working. I've already said we need an increase in interest rates. So reductions in taxes on capital need to be understood as functioning within the context of the entire policy that I am proposing. In other words, low taxes on capital need to be seen as a substitute for low interest rates.

So a 50% tax reduction wouldn't mean a 50% reduction in revenue.

That's true of any tax reduction. It's also true of any tax increase.

Yes. But the trade off with capital is much higher than tax increases on consumer spending.

This is especially true with the corporate tax because the stockholders would still get taxed.

Only if they're people. It's entirely possible to work out a company structure whereby the money never gets passed through an individual's hands at all, and thus never gets taxed at the full rate. Most pension funds, trust funds, and family tax shelters work in this way.

No they do not. As a former trust tax accountant for a bank I can assure you of that. The income from such vehicles gets taxed to the individual recipients. I assume that the "family tax shelters" that you refer to are "generation skipping trusts." Such trusts save on estate taxes, but income taxes still get passed through.

Ultimately, the only way out of our dilemma is to increase endogenous factors so the increased interest rates don't result in reduced asset prices and the best, probably the only, endogenous factor is economic growth.

Eh, you've still not said why reduced asset prices are bad. You've said they're bad because they increase interest rates, but if rates are going up, then why is it an advantage to prevent them from depressing asset prices?

It's the other way round. Increased interest rate reduce asset prices. But if interest rates are unrealistically low especially when they are being kept that way by government intervention, then market forces will eventually force interest rates up. That leads to reduced asset prices and, as I've already stated, reduced asset prices can lead to companies going bankrupt or needing extraordinary mergers. That's what happens during recessions. But because the Fed has kept interest rates so extraordinarily low, the downturn is going to be extraordinarily high.

4. Reduce regulations. The number of new regulations that have been promulgated just since Obama took office is enormous. What have these regulations accomplished? The vast majority are just political payoffs. They protect one private interest group or groups against competition from others while increasing costs for everyone. The public suffers.

The effect of the regulations is supposed to be to increase foreign investment in the US, by making it clear that the financial crisis that cost so many foreign investors their savings is unlikely to be repeated. It's also supposed to reduce the systemic risk of the banking industry. I can see that, for example, banks knowing exactly what risks they are taking and being able to track how and when those risks increase, is a burden. But I'm not sure why that would be a bad thing. Banks make money by taking risks. Reducing the amount of risk they can take does reduce their profitability, and increase the amount of capital they need, but a stable financial market is more valuable than a shaky one.

There are far more regulations than what you have mentioned.

<shrug> The biggest increase has been in the area I described. You want to take as fact the idea that regulations have no purpose, then I'll need evidence, because it's clearly a political belief, rather than an economic one.

Economic regulations increase costs and reduce growth. This isn't necessarily the case with health and safety regulations but it can incidentally be the case there as well.

More significant than the empirical question, however, is the philosophical one. What are the set of principles that tell us when you should regulate and when you shouldn't? And how should you go about it? There aren't any. It's all seat of the pants and that means it' permeated with political influence.

Most economists agree that we can't do without market signals. So why should the Fed be setting interest rates? This is the single market signal that influences virtually all other market signals. Since money isn't allocated according to market conditions, it should be no surprise that there are many market distortions and investors don't know what statistics they can trust.

But in the current situation, the Fed did not reduce the systemic risk. It took it over so the Fed itself is, for practical purposes, insolvent.

That's how risk transfer works. You spread the risk around to make it easier to bear. The way banks make money is by taking on risks that would bankrupt smaller investors, which they can weather by virtue of their size, their ability to match investors to risks, and their ability to hedge risks on the international markets. In doing so they remove risk from the system, making borrowing and investing safer. That's how they justify their charges and make their profits. The recent crisis showed the extent to which banks in practice rely on the Federal government as a backstop, so the Fed has more formally taken on some of those risks, and is taking their cut by requiring banks to actually track their own activities more closely.

No. That completely eliminates the failure mechanism which is what makes capitalism work. The Fed was not created to bail-out insolvent banks. It was not created to assume risk. It was created to rescue illiquid banks from failure when they were otherwise solvent. It's job is to lend money money to solvent banks against good collateral. Taking back good collateral is the opposite of assuming the risk.

What you described is what the Fed did, but it violated all the principles of banking and most of the principles of economics. It took over toxic bank assets at book value which is certainly far higher than their market value.

Meanwhile, the Wall Street banks are still in deep, deep trouble. This is obvious from the simple fact that we have yet to restore the "mark to market" rule.

They may never restore it. It's always been a fairly odd rule in any case, because it assumes efficient markets. At the moment, they aren't, and at any point where you'd care about the market value of the bank's assets, they wouldn't be. That's why the latest financial crisis saw assets being priced at less than their coupon payments (less than the cash they were producing).

I agree that the current markets are not efficient, but it is precisely because of the regulation that you endorse that they are not efficient. Of course banks should mark to market. You cannot evaluate the health of a bank if it hasn't written off bad loans.

Banks can value their assets at pretty much anything they like.

Well, they can't, because of all those pesky regulations you're complaining about. The ones where you have to disclose what assets you're holding and how they're valued.

How they are valued is irrelevant if you don't know their present value. If their present value is zero, that needs to be disclosed.

Keep in mind, that when a company goes bankrupt, the creditors own the company. And when the creditors own the company, that company is debt-free.

No it isn't. As a creditor to a bankrupt bank, I can tell you that the company has to be run to the benefit of the creditors, first and foremost. That means if you want the business to keep going, you have to use money that would otherwise be going to creditors to keep it afloat and running. The trick is to present a plan that you can convince the majority of creditors will get them more money than just stripping the assets. That typically involves taking some small part of the business that has minimal assets but makes cash and keeping it afloat. Just as bailing out a bank involves taking the entire business and keeping it afloat. I'm not seeing much of a distinction between the two, here. The advantage of a bankruptcy is that the creditors can be convinced to slash the size of the liabilities in return for control over the company, while the advantage of a government bailout is that the creditors may not be capable of running the company. Certainly, in the case of Lehman Brothers Europe, the amount of the business they could keep running was tiny, and simply unwinding all the positions and chasing all the various counterparties for payment is likely to take 15 years or so. After you've paid for 15 years of accountants and lawyers, there won't be much left.

My statement stands. When a company goes bankrupt, the creditors own the company. Nothing you said refutes that. Of course, the creditors are represented by a bankruptcy trustee who tries to put the business in as good a shape as possible, and sometimes actual, physical liquidation may be the best route to go. There are no advantages to a government bail-out that I can see. At least not to the public. Of course, when the government is the creditor, then the trustee is likely to be an executive branch entity such as the Resolution Trust Corporation which oversaw the S&L liquidations.

But we're drifting off the point.

I'm not seeing the advantage of propping up asset prices independently of their effect on interest rates. I feel like I'm missing something obvious there.

I don't think you can prop up prices independently of interest rates. I haven't advocated that. I don't see the advantage of propping up asset prices at all.

I'm not seeing the advantage of cutting military spending rather than entitlements, since both liabilities grow over time.

I think I've explained that. I'm in favor of cutting military spending. I just claim that that isn't sufficient.

I'm not seeing why lowering taxes on profits would help in an economy where the baseline return on capital is close to zero in any case.

It won't. The baseline return on capital shouldn't be close to zero.

And I'm certainly not seeing why trying to transfer wealth to investors would help, when we have lots of cheap money but a great reluctance to spend or invest due to the level of indebtedness. Surely transferring money in this way would simply increase the chances of the nightmare you describe - interest rates going up (i.e. money becomes more in demand) without a reduction in the risk or debt embedded in the economy?

The "nightmare" that I described has to happen. The policy recommendations that I put forward here would simply alleviate the hardship, but it would also precipitate the downturn. The downturn should have happened much earlier. Then it wouldn't have been as severe as it is going to be.

What you are saying is equivalent to the guy who says, "I don't see any point is spending all that money to fix the roof when it isn't raining." There's a hardship involved. It's going to rain someday, and fixing the roof won't stop all of the inconvenience of the rain, but that doesn't mean we shouldn't do what we can.

 

[laughing dog]

The "nightmare" that I described has to happen. ....

No, it doesn't. Just like the inflation you claim has to happen has not.

 

[GenesisNemesis]

Corporations can't pay taxes. People pay taxes.

Aren't corporations people though? That's what the conservatives keep telling me.

 

[boneyard bill]

Corporations can't pay taxes. People pay taxes.

Aren't corporations people though? That's what the conservatives keep telling me.

I don't know what conservatives you are talking about. Romney made that point, but I certainly wouldn't regard Romney as a conservative. Otherwise I haven't heard of any references to it. However, the point is true in a legal sense in a very limited way due to a Supreme Court ruling back in the 19th Century. In a legal sense, however, a corporation isn't necessary a form of organization aimed at making a profit. The term has a much wider meaning. Cities are corporations. Yale University is run by the Yale corporation. Business corporations are a relatively new form.

 

[Togo]

Since interest rates are unprecedentedly low, it should be obvious that the only place they can go is up. And when interest rates go up ceterus paribus, asset prices fall. So we should be headed for a big jump in interest rates and when that happens, we would see a big decrease in bond, stock, and real estate prices. And there is no evidence that exogenous factors will rescue any of these markets. In other words, the Fed's bubble will burst. The only question is how long the Fed can keep interest rates this low.

Hang on though... The market price of assets falls, but why is that a bad thing?

It isn't necessarily, if you're free of debt. But if you have a lot of debt, the decline in asset prices reduces your ability to borrow money. So many businesses can face a liquidity problem that can tank the entire company. Then there's the added problem of being unable to raise money in the stock market.

Which again, would be a problem if you're an expanding company desperately looking for investment. But that's not the situation we're in. We're in a sluggish economy, where people are trying to pay off debt, not increase it. A company that can only survive by ever-increasing amounts of debt is unlikely to survive whether rates go up or not, so we're really looking at companies rolling over or servicing debt. But rates aren't going to go up unless there is a shortage of cash - because that's what the borrowing rate actually represents. The condition we're in, with high levels of debt, are the same conditions that are holding interest rates down.

No. Interest rates are being held down by deliberate action of the Fed through the purchase of US Treasuries... If the Fed were not purchasing treasuries, interest rates would go much higher.

That doesn't follow You're contending that, were it not for the actions of the Fed, interest rates would be much higher. I'm not seeing any reason to believe that the actions of the Fed are the only downward pressure here, or even the most important one.

High levels of debt produce higher interest rates, not lower.

Not sure I agree there. High levels of debt would normally indicate lots of excess cash in the system. Why would that make borrowing money harder?

What we have at the moment is sluggish lending because risks are high, returns are low, and many companies that would otherwise invest are instead paying off their liabilities. This is particularly the case with financial lenders, who have a larger obligation to hold cash than they did before the crash. So we have potential lenders building up their balance sheets, and potential borrowers clearing their liabilities. The reason why investment isn't taking place is because of the risks involved, not because of a shortage of cheap liquidity. In order to move back to growth we need stability (i.e. less risk), which means clearing debt, or at least moving back to a level of indebtedness that would survive interest rates going up.

I agree with the general idea you express here. But I disagree that companies are not investing because they need to pay down debt. In general that is not the case at the moment. Many companies are taking advantage of the low interest rates to buy back their own stock. This increases earnings per share even if total earnings are not going up and that increases the stock price and executive's bonuses.

Well of course they are. Interest rates are tiny, and dividend payments are not. Buying back stock makes more sense for a heavily indebted company than paying off debt, because it reduces your outflow. But that's still in the same basket of actions - paying off debt, saving, amassing assets - that indicate they are hoarding money rather than investing. Whether they are paying off the debt directly, or acquiring assets to hold against debt isn't really the point.

Well you just explained why they would go insolvent. Because of debt.

That's not enough. You're suggesting that we get a sharp rise in the scarcity of cash at the same time that vast numbers of people are paying out debt payments. The very conditions that create low interest rates are the one's you're concerned about should interest rates rise.

The only way I can see this coming about is if there is an uneven recovery. If, hypothetically, you moved all the wealth into a small sub-segment of the population, and they then all invested abroad, then you could get a headline rise in the interest rate (borrowing rate) in the US at the same time that everyone else ran out of cash. You'd still need some kind of active recessionary force, such as a shift in the tax burden in favour of the small sub-segment and against the indebted majority. But otherwise you're saying that everyone runs out of cash while they're paying so much of it to each other, which is a bit like saying interest rates and asset prices go up at the same time.

Debt retirement destroys cash. When a bank makes a loan, it creates cash. When that loan is paid off, the cash disappears. It also disappears when debts are liquidated through bankruptcy. That is what is going to happen.

Yes, of course. The vast amounts created by indebtedness of companies and individuals will be gradually paid back, and the money supply will go back to saner levels. I'm not seeing the 'crash' bit though, because the process occurs as debt is paid off, not in advance of it.

The trillions that the Fed has created will disappear and the economy will crash as the money supply settles back to where it was. The policies that I have advocated will trigger this sooner rather than later, and therefore reduce the severity.

eh? Debt is being paid off, and the real economy is recovering. That's precisely why interest rates are being held down, to encourage this process. Why would triggering it earlier make it 'less severe'?

But if there is any chance, this is what we need.

1. Reduce the budget deficit and put balanced budget plan into effect that would include entitlement reform to reduce entitlement spending. (i.e. social security, medicare, Medicaid).

Why entitlement spending in particular? Wouldn't that just increase the indebtedness of such groups? I don't see how transferring wealth from one group to another (ie reducing taxes for all by reducing spending on a particular segment of society) fits in to your argument.

The problem with entitlements is their exponential growth.

That is a problem, yes, in that the figure we need in X years time is higher than it is now. But that's not connected to anything else you've presented so far.

The aging of the baby boomers and the rising costs of health care lead these programs to grow in expense far faster than tax revenue grows. Raising taxes would solve that problem for only the year in which the taxes were increased. The increased tax revenue would then increase in subsequent years only in line with economic growth. Likewise, cuts in defense or other discretionary items only represent a one-time reduction.

But defence spending also grows every year, and the amount we'll need in X years time is higher than it is now. Surely the same argument applies? Weapons increase in cost and sophistication every year in the same way as medical care. Indeed it's the same process driving both effects. So why entitlement cuts rather than defence cuts? Obviously you can prefer one to the other, but I'm not seeing an economic driver here.

No. Defense spending is subject to the appropriation process. Entitlements are not. Suppose the economy is growing at 4% per year and tax revenue is growing at the same rate. But now suppose that entitlements are growing at 7% per year. It should be clear that you are going to be running deficits in this area for as long as those rates continue. A tax increase will only close the gap for one year because the increase taxes will only grow at 4% rate while expenditures grew at a 7% rate. The same is true for cuts elsewhere in the budget. They could close the gap for only one year.

No it isn't true for cuts elsewhere in the budget, only for cuts in programs that don't increase in size faster than the economy.

The logic you've presented says that entitlements are a special case because the liabilities they represent are due to increase faster than tax revenue/growth. Which is true and has been true for decades, but that doesn't make them a special case. The reason this is a problem is because the entitlements programs have not been fully funded to meet their future liabilities. So there is a hole there. We can solve this hole in the same way as any other debt, by raising taxes or cutting spending. Clearly, because the demographic shift is likely to be very expensive, you favour cutting such payments rather than raising taxes to cover them, but that's purely a political preference. There's nothing magical about this future liability that isn't equally true of any other.

Entitlements are part of the law... Defense spending, in contrast, can be reduced in the next budget simply through the appropriation process,

Again this is a political difficulty, rather than an economic one.

eh? If the tax is on profits (i.e. capital increase), then the investments only become more viable if they make the investment a better return than lending the money at the prevailing interest rate. And the prevailing interest rate is near zero. In times of high interest rates, this might be good advice, but in the present climate, it's just throwing a subsidy money at the problem. The economy is already awash with cash - that's what a low interest rate means - that money is cheap to borrow. The problem is find someone safe to lend it to or invest it in, which means the issue is the riskiness of lending. Rather than making already profitable activity more profitable, you're better off dealing with the risks involved.

But the low interest rate policy isn't working. I've already said we need an increase in interest rates.

Um.. Only because an increase would be a disaster, and you want to get that disaster over with. That's not, in itself, a compelling reason.

So reductions in taxes on capital need to be understood as functioning within the context of the entire policy that I am proposing. In other words, low taxes on capital need to be seen as a substitute for low interest rates.

So you increase interest rates for everyone, but then subsidise one particular sector - investors to reduce the impact., by reducing taxes on capital to match. That's still a wealth transfer, and you've still not given a reason why it's a good idea for that one sector alone.

So a 50% tax reduction wouldn't mean a 50% reduction in revenue.

That's true of any tax reduction. It's also true of any tax increase.

Yes. But the trade off with capital is much higher than tax increases on consumer spending.

Why? I need an actual reason here. Something along the lines of 'it's better to transfer wealth from ordinary people to an investor class because _____'

No they do not. As a former trust tax accountant for a bank I can assure you of that. The income from such vehicles gets taxed to the individual recipients. I assume that the "family tax shelters" that you refer to are "generation skipping trusts." Such trusts save on estate taxes, but income taxes still get passed through.

I was thinking more along the lines of keeping money off shore, using the trust to buy education and assets for the beneficiary and other 'tax efficient' schemes. Since we have senior executives announcing on TV that they pay a lower rate of tax than their secretaries, and there is an entire industry dedicated to tax-efficient wealth management, we know some form of tax avoidance occurs, so the only discussion is really on the mechanism and scale.

4. Reduce regulations. The number of new regulations that have been promulgated just since Obama took office is enormous. What have these regulations accomplished? The vast majority are just political payoffs. They protect one private interest group or groups against competition from others while increasing costs for everyone. The public suffers.

The effect of the regulations is supposed to be to increase foreign investment in the US, by making it clear that the financial crisis that cost so many foreign investors their savings is unlikely to be repeated. It's also supposed to reduce the systemic risk of the banking industry. I can see that, for example, banks knowing exactly what risks they are taking and being able to track how and when those risks increase, is a burden. But I'm not sure why that would be a bad thing. Banks make money by taking risks. Reducing the amount of risk they can take does reduce their profitability, and increase the amount of capital they need, but a stable financial market is more valuable than a shaky one.

There are far more regulations than what you have mentioned.

<shrug> The biggest increase has been in the area I described. You want to take as fact the idea that regulations have no purpose, then I'll need evidence, because it's clearly a political belief, rather than an economic one.

Economic regulations increase costs and reduce growth. This isn't necessarily the case with health and safety regulations but it can incidentally be the case there as well.

More significant than the empirical question, however, is the philosophical one.

Actually no. If you want to base part of your argument on the idea that regulations have no purpose, then the empirical question 'do these regulations have no purpose' is pretty darned fundamental. If you want to take it as fact that economic regulations reduce growth, then again, the empirical question is of overwhelming importance.

Clearly it's hard to prove as some kind of natural law that regulations always retard growth, which is why demonstrating it on a case-by-case basis is so important. Even if it is a political belief you take as gospel truth.

What are the set of principles that tell us when you should regulate and when you shouldn't? And how should you go about it?

Well, in the EU they're published as a set of policy papers up to six times a year. The reason for the regulation, the intended impact, and the justification of the cost all has to be published and subject to public discussion. As a result of these discussions, the regulations are changed. Maybe in the US they just stick an finger in the air and guess, but it seems unlikely. Is it possible that there is actually a process, and you've just never tried to find out what it is?

Most economists agree that we can't do without market signals. So why should the Fed be setting interest rates?

Because markets without some regulation of interest rates tend to form boom and bust cycles which are considered disruptive to economic growth.

But in the current situation, the Fed did not reduce the systemic risk. It took it over so the Fed itself is, for practical purposes, insolvent.

That's how risk transfer works. You spread the risk around to make it easier to bear. The way banks make money is by taking on risks that would bankrupt smaller investors, which they can weather by virtue of their size, their ability to match investors to risks, and their ability to hedge risks on the international markets. In doing so they remove risk from the system, making borrowing and investing safer. That's how they justify their charges and make their profits. The recent crisis showed the extent to which banks in practice rely on the Federal government as a backstop, so the Fed has more formally taken on some of those risks, and is taking their cut by requiring banks to actually track their own activities more closely.

No. That completely eliminates the failure mechanism which is what makes capitalism work. The Fed was not created to bail-out insolvent banks. It was not created to assume risk. It was created to rescue illiquid banks from failure when they were otherwise solvent. It's job is to lend money money to solvent banks against good collateral. Taking back good collateral is the opposite of assuming the risk.

What you described is what the Fed did, but it violated all the principles of banking and most of the principles of economics. It took over toxic bank assets at book value which is certainly far higher than their market value.

Sure, but that's because the market value wasn't a useful indicator.

Say I've got 100 million dollars tied up in the mezzanine tranche of a derived sub-prime mortgage securitisation instrument (e.g.CDS squared). Then the financial crisis happens, and no one wants to buy anything with CDS or sub-prime, or even securitisation in the title. So what's the market value of my 100 million investment? Zero. No one will take it off my hands, because even having these things on your books is reason for suspicion and falling stock prices, so the price is zero. You literally can't give it away. It's still producing 5 million a year in coupon payments, because most of the people who have mortgages are still paying them, so we have the situation of something that cost 100 million to buy, with a market value of zero, paying out 5 million a year. You're insisting that the value of this should be the market value, and this zero, and thus that the bank should be insolvent? Why?

Meanwhile, the Wall Street banks are still in deep, deep trouble. This is obvious from the simple fact that we have yet to restore the "mark to market" rule.

They may never restore it. It's always been a fairly odd rule in any case, because it assumes efficient markets. At the moment, they aren't, and at any point where you'd care about the market value of the bank's assets, they wouldn't be. That's why the latest financial crisis saw assets being priced at less than their coupon payments (less than the cash they were producing).

I agree that the current markets are not efficient, but it is precisely because of the regulation that you endorse that they are not efficient. Of course banks should mark to market. You cannot evaluate the health of a bank if it hasn't written off bad loans.

Of course you can - there have been established accounting procedures for bad debt for decades if not centuries. Burying bad news, or bad debt, is neither new, nor a product of government regulation. What you can't do evaluate the balance sheet of a bank if no one can agree how to value certain instruments. Sub-prime CDS squared securtisations are new, the methods for valuing them are insufficient, and there needs to be a new standard for measuring them in light of recent events. Until that consensus emerges, the market is inefficient.

Fortunately, we have new... er... government regulations attempting to establish a new consensus of the valuation of such instruments, by quantifying the risk involved compared to more traditional products, and forcing disclosure on that basis. So we no longer have the unreported bad debt you were complaining about, and there are some signs that the market in simpler securitisation instruments is starting to move again, albeit at a steep discount. We have several banks, including wall street banks, speculating on the final price of these instruments, and in some cases starting to actively trade them again.

This isn't the only area of market inefficiency of course, it comes about whenever there is a product that is hard to value. We get similar market inefficiencies in such areas as third world government bonds, African industrial bonds and stocks, gold held in unstable countries, and the Russian gas market.

Banks can value their assets at pretty much anything they like.

Well, they can't, because of all those pesky regulations you're complaining about. The ones where you have to disclose what assets you're holding and how they're valued.

How they are valued is irrelevant if you don't know their present value. If their present value is zero, that needs to be disclosed.

If you want to use present value, why were you insisting on mark-to-market value? And what about book value, market value, fair value, or any of the other hosts of methods?

And the requirement to disclose any kind of value - that's the government regulation that you are decrying. The reason why we are having so many new regs is precisely because the earlier disclosure rules allowed companies to hide the value of their assets. How can you insist that regulations reduce growth on the one hand, and then demand that firms need to obey government regulations on the other?

Keep in mind, that when a company goes bankrupt, the creditors own the company. And when the creditors own the company, that company is debt-free.

No it isn't. As a creditor to a bankrupt bank, I can tell you that the company has to be run to the benefit of the creditors, first and foremost. That means if you want the business to keep going, you have to use money that would otherwise be going to creditors to keep it afloat and running. The trick is to present a plan that you can convince the majority of creditors will get them more money than just stripping the assets. That typically involves taking some small part of the business that has minimal assets but makes cash and keeping it afloat. Just as bailing out a bank involves taking the entire business and keeping it afloat. I'm not seeing much of a distinction between the two, here. The advantage of a bankruptcy is that the creditors can be convinced to slash the size of the liabilities in return for control over the company, while the advantage of a government bailout is that the creditors may not be capable of running the company. Certainly, in the case of Lehman Brothers Europe, the amount of the business they could keep running was tiny, and simply unwinding all the positions and chasing all the various counterparties for payment is likely to take 15 years or so. After you've paid for 15 years of accountants and lawyers, there won't be much left.

My statement stands. When a company goes bankrupt, the creditors own the company. Nothing you said refutes that.

That's because the statement I was refuting was that a creditor-owned company becomes debt free. It doesn't.

Of course, the creditors are represented by a bankruptcy trustee who tries to put the business in as good a shape as possible, and sometimes actual, physical liquidation may be the best route to go. There are no advantages to a government bail-out that I can see. At least not to the public.

Which is why I said they were broadly equivalent. As someone advocating one over the other, you should be able to see advantages in the private route, or else why the preference?

I'm not seeing why lowering taxes on profits would help in an economy where the baseline return on capital is close to zero in any case.

It won't. The baseline return on capital shouldn't be close to zero.

Then why are people wasting time lending money when they could be participating in the equities market? Capital tax is the same either way.

The "nightmare" that I described has to happen.

You've not said why, except that because rates are low, they must rise, and because the Fed is holding them down, they must rise sharply. Neither seems to be obviously true.

Then it wouldn't have been as severe as it is going to be.

Why does the delay increase severity? If debt is being repaid, and we're moving back to growth, delay is a good thing. No?

You've not said why, except that because rates are low, they must rise, and because the Fed is holding them down, they must rise sharply. Neither seems to be obviously true.

What you are saying is equivalent to the guy who says, "I don't see any point is spending all that money to fix the roof when it isn't raining." There's a hardship involved. It's going to rain someday, and fixing the roof won't stop all of the inconvenience of the rain, but that doesn't mean we shouldn't do what we can.

But it does mean we should not adopt the plan of removing parts of the house to fix the roof, until we are reasonably certain that clouds are starting to form. Because the longer we leave it, the more money we get for roof fixing, and the less of the house we have to dismantle. I mean, you're advocating deliberately triggering a rash of bankruptcies and liquidations - the action is drastic and painful - for the sake of avoiding... future liquidations and bankruptcies. I'm not seeing that you have sufficient reason to make this look like a good idea.

 

[ksen]

Corporations can't pay taxes. People pay taxes.

Aren't corporations people though? That's what the conservatives keep telling me.

"Corporations are people, my friend." - M. Romney

 

[boneyard bill]

Since interest rates are unprecedentedly low, it should be obvious that the only place they can go is up. And when interest rates go up ceterus paribus, asset prices fall. So we should be headed for a big jump in interest rates and when that happens, we would see a big decrease in bond, stock, and real estate prices. And there is no evidence that exogenous factors will rescue any of these markets. In other words, the Fed's bubble will burst. The only question is how long the Fed can keep interest rates this low.

Hang on though... The market price of assets falls, but why is that a bad thing?

It isn't necessarily, if you're free of debt. But if you have a lot of debt, the decline in asset prices reduces your ability to borrow money. So many businesses can face a liquidity problem that can tank the entire company. Then there's the added problem of being unable to raise money in the stock market.

Which again, would be a problem if you're an expanding company desperately looking for investment. But that's not the situation we're in. We're in a sluggish economy, where people are trying to pay off debt, not increase it. A company that can only survive by ever-increasing amounts of debt is unlikely to survive whether rates go up or not, so we're really looking at companies rolling over or servicing debt. But rates aren't going to go up unless there is a shortage of cash - because that's what the borrowing rate actually represents. The condition we're in, with high levels of debt, are the same conditions that are holding interest rates down.

No. Interest rates are being held down by deliberate action of the Fed through the purchase of US Treasuries... If the Fed were not purchasing treasuries, interest rates would go much higher.

That doesn't follow You're contending that, were it not for the actions of the Fed, interest rates would be much higher. I'm not seeing any reason to believe that the actions of the Fed are the only downward pressure here, or even the most important one.

Of course there are other downward pressures. Interest tends to fall in a recession. But we are supposedly in a recovery which means interest rates should be rising, but they aren't. So let's assume that that is due to the weakness of the recovery. You still have the problem that interest rates aren't simply low, they are at historical lows and real interest rates are possibly negative when you consider inflation. But there are more reasons for the assumption that I am making, and that is that the Fed states that it's policy in purchasing these bonds is to raise bond prices and therefore keep interest rates low. So there you have it. Interest rates are being set by the Fed as a deliberate part of their policy.

High levels of debt produce higher interest rates, not lower.

Not sure I agree there. High levels of debt would normally indicate lots of excess cash in the system. Why would that make borrowing money harder?

Higher levels of debt mean there is less cash in the system because it has already been borrowed. Of course, that's "other factors equal" so if more money is being created that wouldn't necessarily apply. In that case, high levels of debt could indicate that more money is being created. The Fed's monetary policy is doing just that.

What we have at the moment is sluggish lending because risks are high, returns are low, and many companies that would otherwise invest are instead paying off their liabilities. This is particularly the case with financial lenders, who have a larger obligation to hold cash than they did before the crash. So we have potential lenders building up their balance sheets, and potential borrowers clearing their liabilities. The reason why investment isn't taking place is because of the risks involved, not because of a shortage of cheap liquidity. In order to move back to growth we need stability (i.e. less risk), which means clearing debt, or at least moving back to a level of indebtedness that would survive interest rates going up.

I agree with the general idea you express here. But I disagree that companies are not investing because they need to pay down debt. In general that is not the case at the moment. Many companies are taking advantage of the low interest rates to buy back their own stock. This increases earnings per share even if total earnings are not going up and that increases the stock price and executive's bonuses.

Well of course they are. Interest rates are tiny, and dividend payments are not. Buying back stock makes more sense for a heavily indebted company than paying off debt, because it reduces your outflow. But that's still in the same basket of actions - paying off debt, saving, amassing assets - that indicate they are hoarding money rather than investing. Whether they are paying off the debt directly, or acquiring assets to hold against debt isn't really the point.

If your point is that the Fed's policy has not produced a stimulus that leads businesses to invest (The stated object of its policy), I agree.

Well you just explained why they would go insolvent. Because of debt.

That's not enough. You're suggesting that we get a sharp rise in the scarcity of cash at the same time that vast numbers of people are paying out debt payments. The very conditions that create low interest rates are the one's you're concerned about should interest rates rise.

The only way I can see this coming about is if there is an uneven recovery. If, hypothetically, you moved all the wealth into a small sub-segment of the population, and they then all invested abroad, then you could get a headline rise in the interest rate (borrowing rate) in the US at the same time that everyone else ran out of cash. You'd still need some kind of active recessionary force, such as a shift in the tax burden in favour of the small sub-segment and against the indebted majority. But otherwise you're saying that everyone runs out of cash while they're paying so much of it to each other, which is a bit like saying interest rates and asset prices go up at the same time.

Debt retirement destroys cash. When a bank makes a loan, it creates cash. When that loan is paid off, the cash disappears. It also disappears when debts are liquidated through bankruptcy. That is what is going to happen.

Yes, of course. The vast amounts created by indebtedness of companies and individuals will be gradually paid back, and the money supply will go back to saner levels. I'm not seeing the 'crash' bit though, because the process occurs as debt is paid off, not in advance of it.

No. Debts that are paid off to the banks are typically re-lent very quickly so there is no reduction in the money supply overall. It's the routine way the economy works when things are going well. However, when you have a rash of bankruptcies coming all at once, that money is lost and the banks do not automatically restore it because they are in bad shape due to the bankruptcies and the demand for money also declines because people are laid off, tightening their belts, etc.

Typically, the reason for the bankruptcies was the prior boom. Excess money creation during the boom created elevated asset values that couldn't be sustained. The Fed had to tighten credit and this produces the crash. The Fed has to tighten credit out of fear of consumer price inflation. What they haven't figured out is that the asset price increases which they had encouraged IS inflation. So they create bubbles thinking that they can get away with it until the excess money actually produces consumer price inflation. That's pretty much what they're doing again. They've created bubbles in the stock market, the bond market, and real estate, and they say that's OK because we don't have consumer price inflation (although we do, but they don't count any thing more than 2% has inflation and then rig the numbers to keep it below 2%).

So they're doing the same thing they did that produced the dot.com bubble which they burst for fear of inflation and then proceeded to create a real estate bubble as a "recovery" from the dot.com bubble. Then, of course, that burst and now we're in a new set of bubbles, but this time it isn't producing much of a recovery because the bursting of the real estate bubble did too much damage.

The trillions that the Fed has created will disappear and the economy will crash as the money supply settles back to where it was. The policies that I have advocated will trigger this sooner rather than later, and therefore reduce the severity.

eh? Debt is being paid off, and the real economy is recovering. That's precisely why interest rates are being held down, to encourage this process. Why would triggering it earlier make it 'less severe'?

They are not allowing prices to reset. Real estate prices dipped for a short while but Fed policy (deliberately) pushed them back up again part way, but now it appears that that is petering out.

When you create a bubble, you lure capital into bad investments. Producers are attracted to the high prices of the bubble assuming that it is simply the result of a good economy. That can be true if the demand is backed by real production. (i.e. the demand for housing in North Dakota). But when the demand is fostered only by easy credit that cannot be sustained, then you've got a bubble which will eventually crash.

So this policy of creating bubbles by easy credit doesn't just create a false prosperity, it actually destroys capital as money get poured into an unprofitable area and the resources expended cannot be fully recovered.

But if there is any chance, this is what we need.

1. Reduce the budget deficit and put balanced budget plan into effect that would include entitlement reform to reduce entitlement spending. (i.e. social security, medicare, Medicaid).

Why entitlement spending in particular? Wouldn't that just increase the indebtedness of such groups? I don't see how transferring wealth from one group to another (ie reducing taxes for all by reducing spending on a particular segment of society) fits in to your argument.

The problem with entitlements is their exponential growth.

That is a problem, yes, in that the figure we need in X years time is higher than it is now. But that's not connected to anything else you've presented so far.

The aging of the baby boomers and the rising costs of health care lead these programs to grow in expense far faster than tax revenue grows. Raising taxes would solve that problem for only the year in which the taxes were increased. The increased tax revenue would then increase in subsequent years only in line with economic growth. Likewise, cuts in defense or other discretionary items only represent a one-time reduction.

But defence spending also grows every year, and the amount we'll need in X years time is higher than it is now. Surely the same argument applies? Weapons increase in cost and sophistication every year in the same way as medical care. Indeed it's the same process driving both effects. So why entitlement cuts rather than defence cuts? Obviously you can prefer one to the other, but I'm not seeing an economic driver here.

No. Defense spending is subject to the appropriation process. Entitlements are not. Suppose the economy is growing at 4% per year and tax revenue is growing at the same rate. But now suppose that entitlements are growing at 7% per year. It should be clear that you are going to be running deficits in this area for as long as those rates continue. A tax increase will only close the gap for one year because the increase taxes will only grow at 4% rate while expenditures grew at a 7% rate. The same is true for cuts elsewhere in the budget. They could close the gap for only one year.

No it isn't true for cuts elsewhere in the budget, only for cuts in programs that don't increase in size faster than the economy.

It's true for all areas of the budget that are subject to the appropriation process.

The logic you've presented says that entitlements are a special case because the liabilities they represent are due to increase faster than tax revenue/growth. Which is true and has been true for decades, but that doesn't make them a special case. The reason this is a problem is because the entitlements programs have not been fully funded to meet their future liabilities. So there is a hole there. We can solve this hole in the same way as any other debt, by raising taxes or cutting spending. Clearly, because the demographic shift is likely to be very expensive, you favour cutting such payments rather than raising taxes to cover them, but that's purely a political preference. There's nothing magical about this future liability that isn't equally true of any other.

I thought I made the math on this pretty easy but apparently not. Or perhaps you just didn't follow the narrative carefully enough. Let me spell it out.

Budget year 1 balanced - $1,000,000.

Expenditures rise by 7% - $70,000. Revenue rises by 4% - $40,000

Budget year two - $1,070,000 expenditures, $1,040,000 revenue.

We have a deficit of $30,000. We raise taxes to balance the budget for year 3.

Budget year three - $1,144,900 expenditures. Revenue $1,081,600 plus $63,600 tax increase.

The budget for year three is balanced due to the tax increase.

Budget year four - $1,144,900 plus 7% growth in expenditures and $1,144,900 plus 4% growth in revenue.

Despite our tax increase, the budget for year four in not balanced. That's because the tax increase only increases the RATE of revenue growth for the year in which it was enacted. To keep the budget balanced in the face to the rapid expenditure growth, you would have to raise taxes every year, but even that wouldn't work as you would eventually reach the point of diminishing return where the tax increases would produce less revenue instead of more.

So you have to cut expenditure growth. With discretionary spending items such as defense, you can do that within the budgetary process each year, but with entitlements, you have to change the law.

So my recommendation here is not a political preference. It is forced by the mathematics of the situation.

Entitlements are part of the law... Defense spending, in contrast, can be reduced in the next budget simply through the appropriation process,

Again this is a political difficulty, rather than an economic one.

I think I've shown that it's cooked into the mathematics of it.

eh? If the tax is on profits (i.e. capital increase), then the investments only become more viable if they make the investment a better return than lending the money at the prevailing interest rate. And the prevailing interest rate is near zero. In times of high interest rates, this might be good advice, but in the present climate, it's just throwing a subsidy money at the problem. The economy is already awash with cash - that's what a low interest rate means - that money is cheap to borrow. The problem is find someone safe to lend it to or invest it in, which means the issue is the riskiness of lending. Rather than making already profitable activity more profitable, you're better off dealing with the risks involved.

But the low interest rate policy isn't working. I've already said we need an increase in interest rates.

Um.. Only because an increase would be a disaster, and you want to get that disaster over with. That's not, in itself, a compelling reason.

I agree. If I were a politician, I probably wouldn't follow my own advice to the full extent. We need to reduce the deficit so that should be our focus, and a lower deficit would mean that the Fed could keep interest rates low without having to be as aggressive as it is in money creation. This is a bit more modest but wouldn't likely do much immediate harm to the economy. You could also cut some taxes on capital that wouldn't cost too much in revenue and could be made up with minor increases elsewhere. That's basically what most Republicans are proposing. It isn't the full monty, but it would still alleviate the crash somewhat when it does occur.

So reductions in taxes on capital need to be understood as functioning within the context of the entire policy that I am proposing. In other words, low taxes on capital need to be seen as a substitute for low interest rates.

So you increase interest rates for everyone, but then subsidise one particular sector - investors to reduce the impact., by reducing taxes on capital to match. That's still a wealth transfer, and you've still not given a reason why it's a good idea for that one sector alone.

I don't want to increase or lower interest rates. I want the market to set interest rates. I simply predict that the market would set interest quite a bit higher. The artificially low interest rates that the Fed has said is a subsidy to some sectors at the expense of other sectors.

A tax cut is not a subsidy. It's letting people keep the money they earned. So I'd like to see taxes cut across the board, but given the budgetary situation, that isn't possible. Reducing taxes on capital will help the economy so people who don't get the tax cut will also benefit.

So a 50% tax reduction wouldn't mean a 50% reduction in revenue.

That's true of any tax reduction. It's also true of any tax increase.

Yes. But the trade off with capital is much higher than tax increases on consumer spending.

Why? I need an actual reason here. Something along the lines of 'it's better to transfer wealth from ordinary people to an investor class because _____'

I meant to say tax cuts on consumer spending. Investment increases employment and puts people to work so they pay taxes on their earnings. Consumer spending doesn't do that. Of course, modern Keynesians and Monetarists, the "demand-side" schools think consumer spending will stimulate the economy because they assume that demand is money. That doesn't make much sense. Demand is a product or service. So you need production to increase true demand. But that's an argument that is on-going on another thread.

No they do not. As a former trust tax accountant for a bank I can assure you of that. The income from such vehicles gets taxed to the individual recipients. I assume that the "family tax shelters" that you refer to are "generation skipping trusts." Such trusts save on estate taxes, but income taxes still get passed through.

I was thinking more along the lines of keeping money off shore, using the trust to buy education and assets for the beneficiary and other 'tax efficient' schemes. Since we have senior executives announcing on TV that they pay a lower rate of tax than their secretaries, and there is an entire industry dedicated to tax-efficient wealth management, we know some form of tax avoidance occurs, so the only discussion is really on the mechanism and scale.

You can have higher rates and lots of loopholes or you can have lower rates and fewer loopholes, but you can't have higher rates and fewer loopholes. That creates real problems for the economy has capital flees overseas and eventually, the capitalists themselves will flee overseas if you try to enforce high rates too rigorously.

Back in the '60's when the top rate was 70%, John D. Rockefeller III said he paid about 15% in income tax, the same rate Warren Buffet claims to pay today with much lower rates.

4. Reduce regulations. The number of new regulations that have been promulgated just since Obama took office is enormous. What have these regulations accomplished? The vast majority are just political payoffs. They protect one private interest group or groups against competition from others while increasing costs for everyone. The public suffers.

The effect of the regulations is supposed to be to increase foreign investment in the US, by making it clear that the financial crisis that cost so many foreign investors their savings is unlikely to be repeated. It's also supposed to reduce the systemic risk of the banking industry. I can see that, for example, banks knowing exactly what risks they are taking and being able to track how and when those risks increase, is a burden. But I'm not sure why that would be a bad thing. Banks make money by taking risks. Reducing the amount of risk they can take does reduce their profitability, and increase the amount of capital they need, but a stable financial market is more valuable than a shaky one.

There are far more regulations than what you have mentioned.

<shrug> The biggest increase has been in the area I described. You want to take as fact the idea that regulations have no purpose, then I'll need evidence, because it's clearly a political belief, rather than an economic one.

You're only talking about the regulations since the bank meltdown. There are many more regulations than that. From what I have heard, banks are even less solvent than they were at the time of the meltdown. As far as bank regulations go, the FDIC guarantees the bank deposits. It would be appropriate, therefore, for the FDIC to put certain requirements on the banks the way any private insurance company would do or else demand higher premiums for the added risk. But that isn't the way the government does it. The FDIC has never charged an adequate fee for their service, and the requirements of Dodd/Frank do not appear to have been written with that in mind. Given the well-known connections to the Wall Street banking industry that both Dodd and Frank are famous for, I doubt these regulations are anything but a banker's bill.

Economic regulations increase costs and reduce growth. This isn't necessarily the case with health and safety regulations but it can incidentally be the case there as well.

More significant than the empirical question, however, is the philosophical one.

Actually no. If you want to base part of your argument on the idea that regulations have no purpose, then the empirical question 'do these regulations have no purpose' is pretty darned fundamental. If you want to take it as fact that economic regulations reduce growth, then again, the empirical question is of overwhelming importance

.

I'm sure they have a purpose for somebody. When the ICC was created to regulate the railroads, the first thing they did was raise railroad rates. When the airlines were de-regulated in the '70's, however, we saw a substantial reductions in airline fares. So the first issue that has to be addressed is whether any regulation can produce a more favorable outcome for the public than regulation through competition would produce.

But the issue I'm addressing is not fundamentally an empirical question. When the physiocrats formulated the law of supply and demand, they did so by looking at the real world, but their principle was largely an analytical one. Given what we see, why does it work? Likewise, the subjective theory of value was an analytical issue. Given our existing analysis of an exchange, how is value determined?

So the question I'm asking is what are the broad principles of regulation that produce an argument in it's favor? What principle says that a bunch of bureaucrats, appointed due to political influence, can or will come up with regulations that produce a better outcome for the public than what the freedom of individuals operating in a free market as consumers and producers is able to produce?

Clearly it's hard to prove as some kind of natural law that regulations always retard growth, which is why demonstrating it on a case-by-case basis is so important. Even if it is a political belief you take as gospel truth.

No. I think the analytical argument is already there. The principles of the free market already suggest that regulations will do that. The burden of proof is on those who would impose regulations.

For example, where is the argument that government rules and regulations on airline safety would produce safer air travel than the rules and the regulations the airlines themselves would adopt? Where is the government interest or expertise that exceeds the interests or expertise of the airlines?

What are the set of principles that tell us when you should regulate and when you shouldn't? And how should you go about it?

Well, in the EU they're published as a set of policy papers up to six times a year. The reason for the regulation, the intended impact, and the justification of the cost all has to be published and subject to public discussion. As a result of these discussions, the regulations are changed. Maybe in the US they just stick an finger in the air and guess, but it seems unlikely. Is it possible that there is actually a process, and you've just never tried to find out what it is?

Of course there's a process but I don't think that it is generally as open and above-board as the process you describe. Nonetheless, the process you describe presupposes that there will be regulations and merely addresses the issue of what those regulations will be. And the fact that such a process exists does not demonstrate that it is efficacious. Again, there are no general principles expressed here that justify regulation. Each situation is judged separately, but each situation has winners and losers and that factors into the discussion from the very start.

Most economists agree that we can't do without market signals. So why should the Fed be setting interest rates?

Because markets without some regulation of interest rates tend to form boom and bust cycles which are considered disruptive to economic growth.

Exactly the opposite. Bubbles can clearly be traced to the activities of the Fed, and the interest rate and lending policies that it seeks to impose. Other factors can play a part, but Fed policy is the elephant in the living room on this issue.

But in the current situation, the Fed did not reduce the systemic risk. It took it over so the Fed itself is, for practical purposes, insolvent.

That's how risk transfer works. You spread the risk around to make it easier to bear. The way banks make money is by taking on risks that would bankrupt smaller investors, which they can weather by virtue of their size, their ability to match investors to risks, and their ability to hedge risks on the international markets. In doing so they remove risk from the system, making borrowing and investing safer. That's how they justify their charges and make their profits. The recent crisis showed the extent to which banks in practice rely on the Federal government as a backstop, so the Fed has more formally taken on some of those risks, and is taking their cut by requiring banks to actually track their own activities more closely.

No. That completely eliminates the failure mechanism which is what makes capitalism work. The Fed was not created to bail-out insolvent banks. It was not created to assume risk. It was created to rescue illiquid banks from failure when they were otherwise solvent. It's job is to lend money money to solvent banks against good collateral. Taking back good collateral is the opposite of assuming the risk.

What you described is what the Fed did, but it violated all the principles of banking and most of the principles of economics. It took over toxic bank assets at book value which is certainly far higher than their market value.

Sure, but that's because the market value wasn't a useful indicator.

Say I've got 100 million dollars tied up in the mezzanine tranche of a derived sub-prime mortgage securitisation instrument (e.g.CDS squared). Then the financial crisis happens, and no one wants to buy anything with CDS or sub-prime, or even securitisation in the title. So what's the market value of my 100 million investment? Zero. No one will take it off my hands, because even having these things on your books is reason for suspicion and falling stock prices, so the price is zero. You literally can't give it away. It's still producing 5 million a year in coupon payments, because most of the people who have mortgages are still paying them, so we have the situation of something that cost 100 million to buy, with a market value of zero, paying out 5 million a year. You're insisting that the value of this should be the market value, and this zero, and thus that the bank should be insolvent? Why?

Actually, that's what TARP was supposed to do. The Treasury was originally supposed to buy the toxic assets and then seek to market them. But TARP failed in the House and had to be voted on again and the new bill included a provision that bank executives couldn't get bonuses until TARP was re-paid. So Secretary Paulson abandoned the original strategy and just lent the money to the banks, and the Fed took over the toxic assets (and is still buying them). Then the banks promptly re-paid the TARP loan and pocketed their bonuses.

So now the Fed has these toxic assets and has done little or nothing to market them.

I didn't say that the SEC shouldn't have suspended mark to market. That may, in fact, have been all that was really necessary. That would have given the banks time to do what they are apparently doing now. What I said is that the failure to restore mark to market is evidence that the banks are insolvent. Despite the Fed having bought trillions in toxic assets, the banks still cannot withstand the scrutiny of mark to market.

Meanwhile, the Wall Street banks are still in deep, deep trouble. This is obvious from the simple fact that we have yet to restore the "mark to market" rule.

They may never restore it. It's always been a fairly odd rule in any case, because it assumes efficient markets. At the moment, they aren't, and at any point where you'd care about the market value of the bank's assets, they wouldn't be. That's why the latest financial crisis saw assets being priced at less than their coupon payments (less than the cash they were producing).

I agree that the current markets are not efficient, but it is precisely because of the regulation that you endorse that they are not efficient. Of course banks should mark to market. You cannot evaluate the health of a bank if it hasn't written off bad loans.

Of course you can - there have been established accounting procedures for bad debt for decades if not centuries. Burying bad news, or bad debt, is neither new, nor a product of government regulation. What you can't do evaluate the balance sheet of a bank if no one can agree how to value certain instruments. Sub-prime CDS squared securtisations are new, the methods for valuing them are insufficient, and there needs to be a new standard for measuring them in light of recent events. Until that consensus emerges, the market is inefficient.

Fortunately, we have new... er... government regulations attempting to establish a new consensus of the valuation of such instruments, by quantifying the risk involved compared to more traditional products, and forcing disclosure on that basis. So we no longer have the unreported bad debt you were complaining about, and there are some signs that the market in simpler securitisation instruments is starting to move again, albeit at a steep discount. We have several banks, including wall street banks, speculating on the final price of these instruments, and in some cases starting to actively trade them again.

This isn't the only area of market inefficiency of course, it comes about whenever there is a product that is hard to value. We get similar market inefficiencies in such areas as third world government bonds, African industrial bonds and stocks, gold held in unstable countries, and the Russian gas market.

Banks can value their assets at pretty much anything they like.

Well, they can't, because of all those pesky regulations you're complaining about. The ones where you have to disclose what assets you're holding and how they're valued.

How they are valued is irrelevant if you don't know their present value. If their present value is zero, that needs to be disclosed.

If you want to use present value, why were you insisting on mark-to-market value? And what about book value, market value, fair value, or any of the other hosts of methods?

Market value is the present value. But I wasn't insisting on mark to market. I think it was appropriate at the time to suspend it. But the failure to restore mark to market certainly suggests that the banks still have serious solvency issues.

And the requirement to disclose any kind of value - that's the government regulation that you are decrying. The reason why we are having so many new regs is precisely because the earlier disclosure rules allowed companies to hide the value of their assets. How can you insist that regulations reduce growth on the one hand, and then demand that firms need to obey government regulations on the other?

When I speak of regulations, I am not referring to rules that support laws against fraud and abuse or even to regulations that improve transparency. Those are just extensions of the government's responsibility to enforce contracts. We have the generally accepted accounting rules, but if the government is involved then they need to pass a law even if the law is only about accepting those rules but, of course, there are times when altering those rules can be necessary. One obvious case is taxes. Tax law does not always dovetail with generally accepted rules.

This is very different from the "fine-tuning" regulation of the economy that is routinely practiced by the Fed.

Keep in mind, that when a company goes bankrupt, the creditors own the company. And when the creditors own the company, that company is debt-free.

No it isn't. As a creditor to a bankrupt bank, I can tell you that the company has to be run to the benefit of the creditors, first and foremost. That means if you want the business to keep going, you have to use money that would otherwise be going to creditors to keep it afloat and running. The trick is to present a plan that you can convince the majority of creditors will get them more money than just stripping the assets. That typically involves taking some small part of the business that has minimal assets but makes cash and keeping it afloat. Just as bailing out a bank involves taking the entire business and keeping it afloat. I'm not seeing much of a distinction between the two, here. The advantage of a bankruptcy is that the creditors can be convinced to slash the size of the liabilities in return for control over the company, while the advantage of a government bailout is that the creditors may not be capable of running the company. Certainly, in the case of Lehman Brothers Europe, the amount of the business they could keep running was tiny, and simply unwinding all the positions and chasing all the various counterparties for payment is likely to take 15 years or so. After you've paid for 15 years of accountants and lawyers, there won't be much left.

My statement stands. When a company goes bankrupt, the creditors own the company. Nothing you said refutes that.

That's because the statement I was refuting was that a creditor-owned company becomes debt free. It doesn't

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If it isn't debt free, it has creditors and if it has creditors, the creditors do not own the company. Of course, the creditors may need to borrow money to provide working capital just to keep the company going.

Of course, the creditors are represented by a bankruptcy trustee who tries to put the business in as good a shape as possible, and sometimes actual, physical liquidation may be the best route to go. There are no advantages to a government bail-out that I can see. At least not to the public.

Which is why I said they were broadly equivalent. As someone advocating one over the other, you should be able to see advantages in the private route, or else why the preference?

I don't see your point here.

I'm not seeing why lowering taxes on profits would help in an economy where the baseline return on capital is close to zero in any case.

It won't. The baseline return on capital shouldn't be close to zero.

Then why are people wasting time lending money when they could be participating in the equities market? Capital tax is the same either way.

Again, what's your point?

The "nightmare" that I described has to happen.

You've not said why, except that because rates are low, they must rise, and because the Fed is holding them down, they must rise sharply. Neither seems to be obviously true.

The Fed is holding them down through monetary inflation i.e it is creating the money to do it. This is creating asset price inflation, but so far it hasn't produced consumer price inflation. When it produces consumer price inflation, interest rates will rise as investors will demand higher rates to cover the increase in prices. Even now effective, real interest rates are barely covering the low inflation that we have. But as the Fed continues to create money, it will eventually produce consumer price inflation or, as happened with the dot.com and real estate bubbles, the Fed, fearing the inflation rise, will reduce tighten credit to reduce money creation and that, too, will cause interest rates to rise.

Then it wouldn't have been as severe as it is going to be.

Why does the delay increase severity? If debt is being repaid, and we're moving back to growth, delay is a good thing. No?

You've not said why, except that because rates are low, they must rise, and because the Fed is holding them down, they must rise sharply. Neither seems to be obviously true.

I've explained why interest rates will have to rise in the above post. The delay increases the severity because the bubble destroys capital. We aren't simply not growing. The long term effect is a decline in American productivity.

What you are saying is equivalent to the guy who says, "I don't see any point is spending all that money to fix the roof when it isn't raining." There's a hardship involved. It's going to rain someday, and fixing the roof won't stop all of the inconvenience of the rain, but that doesn't mean we shouldn't do what we can.

But it does mean we should not adopt the plan of removing parts of the house to fix the roof, until we are reasonably certain that clouds are starting to form. Because the longer we leave it, the more money we get for roof fixing, and the less of the house we have to dismantle. I mean, you're advocating deliberately triggering a rash of bankruptcies and liquidations - the action is drastic and painful - for the sake of avoiding... future liquidations and bankruptcies. I'm not seeing that you have sufficient reason to make this look like a good idea.

If we had done that in 2008 instead of bailing out the banks, the problem would have been solved by now and the economy would be back on track. But now the problem is much worse. Not only are the Wall Street banks insolvent, so is the Fed. So the crash will be much worse now that it would have been in 2008, and if we have the crash now, it will not be as bad as if we wait until 2016 or so.

If your car is heading down hill out of control at break-neck speed, you do not gently tap the breaks. You slam on the breaks and seek to gain control of the car now rather than later.

We've been doing all the wrong things. So when is a good time to do the right things? I would say that now is better than later.

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Aren't corporations people though? That's what the conservatives keep telling me.

"Corporations are people, my friend." - M. Romney

As I noted Romney is a moderate, not a conservative.

You think citing one person settles the issue?

 

[ksen]

Aren't corporations people though? That's what the conservatives keep telling me.

"Corporations are people, my friend." - M. Romney

As I noted Romney is a moderate, not a conservative.

You think citing one person settles the issue?

You think Mitt Romeny is the only one that believes that? Maybe you're unaware of the Hobby Lobby case and all the support the Right gave to a corporation seeking to exercise its first amendment rights?

 

[ksen]

If we had done that in 2008 instead of bailing out the banks, the problem would have been solved by now and the economy would be back on track. But now the problem is much worse. Not only are the Wall Street banks insolvent, so is the Fed.

Saying the Fed can go insolvent is stupid. As long as the Fed can just print money it can't go insolvent.