Poking around in FRED while thinking about money created by banks and by government, I came up with the following graph, which I found to be pretty eye-popping:
Federal Debt Held by the Public as a Percentage of Total Credit Market Debt Owed
That’s a pretty profound secular shift. But far from delivering any obvious conclusions for me, it raises several questions.
• First, what’s included in TCMDO? (Is there a glossary of these measures available somewhere? I haven’t been able to find one.) I assume government bills and bonds are included — including those held by the Fed. I assume it does not include bonds held by the Social Security trust fund — nonpublic debt. (Or does it?)
• Since financial industry debt is “different,” what does the graph look like if we exclude that?
Federal Debt Held by the Public as a Percentage of (Total Credit Market Debt Owed – Financial Sector Debt Owed)
• Should we adjust for credit-market instruments held by the Fed?
• Are there more illuminating measures to display in this graph?
• What does this say about the stock of “safe assets” in the economy?
• How does this relate to JKH and Steve Waldman’s notions of government money (created through deficit spending) as “leverage” — in Michael Sankowski’s words: “JKH points out (S-I) is like the denominator in leverage. When (S-I) [govt deficit spending plus/minus trade imbalance] gets too small compared to S or I, then the private sector steps in with private creation of S. But these claims aren’t always as credible as government NFA. Plus, private sector S can sometimes be marked to market in ways which makes valuation difficult.”
Sorry to be so inconclusive. As always I’m hoping to be educated by finer minds than mine.
College-educated Republicans are more likely to deny scientific reality.
They don’t spend their time in college (or life) trying to learn how the world works; they spend it learning how to mine, harvest, cherry-pick, and twist any “facts” they can find to conform to, and support, their faith-based beliefs.
Is it any wonder that among scientists — who devote their lives to trying to figure out how the world works — 55% are Democrats and only 6% are Republicans? (Click for source.)
Imagine an economy that consists of two households, one firm, one bank, and one government.
The government issues $50 to each household (maybe they do some work for it), crediting their bank accounts and running a $100 deficit. Voila! There’s money!
Now one household works for the firm, creating $50 in value, goods. The firm gives the household $50 in equity — company stock — basically a promise to give them some amount of money in the future. (The firm posts the $50 in newly created value as an asset on the lefthand side of their balance sheet, and $50 as shareholder equity on the righthand side — a liability).
The household can’t use that equity to buy a pack of gum today, so they want to monetize it — sell it to someone else. There’s only one “someone” — the other household.
But what if the other household doesn’t want to buy it because they’ve only got $50 and want to hold it for the future? (It’s the babysitting coop dilemma.)
This is why in a growing economy where extra value is being created through people’s efforts, the government has to run deficits — creating money by crediting people’s/firms’ accounts with newly “printed” dollars.
If people can’t convert that extra value they’ve created into general-purpose “credit” (dollars) that can be exchanged for a variety of goods, they can’t spend. Which 1) gives them notably less incentive to create the value in the first place, and 2) prevents them from continuing the buying/selling log-rolling exercise that is our economy.
You’ve got a lot of newly created value/goods, but nobody with money to buy them.
Imagine if the cumulative government deficits today — the stock of money that government has spent into existence — were at the same level it was in 1900. The economy would be completely inoperable, locked up in primitive barter arrangements for lack of general-purpose money.
Another way to think about this: money — created, provided, by government as a public good — is a means for us to save consumption for the future. (“Saving consumption” is a funny concept, but it’s what we do when we put dollars under a mattress.) The only other way to do so is to create consumable real assets that will last, including those that can be used to create more consumables in the future (themselves being consumed in the process). It’s pretty impractical for a household to save all their consumption in this way, for all sorts of physical, personal, and logistical reasons.
The point of collecting taxes isn’t that the government needs money (it can print money) it’s that if the quantity of taxes is too low relative to the stock of money, then the money loses its value and the price level rises.
He’s riffing on the the idea that tax obligations are the ultimate source of sovereign currencies’ value, the reason everyone has to accept that currency’s value, but I think he’s simplifying things to the point of error.
At least, he should be talking about deficits/surpluses and their Inflation/deflation effects, not just taxes. Now I suppose if you add ceteris paribus re government spending to his statement, it carries more water. But still, this doesn’t really follow: A) the ultimate value of dollars derives from their utility in retiring tax obligations, so B) more taxation makes dollars more valuable.
Assuming the economy is “trying” to reach equilibrium, this suggests that it “wants” less workers.
If that is a secular trend, as suggested by the steadily lengthening jobless recessions since the 80s,
…we’re faced with the need for a new structure wherein people’s claims to a decent share of the pie are not linked to their ability (luck) in finding well-compensated employment. Alternative means are necessary to provide widespread prosperity and the widespread demand that gives producers the incentive to expand and innovate.
The basic problem with this and all comprehensive tax reforms, of course, is that the political system doesn’t work this way, can’t work this way, never has worked this way. We only move forward, improve the system, over centuries — with fitful, stumbling, fumbling steps, forward and backward, never addressing the whole economic ecosystem.
It makes biological evolution look downright intentional and speedy, by comparison.
All that said, I like this proposal. See what you think.
1. Federal Income Tax:
All income and compensation is taxed at a 20% rate except:
– Income under a realistic poverty line (eg $15,000 for a single person), which is taxed at 2% instead
– Income used to pay for large medical expenses (>10% of income) is tax-free
– Income placed into tax-free education-retirement savings account (with modest caps)
– No other adjustments, deductions, or exemptions
Effective rates: 10% on $60,000; 15% on $160,000; 19% on $1,000,000.
Totals about 65% of federal revenue.
2. Federal Net-Worth Tax:
All net worth (accumulated wealth), except the first ~$800,000 is taxed at a progressive 1-1.7% rate.
This tax replaces property, capital gains & estate taxes. Net-worth is the best measure of how much a household has profited from the economic infrastructure governments (all taxpayers) provide.
Effective rates: 0.2% on $1million; 1.0% on $3million; 1.7% on $27million and over.
Totals about 20% of federal revenue.
3. Federal War Tax: Everyone contributes to any war effort: A 6% surcharge increases a federal taxes bill of $10,000 to $10,600 while the nation is at war.
4. Eliminate all these taxes:
– Social Security Taxes – Social Security & Medicare funded from general revenue instead
– Estate Taxes & Capital Gain Taxes – Replaced by more efficient and fair Net-worth Tax
– State Income Taxes in their current form – Replaced by more efficient and fair surcharge – See #5
– Property (real estate) taxes – Replaced by more efficient and fair surcharge – See #5
– Sales taxes, tolls, etc. – Replaced by more efficient and fair surcharge – See #5
– Corporate Taxes – Profits distributed to corporate owners and taxed as income.
5. All states and local governments eliminate all their current taxes and instead set and collect a surcharge on a household’s combined Federal Income and Net-worth Tax.
6. Excise taxes only on products that have a cost to society that is not reflected in their price … e.g. cigarettes, gasoline. Totals only about 10% of federal revenue.
Bruce Wilder had an excellent comment recently in the Crooked Timber thread on markets, economic rents, and the constraints on economic actors, excerpted by Dan here, and more with comments by Jazzbumpah here. (If you like the thinking there, run don’t walk to read this windyanabasis post and comments.)
The emphasis on constraints prompts me to revisit a post I made a few years back, pointing out that constraints, not innovation, are the shaping forces of economies:
Lane Kenworthy’s Big Idea
Attributing the robust state of modern economies to the “free” market is like saying that Arabian stallions, champion Rottweilers, and freshly-picked sweet corn are the result of mutation.
The reason actors engage in economically beneficial behavior, according to the [neoclassical] theory, is not that they have unlimited freedom of choice, but that they must choose within a particular set of constraints — the constraints imposed by market competition. … It is this constraint, rather than freedom of choice, that is the crucial efficiency-generating mechanism in a capitalist economy.
In other words, extolling the “free” part of free markets is like getting all drippy about mutation without selection. More Kenworthy:
The issue is not free choice versus constraints, but what type of constraints produce economically productive activity.
Natural selection — in this case the constraints imposed by the natural and human environment and by other free-market agents — is a powerful force. But Kenworthy asks, quite reasonably, whether it is always more efficiency-producing than artificial selection (a.k.a. human-directed selection, a.k.a….breeding). In many cases, the visible hand of government creates more efficient markets.
Free-market advocates tend to ignore the reality that market-generated constraints often act directly against the formation of efficient markets. To choose what is perhaps the most obvious example: competition creates huge incentives for market participants to make sure that all information is not known. Disclosure regulations address that inefficiency, and result in the kind of robust open markets we see today in prosperous countries. Kenworthy gives three more (detailed and well-analyzed) examples in his chapter.
Even Adam Smith doesn’t assert that market constraints have some a priori claim to superiority. Says Kenworthy, quoting Smith,
…an individual who “intends only his own gain” is “led by an invsible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.”
“Nor is it always.” “Frequently.” Cherry-picked, at least, it verges on a mealy-mouthed endorsement. Smith, in his wisdom, is not nearly so categorical as his latter-day disciples.
Kenworthy’s attention to constraints — market-imposed and otherwise — strikes me as a profound insight, cutting straight to the heart of the laissez faire philosophy of neoclassical economics. But the idea — at least in this form — has not been taken up much by mainstream economists. A notable exception is Kenworthy’s colleague Wolfgang Streeck (who Kenworthy credits with inspiring his chapter in the first place).*
Any knowledgeable economist will tell you that GDP (or GDP/capita) is a profoundly imperfect and non-inclusive measure of national well-being.
In particular, GDP doesn’t count any work isn’t paid for with money — painting your mom’s house, volunteering for the Rotary Club or your church (David Brooks, are you listening?), caring for your kids and your friends’ kids, cooking dinner for your family — even though that work clearly “produces” immense quantities of real human value. (Can you say “family values”?)
A while back I did a rough calc (based on Census time-use surveys and median hourly wage) suggesting that counting unpaid work would increase U.S. GDP by something like a third (and I think that’s an underestimate.) Since Europeans have much more free time for unpaid work, counting it would presumably increase their GDP by an even greater percentage.
If this thinking holds water, you’d expect to see other measures of well-being giving very different readings from the GDP/capita measure.
The U.S. only stands out by one measure (and it’s still not #1) — GDP/capita — and that only if you calculate it by purchasing power parity. (How large a basket of goods would your share of GDP buy in different countries?)
Conservatives constantly point to the U.S.’s high GDP/capita to “prove” that their preferred model of unfettered capitalism and stripped-down government is superior in delivering national well-being. Even if they ignore all those other measures (which conservatives are happy to do, as with any facts that contradict their faith-based beliefs), their claims for GDP superiority themselves contradict their own beliefs.
Think about it: PPP adjustment — the procedure that’s necessary for conservatives to claim American exceptionalism by the one measure that they cling to — by its very nature asserts that currency exchange rates are wrong — that they’re not being properly arbitraged by the market to represent the “true” value of the different currencies in terms of real goods.
So yeah: America kicks everybody else’s ass (except Norway’s) — as long as you assume that markets are imperfect.
In response I give you Exhibit A: the almost-ubiquitous notion that more saving increases the supply of “loanable funds” — hence that more saving causes or at least allows more investment. (The absolute classic fallacy of the S=I accounting identity.)
On casual consideration, it seems like it would be right, right? You spend less than your income, so you have more money (stuffed in your mattress?), and you can lend it out.
Or more likely: you “put money in the bank” — deposit more than you withdraw — so the bank has more money; it can lend more.
Saving is the supply of loanable funds — households lend their saving to investors or deposit their saving in a bank that then loans the funds out.
1. A little careful consideration shows that this casual consideration is logically incoherent — just plain wrong, by accounting identity.
2. Economists are not supposed to be thinking, giving their sage advice, or corrupting our youth based on casual consideration.
Think about it:
You get $100,000 in wages. Your employers’ bank account is debited, and yours is credited. Your bank can lend against your higher balance; your employer’s bank can’t. Net zero.*
You spend $75,000. It’s transferred from your account to other people’s/businesses’ bank accounts. Their banks can lend more, yours can lend less.
Is the total stock of loanable funds affected by whether the money is on deposit at your bank, your employer’s bank, or the banks of people you bought stuff from? No.
Meantime, you don’t spend $25,000. You “save” it. The money sits there in your checking account. If the action of spending — transferring money from one account to another — doesn’t change the total stock, how could not transferring money do so? Your bank still has the money, which it can lend out. Other banks still don’t, and can’t.
It may help to think about this as if there was only one bank. (Which is not so far off. Bank deposits all consolidate back to accounts at the Fed.) Every person and business has an account. All the spending/transfers (or non-transfers, a.k.a. “saving”) just shift deposits between accounts, with no change in the (single) bank’s total deposits.
So the saving/spending mix has no effect on the stock of loanable funds. Shifting (or not shifting) those stocks around has no aggregate effect on the total stock.
But what about the flow — new loans from banks? Again: no.
Here’s a behavioral, rather than accounting-based assertion — not a controversial one, I think: In any period, banks in aggregate lend more — “print” more new money and deposit it in people’s/businesses’ accounts — because they think they can make money doing it at current interest rates. They think that for one primary reason: they are confidently optimistic about future prosperity — borrowers’ future income streams. If they’re less confidently optimistic they lend less, or ask for higher interest rates — which has the same effect: less lending.
Likewise borrowers: they borrow because they think future conditions will be good, and they’ll be able to service their loans at the asking rate out of strong income streams (and/including rising financial asset values).
Likewise spenders: they spend (that new) money because they think it will yield good returns from investment, and/or because they think they can consume today and be able to earn more money to pay for it (repay the loans) in the future.
So how does the saving/spending mix affect those expectations? Another behavioral assertion: Those expectations are set, to a great degree, by current conditions, because they’re the best predictor we’ve got. It’s difficult at best to predict future “shocks” that will change those conditions. Or as the Eight Ball says: “The future is … unclear.” Life is uncertain.
So how does a higher proportion of saving to spending affect current conditions?
It makes them worse. GDP is spending. Less spending (as a proportion of either income or wealth) means less economic activity. Less velocity. Less transactions. Less surplus from trade. Lower GDP. People, businesses, and banks, borrowers and lenders, are less prosperous, and less optimistic. So banks lend less, borrowers borrow less, and (in a potential downward spiral) spenders spend less.
Takeaway: An increased saving/spending proportion has no effect on the stock of loanable funds (it can’t), and it has only a second-order, expectation-driven behavioral effect on flows — it decreases them.
You really have to wonder sometimes where economists get this stuff that they put in their textbooks.
Nick Rowe attempted to save this conceptual situation recently in a comment posted hereabouts (emphasis mine):
Suppose there’s an increased demand for financial assets by households (a rightward shift in the demand curve). Will that increased demand lead to an increased quantity of investment by firms and an increased quantity of financial assets sold to households (a movement along a supply curve)? It may do. That depends on the model. It’s a behavioural question, not an accounting question.
His questions in the middle, and the last statement, are completely on the money. But his explanation begins right in the midst of the conceptual confusion, putting the modeling cart before the behavioral horse. The behavior doesn’t “depend on the model”; the model’s accuracy and usefulness depends on its assumed human response to incentives and constraints.
Or perhaps, rather, he’s climbed aboard the wrong behavioral horse — one that is wandering off rather aimlessly.
The “desire to save” is a conceptual representation, a mini-model, if you will, of one aspect of the economic situation. I’m suggesting that that construct is outside of, peripheral and irrelevant to, the behavioral chain of cause and effect.
People might want to save more/spend less in aggregate for various reasons:
• Times are tough — GDP and employment are weak — and they’re worried about future ability to consumption.
• Times are good, and they’re satisfying all their consumption desires.
• Rich people have a larger proportion of income and wealth, and their lower marginal propensity to consume drags down aggregate spending, relative to income and wealth.
Or some other scenario. (As Keynes said — not looking up the exact quote here — all economic activity is driven by the desire to consume.)
In the second scenario banks will want to lend more — but not because people and businesses (want to) save more. If that were true, banks would also want to lend more in the first scenario — which is completely contrary to what actually happens. (The results in the third scenario seem uncertain.)
Here’s a syllogism to make this widespread confusion clearer:
More investment results in more prosperity.
More saving results in more investment.
More pessimism (or less-confident optimism) results in more saving. (I think monetarists will stipulate to this.)
So more pessimism results in more prosperity!
Mankiw’s conceptual confusion is inevitable, and arises from two causes:
1. He’s starting with snaky (and conceptually confused) assumptions about the sources of human behavior, and:
2. New but related subject: He’s trying to think about flows (and get tender young minds to think about flows) using static, of-an-instant models like the standard S/D and IS-LM diagrams. The problem, when you’re trying to think about “supply,” is that a flow can’t exist in an instant (only stocks can); it’s a meaningless, impossible concept. And since stocks in our discussion here are unaffected by saving, he’s in a pickle, cause it’s all about flows. (And no: “comparative-static” methods don’t solve the conceptual confusion; they arguably only contribute to it because they impart the illusion of time and dynamism.)
The only way (that I know of) to model “flow supply” in a conceptually coherent way — or even think or talk about it really, which is mental modeling — is using a dynamic simulation model. Of late I’ve been quite taken with the power grid as a good metaphor for a dynamic model of the economy — one that I’ll expand and expound upon in a future post.
For now I’ll leave you with this: Clower/Burshaw on the difference between “stock supply” and “flow supply,” or peruse the literature here. Nick also talks quite a bit about the largely forgotten old 70s notion of “nominal” (roughly: “potential”) supply and demand — though mainly regarding money, not real goods.
I almost never see any consideration of these seemingly crucial concepts in economic discussions — much less cogent analysis, or incorporation of said concepts.
Which leads me to ask a question of economists:
Are you sure that you’re perfectly clear on what you mean when you use the words “supply” and “demand”?
* I won’t even touch here on the widespread misconception among economists regarding bank lending, except to say that in practice bank lending is not constrained by deposits — banks lend most of their deposits then lend (much) more based on their excess capital (times X) — which, thus, is their effective constraint on lending. Not deposits.