More on Money, Currency-ness, Wealth, and Spending

May 24th, 2014 5 comments

Arthur over at New Arthurian Economics has posted a much-appreciated though decidedly negative reply to my recent post on the nature of money and financial assets. He and I have had very similar thinking over the years (and he has provided me, at least, with some Aha! moments), so I’d much like to convince him to give the thinking therein a solid road-test. This post is an attempt to encourage that.

First, slightly modified, what I said in a comment reply on that post:

The key (and I think hugely simplifying and clarifying) distinction:

money:financial assets::energy:barrels of oil.

In the vernacular we speak of oil as “energy,” but we know that they’re conceptually distinct. The energy is embodied in the oil. Just as it’s embodied in a rock at the top of a hill.

Pieces of currency are just financial assets (legal claims, or credits) that have particular characteristics, properties. As do barrels of oil and rocks on top of hills. We’ve always called those particular types of financial assets “money,” and therein is rooted much of the confusion and miscommunication we suffer under, IMNSHO.

Also, a key qualification that I’ve discussed in the past but didn’t in that post, which I’ll discuss more below: This thinking only works if you think of deeds as financial assets — claims on real assets, with the claim being conceptually distinct from the asset — the real estate – itself.

Like other financial assets, deeds as claims on real assets embody money. If you have more homeowner equity, you have more money. I don’t think this is crazy; homeowners’ ownership positions in the real-estate market, with associated mortgages, are arguably their most “financialized” positions. Owning (some portion of the claim on) a house in modern economies is fundamentally and conceptually different from owning an apple sitting on your kitchen counter. (I’ve long pondered a post on the nature of asset “ownership,” the legal and social constructs that constitute and define those claims, but I won’t go all the way there in this post…)

With that as background, some responses:

“… ‘money’ should be technically defined, as a term of art, as ‘the exchange value embodied in financial assets.’” To me, money is the medium of exchange, not the exchange value.

Here, from the get-go, you are declining to try on this definition and conceptualization. By saying “money” is the “medium of exchange,” you’re thinking about money being currency-like things. I’m suggesting that that’s the very conceptual problem we’re struggling with. And as I’ve suggested before, the traditional textbook tripartite “definition” of money — medium of exchange, medium of account, and store of value — by its very tripartite nature, is a crippling non-definition. People talk past each other constantly, as I’m sure you’ve noticed in blogs and comments from Sumner to Rowe to Koenig to….

It sounds like you’re talking about erosion of the dollar’s value.

No. In fact that discussion is one key thing (inflation) that’s missing from my explanation and discussion. I was trying to keep that post somewhat short. See below.

But I think you are talking about the liquidity of financial assets.

Again, this is going to the J.P. Koenig “moneyness” place (which he says is purely a function of liquidity, an understanding that’s at the heart of divisia measures, for example). I’m suggesting that what he (and you) are really talking about is “currencyness.” That being the very conceptual problem I’m trying to address.

I see this as the source of our economic troubles. Things that are not money have come to be widely used and accepted as money.

I’m not really talking about our economic troubles here (until the end of the post, where I apply the conceptual framework from the beginning of the post). I’m talking about our economics troubles. Our difficulty thinking about how economies work.

How economies work? But since the crisis, or before, economies DON’T work.

I see you doing the same thing for “work” here that’s going on for “money” — confuting two meanings. I’m talking about how economies operate, how to think about the mechanisms. You’re saying they don’t operate well. (I of course totally agree, and think that’s partially because economists don’t understand how they operate.) Completely different conceptual levels/realms.

You make things too complicated:

I want to suggest: quite the contrary. Put on this conceptual suit of clothes and try it out. I’m finding it to be incredibly clarifying and de-complicating. No need for the endless (and by all appearances fruitless) wrangling about MOE, MOA, MB, M1, divisias, etc.

“dollar bills aren’t money. They’re embodiments of money”

Jesus, Roth. The embodiment of money IS money.

I’m not sure if you’re making that statement or ridiculing it. So two answers:

Making: If this, you are assuming a priori that currency-like things are money. And given that, I’m not sure what you mean by the embodiment of money here.

Ridiculing: That’s not what I’m saying at all. I’m saying that currency-like things (what we’ve always called “money”) are embodiments of money as I define it. As are other financial assets.

“Money and currency aren’t the same thing, and economists’ conceptual confution of “money” with “currency-like things” is central to the difficulties economics faces in understanding how economies work.”

Currency-like things are the things we spend… things that are current, things that flow.

I want to try a physical metaphor in hopes of making this thinking clearer: The stock of money is a bathtub full of financial assets. Their source is the two (or three) methods of creation described in the post. People can exchange those financial assets within the bathtub. (Give me your Apple stock and I’ll give you some currency or currency-like bank deposits. See Jesse Livermore explanation.)

There’s a pipe that comes out of the bathtub and goes directly back in. Every withdrawal is a deposit (between different accounts within the bathtub). Every expenditure is a receipt. Instantaneously, or almost. It must be so.

Those transactions cause transfers of real, newly produced goods and services between parties — sort of by induction as they pass by — thereby causing production of new goods and services. (When you transfer money to another’s account to pay for a massage or an iPhone, you cause a new massage or iPhone to be produced. Magic!)

The instantaneous withdrawal/deposit nature of those transactions is why this has never made any sense to me:

Take a dollar out of the flow and tuck it away as “assets”, and it is no longer in the current: It no longer flows.

I hear this kind of thing all the time. e.g. “Health-care spending is taking all that money out of the economy.” As you would say, “Nonsense!” ;-)

You can’t “take a dollar out” of the bathtub (except by paying off loans to the financial sector, paying taxes to the federal government, or reducing the equity allocation in your portfolio hence driving down stock prices).

You can, however, reduce or increase the turnover of your stock of money in a given period. You can “hoard” or spend your money. Not-spending is indeed taking a dollar “out of the flow” (relative to the counterfactual of spending it) — reducing velocity. But in aggregate, not-spending doesn’t “tuck it away” any more than spending it does. If you spend it, it just ends up tucked away in somebody else’s account.

Spending vs. not-spending doesn’t change the amount of money in the bathtub. (Not directly or immediately, in an accounting sense. Increased turnover does have an economic effect over time: more spending causes more production, hence more surplus, more assets, which over time results in more money being created through 1. federal and private (bank-loan-financed) deficit spending, and 2. market-driven runups in equity values. That’s just describing a growing economy that needs and creates steadily more money.)

In the paragraph just before your graph, you seem to confuse two definitions of the word “real”. Here’s the offending sentence: We see this clearly when we look at recessions and the year-over-year change in real (inflation-adjusted) household assets — a measure of households’ total claims on real assets…

Both right and wrong.

Wrong: I intentionally use both meanings of “real” in that sentence, with no intention of obfuscation, trying to making clear through parentheticals which one I’m using. I should probably take my own advice and stop using real to mean “inflation-adjusted,” and just say “inflation-adjusted.” (As you’ve no doubt noticed, these dual meanings foment no end of confused discussion out there.)

Right: I cheated. The graph of household assets vis-a-vis recessions is indeed inflation-adjusted, while my argument has been (implicitly) about nominal values. The correlation between recessions and YoY change in nominal household assets is still apparent, but considerably less firm (more false negatives and false positives). This whether or not you include household home equity as “financial assets” (click any graph to mess with it in FRED):

I have various notions about how to think about this, but haven’t formulated them into a clear and coherent explanation. This is problematic, but I don’t think it disqualifies the core conceptual approach.

But you also say that if we want to spend more, the money will grow to accommodate us. Your statements are contradictory.

No. Exactly not. I said that “transaction cash” (i.e. currency-like stuff), not money, will grow to accommodate us. See what you did there?

Further, if all financial assets are money as you say, then to calculate the velocity of money one would divide GDP by total financial assets. Not by total assets as you show in your second graph.

This brings us back to the real-estate issue discussed up top. When you ask someone “how much money do you have?”, IOW what are your assets, or your net worth, do they include their real-estate equity in their answer? Heck yes. Especially for low-income/wealth households, their home equity often constitutes a huge portion of their assets/net-worth/”money.”

I admit this can be tricky conceptual stuff given how we’ve always talked about money (the deep meaning of “ownership” aka claims aka credits enters here), but really: if house prices/values go up, people feel like they have more money (especially if increases exceed CPI, in which case they really do), and feel free to spend more (though not necessarily increasing their V) — just as they do when stock prices go up. And of course the reverse when values decline. The economic effects are very similar though probably not identical. (The effects are certainly slower-moving with real estate; people don’t track their house value day to day). Pretty straightforward wealth effect. The only question is the wealth-to-spending multiplier function (which is almost certainly nonlinear on more than one dimension).

I’ve been wrestling with this. Go back to Jesse Livermore’s wonderfully clear discussion of bonds/cash vs. stock/equity, how people’s portfolio allocations relative to the stock of bonds/cash is the primary (short- and arguably long-term) determinant of stock-market valuations (and in my definition, changes in the stock of money). Now add another “equity” class into which people are allocating: home equity.

I pulled this chart — asset allocations into the three types of assets, over the decades:

Screen shot 2014-05-22 at 8.39.23 AM

Think about real-estate decisions: You can make a smaller down payment, and keep more money in stocks and bonds (effectively owning stocks/bonds on margin), or you can sell stocks/bonds and make a larger down payment, shifting your portfolio more into real-estate equity. Ditto with home-equity extraction for spending; you coulda sold bonds or stock and spent that money instead, and kept your real-estate equity allocation high.

In Livermore’s formulation, the key choice is between bonds/cash, and equity — whether that equity is in stocks or real estate. In my formulation, when people shift their allocation from bonds/cash to equity (either type), hence driving up prices, they’re increasing the stock of money. But that money ultimately has only two sources — deficit spending (reflected in debt outstanding), and animal spirits spurring the equity purchases. (High spirits are rooted, ultimately, in high and growing production and productivity, causing people to believe that all the real assets out there — which their financial assets are claims against — are actually more valuable than they thought).

I’m not quite sure what to do with this graph yet, but at the very least I find interesting the long-term secular decline in home-equity percentage since the eighties (with that valuation bump in the 00s). I’m thinking this is largely the result of increasing homeowner (mortgage) debt over that period — they borrowed more, kept their loan balances high and inflating both their own and banks’ balance sheets, hence holding more of their net assets in stocks and bonds/cash. More thinking to come.

Finally, I want to give an example to explain my contention that having a greater proportion of currency-like stuff doesn’t cause more spending as monetarists seem to believe (spending on real, newly produced goods and services, aka GDP stuff), while having more money (as defined by moi) does.

Say you’ve got a $100K portfolio as follows:

Stocks/equity: $60K
Bonds: $30K
Cash: $10k

Now the Fed under its QE program makes an attractive enough offer for your bonds that you sell them $10K worth. (That’s the only way they can suck up those bonds, by offering slightly more than private buyers are offering.) Your new portfolio:

Stocks/equity: $60K
Bonds: $20K
Cash: $20k

Are you going to go out to dinner more often because you now have more cash, even though you still have $100K?

Alternate scenario: the stock market goes up. Your new portfolio:

Stocks/equity: $70K
Bonds: $30K
Cash: $10k

You now have $110K. Will you go out to dinner more often? Quite likely. Some.

This works the same way if you add a fourth asset class, real-estate equity, and that goes up in value. You quite literally have more money — at least in my common-sense, uncomplicated, easily understood, straightforward, perfectly reasonable definition of money [grin] – so you’re more willing to spend money.

And yes: this explanation does serve to support what is to me a rather obvious conclusion — that greater wealth concentration results in less spending/velocity, because richer people spend less of their wealth each year. But that’s not the only reason I like it. I like it because it seems to really make sense.

I think that’s all I have to say at the moment. I’ll keep working on the inflation part of this thinking. Here’s hoping that Arthur has it all figured out for me.

Cross-posted at Angry Bear.

Answering Brad DeLong’s “Deep Question”: Productivity vs. Power

May 24th, 2014 No comments

As a naive young noodler on economic topics I always wondered: Why are players in the financial industry — which produces very few real, human, consumable goods and services that people value in their lives — so well-paid?

I figured it out pretty quickly: it’s because they are able to control who gets that real stuff. Sure: the financial industry is necessary to our ongoing assault on scarcity — increased productivity and production, yadda yadda yadda. But that’s not really why they get the big bucks. It’s because they’re playing the rivalry game. Anyone who doesn’t use their services (or become one of those players) loses that game.

Which brings me to an answer to Brad DeLong’s excellent question.

What is it, precisely, about Apple technology and today’s economy that gives it much more of a winner-take-all nature than Eastman-Kodak technology? And why was the same true of Andrew Carnegie-age technology and organization, but not of Alfred P. Sloan-age technology and organization? Deep questions.

I do like deep questions. My answer:

There are new technologies that produce more/better consumables (and methods to produce consumables with less human effort), and ones that give control over who gets to do the consumption (and take the leisure).

Computer technology is more like double-entry accounting and limited-liability corporations in that respect, and proportionally less like steam engines and electric motors.

Cross-posted at Angry Bear.

(Modern) Monetarist Thoughts on Wealth and Spending: Volume or Velocity?

May 21st, 2014 2 comments

I’ve bruited the notion in the past that “money” should be technically defined, as a term of art, as “the exchange value embodied in financial assets.”

In this definition, counterintuitively relative to the vernacular, dollar bills aren’t money. They’re embodiments of money, as are checking-account balances, stocks, bonds, etc. etc. Money and currency aren’t the same thing, and economists’ conceptual confution of “money” with “currency-like things” is central to the difficulties economics faces in understanding how economies work.

If this definition is safe, then the stock of money (I hate the term “money supply,” which suggests a flow) equals the total value of financial assets. Forget the endless wrangling about monetary base, M1, M2, divisias, and all that. Add up the value of all financial assets, and that’s the money stock. (There are certainly difficult measurement issues to discuss, but I won’t wrangle with those here.) Update: for this to make sense, deeds must be viewed as financial assets — claims on real assets.

People can exchange various financial assets for currency-like financial assets when they need to buy real stuff, but that’s largely mechanical.

In this definition “money” comes from two (or three) places:

1. Deficit spending.

• By government (federal — the sovereign “currency” issuer).

• By private individuals and businesses (using loans from banks, which are chartered by government to create new money for lending).

The second is of much greater magnitude overall, but it is also subject to big and fast periodic downswings (burning instead of printing money, when loans are paid or written off), which is much less true of the first.

2. Animal spirits, a.k.a. confident optimism. When the market thinks that the total value of financial assets under-represents the value of the real assets they’re claims against, prices of financial assets are bid up, and there’s more “money.”

You could call this the wealth effect, and at least in the short- to medium-term — because it can happen so fast — the magnitude of its effects can overwhelm the first method. This change can go in either direction, of course — either creating or destroying huge amounts of money very quickly.

Jesse Livermore explains this mechanism elegantly and simply based on portfolio preferences. If the market wants 60% of its portfolio in stocks and 40% in bonds/cash, and more bonds/cash are issued, the only way for a rebalance to happen is if stock prices are bid up. (He’s got a great graph showing that very little new corporate equity is issued relative to the existing stock, often a negative amount for years on end.) If animal spirits decline (less confident optimism), the market wants less stocks and more bonds; the price of stocks — hence the stock of money — declines.

3. Trade surpluses. This doesn’t actually create money in the world (or an imaginary closed economy) the way the first two do. But if a country exports more goods than it imports, the payments for those net exports bring more money into the country. Trade deficits, the reverse. (U.S. trade deficits of $30-70 billion a year are pretty small change compared to the first two money mechanisms. Correction: That is a monthly figure, so the total is quite significant — 3-5% of GDP.)

The first two methods create money — exchangeable credits, or claims — “out of thin air.” And they destroy it when the debt from that deficit spending is paid back, or markets decide that underlying real assets aren’t so valuable after all. The government, the banks, and the stock market have both printing presses and furnaces.

And it doesn’t much matter how much of that money is embodied in currency-like things. If people want to spend more of their money one year (on newly produced goods and services, the stuff of GDP), the Fed will always accommodate their need for transaction cash; it must do so, or it can’t control the Fed Funds Rate because banks will be scrambling for cash and will bid up the rate. People don’t spend more because there’s a higher proportion of currency-like stuff around. If they want to spend more, there will be more currency-like stuff around; the Fed will ensure it. (At this point there’s a massive superfluity of such stuff, so the Fed controls that rate via its interest-on-reserves rate.)

Which all brings me to a simplified version of the monetarists’ equation of exchange:

(M)oney * V(elocity) = GDP (often designated as Y)

(Forget about PT or PQ; both T and Q are designated in imaginary, circularly-defined “units” of output whose logical coherence was thoroughly eviscerated in the Cambridge Capital Controversy. See the last paragraph of this section.)

If there’s more money around and velocity stays the same (i.e. people spend a certain percentage of their wealth each year), GDP goes up.

We see this clearly when we look at recessions and the year-over-year change in real (inflation-adjusted) household assets — a measure of households’ total claims on real assets, and a proxy for the “money stock” in this definition. (Note that in this measure the net worth of corporations is imputed to households who own their stock.)

Every recession (GDP downturn) since the sixties was preceded by a decline in this measure of the money stock, and every decline in this measure since the sixties preceded a recession (with one exception/false positive: 2011).

When people have less money, they spend less, and GDP declines, or grows more slowly. That is hardly a counterintuitive conclusion.

But what about V(elocity)? How has that played out over the years?

Another of those early-80s inflection points: velocity has declined from about 26% annual turnover of the mony stock, down to the high teens. If you’re looking for an explanation of that, you probably don’t have to look much farther than the spectacular concentration of wealth over the last three decades. Rich people spend a smaller proportion of their wealth each year than poorer people. So if wealth is more concentrated, velocity is lower. Arithmetic.

But there is another, related effect at play as well. A greater proportion of our real assets have been “financialized” (read: indebted monetarily) over the decades. The runup in student debt is an obvious example — whereby students have capitalized/financialized/indebted their most valuable real asset, their future ability to work and produce. They (in cooperation with their lenders) have created money — financial claims – based on those real assets (and given it to colleges).

This effect is very hard to measure because it’s essentially impossible to measure (in dollars) the value of our most valuable real assets — knowledge, ability, skill, organizational setups, legal structures, natural resources, etc. The relationship between total financial asset values and total real asset values is irredeemably opaque.

Bottom line: if GDP (and more importantly, GDP/capita) is to go up, either M or V has to increase.

Increasing M is problematic because either you increase debt (which obviously has its problems) or you (somehow) ignite animal spirits.

How do you increase V? It’s pretty straightforward: reduce the concentration of wealth so it’s more widely held, by those who turn over their wealth more quickly. Like, raise the minimum wage. Or institute a tax regime that actually is progressive, and use that money to provide for the general well-being by increasing funding for a plethora of well-designed programs like the Earned Income Tax Credit, jobs programs, wage subsidies, infrastructure and research spending, or guaranteed basic income.

At the very least, the goal should be to reverse the rampant radical upward distribution of the last thirty years, and the extreme decline in money velocity that has been the direct result.

Cross-posted at Angry Bear.

Eighty percent of current jobs may be replaced by automation in the next several decades.

May 18th, 2014 4 comments

That’s the conclusion of Stuart W. Elliott in his recent paper, “Anticipating a Luddite Revival.” (Hat tip: RobotEconomics.)

We’ve seen that scale of transformation before. But this one promises to be roughly four times as fast, dwarfing Luddite-era concerns:

…the portion of the workforce employed in agriculture shifted from roughly 80% to just a few percent. However, in the shift out of agriculture, the transformation took place over a century and a half, not several decades.

But there’s a much bigger difference this time — a hard limit that time can’t ameliorate:

The level 6 anchoring tasks in Table 2 are not only difficult for IT and robotics systems to carry out, but they are also difficult for many people to carry out. We do not know how successful the nation can be in trying to prepare everyone in the labor force for jobs that require these higher skill levels. It is hard to imagine, for example, that most of the labor force will move into jobs in health care, education, science, engineering, and law.

I’ve said it before: the median IQ is 100, by definition. Fifty percent of people are below that level. We (and they) are facing a hard cognitive limit that the Luddites never approached. I don’t think anybody reading (or writing) this post can appreciate how hard it would be to make a go of it in today’s technological society — even get through high school, much less provide a healthy, happy, financially secure life for one’s family — with an IQ of 80 or 90.

Are people who aren’t born smart lacking in “merit”? That’s what meritocrats are claiming. (Though they will vociferously defend themselves, deploying endless arguments both specious and obfuscatory.) If you’re in the low-IQ group (and don’t inherit), your miserable position in life is fixed at birth. Get over it.

Currently, work is the only way for the majority of people to legitimately claim any significant share of our remarkable prosperity. (Social-support programs provide a pretty insignificant and tenuous, insecure claim that’s not generally viewed as legitimate, only unfortunately necessary.)

If those folks 1. can’t find jobs that they can do, and 2. receive negligible claims on our prosperity if they are lucky enough to find one of the few remaining, we’re facing a world of haves and have-nots. Sound familiar?

Here’s the depressing chart of fastest-growing job categories and their wage levels that Elliott provides, based on BLS data:


One fundamental belief has to change: that finding and doing a job is the only thing that gives you any claim on a decent life. Because for many, jobs that provide decent claims simply aren’t there, or won’t be soon. (Likewise the belief that rebalancing your financial portfolio annually — doing the arduous, taxing work of “allocating resources” — is extremely meritorious and gives you a just claim on an outsized share of our collective prosperity.)

Horses faced exactly this situation in the first industrial revolution. They could never learn to drive tractors and trains.

I’ll be the first to say that people aren’t horses. Which gives rise to the ugly next thought:

They shoot horses, don’t they?

Cross-posted at Angry Bear.


The Lump-of-Capital Fallacy

May 9th, 2014 No comments

Dean Baker gives me the courage, in his recent post on Pikkety, to reiterate a statement I’ve made some few times in the past:

Economists have no coherent or consistent idea of what they’re talking about when they use the word “capital.”

They lump together real capital — fixed, human, organizational, whatever — with “financial capital,” an oxymoron that confutes actual productive stuff with financial claims on that stuff.

Dean (emphasis mine):

This relates to the Cambridge controversies since the Cambridge U.K. people argued that the idea of an aggregate production function did not make sense. They pointed out that there was no way to aggregate different types of capital independent of the rate of return. The equilibirum price of any capital good depended on the rate of return. Therefore we can’t tell a simple story about how the rate of return will change as we get more capital, since we can’t even say what is more capital independent of the rate of return.

The takeaway from this, or at least my takeaway, is that we don’t have a theoretical construct that we can hope more or less approximates how the economy actually works. The theoretical construct doesn’t make sense. This means if we want to determine the rate of return to capital we should not be looking to elasticities of substitution, but rather the institutional and political factors that determine the rate of profit.

So it’s not just Steve Roth, internet econocrank, making this wild-eyed claim. You’ll find similar in Jamie Galbraith’s review of Pikkety. (His opening line? “What is capital?”), and I would suggest that every other review you’ve read wallows in the same quagmire of non- or multiple-definition.

As does Pikkety, unfortunately. He explicitly defines capital as being synonymous with wealth, which is a very tricky and messy conceptual proposition indeed. That does not obviate his work’s incredible value, but he should have called his book Wealth in the 21st Century.

“Capital” means, should mean, real, productive assets: real inputs to production that require real resources to produce, and that are consumed over time (through use, decay, obsolescence, and death). There’s the obvious “fixed capital” as tallied in the national accounts (broken out as structures, equipment (hardware), and software) and there’s all that other real capital that arguably constitute the great bulk of real capital, but that is so deucedly hard to measure — skills, knowledge, ideas, organizational structures and processes, human ability, etc. Then there’s all the tricky stuff that sits on the borderline between real assets and financial assets (thing which have exchange value but cannot be, are not, consumed): land, art and collectibles, etc.

“Financial capital” — all the financial assets out there, embodying all the “money” out there — is, roughly, all the outstanding claims on that real capital, or on the future production from that capital. Financial assets are not inputs to production (though they can be exchanged for such inputs), and they cannot be, are not, consumed.

The stock of financial assets can increase in several ways. 1. A sovereign currency issuer can deficit-spend. 2. A bank can print new money for lending ex nihilo (with the help of borrowers who want to monetize their real assets; think: student loans). 3. The market can decide that the real assets out there are worth more than the outstanding claims against them, and bid up financial-asset prices. Voila, more money, more financial assets, more so-called “financial capital.”

All of this points to the fundamental problem in economic thinking that Dean states so clearly: you can’t lump together, or really even measure, real capital in dollar terms. You certainly can’t just add together the value of real capital and the value of financial capital, which constitutes claims on that real capital.

And: The outstanding value of financial assets/”capital” is not any kind of reliable representation of the value of outstanding real capital. It’s all over the map, depending on how much of that real capital has been monetized/indebted/financialized (via private and public debt and money issuances), and based on the current state of investors’ “animal spirits” — their beliefs about future returns to that financial capital.

A minor aside: The whole “reswitching” business in the Cambridge Capital Controversy is just a carefully explicated special case, or example, of the fundamental confusion that the U.K. gang pointed out (and that Samuelson admitted to): the value of capital is a function of its future returns, and future returns are a function of the value of capital. Economics is based on a circular definition.

Or in Dean’s words, “The theoretical concept doesn’t make sense.” (This is some significant relief to me, because after more a decade of really struggling to make it make sense to me, it still doesn’t make sense to me.)

I’ve made some efforts to sort out this confusion is previous posts, which you can find by wandering through Related Posts, below. I would be more than pleased if those more worthy than I were to take up this task, and deliver an adequately and convincingly theorized understanding of the relationship between real capital and “financial capital.”

Cross-posted at Angry Bear.


Lane Kenworthy, Prosperity, and the Infinite Forms of “Redistribution”

April 19th, 2014 No comments

I haven’t beaten the drum lately for Lane Kenworthy — perhaps the best researcher out there on the economic effects of income and wealth distribution. His years of careful, diligent (and voluminous) statistical and analytic work, tapping the best data sets available, and his cogent, coherent explanations of his findings, should get a lot more attention in the econoblogosphere. Lane Kenworthy rocks.

He’s especially good at trying to suss out causation, which he will be the first to acknowledge is always a difficult business in a discipline that’s inevitably dependent on retrospective data — where you can’t rerun the experiment, much less run it from the start with a randomized control group. (And natural experiments/control groups like the ones that Arindrajit Dube exploited to look at minimum-wage effects — adjacent counties across state lines with different minimum wages — aren’t thick on the ground.)

Nevertheless there are some excellent statistical techniques that can give a good indication of causation. Well-executed, they can really move your Bayesian priors. At the very least, they’re excellent at ruling out causation. Put simply, if there’s a significant negative correlation between presumed-cause A and presumed-effect B (or no correlation at all), you can feel fairly confident that A didn’t cause B. It’s difficult to prove causation with correlation; it’s much easier to disprove causation — to falsify a hypothesis.

But enough with the philosophical throat-clearing. Let’s look at one recent paper (PDF), a multi-country multi-regression analysis comparing rich countries, looking at income inequality and middle-class income growth. He finds that from the late 70s to the mid 2000s (all emphasis mine for easy scanning):

an increase of 1 percentage point in the top 1 percent’s share of pre-tax income reduced growth of income for the median household by about USD530. In the most extreme case-the United States-the top 1 percent’s pre-tax share increased by 8 percentage points between 1979 and 2004. According to this estimate, that may have reduced median household income growth by a little more than USD4,000. The actual rise in the United States during those years was USD8,000, so the estimated impact of rising income inequality is not trivial

In other words, if the 1%’s share of income had not grown by 8%, median household income would have grown by $12,000 instead of $8,000. This bears out Lane’s rather intuitive, common-sense assertion earlier in the paper:

Household income growth is not a zero-sum game because the pie tends to get larger over time. Disproportionately large gains at the top, however, are  likely to come at least partly at the expense of those in the middle.

Always careful, he adds:

At the same time, the data suggest that the income-reducing impact of a rise in top-heavy inequality has been overshadowed by the income-boosting impact of economic growth and of increases in net government transfers.…even after adjusting for these other influences, change in top-heavy inequality is not a very good predictor of growth in middle-class incomes.

So yes: income inequality in and of itself seems to have reduced middle-class income growth significantly. But obviously, of course, that’s not the only economic effect at play. (Only a wild-eyed, ideologically blinded, axe-grinding, bought-and-paid-for Republican would make that kind of foolish claim about some particular economic effect.)

Which brings me to another recent paper (prominently citing the previous one), that questions the Left’s rhetorical emphasis on (in)equality:

I fear the American left’s recent move to put income inequality reduction front and centre might be harmful rather than helpful. It may foster a conviction that the key to addressing America’s social, economic and political problems is to reduce the top 1 per cent’s share or the Gini coefficient. That could distract attention from more direct and effective efforts to address those problems.

Such efforts include fully universal health insurance; improvements in eligibility, duration and benefit level for various social-insurance and social-assistance programmes; wage insurance; early education; enhanced financial support for college; a minimum wage indexed to prices; an expanded earned-income tax credit indexed to average compensation; and monetary policy less tilted towards inflation avoidance. Policy changes like these would go a long way towards improving economic security, enhancing opportunity (and mobility) and ensuring shared prosperity in the US. Inequality of political influence could be lessened via direct reforms, such as reversal of the Citizens United decision, introduction of a strong transparency rule and public funding for congressional election campaigns.

I think Lane’s right. I’ll say it again: if you talk about fairness and equality, Americans change the channel. (They’re only somewhat more open to hearing about “opportunity.”) They want to hear about prosperity — especially widespread prosperity. And the programs Lane points to have a decades-long history of delivering widespread prosperity. Expanding those programs (and funding them with a tax system that actually is progressive) would make us all more prosperous.

And that’s exactly what Lane’s first paper demonstrates. No: just reducing inequality through redistribution doesn’t make everything peachy. No duh. (Though in the current environment of concentrated wealth and income it does improve things a lot in and of itself.) If you really want to increase prosperity, you use methods of redistribution that increase prosperity – like the programs that Lane details above. (Plus publicly funded infrastructure, research, etc.)

So the two things aren’t mutually exclusive. You implement programs that deliver widespread prosperity in and of themselves, and distributive effects also deliver the prosperity benefits of reduced wealth and income concentration. It’s a virtuous cycle, rolling forward on a path to American prosperity. Rinse and repeat.

In brief, widespread prosperity both causes and is greater prosperity.

Cross-posted at Angry Bear.

Repeat After Me: The American Tax System is Hardly Progressive at All

April 19th, 2014 No comments

The latest numbers on 2014 taxes as share of income are out, and they’re saying pretty the same thing as last year:

Above about $80K a year in income, the American tax system is not really progressive. Like, at all:

The people making $100K a year pay about the same share of income as people making $10 million a year.

This is because — while federal income taxes are reasonably progressive — payroll, state, and local taxes are horribly regressive — particularly in (blush) my home state:

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Read it and weep.

Cross-posted at Angry Bear.

The Global “Capital” Glut

April 17th, 2014 No comments

No, I’m not talking about Piketty hitting the Times bestseller list. And it’s not just wild-eyed lefty Frenchman who are expressing concern about the state of world capital these days. Mitt Romney’s shop was beating this drum loudly more than a year ago.

One of the central takeaways from Piketty’s Capital in the 21st Century is the U-shaped long-term trend in the capital-to-income ratio, especially in rich countries. He uses “capital” synonymously with “wealth.” Here are the latest numbers for the U.S. from his compatriots Saez and Zucman (source PDF):

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The economic relationship between wealth (or net worth, financial assets minus liabilities) and real capital  is a sticky one, even if you’re only considering “fixed capital” — structures, equipment (hardware), and software. It’s even more so if you consider  human skills, knowledge (i.e. patents), organizational capital, etc. (The line between organizational capital and “software” is getting especially blurry these days; what would Vanguard’s, much less Google’s, value be without their web presence?) And more so again if you consider natural capital like land and what’s on/under it.

But “Wealth in the 21st Century” wouldn’t have had quite the same ring to it, so let’s just go with it, with the knowledge that we’re talking about wealth (“financial capital”), and wealth has some indeterminate but somewhat representative relationship to real assets/capital. We can at least say, loosely, that financial assets are claims on real assets, or on the production that’s enabled by those assets.

So what about Bain Capital, Romney’s shop? Here from their December 10, 2012 report (PDF; hat tip to the always-remarkable Izabella Kaminska, and to Climateer Investing).

World awash in nearly one quadrillion of cheap capital by end of decade, according to new Bain & Company report

Their takeaways include:

The capital glut will be accompanied by persistently low real interest rates, high volatility and thin real rates of return.

Sound like secular stagnation to you?


The ever-present danger of asset inflation will contribute to an overall steepening of the investment risk curve… companies will need to strengthen their bubble-detection capabilities

In short, there’s a huge amount of money floating around out there relative to income and production. (In Steve World, all financial assets embody money, and the money stock is the total value of financial assets — including dollar bills, deeds, or other formal financial claims — regardless of how currency-like those things are. Equating currency and currency-like things with money is conceptually incoherent.)

With so much money around, is it any surprise that people are lending it cheap?

As usual I have much more to say on this but instead I’ll hand it off to Jesse Livermore, who recently wrote one of the clearest and most cogent posts I’ve seen in years on financial asset values, hence wealth. I’ve been meaning to link to it. Read the whole thing.

The Single Greatest Predictor of Future Stock Market Returns

Hint: it’s about what the herd does with all that money.

Cross-posted at Angry Bear.

ALEC: Destroying the American Economy, One State at a Time

April 14th, 2014 No comments

The American Legislative Exchange Council — which authors ultra-conservative legislation and promulgates it to state legislatures nationwide — has a little index measure of states’ “competitiveness,” which supposedly results in greater prosperity for those states that rank highly.

Does it? Let’s let the numbers speak for themselves:

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Source (PDF).

Cross-posted at Angry Bear.

Thinking About Piketty’s “Capital”

April 6th, 2014 1 comment

The quotes in this post’s subject line are very much intended as a double entendre. I’m of course referring to the title of Piketty’s book (which I’ve read about 80% of, jumping around). But even more, I’m talking about his definition of “capital.”

I’ve ranted frequently about economists’ failure to define this term or agree on what it means, and Piketty is very much laboring under the burden of that failure.

Don’t take my word for it. This confusion about the nature of capital (and the associated term, wealth) is the central point of James Galbraith’s critique of the book:

First, he conflates physical capital equipment with all forms of money-valued wealth, including land and housing, whether that wealth is in productive use or not. He excludes only what neoclassical economists call “human capital,” presumably because it can’t be bought and sold. Then he estimates the market value of that wealth. His measure of capital is not physical but financial.

You’ll find that “capital” conundrum lurking or leaping out within every review you read.

Piketty deserves great credit. Unlike many or most economists, he makes a good-faith effort to define his usage of the term, and a not-altogether-successful effort to think coherently and consistently within the terms of that definition. He addresses his definition head-on on pages 47-49, and wrestles with various aspects of it throughout the book. See for instance page 149 (on the market value of assets), page 163 (on “human capital” that can be bought and sold in a slave society), page 188 (again on the market value of real capital), and page 210 (on “real” vs. “nominal” assets).

I’ll just highlight one subject: In the course of things he expresses disdain for the notion of “human capital.” Many will find this to be problematic, since most estimates would suggest that human capital — our ability to work and produce in the future — constitutes the great bulk of world and national capital. But Piketty’s stance is reasonable or even inevitable: it’s largely impossible to measure this kind of capital outside a slave society (and then you’re only measuring the “value” of the slaves). So for his purposes of analyzing the subject based on recorded numerical data, human capital is a non-starter.

But still, Piketty fails to address the extent to which human capital is increasingly being “capitalized” or “finacialized.” Think, for instance, of the extraordinary runup in U.S. student-loan debt, and asset-backed securities packaging those loans — debt and securities whose only collateral is those students’ enhanced ability to…work and produce in the future.

Here one measure that is at least a proxy for that runup: government-held student loans as a percent of GDP.

Where are the lines between “real” capital, “human” capital, and “financial” capital? What are their economic relationships? (If you’re under the impression that they’re obvious or clearly understood and agreed-upon, you’re not thinking very hard. At all.)

My purpose here is not to solve that capital conundrum — far be it from me. I come not to bury Piketty, but to praise him. His usages and definitions provide a very useful framework in which to discuss issues that have been hard to discuss coherently absent such framing. The evidence he’s assembled within that framework, and his remarkably cogent discussion of that evidence, gives ample evidence of that.

But even more: By tackling these definitional issues head-on (if not always successfully), he has brought an inconclusively theorized crux of economic thinking — the nature of capital (plus wealth, value, and even money) — back to the forefront of discussion. We can all hope that much good will come from that.

Cross-posted at Angry Bear.