Asymptosis

Fiscal austerity–or deficit cutting–is the subject of much current debate. As Europe proves, severe austerity can slow growth or lead to recession.

Despite periodic slowdowns, the US economy is on a sustainable fiscal path. The deficit is projected to drop below 2.5 percent of GDP by 2017, below its 30-year average, helped partially by the sequestration budget cuts.

Instead of pursuing short-term fiscal reform, as suggested in the president’s recently released budget, Congress should focus on working toward long-term tax and entitlement reform.

via Austerity undone – Economics – AEI.

Cross-posted at Asymptosis.

I’d like to push back on Paul Krugman a bit, on this bit in particular:

Yes, the government must pay its bills in the long run

You hear this from him a lot. And I want to ask him:

Paul, are you letting yourself be sucked into the very syndrome that you so bemoan and berate? Are you saying this because you feel the need to cast yourself as being sensible, responsible, moderate, and somewhat centrist — in short, as a Very Serious Person?

I ask because over four centuries and two centuries respectively (six hundred years combined), the U.K. and the U.S. governments have paid off their debts exactly once: the U.S. in 1836.

This happy event was followed, in 1837, by one of the most catastrophic depressions in either country’s centuries-long history. Likewise, the one other time that the U.S. got close to paying off its debt (the U.K. never has), in 1893, a disastrous depression followed immediately thereon.

Every depression in U.S. history has been preceded by a major decline in nominal Federal debt. It’s not a sufficient condition for, or reliable predictor of, depression (many declines have not been followed by depressions), but it does seem to be a necessary condition.

So we haven’t had to pay off our debt, and the one time we did (plus one time we got close), we were not happy with what ensued. From that history, how can you conclude that, now, “the government must pay its bills in the long run”?

To quote Chris Cook (HT Izabella Kaminska; emphasis mine), the national debt:

…is a national equity…

At least two-thirds … came into existence as mortgage loans, and are therefore backed by claims over the productive value of the US land and buildings which they fund. Much of the rest consists of claims over the value of US assets which fund the productive capacity of US corporations. The remainder – which provides the credit necessary to finance the circulation of goods and services in the US – is based upon the magnificent productive capacity of the US people.

Only by liquidating US Incorporated could this National Equity [read: Debt] ever be redeemed.

Such a liquidation, of course, would involve liquidating our overwhelmingly largest real asset: the ability of the American people to work. (Something your ideological opponents seem intent on doing.)

Of course you might well mean that we can’t increase deficits faster than GDP growth forever. But in today’s monetary world you have to at least question even that. Since 1971, when the U.S. stopped promising to redeem its dollar for anything besides…dollars (perhaps in some other “dollar” form, like Fed reserves), that proposition has become at least questionable. Dollars really might be like points issued by a bowling alley, and we may be able to issue a lot of them before we see problems with inflation.

I don’t think we really know; we don’t have any comparable situation to look back on (except maybe Japan, and that’s a glass, darkly). For a decade or so after the ’71 sea change, monetary authorities and markets flailed to adjust their reaction functions to the brave new world. Then those interacting functions settled down and we saw twenty years of steady inflation and steadily-declining interest rates. That may have been the inevitable emergent path for the world’s dominant economy and currency issuer, resulting inexorably from the game rules put into place in ’71/’73.

The place we are now — where Japan landed two or three decades earlier — may be the inevitable (and perhaps enduring) result.

Yes, rising globalization and the political rise of neoliberal Reaganomics may have contributed, but it seems possible that even absent those trends, we would have ended up in this place, perhaps sooner perhaps later.

So now, having arrived at this point, reaction functions are getting rejiggered again, and in a big way. (The institution of IOR was a big change, for both the Fed’s and the markets’ reaction functions.) One key element of those reaction functions is the belief that “we can’t keep running deficits forever.” But at least some parts of the market are acting as if we (and certainly Japan) can. And they may very well be right.

All of which is to say, think again. Think deeply. I’m not sure you’re thinking in your usual clear-eyed manner about a belief that may not be true. At least, given the new rules of the game, we might be a very long way — decades? centuries? — from a point where large government deficits or debt might pose any danger to our economy.

All my tentative language above should make clear that I’m not at all certain of this. I’d sure like to hear what you think.

Cross-posted at Angry Bear.

 

This is utterly brilliant:

Twitter / izakaminska: Why equity is a type of privately issued currency

Steve Randy Waldman has been here before, with the idea that currency issued by government (ultimately through deficit spending) is “equity” in government, or in America. But this reverses it beautifully, with the notion that private equity issuance is also currency issuance. Google stock is currency.

I won’t recap the argument here; you really need to read it. Just some thoughts:

I think different words might help make it clearer. I would say that there are many units of exchange in the world —  dollar bills, t-bills, stock shares, etc. Financial assets. They have various characteristics, a key one being limits on what they can be exchanged for. In general when we say “currency” we mean physical tokens that can be exchanged for (small quantities of) real goods. But we confuse things by not realizing that “currency” is a somewhat vaguely defined subset of “units of exchange.”

(Key distinction: the “units” I’m talking about are not measurement units like inches, degrees, or “the dollar” — units of account. Rather, in the sense of discrete units, chunks. As when a factory produces a certain number of units, which can have their value described relative to a unit of measurement/account, such as the dollar. More on the distinction between “unit” and “medium” of account/exchange here.)

You can’t buy a car or a government bond with quarters. So are quarters currency? Likewise, you can’t buy a pack of gum with a treasury bond — but you can use it to buy Fed reserves (if you’re a bank). Is the bond currency? You decide. But both quarters and bonds (and Google shares) are units of exchange. (This is why I’m still struggling with JP Konig’s “moneyness” concept: it seems to hinge on a single axis of “liquidity,” when in fact different units of exchange are differently liquid.)

We can also call these units of exchange “financial assets.”

I do not define a “bushel of apples” as a unit of exchange or a financial asset, but as a unit of commodity. Ditto an ounce of gold. Because in my definition:

1. Units of exchange/financial assets cannot be consumed by humans to produce human utility, and

2. Their creation requires no (or vanishingly little) input to production.

Returning to a previous (excessively long) post, these units of exchange/financial assets embody exchange value — money. Hence (alert: precise definition here) money is exchange value as embodied in financial assets. Money does not, cannot exist, absent such embodiment. A bushel of apples does not embody money: That bushel has exchange value, but the value is not embodied in non-consumable, only-exchangeable form.

Not sure how much this will help others, but it’s working for me.

Cross posted at Angry Bear.

Revisiting a previous post, “Saving” ≠ “Saving Resources”*, wherein I question Scott Sumner’s notion that people who spend and consume more (save less) take resources “out of society.”

Try this:

John works for Debbie, and Debbie works for John.

They each start out with $100 in dollar bills, $200 total.

They pay each other in dollar bills: $100 a year, each direction.

Between them, through their labor, each year they produce $200 in real resources — things that humans can consume to derive human utility (or to produce more consumables in the future).

But: This year Debbie decides to save money, so she doesn’t hire John for as many hours, and only pays him $80. She leaves $20 sitting in her drawer; she doesn’t circulate it this year.

At the end of the year Debbie has $120, and John has $80.

Debbie has produced $100 worth of real resources, and John has produced $80 worth. $180 total, instead of $200 the year before.

Did Debbie “take those $20 in real resources ‘out of society'”? (Or was it John — lazy, feckless soul that he is — who didn’t do that $20 in resource-creation?)

We can certainly say that Debbie’s decision to leave the $20 sitting in her drawer instead of circulating (spending) it caused “society” (read: John) to produce less resources than it would have if she had circulated (spent) it.

Is Debbie a “taker”?

Cross-posted at Angry Bear.

 

Or to be more precise, all currency is consensus currency.

Units of exchange (dollar bills, great big rocks at the bottom of the ocean) can have value merely because everyone in a community agrees that they have value. That value need not be declared, defined, or enforced by some “fiat” authority with powers of (ultimately physical) coercion — though it often or usually is.

That’s one big realization I came to from Graeber’s Debt: The First Five Thousand Years. (Though he doesn’t state it so succinctly, and I’m not sure he’d agree with it.)

Think of gold coins. If their exchange/consensus value is (enough) less than the (commodity) value of their metal content, people will melt them down and sell the metal. Arbitrage happens. Their consensus exchange value must be higher than the exchange value of their constituent metal, or they’re simply not currency any more; they’re chunks of commodity.

So why gold coins? Because the next city-state over, or the one 500 miles away, might not have the same consensus about those coins’ value as in your city-state. But there is a much wider consensus as to the value of gold. As far as they’re concerned, your ruler’s gold coins have the value of their gold content, and that’s all. But at least they have that value, because the gold-value consensus is widespread. 

So if you’re a trader looking to buy 1,000 yak skins from the remote Azbakalians, you can carry a bunch of gold coins there and trade them instead of carrying 1,000 amphoras of lima-bean oil. Yeah, you sacrifice the extra consensus value you’d have if you instead used those gold coins to buy things locally, but the cost of transporting all that oil is higher than that loss.

So is a physical one-ounce lump of gold a unit of “currency”? I’d say no. Because while the consensus value of gold might be different and might change at different times and places, there is no particular time and place where it has two different exchange values: its local consensus value and its foreign-trade commodity value. It only has its commodity value.

That differential between currencies’ consensus value and their commodity value is their very sine qua non: the thing that makes them what they are, without which they would not be currencies.

How does this work for cigarettes in a POW camp? They’re obviously used as some type of currency, as units of exchange. I’d suggest that because some people smoke and some don’t — some people value them highly for the utility their consumption can deliver, while others have no use for them — their average commodity value is lower than their average exchange/consensus value. (Also: new cigarettes are constantly being delivered and shared out in some way by the Red Cross or whoever, and they’re constantly being consumed. This is never true of coins or paper bills, which can’t be consumed.) This raises issues of distribution, power, wants, needs, and satisfactions, which I’d love to hear discussion of by my gentle readers.

Cross-posted at Angry Bear.

 

The other day I dissed the analysis in Reinhart and Rogoff’s Growth in a Time of Debt as being on the level of a blog post from an amateur internet econocrank. I still hold that opinion.

But I want to walk back on that, or at least clarify, and give lots of credit where due. Because they did make a huge contribution, of a quality that you will not find in econoblog posts from even the best bloggers: they assembled a great data set. As I can attest — having spent hundreds of hours assembling data sets that were far less challenging than theirs — this is not a trivial task. And the value of that data set is high, assuming you throw high-quality analysis at it.

Now of course, they didn’t release the goddam data set for years. That seems unforgivable, especially given the paper’s political and policy impact. This paper wasn’t in a peer-reviewed journal (it was a “discussion paper,” which makes its impact even more eyebrow-raising), but I really wonder why those journals (in any field) would publish such papers without requiring that the data sets accompany them, for vetting by other researchers. (Yeah I know: not a new idea.)

I totally understand why this is problematic. This is the researchers’ crown jewels, upon which they can build future papers, at least. Not just the data, but the analysis methods and the coding of those methods (intellectual property?), is often included in the files. At most, you’re looking at corporate/university/personal assets, trade secrets, generally some (at least potentially) damned valuable stuff. (Throw in the issue of partial or complete government funding for the research, and it’s even more complicated.) But providing the data should be the default requirement, with some clear guidelines justifying and explaining why the data is not provided, when it isn’t.

The “damn valuable stuff” double-points to the other topic I want to mention here: the BEA’s move change the NIPAs, to count spending on R&D and the development of creative works as investment spending rather than consumption spending — as real-capital building.

“Double” because 1. the new accounting highlights the real value of this kind of data-gathering and knowledge-creation, and 2. the change itself required (and will continue to require) a huge amount of data gathering.

I was kind of wowed by this line in the Financial Times writeup on the change:

The Internet Movie Database may not seem like a natural source of data for the national accounts, but it was one of many combed by BEA researcher Rachel Soloveichik, who went through film studio records as far back as the 1920s to build a series on investment in movies.

(Another good FT post on this here.)

So when you hear me kibbitz about the structures and methods used in the national accounts, please know that I have wide-eyed respect for the diligence and skill of hundreds of accountants and economists involved in building those structures, and populating them with data from hundreds of diverse sources. (This actually sounds like one of those Google interview/hiring questions: how would you go about estimating the value of every movie made in America since the 1920s? Books? TV programs?)

That information is hugely valuable. It’s a great example of Your Tax Dollars at Work, delivering value far above the government’s cost.

Or at least, I think it is. Somebody should gather some data on that.

Cross-posted at Angry Bear.

I finally figured out a simple way to explain my confusion (and that of many others, including many economists) with the whole Saving issue. I may also have figured out a useful solution to that confusion, which I present at the bottom here for my gentle readers’ delectation and denunciation.

Econ profs: I’m really curious. Do you think this post would help your intro students understand this stuff?

First: The accounting’s fine. Of course. But for some not-crazy reasons, the definition of “Saving” changes in the course of the accounting.

Thinking of the “real” sector for the moment, for simplicity and clarity. For each of the economic units at the bottom level of that sector (households and nonfinancial businesses), Saving means money saving:

(1) Saving = Income – Expenditure

But at the top, the level of “sectoral” saving, Saving means saving of real goods:

(2) Saving = Income - Consumption Expenditures

Or in words that more aptly describe what’s being depicted:

(3) Saving = Production – Consumption

(Reminder: Consumption Spending + Investment Spending = Expenditures = Income = Production)

Explanatory aside: There’s Gross or Net Saving, depending on whether Consumption just includes Consumption Spending (on goods that are bought and consumed within the period), or also includes Consumption of Fixed Assets — the very real “depreciation” of those assets. Gross is long-lived goods produced; Net is long-lived goods added, above and beyond what’s “consumed.”

Back to identities: Unlike every other measure in the national accounts, if you sum up the money Saving of all the bottom-level units, it doesn’t equal Saving for the sector. Rather:

(4) Sectoral Saving = Units’ Combined Money Saving + Investment Spending*

Investment spending, of course, causes the creation of real, long-lived goods. But this is the thing that has confused me from the get-go: Saving is (savings are) some combination of money and real goods? Aren’t financial assets supposed to be representative of, proxies for, the real assets? (Equally confusing: economists’ insistence on talking about “capital” as if it were some undifferentiated, homogeneous or vaguely contiguous lump of real and financial capital.)

Here’s what you need to know to sort that out: You know that money saving? It’s zero.

Read more…

Or: Thinking About Periods and Lags

No need to rehash this cock-up, except to point to the utterly definitive takedown by Arindrajit Dube over at Next New Deal (hat tip: Krugman), and to point out that the takedown might just take even if you’re looking at R&R’s original, skewed data.

But a larger point: I frequently see econometrics like R&R’s, comparing Year t to Year t and suggesting — usually only implicitly or with ever so many caveats and disqualifiers — that it demonstrates some kind of causation. I.e. GDP growth in 1989 vs. debt in 1989, ’90 vs. ’90, etc.

Haven’t they heard of looking at lags, and at multiple lags and periods? It’s the most elementary and obvious method (though obviously not definitive or dispositive) for trying to tease out causation. Because cause really does almost always precede effect. Time doesn’t run backwards. (Unless you believe, like many economists, that people, populations: 1. form both confident and accurate expectations about future macro variables, 2. fully understand the present implications of those expectations, and 3. act “rationally” — as a Platonic economist would — based on that understanding.)

By this standard of propter hoc analysis, R&R’s paper shows less analytical rigor than many posts by amateur internet econocranks. (Oui, comme moi.) This is a paper by top Harvard economists, and they didn’t use the most elementary analytical techniques used by real growth econometricians, and even by rank amateurs who are doing their first tentative stabs at understanding the data out there.

Here’s one example looking at multiple periods and multiple lags, comparing European growth to U.S. growth (click for larger).

This doesn’t show the correlations between growth and various imagined causes for the periods (tax levels, debt levels, etc.) — just the difference, EU vs. US, in real GDP/capita growth. You have to do the correlations in your head, knowing, for instance, that the U.S. over this period taxed about 28% of GDP, while European countries taxed 30–50%, averaging about 40%.

But it does show the way to analyzing those correlations (and possible causalities), by looking at multiple periods and multiple lags. (I’d love to see multiple tables like this populated with correlation coefficients for different “causes.”)

Dube tackles the lag issue for the R&R sample beautifully in his analysis. In particular, he looks at both positive and negative lags. So, where do we see more correlation:

A. between last year’s growth and this year’s debt, or

B. between last year’s debt and this year’s growth?

The answer is B:

Figure 2:  Future and Past Growth Rates and Current Debt-to-GDP Ratio

(Also: if there’s any breakpoint for the growth effects of government debt, as suggested by R&R, it’s way below 90% of GDP. More like 30%.) See Dube’s addendum for a different version of these graphs, using another method to incorporate multiple lags.

Here’s what I’d really like to see: analysis like Dube’s using as its inputs many tables like the one above, each populated with correlations for a different presumed cause (“instrumental variable”). Combine that with Xavier Sala-i-Martin’s technique in his paper, “I just ran four million regressions“.

That paper looks at fifty-nine different possible causes of growth/instrumental variables (not including government debt/GDP ratio) in every possible combination, to figure out which ones might deliver robust correlations. I’m suggesting combining that with multiple periods and lags for each instrumental variable. IOW, “I just ran 4.2 billion regressions.” Not sure if we’ve got the horsepower yet, but…

Cross-posted at Angry Bear.

 

I really like Hellestal’s comment and linguistic take on this whole business:

I’m comfortable changing my language in order to communicate. I have very little patience for people who aren’t similarly capable of changing their definitions.

This discussion is really about the words we use to describe different accounting constructs. Nick totally gets that as well.

So I’m ready to say, “fine, let’s call investment saving.” That’s perfectly in keeping with the very sensible understanding found in Kuznets, father of the national accounts. He characterized real capital — the actual stuff we can use to create more stuff in the future — as “the real savings of the nation.” (Capital in the American Economy, p. 391.)

So when you spend money to produce something that has long-lived (and especially productive) value, you’re “saving.”

But still, I gotta wonder: why don’t we just call it…investment?

Because this S=I business confuses the heck out of everyone. Some of the smartest econobloggers on the web have spilled hundreds of thousands of words over the last several years trying to sort out this confusion. I’ve read most of them, and I’m still confused. And I’m quite sure that all non-economists who’ve looked at this (and many or even most economists) are as well.

And that’s not a surprise. Here are a few reasons why:

1. When you invest in real assets, you’re spending. That’s why it’s called investment spending. So spending = saving. Really?

2. When you pay someone to build you a drill press, you’re saving. When you don’t eat some of this year’s corn crop, you’re saving. When you pay off some of your money debt, you’re saving. When you don’t spend some of the money in your checking account, you’re saving. Each of these is true within a given (usually implicit) balance-sheet/income-statement accounting construct. But are they anything like the same thing?

3. As I showed in my last post, f you look at the “real” domestic private sector — households and nonfinancial businesses (most people’s implicit default context) — the amount of saving (income minus expenditures) has absolutely no relationship to the amount of investment spending. Saving is always insufficient to “fund” investment. And the changes in the two measures don’t move together, either in magnitude or direction. (Aside from the long, multi-decadal growth in both as the economy grows.)

4. When you “save” by investing, you decrease the amount of money on the left-hand (asset) side of your balance sheet, while increasing the amount of real assets on that tally. Your total assets are unchanged. Have you saved?

5. When you pay someone to write a piece of software, you get a long-lived real asset. You’ve saved. But the money you gave them is income for them, so it contributes to their (money) savings as well. Do you double-count those savings, or did “the economy” get that software for free?

6. Investment means “gross investment” — all the money spent on long-lived goods, including replacement of long-lived assets that have been consumed in the period (through use, decay, and obsolescence, and — for inventory of consumer goods — actual consumption). But in KuznetsWorld, shouldn’t we be talking about net investment — the additions to our stock of long-lived assets? Gross consumption minus consumption of fixed assets (and inventory changes)? Shouldn’t we call net investment “saving”?

I know: there’s (at least apparent) confusion in some of these, but that’s rather my point. And there are answers to all of these in the context of S=I. (All of them, I think, based on the flawed [neo]classical accounting constructs embodied in the NIPAs. That’s my next post.) I’ve read them all, every which way from Sunday. But do they help anybody understand how the economy works, or…quite the contrary? If they do, why do all those econobloggers feel the need to worry at this, constantly?

I’m not sure this really solves the problem, but I’d like to suggest that saving should mean what everybody in a monetary economy means when they use the word: money saving. Monetary income minus money expenditures. In dollars, or whatever. (And while we’re about it, when you take out a loan or spend out of your savings, let’s call those “borrowing” and “spending,” not “dissaving.”)

Meanwhile investment (in economics discussions) should mean what economists mean when they use the word: “spending to create fixed assets and inventory.” (Because the national accounts only count spending on structures, equipment, software, and inventory as investment.)

And actually, that’s what it already means.

Why do we need to call it saving?

Cross-posted at Angry Bear.

 

With all the chaff that’s been flying around (recently, and for years now) about saving and investment, dissaving, and lending/borrowing, I felt the need to go back to the numbers and see how they’ve played out over the decades in what we tend to call the “real” economy — domestic households and nonfinancial business. Click for larger:

Update: The signs were reversed for lending/borrowing. Graphs corrected and updated.

Here’s the lending/borrowing broken out for you:

This is all from the Fed FFAs. Saving is household/nonprofit net saving (after-tax/transfer income minus expenditures) + undistributed business profits (after-tax/transfer income minus expenditures and distributed profits [distributed profits are part of household income]). Details/spreadsheet on request.

I’ve actually written at least three (long) posts on this in course of building out these graphs, but now that the graphs are complete I find myself fairly flummoxed. Saving seems to always be wildly insufficient to fund investment (and no, lending/borrowing + saving has no relationship either). S=I seems to provide exactly zero illumination here.

And the post-1990 lending/borrowing swings I see don’t fit with any real-sector saving/dissaving story I’ve heard (or can remember). We see borrowing spike during the internet boom, dive following the bust, then spike again during the real-estate bust.  ?

So I’m going to leave this open to my gentle readers for the moment. What in the heck is going on here? What story (or stories) would you tell to explain what you see?

If anyone wants to see earlier periods zoomed in to get a better feel what’s going on, let me know. I’m thinking 1946-1975 (to see what seems like a period of consistency), and 1970-1990 (from the fall of Bretton Woods to the start of the internet bubble and the Clinton surplus).

Cross-posted at Angry Bear.