Some recovery!

...reposted from Autos and Economics...

The US recovery continues at a snail's pace; the auto industry is doing better. The rise in the SAAR [seasonally adjusted annual rate of sales] puts us below the bubble-inflated peak of 2005-6, but given subsequent population growth is at a more sustainable level. Other auto-related indicators show marked improvement, but suggest we still have a ways to go. First, the share of the auto industry (retail and manufacturing) was at 2.3% of the labor force in the late 1990s; it then fell steadily to 2.0% before falling off a cliff in 2008. The nadir was 1.6%; today we're back to 1.8%. That is only about halfway, assuming that other structural changes in the US (the continued growth of healthcare) makes it possible to return to the days of yore.

...automotive employment's only about halfway back...

If we look at the details, we get a more nuanced story. The retail side (which includes auto parts and not just vehicles) peaked at about 1.9 million workers; it fell by 300,000 during the Great Recession, and is now 2/3rds of the way back to that level. Manufacturing took a harder hit, falling from 1.1 million at the start of 2006 to 1.0 million in 2007, before dropping by 400,000 in 2008-9 to just above 600,000 workers or less than half the level of the late 1990s. We're now back to almost 850,000, a sharper rise than in retail, but with further to go. Yes, suppliers are running at more than 100% capacity, and that must normalize. So employment will rise further, as overtime and other expedients are replaced by permanent hires. Still, it's not clear that the US is on track to get back to earlier levels, though over the next few years other changes may help (e.g., Honda's goal to export 30% of US-based production).

But overall the story from labor markets is of an anemic recovery. As the baby boomers retire, the growth of the working age population will slow. At present, however, we're only just keeping up with population growth, and the gap between "normal" employment (I tracked age-specific levels back to 1994) is large, roughly 9.1 million workers as of November 2013. Furthermore, more jobs are part-time while a sizeable share of the labor force that had been working employed full-time are still working short hours. If we adjust for that, we're shy 10.8 million full-time jobs. Let's not forget long-term unemployment either, the 27+ week component is improving but is only down to what had been previously been the historic peak.

...the low level of participation isn't just "boomer" retirement...

Finally, this is not due to boomers entering retirement early. Indeed, participation of older workers has trended up throughout the Great Recession and subsequent recovery. In other words, they aren't retiring with past rapidity. That's part of the reason that prime-aged participation rates remain below historic levels. Again, I've traced these levels back much futher – they were essentially flat going into the Great Recession. Now we can see a small increase since the worst of the recession, but only by about 1 percentage point to 95% of the previous norm. And the rate for young workers (age 20-24) remains in the abyss.

As someone who works on the Japanese economy, this halting recovery looks all too familiar. We may not see a lost decade, but we're already in the 6th year since the onset of the Great Recession. Real estate bubbles are matched by lots of debt, and resolving that overhang is a challenge. If lenders aren't expected to bear much of the loss (and through deposit insurance, the government), then households [in the US] and corporations [in Japan] must. That has real ramifications – including ironically a huge buildup in government debt, in the end offering up assets that it stingily refused to do earlier in the game.

      Click on the graphs to expand!

Energy futures

The challenge of "green" is aggregating small amounts of energy – ultimately days of sunlight per surface^[1] – into amounts useable in quantity and continuity. Plants convert some of that energy continuously in daylight hours, but aggregating is the challenge. Currently we rely almost entirely upon a fossil fuel process that takes eons and is not sustainable – even if the amounts of recoverable fuels remains large, the environmental side effects are rising, not falling. Global economic growth has almost immeasurable benefits – hundreds of millions of Chinese no longer face hunger daily. Only recently has the government sufficiently overcome the fear of famine to eliminate the mandate that farmers grow grain. In China point- and regional-source pollution is now sufficiently bad to generate local political action, as it was first in California and then in the US as a whole in the 1960s. But no local government, and most national governments, are uninterested in denying access to electricity (air conditioning, refrigeration, lighting) or mobility (cars). Desirable or not, I don't think it's realistic to expect that governments will do much to repress energy demand. Supply-side developments are thus crucial. That means improving the feasibility of solar, wind, hydro and biomass.

One challenge is operational size. To what extent are economies of scale so intrinsic in the physics (and their engineering implementation) that only large facilities are feasible? Let me speculate on alternatives for wind power to frame this question.

Currently the trend is towards very large turbines. Winds blow stronger above ground; if you're building a tall tower, you then want to generate a lot of power per tower to cover costs. That may work, with better engineering of blades and generators and mechanical connections. Scale on the manufacturing side can help, as standardized designs lead to economies in production, from poles to turbine blades.

What would a small system look like, something found in every backyard? First, the turbines would have to be short and spin on a vertical rather than a horizontal axis; they couldn't look like windmills, but rather spinning windpoles that would face different wind sheer and so might be cheaper structurally – the pole would be the turbine access, with lower stresses cheap bearings or even bushings would do. Now close to the ground they'd "enjoy" far less wind, so would have to be really cheap. Windpoles might be relative to windmills on a watt-hour basis.

Then there's the aggregation issue. Such windpoles probably couldn't each turn a generator, that would be too high in cost per unit of energy. They might however be able to turn a small scroll compressor that would feed through standard lines to a centrally located turbine. Scroll compressors are pretty well understood, there are lots of refrigerators and air conditioners out there. Storing compressed air is also a mature technology, providing a means to enhance continuity. Small air tools – small turbines – have also been around a long time. So the pieces could be assembled quite readily.

I'm not enough of an engineer to cost any of this out. There may be simply too little wind energy at ground level. But versions of this – systems whose cheapness and small size make up for conversion efficiency – seem worth exploring. Perhaps they already have been, and have been found wanting. But in some parts of the world small rooftop solar water panels are pervasive – highly inefficient in the amount of energy they convert but so cheap as to make sense.

...[we'll see] a multiplicity of energy systems … [as in] vehicle drivetrains

In any case, any attempt to move away from fossil fuels is likely to lead to a multiplicity of energy systems – just as we are currently seeing a growing variety of vehicle drivetrains, depending on local fuel options and driving patterns.

mike smitka

Note 1. Nuclear – including geothermal – and tidal sources are exceptions. While in principle fusion is possible only uranium-based fission is commercially available, but that suffers from both political and economic pressures that make it a small slice of currently harnessed energy. Geothermal and tidal energy are at present unimportant.

Here are assorted data for your perusal – unfortunately due to the government shutdown data releases are delayed or (for certain data) a month will be skipped. For example, the "Employment Situation" was scheduled for November 1st; instead it will come out November 8th. Click on charts to expand to full size.

First, the first three charts on employment show a slow gain relative to age-adjusted population growth, but only slow. We still are far below normal levels of employment, and there's no particular reason to think that the fundamental structure of the labor markets and participation decisions changed over the course of a few months back in 2008-9 – no big shift in the ability to claim disability, no basic change in unemployment benefits, no change in wages [indeed, this recession reinforces the claim that wages are rigid downward, absent inflation], and I've already corrected the data for boomer retirement. That's clear if you look at the fourth chart of age-specific participation rates. Older workers – those of historic retirement age – are working more than ever [the chart gives data only from 2000, before then employment structures were relatively stable]. But in 2009 the share of people working in prime age brackets dropped, and that of younger people plummeted. Basically, while the economy is growing, it's not growing enough to eliminate the excess capacity of the Great Recession.

The fifth chart is investment. Again, we're out of the trough of 2009, but the level is still below that of some previous recessions. So more of the same: the economy is growing, but not recovering quickly.

That's not true for all sectors. As per the sixth chart, car sales have boomed; suppliers are at capacity, makers are having a hard time launching new vehicles at target levels of output. Still, we remain below the hyped level of the 2000s, and my sense is that sales are leveling out. There's still an overhang of vehicles from the go-go years, though depreciation operates far more rapidly in housing market. At the micro level I'm an example: since I'm stuck with an unsold house, we waited to replace our aging (240K miles 15 years) Volvo until the last minute – it wouldn't restart in the dealership parking lot so they gave me a tradein value lower than the local junkyard. We did buy a new car, as I judged the price differential relative to used cars too slim. However, too many people are underwater on their mortgages, median income [the point at which half the population has higher, half lower income] is falling. So my judgement is that the upside isn't going to move up very fast, despite our rising population. And while I only include the last couple years in the seventh chart, market shares have been relatively stable – with Toyota and Honda at a lower level. The eighth and final chart is of market groups. The top 4 firms have in the aggregate lost share, but over 2012-13 the Big Three and the Detroit Three have been stable.

Finally, interest rates have dropped back to the new normal under the Fed's antirecessionary monetary policy. With the fears of default eased, short rates are essentially zero. Now from day to day rates jump around, but remain extraordinarily low by historic standards, all the way out to 30 years. The yield curve is flat at maturities under 5 years, but there's now a moderately steep differential at longer maturities. With rates low, this isn't reflecting expected inflation but rather that eventually the economy will recover and with it short-term interest rates will rise. The market, however, is pricing that as years away – like 3-5 years. That is unfortunately consistent with my straight-line projection of labor market growth – at the current pace the gap won't be erased until the start of 2019. While I would not be surprised to see things accelerate as the housing stock normalizes ... well, the housing stock doesn't normalize quickly: according to the IRS, which is generous in such things, depreciation takes 30 years, and with median incomes stagnant, half the population isn't in a position to upgrade their "digs".

Date	1 month	3 mo	6 mo	1 yr	2 yr	3 yr	5 yr	7 yr	10 yr	20 yr	30 yr
10/15/13	0.32	0.14	0.16	0.16	0.37	0.68	1.45	2.11	2.75	3.50	3.78
10/16/13	0.14	0.10	0.11	0.15	0.34	0.64	1.41	2.06	2.69	3.43	3.72
10/17/13	0.01	0.05	0.08	0.13	0.33	0.61	1.35	1.98	2.61	3.36	3.66
11/05/13	0.06	0.05	0.08	0.10	0.32	0.60	1.39	2.06	2.69	3.46	3.76

Folks, The Economy's Stalled (June 9 update)

...the economy is stalled...

The Bureau of Labor Statistics released the Current Population Survey and Current Employment Survey data for April 2013, which provide detail beyond "headline" unemployment (which by the way fell 0.1 percentage point to 7.5%).

I prefer to look at employment data, to lessen the impact of people moving in and out of the labor force. As my baseline I use demographics-adjusted trend employment, to reflect for example the retirement of the baby boomers.

The lead stories (e.g., Bloomberg) point to a drop in the headline rate and a rise in payrolls. However, when we compare employment to what we need to keep up with population growth, April 2013 saw no growth. The graph says it all. (Adding in changes in the number working involuntary short hours doesn't change the story – see the graph to the left.)

Unfortunately, this rate of employment growth leaves us years away from "normalcy" – assuming that we do return to pre-recession levels (and there's no good story why we would not). The projection is based on a regression fit done a couple months ago, when employment growth was higher. So it is if anything pessimistic. Now I can tell a story that once we reach a certain level of recovery, a virtuous circle will kick in leading to faster recovery. The more time passes, the fewer people who are underwater on their mortgages, and the more younger people who have built up a financial cushion sufficient to purchase or renovate housing. As the family budget crunch eases, other consumption will rise, helping the process. And so on. While waiting, let's not think about spillovers from Europe, or disruptions in the BRIC economies, or the possibility of irrational fiscal policy at home.

Finally, because others track employment-population ratios, I present those for 5-year age brackets. The data are noisy, presumably because of small sample sizes (especially for old workers). These show, first of all, that young workers bore the brunt of the recession, but that prime-age workers were hit fairly uniformly, too. Further, while above the 2010 nadir, there's no strong indication that things have improved in the past 12 months.

Note that, contrary to my expectations, early retirement does not jump out of the data. Employment as a share of population is down by 2% for those age 60-64, but actually rises for the 65, 70- and 75+ brackets. While that for age 55-59 is down, it's down by about the same amount as for other prime-age (potential) workers. Now these data make no distinction between part- and full-time employment, nor for wages, so they may mask changes for older workers. However, the overall message is that older workers have postponed retirement, not taken early retirement.

...Mike Smitka...

Prime-Age Worker Employment-Population

Older-age Employment-Population Ratios

Why Support Higher Education?

..."flagship" colleges are not a local public good...

I've long been puzzled by state support for elite universities. In contrast, I've long been puzzled by the lack of state support for community colleges. So what's the puzzle?

To make sense to an economist, states should support goods and services that private markets don't adequately provide and where the benefits accrue primarily to the state. In other words, they should be local public goods.

That may have been true for elite state schools at one point in time. Nowadays, however, they recruit out-state and their graduates enter a national job market. That's not as true for second-tier schools, and not at all true for community colleges.

In othe words elite "flagship" schools are not a local public good, whereas community colleges are.

The Center on Budget and Policy Priorities provides data on dramatic changes in state funding to higher education. Many things drive this; obviously the timing reflects a stringent fiscal environment. In addition, the data don't indicate how these changes are split among tiers in the education system – elite schools, second-tier 4-year schools and community colleges. The latter ought to be the priority, because benefits are local, from both the student end and from the employer end. However, at least in Virginia [mea culpa: my wife teaches in the VCCS] elite schools have alumni lobbying networks (and sports programs that enhance visibility) – Virginia Military Institute, physically adjacent to my own W&L, is an example. The community college system has neither (though in some locations employers may raise their "voice".

Now some "flagship" schools are almost private; the University of Michigan is one such, and the University of Virginia is moving in that direction; both seek to be "national" university. Cause or effect? – in any case, I don't find the diminished state role inappropriate. However, I fear that all are painted with the same broad brush strokes, though the decimation of lower-tier institutions in California is what dominates my thinking. I don't research education, so this is primarily a thought piece, but one hypothesizing on the basis of data. I'll post further as I learn more.

...mike smitka...

Government Efficiency: A Natural Experiment

...sequestrian offers a "natural" experiment to test views of government...

Microeconomists will thank Congress for providing a natural experiment to test competing views of government. One is that government is unnecessary, or at least inefficient in an allocative sense -- lots of money on things that aren't very useful (and perhaps not enough money on things that are). If so, then sequestration won't matter. Economists also employ a second concept of efficiency, which in layman's terms could be phrased as "doing the job in a lean manner." If the government is inefficient in this sense, then sequestration will not matter: fire 10% of our civil servants and the remainder should be able to easily pick up the slack.

Then come alternative views of the impact of fiscal policy on the macroeconomy, "the" multiplier. Now I highlight "the" because Principles textbooks and macroeconomists who live in other than a blackboard world have maintained since the 1920s that the impact of fiscal policy in a great recession is large, while that in the midst of an expansion is small or nil. There is no "the" there. We again have a natural experiment: if the multiplier is really zero or negative, as claimed by those who opposed ARRA (the 2009 stimulus package), then sequestration will do no harm to overall growth.

I hope the sequestration experiment will not undertaken long enough to actually provide the evidence we economists need. That's because my priors are that (i) the bulk of the non-defense spending of the government is productive, that (ii) our bureaucracy is surprisingly efficient, and that given our lingering Great Recession (iii) the multiplier is 1.5 or greater [that is, we get more than a dollar boost in GDP for a dollar of properly accounted stimulus]. So we will (ii) see disruptions that (i) will matter and (iii) that if they go on for long, will aggregate through lower expenditures to have a measurable impact on GDP.

So what of the natural experiment jargon? Well, identifying the direction of causation in economics is really hard. Fiscal measures are affected by a recession. Since taxe receipts are dependent on income, budget deficits explode. While expenditure changers also occur, some of those are a function of our growing economy and population, hence "endogenous". Furthermore, new policies are implemented only slowly; measuring "real" stimulus turns out to be hard. Statistical tests therefore seldom convince open-minded skeptics.

In contrast, sequestration will offer a sharp "exogenous" change with discrete timiing and clear numbers. Of course there are lots of other things affecting the economy, and so a one-time event won't be an unambiguous cause. If sequestration extends for months, however, we'll have another data point generated when it ends.

To reiterate: my priors are that sequestration is a big deal. So I hope that Congress (or more specifically, the House) sits down with the Administration in short order, and leaves us economists bereft of data.

...Mike Smitka...

Steve Rattner on fiscal issues

...header...

Steve Rattner worked very hard on behalf of our economy with the Auto Task Force. The US was already in the throes of the Great Recession. Had the bankruptcy process not been handled in a timely manner, our economy would have been thrust into a second depression. (See the related Autos and Economics blog.

I had had a bankruptcy lawyer into my classroom before the recession began; he described the nightmare that large corporations face, years of uncertainty and hundreds of millions in lawyers fees under Chapter 11. The Task Force was absolutely brilliant in avoiding that scenario.)

However, while Rattner has been able to step back and rethink standard ways of doing things in the realm of corporate restructuring, he has not similarly been able to distance himself from received thinking on fiscal issues. Above all, he continues to view retirement security (Social Security and Medicare) as boats that ought to run on their own bottoms. Since money is fungible, there is nothing inherent in this, except as it changes the politics. However, over the last four decades Congress has not treated the operating budget as something separate from these programs. The "on-budget" and "off-budget" distinction is irrelevant.

Now Rattner is not an economist, and so also misses details here and there. On the surface these are not matters of substance. However, they do affect the tone of the debate, because they exaggerate the magnitude of issues in some places, and understate or obscure them in others.

As a lay person Rattner does a good job. But we really need everyone who approaches these issues with good intentions to do a better one.

...mike smitka...

Rattner slides:

1. Slide 2: Why care?

a. Beholden to China, yes, but they are more beholden to us – they are only one of many bondholders, but almost all their bonds are dollar-denominated.

b. Intergenerational transfers can occur via voluntary saving, involuntary taxing (FICA) and debt issued outside our economy. Don't focus on one to the exclusion of the others. Futhermore, ALL retirement at the societal level has to be financed on a pay-as-you-go basis, since what we consume are services, and they can't be saved.

2. Slide 9: Revenues vs Spending

a. Spending and revenue are distorted in the graph due to the sharp decline in GDP, from which we have yet to recover. So you need to incorporate changes in the numerator and not just the denominator. One way to do that is to use potential GDP. (This same issue applies elsewhere.)

b. On the revenue side, reliance on income taxes accentuates the impact of busts and booms. Graphing against the gap between current and potential GDP would highlight that.

3. Slide 13: Tax Expenditures

a. A focus on tax rates obscures other tax rules (carried interest) that affect actual payments, particularly for those in jobs amenable to relabeling compensation to be other than wages.

b. Perhaps in the discussion of the slide, but it's worth noting that some of the tax expenditures are only relevant if you have enough income to itemize deductions.

4. Slide 16: Healthcare costs

a. Projections of social security expenditures are fairly robust, because you can use replacement rate x GDP x claimants / GDP, and demographic projections are robust while the replacement rate is fixed by law.

b. Projections of healthcare are very dependent on projections of healthcare costs. While we have not been successful in the past in controlling costs, the rate of increase has slowed in recent years. If that continues – and since there's little consensus on why the increase has slowed, we simply don't know – then this graph overstates future levels, potentially by a large percentage of GDP

5. Slide 17: R&D and infrastructure

a. We ought to be spending less on infrastructure today, depreciation versus new construction of roads and the like. That it's fallen by half doesn't tell us what we need to know.

b. Accounting for R&D is hard. For example, nuclear weapons programs don't yield private benefits and should be excluded. That was more important in the 1950s, muddying what we might learn from comparisons.

6. Slide 18: Unfunded obligations

a. These are subject to the discount rate and number of years over which projections are made. Social security goes out 75 years – sensible?

b. Furthermore, no one contemplates repaying all government debt. What matters are changes sufficient to stabilize debt.

c. To communicate with lay people, what is the equivalent steady-state change in taxes as a percentage of GDP required to accomplish this?

7. Slides 21-22: Simpson-Bowles? Let's hope not – I've never figured out why people talk about it. Furthermore, when matters, not just how much. Should we be striving to raise taxes and lower expenditures while unemployment remains far, far above historic levels?

8. Slide 25: Wish list.

a. Skimpy on details.

b. The devil rules therein.

9. Slide 26: Social security.

a. All of this presumes that somehow social security ought to be a boat that rides on its own bottom. As an economist, there's no reason for that.

b. In addition, are benefits so generous that they ought to be cut? The lower CPI adjustment does that, and since retirees aren't average – they consume more healthcare – the overall inflation rate already understates the inflation they face.

c. Raising the cap on social security payments only affects higher income individuals; depending on the level, means testing potentially also affect higher income individuals.

d. Raising the retirement age certainly enhances revenue while lowering outlays, but is offset by higher rates of disability at older ages. Since those who are poor are more likely to be disabled, a blanket increase could result in those most vulnerable falling through the cracks.

e. Social security is intended to provide security, as it insures against inflation and swings in returns on stocks and bonds. Private accounts do not provide those functions. Nor would private accounts add to national savings. They also face phase-in issues.

10. Slide 27: Healthcare reforms

a. Several of these proposals parallel those for Social Security and suffer from the same defects.

b. Cost control ultimately requires saying "no" – but current legislation provides very little ability to limit treatments that are not proven more effective than less costly alternatives. In addition, there are no mechanisms to encourage the terminally ill to seek hospice care rather than hospitalization. These are challenging technically, as well as in politics and ethics. Nevertheless, we fool ourselves to think that co-pays and tougher reimbursement guidelines will be adequate, except as they mean that less well-off individuals do without.

11. Slide 29: Sequestration
a. I have yet to see any proposal for a grand bargain that reflects sensible economic analysis.

...how can you discuss policy if you can't count?...

Some comics are simply too good to pass up. I've seen jokes using the 110% quip, but this is a nice collage. I've linked this to the Dilbert web site via uclick.com; if the link disappears you'll need to look for the Jan 18th strip elsewhere. I'll see if I can find the text of (today's) Founders Day lecture at W&L. I don't want to try to paraphrase without links if I can find the real thing and cite, or at least paraphrase with a link to the original. If I manage, you'll see the connection.

Ron Paul at Washington and Lee: Does gold shine?

...based on discussions following Ron Paul's Wednesday January 15, 2013 talk at W&L...

There's a certain fascination with gold; it seems to offer a way to constrain central bankers, at one end of the rules versus discretion debate. Mind you, central banks don't have a stellar track record. The Federal Reserve raised interest rates during the onset of the Great Depression, surely worsening matters. That's a core criticism of Milton Friedman and Anna Schwartz in their Monetary History of the United States. So it's sensible to ask if there's a viable alternative.

Drawing upon Irving Fisher, Milton Friedman played around with rules that focused on the growth of the monetary base. Empirically, the first pass seemed to be OK. However, that turned out to be an artifact of his particular dataset, drawn from the early post-WWII period in which financial institutions in the US were tightly regulated. By 1980-81, when the Fed briefly tried to use such a rule under Paul Volcker's chairmanship, it was clear that there was no stability of the link between creating additional reserves and banks' creation of money. So if not reserves, then let's try targeting monetary aggregates, first M1 then M2. When those proved unreliable, then let's try an inflation target, now part of the legal mandate for the Bank of England. That, too, has problems; the latest iteration is to focus on holding the constant the growth of nominal gross domestic product. As to Friedman, he eventually concluded that none of the rules he proposed would work. But that was in his academic publications, and in talks before economists. He never went back to emend his popular writings that propounded what has been labeled "monetarism." Nor did he support the gold standard; to reiterate, in his analysis it was the US attempt to adhere to the gold standard that turned a recession into the precipitous decline of the Great Depression.

So what's wrong with gold? For one thing, any claim that it provides a stable source of value fails to pass the laugh test. Jewelry fashions come and go; central banks buy gold and then don't; mines dry up; the global economy booms. All affect the price of gold. Over the past 4 decades (setting 1970 = 100) the price rose to 950 circa 1980, then fell to 150 by the 1990s, and has risen again to 750. Traders in shopping malls booths wouldn't have a business scamming people out of their grandparents jewelry and selling overpriced coins if the price of gold was stable. One of the largest sources of gold is Russia; do we want to give Vladimir Putin the ability to thrust us into a recession if somehow Congress were able to forge a direct link between gold and the US macroeconomy? I suspect not.

Now it's unclear why Rand Paul latched onto gold; I suspect it was that he really wasn't "into" economic policy and never did his homework. Then, too, there is the residual impact of the writings Hayek and other "Austrians" that go back to the days when it looked like monetary policy rules might work. That is compounded by the Austrian school's loss of focus once high socialism was no longer a real threat. Hayek and others engaged in broad-brush arguments against socialism, with the Soviet system as their implicit target. It's hard for young people to fathom, but at one time that model seemed a real threat, both with the Red Army's continued occupation of eastern Europe, and the attraction of Stalin and the meteoric rise of of Russia from a backward peasant society to a military and scientific power that could provide many of the appurtenances of middle class life to its core population. In contrast, England's economy didn't do very well after 1914, and did horribly after 1929. In newly independent colonies, the political model also seemed attractive; bedeviled by unnatural geographies and ethnic tensions, democracy didn't look workable in the short run, and presidents who developed a fondness for the trappings of office found Stalin's example of how to hold onto power more useful than trying to learn lessons from Churchill's electoral failures. But in 1989, the collapse of the Soviet Union, and within a few years of Tiananmen, the success of market-oriented reforms in China. No one now views socialism as a threat.

...he had a store of one-liners, but no coherent story...

Unfortunately, the Austrian school has nothing to say to this new world; its raison d'être vanished in 1989. Yes, government is bad. But we're no longer talking about the heavy hand of the central planners in Moscow and their cruder counterparts in Romania or Beijing. The Austrian's broad-brushed treatment is not amenable to empirical exploration; ironically, unlike the teachings of Marx, it is more political philosophy than economics. (Marx's theories, of course, have been found wanting.) So the Austrians have nothing to offer policymakers, they have no ability to provide a nuanced picture of an economy. Another irony is that without the foil of the Soviet Union, those enthralled by the writings of von Mises and Hayek have become doctrinaire, arguing over fine points, hostile to any who are not true believers. I had hoped that mindset died out with the last generation of Marxists, only to find that today it characterizes the Right rather than the Left [both capitalized – after all, they are/were proud of the label].

Now Ron Paul is an engaging speaker; I've heard him. He makes enough sense here and there to encourage people to listen. But he ranges too far and wide. When it comes to economics, he may have a store of one-liners, but they don't add up to a coherent story.

...mike smitka...

Debt Ceiling Dynamics

...chaos, painful chaos...

What would happen if Congress refuses to raise the debt ceiling? The answer is chaos, painful chaos that would have horrific short-term implications for not just the US but the global economy. Here's why.

Refusing to raise the debt ceiling of course could mean that the government is unable to send out social security checks in a timely manner, or otherwise pay its bills. Mind you, these are all programs duly legislated with expenditures authorized by Congress. So the proper way to do things is to change the law. If members of Congress don't think they can get re-elected if they do that, then ... but let me stick to the economics.

The real nightmare is the uncertainty this would throw into credit markets. The impact would be concentrated in short-term markets, because that's the debt that (by definition!) falls due. An awful lot of our economy is tied to those markets – money market funds, the prime rate that affects small business loans, car loans and credit card interest rates, and of course that also affects the holding cost of financial institutions with short-term funding needs. The Federal Reserve can work to keep the Federal Funds rate low, but that's an arm's length removed, and at best helps out banks. As we've seen, however, the straight banking portion of our financial system is a shadow of its former self, while the shadow banks have taken over.

Normally there's virtually no capital gains risk, upside or downside, in short-term markets – one reason that interest rates are typically much lower. But what if you have a Treaury maturing 5 days from now, and you're not sure it will be good. Now you will get your money, sooner rather than later, but the certainty is gone. Suddenly you're in a seller's market, and face a loss if you try to sell it -- but the possibility of no money on day 5 if you don't.

Now at today's interest rates – let's say 0.04% pa, the rate on a one-month bond at the end of December 2012 – well, a $1 million bond earns roughly $1 a day. But if you're a corporate treasurer that really needs the money to make payroll, you may well prefer to take a $100 loss on your $1 million – that is, get $999,900 today – than have a bunch of workers seeking to lynch you because their car payment check bounced. But that means a 4% interest rate – and if we look at what happened when Lehman failed, rates could go much higher.

That doesn't sound like much, but it would put money market mutual funds at risk, as many have committed to holding short-term Treasuries to minimize risk. Ditto foreign exchange trader from around the globe. With trillions of dollars traded every day, a jump in interest rates of that magnitude would throw a monkey wrench in the economy that would make the fiscal cliff look as flat as a bowling alley.

So I think that an administration pushed into a corner would in fact be willing to do almost anything, even delay social security payments, to avoid a bond default. But market managers won't want to place their careers at risk of politicians, most of whom are lawyers, failing to get their priorities straight. Unlike with the fiscal cliff, a last-minute compromise will thus still cause chaos.

I try to avoid hyperbole, but to me it would be treason – far more dangerous to the US than spilling top secrets – for Congress to use the debt ceiling as a political tool.

...mike smitka...