Random Economic Thoughts

On Saturday Texas Representative Mike Schofield came out to our local Tea Party meeting, talking about the upcoming legislative session, and whatever else was on our minds. He gave an explanation about federal and state economics that made sense to me, and I’d like to share.

Rep. Mike Schofield speaking to us last Saturday
photo: Cypress Texas Tea Party

This is from my notes, so not direct quotes. But he said the federal government ran out of money decades ago. It has no money—so it spends debt. 

This isn’t like you and me, or even the vast majority of states that are required to have a balanced budget. We can spend beyond our ability to repay for a while, but soon we have to tighten our belts or find additional income to repay the debt.

The federal government is far beyond the ability to ever repay, and yet they keep spending. They get away with it in just a couple of ways. One is higher taxes, but you can’t do that indefinitely. People won’t tolerate it, and the economy slows to a crawl or into a recession when government removes so much money from the market.

The other thing they do, which has been their preferred choice lately, is to push programs down to the states. They keep hold of the rules and regulations (so they can take credit for "doing good") but push the bill onto the states.

What is the way out? We can hope that a Trump administration will reverse the trend. Heads of programs can remove requirements (unfunded mandates). Another hope is that new appointments to the Supreme Court will stop ruling those myriad regulations, with laws created by unelected bureaucrats, as unconstitutional.

There is an old view—believed by the democrat party and beyond—that you win the election so you get to do what you want. But we have this document called the Constitution that says otherwise. It’s not about doing what you want; it’s about doing what you’re allowed by the supreme law of the land to do. As for the Supreme Court, you certainly shouldn’t be on the Court if you don’t believe in the Constitution.

Rep. Schofield then talked about the Texas constitution. With a balanced budget requirement, when you cut taxes (and literally cut revenue), you have less money to spend. You can’t expand the size of government.

So when the federal government comes in and mandates a program, it literally cuts what the Texas legislature can do with the state budget.

For example, Medicaid is a cancer on the budget. Of $209.4 billion, $64.2 billion is for this one federal program. All we can do is keep qualifying down to narrow the group.

When you buy into the program, you’re stuck with the terms of the deal. But the federal government can change their part of the deal and still won’t let you out of your requirements. They might provide less federal money. They might stop paying entirely, and you’re still required to provide the program in full—now totally at state expense.

Then they say things like, “Then you’ll need to have an income tax.” They want government to have more control over every citizen’s money, because they think they know better than you how to spend your money.

That brings us to one of the basic principles of the Economic Sphere of the Spherical Model: Who decides what will be done with the fruits of your labors? If you want the benefits of the prosperity hemisphere (north on the sphere), the decider should be the person who did the work to earn the money, not some far distant wielder of power. 

This morning I was listening to the third hour of the Glenn Beck radio show. He was talking with Chris Martenson, of PeakProsperity.com. Glenn asked what we could expect from the Fed this week, and how that would affect us. Martenson responded that they would have to raise rates. And the two discussed why. Eventually they got to talking about imbalances. And Chris Martenson made this assertion:

Chris Martenson of PeakProsperity,com
photo from their website

Chris: These things have all been building for a really long time, Glenn. And I think if we had to, if we wanted to put our finger on something, we would say August 15th, 1971, when the United States abandoned the gold standard for the world—that’s really where all of this started. And these imbalances are enormous now.

Glenn: Well, that’s when we all decided we wanted a life we couldn’t afford. So the United States did that, but we convinced the rest of the world that, we’ll continue to buy your stuff, so that will be good for you. But we all said—all of us—we want more stuff than we can afford if we base our dollar or our currencies on gold. Is that accurate?

Chris: It is, because gold provides a set of restraints that you just can’t get around. And, if you can’t get around those restraints, well, sometimes you get to live beyond your means, but very soon thereafter you have to live below your means. The world kind of collectively said, “We don’t like that below our means part. How can we just forever live above our means?” That’s how these imbalances got started.

And it’s a very human thing, Glenn. We’ve seen this so many times in history, and here we are again.

They discuss the differences between inflation and deflation.

Chris: So, everybody I talk to says, “Look, I like falling prices.”

That’s not what the Fed is targeting when it’s worried about deflation. They have a different thing they’re worried about where prices rising or falling are the symptoms, but the cause is what they’re concerned about. And the cause is either our credit markets are expanding or they’re contracting. When they’re expanding, which is inflation, everything kind of works. Governments can continue to run deficits, and big banks can do crazy dumb things. And it all seems to work out. 

The opposite, though, Glenn, when credit is falling, that’s also known as 2009 in the United States. It is deeply scary. What works in forward doesn’t work at all in reverse. The whole system shudders and threatens to collapse. It’s a really scary moment.…

Remember, the Federal Reserve is not really federal; it’s a private entity. It’s got a charter from the US government, and it operates in a very nice monopoly. But it’s first set of clients, always, is the banks. So if the banking system’s happy and expanding, the Fed’s happy.

Glenn: OK, so they’re not worried about deflation; they’re worried about the bank. But, by doing what they’ve done, they are throwing caution to the wind by printing $7 trillion dollars’ worth of currency. Never been done before in the history of the world. And expecting that hyperinflation won’t happen. How can we have printed that much money and not have the problem of the Weimar Republic? What’s the difference?

There are some discussions, then, about where the printed money has been floating around. Instructive. But we really want to know about that hyperinflation thing looming over us.

Chris: The bubbles always have the same self-reinforcing mental map on the way up. People think it makes sense: “Well the last guy paid $79 million, and I paid $85 million. Surely somebody is going to pay me $100 million for this piece of art.” That’s all self-reinforcing on the way up. And we don’t know why, but eventually there’s a pin that that bubble finds, and when it bursts, then you discover what is the true value of things. And things go down very quickly at that point.

Glenn asks, again, will the bubble burst badly, or are there systems in place to prevent that now?

Chris: Well, you know, if it’s not going to burst, we have to believe in the four most dangerous words in human investing history, which is: This time it’s different.

It’s not different. It’s never different. I’m seeing the exact same psychology, rationalizations, post facto rationalizations that people make.... To me, it’s much easier to understand where we are if you see that we’ve got a very scared set of central planners. They’ve worked themselves into a multi-decade corner. They don’t know what to do. So they print.

 And you can find this story in Roman times; you can find it in the first paper money in China. You can find it all through history. And it boils down to this, Glenn; it’s very simple: humans would much rather take a little risk today, instead of some pain today, in the hopes that things turn out better in the future. We always go down the same path.

I highlighted that. I think it explains a lot. 

But, about that hyperinflation: will we see it, Glenn asks, within the next four years?

Chris: We’re going to see it at some point. It could come at any time. It will happen at some point. And I think that the best quote on this comes from Ludwig von Mises; he’s an Austrian economist. And he said, “There’s no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

This isn’t good news, of course. We probably ought to have some food stored, and have some real assets. I don’t know if gold is the right answer. I don’t know what is the right answer. I guess I’m not here to answer how to mitigate the damage caused by the central planners; I’m here to point out that the central planners never do a better job of controlling the economy than a true free market would do.

If only we could try that for a change.

Chaos Blues

I’ve been worried lately about our friend Farida, who is working in Venezuela. Things have been rough there lately. It hasn’t shown up a lot in our news, but things are pretty chaotic. The root of the economic issues seems to be the government being low on cash (despite taking in $750 billion in oil revenue since taking over that segment of the economy in 1999).  So the government has been taking on debt, mostly from China. Inflation rates are around 54%.

When inflation is high, prices are high—or, rather, the money buys less. President Nicolas Maduro (successor to Chavez) doesn’t like the high prices. So he has declared that certain items—such as appliances—must cut their prices in half.

Venezuelan President Nicolas Maduro
photo from here

Some of the chaos is from crowds forming outside appliance stores, waiting to get in to make the lower cost purchases. But in addition, there has been a fair amount of looting. Crowds think, “The pries are too high; that means the store owner is trying to gouge us; since the store owner is evil, we have a right to take from him.” So they break in and walk off with flat screen TVs—in a country where toilet paper and one in four food items are considered scarce.

The thought of the chaotic mobs is not a far stretch from what government thinks—what we want, we take. These store owners had to purchase the goods ahead, with pre-inflated Bolivars (the currency). If they sell at pre-inflated prices, they cannot replace their costs, let alone purchase more goods for future sale.

Is it possible that some store owners are price gouging? Possibly. But in a free market, if a seller asks a price too high, demand drops, so he has to lower prices in order to make sales. It’s not a problem requiring the incarceration of the “bourgeois” businessmen.

Let’s put it in simple numbers, as an example. Suppose it costs the store owner $100 to purchase a TV wholesale. Between the time of his order and the time he puts it out for sale in his store, inflation has kicked in. The $100 he spent is now equivalent to $154. He has to take in at least $154 to cover his wholesale purchase, to be able to buy another TV to sell in the future. That’s without profit. He also needs enough to cover overhead: cost of his building, cost of his employees, cost of transportation of the goods, and other basics business costs (including taxes on everything sold). But when he puts $154 on the price tag, that looks so high. The president doesn’t like the look of high prices—caused by his inflation-inducing monetary policies—so he blames the store owner and mandates a 50% price cut. That means the price is $77. That’s only going to cover half the cost of the item to the store owner. The government has just taken $77 from the store owner, and demonized him, adding insult to injury.

The store owner has just had his business destroyed, permanently. And crowds are suspicious that the evil store owner might be holding back goods in some back room, so they’re prowling to make sure that can’t happen.

Farida sent me links to videos of the looting. Here’s one, and here’s another. (One more was immediately deleted; I don’t know how paranoid to be about that.) She also said she had been essentially under house arrest for a week (that was her term, but I think she meant the company she works for was insisting she stay inside her home for her safety). She’s trying to get a Christmas break trip to meet family in Europe, but she keeps getting told there are no airline tickets available. However, she was able to spend a recent weekend in the nearby Caribbean, which is better than house arrest with no toilet paper or food. She was scheduled to work in Venezuela for 18 months; this coming February will be the one-year mark. But she says conditions are so bad, she’s going to be relieved from that contract and will be transferred in January. Living in socialist Venezuela has been rough for a young single female engineer; I hope the next opportunity is opposite of tyranny. Farida is a person made for living in civilization.

I am looking at the connection between respecting property rights and civilization. Does government’s disrespect of property lead to the people’s disrespect of property—the looting? Or does a people who fail to live the rules of civilization naturally end up with a life-controlling government? It may be a chicken/egg question. But my guess is that imposition of tyranny—taking away God-given rights—demoralizes a people, quite literally.

On the other hand, the way out of tyranny, and the accompanying savagery and economic desperation, is people choosing to live the laws of civilization, which include respect for property, life, and truth. It’s one of those life problems with a simple but not easy solution.

Cliffs, Valleys, and Flash Floods

Every now and then I get annoyed that the opposition to freedom has control over the national vocabulary. So I’m striking back a little bit with my own small force. What I’d like to do away with is “fiscal cliff.” The term implies that, at a certain point (and this time it’s at the end of the year when the Bush tax cuts expire and everybody’s taxes then suddenly rise to previous rates), there will be financial freefall. It’s looking like a game of chicken.

I want to change the metaphor to something closer to what is about to happen.

Back in late 2008 we went off a cliff—we had the sudden drop of a severe recession. What do you expect after a recession fall? That’s right—a bounce back up to where we were. Under normal circumstances, when the economy hits bottom, it heads back up with about the same amount of energy, sometimes climbing higher than previously. Unless, of course, there’s interference “to help.” I wrote about this in “Parabolas” and “The Trampoline Effect.”

Winter Camp Slot, Near Moab, UT
photo from here

Government interference took away the bounce back up. The trampoline metaphor would look like jumping off a cliff onto a bouncy trampoline floor that would just as robustly put us back up where we had been. But the “help” meant someone stopped the bounce from happening, and we found ourselves pretty much stuck down there on the valley floor. Nothing for it but to walk along the cliff wall until we can find a path with enough possible foot and hand holds to allow us to climb back up.

So we’ve been walking along the valley floor, kind of wandering, for four years. Sometimes the floor of the valley has been heading very slightly up, so we’ve tried to follow that direction, moving along this valley as we go.

But now what is about to happen—the sudden across-the-board tax increases—is we get stuck in a tighter canyon; we’re running out of valley floor to walk on, and the cliff we’re inexorably approaching is even more sheer and imposing than the one we dropped down originally. Can it be climbed out? Maybe, with the right  equipment, some skill, and a lot of determination. As Westley said, while climbing the Cliffs of Insanity in The Princess Bride, “Look, I don’t mean to be rude, but this is not as easy as it looks. So I’d appreciate it if you wouldn’t distract me.”

Private sector business is the climber; the distractors, a combination of Democrats, liberals, media (redundant, I know) are pointing out that they’re waiting to kill the climber when he reaches the top, which “does put a damper on the relationship.”

[We could also see the distractors in this climbing scene between Vizzini and the Fezzik the giant:

Vizzini: You were supposed to be this colossus. You were this great, legendary thing….

Fezzik: Well, I’m carrying three people….

Vizzini: I do not accept excuses. I’m just going to have to find myself a new giant, that’s all.

There are so many ways we can apply The Princes Bride to our world.]

It’s a precarious situation we’re in. What’s even worse is that climbing the economic canyon wall, while necessary and difficult, is made more treacherous by an additional looming danger. We hear distant thunder. That means rain, which, in this terrain, means FLASH FLOOD. If there is enough “rain”—quantitative easing, or printing of money that is not backed by wealth created, as well as debt along with mounting interest, now at higher rates because of our twice-lowered credit rating—then we get hyperinflation. We get washed away down the economic canyon.

Flash floods in this terrain are much more dangerous than in, say, a flatter plain, or more gentle slopes. The tight canyon walls direct the path of the flood and speed it up. Everything in the narrow canyon gets washed away. Occasionally there are survivors [the link is a news story about the 2004 Antelope Canyon flash flood and its one survivor; not about economics, but a fascinating story], but deaths are common. In our analogy, the deaths are business closings and more lost jobs.

Is this for certain going to happen? We don’t know. We just know the conditions to watch for, and we see them. Darkening clouds loom above. Thunder rumbles not too distant. We’re up against the cliff wall, struggling against great odds to get to higher ground.

So, in not-very-cheerful summary: the expiration of Bush tax cuts (which, after a decade simply translate as a sudden tax increase) are a huge sheer wall in the way of recovery. But the real fear isn’t a sudden new drop, or recession; we’re already there on the valley floor, so we’re not about to step off a ledge. What we have to fear is the flash flood of hyperinflation, washing us down, down, down the ravine, with plenty of inevitable drownings.

Congress shouldn’t be overly concerned about the looming cliff wall. Dithering about whether we’re going to walk into the wall isn’t the least bit useful. Better would be to put out warnings: get to higher ground. Now! Save yourselves! Government can’t do anything useful at this point but get out of our way.

In a related mistranslation: tax increase does not equal revenue. I wrote about the Laffer Curve here. This video, from Prager University, is one of the better explanations.

 

Bubbles

A few evenings ago I had the opportunity to hear BobWiedemer (eventually available here), one of the authors of Aftershock, a bestselling book on the economy. His main point is that, rather than the usual image of business cycles, it is more accurate to view America’s economy, at least during the last couple of decades, as a series of bubbles. While being diametrically opposed to the supposed experts, Wiedemer’s group identified and predicted the dot.com bubble, the housing bubble, the rise in the value of gold, and others. One of his main points was that, unlike cycles, where things eventually turn around and get better again, after a bubble pops, it’s not coming back. 

He warns that it is a mistake to assume that because things have always been a certain way means they always will be. Experts assumed housing prices would always rise. But when Wiedemer saw an unusually sharp rise in housing prices, that was a clue that something wasn’t right. Turns out that, as it often does, the bubble happened because of interference with the market. Mortgage standards were forced lower, with the goal of putting more people into their own homes (particularly those previously identified as not financially ready to take on a mortgage). More buyers meant more demand, which meant higher prices, which meant attracting more builders to the booming market, which meant oversupply—and combine that with much higher default rates causing insecurity in a previously safe investment, and housing prices suddenly plummeted. The bubble popped. 

When the government sees a bubble that threatens to pop, its tendency is to avoid (postpone) failure by propping up the industry—purposely allotting greater resources where there capital has obviously been ineffectually used. This is what they did with the bailout of GM and various other entities back in 2009. A better way would be to pop a bubble quickly, when it’s still small. Then the capital becomes available for more promising purposes.  

Serious trouble lurks on the horizon when the economy is a series of interwoven bubbles, so that the outcome is likely to be a domino effect once they start to pop. 

Wiedemer’s group identifies the bubbles, and, when possible, predicts when they will pop. He says the current bubbles are government debt and the dollar. We’ve seen the charts. Debt slowly creeps up over the previous century, and then spikes during Bush’s term, followed by approaching the asymptote as soon as Obama takes over.  

When there is debt, one way government deals with it is printing money to pay for it. (This is something counterfeiters do too, but when government does it, we don’t jail them. Maybe that’s the problem.) Sometimes money isn’t actually printed, just electronically produced by selling treasury bonds, where numbers change on computers, but no actual money gets hefted from place to place. But this “printed” money doesn’t represent wealth (surplus representing work completed that society is willing to pay for). It’s like monopoly money. Well, technically monopoly money has the value of functioning in a certain way for the purpose of playing the game, which is something people are willing to pay for. But, anyway, this printed money isn’t “real,” in the sense we regular mortals think of real wealth. 

The usefulness of printing money to pay your debts is that it doesn’t take as much of that tedious work and wealth building to pay things off. Instead, you use the wealth you’ve already created and call it double that amount (or whatever increase). Your creditor might not be happy about receiving $1Trillion that represents only the work of $500 Billion or so. They will feel cheated. Not as cheated as if they get stiffed for the whole amount, but at some point they’re going to say, “You’re not worth lending to.” When they say things like that, it translates as, “Your Triple-A rating is being downgraded,” which happened last month. And that means, as a higher risk, we don’t get the lowest interest rates when we turn over the debt, but we pay something higher that is still adequate to persuade creditors to take the risk. And then we go ahead and pay with even-lower-value dollars, so they downgrade further and eventually refuse to lend to us at all. At which point any current debt isn’t payable—unless we drastically increase our dollar printing to pay off the debts with paper that doesn’t represent actual wealth.

So, what happens when government presses its luck and prints so much that the value of each dollar shrinks to something infinitesimally small? Hyperinflation. What are the signs that this could be on the horizon? Other countries don’t want to use the dollar as their base currency anymore—they don’t trust its value. (Although, so many countries have inflated their currencies that there isn’t an obvious replacement—which has been propping up the dollar for a while already.)  

Another signal is the price of gold. When we were on the gold standard, in theory you could go to your local bank and turn in your dollars (bank notes) in exchange for that value in gold. When that got too limiting for government experts (back in the 1960s), we left the gold standard, and the dollars are just backed by the federal government’s promise that the dollar has worth. So when we know the dollar represents a lower value, it buys less. So prices rise. Inflation.  

Gold is more stable. If you look at the amount of gold it takes to purchase a home, for example, it would stay relatively stable. But the dollars you would exchange for gold change as trust in the dollar changes. So, right now, while the value of the dollar is drastically shrinking, gold prices are drastically rising.  

He didn’t say this, but I think gold is a bubble. If you’re trying to protect the value of your savings, doing it with gold is a good way. If you started doing that at $300 an ounce, instead of now, even better. It looks like you’ve made huge profits. But actually the profits are in less valuable dollars. At some point you’ll need a wheelbarrow full of dollars in exchange for an ounce of gold. This “bubble” will continue as long as distrust of the dollar continues.  

But even gold has its limits. There is the following exchange about the value of gold in Terry Pratchett’s Making Money (I talked about it here). Moist von Lipwig is talking with journalist Sacharissa Cripslock. 

Moist: “What are we, magpies? Is it all about the gleam? Good heavens, potatoes are worth more than gold!”

Sacharissa: “Surely not!”

Moist: "If you were shipwrecked on a desert island, what would you prefer, a bag of potatoes or a bag of gold?”

Sacharissa: “Yes, but a desert island isn’t Ankh-Morpork!”

Moist: "And that proves gold is only valuable because we agree it is, right? It’s just a dream. But a potato is always worth a potato, anywhere. Add a knob of butter and a pinch of salt and you’ve got a meal, anywhere. Bury gold in the ground and you’ll be worrying about thieves forever. Bury a potato and in due season you could be looking at a dividend of a thousand percent.” (p. 108) 

In other words, even gold’s value is limited to either its usefulness or to whatever we decide to call its value. You can’t eat it. So in famine, when food is scarce, it will take more gold to buy a sack of flour. But it’s traditionally the best we’ve got for being a stable money base value. Certainly better than a piece of paper (or digital message) that the government no longer even claims to represent a given amount of work. 

What is going to happen? I don’t know. I’m just beginning to read the book. Maybe before it’s too late we will elect an administration that will stop the insane rise in debt and government spending. Then maybe trust will continue so that getting out of the bubble will be less painful than if it continues to grow before popping. Maybe we can keep enough trust in the dollar that hyperinflation and collapse won’t be the inevitable only way to stop the current practice. 

One thing in our favor is that we are used to being a free, hard-working, inventive and entrepreneurial people. Our behavior has always created real wealth. The system of exchanging that wealth is the problem—and it’s a big problem. But it’s not as big a problem as many countries face: a growing entitlement mentality. OK, we have that problem too. But maybe it’s not too late to pop that bubble quickly and move along with a better allocation of resources.