Collective Conscious A Notably Rare Exception

From The Ground Up, Part 1

The perfect story to summarize my understanding of how macroeconomics works showed up today, via Arnold Kling. Read it below, and then we'll start from the beginning. Economics, after all, isn't that hard.

Once upon a time, Joe lived in Keynesiana, where he was a typical worker/consumer.

Joe worked in a GDP factory, making GDP. Every Monday morning, he went to work, and he worked five days a week. He was paid $1 for every 24-minute segment he worked, and he worked 100 segments (40 hours), so he earned $100 a week. Every Friday afternoon, Joe cashed his paycheck and went to the GDP factory outlet, where he spent it all on GDP.

One day, Joe decided that he needed to accumulate some savings. He made up a rule for himself. Knowing that he needed to consume at least $40 of GDP each week, he decided that his rule would be to save 20 percent of everything he earned over and above that $40. Since he made $100, his rule called for saving 20 percent of $60, or $12. So he cashed his $100 paycheck, but that Friday afternoon he only spent $88.

Next Monday, morning, Joe's boss had some news. "A funny thing happened last week. We sold 12 percent less GDP than usual. So this week, we're gonna put you on a short week. You work 88 segments, instead of 100."

Joe was disappointed, because this meant he would only be paid $88 this week. Sticking to his new rule, he resolved to save 20 percent of $48, or $9.60. So that Friday afternoon, he cashed his $88 paycheck and spent $78.40.

Next Monday morning, Joe's boss said. "Well, golly, it looks like we sold even less GDP last week. I'm afraid we'll have to cut you back to 78.40 segments this week." Still following his rule, Joe resolved to save 20 percent of $38.40, or $7.68. So he spent only $70.72 at the GDP factory outlet that Friday.

Seeing where this was going, the country asked Krug Paulman, the famous economist, what to do. He said, "The stupid people are saving too much. We need government to spend what the idiots are not spending." So the government borrowed $29.28 from Joe and spent it at the GDP factory outlet.

Now, when Joe came to work on Monday morning, his boss said, "Good news, we sold 100 percent of what we used to sell, so you can work 100 segments this week." Sticking to his rule, Joe saved $12 on Friday afternoon. But the government borrowed the $12 and spent it at the GDP factory outlet. They all lived happily ever after.

There's more to this story, and I'm going to continue building on it over the next several installments. But for today, there are a few key ideas to pull out.

First is the circularity of income and money. The $100 that Joe initially earned and spent in each 'period' is the same $100. It can be visualized as a single bill endlessly cycling betwixt him, the shop register, and the factory ledger. At each stop, it represents an abstract conception of 'value'; it is passed from the factory to Joe in exchange for his hard work, then from Joe to the shop in exchange for the goods/GDP produced at the factory, and then back to the factory to purchase wholesale those goods (questions of markup and profit are saved for a more complex model).

The second major principle from the parable is what's known as the 'paradox of thrift'. It's plain to see that when Joe saves his money, the economy gets worse. But we all 'know' that saving is a Good Thing, so how can that be? What we don't always realize is that we can't all save up money at the same time - in order for one person to save, another person has to borrow the money (usually a bank, in the form of a deposit). We can work more on this later too.

Third is the initial stage of a national accounting theory. This sounds scary but it's really not - it is more of a corollary to the second principle. By breaking the overall economy into segments, we can see where balances have to occur in order to maintain equilibrium. In this case, we have Joe and the Government. In equilibrium, we see that whatever Joe saves, the Government must exactly match in deficit spending. That is, Joe's surplus equals the Government's deficit - there's no way around it in equilibrium. Later we can add more to this concept, but it's a very robust and important point even in this simple form.

Stay tuned for more.

Why Not Overdraft “Loans”?

If you run out of money in your checking account during a debit transaction, you get charged an overdraft fee. Generally these are a fixed cost of some $20 or $30 for each transaction over the limit - and until the previous credit card reform bill passed, transactions were generally processed in the order which would result in the greatest total fee. You don't get any option to decline such a transaction; you simply get hit with the charge.

This isn't fair, for several reasons. First of all, an overdraft "fee" is really a short-term loan. It's true that you're getting charged for a service, but because the service is the special case of a cash advance (you do, after all, have to pay back your overage), overdrafts technically ought to fall under the regulation that applies to lending. In the UK this is widely understood, and overdrafts are treated as short-term loans with an appropriate rate of interest, as well as an "overdraft cap" - effectively a credit limit - beyond which harsher penalties are applied.

So why not simply treat overdrafts as loans in the US as well? The key problem is the manner by which the federal system regulates interest rates. Many states have enacted usury laws, which cap the legal rate of interest. However, because of the policy of "interest rate exportation", lenders get to apply the capof the state in which the lender is incorporated (usually South Dakota, which has no cap because its loan laws were written by bankers), not of the state in which the loan occurs. This means that US interest rates are effectively unlimited for a major corporation.

What all this means is that an attempt to regulate overdraft fees through the loan system open up a big ol' can of worms about the usury law system, and interest rates in general. Politically, that's a heavy lift, and it's not going to happen. South Dakota went through enough trouble to make itself a lender's paradise, and it wants to stay that way. Plenty of other states benefit off the equally short-term, equally extortionate "payday loan" industry, which charges comparatively exorbitant rates in the form of "fees" on cash advances to cash-strapped workers. Neither of these industries are vulnerable to reform, for the same reasons that car dealers dodged new lending regulation this week: they're all extremely profitable, and they all adversely affect a relatively poor constituency (read: not an "important" one).

In other words, don't expect action - we're lucky enough that Congress is able to cut abusive overdraft fees, even if it costs us our beloved free checking (which isn't really free anyway).

(Photo: laverrue)

Congress Can’t Control the Deficit

They can cut whatever programs they want, but a basic accounting identity prevent the federal budget from ever balancing. Essentially, a given country (say the US) can never have "net saving" in the sense that it is just piling money away somewhere: in order for somebody to be saving money (as bonds), somebody else has to be borrowing money (also through bonds). If you divide the economy into three sectors - private, public, and foreign - you get the basic identity that they all must sum to zero. Reality backs this up:

The big swing over the past few years has been the complete collapse in private borrowing coinciding perfectly with the recession. As the identity predicted, government borrowing rose exactly to match the new net savings undertaken by the public sector (assuming the foreign balance - which is equivalent to the trade deficit - is exogenous and/or stable). The rule is general: as long as the private sector is trying to save money rather than spend it, the government will have to keep spending.

The identity also makes the solution to the deficit "problem" quite obvious. All we have to do is get businesses spending again rather than saving, and the government will find its fiscal burden "magically" lifted. The explanation is also fairly straightforward. When businesses are borrowing and spending, GDP rises, tax revenues rise, unemployment falls... and so on, relieving the government of the need to take expensive measures such as unemployment relief and COBRA insurance.

The cycle is self-enforcing, however, and therein lies the danger. If the government adopts an austerity program that threatens the investment environment, the economy may become further depressed. If businesses then choose to save more rather than invest, tax collection will fall even further, nixing completely the saving intention of the austerity program and keeping federal debt at their prior level.

The answer? Government spending - specifically, investment. The process described above is simply reversed: the resulting better business environment means net investment (private expenditure), which allows the government to save (reduced deficit). And thanks to Keynes' multiplier effect, the net outlay from government will more than offset itself.

So why isn't Congress pushing for increased expenditures? Well, it's gotta be political. The simple truth is that most voters don't understand how the economy at large works (and I don't blame them - it's counterintuitive at best and uncertain at worst). So people use the simplest shortcut possible: their own lives. Consumers can't borrow indiscriminately; why should the government? Politicians are, so the story goes, afraid of incurring the wrath of the voter.

But this story doesn't go far enough: political data shows that unemployment is a much better indicator of election results than just about anything else. Politicians know this. And strong governments have been happy to provide the necessary fiscal relief. China, for example, dumped hundreds of billions of well-targeted investment stimulus into its own economy, resuming immense growth this year. Britain (before its current coalition was elected) ran similarly large deficits.

America, however, does not have a strong government. It has a weak government - a divided government. It takes 60 votes in the Senate and 218 in the House. Since the Democrats don't have it, and were relatively divided even when they did, creating a compromise that targets stimulus funds effectively does not come easily. It's hard to get the votes, so other bills, while less effective for the economy, get political priority. It's better to accomplish something, I guess.

(Photo: Neubie)

Transparency Fail

Politico takes a whole article today to tell us what we already knew: that televised conference committee looks a lot like televised floor debate. And why shouldn't it? Bills simply don't get written on live TV, no matter how long you put Senators in front of running cameras.

Language gets drafted in back rooms, and always will be. Each clause is turned inside-out by a team of lawyers and economists to evaluate every impact. Often the legislators don't even write it - lobbying firms are more than happy to deliver "suggested language" on behalf of their clients to overworked committee staffers. Whining that they don't do it on TV doesn't get anyone anywhere.

If "transparency" is really the goal, then it's reform of the lobbying process itself that will have to be pursued. But I don't expect much success in that direction. People will find ways to produce the language they want, and in the privacy of their offices Senators will make the compromises and adjustments so that everyone can claim victory. That's how compromises must be made if government is to work at all.

(Photo: woodleywonderworks)