The President's Speach on the Economy: a Review

Let's critique the President's speech and see what it tells us.

"Nevertheless, during the post-World War II years, the economic ground felt stable and secure for most Americans, and the future looked brighter than the past. "  - Yes, he's got the right idea.  We had good policies and programs that supported the middle class and a prosperous future for all.

"But starting in the late ‘70s, this social compact began to unravel." - Actually, it started in the early '70s, but no one noticed.

“Technology made it easier for companies to do more with less, eliminating certain job occupations. “ – NO.  This is always true, but not a cause of long term unemployment or dwindling prospects.  A common mistake made today.

“A more competitive world lets companies ship jobs anywhere. “  - NO.  Again, a common misconception.  The world has always been competitive, and globalized.  It was changing trade policies that allowed US corporations to ship jobs overseas, at least for now.

“And as good manufacturing jobs automated or headed offshore, workers lost their leverage, jobs paid less and offered fewer benefits.”  - Yep.

“As values of community broke down,…”  - He hits it on the head here.  We are no longer “One Nation”.  We have become “us” and “them”.

“As a trickle-down ideology became more prominent, taxes were slashed for the wealthiest, while investments in things that make us all richer, like schools and infrastructure, were allowed to wither.  And for a certain period of time, we could ignore this weakening economic foundation, in part because more families were relying on two earners as women entered the workforce.  We took on more debt financed by a juiced-up housing market.  But when the music stopped, and the crisis hit, millions of families were stripped of whatever cushion they had left.”  - So true.  Investment in future productivity makes us richer.

“Since 1979, when I graduated from high school, our productivity is up by more than 90 percent, but the income of the typical family has increased by less than eight percent.” – So true, so sad.

“The combined trends of increased inequality and decreasing mobility pose a fundamental threat to the American Dream, our way of life, and what we stand for around the globe. “  - Yes.  This is what being American is all about.  The current challenges being brought onto America are an existential threat.

“…and together with lax regulation, may contribute to risky speculative bubbles.” – The lax regulations, rather than the concentration of wealth itself, are the chief culprit.  Bring back Glass-Steagall.

“The opportunity gap in America is now as much about class as it is about race, and that gap is growing.”  - Yes, this is class issue and always has been.

“Second, we need to dispel the myth that the goals of growing the economy and reducing inequality are necessarily in conflict, when they should actually work in concert.  We know from our history that our economy grows best from the middle out, when growth is more widely shared.  And we know that beyond a certain level of inequality, growth actually slows altogether.”  - Absolutely.  Spot on.

“Third, we need to set aside the belief that government cannot do anything about reducing inequality.” – Again, right on.

“To begin with, we have to continue to relentlessly push a growth agenda.” – Good, but the devil is in the details as they say.

” And that means simplifying our corporate tax code in a way that closes wasteful loopholes and ends incentives to ship jobs overseas.” – Yes to ending the incentives to move jobs overseas, but too much emphasis on corporate taxes which have little impact on hiring.  This is just a cave in to special interests, and ignores the problems of trade imbalances and more appropriate mechanisms to remedy this such as tariffs.

“It means a trade agenda that grows exports and works for the middle class.  It means streamlining regulations that are outdated or unnecessary or too costly.”  - yes, but the problem is not regulations!!  It’s the trade imbalance caused by a lack of protective measures like tariffs which are traditionally used by all advanced countries.

Overall, the President ignores the trade deficit and does not tackle financial regulation that is needed for any meaningful recovery.

“Step two is making sure we empower more Americans with the skills and education they need to compete in a highly competitive global economy.”  - Good, we all need education to get good jobs.

“so we’ve helped more students go to college with grants and loans that go farther than before.  We’ve made it more practical to repay those loans.  And today, more students are graduating from college than ever before.” – Umm, I’m not sure what he’s talking about as grants are almost non-existent for the middle class and the costs of college are more burdensome than ever.  Also, more college graduates aren’t necessarily a good thing.  We need the proper education for kids as not everyone should go to college; sometimes vocational training is what is more useful.

“So we should offer our people the best technical education in the world.  That’s why we’ve worked to connect local businesses with community colleges, so that workers young and old can earn the new skills that earn them more money.” – As long as he’s not referring to ‘STEM’ because we have plenty of computer people.  We need more broad based skills for a wide variety of jobs.

“the third part of this middle-class economics is empowering our workers.  It’s time to ensure our collective bargaining laws function as they’re supposed to so unions have a level playing field to organize for a better deal for workers and better wages for the middle class.” – Good, this is how it’s supposed to work.  Unions have lost most of the clout that they had acquired by the 1950’s.  They need to organize and act more vigorously than ever.

“And that’s why it’s well past the time to raise a minimum wage that in real terms right now is below where it was when Harry Truman was in office. “  - Yes, the free market needs a bottom so people don’t drop right through.

“But there’s no solid evidence that a higher minimum wage costs jobs, and research shows it raises incomes for low-wage workers and boosts short-term economic growth. “ – Correct.

“Number four, as I alluded to earlier, we still need targeted programs for the communities and workers that have been hit hardest by economic change and the Great Recession… Promise Zones, urban and rural communities where we’re going to support local efforts focused on a national goal -- and that is a child’s course in life should not be determined by the zip code he’s born in, but by the strength of his work ethic and the scope of his dreams. “  - This is misguided and does not help the middle class which he so touted through the speech.  This will not help the structural problems of the economy or financial system.

“So we’re going to have to do more to encourage private savings and shore up the promise of Social Security for future generations.  And remember, these are promises we make to one another.  We don’t do it to replace the free market, but we do it to reduce risk in our society by giving people the ability to take a chance and catch them if they fall.” – Yes.  The name says it all: Social Security.  Only the Federal government has the ability to guarantee income in spite of the vagaries of life that befall all of us.

“…SNAP…unemployment insurance… These programs are almost always temporary means for hardworking people to stay afloat while they try to find a new job or go into school to retrain themselves for the jobs that are out there, or sometimes just to cope with a bout of bad luck. “  - Yes, the idea is that the normal state is for people to have good, well-paying jobs, that the government supplies support when those good jobs become unavailable for a time.

“That’s why we fought for the Affordable Care Act -- (applause) -- because 14,000 Americans lost their health insurance every single day, and even more died each year because they didn’t have health insurance at all.  We did it because millions of families who thought they had coverage were driven into bankruptcy by out-of-pocket costs that they didn't realize would be there.  Tens of millions of our fellow citizens couldn’t get any coverage at all.  And Dr. King once said, "Of all the forms of inequality, injustice in health care is the most shocking and inhumane.” – Yes, the American people, acting through their government, has a responsibility to see that all Americans get needed health care.  Is the ACA it, probably not, but it might be better than what existed before.

The President has some idea of the forces acting against the middle class, but does not seem to comprehend the fundamental causes of these.  Those are: the lack of balanced trade, the lack of trade protections for industries which provide high value added, high wage jobs and the economic foundation of our country, the regulation of finance which separated depository institutions from investment and speculation, the control over the money creation process, and the restoration of a trade settlement system like Bretton Woods.  All the good intentions and laudable goals will do nothing if these fundamental issues are not addressed.

What can we learn about trade from Germany???

The Germans are taking a lot of heat lately for their large trade surplus of nearly $250B this year.  This kind of criticism is par for the course from the talking heads, but what really stunned me is that nobody asked "how did Germany manage to have such a large trade surplus when they have such high labor and structural costs?"  This to me is the key issue here, so I did a little searching around and found this great article from 2010 about just this issue.  Ian Fletcher has written an interesting piece about what the Germans are doing right and how they do it.  You can find it here:

http://www.huffingtonpost.com/ian-fletcher/how-do-other-nations-bala_b_628157.html

The principle reason for the German trade surplus is the underlying philosophy of the Germans which Ian describes as: "Germany, like the U.S., is nominally a free-trading country. The difference is that while the U.S. genuinely believes in free trade, Germany quietly follows a contrary tradition that goes back to the 19th-century German economist Friedrich List (who was, ironically, a student of our own Alexander Hamilton, the man on the $10 bill). So despite Germany's nominal policy of free trade, in reality, a huge key to its trading success is a vast and half-hidden thicket of de facto non-tariff trade barriers."  They, being disciples of List, understand the importance of protecting their high value added, high wage, high tech industries and never running trade deficits as the path to prosperity.  List wrote the brilliant critique of Adam Smith in "The National System of Political Economy", which I highly recommend to all.

What is unfortunate about the German trade policy is that they must maintain the pretense of "free trade" while they nonetheless go about instituting obscure policies which provide protections.  Wouldn't it be easier, clearer, fairer, and more straightforward to simply replace many of these rules and regulations with tariffs?  Let's just state again that all nations have the right to balanced trade, and that tariffs are a legitimate mechanism for achieving this balanced condition.  Indeed tariffs should be the preferred mechanism due to the reasons above.  Certainly, the need for balanced trade is self evident as in the long run trade deficits are unsustainable and trade will come back into balance as the "free trade" crowd insists, but this will likely be accomplished through a variety of shocks that will inflict more suffering on the public.

Now List goes beyond balanced trade to requiring protection of key industries that provide for high value, high wage jobs be protected and promoted above  that necessary for domestic consumption, with the surplus being exported in exchange for low value commodities produced at low wages.  This policy, will as List adequately shows, create prosperity at home, but at the cost of prosperity for other nations.  A balance of trade with all providing roughly for their own needs, or trading for similarly value added goods will likely be more palatable to all.

As to the current criticism that the Germans are suffering?  Well, there is some merit in that, as we'll say again, all nations have the right to balanced trade, including the Germans.  They will eventually have to spend what they are saving from running a trade surplus so they might as well do it now and give a demand boost to production in other EU countries, such as Spain and Greece, which are running far below their production potential.  This may induce some inflation in the Eurozone, but maybe that will provide the impetus that the Germans need to exit the EU.

In praise of wage inflation!!!!

"Wage inflation". The very words strike terror into the hearts of economists and financiers everywhere. We are taught that wage inflation is categorically evil, as if some comprehensive set of data proved this beyond any doubt. But, maybe there is a time and place for wage inflation, and maybe that time is now and that place is here.

A primary goal of the government today should be to stimulate the economy to, in principle, cause hiring to create additional GDP. US companies are sitting on record balances of cash, so they have no problem funding capital expansion and hiring. The low interest rates may help them on current interest payments by some refinancing, but otherwise makes not difference to them. They see no demand for more goods and services beyond what they currently plan to produce, so they sit and wait. They are waiting to be signaled by consumers to increase production by consumers buying more goods and services than these companies are currently planning for. This is the demand signal that moves companies to hire workers and invest in capital expansion.

Consumers, seeing their pay stagnate or shrink, and being up to their ears in debt, are in no position to increase their spending to create the demand needed to signal companies. So, they muddle through hoping not to loose the jobs they have and become one of the tens of millions of unemployed.

The long-term unemployed try to find work, but are unable. Neither are they in much of a position to start businesses of their own. I suppose some try to do odd jobs or deal things at flea market and on line. But they just hope to find some decent job before their unemployment runs out. BTW, unemployment insurance payment is the one fiscal stimulus that is actually in effect to boost demand.

I believe this whole line of argument is the one Keynes made to justify government intervention in the first place. And that fiscal policy is needed during recessions.

Consumers are spending all they can afford to, but that level is below the amount that the businesses in the economy are structured to produce. The lack of growth in the economy is because the consumer isn't buying more. And the consumer isn't buying more because they lack the income to do so. In other words, incomes have not kept up with expectations of producers. So, production is cut back to a level that consumers can currently afford. This means the supply and demand curve is moved to lower demand and thus lower supply at a lower price. This is source of the lack of inflation that we've been seeing.

What is needed is for consumers incomes to grow, which would spur purchasing, which would spur increased production, which would spur hiring and capital expansion. Which would...increase incomes. This is, in fact, wage inflation. Prices would necessarily rise as demand is bid up by rising incomes, and rising supply would only happen if prices were bid up to motivate the increase in production.

The happy side effects of this wage inflation are: lowered unemployment, raised taxes, and likely increases in long term profits for companies as those sales increases accrue over the years. This is a much better situation for all then if those unemployed stay idle, government deficits continue at the current pace, and production at companies remain below the potential output.

Going back to Keynes, this is where the government needs to step in. How to achieve wage inflation? By cutting taxes on wage earners. I.e. those folks who make their incomes through work producing real goods and services. Also known as the middle class and the working class. The groups who have been taking the brunt of the economic crisis. One which they largely didn't create. How to pay for this? By increasing taxes on those who benefit by increased incomes from unproductive activities. I.e. Wall St types and those who's incomes come from rents and capital gains. This isn't a punitive suggestion, merely a recognition that the wealth is flowing to those groups and they are not spending it to produce increased demand for the goods and services that the nation's companies are set up to produce. Such a trade off of taxes would be essentially revenue neutral, but would increase demand in the economy and send it back to full production and employment.

Such a suggestion goes against the entire "cut taxes on job creators and the wealthy" arguments.  But, I think that those arguments were weak to begin with, and have now been largely discredited by the current economic and financial crisis.  Will government have the will to make these changes?  Will the economics profession have the will to acknowledge these new policies are the correct ones to make?  Only time will tell.

Should America remain a sovereign nation??

The modern nation-state is a political entity that was created at the end of the thirty years war by the Peace of Westphalia.  This new concept recognized geographic boundaries of a nation and that nations should largely be free of outside influence.  Also, that the nation was the primary, cohesive entity with common internal interest that negotiated with other nation states that have their own interests.  The idea of empire became passe', particularly as related to a single sovereign person (king, emperor) or one of a religious state that ailed with a particular religious sect.

The essential properties of a nation-state are:
Sovereignty:  being independent from other nations.
Independence of the influence of external agents, either other nations or others.
Have relations with other nations.  The nation is the primary negotiating entity.
Has a population of citizens.  These folks have rights and responsibilities to the nation.
Has a geographic boundary.  The nation controls the land within its boundaries.
Has a national currency.  Controls and regulates the values of the currency used by the nation.
Has a common culture.  Common values, rituals, symbols, mythology, and history.
System of laws aligned with the culture.
A national defense to defend against other nations which could be hostile.

The United States of America, one could argue, became by the mid-twentieth century, the purest realization of the ideal of the nation-state.  It kicked out the british king and became sovereign.  It kicked out the british to get rid of external agents (at least they tried).  It formed relations with other nations, e.g. France.  Americans then thought of themselves as, well, Americans rather than brits.  The borders were the combination of the state boarders.  They eventually created a national currency, but that took some time.  By mid-twentieth century the US had a culture that bound its citizens (most of them at least) together with a common identity.  It had laws which reflected this culture and the founding principles of the rights of man.  And it developed a military in WWII that was able to overwhelm fascism.  So, the USA became truly a nation-state.

But how does a nation cause those properties to come into being and continue into the future?  That is what actions does a nation-state take and what structures does it put in place to actually be a nation-state?  Looking back at the list we see that the essential feature of a nation-state is controlling what transits boarders.  That is, what leaves and enters the geographic boundary of the nation.  Control over boarders is how the nation-state puts into effect the properties to be a nation-state.  In a sense, a nation is defined by its borders and the control thereof.  Well, what transits borders?  People, goods, services, money, communications, ideas.  These elements that transit borders are mostly economic and financial in nature.  So, being a nation entails border concerns with economic and finance issues as well as political issues.  So the opposite must also be true.  That is, nations which don't control their borders are no longer sovereign.

The US used to control these boarder crossing entities quite strictly, as do all sovereign nations.  Entering and leaving the country was controlled by strict visas on how long one could visit.  And for work, relatively few could enter and stay on a temporary basis.  Entry for work was predicate upon intent to immigrate and become a citizen.  And the right to immigrate was relatively difficult to secure.  The currency, i.e. the US dollar, was backed by gold and then by the gold exchange mechanism of Bretton Woods, which ensured its value and stability.  Trade was regulated to prevent deficits and protect key national industries by means of tariffs and quotas.  Even ideas were regulated to some extent as certain books and publications were prohibited from import.

Today the situation for the US is much different.  No longer are borders so controlled.  People flow over the border relatively unimpeded as illegals aliens to work in agriculture and construction.  H1-B visa workers come by the tens of thousands for years to fill technology positions because of a supposed shortage of domestic talent.  Trade is now almost totally unregulated, so massive deficits accrue year after year.  Financial transactions across the border are similarly almost unregulated with foreigners able to buy up property and businesses unimpeded.  National defense has become world policing for someone's interests.  However, who's interests that is remains a bit unclear.

Many of the essential characteristics of a sovereign nation have been given up by the US over the last few decades.  The US really doesn't control its borders anymore.  Which makes me ask: is the US still a sovereign nation?  and should it even continue to try to be one?  Perhaps the globalists are right? or at least are getting their way?

Dealing with China

In 2012 the US had a trade deficit with China of $315.0B.  That is, the US exported $110.6 to China while importing $425.6B of goods and services[1].  This is an extraordinary imbalance and constitutes the largest single contributor to the total trade deficit of $735B that same year.

Why would China want to run such a huge trade surplus with the US? And why would the US allow such a situation to continue so long?  There has been much speculation about these reasons.  Mainly because in politics the announced reasons are often not the real reasons.  So, I will also speculate about these as well.

For the first question, the Chinese have been growing their economy at a furious rate of about 8-10%/year in a bid to become a technologically advanced, developed nation.

In order to do this they need to spur domestic development at a level that is much higher than in the developed countries.  To do so using only domestic resources and investment mechanisms would likely proceed at a slower rate simply due to the inherent difficulties in growing that quickly.  Instead, the Chinese are supplementing growth by exporting the excess production, mainly to the US.  Thus, the US provides the demand to spur growth that would not generally come at home in China so quickly.  The other reason, which may be the more important one, is that China wants to import advanced technology that is only available in the west, and in the US in particular.  Many of the deals China now makes are not to purchase goods and services from the US with its vast holdings of USD, but to buy US companies with technologies that they need.  Or, to enter into production agreements with US firms which requires the US company to share their technology with their Chinese counterpart.

Why the US would allow this?  From a national perspective this ongoing deficit is bad as it adds to the total deficit and reduces employment in manufacturing in the US.  Worse, it transfers important technology from US companies to Chinese ones, or transfers the whole company to China.  Who benefits from this situation?  Well, US companies that move manufacturing to China can reduce their manufacturing costs to generate larger profits, as long as the Chinese Yuan (CNY) remains low relative to the USD.  That's the key for US companies, a low Yuan.  If the Yuan rises in value relative to the USD then the advantages of manufacturing in China drop and will eventually disappear, and so will their out-sized profits.

China, it is well known, intervenes in the currency market to keep the Yuan low against the dollar.  This keeps their exports up and technology flowing in.  It also pleases US companies that import from China, as they can continue to generate large profits.  But this creates the trade imbalance that doesn't allow market forces to bring trade into balance, and continues all the dislocations to the economy that have occurred.  One would think that the advocates of free trade would be furious at this and vociferous in their demands for market exchange rates for the Yuan.  But, hardly a peep.  The US sends some trade delegates, and even the President, to ask for a floating Yuan, but nothing happens.  In response, Washington does nothing.  Why would the Chinese change anything if there are no consequences to their policies?

The traditional solution to this is again the tariff.  Imposing a tariff is the needed consequence to not allowing the Yuan to float.  To be clear, a tariff for this reason has nothing to do with trade imbalances that exist for reasons other than China's intervention in the Yuan currency market.  The sole reason is that the currency market is designed to work only when exchanges of currencies are due to market forces alone.  Intervention breaks this system, so either China needs to play by the rules or we need a new system.  Now, I'm not a fan of floating market currency systems, as they have many problems that have be previously discussed.  But, at a minimum, if we're going to use this system then all participants need to play by the rules.  Or else face consequences.

A significant tariff (in a previous post I suggested ~60% for general trade) should be applied to imports from China.  The Chinese might not like this, as it thwarts their plan for growth and technology acquisition, and US companies which import would certainly not like the immediate hit to their bottom line.  So, imposing a tariff would largely be a political fight.  But with such powerful foes like China and US corporations on one side, who will represent America's interests in this fight?


[1] http://en.wikipedia.org/wiki/List_of_the_largest_trading_partners_of_the_United_States#cite_note-2

Two kinds of growth

Much has been written about how China and other developing nations are growing much faster than the developed nations in general, and the US in particular.  The growth of China's GDP over the last decade has averaged nearly 10%, while that of the US has been below 3%. 

 

This difference, it is implied, is due to the superiority of the Chinese model over the US model, which is now seen as faltering.  I think this kind of comparison is unfounded.  There are really two kinds of growth which I will term: Innovative growth, and Catch-up growth.

Developed nations, like the US, are operating near their potential production.  Although recently the recession has put a major dent in this.  What being near potential production means is that the economy is at full employment using state-of-the-art technology and is producing the maximum possible output.  More importantly the per capita production is maximal.  Any increase in production has to come from either increases in efficiency of current methods or innovations of new methods of production.  And, in any case, the former is usually a form of the latter.  So, for an advanced developed nation like the US to grow it has to innovate.  Innovation is risky, expensive, and time consuming.  Innovation forms a cost to current consumption that promises an increase in future growth, albeit at an uncertain rate.  The rate of growth in a developed country is mainly determined by the rate of investment in innovation.

In a developing country like China, the state of technology is generally far behind that of the developed countries.  That's pretty much the definition of developed and less-developed nations.  So, for that country to develop further it must first acquire existing technologies from the developed countries and implement them domestically.  The developing country must catch up technologically with the developed countries.  Importing technology is much simpler, cheaper, less risky, and less time consuming than creating new innovation themselves.  So, the developing country can grow much faster than the developed country.

The real issue for the US is that investment in innovation and new production has fallen, which limits the rate of growth of the economy.  But, even when those pick up again, a growth rate much above 3% is unlikely due to the need for massive investment in innovation to spur such high growth rates.  A massive level of investment does not seem likely without some government mandate for some great national cause.

The effects of imposing tarrifs on trade

Today tariffs average a mere 1.3% [1], which is quite low by historical levels, where tariffs have more typically been in the 10%-30% range.  What would be the effect of raising the average tariff to 10%?  The US imported $2299B of goods and services in 2012 [2], and exports of $1564B in the same year [3], so we'll use these number for a simple analysis.

What effect would that 10% tariff have on the balance of trade?  This is a complicated question but one for which we can make some simple estimates.  A recent study of the effects of trade barriers [4] finds that "The elasticity of imports to the domestic cost of importing is about 0.50, and that of exports to the domestic cost of exporting is about 0.48. That is, a 10% reduction in the cost associated with importing (exporting) would increase imports (exports) by about 5% (4.8%)."  Per country details vary but we can nonetheless use these values to estimate the effect of changes in tariffs on the level of imports and exports for the US.  An increase in tariffs acts the same way.  That is, for imports an increase in the tariff of 10% will decrease the amount of imports by 5%.  A tariff is just a percentage increase in price of an imported good.

Elasticity is a bit difficult for many people to understand.  But it basically says if I perturb one value a little bit, how much does the other value change?  In the case of imports a small change in price causes half as much change in imports.  A key concept here is that elasticity is only valid for small changes in values.  Even the change of 10% in price is probably a bit unrealistic, but it will nonetheless give us some idea of how imports are changing with price.

Balancing trade requires that the level of imports equals the level of exports.  So, to decrease the level of imports to that of the level of exports in 2012 is a drop from $2299B to $1564B, which is a large reduction of imports of 32%.  Given the elasticity factor of tariffs for imports of 0.50, this means the tariff increase needed on imports to achieve this goal is 32%/0.50 = 64%.  This is a large tariff by historical standards, and in practice this amount may not be needed as the actual adjusting of trade is not so simply defined by the elasticity.

The complexities of trade suggest that an incremental approach to tariff be taken.  Start by increasing the tariff to 10% one year and see the effects.  Perhaps increase the tariff again the next year and see the effects.  Continue increasing the tariff until trade comes to a balance.  Or in the case of the US, a surplus is generated, which is needed to pay down the years of accumulated trade deficits.

A second benefit of the tariff is raising revenue for the government.  A simple application of the tariff assuming no change in imports for a 10% tariff  to all of the new level of imports of $2184B it would produce $218.4B of revenue for the US government, which is $190B more than the government collected would have collected.  Tariffs reduce the tax burden on Americans and helps balance the budget as well as affecting trade.


Still using general references due to the government shutdown
[1] http://en.wikipedia.org/wiki/Tariffs_in_United_States_history
[2] https://www.cia.gov/library/publications/the-world-factbook/rankorder/2087rank.html
[3] https://www.cia.gov/library/publications/the-world-factbook/rankorder/2078rank.html
[4] Hoekman, Bernard & Nicita, Alessandro, 2011. "Trade Policy, Trade Costs, and Developing Country Trade," World Development, Elsevier, vol. 39(12), pages 2069-2079.

Balancing trade by tariff is a Keynsian approach

The previous policy recommendation of balancing trade by the use of tariffs, when the market mechanism are not working in a rapid enough manner to balance trade on its own, is a kind of Keynesian response to the problem.

The problem addressed by Keynesian economics is a recession, where unemployment is high and production is below the potential production levels.  The market forces will, in the long run, bring the production levels up and the unemployment levels down, but not in a timely manner that is acceptable to society.  And as Keynes said "in the long run, we are all dead".  Instead, Keynes argued that the government needs to take an active role in returning the economy to a level of its potential output and employment to normal levels.

Similarly, the imbalance of trade over long periods, and in particular, the running of trade deficits over those long periods, also causes economic dislocations that are adverse to the economic prosperity of society and long term economic growth.  Thus, the government must also take an active approach in dealing with the long term trade deficits by taking actions which will move trade back to a state of balance.  The government needs to approach long term trade imbalances with the same urgency as it does recessions.

The previous post examined the time scale of the long term run of trade deficits and found that the deficits had continued for many decades, and it would be at least 50 years, and probably much longer, before any market mechanism caused anual trade to return to a balanced condition.  This did not include the additional time needed to run surpluses to pay down the accumulated trade debt, which we can only assume would be a similar time scale of decades.  It also looked at the time scale of the beginning of adverse effects of these deficits and found that they start to occur in only one to few years, which is much less than the time scale over which the market actions are operating   Thus, some action needed by the federal government to counter these trade deficits and return trade to a balanced condition within a few years of the beginning of persistent trade deficits.

The Great Depression showed that government intervention is required when the difference between what the economy could do and what it is doing is great.  Similarly, the Great Recession has shown that the government can't ignore trade when dealing with a recession, but needs to address trade imbalances when they become persistent to avoid the harmful dislocations that long term deficits produce.

Trillion dollar coin and bonds have a markedly different effect on the money supply

Much has been made of issuing a "trillion dollar platinum coin" as a part of a solution for the current budget crisis.  While such an action is possible it will produce monetary outcomes which are significantly different than if the government sold an additional $1 trillion in bonds as it usually does to finance its deficit spending.

The difference comes down to what is money?  In the case of the US it is the US dollar.  A bond, while having value and a use in exchanges, is not money.  Thus, adding bonds to the market does not increase the amount of money in circulation.  Adding $1 trillion does add to the money supply.  But the change to the money supply does not end there.  The US banking system is a fractional reserve system in which the vast majority of money is created not by the government, but by the banks.

Under a fractional reserve system the amount of money is largely determined by the so called money multiplier, which is derived from the reserve requirements in effect at the time.  Currently, this is about 10% of deposits, which indicates that the money multiplier is about 10x the amount of the monetary base.  This mean that for every dollar of monetary base, or high-powered money, the total money supply (M1) will increase by 10 dollars through bank lending.  The monetary base is created by the government mostly through the purchasing of bonds by the Fed.

The issuing of bond by the government doesn't change the money supply, but the issuing of a trillion dollar coin not only changes the money supply directly, but induces a multiplier effect because the trillion dollars will add to the monetary base.   Therefore, the trillion dollars deposited in the treasury account will add 10 trillion dollars to the money supply (M1) as the government spends that money.  This won't happen immediately, as the government won't actually spend that trillion dollars at once, but will leak into the financial system as the government uses those funds to pay its bills.

This addition to the money supply is, of course, of crucial interest to the Fed as its job is to regulate the money supply.  It could react to the addition to the monetary base in many ways.  1) it could reduce its own purchases of bonds, 2) it could increase the reserve requirements such the the money multiplier is reduced from the current value, 3) it could use its recently formed mechanism of paying interest on reserves held at the Fed by banks to induce the banks to leave the extra money in their Fed accounts so as to not lend it out.

One important benefit to the government of issuing the trillion dollars is that it won't have to pay interest on it as it would if it had issued a trillion dollars in bonds.  This adds up to a big savings for the American people over time.

Tariffs as a mechanism to balance trade

We've seen that the US is running a large trade imbalance and that this has been ongoing for decades and will likely continue for many years if not decades in the future.  That this represents a significant balance of unsettled trade.  That the expected mechanisms of the market have not rectified this imbalance  even though decades have past, and that distortions in our economy have occurred after only a few years of such trade imbalances.  Some of these distortions have been detrimental to the US, such as the loss of many manufacturing businesses and their associated jobs, and the build up of the trade debt itself which one day needs to be repaid by settling the debt.  That this trade debt can only be settled by producing goods and services here in the US that will be sent overseas to the holders of this trade debt.  In other words, the lack of settlement of trade over the last few decades has shown that that market mechanism are too slow to resolve the imbalance before adverse effects show up in the economy.  This suggests that some mechanism is needed to resolve the imbalance over this shorter timescale of one to few years.  We just can't wait for markets to do their thing.  We have to act in the mean time.

Let me introduce you to the tariff.  This has been the traditional mechanism for regulating trade that has been used since the inception of the US.  But today this word seems to provoke howls of anguish and scoffs from many as being backward and an indication that the author is merely naive and doesn't understand all the advantages to all sides of free trade and markets.  To which I say, I'm not even talking about free trade or markets, that is a discussion for the future.  The situation today is that we don't even have trade.   What we have is multi-currency purchase and sales that are unbalanced.  That a trade is only complete when it is settled, and we have seen that trade is not being settled, and hasn't been for decades.  Only after we have actual trade, i.e. settlement, can we have a discussion about the merits of regulated vs. free trade.  Instead, I'm suggesting tariffs as a mechanism to force the settlement of trade so as to thus prevent the economic dislocations in the short term of a year to years that we are now experiencing.

Today, the US runs a massive trade deficit in the hundreds of billions of USD per year.  In 2011 the trade deficit totaled USD 785B [1], with China contributing the largest portion of this at USD 315B in 2012 [2].  Efforts to get China to reduce its trade surplus with the US by letting its currency, the Renminbi (CNY), float so as to let market mechanism presumably drive up the value of the Renminbi relative to the USD, have come to naught.[3]

How would a tariff help?  Well, the immediate reason for the deficit is that consumers in the US purchase a good made overseas, from say China, because it is cheaper than the good made in USA.  NB. that this doesn't mean the good is cheaper in terms of value, that is of relative values of goods and services.  Only that the price in terms of money is less for the imported good.  So, to reduce the amount of imported goods that consumers buy, the thing to do is raise their prices so that domestically produced goods are cheaper or at least the same price.  The easiest, and most traditional, way to do this is by imposing a tariff on the imported goods.  That is, a fee on each import paid by the importer to the government for the privilege of importing the good.  Typically, the cost of that fee is directly added to the price of the imported good, so the price to the consumer goes up about the same amount.  Thus, a significant tariff on imports would lower imports and reduce the trade deficit.  The tariff can be progressively increased as needed to achieve a balance of trade.   Balanced trade means that settlement is occurring.

Before anyone shouts "protectionism", let me say that has nothing to do with this particular tariff.  The sole purpose is to balance trade.    Only then can we discuss trade policy itself, and the merits of protection vs. Laissez-faire policies.

But other nations will retaliate some may say, and we will have a trade war.  We won't have a trade war or retaliation if the US emphasizes that the purpose of the tariff is merely to balance trade.  And that the tariff will be reduced as trade is balanced on its own.  That if other conditions like exchange rates are allowed to change to create balanced trade then the tariff will not be needed at all.

In other words, every nation has the right to balanced trade.  And the right to enforce mechanisms that will ensure balanced trade over periods short enough to prevent any economic distortions that a lack of balance may cause.

In practice, the tariff for the US would need to drive trade to a surplus of large size for many years as a massive trade debt exists that needs to be paid off through settlement.  This would constitute a shift from the USD 700billon+/yr deficits today to something comparable of trade surpluses, say USD 500billion/yr.  That's a shift of over USD 1trillion in trade!  This would bring back all those lost manufacturing jobs and spawn a renaissance of growth in America.

The US has suffered from trade deficits for too long.  Now is the time to implement mechanisms, like tariffs, that will rebalance trade so our economy can return to a normal state of operation.


NB. due to the government shutdown I'm using sources from others sites that have aggregated this data.
[1] http://en.wikipedia.org/wiki/List_of_countries_by_net_exports
[2] http://en.wikipedia.org/wiki/List_of_the_largest_trading_partners_of_the_United_States
[3] http://en.wikipedia.org/wiki/Renminbi_currency_value

Gov Shutdown

Well, it's been more than a week.  And everyone is speculating when it will end.  Only a true anarchist would want it to continue much longer, but how and when it will end is not so clear.  For that is what we are heading for without a functioning government, anarchy.

Those who look a bit further into the future see the upcoming borrowing ceiling as a more serious issue as the government will start to run out of money by the middle of October.   By the end of the month the government would be out of all tricks and resources and would need to either default or selectively pay the bills.  As selective paying of bills a minefield in itself, probably the course of action will be to not pay anything.  This would, as many have pointed out, have serious repercussions for the US reputation and credit worthiness.  But, more importantly the confidence in the soundness of a US bond will be shattered.  US debt is considered so secure that the interest rate on it is considered the standard of risk free return on investment.  All other investments are compared to US debt when deciding whether the risk/reward is worth the premium of return above that which could be had from parking the funds in US debt.  Thus the entire worldwide financial planning system would be shaken.  Still, a few missed payments may not have such a dramatic effect if the government is funded shortly thereafter and any who suffered losses were made whole by receiving their payments with some extra interest.

But more seriously, and I have to give credit to the President that he sees this, is that the threat and action of shutting down the government is being used to try to create yet another way to legislate, outside of the standard Constitutional process.  "Obamancare", the law that opponents want to overturn was passed by the standard lawmaking process.  Those who supported and opposed the legislation put up their arguments, their influence, and their votes.  In spite of all opposition, the bill passed and became law in the United States.  Opponents, not happy to have lost by the Constitutional lawmaking process see shutting down the government as a mechanism to get their way after all.  If they were to succeed this would enshrine a new form of coercion as a mechanism to enact or repeal laws outside the standard Constitutional framework.  Ultimately, the President has to stand firm to prevent this radical alteration in our lawmaking process

Timescales of Interest - Important application to trade

A common metric in the natural sciences is the "timescale of interest".  This is the length of a typical period or the pertinent period of time in the system under study.  This time scale of interest is often used to evaluate effects or relevance of other effects of different time periods.  A couple examples will make this clearer.  If we are discussing geologic events such as the formation of a mountain range the typical time for this, and hence the timescale of interest, is in the tens of millions of years.  Shorter timescales, such as years or millennia, are of little interest because the mountain range changes little over this time period.  A more relatable example is that of disease.  Let's say someone has a disease that will kill them in one year.  Dying from the disease is the major issue, so the timescale of interest is also one year.  If a treatment is found that will take and average of 10 years to cure the disease, then this is interesting, but not of use to the individuals who have the disease as this time period is much longer than the time it takes the disease to kill the him or her.  A second treatment the is effective in only one month is of much greater interest because the patient will survive long enough to benefit from the treatment.  The timescale of interest, or one year, determines the relevance of the treatments based on their timescales.

An interesting exercise is to apply this idea to trade and find timescales of interest and determine what effects and actions they suggest.  One metric to look at is the time to balance the trade deficit.  That is, if left to itself as the popular school of free trade supporters suggest, how long will it take for a trade imbalance, deficit or surplus, to come into balance on its own.  Let's accept the idea that the free trade supporters suggest, that in the long run the markets will sort out imbalances and trade will eventually find a new balance where exports equal imports.  We have some data to lead us to some conclusions about trade deficits and timescales of balanced trade restoration.  Here, by balanced trade I mean settlement in the sense that has been discussed so far in previous posts.  We know that the US has been running a trade deficit (no longer settling) since the repeal of Bretton Woods in 1971, and has shown no sign of heading to a return to a balance of trade.  Indeed, trade deficits are projected to continue for more than a decade in the future.  So, the period of a continual trade deficit appears to be at least 50 years as a lower bound.  The markets have not restored a balance of trade during this period through the mechanisms of free trade.

Another time scale to look at is what period of time has to elapse for a trade imbalance to cause some effect on the economy that would otherwise have not happened?  How fast does an imbalance build up that causes an issue whether good or bad.  Of course we are most concerned with the bad, but some good might come too.  So, first we have to determine what is a large enough imbalance to cause an issue, then how fast it takes to get there, this is the timescale of interest for imbalance effects.  Put differently, if, as most admit, a return to a balance of trade is the inevitable state of trading in the long run, what can happen in the mean time while trade is out of balance.  That is what economic effects related to a trade imbalance have a timescale of interest which is less than the timescale of the trade imbalance?  In particular, what bad things can happen while we await the great rebalancing?

How would this rebalancing happen?  According to the popular idea of free trade one would have expected that the trade deficit would have been reduced and trade balance restored by a number of mechanisms.  These include a falling USD relative to other currencies, lower wages in the US, and rising wages in other countries.  Resulting in higher prices for imports and lower prices for exports.  Thus, consumers in the US should buy fewer foreign goods and foreigners should buy more US goods.  But, this has not happened in the last 40 years and is not projected to happen for many more years.  This suggest that if the market idea of free trade is true, the timescale of interest is longer than this period.  Even the most staunch opponent of free trade will concede that an imbalance can't continue indefinitely.  Thus, its not a question of if, but a question of when, which is what we are trying to estimate.  Also, according to the popular idea of free trade one would have expected that this correction or rebalancing would happen rather gradually and continuously rather than hold off for so long as it has so far.  This suggests that a correction or rebalancing when it does occur, may come rapidly over a short time compared to this timescale of interest.  A trade shock may happen over perhaps a few weeks or days as many other financial corrections have in the past?

A comparison of the fraction of the trade to total trade that makes up the deficit is a place to start.  In 2012 the total exports were $2196B and the imbalance was -$540B (1),which is almost 25% of the exports.  Certainly, 25% is a significant portion, one where people start to take notice.  So, it takes a year to reach that level.  GDP in 2012 was $16,200B (2), so the imbalance was 3.3% of GDP, again over one year.  What can happen in the economic and business world in one year?

Well, to look at events in the last few decades that have had an adverse effect that are directly related to trade, we see two effect that have had a major impact on the US economy.  They are: the transfer of manufacturing businesses and their associated jobs to so called low wage countries, and the build up of the trade debt itself.  The rational used by companies for moving their operations and the corresponding jobs overseas is that the relative high wages of US workers compared to workers in low wage countries makes manufacturing cheaper in those countries and so encourages US companies to move to those low wage countries.  This flight of companies would not have happened had the balance of trade been restored through a lower dollar, lower wages in the US, and higher wages in the foreign countries.  Balanced trade prevents the flight of companies and jobs overseas.  A balance of trade implicitly means that US companies are producing at home and trading the product to other countries.  Some movement overseas may happen but it would also be balanced by some foreign companies moving to the US.

The question then is what are the timescales of interest for the flight of US companies and jobs overseas, and for the buildup of a significant deficit?  Put another way, how long does an imbalance of trade due to dollar value and wage levels have to persist for companies to choose to leave the US? One clue is the question itself, and how long does it take to accrue a deficit which would have a noticeable effect on trade and economic activity?  We wouldn't be asking this if the effect wasn't happening, so we know that the timescale of interest is less than the 50 years of the trade deficits.  We also know that large deficits don't take long to accrue and that significant deficit now accrues in only a month.

A site that tracks the transfer of US companies to foreign countries (3) gives a good idea of the rate of this transfer, shows that about $130B worth of companies move overseas each year.  This happens through a combination of US companies moving overseas or the equivalent of US companies building operations in foreign countries and hiring foreign workers. (4)  And the trade deficit builds up over a few years to an amount comparable with the trade levels and large compared to GDP.

So, from these figures above a good first estimate of the timescale for significant effects to happen because of a trade imbalance is on the order of one to few years.  This value is over an order of magnitude less than the time we said it takes to bring trade back to balance by itself through current market effects.  In other words, the market corrective mechanism, left to itself, is too slow to prevent effects from the trade imbalance taking place while we wait for the great correction to occur.

This suggest that some additional mechanism needs to be put in place to correct these trade imbalances on the timescale they occur, of one to few years.  I'll discuss some mechanisms in future posts.


(1) http://www.census.gov/foreign-trade/statistics/highlights/annual.html
(2) http://www.bea.gov/national/txt/dpga.txt
(3) http://americawakeup.net/
(4) http://www.cnn.com/CNN/Programs/lou.dobbs.tonight/popups/exporting.america/content.html

Fed no "taper" - So I guess I'll comment too

Why is everyone so surprised that the Fed didn't "taper"?  I guess the consensus of the "in the know" was that they would, or rather that they must.  But, they didn't.  Why would they?  What has changed?  Well, not much really.

The BLS unemployment rate continues to improve with a reading of 7.3 for Aug, 2013 (1).

From this graph we can see that the rate is heading down, but is not yet back to pre-recession levels.  What is not captured in this graph is that the reason the rate is heading down has nothing to do with people finding work, rather the formulas used to calculate the value assumes that people who are not working for a certain number of months have stopped looking and are no longer part of the work force, so don't need to be counted.  A better measure is the labor participation rate which continues to fall, with a reading of 63.2 for Aug, 2013 (2), much below the pre-recession level of ~66, as seen in the graph.

This means that about 3% of the population that were in the workforce are now not.  That translates to about 9,000,000 people!  Which is consistent with the job loss estimate of 8,800,000 jobs during this recession.  For these people this is a depression not another recession.

The only good news on the jobless front is the initial claims reported by the DoL has fallen from a high of ~660,000 in Mar, 2009 to 305,000 in Sept, 2013 (3).  From this chart we can see that the level is about at the historical low level, that may suggest the job market has nearly bottomed.

What about economic growth?  In the second quarter of 2013 the BEA reported a GDP growth of 2.5% (4).  A minimally OK figure, but not signally a strong recover which would be expected coming from the depths to which the economy had plunged in the last five years.  This rate of growth is about what has been seen for the last few years.  The BEA graph shows this less than amazing growth is about all the economy could do.  All this in spite of years of "ZIRP" or near zero interest rates to major banks.  

What about the housing market?  This should be doing well as the Fed has been buying up MBS shares like crazy.  The latest Case-Shiller nominal index is up to 146 in Sept, 2013 (5)  But, this is not good news as this level is still too high as it is above the long term trend which is driven by personal incomes.  The index was below 100 until Mar, 2000 when is started its meteoric rise, and this rebound once again takes the rate of growth above the long term trend.  The increase may make some folks happy, those who own MBS' and those who bought at the peak in 2006, but for regular folks this is just a "head fake" as they say in sports.  This only make housing unaffordable for many and unsustainable again.

The stock market is doing well.  S&P index is up over 18% this year.  This is great if you own stock, of which only a few percent of American have any significant holdings.  

So, in reality there is no good reason for the Fed to "taper" as withdrawing all that juicing of the financial markets will just cause this tepid "recovery" to stall or reverse.  What will the Fed do?  Probably continue as they are until unemployment drops below 6%, and the rest of the overhang of foreclosures works its way through the system.  That will be at least another year.  In the meantime, you can play some nice trades on whether they will "taper" or not, and maybe make a few bucks from those Wall St folks, or loose some if you guess wrong.  Good luck.

PS I like having all these charts on one page.  It really gives a good survey of the state of the economy and financial markets in one look.

(1) http://data.bls.gov/timeseries/LNS14000000

(2) http://data.bls.gov/timeseries/LNS11300000

(3) http://www.dol.gov/opa/media/press/eta/ui/current.htm

(4) http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm

(5) http://us.spindices.com/indices/real-estate/sp-case-shiller-us-national-home-price-index

Comparative advantage no longer matters for the US

The idea of comparative advantage still gets banded about in discussions of trade as a justification for the need for free trade.  But for developed countries like the US, comparative advantage doesn't really matter anymore.

Formulated by the British liberal economist David Ricardo (1), the idea of comparative advantage states  that a country that has an advantage in producing a good, due to natural resources or environment, over that of another country should produce more of that good and trade the excess with the other country for something that is produced with an advantage over the first country.  For example, Haiti has an advantage in producing sugar compared with Canada, which has an advantage in producing Maple syrup.  If Haitians want Maple syrup and Canadians want sugar, then Haiti should produce an excess of sugar and Canada should produce an excess of Maple syrup.  Both would then trade their excesses to each other to satisfy their needs.  Ricardo showed that by this mechanism both countries would actually have more of each product than if they were to produce both products themselves.  Canada is said to have a comparative advantage over Haiti in producing Maple syrup because of Canada's climate which is ideal for growing Maple trees, whereas those trees would not grow so well in Haiti.  Thus for the same effort and resources expended, Canada can produce more Maple syrup than can Haiti.  Similarly, Haiti has a comparative advantage over Canada in producing sugar.  Thus, if each nation produces those product for which it has a comparative advantage, the total amount of goods from both nations is more than if they each tried to produce all the goods themselves.

Some other products, such as minerals, can also be subject to a comparative advantage.  For example, if one country has coal that is easy to mine because it is near the surface, while a second country has coal that has to be mined from deep underground at great expense, then the former country has a comparative advantage over the latter in producing coal.

The key to this principle is that the comparative advantage of a good is due to some native condition which is not transferable from one nation to another, or more specifically from one location to another.  E.g. the climate of Haiti can't be transferred to Canada.  The advantage is permanently
tied to the land of the controlling country.

In 1817 when Ricardo formulated these ideas much of the produce in the world was agricultural, so  comparative advantage had a major affect on what crops should be produced where and what should be traded.  In that year 87% of US exports were agricultural products, so clearly the ideas of comparative advantage dominated the discussion of what the US should produce for trade.  But, by July 2013 the fraction of agriculture that comprised exports had dropped to 7.9% (2).  Production and trade of manufactured goods has come to dominate the trade of the US.  By contrast a country like Madagascar still counts agriculture as a major component of trade, where in 2012 it comprised 44.6% of its trade with the EU. (3)  Developed countries like the US have little need for guidance in trade by the principle of comparative advantage.  Other principles like national sovereignty, self sufficiency, and maintaining the lead in producing high value-added and high tech goods are more important.

Occasionally, the idea of comparative advantage is used erroneously to describe conditions in a nation that prevail but are not themselves tied to that country.  This is sometimes done with regard to wages to insist that a country which has lower wages for a particular occupation has a comparative advantage over another country with higher wages in that occupation.  A nation may have an advantage in getting some business for some occupation at some point in time.  But this is not a condition that is tied to that country permanently or not transferable to another country.  If anything, this is an indication of relatively high unemployment in that occupation in the low wage country, which will be remedied over time by rising wages as more work flows in, and increasing emigration as the workers in that occupation move to where they can get better pay for the same work.  For instance, if a country has a surplus of engineers who are getting paid less than in another country, the first country may get more business than the second for a while, but eventually the salaries will be bid up to match the second country and engineers from the first will emigrate to countries like the second that pay better.  This is the condition today with regards to India and the US.  Salaries for engineers are rising in India and many emigrate to the US for better jobs.  Of course all of this depends on national policies on trade and immigration, but there is nothing germane about such a compensation imbalance that makes it tied to any one nation.

Comparative advantage is a principle which has relatively little application in developed, high-tech economies.  Therefore, arguments based on it are suspect when applied to developed countries.


(1) http://www.econlib.org/library/Ricardo/ricP.html
(2) http://www.census.gov/foreign-trade/Press-Release/current_press_release/exh7.pdf
(3) http://trade.ec.europa.eu/doclib/docs/2011/january/tradoc_147315.pdf

A Misguided Recommendation Needs a Reply

Recently, a number of leading US economists, led by Lawrence J. Kotlikoff, have called for new annual financial projections from the  US government.  That of fiscal gap analysis and generational analysis.  Fiscal gap is supposed to be a true evaluation of expected government outlays, and the generational analysis is a measure of how much cost is pasted from the current generation to future generations.

Hugo Scott-Gall interviews Dr. Kotlikoff about this, which can be found, among other sites, here:
http://www.zerohedge.com/news/2013-09-11/lawrence-kotlikoff-us-fiscal-gap-200-trillion-our-country-broke

I believe that a response of some kind is in order as this interview reveals the rational behind this call for new accounting and what I believe to be a common mindset that has taken over the economics community, which is at odds with the facts and with the best interest of the US.  This is what happens when a profession suffers from self-selection.

Kotlikoff is essentially calling for fiscal responsibility, and fiscal responsibility is a good thing.   Unfortunately the US government has chosen to not follow that path starting in 1971 with the repeal of Bretton Woods.  Then the election of Reagan and his creation of massive deficits, and the changes in how many figures like GDP, CPI, etc., are calculated.  Then Alan Greenspan in Jan, 2001 predicted that the US would pay off the national debt by 2011 (1), which was used to justify the Bush tax cuts in order to prevent the US government from running a surplus.  And finally the often quoted “deficits don’t matter” of the Dick Cheney era.  Before these events we had a functioning system.  It is unfortunate that the government saw fit to throw this system away.  Why did the US choose to go this route?

A key lesson from examining these events is that it is unwise to make budget projections more than 10 years into the future, as circumstances and events can change these values dramatically from what was projected.  The gap and generational estimates go forward many decades into the future so that their value is suspect, and their impact may be misleading.

The problem with the analysis from Kotlikoff, and similar economists, is that they choose to ignore the history of how and why we got where we are, so they don’t go back and say this choice was bad or that policy was wrong, and  do a comparative analysis of what would have happened without those choices and policies (or maybe they do many who knows).  I.e. where would we be today if we didn’t choose deficits through massive tax cuts for the wealthy, or didn’t allow massive trade deficits?  Didn’t choose abandon trade settlement? Didn't change government economic formulas?  I suspect we would not be having this conversation today.

So, having ignored this history, he goes on to imply that the problem is caused mainly by the common folks being greedy because of the cost of social programs.  He claims that 60% of the future shortfall in government budgets can be attributed to medical spending.  He then claims to be an economist, but makes predominantly financial arguments!?  His discussion is primarily about money, rather than the production and consumption of goods and services.  He don’t even mention trade policy and its effects.  The one time he does mention true economics is when he insists on limiting the fraction of public health care spending to 10% of GDP by fiat, without regards to the effect on the health of the American people.  A true economic analysis of health care would consider the population size and distribution, the likely health problems and care needs for each segment of the population, the health care facilities and staff needed to provide this care, etc.  But all of this goes unmentioned, which suggests that health care for the American people isn't a goal.  Merely constraining the cost of government spending on health care is all that matters.  (He does make an exception for the affluent who can pay for their health care from their own resources)

The main effects of deficits, and the resulting curtailment of government spending, and tax and trade policies, which has been noted repeatedly in many sources, has been to reduce the middle class, and to enrich the already wealthy.  The tax cuts have mainly benefited the very wealthy while the various bailouts and business support policies have moved their liabilities onto the public books.  Why does he ignore the multi trillion dollar bailout of Wall Street?  What about taxing them to get some of that money back?  Why does he think that the taxes must be shared equally by everyone, if a small fraction of the population caused most of the problems?   This seems to me an institutionalizing of privatizing gains and socializing losses.

His argument about a lack of national savings is somewhat irrelevant as corporations are sitting on record amounts of cash and short term assets which they choose not to invest. (2)  It is the lack of investment in capital expenditures, which he acknowledges, that is the immediate cause of insufficient growth in the US.  But why would companies invest in the US if they are induced by government policy to invest overseas instead?

What about the 8.8 million Americans who have lost their jobs since the start of the recession? (3)  What if we put them back to work in manufacturing and balanced our trade?  Wouldn't that produce an increase in the receipts of the government as those new workers paid taxes?  What if we had a national economic policy again that promotes the best interests of our nation?

Yes, all programs like health care must be weighed in terms of their economic cost.  And not all expenditures are possible.  But these are policy decisions about how the nation, acting as a nation, will allocate its resources.  If our society determines that spending 10% of GDP on health care is good, or even if spending 15% is good, then so be it.  I don’t mind the gap accounting, as that is just a guide to future costs that should be taken with a grain of salt.  However, I think that Kotlikoff and others will use it to keep claiming “we’re broke” everytime a good investment in the American people, or a program to “promote the general welfare” as the Constitution mandates, is proposed.  The Congress must return to fiscal responsibility and no gimmicks will cause that to happen.  A fundamental change in how our country sees itself and acts as a nation is needed to return to the prosperity of the past.  Only then will Congress return to valuing fiscal responsibility.

(1) http://www.federalreserve.gov/boarddocs/testimony/2001/20010125/

(2) http://www.stlouisfed.org/publications/re/articles/?id=2314 for an analysis

(3) http://en.wikipedia.org/wiki/Job_losses_caused_by_the_Great_Recession  totals the government numbers