Still waiting on that hyperinflation.

In 2009, there was a crazy, wild-eyed passion spreading among conservatives and the Teabagger.  Here are some choice quotes from prominent conservatives and teabagger favorites.

Glenn Beck and Ron Paul

Ron Paul:  [snip] So the bailout is a disease, it’s contagious, it’s ongoing, and the result of this will be the destruction of the dollar, which to me means runaway inflation, and political chaos. It’s very, very dangerous.
Glenn Beck: OK, hang on, because you are saying “runaway inflation”. You’re meaning Weimar Republic, wheelbarrow full of money type of stuff to buy a loaf of bread. Is that the kind of inflation you are talking about?

Eric Cantor

Finally, we must ensure that vast government spending doesn't lead to rampant inflation in the future. At $825 billion, this Democrat stimulus proposal causes us great concern. While the Fed remains rightfully concentrated on fighting deflation, uncontrolled spending and borrowing will most ultimately lead to inflation if the spigot is not turned off in time. That could trigger a flight of foreign capital and a steep drop in the purchasing power of the dollar for the American consumer. As interests rates rise to keep foreigners financing our debt, the pain dealt to businesses and families alike promises to be sharp.

Michele Bachman

Make no mistake. This stimulus bill has very little to do with stimulating the economy and helping the average American . This is a bailout for big government. And let's get ready. We are looking at massive tax increases and we are looking at massive inflation or both. In fact, we could be looking at hyperinflation.

Arthur Laffer (The "Father of supply-side economics" or Reaganomics)

With the crisis, the ill-conceived government reactions, and the ensuing economic downturn, the unfunded liabilities of federal programs -- such as Social Security, civil-service and military pensions, the Pension Benefit Guarantee Corporation, Medicare and Medicaid -- are over the $100 trillion mark. With U.S. GDP and federal tax receipts at about $14 trillion and $2.4 trillion respectively, such a debt all but guarantees higher interest rates, massive tax increases, and partial default on government promises.
But as bad as the fiscal picture is, panic-driven monetary policies portend to have even more dire consequences. We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s.

We are a couple of months away from the close of the third year of the Obama Administration.  Before that we will mark the 4 year anniversary of the start of the Great Recession(Dec 2007).  And, most importantly we've just finished our third fiscal year in a row of having more than a trillion-dollar budget deficit.

So based on all the hyperbole of conservatives, and the fact we've had such huge budget deficits, one might think we were facing huge bouts of inflation.  So let's take a look at the inflation rate for the last three years.

As you can see, since the stimulus and other government spending brought us out of a recession, month to month changes bounced around between .4 and negative .2 and only briefly went higher than .5 percent.  However, is that a lot?  Let's compare it to the previous years.  Let's take at the data since January 2001.

As you can see, after officially exiting the recession, inflation has actually been consistently lower than in the earlier, non-recession ,years.  The only spike you see was from earlier this year and was almost entirely driven by energy costs.  How do I know?  Let's lay over the cost of energy in general and gasoline into the graphs.

Remember these are month-to-month changes.  As you can see, the energy costs went up so much higher and faster that I had to adjust the scale of the graph to show the increase.  General Prices(blue line) barely looks like a bump while Gas Prices(Red) and general energy costs(Green) went up about 10 times as fast.  So those price increases weren't driven by general inflation, they were driven by an increase in energy costs.

So in spite of these billion and trillion-dollar budget deficits, how has there been such low inflation?  Didn't Weimer Germany prove that always happens?  The assumption that a large budget deficits will automatically lead to high inflation is deeply ingrained in our politics.  Based on the last 3 years, you would think that this belief would be re-examined.   And yet, republicans and conservative allies are still warning that the sky is falling inflation is coming.  The whole theory of oncoming inflation is based on the flawed quantity theory of money.  A theory rendered even less relevant since it was developed when we were still on a gold standard.

So what is an alternative explanation?  Does this mean that government can spend and spend without consequence?  MMT (which evolved from keynesian economics) provides an alternative economic framework for understanding why a government can have a trillion dollar deficit 3 years running and still have inflation that is lower than it was when deficits were less than 400 billion.  First of all, inflation comes from spending money, not creating it.

As long as all spending is matched by an equal increase in the amount of goods and services produced by an economy, that spending won't be inflationary.  Here's the macro economic implications:  During a recession dollar savings tends to increase - i.e. people tend not to spend their money.  People are afraid of losing their job, and businesses are afraid to expand, leading to reinforcing recessionary effects. One thing that doesn't change right away is the capacity in the economy. Therefore, when people save dollars, they open up room for the federal government to deficit spend money that won't be inflationary.  In fact, if the government doesn't spend it'll cause deflation which is really bad for an economy.

To better understand the macro economics, let's take a look at a micro economic example:  Presumably, even during a recession, a factory that produced 100 cars yesterday, can still produce 100 today.  If all the people in the economy bought 100 cars yesterday, but only bought 99 today, then that means that the government can come in and buy an extra car and it won't be inflationary because the factory can produce it.  Now, of course I'm not suggesting that the government start asking factories how much it can produce and directly buy what it doesn't sell.  Instead, I'm just trying to give a micro example of what is happening across an entire economy.  The economy has excess capacity that the people producing the items aren't buying because they are saving their dollars.

The take away is that the federal government has the ability to have deficits until the economy can no longer increase the amount of goods the economy is capable of producing, then inflation happens.  The size the budget deficit can be depends on many things.  One of the things as explained above is the rate of private savings which tends to be higher during recessions.  That is why the federal government can run a trillion dollar plus deficit 3 years running and the economy can still have a lower inflation rate than when it was running sub 400 billion dollar deficit.

Euro and Free Trade

No two countries are exactly the same.  One would think this would be obvious, but to many politicians and economists it is not.  Economists "assume" that they are to simplify certain models where the differences are irrelevant to what they are studying, but then forget to "unassume" for others.  No where was this more obvious than in the design of the Eurozone.

I explained before one of the reasons that the Euro failed was because it failed to take into account recessions.  Sometimes a country needs to run a currency deficit, and there is nothing wrong with that when done for the right reasons and at the needed level.  This is the primary reason the entire region is failing.

A secondary reason that the Euro is failing is because it provides no ability to account for trade deficits between regions.  Trade deficits occur, and there must be a mechanism to correct them when they start occurring.  Think of it as some kind of  regulator gauge.  Let's look at 3 popular ways of balancing out a trade deficit.

1. The first way is my preferred method.  To have a floating currency between the two regions so that as goods and services flow to one region(which means currency flows to the other) the value of the currency in that region goes down.  At that point it is now cheaper to produce in that region and they will start producing and selling more to the other region until the currency is brought back to even. Rinse & repeat.
2. Another way of dealing with a trade imbalance is for the countries to implement protectionist trade policies to encourage exports and encourage imports until the trade deficit disappears.  This runs the risk of a so-called "trade war" erupting.
3. The third method is the most popular method by market fundamentalists:  Wreck the economy through draconian cuts to government and have across-the-board tax increases.

Number 3 is the favored option by members of Europe.  Especially when it's not their own country that must go through with it.

Let us take a look at a hypothetical eurozone country running a trade deficit.  If it is running a trade deficit, then that means Euros are leaving the country.  If the government makes no attempt to accommodate the loss of currency within the country, it can cause local deflation.  As we all know, deflation is bad for an economy and unemployment rises until the economy is so bad, people quit buying items and the trade deficit disappears, but only after rampant unemployment and other recessionary ills.

In a Eurozone country, a country's government might try to accommodate a trade deficit by running a government deficit.  That way the local economy won't deflate by keeping the same amount of currency in the local economy.  This creates an "unfair" condition, because it means the country can continue to import more goods and services than it exports.  The whole reason that Eurozone countries aren't allowed to run perpetually high trade deficits.

Notice though, that the only alternative for a Eurozone country to fix a trade imbalance is through wrecking the economy.  This is what happened in so many of the Eurozone countries.  Greece, Italy, etc...  The other countries made them practice austerity which caused recession and unemployment.  That recession and unemployment causes a spiral because of reasons discussed before.

This is among the reasons why so many MMT economists predicted that the Euro would fail.  Besides having no mechanism to deal with recessions, it has no mechanism for dealing with trade imbalances that doesn't wreck a local economy.

Revisiting the Confidence of our Sophisticated Financial Wizards

I ran across this "old" testimony from a spokesperson for the "American Securitization Forum"(ASF) to congress in 2003(pdf).  The ASF is made up of mostly large financial firms involved in the securities market including the now infamous mortgage backed securities(MBS).  Much of the testimony included is a matter-of-fact history of the development of the secondary market for mortgages.  What made me laugh was reading their conclusion and message for congress.  Their message was basically, we are awesome.  We've 'innovated' this awesome new market to provide credit to everybody.  Anything you do to regulate predatory lending will ruin this awesome thing we created.

Securitization reflects innovation in the financial markets at its best. Pooling assets and using the cash flows to back securities allows originators to unlock the value of illiquid assets and provide consumers lower borrowing costs at the same time. MBS and ABS securities offer investors with an array of high quality fixed-income products with attractive yields. The popularity of this market among issuers and investors has grown dramatically since its inception 30 years ago to $6.6 trillion in outstanding MBS/ABS today.

The success of the securitization industry has helped many individuals with subprime credit histories obtain credit. Securitization allows more subprime loans to be made because it provides lenders an efficient way to manage credit risk. Efforts to curb “predatory” lending that inhibit the legitimate use of securitization by assigning liability to the purchaser of a loan or some other means, threaten the success of the beneficial subprime market. Secondary market purchasers of loans, traders of securitized bonds and investors are not in a position to control origination practices loan-by-loan. Regulation that seeks to place disproportionate responsibilities on the secondary market will only succeed in driving away the capital loan purchasers provide in the subprime market.

I urge Congress to move with great care as it addresses the problem of predatory lending. The secondary markets are a tremendous success story that has helped democratize credit in this country. Well intended, but overly restrictive, regulation in this area could easily do more harm than good. This is particularly the case when state and local governments craft disparate anti-predatory lending statutes that place different compliance burdens on the secondary market. For this reason, the ASF urges this committee to consider legislation to pre-empt the authority of state and local governments in the area of predatory lending and to construct a safe harbor from assignee liability for secondary market participants.

These guys were so high on their own awesomeness that not only did they want congress to leave them alone, they wanted congress to MAKE the states leave them alone too.  The lobbying firm had some success with this.

Then, of course, 2008 rolls around and those financial wizards found out they were full of crap.  The punchline to all of this is that the ASF then lobbied for TARP to bail them out(pdf).

SIFMA and ASF support the use of a Guarantee Program to cover assets with high illiquidity premiums relative to their expected losses. In such instances, the assets are unable to be sold at prices that are reasonable based on the quality of the asset. SIFMA and ASF believe that the Guarantee Program should be considered for use with a full spectrum of financial assets, including both securities and whole loans. Treasury may consider whether identifying frequently referenced assets (such as RMBS referenced in multiple CDO transactions) may present an opportunity to magnify the benefits of any purchase or guarantee program

So the same group that 5 years earlier was telling everyone to leave them alone because if we try to make them stop selling deceptive loans, we'd ruin all their awesomeness, then they get congress to bail them out when their "innovations" blow up in their face.  Then they wonder why everyone is so upset with them.

Euro Zone Debt Crisis Was Going to Happen Eventually

The European Union was set up in a manner that guaranteed that eventually, one of its members was going to have a debt crisis.  What makes the Euro so unique is that it was setup almost like a gold standard.   Each nation does in the Eurozone does not issue it's own money.  It must be borrowed.  That borrowing must come from someone who has Euros.  This is very different from most other modern countries like the U.K., United States, Canada, or Japan.  The reason this becomes important is not during economic booms, but during the busts.

During an economic bust - or recession - people are out of work and pay less taxes.  Therefore the nation brings in less tax money.  Additionally, the increasing unemployed add to the costs of the social safety net.  Therefore as the recession goes on, countries bring in less tax dollars, but are obliged to pay out more benefits.  This becomes a problem when you cannot have a budget deficit.  The U.S. states are having that problem right now.  Greece and other Euro zone nations aren't supposed to have budget deficits greater than 3% of GDP.  That is impossible during a deep enough recession.

During a deep recession, a Sovereign nation like Japan or the United States could run a large budget deficit to counter-act the recession.  Eurozone nations cannot do that.  They must cut back along with the rest of their private sector.  Well, when a recession is caused by people cutting back, and then the government cuts back... it's only going to make the recession worse!

Even if Greece perfectly managed their finances and economy, this would've just happened to another euro zone country.  Greece just happened to be first.  MMT economists predicted this would happen several times over the years(See here, here, and here and again here).

Governments must be able to counter act recessions.  The Euro was designed without thinking about recessions.

Dumbest. Anti-Keynesian economics. Article. Ever!

Whoever claimed that there are 3 kinds of lies: Lies, Damn Lies, and statistics really got it.  I ran across a silly blog post over at seeking alpha.  It was old, but it was so stupid it was worth bringing up.  The writer was trying to make an argument against classic keynesian economics.  His principal argument was the government spending causes unemployment.  Since most keynesians advocate fiscal policy to maintain aggregate demand, that would be quite a blow if he could prove it.

Unfortunately for the writer, his entire premise was based on a chart he made that showed the unemployment rate and government spending as a percentage of total GDP, graphed over time.  The result was a  direct correlation between unemployment and increased government spending - as a percentage of GDP.  Both went up and down at roughly the same time.  Game-set-match.  The statistics prove it!  /snark.

A few objections come to mind.  A statistician would jump in and say that "correlation doesn't prove causation".  That is to mean, just because they happen at the same time doesn't mean that one necessarily causes the other.  However, pointing out that logical fallacy isn't even the strongest argument against this guy's point.

The second thing to disprove this non-sense was mentioned in the articles comments.  I'll call it the "aspirin" factor.

The above article is a brilliant piece of false logic. I’m sure there is an equally close relationship between headaches and aspirin consumption. Which proves that aspirin does not ameliorate head aches. In fact, if you want to be totally and completely illogical, you might deduce that aspirin actually CAUSES headaches.

In the past, governments have often responded to recessions with stimulus spending.  What that means is that the unemployment caused the spending, not the other way around.  Thanks to many "automatic stabalizers" like unemployment and such, some of this spending increases now happens without even political intervention, but it's still in response to the unemployment, not the other way around.

So we've had the "lies" and "damn lies" part.  Now time for the "statistics".  For the graphs, the person completely rigged the results by not using total spending and instead he used "spending as percentage of GDP".  Why is that important?  Well, to get the number, you take total spending and divide it by total GDP.  What that means is that if dollar spending stays the same, but GDP gets smaller, that spending number would rise even though the total dollar amount stayed the same.  Well guess what happens during a recession?  By definition, the GDP gets smaller.   Therefore, even if total dollar spending stayed flat, it would appear that government spending increased along with the oncoming recession.  The data tells a lie that you would only believe when looking at a picture graph of the data.

So there you have it.  All in one article, lies, damn lies, and statistics.

Unemployment Vs. Economic Efficiency

Nothing makes an argument more frustrating than when 2 people are using the same words to argue over 2 different things.  When discussing strategies to get out of the recession, market fundamentalists (usually conservatives) argue to let the markets work.  Others, usually liberals who sorta-kinda understand Keynesian economics, argue that we need more stimulus to jump-start the economy.  Then the market fundamentalists respond with "markets are more efficient than government" it is always better.  Then they give some example of the government, in fact, screwing something up.  Then the liberal Keynesian says, free markets got us into this mess, and then gives an example of a corporation, in fact, either screwing something up or doing something evil.  This goes back and forth and is never resolved because they are talking about two different things.

If you're arguing for more stimulus or increased aggregate demand and end up arguing over how much governments and markets do or don't suck, you've lost the argument or - at best - will stalemate.  The reason is that in most cases markets are more efficient than government trying to do it.  Be it selling shoes or setting apartment rent prices.  The liberal position is not to suggest otherwise.  The problem is that it has nothing to do with your argument for demand management.  An economy that is deficient of aggregate demand can not fix itself because it has nothing to do with an individual product or industry.

To understand why these are two different things, let's take a look at a proto-typical private market.  Let's say that you run a company that sells dish soap and one day people  buy less dish soap.  Pretty soon you'll notice you're selling less dish soap and will start making less of it.  You'll now need fewer employees and equipment to make that dish soap.  You can either move those employees and equipment to make other things(like paper plates) or you can lay off your employees and sell the equipment.  In a good economy those employees and equipment would eventually go to a company making other things.  That is economic efficiency that government should stay out of.

What happens when people start buying less of everything?  Those employees that were laid off would have no where to go because all companies are making less things because they are selling fewer things.  That's what happens during a recession.  Now you have high unemployment and nowhere for those employees to go.  It is the difference between micro and macro economics.  If one is thinking "micro" they will think that the economy will simply sort things out - "let the markets work".  However, when one looks at the big picture you'll see that private markets can't sort it out because it has nothing to do with the efficiency that markets are good at.

Additionally, if one takes a micro approach to a recession and sees that workers are being laid off, they might (rightfully, in a "micro" approach) suggest that the workers need to take a pay cut to stay employed.  Take our dish soap example.  If consumers are buying only less dish soap, then workers could take a pay cut to keep everyone employed.  If workers demand less money, then it might be better for the company owner to hire people instead of buying and maintaining expensive machines and computers to do the same work.  If however, the problem is that consumers are buying less of everything, pay cuts for all workers will only make the problem worse.  If all workers in an economy take a pay cut, those workers will then turn around and buy less of everything because they now have less money.  That must then be followed by another pay cut which would then lead to another general drop in people buying stuff which would lead to another pay cut... etc...

To suggest that an economy needs increased demand does not require one to reject free enterprise.  The private market cannot deal with a drop in aggregate demand because no single company or person can control overall demand.  John Maynard Keynes was the first to show this systemic problem.  His recommendation was for the government to be that outside force that adds demand to the economy by doing social investment.  The idea was that government would give more people money to work, and then they would spend that money which would then cause people beyond the government to get jobs.  Doing this restored demand and had the bonus of providing public works that society could benefit from like parks and libraries.  Since his time, economists have come up with further refinements to his original recommendation.

For market fundamentalists of course, this is all heresy.  Instead, the market fundamentalists continue blaming the government for everything.  To any other reasoned person, you see a deep systemic problem that requires outside intervention to balance.  These two concepts don't have to conflict.  You can advocate for private markets and government intervention to restore aggregate demand.  Only dogmatic market fundamentalists can't see the difference between that and eliminating free enterprise.