Where Keynes Went Wrong, by Hunter Lewis.

I just read “Where Keynes Went Wrong” by Hunter Lewis (or parts of it). The chapter entitled “Markets Do Self-Correct” looked interesting, because Keyes’s main point was that they don’t.

The crucial passage reads:

“During a slump, people buy less. This reduces business revenues. Because revenues fall first, before expenses, profits fall. Business owners then lay off employees to reduce costs and restore profitability. If, instead, wages fall, profitability can be restored without layoffs.

This is especially necessary if prices start falling throughout the economy. If people buy so much less that almost all prices start to fall, businesses revenues will be especially hard hit. Not only will fewer widgets be sold, but each individual widget will sell for less. Under these circumstances, if wages do not fall with prices, businesses will certainly face bankruptcy. On the other hand, if both prices and wages fall together workers should be no worse off. Although wages are lower, the consumer products workers buy will also cost less. It will be a wash.”

Poor old Hunter Lewis just doesn’t get it: if prices, wages (and profits come to that) all fall by X%, everyone is back where they started! The only change is that the value of the monetary base in real terms has risen which would encourage spending (the Pigou effect). Hunter Lewis has evidently not heard of Pigou or the Pigou effect; at least he doesn’t mention them.

The latter effect would certainly work, but we might have to wait rather a long time. It’s far easier to have the central bank continuously create monetary base. That more or less condemns us to inflation, but as long as we’re talking say 2% year, that’s not so bad.

Mistakes by Yeva Nersisyan and L. Randall Wray.

This is a good article by the above two. It’s about foreign holders of national debt.

However there are a couple of mistakes near the end. In relation to interest paid they claim “We don’t owe China anything more than a bank statement showing the accounts at the Federal Reserve Bank where their funds are recorded.”

Somehow I don’t think the Chinese would be too happy with being told their billions of dollars and Treasuries have been ripped up, but that they can have a “bank statement” if they like.

The interest that non-U.S. entities earn on U.S. national debt is a genuine increase in U.S. indebtedness to those entities. Though for the moment, as the above authors rightly point out, many of these entities have no immediate intention of calling in the debt, and are happy with “bank statements” for the moment.

As regards foreign entities cashing in their Treasuries and turning these into real goods and services purchased in the U.S., the authors claim this “would almost certainly increase US production and hence employment.”

Well, the latter would not be the effect if the U.S. was at that point in time enjoying full employment, which it should be assuming its economy was being properly run. In this scenario, no more demand is possible. Thus demand from U.S. consumers would have be pared back to make room for the demand coming from foreign entities. That means U.S. citizens working just as hard as before, but not consuming so many of the goods produced. That means a real, if only temporary drop in U.S. living standards.

Alternatively, given excess unemployment in the U.S., the additional demand from foreign entities WOULD raise employment. But there would be little or no increase in U.S. living standards because the extra goods being produced are exported, not consumed in the U.S.

Thus to say that this additional demand from foreign entities results in extra “production and employment” is misleading. Extra “production and employment” are normally seen as “good” because they increase living standards. Extra “production and employment” which result in no living standard improvement is not a great deal.

Anyone out there want to work for me for no pay?

Important people can’t stick ordinary people.

The ultimate source of all demand is households: ordinary people – Mr & Mrs Average. Plus the basic purpose of economic activity is to produce what households want. Thus when an increase in aggregate demand is required it should be pretty obvious who needs to be given extra spending power: households. That is, it is Main Street rather than Wall Street that should get the extra funds.

Give households extra funds and they’d spend more. Businesses would compete for this extra demand. And businesses with healthy order books are a good bet for any bank looking for someone to lend money to. Simple.

But no: this would be TOO simple. Economists cannot while away their hours in academic ivory towers erecting useless mathematical models based on this sort of simple stuff. So there are plenty of economists don’t like the idea.

And smartly dressed Wall Steet and City of London bankers don’t like the above simple idea: they want direct access to the extra money, Goldman Sachs in particular.

Large banks are clearly incompetent. Moreover, ordinary people to a significant extent act as banks: that is, people lend money to each other. I’ve just lent my niece money to buy a house and a friend of mine has just borrowed money off his mother to buy a van for his business. If government is going to help “banks”, there is no justification whatsoever for large banks getting any sort of preferential treatment over “ordinary people acting as banks”.

Politicians (most of whom couldn’t run a MacDonald’s restaurant) are all self appointed experts in running something a thousand times the size of the entire MacDonald’s chain: the entire economy. Moreover, they are apparently able to do this without having accumulated the knowledge of the subject required of those at the end of their first year in a university economics course.

Politicians all have their own pet schemes for “stimulating the economy”: extra investment, “shovel ready” projects, etc. These “shovel ready” projects would of course do all sorts of socially useful things: the sort of things that local and state government employees were already doing before they were sacked because of the recession. Mad or what?

The there is the $2bn “give away” to builders in the U.S. - when there is a surplus of builders and existing houses cannot be sold !!!!

The UK’s finance minister, Alistair Darling has just announced £2.5bn worth of support for small firms, including a scheme to force banks to lend to small firms. That should keep a few thousand bureaucrats and other unproductive paper pushers employed.

And then in the U.S. there is the payroll tax credit which will result in the creation of about as many jobs for foreigners as U.S. citizens.

Next on this list of shambolic schemes is the Home Affordable Foreclosure Alternative (a scheme in the U.S. for helping those in arrears with mortgage payments, and which by the looks of it won’ work). Plus see here and here.

And we mustn’t forget the farce that is cash for clunkers.

Meanwhile, house repossessions skyrocket.

Two mutually exclusive criticisms are normally made by important people of the idea that ordinary people be given stimulus money. First, households will just save the money, and second, they’ll spend too much, which would be inflationary. Well, which is it folks?

20 hilariously incompetent academics display their ignorance in – where else – The Guardian.

This article is a peach. Signed by 20 academics, it claims that the best way to repay the national debt is via economic growth. And economic growth brought about by expanding the “knowledge economy”.

Now who benefits from expanding the “knowledge” section of the economy? Um . . er. . it’s academics isn’t it? No doubt fish and chip shop owners are all for favourable treatment for fish and chip shops.

Of course economic growth is good (assuming it’s within environmental constraints). But the idea that economic growth is needed to repay a national debt is just nonsense.

Incurring national debt in the first place consists essentially of one lot of people effectively paying taxes early and getting rewarded for this with interest payments. While another lot of citizens are temporarily excused paying taxes, though they have to pay tax to fund the above mentioned interest. (For the sake of brevity, I’ll ignore the complicating factors that arise when it’s foreigners that buy national debt).

As to repaying national debt, well this just consists of reversing the above process. That is, the less well off have to pay a bit more tax, and the money collected gets repaid to those who made the loan in the first place.

Assuming it is considered desirable to keep the relative incomes of debtors and creditors constant throughout this process, then obviously taxes on rich need to be reduced while the debt is outstanding and re-imposed when the debt is repaid.

Economic growth is totally unnecessary so far as repaying national debt goes.

Bizarre ideas from a former governor of the Bank of England.

For some strange reason two UK newspapers have chosen to report comments made by a former governor of the BoE to the Treasury Select Committee in 2007, yes 2007. I’ve heard of newspapers dressing up old news as “news”, but this is stretching it a bit. Anyway, the “old news” is actually very interesting, so well done the Independent and the Daily Mail.

There a few mysteries surrounding this story. For example, why are these newspapers reporting this storey NOW? What is their source? I’ve looked at old Treasury Select Committee hearings on the Internet and cannot find anything.

My comments below are based just on these press reports. Hopefully the source of these stories will become generally known quite soon. Anyway, according to the Independent and the mail the governor said:

"In the environment of global economic weakness at the beginning of this decade ... external demand was declining and related to that business investment was declining. We only had two alternative ways of sustaining demand and keeping the economy moving forward: One was public spending and the other was consumption. Now of course it's true that taxation and public spending may influence the economic climate, may influence consumer spending. But we knew that we were having to stimulate consumer spending; we knew we had pushed it up to levels which couldn't possibly be sustained into the medium and long term.

But for the time being, if we had not done that the UK economy would have gone into recession just as has the United States. That pushed up house prices, it increased household debt ... my legacy to the MPC if you like has been 'sort that out'."

There is a huge amount of nonsense here.

First, take the phrase “We only had two alternative ways of sustaining demand and keeping the economy moving forward: One was public spending and the other was consumption.”

Well what other elements ARE there to aggregate demand? The only other one is exports, over which government has little control. The fact that the above two are the only ways that government has of influencing demand has been true of every country worldwide for the last hundred years. The governor might as well have announced that water is wet.

Second, take the statement “But we knew that we were having to stimulate consumer spending; we knew we had pushed it up to levels which couldn't possibly be sustained into the medium and long term.” Now why is this a problem?

Given inadequate demand, governments and/or central banks can boost spending: as Keynes and others pointed out long ago, this is what governments NEED to do. It is what the OUGHT to do. To complain about the need to do this is a bit like complaining that growing children consume a lot of food.

Third, take the phrase “That pushed up house prices, it increased household debt ...”. Why do stimulatory measures push up house prices? If demand drops, house prices drop. If government then takes measures to return demand to its previous level, that should not result in an excessive house price boom: prices should simply revert to their previous level.

Low interest rates should not of themselves result in excessive debt because banks ought to lend on the basis that mortgagees can still afford the mortgage if interest rates rise. The REAL problem was that banks started playing silly buggers and offering ninja mortgages. And a ninja mortgage is a disaster waiting to happen whether it is offered during a period of high OR low interest rates.

Bank of England realizes that QE boosts share prices, and Mish doesn’t realize that wages are sticky downwards.

Well done the Bank of England for tumbling to the fact that Q.E. boosts share prices. If people and institutions are given cash in exchange for their securities, they are going to diversify into other assets. Some of us predicted this before Q.E. started in early 2009.

And Mish in an unusual lapse from his usual high standards claims that the money supply might as well be left constant in dollar terms because when the money supply is inadequate, prices will fall, i.e. the real value of the money supply will rise, until the real value of the money supply is adequate.

The flaw in this argument was pointed out by Keynes: “wages are sticky downwards”.

Obviously if prices AND wages changed rapidly in sympathy with changes in supply and demand, then the “Mish” theory would hold. But wages just don’t fall fast enough: or don’t fall at all. Churchill tried to cut miners’ wages in the 1920s. The result was a year long miners’ strike. And they are trying to shave a bit of bureaucrats’ salaries in Greece at the moment. Same result: riots, strikes, etc.

Afterthough (20th March): The above criticism of the BoE is unfair - it was not 100% clear in early or mid 2009 WHAT the optimum amount of QE was.

Fed pays interest on bank reserves!

This is sticking plaster to cover up a blunder, isn’t it?

Instead of giving stimulus to Main Street or State or local governments, most of the stimulus has gone to Wall Street.

Put another way, Government – central bank machines have stuffed the pockets of people and institutions who are unlikely to spend the trillions involved, e.g. as part of the quantitative easing program. These trillions just get dumped in commercial banks.

The banks cannot lend much of it because not much demand is coming from Main Street. Thus interest rates plummet. Thus the Fed has to pay interest on bank reserves, unless interest rates are to go negative. Or as the Fed puts it “Recently the Desk has encountered difficulty achieving the operating target for the federal funds rate set by the FOMC....” (See item 3 here.)