The free market is the best economic system we’ve been able to come up with so far. But it’s a mistake to believe that it’s a perfect system. One commentator believes it is a system bestowed upon us by God himself. What an idiot. The free market system is far from perfect, and it is important for us to continue to study it so that its limitations can be identified thereby contributing to a solution to its weaknesses. One area worthy of looking into is health care. There are various aspects of health care that we can consider.

An economic model is a method of allocating society’s resources. Take Snickers Bars as an example: a state controlled economy would dictate how many Snickers Bars are produced and who gets them. In a free market economy the producer would decide how many Snickers Bars to produce based on their estimate of the market. If inventory builds up, then they stop producing Snickers Bars and maybe produce something else like Almond Joys. If they’re flying off the shelves of stores, then they might increase production, add another shift or even build another manufacturing plant. Consumers would determine the distribution. If someone wants a Snickers Bar, then they can use their money to buy a Snickers Bar. If someone would rather have the Almond Joy, then they don’t buy a Snickers Bar. Someone with no money gets no Snickers Bar but is encouraged to work to make enough money to buy said Snickers Bar. It’s a pretty good system of distribution. He who wants a Snickers Bar pretty much gets a Snickers Bar. It works pretty good for Snickers Bars.

But is a purely free market approach the best method of distributing health care? Is it acceptable that wealthy people receive health care and the poor do not? First, let’s consider the distribution of health care. Who gets health care? In a free market system those that get health care are those that can afford it. In the United States with various state run Medicaid programs and Medicare and employer provided insurance not to mention more laws and regulations than one can reasonably digest, the distribution of health care in the United States hardly represents a free market system. The result is that health care is more evenly distributed in the United States. Most poor inner city infants can get emergency treatment if needed.

But consider the worldwide distribution of health care providers. To do this you don’t even have to look very far: my former primary care physician is from Bolivia, my current primary care physician is from the Philippines, my dentist is from Cambodia, one of my students is a certified nursing assistant from El Salvador, etc. There are countless medical professionals trained in poor countries who come to the United States to practice because the money is so much better. This is good for the United States. However, it is not good for the poor countries. Bolivia has one less doctor. Cambodia has one less dentist to treat the impoverished people of that beautiful country.

The question is whether this is the best distribution of society’s resources. Some may dare to submit that this is the best distribution of resources. I curse them. It is outrageous that a third world country like the Philippines use its limited resources to educate and train a person to be a doctor and then have that doctor leave and go to a rich country to practice. It’s good for the doctor. It’s good for me. But it is not good for the people that remain in the Philippines. I submit that this is not the most efficient distribution of health care resources.

What about research and development? The free market model dictates that private interests will invest in research and development with the intention of creating a product that can be sold at a profit that over time exceeds the cost of the research and development. Companies have invested in developing and producing medicines for high blood pressure, high cholesterol, diabetes and erectile dysfunction. Former Vice President Dick Cheney walks around with a heart pump. Artificial knees, hips and other body parts. [Last summer I was visiting my mom. We were at the pool. We were talking about health care, and I mentioned that they’ve got a pill for almost anything that ails you. My mom declared loud enough for everyone to hear that they haven’t yet developed a pill that will cure her diarrhea. Hold on, mom. It’s coming.] Not only have that, but drug companies produce these drugs in enough quantities so that everyone who can pay for it can had it.

But few private sector resources are devoted to drugs to fight malaria and dengue and other maladies that are unique to third world countries. Again the question is whether this is the best method of distribution of medical research. Some may submit that yes, the free market economic model is the best method of distribution of medical research that society has come up with to date. I question whether investment in cosmetic surgery and cholesterol drugs for those who have eaten cheeseburgers and French fries their entire lives is better than investing in producing and distributing drugs for malaria.

How can it be made better? Examples already exist. Government investment in research and development of treatment of AIDS has benefited untold numbers of AIDS patients in third world countries. Former President George W. Bush is rarely given praise for his initiative to fight AIDS in Africa. One estimate claimed that he may have saved as many as a million lives.

Another example is philanthropy. Many doctors donate their time, and many hospitals donate resources to provide health care to the poor in third world countries. Doctors Without Borders is a fine organization the provides medical treatment to people who otherwise would receive none under the free market. Dennis Quaid is a good example of an individual. He has escorted several patients from Central America to the United States and funded needed surgery. He also funded and helped establish the Ruth Paz Medical Center in San Pedro Sula, Honduras.

Another example is Cuba and its production of thousands of doctors. Medical schools in Cuba train doctors from both Cuba and other developing countries to practice in medicine with the intention that these doctors will treat patients who otherwise could not afford treatment. Cuban doctors and Cuban trained doctors can be found in various countries from Latin America to Africa.

The free market economic model is the best economic model that we have. However, it is not the most efficient method of distributing health care. That doesn’t mean that it should be abandoned.

A Slave to Figures

They say that if you remain silent then people will think that you’re in idiot, but that if you open your mouth then you remove all doubt. Larry Kudlow has removed all doubt a long time ago. In a recent column http://tinyurl.com/3cax6um Kudlow gives us a glimpse into the depth of his ignorance. This might be failing to see the forest through the trees.

Sometimes economists make the argument that damage caused by natural disasters stimulates economic activity thereby contributing to economic growth. Some argue that the money spent on expenditures to repair said damage would have otherwise been spent on other expenditures thereby resulting in a wash. What both sides of this argument are missing is the very heart of our economy.

What do we want from our economy? Answer: stuff. Why do you get up and go to work? Do you get up and go to work so that the numbers on your bank statement get bigger? No. You do it so that you can have more stuff. You can have a car or a nicer car or a house or buy an x-box or a diamond ring for your sweetheart or take a vacation. The reason we want our GDP figure to be bigger is because a bigger GDP figure represents more stuff we can have. A number on a government report doesn’t do any good for anybody except for a politician who is trying to get re-elected based on the performance of the economy.

So for that reason people think that a bigger GDP figure means a better economy and therefore more prosperity. One thing the GDP figure does not measure is the loss. The expenditures to rebuild the damaged road are included in the GDP figure, but the damage is not included in the GDP figure. Kudlow’s failure to realize that this damage is not included in the GDP figure is his most grievous error.

Kudlow makes the mistake of being a slave to figures. One might consider it failing to see the forest through the trees.

Some often like to start at a conclusion, and then look for facts that support the pre-drawn conclusion. Sometimes they rewrite history to shape the facts so that they support their premise. It’s often said that the Kennedy tax cuts triggered the economic boom of the 1960s. A few clicks of a mouse will tell you that the economy had been booming for years prior to that tax cut. In analyzing the Great Depression these people pick their pet peeve and declare it either as a cause of the Great Depression or a contributor to the elongation.

Christianity experiences something similar. The Bible is such a large and complex book that things can be taken out of context and exaggerated and twisted and spun to the extent that the Bible has been used to support selfishness, hatred, and even war. A good preacher will take a passage from the Bible, a proverb or an entire chapter from an epistle, and teach the message that said scripture intends to teach. A bad preacher will start with his own thought, and then search for scripture references that support what the preacher wants to teach that day.

Hack faux economist Jerry Bowyer commits both errors at the same time. He has been writing some blog entries arguing that the free market model of economics is an economic model designed by God to contribute to the prosperity of mankind. He started off arguing that Adam Smith intended that his “invisible hand” was the actual invisible hand of God himself. In his recent column http://tinyurl.com/4xfajob Bowyer leaves no doubt of his belief that his model of free market economics was designed by God so that mankind could enjoy the fruitfulness of creation.

“God created the world with a plan that free individuals pursuing peaceful commerce would be of benefit to all,” writes Bowyer.

I’m going to get right to the point: there is no evidence whether in economic research or in the Bible that God or some supreme being designed the Universe so that free market capitalism would be a perfect economic system. If Jerry wants to argue that Adam Smith believed that free market economics was designed by God, then he’s free to do so. In fact, it makes not one bit of difference whether Adam Smith thought that free market economics was inspired by God or whether he wore women’s underwear.

But let’s take a look at Jerry’s argument. Jerry writes, “God made a world which is fit for us, and He made us fit for the world.” Indeed He did. I agree with that. But a critical problem arises because a key feature in the mix has been corrupted. When man disobeyed God, man changed, and his relationship with God changed. Man obtained a sinful nature. The Apostle Paul writes, “There is no one righteous, not even one; there is no one who understands; there is no one who seeks God. All have turned away, they have together become worthless; there is no one who does good, not even one.” A key ingredient in God’s utopian economic plan changed significantly.

God’s original plan was to have Adam in the garden tending to the garden and eating the fruits of the trees (except one). But God’s original economic plan changed abruptly. After man’s rebellion (or as Jerry calls it, a “misunderstanding”), God said “Cursed is the ground because of you. Through painful toil you will eat food from it all the days of your life. It will produce thorns and thistles for you and you will eat the plants of the field. By the sweat of your brow you will eat your food until you return to the ground…”

“Painful toil” “all the days of [our] lives” and then we die does not sound how one would describe God’s best economic system God bequeathed upon us to fruitfully enjoy. From a Biblical standpoint, it’s clear that our current economic system is not God’s original plan for us.

With respect to an economic argument, there is no evidence that Adam Smith’s free market economic system was designed by God. There’s no evidence that it wasn’t. But would an economic system designed by God have so many faults and limitations and need so much help from mankind?

Free market economics has unreasonable assumptions like perfect market information, no participant with market power to set prices and no barriers to entry or exit among others. Second, government involvement is necessary for the system to work most efficiently. Institutional infrastructure to enforce contracts, externalities, public goods, police, national defense… Would an all-powerful omnipotent God design an economic system that had so many flaws, unreasonable assumptions and needed so much help from government?

What Jerry is doing here is putting forth a tired argument, and it’s not new. Many politicians purport that God is on their side. The entire Republican Party often tries to claim that God is on their side. It’s a tired argument because it discourages analysis of the actual issues. Jerry declares that free market economics is the economic system designed by God. Who can argue with that? If God is for it, who can be against it? The damage that this argument does is that it discourages careful analysis of free market economics.

Free Market Economics may not be ordained by God, but it’s the best system of economics we’ve got. And careful analysis of the market, its failures, its successes and careful analysis of the effects of government policies are essential in determining the best way to refine the model. Jerry’s argument undermines that.

In a recent column found at Townhall Finance http://tinyurl.com/3hox97h one Bill Tatro describes what he believes to be the cause of the current high rates of unemployment: The most significant cause of joblessness and why it will be years before it will be better, he writes, is debt.

 

Bill starts off his column by explaining why debt grew so much. “People decided they wanted material possessions instantly, not sometime in the future.” He describes how people wanted cars and vacations and bigger houses and that much of it was financed by debt. [He didn’t mention that low interest rates (thanks Greenspan) made such debt accumulation affordable].

Bill goes on to explain how the economy was boosted by the increased consumer spending. More restaurants, movie theatres and other services in a community to service the consumers led to increased employment [He said that this did not increase manufacturing, but he’s wrong. This also led to increased manufacturing in places like Honduras and China].

Bill explains how spending came to a complete standstill after the housing collapse brought the borrowing and spending to a sudden end. Bill is pessimistic about the future. It is his contention that consumers’ wealth isn’t expected to increase significantly in the near future and that, therefore, he expects the economy and employment to remain in the crapper for a long time.

While Bill missed the fact that low interest rates made the increased spending feasible. He also failed to understand how much manufacturing increased as a result. But, nevertheless, Bill is almost there. He’s right in that consumer spending was a primary engine of the economy for a long time. He’s right that significant reductions in consumer spending are the primary cause of the current economic funk that we’re now experiencing, and he’s right that it will be a long time before consumers recover.

But what he fails to see is that relying on consumer spending as a primary engine of the economy is not sustainable. For decades every time there had been an economic slowdown, you’d hear talk of how to get consumers spending again. Greenspan reduced interest rates and reduced interest rates again and again. Auto loans for 1.9% were common; some were 0% interest. Low mortgage rates. Home equity loans. Consumers were spurred and spurred to spend. Now it’s tapped out.

The solution is not to encourage American consumers to spend even more. There is a huge imbalance in the world economy. Get consumers to spend more or wait until consumer wealth increases so they can spend more is not a sustainable solution. The fact is that the nation’s and the world’s economy cannot be based on an engine that will inevitably result in an imbalance and recession. The world’s economy must adjust and must find a way to progress and grow without depending on American consumers. It’s just not viable in the long term. 

 

 

 

Genius Jeff Carter writes a column http://tinyurl.com/3uzw4mw that eloquently illustrates some commonly held economic fallacies. I’m going to address these as they occur in his column. 

The first fallacy is that people adjust their behavior to prepare because they believe a future tax increase will result from government borrowing. Way back during the Reagan administration it was believed that people would increase their savings as a result of tax cuts because they believed that taxes would have to be increased in the future. People were surprised when savings didn’t increase. 

This is based on the economic assumption of rational behavior. It is believed that people act rationally. In reality, people don’t act rationally and expect other people to not act rationally either. Oftentimes people count on the fact that other participants in the economy will not act rationally. Back in the late 90s when P/E ratios were going through the roof far beyond what had ever been seen, people knew that the companies behind most of those stocks were not worth what the stock price suggested. But they bought and held such stocks. Why? That’s irrational. The reason they did so was because they expected another investor to act even more irrationally and pay even more for the same stock at a later date. Eventually the bubble burst. 

Another reason people aren’t as a result of government borrowing is because many don’t believe that a tax increase is coming. Talk radio hosts and hack economists like Jeff Carter have convinced many that an increase in taxes results in a decrease in revenue. They’re convinced that a reduction in tax rates will increase revenues. Carter’s suggestion that people are going to change their behavior based on an expectation of a future tax increased as a result of government borrowing is unrealistic. 

Another fallacy is that government borrowing during a recession prohibits businesses from investing. “Let’s say that Peter was going to do something else with the money. Maybe he owns a business and was going to spend $1 on more production. Now he can’t because the government borrowed it.”

This is ridiculous. First of all, the government is borrowing the money in this case, not stealing it. Peter has the option as to whether he wants to put his money into an investment in more production or buy a government bond. If he believes that his investment in more production will reap a healthy return, then he will invest in the production. 

But the fact is that right now businesses are not expanding because they don’t anticipate a return on the investment. Carter writes in his column,“Cash is piling up on corporate balance sheets. Businesses are not expanding. That shows businesses are not investing.” Exactly. Businesses are not investing anyway. Rather than having the cash sitting in a bank account, the government uses the funds hopefully for projects that will benefit society like improving and maintaining infrastructure. 

“Governments cannot invest, they can only spend” is another fallacy brought up by Carter. The fact is that governments do invest. A road is an investment. A road is a capital asset that facilitates production. Let’s face it: the economy wouldn’t be able to function very well without roads. Roads, bridges, ports, dykes and dams, not to mention education and research are all investments.

 Another fallacy that Carter brings up is that the Kennedy tax cuts generated an economic boom. “Two times in the last fifty years have we lowered marginal rates and eliminated deductions. JFK, a Democrat, did it in 1961.” JFK didn’t do it at all. Kennedy proposed tax cuts. The actual tax cuts were signed by President Johnson after Kennedy had been assassinated, and by that time the economy had already been booming for years. 

Carter brings up these fallacies in an attempt to discredit Keynesian stimulus spending. Keynes is dead, he believes. 
To evaluate whether Keynesian spending is effective, one must apply it in a clinical setting. With so many inputs and variables that affect economic growth, it’s impossible to tell the exact effect each input has. The only way to do this would to go back in time, change one input and then evaluate the results. This is impossible. But that doesn’t stop us from pondering whether a stimulus can work. 

It is often argued that the benefits of government spending (if any) are more than offset by the reduction in private spending. Those that submit this argument believe that the money supply is fixed, that a dollar spent by government is one dollar less spent by the private sector regardless of whether it is taxed or borrowed. In the long term, that is a valid argument. However, in the short term, it doesn’t hold up.

Jeff Carter already admitted that corporations are not investing. Cash is piling up on corporate balance sheets, he wrote. In the short term, the government can borrow that cash and use it to pay unemployment benefits or teachers or construction workers to build a bridge or public transportation. This reduces unemployment and increases economic activity in the short term. 

Consider the data for economic growth and employment. After the financial crisis the economy shrank and unemployment increased rapidly. A stimulus was implemented in mid-2009, and spending began increasing later that year. As the stimulus was spent, the economy recovered albeit slightly, and the sharply increasing unemployment rate was stabilized. Then in late 2010 and early 2011 as the stimulus funds ran out, economic growth slowed. This is not proof that the stimulus was effective. However, the results do not support the argument that Keynesian stimulus doesn’t have any short term effect at all. 

One question is begging to be asked: Was it worth it? Was it worth accumulating a trillion dollars in extra debt to produce a stimulus that didn't address the causes of the recession, didn't improve our financial position and if anything only produced a temporary minor increase in economic growth? Was it worth it? I think the answer is obvious: HELL NO!!

Those familiar with Larry Kudlow know his poor track record in predicting the economy and stock market.  He was predicting the continued growth of tech stocks until the market crashed in 2001.  In December 2007 he wrote a column predicting that the "Bush Boom" would continue.  He criticized those who were predicting recession saying that they would have egg on their faces.  In 2009 he predicted a V-shaped recovery for the U.S. economy.  Then in 2010 he predicted high inflation and a stock market decline as a result of the Fed's QE2.

His most recent prediction provides a little insight into why his track record is so poor http://tinyurl.com/3gnsdml  In May of 2011 the stock market which had been rising since spring 2009 began to decline.  It declined about 7% from May 1 through mid-June.  Meanwhile negative economic news permeated the airwaves.  Economic growth has declined in the first quarter.  Disappointing jobs reports.  The unemployment rate increased.  The housing market had made a double dip.

But on June 14, the Dow Jones Industrial Average increased a little over 100 points.  Based on that one day fluctuation Kudlow predicted that the stock market correction was over.  He went fishing for some data to support his conclusion.  He found that retail sales increased a few tenths of a percent and that retail sales and production in China increased somewhat.  So based on that he's predicting a better economy and an end to the recent decline in the stock market.

We've got a slowly growing economy.  The unemployment rate has just increased.  The number of jobs created is anemic.  A large percentage of homes are in some state of foreclosure.  An even larger percentage of homes are behind in the mortgage payments and/or underwater.  The home construction industry has almost ground to a halt.  Plumbers, electricians and carpenters are out of work by the millions.  Consumer debt is near its all-time high.  And based on a one day fluctuation and one month's worth of retail sales data, Kudlow is predicting a reversal of a two month long stock market decline.

Back in 2007 I remember sitting in a conference room in the office of a CPA firm in San Francisco participating in a conversation about the housing market.  I don't remember the details of the conversation, but I do remember that I exclaimed that it was going to take many years before the housing market recovered.  My colleagues disagreed with me.  They said that I was wrong.  They probably don't remember the conversation, but I wouldn't get much pleasure from rubbing their noses in it anyway.  We are still in a long slog.

But even then I didn't understand the severity of the problem.  I didn't think the overall value of the real estate market would decrease so much.  Back in the early 90s the real estate market had stalled, but housing prices didn't collapse.  The theory is that homeowners aren't likely to sell their homes at a loss; they'll instead just wait it out thereby preventing overall housing prices from dropping.  In the case in the last 00s, many of those homes had adjustable rate mortgages.  The rates increased thereby making the monthly payment increase, and the homeowner couldn't refinance because the value of the property fell to less than the loan.  Not being able to make the payments caused the banks to foreclose.  To get rid of the properties they sold many at big losses thereby depressing the market even more.

But someone agreed with me.  Back in January 2008 The Economist magazine published a column called "America's Economy: The Long Slog".  And four years after my prediction of a long slog, we're still in a long slog, according to Dr Charles Plosser, president of the Federal Reserve Bank of Philadelphia.  In a radio interview with BBC economics editor Stephanie Flanders, Dr. Plosser said that the U.S. economy is headed for a "long, slow slog".

The same factors that caused the Great Recession are still in effect.  Millions of homes are in some stage of foreclosure.  Tens of millions are behind on their mortgage payments, and even more are underwater.

For decades the engine of the nation's and truth be told the world's economy has been the American consumer.  For decades Americans have been spending more than their incomes.  Savings rates have been at historical lows.  People were taking out home equity loans to spend on consumer goods and entertainment.  But the party ended when home prices dropped thereby eroding the wealth of Americans.  We hear a lot about the national debt, the amount the Federal government owes to bond holders.  But debt held by private Americans surpasses the Federal government's debt.  Consumers aren't going to be fueling the economy for years to come.

It's going to take years before all the homes that need to be foreclosed are sold.  Housing prices won't increase until that happens.  Then after that it will take years for consumer to recover.  It may take as long as 2015 before the economy regains its footing.  And neither a tax cut nor a stimulus isn't going to resolve this process no matter how strategically designed.

In a recent opinion column http://tinyurl.com/2az9y4b published by Forbes, Jerry Bowyer decries the value of a college education in the United States. He calls it a “higher education bubble”. Bowyer contends that “higher education shows every reasonable sign of having a completely unrealistic, astronomical price tag” and that those that argue the benefits of higher education are irrational.

The return on investment of a college degree varies by school, subject of study, gender, race, geographic location and other factors, and the value of a college degree is an ongoing debate. Unfortunately, Bowyer’s submission provides absolutely no valuable contribution to the debate.

First, rather than performing a cost/benefit analysis (i.e. computing the cost and comparing it to the expected benefits), Bowyer calculates a Price/Earnings ratio. The P/E ratio is one of many analytical tools used to evaluate securities whereby the price of the stock is compared to the corporation’s most recent earnings. It’s a simple calculation that can be used to compare stocks of many corporations. Up until now, no one has been stupid enough to think that P/E ratios are useful comparing the relative value of stock to a college education.

Second, Bowyer blatantly overestimates the “P”. In estimating the cost of college, Bowyer makes convenient assumptions that overstate the cost. A typical bachelor’s degree program is designed for four years of study. Bowyers claims that on average students take six years to complete a four year program. He claims he got this from a book entitled “The Five-Year Party”. He says this is because students increasingly drop classes late in the term to avoid failing grades.

And in calculating the “E” part of the equation, Bowyers is equally unfair. For the “E”, Bowyer uses the increase in earnings only for the first year out of college. He calculated that the increase in earnings due to a college degree is only $2,000 for the first year and that the P/E Ratio is 100. Coca-Cola stock P/E is around 20. Microsoft is less than that. Bowyer’s conclusion: An investment in a college degree “doesn’t look very attractive”.

Because one statistic is not sufficient to analyze an investment in a security, investors use dozens of statistics and trends in statistics and audited financial data. Bowyer uses manipulated inputs to one convenient statistic to draw his conclusion that it “doesn’t look very attractive”.

But a P/E Ratio is a stupid way to evaluate a long-term investment. When a business decides to invest in equipment, they don’t compare the cost to what the income would be for the first year. They compare the cost to the present value of the expected income stream and calculate the return on investment. For a college degree, that’s already been done.

Not only has it been done, but PayScale estimated the return on investment for hundreds of institutions http://tinyurl.com/29r7ah4 Using the same inputs used by Bowyer (only they used actual inputs, i.e. actual cost, actual earnings of graduates), they estimated returns on

investment for four-year college degrees. The returns vary from as high as 12.6% (How’s that, Jerry?) to 4.3%.  But not all college degrees are alike.  Not only do the returns vary by school, but they also vary by field of study.  Someone who studies accounting will get a higher return on their investment than someone who studies 18th century French poetry.  And the inputs are not just financial.  Someone who works hard will realize a better return than someone who parties and drops classes.

Figures can be manipulated. A clever hack can manipulate one statistic to support a pre-drawn conclusion. Jerry Bowyer seems to be in the habit of doing it.

Sometimes in church you'll hear a preacher preach on a passage.  Romans chapter 8 is a good passage.  "Therefore, there is now no condemnation for those who are in Christ Jesus..."  It's a beautiful passage.  Sometimes a preacher will preach on a subject like wealth or something.  When they do it this way, you can take a verse out of context and/or twist it, and you can make it seem like the Bible supports almost anything you want to say.  It's not a new approach.  Peter spoke of it: "[Paul's] letters contain some things that are hard to understand, which ignorant and unstable people distort, as they do the other Scriptures, to their own destruction."

This deceitful tactic isn't limited to just scripture interpretation.  It's very common in politics and economics.  You can approach things in two ways: 1. Evaluate the information and draw conclusions based on said information, or 2. Start with a conclusion and then search the data for something that seems to reinforce your pre-drawn conclusion. Larry Kudlow commits this offense in a recent column: http://tinyurl.com/28ckp2g

For as long as I can remember, Kudlow has lauded the market.  The market consists of millions of investors who make decisions based on available information.  Millions of brains working together are smarter than a handful of government bureaucrats so Kudlow claims that the movement of the market is the best measure to evaluate economic and political news as well as government decisions.  For the past year or more, Kudlow has been criticizing the Fed's easy money policy claiming that it will result in high inflation which is detrimental to the economy despite the fact that the market has been increasing.

Last week the Fed announced that it will intensify its easy money policy buying hundreds of billions of dollars in bonds.  Investors were anticipating this announcement by the Fed which came Wednesday afternoon, but no one was sure about how much the Fed was going to put down.  The market showed little change during the first part of the week as investors awaited news of the Fed's decison.  Monday, Tuesday and Wednesday the markets barely moved.  The Fed announced its plans Wednesday after the market closed.  On Thursday morning, markets around the world shot up; the Dow gained nearly a hundred points right after opening.

An objective observer might tend to suspect that this sudden distinct rise in world markets was a result of the Fed's action.  But not Kudlow.

Kudlow had been lauding that the Fed's easy money policy was bad for the economy.  Intensifying this policy in Kudlow's eyes would be even more detrimental to the economy.  Kudlow's perfect market belief demands that the market would tank as a result of the Fed's Wednesday afternoon announcement.  When markets shot up immediately after the Fed's announcement, this conflicted with Kudlow's belief system.  But rather than evaluate his theories based on available information, Kudlow searched for something that would support his pre-conceived beliefs.

He found it in a White House press briefing on Thursday, November 4.  White House Press Secretary Robert Gibbs said that the Obama administration is “open” to negotiations on temporarily extending tax cuts for upper- income individuals to win extensions for middle-income families.  Kudlow used the White House's openness to negotiating tax cuts for the wealthy as the reason the market increased.

Kudlow's problem is that Gibbs' announcement came AFTER the markets shot up.  Gibbs' announcement was on the same day so Kudlow might have been able to convince himself and his ignorant fan base, but inquiring minds who investigated Kudlow's claims know that markets had already been rising significantly prior to Gibb's announcement.

Walter Williams writes a column http://tinyurl.com/27yznyt on tax incidence and explains that politicians exploit the ignorance of the voters with respect to tax incidence. In the column, Williams commits the same offense that he decries.

Williams correctly explains that a tax is not necessarily borne by the entity on which it is levied. A tax on gasoline retailers is borne partially by consumers and partially by producers (i.e. employees or owners of the business). Either way, explains Williams, the tax is eventually borne by people, not corporations. Williams explains this to emphasize the point that President Obama's expressed intent to tax businesses will not be paid by said businesses but will be paid eventually by people, some rich and some not-so-rich.

Williams is correct in that a tax on business income ultimately is paid from the pockets of people. But he conveniently leaves out the rest of the story. What would be the result of not assessing a tax on business income? The result would be a subsidy. But that's good. Right? Shouldn't we be subsidizing business?

When the costs are not properly matched with an activity, it results in a subsidy to said activity thereby producing more of said activity than is best for society. It results in an inefficient allocation of resources. For example, there was a show on TV where a kid started a burrito business. He used his mom's credit to purchase the ingredients, prepared the burritos in his mom's kitchen and then sold them to his classmates. Without having to pay for the ingredients, the kid was making a good profit. The business was subsidized. The problem came when his mom noticed the charges. When the costs of the ingredients were considered, the boy's business was actually not profitable. In fact, the family lost money.

But taxes don't reflect a cost of a business. A tax is just the government taking what rightfully belongs to the business, people argue. Not so fast.

The purpose of tax is to provide funds for public goods. An example of a public good is a road. People drive on the road. Similar public goods are police, national defense and courts. It's possible to put up a toll booth at every intersection to pay for the upkeep of each road, but it's not practical. It's more efficient to get the money to pay for roads from taxes. Similarly, it's more efficient to pay for national defense through taxes. It's just not possible to calculate how much each person benefits from national defense and send them a bill.

Corporations use these public goods when conducting business. Corporations benefit from roads. Trucks transport goods on public roads. Workers commute on said public roads. Businesses benefit from public education by having an educated workforce. Thanks to Social Security and Medicare workers don't demand as much pay or retirement benefits thereby resulting in the government picking up the tab for a portion of worker compensation. Safe shipping lanes exist courtesy of our armed forces. Courts enforce contracts. Police provide safe neighborhoods thereby facilitating business.

The free market matches expenses with actions. If you want an ice cream cone, then you pay for an ice cream cone. A decision is made. I want that ice cream cone more than I want that money. With government provided goods, that decision is not made. The road is there. It's free. I can drive on it, and my action of using that road does not result in any additional cost to me.

In an ideal situation, the costs of something would be paid for by those benefiting. Because corporations and other businesses benefit from public goods, a tax is levied on their income. Theoretically the higher the income the more the entity benefits from the public goods. Thus, the higher their income, then the higher tax they pay.

But what's so bad about subsidizing business? It's still good to subsidize business, isn't it? A business that is not profitable, that is propped up by taxpayers is a drain on society. Subsidies for steel manufacturers sucked blood out of consumers and taxpayers for decades. The unprofitable steel companies avoided making necessary changes to make their businesses more efficient. Those that couldn't survive went bankrupt anyway leaving creditors holding millions in unpaid debt, leaving employees without jobs and retirees without their pensions.

Look at the auto companies. Bailout after subsidy after preferential tax treatment permitted the auto companies to overpay workers and fold to pressure from unions and make promises of post-retirement benefits that they had no way of paying. They've been struggling for decades, and subsidies have permitted them to continue their inefficient ways of doing business.

Another example is the homebuilding industry. The mortgage interest deduction provided a tax incentive, and there have been and still are plenty of other artificial government subsidies to the homebuilding industry. It created a bubble, artificially inflated home prices and profits for homebuilders, and allocated resources towards building houses that could have been allocated to more efficient uses (like building apartments).

Walter Williams wants his readers to believe that it doesn't matter who pays the tax. Individuals ultimately pay the tax anyway. But the absence of a tax directly on corporate income exaggerates corporate income thereby permitting unprofitable businesses to continue to suck blood out of society thereby resulting in an inefficient allocation of resources.

In the late 1970s Jack Kemp and others started an idea that Ronald Reagan made famous. They called it "Supply-Side Economics", and the general idea is that reducing costs to businesses (i.e. the supply side of the demand/supply equation) would stimulate the economy and result in economic growth. Tax rates were reduced, the economy grew, and Supply-Side Economics was credited for the growth. Since then it was believed that government policies aimed at stimulating the economy in this manner would result in more and more economic growth.

Some who identify themselves as Supply-Side Economists claim that the demand side of the equation doesn't even matter. There will always be demand, they say. Arthur Laffer, one of the most famous of the Supply-Side Economists, says that demand is not a problem. He includes this in a recent book "The End of Prosperity".

Convenient for people like Laffer, another phenomenon that is less often discussed that took place during the same period is the demand side of the equation (i.e. consumer demand). Consumer demand was seemingly insatiable for much of the past three decades. Consumers consumed. They used their savings. They borrowed. When they couldn't borrow anymore, interest rates were lowered, and new ways of borrowing more money were invented. Credit cards were offered to college students and others with little or no credit and even to people with bad credit, and limits were increased. People were permitted to borrow from retirement accounts. Home equity loans were nearly synonymous with ATMs.

This consumer spending by Americans was the root of much of the economic growth over the past several decades not just in the United States but in many other countries as well. In the 80s Japan's economy took off with much of the growth a result of sales to American consumers. In the 90s the Asian Tiger economies took off and in the aughts China's economy grew at double-digit pace every year.

By 2008 American consumers were tapped out. Housing prices had declined so home equity loans could no longer provide a source of funds for consumers. Consumers were also up to their necks in auto loans and credit card balances. When consumer spending declined, businesses stopped selling, and when businesses stopped selling they stopped making profits.

When you talk about economics, a lot of people automatically think of supply and demand. And they'd be right. There is the supply side, and there is the demand side. Both sides are equally important in the equation.

http://tinyurl.com/26gvrwk

In a recent column, Lawrence Kudlow criticizes Treasury Secretary Geithner and Congressional Democrats for policies that discourage saving.

“The great flaw in the thinking of the Democrats,” writes Kudlow, “is that they are ignorant of the economic power of saving and investment.”

Kudlow goes on: “Saving is a good thing. Stocks, bonds, bank deposits, money-market funds, commercial paper, venture capital, private equity, real estate partnerships -- all that saving is channeled into business investment. And whether that capital goes into new start-ups or small businesses or large firms, it finances the kind of new investment in plants and equipment and software and buildings that ultimately creates jobs and family incomes. And that, in turn, spurs consumption… Without saving there can be no investment. And without investment there can be no enhanced productivity, which is the ultimate source of long-term prosperity and wealth.”

Kudlow goes on an on about how the policies proposed by Democrats (i.e. raising marginal tax rates by a mere 5%) is somehow going to doom the economy.

“My answer is to keep the incentives for investment,” writes Kudlow.

Kudlow’s incentives for investment involve low tax rates on investment by extending the W. Bush tax cuts for high income taxpayers. Kudlow is saying in his column that lower taxes on investment income will encourage people to save and invest. But does empirical evidence support it? As tax rates on investment have changed, has the personal savings rate also changed?

Capital gains tax rates have fluctuated over the years. In the 70s the top marginal capital gains tax rate was 39%. In the 80s it was reduced to 20% and then increased to 28% in 1986. In 1997 it was reduced back to 20%. In 2003 it was reduced to 15%. With the marginal tax rate on capital gains declining over 50% since the late 70s, Kudlow would expect the savings rate to have increased over that time as well.

But it didn’t. The Bureau of Economic Analysis keeps this statistic via its National Income and Product Accounts (“NIPA”) savings rate. The U.S. personal savings rate has declined considerably and steadily since the 1980s and is lower than most industrialized nations.

Kudlow’s claim that lower capital gains tax rates encourage savings is without evidence.

Nevertheless, investment in the U.S. has increased. The main reason is because investors from abroad have moved their assets to the U.S. Low marginal tax rates on capital gains can be a factor in this decision. Other things being equal, it’s better if income is taxed at 15% than at 20%. Investors have to ask themselves, “Do we want to invest in Europe or Asia or do we want to invest in the U.S.?” Reducing capital gains tax rate from 39% to 15% is a significant reduction.

But does it increase savings?

How much do I want to save for Chauncey’s education? How much do I want to save for retirement? Is a higher capital gains rate going to factor into the decision as to whether and how much I should save for Chauncey’s education? If the tax rate increases, am I going to decide to save less? If the tax rate decreases, am I going to decided to save more? It probably won’t have much effect. It will play a part into whether I invest my savings in capital assets or income producing assets, but it probably won’t affect how much I need to save or whether I decide to save. For Kudlow to suggest that a decrease in capital gains tax rates encourages people to save more is just not supported by the facts or by theory.

So what caused the savings rate in the nation to decline so dramatically?  There are a few primary causes.

First, the lessened need to save for retirement.  Americans expect to receive a monthly Social Security benefit that will fund at least part of their retirement.  Medicare reduces the need to save for medical expenses during retirement.  Since 2003 people don't even need to worry about prescription drug expenses.  Without these government programs, people would feel the need to save much more for retirement.

The housing boom also reduced the felt need to save.  As home prices skyrocketed, people expected to be able to sell their home and move into smaller, less expensive houses at retirement and use the difference to supplement their retirement.  Without rising home equities, people would feel more of a need to save.  It's not a coincidence that the savings rate increased immediately after housing prices tanked.

Another is the availability of credit.  With the United States as an attractive place for investment, it's no surprise that money poured into our economy from abroad.  Credit was readily available.  A statement often made was that consumers used their homes as ATM's.  Even without home equity, loans could be obtained even by people who had bad credit.  People with good credit could get low interest or no interest credit cards and auto loans.  It was no longer necessary to save up to buy that car or stereo.  Buy now.  Pay later.

It's later. And we're paying big time for our irresponsibility.

“It” Is a Fiscal Problem


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In Kudlow’s analysis of “the problem”, he is unable to look beyond the government. If it’s not a monetary problem, then it must be fiscal problem, concludes Kudlow. It never occurred to him that “the problem” might not be with the government. Maybe the worldwide recession isn’t a result of U.S. government tax rates but an imbalance that had been growing for decades. Maybe the fact that consumers are swamped in consumer debt has something to do with it. Maybe the fact that many homeowners are underwater in their mortgages has something to do with the sluggish recovery.

Kudlow calls himself a “supply-sider”. Like many supply-siders, Kudlow believes that the only engine of the economy is the supply side. Supply-Side Godfather Arthur Laffer writes in a recent book that demand is not a problem. There is never any lack of demand even in poor countries like Bangladesh. The problem is supply. I’d like to see Laffer open up a BMW dealership in a Bangladesh slum and see how high the demand is there.

Whether it fits your pre-drawn conclusions about economic growth or not, consumer demand has been a major engine in not just the U.S. economy but the world economy over the past decade. Look at China. Its double-digit economic growth over the past decade is a result primarily of producing products to be sold in the U.S. and European markets. In the past couple of years as U.S. consumers reduced consumption so much due to high debt levels that China’s economic growth has decreased considerably.

Back in 2002 after September 11 the Fed reduced interest rates to spur the economy. Consumers were able to borrow at extremely low interest rates to fund consumption. Auto dealerships were providing loans at zero percent interest rates. Then housing boomed. Low interest mortgages permitted people to buy more house for less monthly payments. The construction industry boomed as a result of this along with real estate brokers, mortgage brokers, the lending industry and title attorneys. This was all spurred by high demand. As housing values increased, homeowners were able to get low interest home equity loans to finance even more spending thereby fueling electronic, travel and tourism and other industries. President Bush reducing the top personal income tax bracket from 39% to 36% probably had very little to do with the booming economy of the mid-00s.

Then it crashed starting with home values. Those who has low interest adjustable mortgages saw the interest rates on their mortgages adjust upwards. People were able to refinance until real estate values tanked. Then they were stuck with high monthly payments. As real estate values tanked nationwide, consumers lost trillions in wealth. They reduced consumer spending considerably. No more new cars. No more big screen TVs. No expensive cruises or vacations. No new decks or new bathrooms or remodeling.

This is what caused the current depression, and the same parameters exist today. Millions of homeowners are underwater in their mortgages. Millions of people are unemployed. People who are employed are saving just in case they lose their jobs as business and local governments are strapped and looking for areas to cut.

The problem is not monetary. The problem was not caused or worsened by government fiscal inputs. The problem was and is a demand side problem and requires a demand side solution. It’s basically a hole, a deep, wide hole that’s going to take years to turn around and decades to recover from. Those that think that the economy rises and falls based on supply side factors only are only seeing half the picture.

ubtitle: Arthur Laffer Makes Me Chuckle

A common mistake made by economists is assuming that economic policies have the same effect under all economic conditions. But it’s not true. It is a general principle that water will turn to ice if the temperature is reduced. But that general principle does not hold true if the temperature is reduced from 95 degrees to 40 degrees. Only when the temperature declines to 32 degrees or below will any ice form.

Similarly, the effectiveness of fiscal and monetary policy varies depending on current economic conditions. Policies to curb inflation are helpful during periods of high inflation, but during periods of deflation they could be harmful. Tax cuts generally result in increase net after tax income, but during periods of losses, there is no effect.

One would think that Arthur Laffer, an educated economist who has practiced the craft for decades, would get it. Instead he fails to consider the current economic conditions while advocating policies. Laffer writes a column http://tinyurl.com/2auuu6g in the Wall Street Journal advocating that unemployment insurance benefits cause higher unemployment.

Under healthy economic conditions, it’s a sound theory. Higher unemployment benefits make unemployment more attractive thereby increasing the incentive to remain unemployed and decreasing the incentive to look for a new job. Laffer imagines unemployment benefits of $150,000 per year and correctly guesses that the unemployment rate would be higher if such a generous unemployment benefit were offered.

Laffer offers a chart that shows the correlation between increased unemployment benefits and unemployment. A glance at the chart shows that the more unemployment benefits are paid, the higher the unemployment rate rises. Laffer uses this to prove that high unemployment benefit payments cause unemployment.


And this is what is most annoying. He wants his audience to conclude that unemployment benefits cause unemployment. Of course, a closer look at his chart shows that the unemployment rate actually rose BEFORE unemployment benefits rose. How can an increase in unemployment benefits in 1975 cause unemployment to rise in 1974? It’s clear from Laffer’s chart and from just plain common sense that high unemployment is the cause and high unemployment benefit payments are the effect. For Laffer to suggest otherwise tells me that he is being dishonest.

Another policy about which he is clueless is stimulus. He believes that if the government spends money on stimulus, such as unemployment benefits, then the money must come out of the pocket of some other productive participant in the economy. This assumption also holds true under normal circumstances. In order to pay Peter, the government must tax Paul. It makes sense.

But it’s not always true. Currently, financial institutions are hoarding trillions of dollars that are not being invested in the economy. This normally causes deflation. However, the Federal Reserve is operating an anti-deflation policy. Bonds issues to pay for the Federal deficit are being bought up by the Fed. The money for the stimulus is not being taken out of anyone’s pocket.

We’re all familiar with the Laffer Curve. Lower taxes leave more money for businesses and productive individuals to invest and create an incentive for businesses. That’s sound economic theory. I’ve always had a lot of respect for Laffer. But this column is pathetic, and his use of deceit and his display of ignorance with respect to economics causes me to question his integrity as well as his competence.

In an episode of the popular 90s sitcom “Seinfeld”, Elaine suffered an injury to the neck. Kramer insists on helping her. Jerry joked, “His formal training is in pediatrics.” Not surprisingly, Kramer’s treatment ended up doing more harm to Elaine.

Bruce Bartlett has had a hand in developing the economic policy of the nation over the past three decades. In 1977, Bartlett went to work for Congressman Jack Kemp as a staff economist. He helped to draft the Kemp-Roth tax bill that eventually became the basis for Ronald Reagan’s 1981 tax cut. In 1983 he became executive director of the Joint Economic Committee of Congress. In 1987 he became a senior policy analyst in the White House Office of Policy Development. During the administration of George H.W. Bush he was deputy assistant secretary for economic policy at the Treasury Department.

Just as Kramer had no formal education in chiropractic medicine, Bruce Bartlett has had no formal education in economics. He majored in history. His master’s thesis was on the attack at Pearl Harbor. He obtained his knowledge of economics from listening to politicians and reading bumper stickers. And not surprisingly, his policy recommendations have done more harm than good.

In chapter 6 of his latest book, The New American Economy, Bartlett describes the “starve-the-beast” political strategy. It was believed that “tax cuts would channel concerns about budget deficits into political pressure to cut spending”. This idea had a lot of support, not just from political hack pop-economists like Bartlett but by none other than Milton Friedman himself who is quoted by Bartlett, “I have concluded that the only effective way to restrain government spending is by limiting government’s explicit tax revenue.”

In my opinion it’s a cop-out. Rather than roll up your sleeves and fight against overspending, they devised this method. It stems from weakness and cowardice.

This strategy was embraced by many over the years including Greenspan, Rick Santorum, Stephen Moore of the Club for Growth, President George W. Bush,William A. Niskanen, a member of Reagan's Council of Economic Advisers, and Richard Cheney. Barlett writes, “Instead of being viewed as the height of fiscal irresponsibility, cutting taxes without any corresponding effort to cut spending was now seen as the epitome of conservative fiscal policy.”

And it didn’t work.

Despite thirty years of outrageous budget deficits and a growing and growing and growing national debt, no significant spending cuts were ever implemented. Even when Republicans controlled the House, the Senate, and the White House, spending rose including the outrageous Medicare prescription drug benefit. Few made any effort to control spending.

We are faced with a national debt approaching 100% of GDP, and that national debt is dwarfed by continually rising unfunded Social Security and Medicare obligations. We are in a fiscal hole so deep that it will take generations to get out of. And it was all intentional.