Keynes, Hayek, and Fisher

Most people who follow economic events have some familiarity with John Maynard Keynes and Frederick Hayek.  Both economists were contemporaries at the London School of Economics in the 1930’s and have huge followings in economics and public policy to this day.  People associate the public policies of expanding government during recessions financed through public debt and a weak dollar with Keynes.  They also associate austere government programs and a strong dollar policy with Hayek.  While Barack Obama would be characterized as a follower of Keynes, Ron Paul would be characterized as a follower of Hayek or what is currently referred to as the Austrian school, which was Hayek’s home country where he grew up and first taught economics.   While these two people represent the extremes of contemporary economic thought, there is a third economist that should be mentioned when attempting to understand the major economic event of the last five years.

That person is Irving Fisher who was an economist in the United States in the 1930’s during the Great Depression.  He had a number of followers who elaborated on his work.  Among them was Charles Kindleberger.  These two economists described the mechanisms associated with great financial economic depressions that apply to today’s economics. 

A financial collapse, such as the ones that were experienced in 1929 and 2007, usually begin with an asset that can grow over time faster than the average asset.  Speculators begin to recognize the growth potential and borrow money to buy more of the asset, which in turn, causes the value of the asset to grow at a more accelerated rate.  Financiers begin to see the potential of financing the asset as a growth market and put more funds into the area.  Soon, credit requirements are lowered.  More speculators are enticed by the financing possibilities and more credit is put into the market.  This cycle continues until there are no more speculators that can be enticed into the market to bid up the value of the asset in question.  In other words, there is no more credit that can be drawn into the market to finance the asset.  Either way, the value of the asset will fall leaving vast sums of unsecured credit exposure.  There is a financial collapse and neither Keynes nor Hayek adequately addresses it.

Fundamentally, what do we have here?  Assume that the national economy can be represented by a set of financial statements that a company, whether big or small, would maintain.  There is a balance sheet, which is a snapshot statement of assets, liabilities and equities, and an income statement, which is a summary of revenues and experiences.  Note that the Fisher process focuses on assets and liabilities, or balance sheet items.  It does not focus on employment, jobs, and growth, which are income statement items.

The policy responses of a Keynesian would be to expand government to take up the slack in the GPD.  In short, borrow funds to keep people working, which is an income statement strategy.   It assumes that the income statement would correct the balance sheet, which is rarely the case.   The policy responses of an Austrian would be to assume that the capital markets heal themselves.  In short, the impairment to the capital markets will result in creative destruction.  The economy will heal itself faster though a great many more people being hurt in the process when compared to a Keynesian approach that will not grow the economy much while not hurting as many people.  Both sides of this continuum sound silly, don’t they?

The policy response of the Fisher approach is to repair the balance sheet.  Unfortunately, we cannot do that without betraying a lot of bedrock American principles.  We do not take over banks and forgive the debt of the American public.  We recognize “moral hazards”, and avoid forgiving rational people for rational decisions that ended up badly.   So, how do we get out of this mess?

One thing that should not have been done is to adopt the stimulus program that was executed.  It turned out to be a “make work” program to keep as many people working for as long as it could.  If the President recast it into acquiring assets that could be leveraged for growth, then we would have been better off.  He talked about improving the electrical grid, which would have lowered energy prices and help businesses and consumers operate with lower margins.   He also talked about solar farms and similar things that would have improved our competitiveness globally.  This did not happen and we are left with the debt and not much productive improvement to our base that can be used to pay it down.  The result is more burdens on all of us.  It turned out to be a bad investment.  It still does not answer the question of what we do now.

One thing that should not be done is to increase the taxes on capital, which would be the impact of the current tax plan advocated by the Democrats and President Obama.  Assets need to be leveraged for productive use, and taxing capital will reduce this country’s ability to acquiring productive assets that create jobs.  Tax fairness is a legitimate issue, but cutting off one’s nose despite the face is not the way to go.

The public wants an administration that will increase employment and lower the unemployment rate.   Government has proven itself incapable of achieving this goal.  The business sector is all that is left and that raises the question of how do we make business work without raising our risks of capital destruction in a Fisher asset bubble?  Not totally sure, but the two approaches we have in our major political parties are not producing answers to our problems.   What I am looking for is a pro-growth economic philosophy that includes not just protecting our capital assets but also leveraging them for growth.  So far, I have not seen anyone on the current stage that talks this stuff, though Romney comes closest.

My apologies.  I led you, the reader, through a number of economic alternatives that probably raised the hope of you reading a bunch of easy to remember policy prescriptions only to find out that I don’t have any  -- yet.  I only have a bunch of questions with some clues as to what those prescriptions should be, and the realization that the current crop of answers is inadequate.

Public policy is not easy.  Those who say it is are not being honest.

 

  

President Obama, Capital and Property Rights

If you’ve got a business -- you didn’t build that.  Somebody else made that happen. 

President Obama, July 15, 2012

Having a business requires capital, and having capital empowers an employer to hire employees.  Capital comes in the form of assets, and owners of assets have property rights with respect to those assets.  The owner can sell them or loan them out for a fee or use them to create a product or service.  In other words, assets have productive uses and owners can expect a return on them.  These rights are guaranteed in law.

An expected return on assets is a function of the prevailing competitive rate of return on similar assets adjusted for the risk incurred on the investment in the asset.  Again, the decision to use that asset for a particular reason is the right of the owner.  If the asset is usurped by the government to use on a purpose other than that the owner intended drives up the risk attached to the asset.  Correspondingly, the expected rate or return on the asset goes up significantly to compensate for the increased risk.

The Obama administration has demonstrated that it does not respect property rights.  The most notable example is the auto bailout in which the Obama administration forced General Motors and Chrysler Corporation bondholders to accept stock in place of cash payment for their bonds.   In a bankruptcy, bondholders usually get a first or secondary call to liquidation proceeds.  This did not happen.  The result is that it sent a signal to the investment community that their assets were at a higher risk than they originally planned, and it was one of several factors that persuaded many investors to withhold money from the markets.  There is a high amount of business cash waiting on the sidelines.  One of the reasons why the economy did not grow during the first three years of the Obama administration is because the process of investing private capital in projects was frozen, and one of the contributing factors was the Obama administration attitude on capital.  

President Obama is campaigning for re-election with an 8.2% employment rate.  The President wants hiring to increase.  Now we see his quote from yesterday and it appears the Obama administration attitude on capital has not changed.

The lesson is very clear.  Capital employs people.  If you want hiring to increase, respect capital and the property rights that go with it.  It would be a win-win for President Obama and investors, unlike todays loose-loose.

   

It’s A Tax!!!

President Obama, Nancy Pelosi, and even one of Mitt Romney’s campaign advisors have expressed the opinion that the mandate to participate in the national health care program, which is also referred to as Obamacare, is not a tax but a penalty.  This is not correct.

The Congress levies a tax.  The Congress does not levy a mandate.  We, the taxpayers, can receive relief from paying the tax by participating in an activity that reduces or even eliminates the tax in our individual cases.  In this case, Congress levied a tax on healthcare that we can avoid by buying health insurance.  This is the way tax levies have been interpreted since The Constitution was written, and this is the interpretation of the Roberts Court.

So, to President Obama, Nancy Pelosi, and Mr. Romney’s advisors, it's a tax.

More on Obamacare – The President Must Defend His Base

Last week I posted a blog about how the Roberts Court broke Obamacare.  By redefining the mandate as a tax and by striking down the penalties for States who do not increase their participation in Medicaid, the program is no longer deficit neutral, which was a major selling point of the President when the program passed.  Romney wants to repeal and replace Obamacare with the press pressuring him to identify what he will replace it with.  My blog suggested that the press should also ask President Obama how he would fix the program to bring it back to deficit neutral.     

There was some interesting politic theater on Sunday in the morning news programs.  Jack Lew, the White House Chief of Staff, was interviewed and insisted that the tax was not a tax, but a penalty.  Mitch McConnell, the Senate Minority Leader could not articulate the program the Republicans will propose as a replacement for Obamacare, or what is formally the Affordable Care Act.  Though the Republican leader can wait for Romney to define the replacement program, Jack Lew is in a more precarious situation.  He is redefining the term used by the Chief Justice in settling the issue of the mandate.  It will be easy for Republicans to criticize this, and the credibility of President Obama and his White House Staff will decrease as a result.

There is a more interesting political effect from the decision.  It has put President Obama on the defensive to a point that he must protect his base.  Let’s go back to Keith Hennessey’s article on the mandate and who will pay it.  Keep in mind that the health care tax, a regressive tax, is a single amount of $750 per adult and $375 per child regardless of income.  This means that as income remains low, the portion of income paid to support this tax will be high.  There are 400,000 people made up of singles making $11,800 or less per year and families of four making $24,000 or less.  For the single person, that is 6% or more of income.  For the family of four, that is 9% or more of annual income.  There are 600,000 people made up of singles making between $11,800 and $23,600, and families of four making between $24,000 and $48,000.  This means that singles in this group will be subject to a tax representing 3% or more of their income, and families of four will be subject to a tax representing 4% or more of their income.

Keep in mind that the median income in the United States is about $45,000, and that the group making the median income and below generally favor the re-election of President Obama.   It is part of his base.  Though the tax will impact only about 1 million earners in this group, not everyone in the group will know by Election Day if they will be subject to the tax.  It is very clear that Republicans could communicate directly with this group that Romney will repeal this tax via direct mailers and targeted radio and television ads.

In addition, seniors have been upset since the passage of the Affordable Care Act over the fact that it cuts $500 billion from Medicare.  Republicans could target them with a message to restore that funding. 

Using a football analogy, President Obama has weakness in his defensive line and the fullback is coming through.  However, the Republicans need to keep one point in mind.  Though about 52% of the American electorate want Obamacare repealed, about a fourth of these want it repealed because they want a stronger government program, not less.  Republican arguments will only get them down the field.  They will not score a touchdown on that play alone.

Roberts Left Obamacare Broken. It is Obama Who Must Now Fix It.

Conservatives are criticizing Chief Justice John Roberts for not voting with the conservative branch of the Supreme Court and declaring the entire Affordable Care Act unconstitutional.  Now that a day has passed on the decision conservatives should evaluate what really happened in the Roberts’ decision.

First, the Court reframed the mandate to participate in Obamacare as a tax.  If you don’t have medical coverage, the IRS will impose a tax.  John Hennessey has some interesting facts about how the tax will work.   There will 21 million uninsured Americans, and of this number, 3.9 million will be subject to the tax.  This includes 400,000 people who make less than $11,800.  The tax will be $750 per adult and $375 per child each year.   This will raise between $2 to $ 3 Billion per year, which will not cover the health care cost of 3.9 million people.  Further, as Hennessey points out, since the mandate is now a tax, there is no longer a moral stigma not to buy a health care policy from a carrier.   The exercise of determining whether to buy one or not will become a simple cost-benefit analysis for most people, and since the costs of the penalty tax are far less than the cost of most policies, then it is fair to say that the number of people electing to pay the penalty will rise much higher than the current projected number of 3.9 million.  The result will be that the costs of health care for this group that exceed the corresponding tax revenues that the government will now pick up will be seriously high.

Second, the Court enabled the States to opt out of the plan when it comes to Medicaid.  There were 26 States who objected to the Obamacare provisions that required them to increase their participation in Medicaid or suffer penalties.  If the States did not invest additional dollars in Medicaid, they would loose the ability to participate in the Medicaid altogether.  The Court stuck down the penalties and States can continue their participation in Medicaid at current levels.   This will apply to most of the 50 States.  Even those who did not join the 26 States who petitioned the Court will see that the advantages of not raising support levels to balance their budgets.   The higher support levels will transfer to the Federal Government.  This increases the cost of Obamacare considerably.

These two facts by themselves mean that Obamacare is broken.  It will run huge deficits.  Yesterday, Senator Lindsey Graham from South Carolina said he wanted the Congressional Budget Office (CBO) to re-evaluate the cost of Obamacare under the new financial conditions that the Court imposed yesterday.  When the program passed the Senate the CBO said that the program would be revenue neutral, meaning the costs and the revenues would be equal and the Obamacare would not run a deficit.  That can no longer be said and we need a new cost analysis.

Since Obamacare is broken, it is up to President Obama to fix it.  It is his singular accomplishment and he sold it on the condition that it would not contribute to the national debt.   Since it will contribute to the debt, he must propose changes that will fix it.

Now for the politics of this.  Governor Romney, the presumed Republican Presidential candidate said that he wants to “Repeal and Replace” Obamacare.  The press is starting to question him as on what he will use as a replacement for Obamacare.    Fair Question.   But it is also a fair question to ask President Obama how he will fix his own Obamacare to bring it back to being deficit neutral.  This is the way he sold it, and he should fix it.

This is no small task for the President.  Republicans are angry at the President for his remarks from March 2009 when he said the mandate was not a tax and then he defended the mandate before the Court on the basis that it was a tax.   Senator Graham said that if he defended it before the Senate as a tax it would have received only 10 votes and would not have passed.  Clearly, the President has a credibility problem.  Add to this that he has not been serious about restraining the growth in the national debt, and his refusal to recognize that Obamacare has been a deterrent to job growth, and one can conclude that he has a major re-selling problem.

It was Queen Victoria’s favorite Prime Minister Benjamin Disraeli who said that inside every success lie the seeds of tomorrow’s problems.  Apparently, tomorrow has come for Obamacare.

On a related topic, I recommend George Will’s column on how the Court restricted the use of the interstate commerce clause for the mandate.  It is available at this link.

Obama Claim About Romney is False

In the current week’s issues of Automotive News, Joseph Lichterman writes about how a claim that the Obama campaign has launched against Mitt Romney regarding Bain Capital and Cambridge Industries is false.  Automotive News is the most trusted and independent newspaper in the auto industry.

Romney was not part of Bain Capital when the Bain decision was made to put Cambridge into bankruptcy.   Romney left Bain Capital in February 1999 to save the Olympics.  The Bain decision not to inject more cash into Cambridge came in November 1999 with the decision to enter into bankruptcy in 2000.  According to the Cambridge CFO at the time, “Mitt Romney wasn’t even there.”

By law, at the end of every political advertisement, the candidate says, “I approved this message”.  It appears that this specific charge is false

For those who need some context, the Obama campaign has a commercial running in some key battleground states that charges Romney with seeking profit over jobs during his time at Bain.  As part of this commercial, the case at Cambridge is used to say that Bain withdrew substantial cash from Cambridge before it entered bankruptcy.  This eventually led to Cambridge loosing about a thousand jobs once it was in bankruptcy.  The rhetoric is that Bain was a vampire capitalist.  All of this happened when Romney was not there.