The Second Paradox of Thrift

We generally consider savings good for individuals as a matter of common sense. One would naturally think it would be good for the nation as well. As it was put to me at one point, "But if a household gets ahead by saving, not spending, why don't a million households?" The question requires different answers depending on whether you're concerned with those million households as an aggregate of individual spenders or as a unified spender through a national government.

The traditional answer considering the aggregate of individual spending hails as the paradox of thrift. The typical increase in savings by the average consumer comes via reducing spending rather than from an increased income. Given level income, as one consumer spends less in order to save more, that consumer increases his personal net worth. However, the decrease in spending lowers that individual's contribution to demand. If decreased spending by half the potential spenders is offset by increased spending from the other half, then there's a break even for the overall economy. But if every spender in an economy spends 1% less in an effort to save more, then overall demand for goods and services would be diminished by roughly 1%. When supply and demand happen to be matched, that reduced demand doesn't require as many employees as before to fill the orders. The resulting layoffs mean fewer people can save thus ironically causing reduced aggregate savings from a too aggressive (or panicked) shift towards individual savings.

On the other hand, if we're talking about those million households in the unified sense of a national government, we need to look at a different aspect of the question. At that point, we can shift our focus to that first part about "gets ahead". Almost no household truly ever gets ahead by saving rather than spending in real life. Saving is how households that are already ahead maintain that being ahead. Households get ahead in the first place by spending on tools to increase income (such as job training, education for higher-wage jobs, tools for trades, goods to improve and sell, etc.). Saving foolishly can be far worse than spending wisely.

In that sense that recognizes that certain debts can increase future income by more than the debt, what's good for households can be good for nations. For a nation that's already doing great, saving could do a wonderful job of steadying the already rolling wealth. For a nation that's not doing well, investments in improving the national potential will tend to do much better. In that sense, it's just like an individual. Your high-income CEO would be wise to put enough money into safe investments that he no longer has to have his job to pay the bills and just does it for personal satisfaction. Your broke high-school graduate would be better advised to get an engineering degree on loans than to try to save up from working at a gas station or other low-wage job. A nation in steady growth (or a boom) mirrors the situation of the well-paid CEO or engineer. A nation in low growth (or recession) mirrors the situation of the low-paid laborer who can't quite afford the basic cost of living and will never be able to save up enough to make a difference without taking on debt to achieve a higher income.

Simply put: If you have a high income (strong growth), it is wise to save. If you have a low income (weak or negative growth), it is more wise to spend on increasing your income. The second paradox of thrift: for an individual or nation, you have to already be doing well before thrift makes as much sense as spending wisely.

We Could Pay Off The Debt. But Should We?

We could do it. If we wanted to, we could eliminate the deficit with taxes alone. The real question is whether we should.

Debt in perspective

Yes, you've probably heard that we can't. You've probably heard the claim that the deficit is unmanageable. You've probably heard the claim that the debt is some grand, unapproachable amount that we already can't possibly hope to pay off. You've probably heard the claims that our debt is so high there aren't enough assets or income in the country to cover it.

They're flat-out false. The only question is whether they believe what they're saying or they're purposefully lying.

Here are the numbers from the census data, the treasury, the fed, and the standard deficit projection:

• Number of households in 2010: 118,682,000
• Mean 2010 household income in 2010 dollars: $67,530
• 9/23/2011 current debt: $14.7 trillion
• Projected 2011 deficit: roughly $1.3 trillion
• Household 2010 net worth: roughly $57 trillion

So take those numbers above and we can see that:

• Net worth / household: $480,275
• Federal debt / household: $123,861
• Net worth after US debt / household: $356,414 (far higher than median net worth)
• National income / household: $67,530
• Federal deficit / household: $10,954
• Net income after deficit: $56,574 (significantly higher than median income)
• Deficit / income / household: 16.2%

The particular items of interest here are: 

• $356,414 dollars left over if we were to pay all all federal debt from all household net worth today
• 16.2% as the mean increase required to eliminate the deficit with tax increases alone

As $356,414 is far above the median net worth, most people would say that's far from broke. There would be lots of problems with actually liquidating private net worth, of course, so that's strictly hypothetical. The fact remains, however, that there is enough household net worth in the US to do it and still have quite a bit of wealth. Just because it isn't something we want to do doesn't mean it couldn't be done.

The 16.2% seems like a massive tax increase. But then consider that we've had higher taxes than that before. It wouldn't be all that bad if such an increase were done in a progressive manner. For the bottom 50% of taxpayers, losing 16.2% more of income would be catastrophic. But together they only make about 12.75% of total AGI, so managing without the bottom 50% isn't so hard. For the top 1% such an increase would be easily survivable and still far below what folks with such incomes would have paid in the 1950s and 60s. Based on the AGI's if we taxed the top 1% an additional 40%, that alone would cover over half the deficit. Just for a rough example, if we were to raise effective tax rates by 40% on the top 1%, 15% on the rest of the top 5%, 10% on the rest of the top 10%, 5% on the rest of the top 25%, and 2% on the rest of the top 50%, that would net us an additional $1.38 trillion. That'd be well more than enough to cover the deficit. Whether we want to do something like that or not, the fact remains that it could be done. If we collectively wanted to, we clearly could close the deficit with tax increases alone.

If you don't believe my numbers, please look them up yourself. If you don't believe these basic calculations, please pull out your calculator or spreadsheet and run them yourself. You'll find the same thing. We could cancel out the deficit if we wanted to. And we could pay off the debt if we really wanted to. That's part of why our debt is an international safe-haven investment at very low interest rates. But there's another side to the story. Do we really want to have no national debt?

2010 Intragovernmental Holdings

Of that $14.7 trillion, $4.6 trillion is intragovernmental holdings. Over $2.6 trillion is held by the Social Security trust fund alone. Social Security needs someplace secure to hold that cash till it's needed. We don't want them gambling it on stocks or volatile commodities like gold or oil. Even if the rest of the world weren't seeing lots of instability, U.S. Treasuries are the only reasonable option. That means our federal govt must borrow at least enough to be able give the Social Security trust fund a safe place to invest. The same holds true for at least most of the rest of intragovernmental holdings, many of which are insurance or retirement accounts. We don't want them anywhere less safe; and anywhere else is less safe.

So far, we've identified roughly $4.6 trillion of debt that we want right where it is. It would be senseless to force ourselves to find alternatives less secure than the full faith and credit of our own government for those holdings.

Holders of debt, Dec 2010

The rest? As of the end of 2010, there was $802 billion in pension funds. Shall we tell all the pensioners their funds have to be less secure because our debt hawks don't want us to have govt debt anymore? There's $517 billion held by state and local govts. Shall we force our other levels of govt to engage in risky speculation? Depository institutions (i.e., banks) hold $323 billion. Didn't we already get burned by letting banks increase their risk? Do we really want to go there? Wouldn't that be exactly the opposite direction from where we've been trying to push the financial industry? Insurance companies hold $244 billion. Guess why they've put it into Treasuries ... because they need the stability in order to keep insuring us without entirely relying on risky sources to back up our claims. Then there's another $2,046 billion held among mutual funds, savings bonds, and other investors. All of whom look to Treasuries for low-risk investments to balance out our riskier investments with some safe, guaranteed income. Shall we deny all our investors -- both wealthy folks and the grandmother nearing retirement -- the opportunity to choose additional investment beyond Social Security that's backed by the full faith and credit of our govt? To stop issuing federal debt would be to say, "No, you may be ready to retire and seeking to move your funds out of risky assets, but we're not going to let you have this guaranteed income option." Do we really want to say that? Seriously?

What's that leave? The foreign portion, under a third of our debt. That's the part we could seriously consider. That's the part we could pay off without forcing our own govt institutions, companies, and individuals to shift all of their investments into riskier options. But what does that part mean to us? Foreign investments aren't invested in our debt because of attractive rates to them. Quite the opposite; they could easily choose any number of investments with higher rates. But those higher rates all come with more risk. We're the place nations stow cash in case everything else fails, safer than burying it. It isn't about making money off us; it's about making sure they've got enough money socked away where it is more certain to be available than any other option. It's about stability. That means we're issuing debt at very low rates, lower than ordinary inflation. After factoring for inflation, all the world is literally paying us to hold their money safely for them. Why should we turn that down instead of using it to improve our infrastructure and lower our domestic cost of doing business?

Bastiat's Fallacy In The Parable Of The Broken Window

Frédéric Bastiat

The Broken Window may be the most popular story among today's Libertarians and disciples of Mises. Discuss government spending, and they will almost assuredly bring up Bastiat's parable of the Broken Window as if its mere mention should ward off all thought of govt spending. Unfortunately for Broken Window devotees, Bastiat's bases his conclusion on a false assumption.

For anyone not already familiar with the story, Bastiat presented us with a citizen whose son had broken his window. Bystanders consoled the citizen with the thought that at least some good would come of the broken window in that it would mean business for the glaziers. Bastiat, however, argued that had the citizen not needed to pay six francs to the glaziers to fix the window, then those six franks would have been spent on new shoes or a new book. As such, according to Bastiat's telling, the additional work for the glazier came only at the cost of work for the cobbler, the bookbinder, or some other profession. Bastiat offered up his story as an argument against the trade restrictions of protectionism, although today it is more commonly used as an argument against figures showing an increase in economic activity in the wake of a disaster. It's also rolled out against any govt project on the basis of the opportunity cost of what might have happened otherwise.

Bastiat's fallacy: The six francs would not necessarily have been spent. The shoes might not have been bought. Nor the book. His six francs might well have sat buried in his mattress, his house fell down, and someone built over it. Bastiat and all those who call out "the parable of the Broken Window" depend upon an assumption that does not hold, namely that the citizen must certainly have spent that six francs. Clearly that is not the case. The citizen may or may not have spent the six francs. If they were not spent at that time, the six francs may have been lost or forever stored in a static asset (such as cash or gold physically kept in a safety deposit box). Even if it were spent, there is no guarantee that it would be spent in the region of the window and employ a local cobbler or bookbinder.

The safe or safety deposit box are among many options for static assets representing inactive money for our economy. For a domestic economy, any store of assets outside of that economy (e.g., in a foreign nation) will generally spur no activity whatsoever in the domestic economy while those funds remain outside. If the citizen must withdraw funds from a foreign investment to fix the window and those funds would have otherwise stayed in the foreign investment indefinitely, then activity has been added to the domestic economy. Likewise, funds that the citizen would otherwise have invested in foreign assets can not be said to cause the domestic bookbinder to lose a sale because of those funds going into fixing a window. An event that diverts funds back into the domestic economy has increased the domestic economy from funds that would not otherwise have been put to use in the domestic economy.

In Bastiat's example, this obviously means the son breaking the window did not necessarily hurt the cobbler or bookbinder. That would only be the case if the citizen was sufficiently impoverished by the replacement of the window as to be unable to afford the shoes or the book. That may have been the case for Bastiat's citizen, but will not necessarily be the case whenever a citizen's window is broken by his son. Some citizens will have spare gold in the vault or spare funds in foreign investments that they will bring into the economy in order to replace the window and still get the new shoes or book.

Beyond Bastiat's example, at least some of the funds used to rebuild after a disaster will normally have been sitting in static assets. For the region being rebuilt, it doesn't matter what those static assets were so long as they were not otherwise going to be spent in that region. That's how regions get an economic boost from disaster recovery, such as fixing windows. Of course, recognizing this effect does not mean celebrating the disaster. No reasonable person is happy to see damage just because of the effects of the rebuilding. Among other reasons for non-celebration, the additional activity for repairs will not always be sufficient to more than make up for jobs lost or suspended because of damages. Still, deploring the damage doesn't mean we can't recognize the economic effects of the rebuilding itself.

For govt projects in general, the fallacy shows us that govt spending will generally defy its Broken Window critics and add to the economy so long as the spending draws a sufficient portion from outside the active, domestic economy. Unless too much of the funding comes from taxing those on a tight budget, building a new or expanded road and hiring a construction worker should not be expected to impoverish the taxpayer even before we consider the long term benefit of the road to the taxpayer. Only taxes on those who have the least will necessarily withdraw money from the economy. Upper-bracket taxes can simply mean somewhat less being stored in static assets such as foreign investments that would not benefit the domestic economy anyway. And issuing T-Bills at today's extraordinarily low rates to pay for expanding and improving infrastructure will not tend to divert funds from business investment either. My choice of how much to invest in risky start-ups with high potential return will be determined by my risk tolerance rather than how many bonds the Treasury issues. It's a safe bet that's the case for most other investors too. That risk tolerance isn't likely to increase until we have a credible boost for the economy -- not just some half-hearted nod to the idea. Let's fix some windows. And make those "windows" big infrastructure improvements and lot's of 'em.

No, World War 2 Didn't End The Depression

There's a common myth out there that goes, "the Great Depression was finally ended by World War 2". It has some slight variations, such as "the Great Depression lasted 15 years" or even "the market didn't recover until govt spending stopped".

All of these are complete misunderstandings of history if not outright lies.

While there may not be as accepted a definition for depression as for recession, there's a good bit of consensus along the lines of these two criteria for an economic depression:

1. real GDP decline beyond 10%
2. period of decline lasting more than three years

Year	2005 Real GDP
1929	977,000
1930	892,800
1931	834,900
1932	725,800
1933	716,400
1934	794,400

Real GDP declined every year from 1929 through 1933. By 1934, the economy had been pushed back into growth again. There you have it: the end of the Great Depression. It was 1929-1933, far short of 15 years. One can not be in a depression and have real GDP growth because a depression is defined by GDP decline. One can note other factors peculiar to depression, such as deflation. But a depression only exists while there is a declining economy as measured by real GDP. One can debate what ended the Great Depression, whether it was a combination of monetary and fiscal policy, deficit spending alone, monetary policy alone, or some other set of factors. But there is no reasonable debate that the Great Depression ended years before World War 2 when the economy returned to growth.

Some effects of the Great Depression -- though mostly diminished -- did linger somewhat until World War 2. That much is true. Although unemployment had been drastically reduced before the war, it was still high until the war. Yet while it took quite a while to achieve full recovery, it did not take all that long to achieve renewed growth. Unemployment peaked in 1933. By 1936, the New Deal had kicked the economy into rolling again and -- though unemployment was still high -- the main economic indicators were back in gear. In early 1937, industrial production reached a level above that of 1929. But then pressure picked up to balance the budget, and FDR and Congress cut back spending. Although unemployment had been dramatically reduced from its peak, it was still too high for the economy to be self-sustaining. With the fiscal and monetary tightening of 1937, production dropped and unemployment went back up. Seeing the mistake, they stoked spending back up in 1938 and the recovery resumed.

Unemployment remained problematic throughout the 1930s and into the start of the 1940s. But even that measure declined every year that the New Deal was fully in force. The recession of 1937-1938 showed the effect of govt cutbacks pushed by Republicans overzealous to balance the budget at the wrong time. The cuts interrupted the full weight of the New Deal to push the economy forward. The unemployment rate continued to drop right up until the start of the war. We were already growing towards full recovery before the war. Admittedly, the massive increase of spending for the war -- far beyond that of the New Deal -- did push unemployment to very low levels far more rapidly than we would have achieved without the focus of a war effort. But the war boom runs quite the opposite of a case against spending. The extreme, focused spending for the war effort rocketed our economy higher. It was a finale to the New Deal, like a burst of fireworks at the end of a good 4th of July show. It couldn't be further from the truth to say that "the market didn't recover until govt spending stopped". When govt cut spending while the economy was still weak, the economy suffered. Except for the disastrous cut-backs that brought us the recession of 1937-1938, government didn't stop spending until the markets had recovered.

Cure For Economic Blindness: Why The Wealthy Should Want To Be Taxed

"No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable." - Adam Smith

To see poverty as good for the economy requires blindness to the effect on commerce if those starving citizens were to have even a few dollars to spend on food. If those dollars would otherwise have been idle, then ignoring the benefit of putting that money to use embodies the economic equivalent of sticking our fingers in our ears and screaming "Nyah, nyah, nyah, I don't hear you!" Rich and poor alike, all benefit from the poor having money to spend. How can anyone miss the benefit to the wealthy of more customers for their business? If it must come by filtering some larger portion from what's headed into the deep pockets of the wealthy, why worry for their pockets as long as they're still being filled? With thriving commerce, wealth grows. Expansion requires sufficient circulating money. Money sitting idly in stockpiles doesn't increase wealth but merely stores it. If the wealthy have smaller amounts after taxes to add to their stockpiles in the short term -- as long as they're left their assets and more than enough income to cover costs -- they'll gain even more by that money being put to use to generate ever more money down the road. After all, we're not talking about removing their accumulated assets that they use to reap money from the system. We're just talking about skimming a portion of what they'd be adding to the hoard (via higher marginal upper-bracket taxes) so that we can put it to active use.

Should we just cut checks to the poor then? No, there are far more beneficial ways to put the money to active use. Bring back the WPA to build new roads, bridges, and parks. Perhaps invest in a few additional backhoes and such -- especially for the road and bridge work. But for the parks, skip as much of the modern machinery as possible and issue the workers a bunch of shovels, hammers & nails, and materials and build 'em the old-fashioned way. We have a shortage of decent paychecks. We can use investments in infrastructure to fix that. And when the economy picks up and unemployment lowers, we wind down projects to ordinary levels and gradually release those workers back into the ordinary system. The infrastructure improvements will remain and keep helping business. It's a win for everyone.

Reaganomics Author Sees The Light: Bruce Bartlett's Call For Higher Taxes On The Wealthy

That's not just anybody. Bruce Bartlett called for tax increases on the wealthy. Bruce Bartlett! Bruce Ron-Paul-Staffer Bartlett. Bruce Supply-Side-Author Bartlett. The man wrote one of the first books advocating Reaganomics. Advisor to President Reagan. Senior fellow at the Heritage Foundation. Treasury official under President Bush I. Worked at the Cato Institute. We're talking about a major figure in tax reduction efforts in the 80s and 90s, responsible for convincing many to support lower taxes.

But here we are now with the lowest taxes in 60 years. We've got lax demand. The supply-side approach clearly failed for the past decade that we've had tax cuts. As Mr. Bartlett put it in answer to the question "Are Taxes in the U.S. High or Low?", "The truth of the matter is that federal taxes in the United States are very low. There is no reason to believe that reducing them further will do anything to raise growth or reduce unemployment." With tax rates already low and the economy not doing as well as it was under higher rates, there's no reason to think it'll do any better with even lower tax rates.

But now he's gone even further and, like Warren Buffett, Mr. Bartlett called for tax increases on the wealthy. That's major. That's fresh facing of reality from one of those who sold us the lower taxes idea in the first place. Even Bruce Bartlett -- an architect of Reaganomics -- has apparently seen the light. Given enough such calls for rationality, maybe we can get past the "starve the beast" insanity and start doing what needs to be done. All those folks who bought Grover Norquist's bill of goods can take Mr. Bartlett's realization as a wake-up call. It's not too late to get a grip on our situation, fix up our ridiculously low tax rates, rebuild our infrastructure, and get the American economy back in gear.

The Wealthy Don't Create Jobs; Good Jobs Create The Wealthy

What came first, the wealthy or the building blocks of wealth? This is no idle "chicken or the egg" question. Major political players base real policies with serious impact on their own answer to the question. What if most of them are getting it wrong? What if getting it wrong could wreck the system and ransack wealth?

To get the answer, the GOP base are obviously looking at wealthy investors. Our tax-cutting crowd clearly thinks they're the starting point. They say that getting more money to them will mean more jobs. The idea runs that investors bet their capital on starting or expanding a company that can then hire folks, thus jobs. This seems to pass for unquestionable truth among the "starve the beast" set. They figure that the more money the wealthy have the more they'll put into creating jobs. Even leaving aside the question of whether they'd likely choose to invest their money elsewhere, the anti-tax set need to reconsider two questions: 1) Is that usually how jobs are made? and 2) Where'd the capital come from in the first place? These two questions are necessarily linked. You can't explain where the capital came from without considering ways to make jobs without capital.

So where'd the first capital come from? Unless you think it was somehow handed over to man by divine intervention -- capital raining down from heaven or appearing from nothing -- it had to come from work. We can set aside the factor of inherited wealth, since somebody had to collect it in order to pass it down to lucky heirs. That first capital accumulating work -- whatever it was -- was collecting and/or making something that could be sold or traded. In short, it was a job. It may not have been a modern job, but close enough for our question. Somebody did some work. It may have been all on his own. Or the work may have been getting others to do things for him. But whatever it was, somebody did some work that produced a surplus. Perhaps that surplus was then -- directly or through heirs -- reinvested by getting other folks to do more work to produce more surplus. At root, the workers involved still created the surplus. The worker-created surplus was then used to spur more work to create more surplus. The job came first. The assets produced were just a product of the job that lets that job contribute to even more jobs. Get together a lot of surplus produced from a lot of jobs, and you've got wealth. Even if you then use that wealth to spur more work that creates more wealth, the wealth still didn't create itself but rather came as the sum effect of the work ... the jobs.

"Labour was the first price, the original purchase - money that was paid for all things. It was not by gold or by silver, but by labour, that all wealth of the world was originally purchased." -- Adam Smith 

Ultimately, the idea that wealth comes from somebody investing in business is a myth. If I build a factory and hire 50 people to make widgets, I'm not going to get any return on my investment unless there are people who can be interested in widgets and have enough money to spend on my widgets. If my widgets aren't essentials, those people will only have enough money to spend if they're making a surplus beyond the cost of living. Even if the widgets are essential, folks who don't have an income aren't going to be buying many widgets. If I don't have enough potential customers to break even, I'm not going to be employing those 50 widget makers for long. But if I have enough customers to make a profit, I'll keep employing them. And if I have too many customers for them to keep up, I'll hire more. Then who really created the wealth I reap from my factory? Sure, I made the factory investment that allowed me to sell widgets. But without the customers, that investment would have just been a foolish building that couldn't support long term jobs. It's the customers who really make the difference.

Jobs further wealth in two ways. Obviously there's the surplus collected by the initial business owner. But there's also the circulation of resources wherein the worker's share of surplus is spent at other businesses. The worker's paycheck allows him to be a customer contributing to other jobs that yield other surpluses for other business owners. The paychecks from those other jobs may in turn be spent at yet further businesses or even end up winding back to the initial business. Jobs have no choice but to create wealth, even when they fail to do so directly for a specific employer. Unless they're inefficient jobs, they'll create a surplus. And even if they're inefficient jobs they'll mean money for workers to spend at efficient businesses yielding surplus. The job just can't hold itself back from contributing to the creation of wealth. Wealth, on the other hand, can sit idle. It can be stored in some valuable thing that'll sit collecting dust. Sure, wealth may be further invested in jobs and help yield more wealth. But it can also hang on the sidelines for years or even centuries and do nothing productive.

Clearly it's the job that creates the wealth. We can use that answer to figure out what to do to get our economy rolling again. We want wealth and jobs. We need to push the one that creates the other. If we change our tax structure to get more money to the wealthy, we're just tinkering with accelerating redistribution of income to the rich who may just sit on it. That risks having it grind to a halt if too much money is removed from the system to just sit idly in the stockpiles of the wealthy. I'm all for building wealth, but not at the cost of having all the money locked down to the point where it no longer flows from business to business through employees and customers. Since wealth ultimately comes from jobs, those of us who want both more jobs and more wealth need to focus on jobs in order to get both. With more wealth, there doesn't necessarily have to be more jobs. With more jobs, there will be more wealth.

Now we've got a situation where there isn't enough demand for products and services to spur widespread hiring. Too many people don't have enough money to spend. And unemployment causes much of that current lack. Private industry can't fix the situation because it won't make any sense for them to hire until there's demand for products and services. There's only one credible way out: govt must step in to fill the void. Govt must stop hiding their heads in the sand and pretending that we can count on the wealthy to hire out of the goodness of their hearts -- without enough demand causing it to make sense as an investment -- if we just help a bit more money stick in their accounts. Govt must stop laying off workers and start hiring so there will be more paychecks to spend on goods and services. And to do that, govt is going to have to start leveling with us and facing that we'll have to rack up a future bill in order to make things work here and now ... and for the future.