201109

September 22, 2011 9:04AM

The Federal Reserve, the ‘Twist,’ Inflation, QE3, and Pushing on a String

In a move that some are calling QE3, the Federal Reserve announced yesterday that it will engage in a policy called "the twist" -- selling short-term bonds and buying long-term bonds in hopes of artificially reducing long-term interest rates. If successful, this policy (we are told) will incentivize more borrowing and stimulate growth.

I've freely admitted before that it is difficult to identify the right monetary policy, but it certainly seems like this policy is -- at best -- an ineffective gesture. This is why the Fed's various efforts to goose the economy with easy money have been described as "pushing on a string."

Here are two related questions that need to be answered.

1. Is the economy's performance being undermined by high long-term rates?

Considering that interest rates are at very low levels already, it seems rather odd to claim that the economy will suddenly rebound if they get pushed down a bit further. Japan has had very low interest rates (both short-run and long-run) for a couple of decades, yet the economy has remained stagnant.

Perhaps the problem is bad policy in other areas. After all, who wants to borrow money, expand business, create jobs, and boost output if Washington is pursuing a toxic combination of excessive spending and regulation, augmented by the threat of higher taxes.

2. Is the economy hampered by lack of credit?

Low interest rates, some argue, may not help the economy if banks don't have any money to lend. Yet I've already pointed out that banks have more than $1 trillion of excess reserves deposited at the Fed.

Perhaps the problem is that banks don't want to lend money because they don't see profitable opportunities. After all, it's better to sit on money than to lend it to people who won't pay it back because of an economy weakened by too much government.

The Wall Street Journal makes all the relevant points in its editorial.

The Fed announced that through June 2012 it will buy $400 billion in Treasury bonds at the long end of the market—with six- to 30-year maturities—and sell an equal amount of securities of three years' duration or less. The point, said the FOMC statement, is to put further "downward pressure on longer-term interest rates and help make broader financial conditions more accommodative." It's hard to see how this will make much difference to economic growth. Long rates are already at historic lows, and even a move of 10 or 20 basis points isn't likely to affect many investment decisions at the margin. The Fed isn't acting in a vacuum, and any move in bond prices could well be swamped by other economic news. Europe's woes are accelerating, and every CEO in America these days is worried more about what the National Labor Relations Board is doing to Boeing than he is about the 30-year bond rate. The Fed will also reinvest the principal payments it receives on its asset holdings into mortgage-backed securities, rather than in U.S. Treasurys. The goal here is to further reduce mortgage costs and thus help the housing market. But home borrowing costs are also at historic lows, and the housing market suffers far more from the foreclosure overhang and uncertainty encouraged by government policy than it does from the price of money. The Fed's announcement thus had the feel of an attempt to show it is doing something to help the economy, even if it can't do much. ...the economy's problems aren't rooted in the supply and price of money. They result from the damage done to business confidence and investment by fiscal and regulatory policy, and that's where the solutions must come. Investors on Wall Street and politicians in Washington want to believe that the Fed can make up for years of policy mistakes. The sooner they realize it can't, the sooner they'll have no choice but to correct the mistakes.

Let's also take this issue to the next level. Some people are explicitly arguing in favor of more "quantitative easing" because they want some inflation. They argue that "moderate" inflation will help the economy by indirectly wiping out some existing debt.

This is a very dangerous gambit. Letting the inflation genie out of the bottle could trigger 1970s-style stagflation. Paul Volcker fires a warning shot against this risky approach in a New York Times column. Here are the key passages.

...we are beginning to hear murmurings about the possible invigorating effects of “just a little inflation.” Perhaps 4 or 5 percent a year would be just the thing to deal with the overhang of debt and encourage the “animal spirits” of business, or so the argument goes. The siren song is both alluring and predictable. ...After all, if 1 or 2 percent inflation is O.K. and has not raised inflationary expectations — as the Fed and most central banks believe — why not 3 or 4 or even more? ...all of our economic history says it won’t work that way. I thought we learned that lesson in the 1970s. That’s when the word stagflation was invented to describe a truly ugly combination of rising inflation and stunted growth. ...What we know, or should know, from the past is that once inflation becomes anticipated and ingrained — as it eventually would — then the stimulating effects are lost. Once an independent central bank does not simply tolerate a low level of inflation as consistent with “stability,” but invokes inflation as a policy, it becomes very difficult to eliminate. ...At a time when foreign countries own trillions of our dollars, when we are dependent on borrowing still more abroad, and when the whole world counts on the dollar’s maintaining its purchasing power, taking on the risks of deliberately promoting inflation would be simply irresponsible.

Last but not least, here is my video on the origin of central banking, which starts with an explanation of how currency evolved in the private sector, then describes how governments then seized that role by creating monopoly central banks, and closes with a list of options to promote good monetary policy.

And I can't resist including a link to the famous "Ben Bernank" QE2 video that was a viral smash.

September 22, 2011 9:00AM

The Right Way to ‘Enforce’ Trade Agreements

On Tuesday, the Office of the U.S. Trade Representative launched a formal dispute at the World Trade Organization over China’s imposition of antidumping and countervailing duties on U.S. exports of chicken broilers.  According to a summary of the U.S. complaint, China implemented its antidumping and countervailing duty laws in manners that violate that country’s WTO obligations.  The alleged violations include: failure to observe numerous transparency and due process requirements; failure to properly explain the basis for its findings and conclusions; failure to properly calculate margins of dumping and subsidy amounts, and; failure to support findings of material injury to the Chinese chicken industry.

Under the WTO agreements, member governments are entitled to use their domestic “trade remedies” laws to measure and address imports that are alleged to be “unfairly” priced and injurious of the domestic industry.  However, execution of those laws must comport with certain standards – fairly deferential standards, no doubt – that are spelled out in the WTO Antidumping Agreement and the WTO Agreement on Subsidies and Countervailing Measures.  The basis for the U.S. complaint is that those standards were not met by the Chinese government, when it investigated and ultimately foundU.S.chicken exporters to be engaging in injurious dumping and benefiting from government subsidies.

I would say something about “just deserts” or “comeuppance” or “what goes around, comes around,” but that would wrongly imply that the U.S. poultry industry is to blame for U.S. antidumping abuse or its protégé, proliferating global antidumping abuse.  Besides, there’s a different point to be made on this occasion.  That is, transactions between parties in the world’s two largest economies are going to generate frictions from time to time.  Sometimes those frictions will rub raw.  But, by and large, there are proven mechanisms in place to alleviate pressures and resolve disputes that should be respected.  Regardless of the final outcome in this case – the parties could settle after consulting over the issues or, barring settlement, the issues could be adjudicated by a dispute settlement panel and, ultimately, by the WTO Appellate Body – the course being taken comports with the meaning of trade enforcement and respects the rules of international trade.

Kudos to the USTR and his General Counsel’s office for doing the legal research and analyses necessary to ensure the strongest of cases, and for reminding antsy lawmakers across town that there are reasonable alternative to trade unilateralism.

September 21, 2011 4:29PM

Ronald Dworkin: Heartless Libertarian?

Ronald Dworkin is probably the most prominent living liberal political philosopher in the United States. Unsurprisingly, he favors a national system of universal healthcare. But at a philosophical level, Dworkin also very clearly holds exactly the same position a lot of viewers seem to regard as not simply wrong, but self evidently monstrous when it was ascribed to Ron Paul (or at least Republicans in the audience) after the recent Tea Party debate. That is, Dworkin believes that if someone enjoys a fair share of social wealth and resources, and makes a free and informed choice about the level of health coverage and care they wish to purchase, then justice is satisfied when they receive the care they have chosen to pay for (either directly or by way of insurance). If it turns out that someone then needs care beyond what they chose to purchase under these conditions, it is not morally incumbent on society to provide that care. If you want to be melodramatic about it: Society (or at least the government) should “let him die.”

You don’t have to take my word for it, of course: Go read chapter 8 of Sovereign Virtue, Dworkin’s major work of political (as opposed to legal) philosophy. As he makes clear there, he believes government should provide some level of universal coverage under conditions where wealth and genetic luck are unjustly distributed, and the difficulty of becoming properly informed about the state of medical care and relevant statistics is so great. But he also reasonably rejects a general “rescue principle” for healthcare—the principle that society must never “let someone die” or go without care if there is money in the public coffers to intervene—as “useless,” “preposterous,” and one that “no sane society” would adopt. The correct standard for what kind of coverage a society should provide, he argues, is given by trying to figure out what kind of health insurance policy and coverage most members of a particular society would choose if they were well informed and had whatever fair share of social resources is specified by general principles of economic justice. (Those principles might specify that people just born with unlucky ailments are independently entitled to a larger share; Dworkin is mostly thinking here about people who begin life reasonably healthy and will require different levels and types of care over time owing to the vagaries of life.)

Most people, Dworkin acknowledges, would reasonably forgo coverage for many types of risks or treatments, preferring lower premiums and greater present consumption. He suggests, for instance, that most reasonable people under his idealized conditions would not find it worthwhile to purchase coverage that would support their indefinite sustenance in a persistent vegetative state, or heroic and expensive interventions likely to extend life by a few months in old age.

In a society where Dworkin’s background conditions are met:

[H]owever health care is distributed in that society is just for that society: justice would not require providing health care for anyone that he or his family had not purchased. These claims follow directly from an extremely appealing assumption: that a just distribution is one that well-informed people create for themselves by individual choices, provided that the economic system and the distribution of wealth in the community in which these choices are made are themselves just.

Now, again, Dworkin’s premise all along in this argument is precisely that our society does not meet his background conditions, requiring government to supply care as a kind of second best. In our far-from-ideal world, he writes, the government should simply “construct a mandatory coverage scheme on the basis of assumptions about what all but a small number of people could think appropriate, allowing those few who would be willing to spend more on special care to do so, if they can afford it, through supplemental insurance.” In Dworkin’s view, then, if someone needs medical care that the model informed consumer would not have chosen to cover under conditions of economic justice, that patient should get that treatment if and only if he has chosen to purchase supplemental insurance. If he has not chosen to purchase that coverage, there is no moral requirement for the public to provide it. Or again, if you still want to be melodramatic, society should “let him die.”

In a society that did satisfy Dworkin’s background ideal of economic justice—a society not perfectly egalitarian, but clearly far more so than our own—it follows from his argument that someone who made a free and informed choice to purchase less coverage than most also need not be provided by society with additional care. Our own society, of course, does not meet Dworkin’s background conditions. But Wolf Blitzer’s thought experiment at least arguably does satisfy them, if we take the liberty of reading his stipulation that the imagined patient “makes a good living” to imply that the person enjoys an economically just share of social resources, and has made the choice to forgo coverage after informed deliberation.

So under appropriate conditions—clearly not satisfied for very many poor Americans, but at least arguably satisfied within parameters of Blitzer’s hypothetical—the most prominent living liberal philosopher gives pretty much the same answer as Ron Paul: People should bear the consequences of their freely assumed risks, and “society”—or at least the government—should let them.

”But,” I hear the indignant cry, “Dworkin still advocates universal healthcare as a matter of public policy!” Well, yes. But you don’t pose stripped down, idealized, and unrealistic hypotheticals about single individuals to answer complicated public policy questions. You use them to get at very elementary moral principles. If the question is really about what kind of complex institutions should be established by statute in light of all we know about healthcare markets, reducing it to a single decision about how to respond to one imaginary person is obtuse. If the point is to reveal underlying principles, then those are valid or invalid independently of how they interact with other moral or political principles, or empirical considerations, to generate a real-world policy view.

Anyone who thinks Ron Paul’s answer to the hypothetical is appalling and outrageous, then, should direct some appalled outrage at Dworkin, because he gives exactly the same answer within its artificial, stipulated parameters. If Paul is a ghoul but Dworkin’s cool in virtue of their different policy positions outside the conditions of the hypothetical, then those who see Paul’s view as appalling should acknowledge that the reaction to the Blitzer thought experiment is an irrelevant red herring, and what matters is (say) Paul’s awful views on economic justice, where he pretty clearly does differ from Dworkin. Then at least everyone can work up a righteous lather about the correct issue.

September 21, 2011 2:14PM

Warren Buffett’s Tax Story Is Bogus

For years, Warren Buffett has been claiming that his secretary pays a higher tax rate than he does. Recently, President Obama has taken that claim and run with it. I don’t know Mr. Buffett’s particular tax situation, but I do know that his claim as a general matter is bogus.

Let’s look at some numbers. The first chart shows IRS data for income tax rates by income group for 2009. These are average effective tax rates, calculated as income taxes paid divided by adjusted gross income (AGI). The chart shows that taxpayers with incomes above $500,000 had tax rates averaging about 25 percent. Middle-income taxpayers had tax rates of half of that or less. A few years ago, Buffett claimed that his secretary earned $60,000 and paid a 30 percent tax rate. But looking just at income taxes, that seems way off. (Note that this data doesn’t include the “refundable” portion of tax credits, which wipes out taxes for many people at the bottom end).

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Perhaps Buffett was referring to the fact that his secretary pays a heavy load of payroll taxes in addition to income taxes. But when you look at data which includes all federal taxes, the system is still highly graduated with much higher rates at the top end.

Chart 2 shows CBO data for 2007 on average effective tax rates, including essentially all federal taxes—individual income, corporate income, payroll, and excise. Buffett’s secretary would fit into the fourth group in the chart, where the average tax rate was 17.4 percent. So if she is really paying 30 percent, then Buffett needs to show her some of his tax-reduction tricks. Note in the chart that Buffett’s peers in the top 1 percent paid an average rate of 29.5 percent, which is double the rate paid by middle-income taxpayers.

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In 2007, Buffett said that he paid a 17.7 percent tax rate. Alan Reynolds notes that Buffett earns large amounts of capital gains, which are taxed at a maximum federal rate of 15 percent. People in the top income groups do report a lot of capital gains, which reduces their overall effective tax rate. However, capital gains are included in chart 1, above, and you can see that the top income groups still pay much higher tax rates than others on average. One reason is that a large amount of income at the top is small business income, which is hit by ordinary income tax rates of up to 35 percent.

You have to go to the extreme top end of the income spectrum in order for capital gains realizations to really push down overall effective tax rates. The IRS publishes data for the 400 highest-income taxpayers. For these taxpayers, the average effective income tax rate in 2008 was 18.1 percent.

Since the beginning of the income tax, we have nearly always had special treatment of capital gains for some very good reasons, as I discuss here. I point out that virtually all high-income nations recognize that capital gains are different and that special rules are needed. A number of OECD nations have long-term capital gains tax rates of zero, including New Zealand and the Netherlands.

Another important aspect to this debate regards the link between capital gains and dynamism in the economy and dynamism in tax payments. The political left makes it seem as if there were a permanent aristocracy at the top end of the income spectrum in America. However, IRS data show the exact opposite—the top 400 are a highly dynamic group. Notice first in IRS Table 1 that 57 percent of AGI for these taxpayers is capital gains. That is a key reason why the people in this group are constantly changing—large capital gains realizations are occasional events that rocket people to the top of the AGI heap. One example is when an entrepreneur sells her successful and longstanding business and retires.

The last table in the IRS document reveals the dynamism. The IRS traced the identities of all taxpayers who showed up in the top 400 anytime between 1992 and 2008. The IRS found that there were a huge 3,672 different taxpayers who appeared during that timeframe. Of these 3,672, fully 73 percent only appeared once in the top 400! And 85 percent appeared only once or twice.

So at the top end of our capitalist system is a continual generation of new wealth and new wealthy people, and that dynamism reflects the still-energetic and free-wheeling nature of our economy.

September 21, 2011 12:56PM

Fiction Still Drives the U.S.-China Trade Debate

The Economic Policy Institute is at it again, asserting itself as an unrivaled purveyor of economic nonsense. Every year, the labor-sponsored lobbying shop produces a sensational report, which presumes to measure the deleterious impact of trade with China on U.S. employment. And every year those figures become scripture to the likes of Sen. Sherrod Brown and Rep. Mike Michaud, in their efforts to make Americans less free to choose how and with whom to transact.

This year’s takeaway is: "Growing U.S. trade deficit with China cost 2.8 million jobs between 2001 and 2010." In the report summary on EPI’s homepage, author Robert Scott makes the following claim: "Increases in U.S. exports tend to create jobs in the United States, and increases in imports tend to lead to job loss. Thus, a growing trade deficit signifies growing job loss."

Well, that might be true...but for the fact that it’s demonstrably false.

As the chart below (which is based on easily verifiable figures published in the Economic Report of the President) reveals, the trade deficit and job creation appear to be positively correlated. When the deficit rises, employment increases; when the deficit shrinks, employment declines. So, right off the bat, a central premise of Scott’s analysis is in doubt.

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Beyond that problem, EPI's methodology is not taken seriously by most economists because, for one, it approximates job gains from export value and job losses from import value, as though there were a straight line correlation between the figures. There’s not. And it pretends that imports do not create or support U.S. jobs, which is clearly wrong. After all, U.S. producers — purchasing raw materials, components and capital equipment — accounted for more than half of the value of all U.S. imports last year ($1.05 trillion). In other words, the majority of U.S. imports support U.S. economic activity, which is the basis of U.S. employment. Yet EPI’s methodology counts those imports as jobs-reducing.

Last month, the U.S. International Trade Commission published its seventh update to the "The Economic Effects of Significant U.S. Import Restraints" study, which contains a special section on global supply chains. On page xv of the executive summary is a table that not only raises more serious doubts about EPI’s methodology, but should put to rest once and for all the hyperbole employed and anxiety caused by alarmist public relations campaigns and the politicians they serve.

Table ES.4 of that study indicates that there is more U.S. valued added (U.S. labor, material, and overhead) in U.S. imports than there is Chinese valued added in U.S. imports. Specifically, 8.3 percent of the value of U.S. imports (about $160 billion last year) is U.S. value, while 7.7 percent of the value of U.S. imports is Chinese value added. EPI’s methodology does not account for the U.S. jobs associated with the U.S. value added in U.S. imports.

Furthermore, that same table reveals that U.S. value added accounts for 89 percent of total U.S. consumption (a figure that confirms the findings in a recent San Francisco Federal Reserve study), which means that foreign value-added accounts for just 11 percent of U.S. consumption, making the United States a fairly closed economy—or at least, a relatively non-integrated economy. And China? Well, China only accounts for a measly 0.9 percent of the goods and services consumed in the United States. So, if 2.8 million U.S. jobs were lost to a country that produces less than one percent of what Americans consume, I say its about time we shed those highly inefficient jobs that have been a drag on the U.S. economy. The fact is, however, that 2.8 million is a fiction.

EPI’s jobs loss figures also fail to reflect the fact that the U.S. capital account surplus – the flip side of the current account deficit – is a considerable source of U.S. employment. Foreign investment in U.S. plants, property, hotels, equities, debt, and other assets provide employment for millions of Americans in much the same way that U.S. exports do.

Yes, the 2.8 million job loss figure is a fiction, concocted to support political talking points and a narrow agenda that distract the public from the real problems that ail our economy. Some Chinese government policies are genuine causes for concern, worthy of efforts to resolve, but we limit our capacity to address the real problems effectively when every last gripe becomes a call to arms.

September 21, 2011 8:41AM

Free Market Capitalism vs. Cronyism in Russia

Russian philosopher Leonid Nikonov explains the differences between socialism, cronyism, and free market capitalism.  Nikonov is a contributor to The Morality of Capitalism, a new book that is being distributed worldwide by the Atlas Network and the Students for Liberty.  (You can download the introduction to the book here.)  Students can obtain copies of the book here; all others can obtain copies here.)