Free Markets, Free People

The markets are telling us things

Let’s see how today went, shall we? We got our debt ceiling deal, but the Dow dropped 266 points, and the S&P 500 fell 33 points, so it’s now negative for the year. The yield on the 10-year T-note dropped to 2.61%. Gold, meanwhile, hit a fresh record high of $1,644.50/oz. So, I guess this year’s Recovery Summer is over.

None of this, by the way, has anything to do with the debt limit battle in DC. No one on Wall Street really thought a deal wouldn’t be struck. At the end of the day, everybody was pretty confident that the debt ceiling would be raised, and a default avoided.

Stock prices are volatile, of course, so one day’s movement doesn’t mean much, but we have lost about 800 points on the Dow since 22 July, so the trend isn’t good.  What’s worse is the steady decline on treasury yields and the climbing price of gold. When you couple that with the 0.4% 1Q GDP increase, and the danger of downward revisions to the lackluster 2Q GDP over the next two months, the evolving picture doesn’t look pretty. We’ve also has a few weeks of unremittingly bad economic releases, showing the economy might be heading back towards recession, and unemployment getting closer to 10% than 8%.

So then what’s the problem? I mean, we’ve had our big stimulus, and our TARP and our Quantitative Easing I and II, and we’re still not only barely budging into positive GDP territory, but now all the signs are showing the economy slowing. What’s happening? Why isn’t any of this working?

I think the answer can be found in what I wrote in my previous post about debt levels, and how over the last several years…

…a body of peer-reviewed work has been developed (PDF) that shows that an excess of government debt serves as a drag on the economy, shaving at least a full percentage point off of annual GDP growth. And we’ve learned that this negative economic effect has a non-linear effect on economic growth as debt increases.

What seems to happen is that, as you begin to approach a debt-to-GDP ratio of 100%, economic growth slows. As you add debt, there’s a non-linear decrease in economic growth. and each additional increment of debt slows growth more than the last. As I also pointed out, this has some pretty scary implications for Keynesian policies, because as you add debt, you’re no longer stimulating growth, you’re hindering it ever more strongly.

That puts policy makers in a pretty bad spot.  For instance, right now, real short-term interest rates are effectively zero, so the interest rate tool is no longer of any use to the Fed. You can’t lower rates below 0%. With that tool gone, the only thing left to try and stimulate the economy is to add more debt. Conversely, cutting spending will result in more government workers and contractors being moved over to the unemployment line, and the economy still slows. It’s a trap, where all the standard policy moves result in a slowing economy.

Back in the 80’s my fellow Econ and Business undergrads would debate about all the debt Reagan was adding, and trying to figure out when all that debt would begin crowding out private investment and slowing economic growth. As it turned out, it took far longer than any of us believed it would, but I think we finally have the answer.

The really scary this is that, if we decided that we had to bite the bullet, and impose some austerity, it really wouldn’t help much.  We could cut discretionary spending by half, and all it would do is gain us a few years of breathing space before the coming explosion in Social Security and Medicare entitlements—about $60-76 trillion worth of them—eat up any short-term savings and debt reduction we might acquire.  After all, discretionary spending—including defense—is only about 39% of the current budget anyway.

What part does economic growth play in all this?  Well, it’s clear that 2% per year isn’t going to help much.

It is a generally accepted truism that the trend rate of growth in a mature economy is 3%. There are a lot of reasons given for this; slower population growth in developed countries, large sunk costs in plant and capital, blah, blah, blah. But why should any of that matter? Just because population growth is slow, it doesn’t necessarily follow that the growth of wealth or human ingenuity is hampered.

Here is a reason for that slow growth that’s almost never given.  You see, one of the things that mature economies all seem to have in common is large government expenditures, extensive entitlements, massive regulatory oversight, and increasing debt. All of that is financed by taxation to remove money from the productive portion of the economy. So, one of the primary reasons we have slower economic growth is because we trade it for public goods.

Now, we may love these public goods. And they are certainly nice to have if you can afford them.  But the evidence is increasingly that we cannot.  if we could, we wouldn’t be racking up a level of peacetime debt that’s nearly 90% of GDP. Not only do we give up a lot of economic growth to sustain these public goods, but, apparently, we eventually give up all of it…at which point, we have to give up the public goods as well.

If we really want to climb out of this hole, then what we really need to do is to radically rethink what government should be, what it should be allowed to do, and how it’s funded. It’s not enough any more to cut budgets, while leaving the regulatory, entitlement, taxation, and spending structure intact. A truly radical solution would be to limit government spending and revenues to no more than 10% of GDP in peacetime. Replace the income tax with a 10% VAT. Eliminate the departments of Education, Commerce, Labor, Transportation and Agriculture. Repeal most Federal criminal laws. Privatize social security. Enforce free markets, rather than the crony capitalism we have now.

*sigh*

No one in our current political class has the slightest interest in any of those suggestions. Drastically reducing the size and scope of government is the only solution that can possibly increase economic growth substantially, and give us a shot at paying off our ever-increasing debt, but our current political class will never embrace that.

The thing is, reality doesn’t care what the political class—or anyone else for that matter—wants. It just is what it is. So, no matter what happens, we won’t have to worry about the deficit or government spending for much longer. Either we’ll fix the problem by electing a political class that’s devoted to cutting government across the board and paying down the debt. Or we won’t fix the problem, and the resulting bankruptcy and hyperinflation will allow us to monetize our debt, wipe out the life savings of every person in the country, and we will start over from scratch with a bright shiny new currency!

But the problem will get solved. The only question is how much control we’ll retain over the process, and how much government we’ll retain at the end of it.

~
Dale Franks
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16 Responses to The markets are telling us things

  •  

    * S&P 500 turns negative for year
    * S&P closes below 200-day moving average
    * Global growth fears weigh on stocks
    * Dow off 2.2 pct, S&P off 2.6 pct, Nasdaq 2.8 pct
    * For up-to-the-minute market news see [STXNEWS/US] (Updates to close)
    NEW YORK, Aug 2 (Reuters) – The S&P 500 turned negative for the year on Tuesday as the wrangling over the U.S. debt ceiling faded and investors turned their attention to the stalling economy.
    The broad-based index fell for a seventh day and crashed through the key 200-day moving average in an ominous sign for markets. The seven days of losses mark the longest losing streak since October 2008.
    “It is going to be a long week,” said Jim Maguire Jr., a NYSE floor trader at E.H. Smith Jacobs. “The bid is not here in the market.”

    Main St. is shooting Pennsylvania Ave. the finger.

  • Since Reagan, they have been predicting an economic Armageddon, but the signs were always a bit vague what it would look like.  Personally, I always expected it to be a bit more dramatic, but reality usually moves in a slow and steady manner till it has just completely envelopes you.
    Frankly, I don’t think the “Economic Big One” (to steal a phrase from earthquake jargon) is upon us yet, but it isn’t as far off as many want to believe.  What is now coming into view, at least, is a “double dip” recession.  This one, whose architects are Pelosi, Reid and Obama, is owned by the Democrats, but is being fueled by the bureaucrats, especially those at the EPA..

    • Name for me…please…ANY area of this administration that does not seem intent on screwing the nation.  With the partial exception of Defense, I cannot find one.
      Not.  One.

  • Dale FranksIf we really want to climb out of this hole, then what we really need to do is to radically rethink what government should be, what it should be allowed to do, and how it’s funded. It’s not enough any more to cut budgets, while leaving the regulatory, entitlement, taxation, and spending structure intact. A truly radical solution would be to limit government spending and revenues to no more than 10% of GDP in peacetime. Replace the income tax with a 10% VAT. Eliminate the departments of Education, Commerce, Labor, Transportation and Agriculture. Repeal most Federal criminal laws. Privatize social security. Enforce free markets, rather than the crony capitalism we have now.

    I suggest that it’s less a case of “radically rethinking what government should be” and more of “doing what the Constitution allows it to do.” If we did that, then all the rest would follow.  I often wonder what members of Congress and the president actually did back in the 19th century.  No Social Security, no Medicare, no bailouts, not massive tax code… I suppose that they named post offices and occasionally voted for some military appropriations to shoot Indians.

    But this rather hints at the real struggle: not between “left” and “right”, but between “more” and “less”, i.e. people who want the government to DO things and those who want it to stay pretty much out of their lives. 

    Dale Franks[O]ne of the things that mature economies all seem to have in common is large government expenditures, extensive entitlements, massive regulatory oversight, and increasing debt. All of that is financed by taxation to remove money from the productive portion of the economy. So, one of the primary reasons we have slower economic growth is because we trade it for public goods. [emphasis original – dj505]

    Classic case of the goose that laid the golden egg.  “Mature” economies tend to be wealthy: there is a large surplus of capital.  People not only come up with altruistic uses for that capital, but tend to think that the supply of it is inexhaustible.  So, they keep taking and taking and taking, until they confiscate so much of the wealth that the economy starts to degrade.  The real problem is that, by the time that this is obvious, the dead beats outnumber the producers, and attempt to FORCE them to produce absent a profit motive: they try to force the goose to keep laying.  This kills the goose and everybody suffers.

    • But this rather hints at the real struggle: not between “left” and “right”, but between “more” and “less”…

      Or, as framed elsewhere, between Statists and liberty.  Or between The Revolution and The Reaction.  Or between freedom and tyranny.  Or between central planning and the cloud information system we call “the market”.

  • What makes y’all think that the only options are fixing the problem or monetization/hyperinflation/currency re-set?

    As for the first option: there is no way, no how, that DC will solve the problem. It is impossible. The reason is simple: too much of the population lives off of it. There are entire swaths of this country, from the ghettoes to the Appalachian mountains, from the barrios to the wilds of Mississippi, that depend (for life itself) on federal largesse of one form or another. There are tens of millions of bureaucrats, “community organizers”, teachers, welfare moochers, single mothers, elderly pensioners, people with disabilities, children, “artists”, and assorted race hustlers who cannot make it without partial or full subsidies from the government. They will vote for anyone who will keep those subsidies flowing. I hate to say it, but they outnumber us by an order of magnitude. In effect, DC will not solve the problem because no politician who is willing to do what is necessary will be elected to office. Any politician like Churchill promising “…blood, toil, tears, and sweat…” is doomed to irrelevance.

    It is true that monetization of the debt and eventual hyperinflation is a foregone conclusion: barring debt repudiation, there is no other way to make the math work. Where I have my doubts is in the last step: currency re-set. Unfortunately, even if we develop a new currency, we’ll still be stuck with the same population as now. In fact, after a period of Weimar-like instability and chaos, we may witness an American electorate desperate for the comfort of an all-encompassing welfare state that provides bread, security, and stability. In other words, after such a period of chaos, the People themselves will clamor for a Soviet-style polity. The way I see it, we will simply reprise the current situation with an entirely new currency.

    No, neither path is what I see. Instead, I foresee what no one envisioned for the Soviet Union: dissolution. After monetization and hyperinflation, I foresee a general consensus that the United States of America (as currently constituted) is a failure. The path forward then will be clear to all: secession. There may be regional entities (e.g., New England), or individual nation-states (e.g., Texas), but the American monolith is doomed to failure by the actions we, as a people, took during the 20th century. It will be an exciting, and scary time, and it will by no means be bloodless. There will be battles in the street as the dispossessed of the welfare state will fight to retain, or regain, the wealth they believe they are entitled to. There is also an open question as to whether the federal government will attempt to use force to maintain the integrity of the country. Expect lots of dead, folks: from rampant infectious diseases, from violence, from starvation, and despair (i.e., suicides). It’s not going to look like Mad Max, by any means: it will be, I think, I mix of Argentina circa 2001, the USSR circa 1991-1995, and Weimar Germany circa 1919-1923.

    • That post is the equivilant of listen to Johnny Cash sing “hurt”

    • I foresee a general consensus that the United States of America (as currently constituted) is a failure. The path forward then will be clear to all: secession.

      I’ve been arguing this for years.  Even referred to it on the podcast this week.

    • I read a blub by a guy who observed that nations the size of the U.S. are structurally unstable, and prone to dissolution.
      His arguments made sense to me.  One was that only under what we would call a federalist system could they endure long.
      The time is rapidly coming, I am afraid, when the goats and sheep will need to separate.  The productive will not always be as forbearing as they have been in the past.  The tipping point is very, very near.
      I do not agree that it need be bloody.  In fact, I can think of several mechanisms where it would not be.

      • Ragspierre:

        I agree with you 100% that the outcome need not be bloody, as was the case with the dissolution of Czechoslovakia. However, I believe that OUR dissolution is highly likely to be bloody. A confluence of factors support this conclusion: a powerful and well-entrenched entitlement mentality, even within the middle class; a large, demographically and geographically diverse underclass; a well-disciplined cadre of race and class demagogues (“community activists”, “community organizers”) working to direct the anger and energy of the poor and the underclass; a powerful media combine guided by cultural Marxists sympathetic to the radical augmentation and centralization of State power; and an awakening populace, well-armed and no longer willing to be exploited for the ambitions of the political, economic, and cultural elite.

        This will NOT end well.

        • a well-disciplined cadre of race and class demagogues (“community activists”, “community organizers”)

          None of whom want to face hot metal.  They might send others out…but you make them understand you will take that from them.
          The head of the snake is where the first shot goes.

  • As I also pointed out, this has some pretty scary implications for Keynesian policies, because as you add debt, you’re no longer stimulating growth, you’re hindering it ever more strongly.

    Actually, you’re not stimulating anything but the money supply. You might be simulating growth, but Keynesianism is all “demand based”, not supply based (IE, consumption, not production, orient. Growth can only come from enhanced production.

    A truly radical solution would be to limit government spending and revenues to no more than 10% of GDP in peacetime.

    Even more radical would be to limit government to the level of spending it utilized from 1790 to about 1900: about 3.5% of GDP (a Keynesian notion, GDP) with a peak at 8% during the Civil War.
    None of these two will occur until the proper function of government is redefined (and a corresponding definition of rights vs privileges. That would take a couple generations at best. And given the state of “education” today, well…