Sunday, May 31, 2009

Recession/Credit Crisis or Social Engineering?

Tax Increases on Consumers and Businesses.

Is the laundry list of tax increases proposed by the Obama Administration, while the economy is in a deep recession, sound economic policy?.

If you look at the many empirical economic studies of the Great Depression one reoccurring finding is that tax increases during the Depression reversed/dampened any positive effects of Keynesian Deficit Government Spending.

Its clear in the Theory of Keynesian Deficit Government Spending that the spending is intended to be temporary until the Private Sector rebounds. The Private Sector needs Private Capital Formation to rebound.

However, the list of tax increases proposed by the Obama Administration is so long, affecting so many sectors, affecting both consumers and business, that the varying and several tax increases are going to create a tax increase multiplier effect cascading within the Private Sector. Add in State Government tax increases and the multiplier effect is further magnified.

The effect of the Tax Increase Multiplier will be that Capital Formation as well as consumer and business consumption will be decreasing at an increasing rate.

Keynesian Deficit Government Spending and Quantitative Easing

Keynesian Deficit Government Spending during the Depression was in an environment of zero or low current Government Debt. Current Keynesian Deficit Spending is occurring in an environment of high current and future Government Debt. Moreover, Keynesian Deficit Government Spending as well as Quantitative Easing were theories developed in an environment of zero or low government debt as well as significant deflation. That the current deployment of Quantitative Easing is occurring in an environment of small, moderate or even zero deflation. Finally, Keynesian Government Spending and Quantitative Easing are being deployed simultaneously. The only time Quantitative Easing and Keynesian Deficit Government Spending have been simultaneously deployed in a Modern Economy was 2001-2006 in Japan. Japan continues to this day in a 20 year long recession (1989 to present).

Economic Train Wrecks and Unintended Consequences

Countervailing Economic Policies create unintended consequences. Quantitative Easing is creating a less valuable US Dollar hence creating upward pressure on US Government Debt in two areas: the quality of the debt is being downgraded causing the perceived risk to increase hence causing the interest rate on the debt to increase. Further, Quantitative Easing is causing the specter of inflation to raise its ugly head as the money supply has increased by nearly 700 Billion Dollars since 10/2008 as measured by M2.

Meanwhile, Keynesian Deficit Government Spending has been deployed nearly simultaneously with Quantitative Easing. US Government Debt is increasing at an increasing rate. The current US Government Debt was high before the Enactment of the $800 Billion Dollar Stimulus Package. Add to the Stimulus Package a massive current Budget Spending Plan, and debt is increasing at an increasing rate. Hence the economic phenomena of increasing debt at an increasing rate is affecting the Value of US Government Debt as well as interest rates associated with the debt.

One of the Unintended Consequences of simultaneously deploying Quantitative Easing and Keynesian Deficit Government Spending in an environment of high current debt and debt increasing at an increasing rate is that the debt is downgraded and interest rates move upward.

Moreover, the proposed laundry list of consumer and business tax increases will cause households and business to have less disposable income. Further, business tax increases depress Private Capital Formation. Hence the deployment of Keynesian Deficit Government Spending to stimulate the economy is counter acted by the laundry list of tax increases. That is, Demand is increased by Deficit Government Spending and Demand is decreased by tax increases. Also, the tax increases depress Private Capital Formation that in the Theory of Keynesian Economics is suppose to create jobs when the stimulus money runs out.

Add to the above countervailing forces and unintended consequences the cost of a Social Engineering agenda on par with Lyndon Johnson's Great Society, and you add Government Debt that becomes unsustainable.

Pick and Choose

Basically you have Recession/Credit Crisis or you have Social Engineering Program. The US Economy can barely afford one option but not both options. Attempting to initiate Great Society Entitlement Programs while in the mist of a Recession/Credit Crisis is a recipe for Economic disaster.

If you pick the Political Economy of fixing the Recession/Credit Crisis, once the problem is solved you will not be able to initiate the Social Engineering programs as the current entitlements (Social Security, Medicare, Medicaid, etc.) are overbearing as they stand now. One would need to address the current financing of the current entitlements.

If you pick the Political Economy of Social Engineering (expanding entitlements) you end up with an economy in Stagflation with a debt burden increasing at an increasing rate.

Saturday, May 30, 2009

Cascading Unintended Consequences

Have you noticed you keep hearing examples reported in the media of "unintended consequences" of the current economic policy put forth by the Obama Administration. When you intervene into free market demand and supply, you get outcomes you never expected.

Actually you should expect unintended consequences because markets naturally reach equilibrium and intervening then distorts equilibrium. The distortion of equilibrium then breeds unintended consequences.

However, if you simultaneously intervene in many Economic Sectors e.g. Homes, Autos, Financials, Health Care, etc. then unintended consequences from one Sector interact with other unintended consequences generated from another Sector, creating yet another unintended consequence or even a new set of unintended consequences.

Those new unintended consequences begin to interact with other unintended consequences. That is, unintended consequences have a multiplier effect and certainly cascade across Sectors and hence the Macro Economy. Look at it this way, intervention is an attempt to influence outcomes to a new artificial equilibrium. The artificial equilibrium may create the outcome you seek, but the artificial equilibrium comes with unintended consequences due to distortion of equilibrium. Distorting equilibrium across many sectors simultaneously, creates a multiplier effect within unintended consequences.

Cap and Trade and the 1970's Oil Shocks

Beyond all the arguments put forth regarding Cap and Trade aka Cap and Tax, what about Cap and Trade having the economic effect of the 1970's Oil Shocks?

An argument exists that the Obama Administration is deploying economic policy akin to the 1970's (O'Carternomics). During the 1970's, Oil Shocks derailed the economy. In the 1970's a Political Economy argument put forth was that cheap energy can make any economy, no matter how poorly organized the economy, create more jobs and lessen inflation.

The Phillips Curve, which in the 1970's was being rigorously examined and subsequently disproved, was used as the model, and as the argument went, that the trade off between inflation and employment within the Phillips Curve worked better with low energy costs.

Putting the 1970's Phillips Curve discussion aside, cheap energy reduces business sector input costs as well as reduces consumer costs. Larry Kudlow of CNBC has referred to the reduction in cost of $147 barrel of oil, to the low in the $40 range for oil, as akin to a tax cut for businesses and consumers.

Would the passage of Cap and Trade, and the associated increase in energy costs, have similar basic effects on current US economic activity as the Oil Shocks of the 1970's? That is, Cap and Trade is a replay of the 1970's Oil Shocks.

With increased energy costs for businesses and consumers via Cap and Trade, the same economic dampening effect as the Oil Shocks of the 1970's will be plugged into the current anemic economic recovery.