Keynesian Medicine losing its efficacy

[gnk]

U.S. debt reaches level at which economic growth begins to slow
By Walter Alarkon - 05/26/10 12:25 PM ET

The level of U.S. debt has reached a point at which economic growth traditionally begins to slow, a bipartisan fiscal commission making recommendations to the White House and Congress was told Wednesday.

The gross U.S. debt is approaching a level equivalent to 90 percent of the country's gross domestic product, the level at which growth has historically declined, said Carmen Reinhart, a University of Maryland economist.

When gross debt hits 90 percent of GDP, Reinhart told the commission during a hearing in the Capitol, growth "deteriorates markedly." Median growth rates fall by 1 percent, and average growth rates fall "considerably more," she said.

Reinhart said the commission shouldn't wait to put in place a plan to rein in deficits.

"I have no positive news to give," she said. "Fiscal austerity is something nobody wants, but it is a fact.

Gross debt is at 89 percent and will reach 90 percent by the end of the year, said Sen. Kent Conrad (D-N.D.), a member of the commission.

Another commission member, Rep. Jeb Hensarling (R-Texas), described the situation: "Essentially, the needle is hitting the red zone in respect to economic growth.”

Gross debt, unlike the public debt measure used by the Congressional Budget Office (CBO) and other economic forecasters, includes the money the government owes to all entities it supports, such as mortgage firms Freddie Mac and Fannie Mae, Reinhart said. The CBO expects public debt to grow from 63 percent this year to 90 percent in 2020, largely because of rising healthcare costs.

The bipartisan fiscal commission, which was created by President Barack Obama and contains lawmakers from both parties, is tasked with producing a plan to rein in debt by December 1. Leaders in both the House and Senate have said the commission's proposals would receive votes on the floor later that month.

Reinhart cautioned policymakers against seeing the strengthening of the dollar as a sign that investors can wait for the United States to show how it will deal with the debt.

"I am concerned about complacency," she said. "I am concerned that because the dollar has renewed its role as a reserve currency, we may wait too long."

Source: http://thehill.com/blogs/on-the-mone...age=2#comments

From Nathan's Ec. Edge blog:


And on Government Spending multipliers:

Friday, May 21, 2010

The Administration and the IMF on the Multiplier

In a soon to be published paper, several economists at the International Monetary Fund report estimates of government spending multipliers which are much smaller than those previously reported by the U.S. Administration. In order to obtain the estimates the IMF economists use a very large complex model called the Global Integrated Monetary and Fiscal (GIMF) Model developed by Douglas Laxton and his colleagues at the IMF . The paper is quite technical, but the bottom line summary is that a one percent increase in government purchases (as a share of GDP) increases GDP by a maximum of 0.7 percent and then fades out rapidly. This means that government spending crowds out other components of GDP (investment, consumption, net exports) immediately and by a large amount.

The IMF estimate is much less than the multiplier reported in a paper released last year by Christina Romer of the President’s Council of Economic Advisers and Jared Bernstein of the Vice President’s Office. The attached graph shows how huge the difference is. It shows the impact on GDP of a one percentage point permanent increase in government purchases as a share of GDP reported in the IMF paper (labeled GIMF) and in the Administration paper (labeled Romer-Bernstein).

Source: http://johnbtaylorsblog.blogspot.com...ultiplier.html

[Chomsky]

Re: Keynesian Medicine losing its efficacy

Great post and links, thanks.

[tsetsefly]

Re: Keynesian Medicine losing its efficacy

losing its efficacy? I wasn't aware it had any... I though the 1970's proved that...

[ViC78]

Re: Keynesian Medicine losing its efficacy

Keynesian fiscal stimulus was never meant to be a permanent solution. It is govt stepping in to supply demand when there is none forthcoming from the private sector. Unfortunately, the stimulus was not targeted well at all. It should have been about jobs, jobs and jobs - a WPA type effort. At the same time, the government should have allowed the private debt to default and start afresh, but unfortunately, we have transferred private debt onto the public balance sheet.

Sorry, I don't think you can blame Keynes for politicians being politicians and looking at only one side of the equation. They do not understand the meaning of the word - "counter-cyclical".

[gnk]

Re: Keynesian Medicine losing its efficacy

Keynesian fiscal stimulus was never meant to be a permanent solution. It is govt stepping in to supply demand when there is none forthcoming from the private sector. Unfortunately, the stimulus was not targeted well at all. It should have been about jobs, jobs and jobs - a WPA type effort. At the same time, the government should have allowed the private debt to default and start afresh, but unfortunately, we have transferred private debt onto the public balance sheet.

Sorry, I don't think you can blame Keynes for politicians being politicians and looking at only one side of the equation. They do not understand the meaning of the word - "counter-cyclical".

I agree that Keyne's views have been extremely distorted by politicians and the current crop of influential economists. But maybe the demand we are trying to re-inflate/re-invigorate was debt based to a significant extent and reached beyond ability to service, and therefore was illusory to a large degree? We are trying to "uncorrect" a natural self-correcting process?

But I also lean towards tsetsefly's view:

Total debt to gdp:


And here, just government debt to gdp:

Interesting to note that during the era of industrialization, late 1800s to early pre WWI government expenditure was minimal. In the 1880-1914 period, gdp in nominal terms went from $10.4 billion to $36.5 billion. Governement debt decreased as a percentage of gdp.

To me, it looks like all debt - private and public - has lost its efficacy. Is it because we have debt backed money? Is it because of FIRE's increased prominence? Or increasing consumption as a percent of gdp? Or a combination of all of the above? That's the million dollar question. I think monetary theory - what money is, how it performs, how it influences an economy... that's where we'll find our answers.

FYI - Here is a great site for charting US gdp in various terms, from 1790 on:
http://www.measuringworth.org/usgdp/

[Chomsky]

Re: Keynesian Medicine losing its efficacy

Doesn't increasing debt naturally lose its efficacy because it needs to be repaid? Once you're borrowing to pay the interest on past loans...

[Fiat Currency]

Re: Keynesian Medicine losing its efficacy

Doesn't increasing debt naturally lose its efficacy because it needs to be repaid? Once you're borrowing to pay the interest on past loans...

Yes - but isn't the real issue that we don't allow BAD debt to extinguish? Everybody gets a soccer trophy just for playing now.

[gnk]

Re: Keynesian Medicine losing its efficacy

Yes - but isn't the real issue that we don't allow BAD debt to extinguish? Everybody gets a soccer trophy just for playing now.

You used the word "extinguish" which I find very interesting. Your connotation can have two meanings - paying off debt or defaulting debt. Either way, debt no longer exists. But does it?

When I use the phrase "irredeemable currency" I am describing our current monetary system. Here is a definition of "irredeemable currency":

Paper money redeemable neither in gold nor silver; fiat money.

Good read:

The Twilight of Irredeemable Debt

When Richard Nixon closed the gold redemption window on August 14, 1971, redeemable debt gave way to irredeemable debt. This watershed event set the stage for the global financial chaos being experienced today. Here's why...

By Professor Antal E. Fekete
May 2, 2008

The most powerful of the latter-day pagan gods that have guided the destinies of humanity for the past two-score years is irredeemable debt. Before August 14, 1971, debts were obligations, and the word "bond" was to mean literally what it said: the opposite of freedom. The privilege of issuing debt had a countervailing responsibility: that of repayment.

On that fateful day all that was changed by a stroke of the pen. President Richard Nixon embraced the woolly theory of Milton Friedman and declared the irredeemable dollar a monad, that is, a thing that exists in and of itself.

According to this theory the government has the power to create irredeemable debt - debt that never needs to be repaid yet will not lose its value - subject only to a "quantity rule", for example, it must not be increased by more than 3% annually. This idea is so preposterously silly that "only very learned men could have thought of it".

If the thief is thieving modestly, then he will not be detected. It never occurred to the professors of economics and financial journalists that a modest thief is an oxymoron, a contradiction in terms. How did they get to believing in irredeemable debt? The explanation is most likely found in Schiller's dictum: "Anyone taken as an individual is tolerably sensible and reasonable. But taken as a member of a crowd - he at once becomes a blockhead." Economics professors and financial journalists are no exception.

For a time it appeared that Friedman was right. The world has become dedicated to the proposition that it is possible, even desirable, to expand irredeemable debt in order to make the economy prosper. Never mind the default of the US government on its bonded debt held by foreigners. Never mind people victimized by theft. Thanks to the quantity rule, they will never notice the difference.

For all its seductive attractiveness, Friedmanite economics is ignoring the effect of irredeemable debt on productivity. It watches debt per GDP and is happy as long as this ratio stays below 100% by a fair amount. However, what should be watched is the ratio of additional debt to additional GDP. By that indicator the patient's condition could be diagnosed as that of pernicious anemia. It set in immediately after the US dollar debt in the world was converted into irredeemable debt.

The increase in GDP brought about by the addition of $1 of new debt to the economy is called the marginal productivity of debt. That ratio is the only one that matters in judging the quality of debt. After all, the purpose of contracting debt is to increase productivity. If debt volume rises faster than national income, there is big trouble is brewing, but only the marginal productivity of debt is capable of revealing it.

Precipitous decline
Before 1971, the introduction of $1 new debt used to increase the GDP by as much as $3 or more. Since 1971, this ratio started its precipitous decline that has continued to this day without interruption. It went negative in 2006, forecasting the financial crisis that broke a year later. The reason for the decline is that irredeemable debt causes capital destruction. It adds nothing to the per capita quota of capital invested in aid of production. Indeed, it may take away from it. As it displaces real capital, which represents the deployment of more and better tools, productivity declines. The laws of physics, unlike human beings, cannot be conned. Irredeemable debt may only create make-belief capital.

By confusing capital and credit, Friedmanite economics obliterates truth. It makes the cost of running the merry-go-round of debt-breeding disappear. It makes capital destruction invisible. The stock of accumulated capital supporting world production, large as it may be, is not inexhaustible. When it is exhausted, the music stops and the merry-go-round comes to a screechy halt. It does not happen everywhere all at the same time, but it will happen everywhere sooner or later. When it does, Swissair falls out of the sky, Enron goes belly-up, and Bear Stearns caves in.

The marginal productivity of debt is an unimaginative taskmaster. It insists that new debt be justified by a minimum increase in the GDP. Otherwise capital destruction follows, a most vicious process. At first, there are no signs of trouble. If anything the picture looks rosier than ever. But the seeds of destruction inevitably, if invisibly, have sprouted and will at one point paralyze further growth and production. To deny this is tantamount to denying the most fundamental law of the universe: the Law of Conservation of Energy and Matter.

The captains of the banking system in effect deny and defy that basic law. They are leading a blind crowd of mesmerized people to the brink where momentum may sweep most of them into the abyss to their financial destruction. Yet not one university in the world has issued a warning, and not one court of justice allowed indictments to be heard from individuals and institutions charging that the issuance of irredeemable debt is a crude form of fraud, calling for the punishment of the swindlers issuing it, whether they are in the Treasury or in the central bank. The behavior of universities and courts in this regard could not be more reprehensible. Rather than acting to protect the weak, they act to cover up plundering by the mighty.

The inconspicuous beginnings of irredeemable debt have blossomed into a colossal edifice, a fantastic debt tower that is bound to topple upon the prevailing complacency and apathy. Actually "tower" is a misnomer. Rather, what we have is an inverted pyramid, a vast and expanding superstructure precariously balanced on a tiny and ever-shrinking gold foundation - the only asset in existence with power to reduce gross debt.

The construction has no precedent in history, and no place in theory, whether Ricardian, Walrasian, Marxian, Keynesian or Austrian. As a matter of fact, no one is analyzing the process. Research has been placed under taboo by the powers that be, lest diagnosis reveal the presence of cancer caused by irredeemability. There is no known pattern or model that would apply to its mechanism in terms of equilibrium analysis.

Two negative conclusions emerge. One is that the edifice of irredeemable debt must grow at an accelerating pace as markets for derivatives providing "insurance" to holders of debt proliferate. The insurer of debt must also be insured, as must the insurer of the insurers, and so on, ad infinitum. This is due to the fact that the risk of collapsing bond values has been created by man. In contrast, the risk of price changes of agricultural commodities are created by nature, and the futures market provides insurance, with no need to re-insure. The other conclusion is that the unwieldy size of the debt structure excludes the possibility of a normal correction: a major liquidation would dwarf the calamities of the Great Depression.

The debt delusion
It is a delusion to think that the government can splatter debt all over the economic landscape to cover up its warts, and reap everlasting prosperity as a result. The stimulation and leverage of debt has always caused stock markets to boom, so that the impact of debt was aided and magnified by the added paper wealth which, in turn, increased the propensity to spend and borrow still more.

Businessmen are supposed to be more realistic in contracting debt. Yet the pattern of increase in corporate debt has also changed tremendously. Whereas traditionally corporations used to finance their capital needs in a ratio of $3 in debt for every $1 in stock, in the years leading up to 1971 they issued $20 in debt for every $1 in stock, with the ratio sky-rocketing thereafter.

We hear arguments that economists have by now learned how to control the economy with the so-called built-in stabilizers. Debt has largely lost its sting as a consequence, we are told. For example, bank deposits can now be insured. They couldn't in the 1930s. But when the government itself is loaded with debt, and runs boom-time deficits, the built-in stabilizers may backfire and destabilize the economy further.

The government has commitments so great that its endeavor to offset a depression in our vast economy can only result in a loss of confidence. Anxious withholding of purchasing power in the private sector could far outweigh anything the government can add. To make matters worse, government income is highly dependent on a prosperous economy. The magnitude of the problem of offsetting a depression is grossly disproportionate to resources available.

One of the marks of great delusions is that nearly everyone tends to share them. It is a sorry tale - any delusion gives rise to a rude awakening in due course. Public attitudes to debt have changed so radically since 1971 that today indebtedness is practically a status symbol, instead of the shameful condition it used to be in a bygone era. The most striking reversal in traditional American attitudes towards debt is the widespread acceptance of perpetual national indebtedness, copied by perpetual personal indebtedness - a never-ending lien on future income.

Perhaps the worst aspect of the regime of irredeemable debt is the lowest level of morals followed by governments in modern history. It is epitomized by an elaborate check-kiting (using a bad check to get money) conspiracy between the US Treasury and the Federal Reserve.

Treasury bonds, contrary to appearances, are no more redeemable than Federal Reserve notes. It’s all very neat: the notes are backed by the bonds, and the bonds are redeemable by the notes. Therefore each is valued in terms of itself, rather than by an independent outside asset. Each is an irredeemable liability of the US government. The whole scheme boils down to a farce. It is check-kiting at the highest level.

At maturity the bonds are replaced by another with a more distant maturity date, or they are ostensibly paid in the form of irredeemable currency. The issuer of either type of debt is usurping a privilege without accepting the countervailing duty. They issue obligations without taking any further responsibility for their fate or for the effect they have on the economy. Moreover, a double standard of justice is involved. Check-kiting is a crime under the Criminal Code. That is, provided that it is perpetrated by private individuals. Practiced at the highest level, check-kiting is the corner-stone of the monetary system.

But our world is still one of crime and punishment, tolerating no double standard. The twilight of irredeemable debt is upon us. The sign is that banks are reluctant to take the promissory notes of one another. Significantly, this also includes overnight drafts. The banks know there is bad debt at large, and they don't want to be victimized by taking in some inadvertently. What the banks don't yet know, but will soon learn, is that all irredeemable debt is bad debt, and there is no way to rid the system of poison through administering more.

Redeemability of debt is not a superfluous embellishment. It has a function of fundamental importance: the proper allocation of resources to the different channels of their utilization.

The obligation to redeem debt hangs as the sword of Damocles over the government, just as it does over the head of every economic participant. It compels economy and foresight. It forces balancing of income and expenditures. It adjusts claims and commitments. It limits expansion by shifting resources away from the incompetent, and away from unhealthy projects.

The regime of irredeemable debt creates an escape route from commitments by the promise of eliminating the pressure of solvency. Whether it promises eternal prosperity, or it promises eternal subsidies, it does not matter. The results are the same. They consist in misleading people, enticing them to skate on thin ice, and luring them into financial adventures, private or public, which are not warranted by the ability to pay. The logical consequence is wholesale bankruptcy of individuals as well as that of the political setup. Losses breed more losses, until they become an avalanche. The present crisis is just the first sign of that denouement. More is on the way.

It is still possible to escape the catastrophe which this process would entail. The way out is to open the US Mint to gold and silver, as advocated by presidential candidate Ron Paul. The logic of this remedy is that it would mobilize potentially unlimited resources, presently tied up in idled gold, and re-introduce the indispensable means of debt-retirement into the economy.

Failing to bring gold back, where are we heading? The short answer is: we are marching into the death-valley of collectivism. The alternative to re-introducing redeemable currency is that the debt behemoth will force the imposition of a capital-levy type of taxation - along the lines of Solon, back in the Athens of 594 BC.

Source: http://www.augustreview.com/news_com...bt_2008050890/

[cjppjc]

Re: Keynesian Medicine losing its efficacy

Fekete talks about capital destruction in a way I am unable to understand. Previously he said banks while earning huge sums were unaware of their capital being destoyed. I've asked this before, Spartacus and I think JK have tried to help me. What is he saying? Maybe an analogy to something else might help me get it.


By confusing capital and credit, Friedmanite economics obliterates truth. It makes the cost of running the merry-go-round of debt-breeding disappear. It makes capital destruction invisible. The stock of accumulated capital supporting world production, large as it may be, is not inexhaustible. When it is exhausted, the music stops and the merry-go-round comes to a screechy halt. It does not happen everywhere all at the same time, but it will happen everywhere sooner or later. When it does, Swissair falls out of the sky, Enron goes belly-up, and Bear Stearns caves in.

[ECON]

Re: Keynesian Medicine losing its efficacy

Keynesian fiscal stimulus was never meant to be a permanent solution. It is govt stepping in to supply demand when there is none forthcoming from the private sector. Unfortunately, the stimulus was not targeted well at all. It should have been about jobs, jobs and jobs - a WPA type effort. At the same time, the government should have allowed the private debt to default and start afresh, but unfortunately, we have transferred private debt onto the public balance sheet.

Sorry, I don't think you can blame Keynes for politicians being politicians and looking at only one side of the equation. They do not understand the meaning of the word - "counter-cyclical".

Excellent post and anyone who had read the 1936 work that Keynes is most known
would understand that Keynes never advocated perpetual deficits and build up of higher
national debt...only a government captured by financial banking interests and other capitalist enterprises would be immune to reducing big time public subsidies on the private sector. Remember the recent Wall St disaster shifted its debts onto Washington (socialism)
so they would avoid the bankruptcy that should have occurred. Volcker was correct that there is need for a mechanism to have an orderly bankruptcy process for the TBTF banks.

[medved]

Re: Keynesian Medicine losing its efficacy

Excellent post and anyone who had read the 1936 work that Keynes is most known
would understand that Keynes never advocated perpetual deficits and build up of higher
national debt...only a government captured by financial banking interests and other capitalist enterprises would be immune to reducing big time public subsidies on the private sector. Remember the recent Wall St disaster shifted its debts onto Washington (socialism)
so they would avoid the bankruptcy that should have occurred. Volcker was correct that there is need for a mechanism to have an orderly bankruptcy process for the TBTF banks.

Marx never advocated totalitarian regimes either. But both in the cases of Marx and Keynes what really happens is just a logical consequence of both theories, and this is something that socialists/statists will never understand.

Both theories advocate increase in gov’t power that will destroy Western democratic society AWKI. Both systems advocate elimination of the gold standard. In both cases corrupt and efficient system of capitalism is being replaced by corrupt and inefficient system of socialism.

Now we know, Keynesian medicine is dead. It does not mean, socialism will stop here. The Marxist medicine is next.

[gnk]

Re: Keynesian Medicine losing its efficacy

Fekete talks about capital destruction in a way I am unable to understand. Previously he said banks while earning huge sums were unaware of their capital being destoyed. I've asked this before, Spartacus and I think JK have tried to help me. What is he saying? Maybe an analogy to something else might help me get it.


By confusing capital and credit, Friedmanite economics obliterates truth. It makes the cost of running the merry-go-round of debt-breeding disappear. It makes capital destruction invisible. The stock of accumulated capital supporting world production, large as it may be, is not inexhaustible. When it is exhausted, the music stops and the merry-go-round comes to a screechy halt. It does not happen everywhere all at the same time, but it will happen everywhere sooner or later. When it does, Swissair falls out of the sky, Enron goes belly-up, and Bear Stearns caves in.

Look to the prior paragraph of the one you posted:

Before 1971, the introduction of $1 new debt used to increase the GDP by as much as $3 or more. Since 1971, this ratio started its precipitous decline that has continued to this day without interruption. It went negative in 2006, forecasting the financial crisis that broke a year later. The reason for the decline is that irredeemable debt causes capital destruction. It adds nothing to the per capita quota of capital invested in aid of production. Indeed, it may take away from it. As it displaces real capital, which represents the deployment of more and better tools, productivity declines. The laws of physics, unlike human beings, cannot be conned. Irredeemable debt may only create make-belief capital.

This is how I see it:

Fekete and Friedman define both capital and debt differently. Look not at what capital and debt are created to accomplish, but how capital and debt are created and backed.

For example, under a gold standard, capital cannot be destroyed, as it is backed by something tangible - gold. Debt is truly "extinguished" by using gold to pay it off.

Under a debt based fiat standard, capital is created thru debt - it is backed by debt.

Think of these questions: If credit (money) can be made from thin air, over time, how will it be treated? How will it be invested? What type of investments ("financial instruments") evolve from such a standard? How fast can it grow? How long can it maintain its value? Will it exceed the value of the real economy? If so, then what?

The answers to the questions above? Hint: look at the financial world today.

And now for something completely different - a visual test - what is the real difference between these two $50 dollar bills?






What is a "note"? It is a promise to pay - a debt. And what does one receive from the issuer of such a promise to pay? Another note?

[gnk]

Re: Keynesian Medicine losing its efficacy

Marx never advocated totalitarian regimes either. But both in the cases of Marx and Keynes what really happens is just a logical consequence of both theories, and this is something that socialists/statists will never understand.

Both theories advocate increase in gov’t power that will destroy Western democratic society AWKI. Both systems advocate elimination of the gold standard. In both cases corrupt and efficient system of capitalism is being replaced by corrupt and inefficient system of socialism.

Now we know, Keynesian medicine is dead. It does not mean, socialism will stop here. The Marxist medicine is next.

I'm afraid you're right. If we don't go back to a gold standard of sorts, and continue this fiat charade, government will have to continue to expand its control of the economy and many other aspects of daily life, even more so than today after it destroys the currency thru its current "attempts" at saving the economy.

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.


This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard.


- Alan Greenspan

[cjppjc]

Re: Keynesian Medicine losing its efficacy

Thank you gnk for your attempt to help me understand. His theory of capital destruction is just a bit too esoteric for me to get my mind around. Perhaps I'm overthinking it. Again thank you.

[ThePythonicCow]

Re: Keynesian Medicine losing its efficacy

I'm afraid you're right. If we don't go back to a gold standard of sorts, and continue this fiat charade, government will have to continue to expand its control of the economy

Hmm... how about both, both gold and a continuance of the fiat charade?

Following up on FOFOA's latest column Reflection, how about:

• U.S. ships some gold to its largest creditors (e.g. China), in return for most of its Treasuries.
• A "Bretton Woods III" replaces the Dollar with some IMG/G20/SDR/BIS concoction for the world's "Reserve Currency."
• Suitable other major centralization of world banking regulation and resetting of major debts.

This way, gold plays a role, but not directly in ways that you or I can easily participate, rather indirectly via the Central Bank holdings of various nations participating in the G20, a basket of whose currencies comprise the defining base of the SDR concoction that each of those Central Banks hold in turn as reserves.

Note: I'm not saying I like this, nor am I saying that the U.S. will willingly participate in this, nor am I saying that we get to this right away, without some intervening Sturm and Dangst.