We should not be in this economic mess. In 1930, the United States had a string of bank failures that set off the Great Depression. The economy struggled for a decade. John Maynard Keynes, who had made a name for himself by correctly predicting what would happen to the German economy after the First World War in The Economic Consequences of the Peace, turned his attention to the Depression in The General Theory of Employment, Interest, and Money, published in 1935.
Keynes warned of a liquidity trap, which happens when consumers save all of their money, instead of using it to invest or consume. The supply of cash gets huge, relative to demand, so interest rates go down to practically nothing. But everyone is too scared to invest or consume. So everyone just keeps saving. Although prices fall, consumers believe that they can get a better deal by waiting a little longer. Businesses have the funds to invest and expand, but they figure it will be better to wait until customers spend money again. Meanwhile, interest rates drop even more as cash balances rise.
It becomes a vicious circle.
Gross Domestic Product is the total of consumption, investment, government spending, and net exports. You often see it written as C + I + G. Keynes said that if consumption and investment are too low to get the economy moving, the best option is for the government to spend money, even if it has to use deficit spending to do so. Roosevelt's New Deal was a model. The government established programs like Social Security so older Americans would have money to spend, and it launched huge infrastructure projects under the Works Progress Administration to build roads, national parks, and post offices. It even set up programs to hire artists. The WPA post office in my neighborhood boasts a marvelous WPA mural.
Keynes fell out of favor in the United States in the late 1970s and early 1980s -- not because he was wrong, but because of concerns government spending was crowding out consumption and investment. Somehow, though, this was twisted into a general belief that Keynes was bad and evil, and besides, the Depression was one of those things that would never happen again. Of course, the response was to cut taxes but not government spending, as everyone loves government programs as long as they don't have to pay for them.
Meanwhile, the Japanese economy in the 1980s was hotter than a Chicago summer... until the real estate bubble collapsed there. This took down many Japanese banks, although the government kept the failed banks open anyway. People put all their money in cash because they were scared to invest or consume, even though interest rates kept going down. The government spent its capital propping up businesses and banks that deserved to fail. The liquidity trap that Keynes warned about proved true.
In deflation, prices and interest rates fall. You don't actually see negative interest rates. Instead, service charges go up. In Japan in the 1990s, banks started charging fees for safekeeping instead of paying interest, because a bank is a better place for money than a mattress, yes? Last week, the Bank of New York Mellon Corp. (NYSE: BK) announced it was doing the same for its largest customers. Good luck trying to find free checking anywhere in the near future. It'll likely be a perk only for those who carry huge balances or who agree to frighteningly large ATM fee schedules.
We are in a liquidity trap, ladies and gentlemen. The sad thing is: We didn't have to be here. Even worse: We're not getting out any time soon. Americans are tapped out, and 9.1% of us are unemployed. We're not consuming. Businesses could invest, but they aren't, at least not here. Instead, they're carrying so much cash that the Bank of New York Mellon is charging fees to pay for guards, safes, and network security. What we should be doing now is what we should have started doing as soon as the financial crisis hit: spend big government money on infrastructure projects, even if we had to raise taxes to do it.
Look, cutting taxes now won't stimulate investment. Even with negative interest rates, companies aren't investing. "Job creators" aren't creating jobs. Heck, it may be cheaper to have taxes go up a percentage or two than to pay service charges on all that cash stuck in the bank.
But we didn't do that, because of a combination of greed, economic illiteracy, and intransigence. Hence, ratings agencies are downgrading our debt, and we're getting a few more years of recession.
Back in the early 1980s, my high school chemistry teacher would admonish us for taking sick days. He didn't believe in school holidays, either. "There are a billion Chinese waiting to take your seat," he would say, and we would all laugh.
I think taxes are only small part of the problem. And you are saying only some expenses like Senators pay can be reduced? That's nuts. It's been clearly demonstrated that SS and Medicare are growing in excess of inflation rate and if we don't do something soon the costs will bankrupt us. We have to figure out how to cut those costs. To ignore this shows an avoidance of basic math.
Yes, some compromise is needed. Like raises taxes a couple of percentage points. Big deal. But that's really not the main problem. Any taxes you increase, especially the payroll taxes which will go back to normal in 2012, will put an additonal burden on the economy. Anybody that thinks that is the main problem is ignoring the issue.
The government does not create jobs, Ann. Companies like Apple create jobs. The reason is that the government has no capacity to generate profits or income -- it is a cost-center, who sucks money from you and me. Yes it's fine for basic services but it's a zero-sum gain in job creation since by definition the government only spends money it raises through taxes, it does not generate profits or create value.
Also, how do you explain or justify that government costs have skyrocketed 35% in the last five years!? During a deflationary environment? Clearly there is a lack of productivity in the capital being sent down that rathole. Added $1T to the deficit per year? Only some of that is lost tax revenue due to the recession... the rest is the result in a 35% increase in government spending in 5 years. I mean, that's crazy.
I really just don't know how anybody could justify a 35%increase in five years. Imagine that your salary gets cut so your respond by spending 35% more. It's so counter-logical that I don't even know where to begin.
Clearly, it's unsustainable.
Also, I'm not sure what your response is to Muhlenkamp's point, which that Canada was in a very similar crisis in the early 1990s. Their debt was downgraded to AA, in fact, They responded by cutting government spending as a percentage of GDP, they reduced debt, and their economy boomed for the next 10 years. They did not raise taxes. How do you explain that?
Sorry, your response is too general for me. I will prepare an encyclopedia of referenses for you to read. But in the meantime. I think you understand that my suggestion that Congress cut spending references more than the symbolic change to their salaries that I used to introduce the point. I was suggesting that Congress reduce the incredible wasteful spending that they do in order to further their careers and get reelected.
I am certain that you are aware that there is district spending to provide jobs for their constituents at the expense of reason. From your response it appears to me that you prefer to trivialize the problem to make the point that we can't cut expenses so we must raise taxes. I have no argument with increasng revenues if necessary after FREEZING spending at its current rate. Eliminate the built-in annual baseline increase of 10% and then I'll talk to you about raising taxes.
Yes, yes, indeed. Some expenses can be reduced. Great. So we cut each Senator's pay by $10,000 per year and save a whole MILLION dollars. That will cover Social Security benefits for about 50 people. Wow. If the Senate were to work for free, we could pay Social Security for, what, 1000 people? Once you look at it that way, the solution is, um, impossible?
The US has four main expenses: defense, Social Security, Medicare, and interest on the Federal debt. We are fighting two wars, so we can't cut defense. There is no political will for cutting Social Security and Medicare, especially because the beneficiaries believe that they are owed these benefits. Skipping out on interest payments is known as default.
As for tax cuts and revenue, I think your chart is a little off.
This line from the Heritage Foundation, from a 2007 article about the Bush tax cuts is nice:
The tax cuts have not substantially reduced current tax revenues, which were in fact not far from the 2000 pre-tax cut baseline and over the 2003 pre-tax cut baseline in 2006. (emphasis mine; if Heritage can't argue that they increase revenues, who can?)
It's a tired issue. There are beliefs, and there is reality, and we would all be better off if our politicians operated under reality.
With all due respect Ann, your anaysis ignores the possibility of a business reducing its expenses when business is slow. One good way is for the owner to work more hours and reduce his/her draw.
I have not heard of the owners of the government (read Congress and the President) offering to work more hours or cut their benefits and salary. They are happy to vacation at our expense and raise taxes to further their waste.
It's like this: taxes are revenues. Sometimes, when a business is slow, it makes sense to cut prices. But cut prices too much, and you are out of business.
I was addressing the specific statement Ann made -- "There is no evidence that cutting taxes leads to increased revenue, but everyone clings to that belief" -- and I think I have addressed it sufficiently.
There are many mistakes made by government no matter who is leading it, as you pointed out. I have little use for the vast majority of our current elected officials. However, there is little to be gained by complaining about the past errors. What must be done is to address the mess that currently exists and certainly not to compound the problem by doing more of the same.
I am reading the Chernoff biography of Hamilton on vacation and it is clear that the same partisan politics existed then that exist today. Hamilton and Jefferson had good and bad ideas and fought like cats and dogs -- there has been no change since.
Increasing the debt ceiling while making a token attempt to curtail the incredible waste and fraud currently incorporated into the spending plan (note I didn't say "budget" because there is no budget) will only make it worse and guarantee the reelection of those responsible for it by diverting our taxes to their campaigns.
So, a possible method of addressing the problem might be to hold current spending at this level rather than to quote Keynes and say we should increase the spending without removing totally the waste and fraud. Let's start with tort reform, analysis of all medicare payments and stopping the payment to politicians by unions and corporations. Eliminate lobbying while you are at it.
The above is totally non-partisan. They are all useless, but some are worse than others.
I am all for tax cuts and that is interesting data, but I do have problems with supply-side orthodoxy, especially as practiced during the Bush administration. The original purveryors of supply-side economics pointed out that it only works if 1) you keep money supply tight and 2) you keep spending level.
The Bush administration (and the Obama admin/current Congress) have failed miserably at both 1) and 2). This is why we have a disastrous situation of higher costs, less revenue, and monetary inflation. It's a cocktail for misery.
My question is: Can you ever really expect the U.S. government to curtail spending? They have never done it ever before, whether it be Republicans, Democrats or aliens from out of space. Even Reagan and his famous supply-side economics boosted spending.
For this reason, I think the policy of constantly reducing taxes can be disastrous if it goes to far (as it appears to have done in the last tax cut). You get to a certain point where tax rates are at historical lows, there are gigantic loopholes for the ultra-wealthy, and all it does it contribute to a worsening deficit situation and a potential death spiral in debt.
Case in point: Where are the rewards from the famous Bush supply-side cuts? Maybe it would have worked great if we hadn't rewarded bankers with massive bonuses for going bankrupty and started two wars at the same time.
I think a more realistic policy would be some sort of compromise that keeps taxes relatively low, but maybe generates some extra income from a complete overhaul of the tax code. And Congress has to figure out how to be discplined -- I like your idea of holding growth to inflation rates. Makes a lot of sense to me. I love how the government reduces S.S. payments below inflation but pays themselves more than inflation.
Here is a chart showing Treasury revenues since the early 1980s and I have superimposed on it the only three tax cuts since then. Perhaps it's just a coincidence, but it certainly seems that there may be an increase in revenue with a decrease in taxes.
Then, when you accept the fact that the total Treasury revenues are around 2.5 trillion and we are spending close to 4 trillion, it becomes apparent that one would have to increase the tax rate by more than 50% to close the deficit and that won't pay one dime of the debt.
It certainly seems to me that there must be some changes in spending. Just eliminating the automatic increase in the baseline from around 10% annually to the rate of inflation would go a long way without cutting one dime in spending.
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There's a relationship between unemployment and inflation. High inflation, high employment. Low inflation, low employment. Guess what you can expect with jobs these days?
For bondholders, it doesn't matter if rates go up because of default, inflation, or economic activity. All that matters is that rates are going up, and that's bad for them.
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