Bastiat's Bastions

Unless you have been laid up in bed, you are sure to have noticed that the price for gasoline has skyrocketed in the last few days, rising by about $0.25 a gallon here in south Louisiana, or about 8%.  For extra credit only to the first of my students to correctly post the right answer, explain to me, in terms of supply and demand and the factors that affect them, why gasoline prices have gone up so much so fast.

Now, gasoline prices have been trending up a bit over a much longer period, peaking finally in the summer of 2008, and then the price for fuel plummeted. 

Researchers with the International Monetary Fund, the IMF, have noticed a peculiar correlation, as reported here at the Public Radio Program, Market Watch—the very high correlation of the price of oil and the price of fine wine, like the wine from the French wine region on Bordeaux.  These two prices move closely up and down together (see also this Wall Street Journal article ), and not for the reason one might suspect–it is not because of transportation costs, as transportation does not make up as much of the price of expensive wine as it would, say, for cheap wine. 

Again, for extra credit, but only for the first to answer this correctly, explain to me, in terms of supply and demand and the factors that affect them, why oil and wine prices move so closely together, that is, why are they strongly, positively correlated?

-MC

Economists recognize a limit on government spending due to the sources for the spending for those dollars to be spent.  Economists call this limitation the “government budget constraint.”  We recognize that there is a tax to be paid one way or the other, different ways of raising the funds implies different taxes.  Some of these are up front taxes, where we know we are being taxed, while others are hidden taxes that we pay, nonetheless.

Indulge me to some simple math.  Let’s use “G” for Government Spending, ”T” for Taxes, and “D” for Deficit.  The Deficit, D, is, of course, just G-T, so D = G-T.  That part is obvious:  the part of government spending that exceeds the taxes raised to pay for that spending is the deficit (government debt on the other hand, is the deficit accumulated over the years minus the few surpluses we have had).

So, the excess of government spending over above the taxes to pay for that spending is the deficit.  A hallmark of Keynesian economics has been the idea that deficits are ok, that they are even a good thing during recessionary periods.  This approval of deficit spending by the federal government removed the moral constraint to not run deficits that had been in play for years.

Borrowing to pay deficits and taxes on capital and labor

The next question is “how do we pay for this deficit?” Well, of course, we borrow the money–we choose to increase our debt by borrowing from anyone who thinks that we are credit worthy, better risks than others at the interest rate we are paying.   We simply put IOUs (or treasury bills) up for sale. Some of the creditors or buyers of these IOUs are our own citizens, and some are not.

If we only sell our IOUs only to our own citizens, we soon have to lower the price of our IOUs in order to sell more, as there will be a point where the our citizens will start to have to take their funds from investment projects in which they are willing to invest and keep those funds in treasuries, or government IOUs.  While I will not go into the explanation in this post, interest rates and the prices of IOUs go in opposite directions, but here is a sufficient explanation from About.com.

As we drop our price to sell more, our interest expense increases.   So, as we increase the size of our debt with deficits year after year, we also drive up interest expenses for most of the debt we owe, as much of it is in short-term securities.  Since interest payments amount to part of our G, government spending, the deficit goes up at an even faster rate.

Of course, we sell our IOUs not only to our own citizens, but to all those around the world.   By selling them to those outside our borders we are able to raise more funds at the same interest rate as compared to only selling them domestically.  Still, as our debt creeps upward, we have a larger proportion of our spending going to pay the interest on this debt.  Since so much of our current debt obligations are in short-term obligations, new debt from additional deficit spending raises our interest expense on most of our debt.   As more borrowing to finance new deficits begin to push interest rates up as the default risk on these funds increases (just like a lender runs a higher risk of not getting his funds back from someone who owes ten times what they make in a year compared to someone who is now debt free, but once had a mortgage), and so, lenders must get higher rates to take the risk of making the loan.

Interest rates start to edge upward as it becomes more difficult to sell our IOUs.  Higher interest rates mean fewer business investments in machinery, equipment, factories, etc. will be worth making and less of these tools will be available for workers to use.  Less capital per worker means lower productivity for workers and less pay, as workers are ultimately paid because they are productive.  If the worker does not produce as much, the worker cannot be paid as much.

So, increased borrowing is a tax on workers and owners alike, as lower wages for workers and less capital held by owners harms both of these producer groups.  This tax is hidden from immediate view, as it is not obvious that excessive government spending is immediately coming out of their pockets.  The tag line for our blog, “what is seen and what is unseen” becomes important here, as people usually perceive taxes that they get a bill for as a tax, but they don’t see deficits as taxing them.  As Louisiana Sen. Russell Long was noted for saying, voters really mean “Don’t tax me and don’t tax thee, tax the man behind the tree.”  We are the men behind the tree.  Or, when it comes to taxation, as Walt Kelly’s Pogo said “We have met the enemy and he is us.”

Printing money to pay the deficit and the inflation tax

Now one of the tricks that governments have used in the past is to have its central bank (our Federal Reserve) become one of the creditors and buy up these IOUs.  In an earlier day, we would simply have some institution print or coin money.  Increases in the supply of money in an economy usually or eventually results in raising prices, in inflation.  If the increased money supply causes people to reduce their acceptance of the money involve as they expect the money to have a declining value,

The unstable Weimar Republic, the post-WWI German government, did exactly that, resulting in inflation rates that boggle the mind, reaching a rate of 100% every 2 days.  In other words, prices were doubling every two days for a while.

Another way of thinking about that is that a person’s savings in money fell in half every two days.  There is an often-repeated story of someone choosing between a huge prize and a penny payment that doubled every day for a month (30 days—we won’t get greedy here).  Imagine getting a million dollars in 30 days or the penny payment doubling every 30 days.  Here is a little article on that choice.   The doubling penny ends up being $5,368,709.12 in just 30 days.

Now imagine the reverse, where you start off with cash holdings of $5,368,709.12, and you face inflation of 100% every two days.  In only 60 days the buying power of your cash holdings is reduced to a single penny.  In those short 60 days, the government’s inflation policy, turning its debt into money, has taxed away over $5 million of your savings.  “My father was a lawyer,” says Walter Levy, a German-born oil consultant in New York, “and he had taken out an insurance policy in 1903, and every month he had made the payments faithfully. It was a 20-year policy, and when it came due, he cashed it in and bought a single loaf of bread.” (From the PBS series, Commanding Heights )

While everyone may try to rid their portfolios of money assets, it cannot be done for the whole economy, and so, wealth held in dollar assets falls, making us all poorer, but also making the inflation tax even higher.   As people try to protect their portfolios by buying real assets (not money or dollar denominated IOUs), we end up in a game of “who gets stuck with the worthless money.”  We spend that money at a faster and faster rate.  For instance, the German hyperinflation mentioned above led to retailers raising their prices several times a day.  Workers and their spouses soon started demanding to get paid several times a day so that the same marks were going around the economy at faster and faster rates.  A very old and well known relationship in economics is that the price level (think CPI) times the output of real goods and services produced (think real GDP) equals the Money in the system times the speed at which money circulates (something called Velocity).  Or, put another way, the growth rate in the Money Supply times the growth in Velocity divided by the growth in the economy is the growth in prices better known as inflation.  Either more money or faster circulating money will drive up prices if we don’t increase our output.

We see store owners and farmers raising prices and seldom think that it is really the government and the central bank behind these price increases, making inflation amount to an invisible tax eroding away at the cash savings we worked years to build up.

I should point out that economists recognition of a government budget constraint, that we are taxed one way or the other for all of our spending is noted in the acronym “TANSTAAFL,” standing for “There Ain’t No Such Thing as a Free Lunch,” coined by Robert Heinlein in his science fiction book, “The Moon is a Harsh Mistress.” Still earlier, David Ricardo noted the equivalence of taxing and borrowing in his 1820 “Essay on the Funding System.”

Why Do Deficits Matter?

If we are taxed one way or the other as has been shown, why do deficits matter, why should we care about deficits and running up big national debts?

Well, just as Ricardo noted the monetary equivalence between borrowing and taxing to pay for some large government expense, such as a war (Ricardo’s example), Ricardo also suggested ways that these were not the same, noting that people often fail to perceive the full costs of government spending when it is financed by borrowing, noting what has been called by one of my professors, James Buchanan, “Fiscal Illusion.”  The problem is that the taxpayer-voter seldom notices the perpetual interest payment the government must make as the same as the immediate tax increase to avoid a deficit.

Another way of putting this is that not all taxes are seen as such.  People seldom connect the inflation that they face because of government services that they receive while refusing to pay higher taxes.   People also do not notice that they have less equipment and tools at work and fewer sellers in each industry because investments were not made at some earlier time because interest rates were too high.

Taxes out of their own pockets are seen and kept to a minimum, while government benefits they get are seen and kept to a maximum.  On the other hand, stealth taxes on capital and on money holdings are not seen as payments for their government benefits or the reductions in taxes for which they themselves are liable.

So, voters ask for lower taxes and higher benefits, more spending, and their representatives oblige.  The cost of government is perceived as being very low.  When we do not see the full cost of something, we usually ask for more, just as the consumer who does not pay for the environmental costs of the products they consumer want more to be produced.

Deficits matter because they misrepresent the true costs of decisions to voters.  Voters who benefit from the spending vote for it, as it is clear that they benefit.  Voters who pay the inflation tax or the capital tax (higher interest rates) do not perceive their liabilities and do not try to block passage.  The most popular legislation, then, raises deficits.  Fiscal Illusion that plagues us, especially when we employ deficit financing of government spending, makes continued deficits more likely, as voters, more than Twist, find it easy to ask for “More, please.”

-MC

In this article from the U.K. newspaper, The Telegraph, Ambrose Evans-Pritchard writes about how increasing food prices and food scarcity, while not causing the tumult in Tunisia and Egypt, may have triggered recent riots and revolution in those countries, the straw that broke the camel’s back, so to speak.

When prices for major necessities, such as food, begin to rise sharply, people become very desperate.  While not taking the sting out of rising prices, it does help to understand what lies at the root of price changes and what social purpose prices serve, how prices both help us to conserve the food we do have and give food producers the incentive to produce more food.  International trade in food also gives merchants the incentive to move food from low scarcity to high scarcity realms, to get food to where it is most wanted and least available.

Bastiat’s compatriots in England, Bright and Cobden, worked furiously to rid the U.K. of is corn laws, which made it difficult to import food, a factor that made the Irish Potato Famine more severe.

Learning about the social role of prices and exchange really is important.

-MC

In posts as early as July of 2007, I have bemoaned the misallocation of resources as a result of poorly conceived policies by politicians to help special interests line their pockets.  For humorous effect, I have pointed out that the ethanol subsidy increases the use of corn as fuel instead of as food, and that land used for other crops, such as barley, gets transferred into land to produce corn. For instance, read these two posts: “John Barleycorn must die” and “A misallocation of agricultural resources.”

Al Gore, who has had an enormous effect of U.S. energy policy, admits in this article from Reuters http://af.reuters.com/article/energyOilNews/idAFLDE6AL0YT20101122?sp=true

that he was wrong in promoting ethanol subsidies, and that those subsidies have proven disastrous in raising food prices.  He also states that the subsidy created rent-seeking and rent-protecting lobbies that will make it difficult to eliminate the subsidy.

Gore’s excuse for promoting a poorly thought-out policy was his political ambitions for the presidency and seeking the support of Tennessee (his home state) and Iowa farmers.   While the effect  political ambition on poorly conceived policy remains long after it is shown to be bad policy, the short-sighted rush for “change,” AKA, the quick fix, turns into wonder at why we have problems elsewhere in the society.  In the case of ethanol, the wonder is why we have such high food prices.  Inflation from our ineffective quick fixes for our recession are surely playing a huge part in food prices–but only part of the problem.  Let’s hope we give some more thought and more debate to fixing our high food prices.

-MC

Lob STER WARS

On a small island off of the coast of Maine, lobstermen are shooting at each other (Lobster wars rock remote Maine island, Clarke Canfield, Associated Press Writer).  Much like urban gangbangers, they are fighting over profitable territory.  And just like their urban counterparts, the territory under dispute is “un-ownable” or for the lobstermen, un-ownable under current state laws.  But, just as with the gangbangers, they are enforcing their property rights themselves.  With both street territory and fishing territory, agreement as to ownership or property rights reduces conflict and violence. 

When property rights are under dispute, conflicts arise.  When property rights are not enforced by a more powerful authority, such as the state, these conflicts are not settled in courts with lawyers and judges, but in the streets or the seas with AK-47s or 12-guage shotguns.  This is especially costly in human lives.  It also causes people to invest in weapons and armor and shooting skills rather than in boats and fishing skills. 

The violence in the Maine lobster fisheries is nothing new.  J.M. Acheson (Capturing the Commons: Devising Institutions to Manage the Maine Lobster Fishery, 2003) discusses how gangs of Maine lobster fishermen restrict access to what they consider their territory by cutting lobster trap lines, so that they cannot be retrieved.  Ahceson notes that in areas where gangs defend their territory, the lobsters were bigger and more pounds of lobsters were caught per trap.

Property rights are the rules of the game, telling us who gets to make what decisions in what circumstances.  Different property rights result in different outcomes.  Certain property rights regimes allow who ever gets there first to rule.  For instance, open access fisheries where the fish are considered private property only after being caught, can have disastrous results.  Think for a moment about a population of fish where anyone can take whatever fish they can catch.  As long as the fish can be sold for more than it costs to catch the fish, a profit is available to fishermen, more people become fishermen, prices of fish drop and costs to fishing rise.  As more people turn to fishing and total fishing effort intensifies, the population of fish drops.  This continues until the prices drop far enough and the costs to the fishermen rise enough, that it is no longer more profitable than other ventures for these fishermen and the number of fishermen levels off. 

There is just one problem with all of this.  The fishermen, as individuals, do not bear all of the costs of their actions.  There are two distinct cost categories that we should recognize. 

One of these costs is the cost of catching or harvesting the fish.  These costs are born completely by the individual fishermen.  This includes not only their fuel, boat, and fishing gear, but also the cost of their time spent fishing.

Another cost of catching or harvesting fish is the cost of reduced populations in the future.  When the future populations of the fish drop, it becomes more costly to catch the same amount of fish.  This cost from increased future scarcity is sometimes called “scarcity costs.”  In the case of open access fisheries, this scarcity cost from of a reduced future population is borne by all of the fishermen, as a group–it is shared, so that each fisherman only faces a small part of their own costs.  This also means that all of them face costs imposed on them by the rest.

What happens when costs are borne individually is that the action is only undertaken when the benefits of the action exceed the costs.  But when someone bears only a portion of the costs of their actions, they do more of that action than they would if they bore the entire costs.   So, when fishermen harvest so much that the fish population decreases, no fisherman connects their fishing activity this year with the falling fish population and the rising difficulty of catching fish next year.  Also, each fisherman recognizes that even if he reduces his fishing this year to make fishing more sustainable, other fishermen will just catch what he did not, nullifying his individual efforts toward sustainability.  Under these circumstances, no fisherman has an incentive to cut back on fishing, and the population of fish dwindles.

While the defense of territory by these lobster gangs increases the incomes of lobstermen and moves lobster fishing toward sustainability, it could be pushed even further toward sustainability and the level of violence and destruction of traps could be brought down if Maine would follow something that we do in Louisiana with oyster production.  Louisiana leases areas to oystermen, establishing state recognized property rights.  While the state cannot always be there to enforce leases rights against encroachment (and theft), the oystermen are backed up by the state.  Anyone caught tampering with oysters on a leased bed face state-enforced penalties.  While oystermen do often have to protect their own property, they clearly have an advantage by being backed up by game wardens, sheriffs, and the courts.  They do not have to point guns as much as they would if they had no recognized claim. 

-MC

Last year, at this blog site I wrote  about the terrible drought facing Atlanta and their trouble dealing with it.  And now, after facing two years of below average rainfall, Gov. Schwarzenegger has declared a drought in California. (And see this article  on California’s problems, too.)

The availability of a sufficient supply of fresh water is getting to be a more frequent problem in the U.S. and in the rest of the world, and the problem is likely to be getting worse, not just because of global warming, though that may be a contributing factor, rather because of our institutions governing or perhaps, failing to govern the way we extract and use water from our aquifers, well water.

The financial gurus of New York and London are now seeing shortages of water as the major problem of this next century  (as suggested in this article from the U.K.’s The Telegraph), as being more of a problem than rising food prices or rising energy costs.

Our energy troubles and rising food prices are making things even worse for our water prospects.   With more emphasis being placed on agriculture for “growing” energy, the water tables, our aquifers, will get tapped more and more as many farmers continue to tap into those aquifers, our main source of pristine water, for wells for irrigation rather than for human consumption as drinking water.  

Lord Stern in the Telegraph article was right that water from aquifers is not a renewable resource and that the problem is that we have never priced water, especially water from aquifers, well water, in a way that reflects its scarcity  (by contrast, surface water is renewable through regular evaporation and condensation cycles).

Another problem with water from aquifers is that aquifers are an open-access common property resource. In legal terms, this is referred to as res nullius property rights.  Anyone can take water from aquifers and face no charge for the depletion of this resource.   As far as I know, no state charges those who deplete aquifers.   Such a charge, a depletion allowance, would be cause for farmers and others who mine our aquifers for one of our most crucial resources, water, to be careful of how they use it.   Since it is now  almost free to the user, the way that sunlight is, those who mine it pay no attention to the future value of the water, because they cannot profit by that future value—if they don’t use it now, somebody else will.    Unlike sunlight,  our aquifers are replenished at a such a slow rate that the replinishment rate is of little consequence relative to our use.    Of course,  also unlike sunlight, our aquifers have  been built up over centuries, but are being depleted rather rapidly.  

Farmers have more incentive to use underground water to irrigate fields, where much of the water evaporates, than to divert water from streams in canals or pipelines, relying on less pristine surface water.   Of course, cities and suburban residents also contribute to this depletion as well.   Some businesses, such as some electricity generating firms, are also contributing to this overuse of water.   The problem is not who is depleting it, but rather that we all refuse to face the real cost of using water from wells, rather treating it as free.   However, the more water we pump from our aquifers, the less will be available in the future.   Cities that rely on water wells will be in for a shock when they drill ever deeper and still can find no subsurface water.

This is the same problem that led to the over-hunting of the American Bison.   A hunter could not own the beast alive, but could own any bison he killed.   To the society as a whole, the bison were worth more alive, but to the individual hunter, they were only worth something dead.   Water left in the aquifer is worth more to society than water that is mostly allowed to evaporate in a field.   Farmers and otherw who use  well water  can only get value from the water they pump out of the ground rather than the water they keep in the ground.   Hence, water from our aquifers is being pumped out at alarming rates, mostly to evaporate into the air and fall as rain elsewhere.   We need to change the property rights concerning sub-surface water.

-MC

As we have seen recently, high energy prices along with rent-seeking from Midwestern farmers have prompted politicians in the U.S. to subsidize ethanol production.   This has, raised the price of corn, other crops that grow on land that could grow corn, and other crops that could serve as substitutes for consumers for corn.   With crop prices going up, farmers are encouraged to grow more and to grow more on the same amount of land, so with a high output price, the derived demand for inputs has gone up as well.   In class, we concentrated on the derived demand for labor.   Take a look at this story from the New York Times on the demand for fertilizer in Vietnam.  

Higher output prices for corn, rice, wheat, barley, soybeans and other crops has driven up the price for an important input in agriculture–fertilizer.   We begin with a surplus of fertilizer in Washington, D.C. and end up with a shortage of fertilizer in Vietnam, but we cannot seem to get rid of that fertilizer surplus in D.C. Talk about a misallocation of resources!

-MC

In this recent front page headline story in the Thibodaux Daily Comet, Landrieu calls for imported-shrimp ban, Sen. Mary Landrieu follows the lead of the AFL-CIO in calling for a ban on shrimp from Thailand and Bangladesh. The reason, the AFL-CIO and Sen. Landrieu cite for requesting a ban on importing shrimp from these countries is the condition of labor in these countries. The real reason, of course, that Sen. Landrieu wants to ban any foreign shrimp is to curry favor with Louisiana shrimp fishermen. Of course, as we know from basic consumer and producer surplus analysis, the gains of Louisiana fishermen are more than offset by losses to U.S. consumers who are being asked to pay more for shrimp while they are already paying subsidies for ethanol, higher prices for corn and other grains, and so, for meat, as well.

Of course, a U.S. ban on shrimp from Thailand and Bangladesh will only slightly depress the prices and production of shrimp from those Asian countries. But, for the life of me, I have a difficult time grasping how putting Asian shrimp fishermen out of business or reducing the prices of shrimp in those countries could ever hope to do anything but worsen the working conditions in those countries. If the AFL-CIO or Sen. Landrieu cared anything about foreign workers, they would work to increase their sales of shrimp in the U.S. Surely she would not advocate that other countries ban our shrimp, or any other product from Louisiana as a way of helping Louisianans.

What she and the AFL-CIO are protesting are the low prices that these countries are able to sell shrimp at–prices that worry Louisiana producers.

Here is a short essay written by this blog’s namesake, Bastiat, about a similar request for a ban of an inexpensive foreign import. So cheap, in fact, that the foreign supplier was giving away this cheap subsidy for domestic production of energy.

Consumers, of course, don’t speak up for their own interests because most do no realize that they are in line to be fleeced. Even if they knew, few, except for a handful of seafood restaurants are in a position to realize what is going on or to have an incentive to fight these attempts to take more money out of consumers’ pockets to buy votes for politicians, like Sen. Landrieu, who owe their offices to special interest groups such as Louisiana shrimpers and the AFL-CIO.

-MC