The problem with such programs that give something away is that people come to depend on the program, and then, more and more become attracted to the giveaway.  With increasing numbers of people depending on the program, spending goes up and up and the taxpayers are asked to assume a heavier and heavier burden.  The ranks of the dependent swell while the number of those providing the payments shrinks. 

Now it looks as if a similar problem is occurring.  Take a look at this recent report from Andrew Breitbart about the reported gasoline shortages in Egypt.  Prices of gasoline have been held down through the Egyptian government’s subsidies, but such subsidies look to be unaffordable, leaving the government but little choice to end them, meaning prices will rise.  How do you think the Egyptians will respond to a government that causes gasoline prices to double?  The new leaders of Egypt have not yet solidified their power.  Just like Mubarak, they may soon be out of a job.

As you can read in the Breitbart article, the authorities blame speculators and smugglers.  Hmm? Maybe.  What needs to be asked is “why is smuggling going on in the first place?  Could it be that the policy that keeps prices of gasoline at half of the price in a neighboring country CREATES the opportunity for someone clever to buy in one market at a low price and sells in another at a higher price?  Here is an excellent analysis of what is going on with subsidized oil in Indonesia Price differences create profit opportunities for smugglers.  They create even larger opportunities for thieves. 

So, are the smugglers causing the shortages, or are they just taking advantage of a situation that politicians set up to build and maintain support?

What we will see this term is that when it takes government edicts to keep prices low, the amount buyers want becomes high compared to the amount that sellers want to sell—the textbook definition of a shortage.

-MC

During the war in Iraq and the war in Afghanistan, some thoughtful observers noted that African Americans paid a disproportionate  price in casualties.  Michelle Alexander’s book, The New Jim Crow: Mass Incarceration in the Age of Colorblindness is about how our 30+ years of a “war on drugs” has piled up far more black than white casualties in our jails, destined more black than white families to failure.     

Well, our drug laws and their disproportionate effects on Black vs. White America is something we must examine more closely and more thoughtfully.  Our “War on Drugs” is a war we cannot win.  However, some Americans lose more in this war than others.

- MC

Well, amid Congressional disaster over the dealing (or not dealing) with the deficit problem, Louisiana Senator Mary Landrieu is doing something about these baggage fees.  You can see a news story about her proposal here.  To keep travelers from getting nickeled and dimed with baggage fees, she is proposing legislation to ban charges for the first checked bag.  While this may sound good, especially good to those who waited patiently behind me while I fought with my luggage, it really represents the rather typical lack of critical thinking by those in power in our nation’s capital. 

It does not look as if either Senator Landrieu or any member of her staff stopped to consider the consequences of her proposed bag fee ban legislation.   It should be obvious as to the reaction of the airlines.  They will just charge higher fares, and travelers, whether they checked baggage or not, will pay for checked bags, and more bags will be checked than now.  I certainly would have checked my luggage, and probably would have brought a larger bag if I could check it with no additionaly cost. 

Notice what happens with charges for checked bags–travelers packing lighter, airlines carrying less luggage, fewer baggage handlers per plane, and less lost luggage problems.  And these are just the obvious savings to the airlines from the behavioral consequences of baggage fees.  I am sure there are probably some that have not occured to me.  Some of these savings are passed on to travelers who carry their own luggage with them.   

With first bag checked for “free,” airlines will not be able to make these savings and instead of a separate charge, the fares will rise as a result.  They probably would not rise by the baggage fee, but now, travelers would not be able to save those fees.  They would not be given the option of saving some money by carrying their own luggage.  The airlines would raise fares because they would be carrying heavier loads and paying more to handle the extra luggage. 

It looks as if our costliest baggage is the lack of thinking that takes place in Washington, thinking that has given us heavy tax and debt burdens and promises that we cannot financially sustain.  

-MC

Maybe if I give them a lot of money, I could get the federal government to buy my product, a true technological breakthrough, a circular shaped object used to roll things on, something I call “the wheel.”

–MC

-MC

an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier-stage investors and to use for personal expenses, instead of engaging in any legitimate investment activity.

And, as the SEC page for “frequently asked questions” on Ponzi schemes points out, such schemes tend to collapse because

With little or no legitimate earnings, the schemes require a consistent flow of money from new investors to continue. Ponzi schemes tend to collapse when it becomes difficult to recruit new investors or when a large number of investors ask to cash out.

Recently, Republican frontrunner and Texas governor, Rick Perry, has come under attack for calling our Social Security system a “Ponzi Scheme.”   While no fan of the governor, I am not sure he is as far off the mark in his criticism of the program as his critics claim.

On one of the New York Times’ blogs, The Caucus, there was this item:

Social Security, by contrast, is a pay-as-you-go retirement system by design. Current workers and employers pay taxes that are used to pay benefits to current retirees. For many years, the program took in more money than it paid out, and invested the surplus — the “Social Security trust fund” — in treasuries. In 2010, Social Security began paying out more in benefits than it received in taxes. As more baby boomers retire, and there is a shortage of new workers, that shortfall is expected to grow.

The Social Security Administration issued a briefing paper in 2009 noting the differences between Social Security and a Ponzi scheme. “There is a superficial analogy between pyramid or Ponzi schemes and pay-as-you-go programs in that in both money from later participants goes to pay the benefits of earlier participants,’’ it wrote. “But that is where the similarity ends.”

The paper noted that a program with 40 million people receiving benefits, and 40 million people paying taxes, could be sustained forever. “It does not require a doubling of participants every time a payment is made to a current beneficiary, or a geometric increase in the number of participants,’’ it found.

Well, I guess such a retirement system could theoretically be sustained, but consider this, the average social security payment received at the beginning of 2011 was $1,177, so for 40 million workers to support 40 million social security recipients, the average worker would have to pay $1,177 into the system every month of their work life. They would have to continue to do this knowing that they are paying into the system for about 40 years, but with the confidence that they will receive payments themselves for about 15-20 years, given no change in benefits or retirement ages.    But if we assume that the person will live until he or she is 90 years old, then that  monthly payment of $1177, if invested at only a rate of 2%, would amount to about $864,430 by the time they reach 65.  If the person were to retire at 65, they could receive $3663 for every month until they reach 90, which would be a much better deal than the social security promise of only getting back $1177 per month.  How politically viable would such a social security system be?   Imagine having to pay over $1000 a month just for social security taxes.

Whoops, I forgot that there is the overhead of the social security administration to pay as well.  So let’s make that $1200 a month for each worker to pay.  Realistically, though, there is projected to be a sustained 2 workers for each retiree, so we can figure that the social security tax would “only” amount to $600 per month.  Still, while social security is popular now among those receiving payments, a large part of that popularity may have to do with the fact that current recipients get far more in benefits than they could have earned on the amounts they paid in.

But what about the social security trust fund?  Won’t that help keep so much from being paid for by current workers?  The answer there is no.  That trust fund gets spent every year by congress.  Or should I say, they have wisely invested it in safe government securities.  Ask those holding Greek government debt how safe they feel with those investments.  Government securities, instruments of our government debt, require taxpayers to pay the debt.  The system is still “pay as you go” even when taking into account the amounts that have been invested in government securities.  While I feel rather confident that we will continue to pay our debt, and that we will continue to fund social security payments, we have to get realistic about what we can expect our younger generations to pay us.

Actually, the long term problem has been discussed over the years.  In 1998 I penned an article for the Bayou Business Review that expressed some hope for the future of Social Security.

Now back then, quite a bit was done to improve funding for Social Security.  It just was not enough to keep it funded.  Already, part of Social Security funding is coming from the general fund.  Social Security may be a promise, but is it one we can really keep any more than Bernie could keep his?

-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

First is this article from Reuters on how some Federal Reserve officials are advocating inflation to affect the dollar’s exchange rates.  

Next is this article from Bloomberg on how the expectations of the Federal Reserve expansion of the money supply to increase inflation is already affecting our exchange rates with other currencies. 

With this devaluation of the dollar relative other major currencies as reported here by the Financial Times, there is the possibility that other countries will retaliate with their own devaluations (see this article from Reuters).   With no major currencies holding their value, one would expect gold to get bid up even higher. 

The US continues its fight with China, claiming that the Chinese are manipulating their currency, but ignore that man behind the curtain who seems to be pulling levers and turning knobs, just watch the Chinese currency.  Even if the Chinese are pushing their prices down, why should we in the US really complain?  This just gives us lower prices, particularly at Wal-Mart, helping the poor and the unemployed. 

At least for now, the Obama administration is taking the higher road, and has backed off of labeling the Chinese as currency manipulators.  They seem to be waiting at least until after the midterm elections in the US and after the meeting by the leaders of the “Group of 20″ in Seoul, S. Korea on 11/11/10. 

Update on this update–this just in–(10/25/2010), from Reuters and on the CNBC website: I just read hear that Germany is now accusing the US of currency manipulation, the same claim the US is about to make against China.   

Perhaps our own leaders would do well to follow that New Testament advice, to ”Judge not, lest ye be judged.”

–MC

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

-MC