Back to the 60s

Ed Comment:”I’m reacting to both of these at first blush off the top of my head with a quasi-random steam of thoughts. I would love your reaction. I may write this into an op-ed, although it would take a lot more work. Sorry for the typos, I am just banging this out. …and I am very dyslexic. You might want to read the Mason and Cochrane in the thread below first. I don’t think that what the Dems are doing has anything to do with economic theory. It’s just political power. …and wishful thinkers on both sides of the debate justifying their side’s view by over and understating the risks. There is plenty from both Mason and Cochrane to agree and disagree with. But both overlook critical issues. I love Cochrane, but occasionally find that his perfect information/competition/rational POV falls short, even if it is always a side of the argument worth considering. He doesn’t make those mistakes here. Instead, like most economists on the right, his logic largely applies to a 1970-style capital-intensive manufacturing economy with limited international trade, that’s largely constrained by domestic savings and blue-collar labor. Since then, we seem to have eases inflationary pressures by accessing a seemingly unconstrained supply of cheap offshore labor and savings combined with previously restrained monetary policy and now, perhaps clever but surely misunderstood, monetary policy that uses increased regulatory powers, albeit perhaps not explicit, to lock up monetary surpluses as excess bank deposits It’s harder to imagine inflation under these circumstances. Proponents of increased borrowing, like Mason, may be right that we can borrow without constraint, but they are surely driving the car looking in the rearview mirror without differentiating between the one-time expansion of these constrained factors of production and limits we may encounter in the future. Interest rates declining in the face of increased borrowing is not, on its own, evidence that borrowing won't matter in the future. It's not hard to imagine adverse shifts in the supply and demand for savings. The world’s demographics are aging into retirement, especially those of the surplus savers/exporter, chiefly China, Germany and Japan. Europe and Japan’s low fertility and China’s one-child policy exacerbates their demographic shift. That should increase consumption and reduce savings. The Chinese are gradually consuming more regardless. Africa, South America, and South East Asia seem unlikely to replace the surplus savings of brilliant China, Germany, Japan, and Korea. German manufacturers are gradually growing less competitive, as is the rest of Europe, as evidenced by their lower equity multiples. They haven’t been able to transition their industries to the production of information and information technology successfully as the US has. That should pressure profits, prosperity and future savings. American tech companies have spewed profitability and excess savings but are under attack by government regulators across the globe. Regardless, the productivity of research seems to be slowing down, although we may capture some value if the rest of the world, chiefly China, starts to contribute its fair shar. Pay down of domestic mortgages increased the supply of savings after the financial crisis, but that trend seems to be reversing. US investors are likely to be taxed more heavily. And America’s demographics are gradually shifting toward lower-skilled consumers. Mitigating global warming and a growing Chinese military threat could increase demand for capital. Rising interest rates could reduce sky high financial asset multiples, reducing the apparent value of collateral, increasing the risk to lenders, and subsequently increasing real interest rates. In effect we grew assets without needing to grow investment proportionally. Not having to borrowing as much to grow investment, we were able to borrow to increase consumption. That seems unlikely to continue.That said, historically unanticipated creativity has always led to over performance. Although that many not be true if the pond is getting fished out.Neither Mason nor Cochrane raises any of these issues. Without them, it’s hard to take their macroeconomic analysis seriously. As I often say, generalizable chess theory won’t take you very far. You must also carefully study the ever-changing circumstances on the board. So, it’s not hard to imagine a scenario in which future generations wish we had spent the borrowed savings more wisely—to mitigate global warming for example rather than stupidly letting my already pretty prosperous 83-year-old mother-in-law further increase her consumption. Future generations will simply complain that they need more money (ie reallocated production) to mitigate warming rather than blaming Dems for this bout of wasteful consumption. When are children are paying higher interest rates on a lot more debt and demotivating their brightest people with decades of high taxes and lower asset values, at least they won’t have an I-told-you-so counterfactual to compare their “new normal” to. It’s true the government can print money, and savers may not be asking for enough compensation to bear that risk. But it’s also the case that pursuing that strategy in the future, while perhaps more optimal than not, will nevertheless increase the cost of borrowing. Unlke the private sector, when the government borrows and spends by fiat, it distorts the allocation of resources.If it cuts taxes on the payoff for successful risk-taking, it might spur a gradual increase in risk-taking. But increased risk-taking occurs gradually over a long period of time because mining the technological frontier is harder and more complicated than just adding resources. It’s hard to get ultra high-skilled people—the binding constraint to growth today—to switch careers and take new/more risks with their careers. They likely won’t take those risks until they get the necessary on-the-job training and find valuable ideas from years of mining the frontier—both of which are critically important to reducing the risk talented people fear most—missing out on the cushy life they can have without taking much risk at all.For the same reason, we can always raise taxes and increase prosperity in the short run. California can tax the multiplier on the productivity Silicon Valley creates for its workers. Higher taxes obviously reduce the pool/distribution of viable investment opportunities. But a slightly smaller pool has only a gradual effect over a long period of time. Similarly, it’s not as though Europeans would start taking risks tomorrow if they cut their tax rates. Without decades spent gradually building companies like Google to mine the technological frontier, they don’t currently have a wealth of investment-worthy ideas no matter the tax rate. The issue is whether a positive feedback loop gradually takes hold, like it has in the US, and the most capable students eagerly become failed technological innovators rather than do-nothing professors. If, on the other hand, the government gives low-skilled workers money for increased consumption, it demotivates many of them to work. Work sucks for most of those workers. No surprise, over time lower-skilled workers have worked less as they have grown richer and consumption/leisure has grown cheaper and better. Giving them money increases the cost of employing them. In effect, when we borrow money and give it to low-skilled workers we have a choice: hire a domestic worker at a high wage who charges a lot to save, or an offshore worker who does the opposite. Fiscal deficits largely “stimulate” surplus exporters. How? Surplus exporters loan us their risk-averse savings. We underwrite the risk of guaranteeing the return, via government guarantees, and by using the borrowed savings to fund risky consumption rather than investment that would grow the economy enough to pay the interest on the loan. We consume our finite willingness and capacity to bear risk. By borrowing against our collateral, we turn their debt into equity and use it to stimulate their economy, not ours. That said, Americans, often ones who aren’t working, get to increase their consumption without working more. The cost of this consumption is foisted upon future Americans as future interest payments that decrease future consumption. Young people are naively/stupidly liberal. Now I think Keynes was right and Lucas was wrong. The private sector doesn’t logically dial back risk-taking 1:1 to compensate for the risks they are underwriting via the government. Until the risks materialize, we appear to get a free lunch. That’s the beauty of risk-taking. It’s substantially cheaper as long as the risks don’t materialize. However, Ricardian equivalence probably grows as debt grows relative to GDP driving down the value captured by current generations. Leaving aside secondary issues, we spend a dollar of future prosperity for less than a dollar today and the rest of the world captures most of any multiplier over and above the dollar. Again, that might be ok if we were spending the dollar wisely, but we’re not. BTW this is the logic behind the infrastructure investment argument. Sadly though, you mistake a good idea in theory for one that sucks in reality by the time the NYC subways cost multiples of what they should and politicians spread the pork like peanut butter to unproductive investment. And this exposes another flaw in Mason’s and Keynes’s logic. While some downturns may just be peculiar anomalies of animal spirits, many recessions surely result from real failures. Flooding an inherently unstable banking system with risk-averse offshore savings for example, increases the risk of a bank run. But until it occurs, the economy grows faster than it should have. Taking risks accelerates growth, but not without increasing volatility. You don’t get peaks without some valleys. In general, the economy grows faster because it takes risks it fails to recognize. It’s true the economy is probably like a rodent that wanders further and further from its den when it doesn’t encounter danger, and then overreacts and scurs back with it does, only to start its search all over again. But its also the case that every newly encounter threat/risk/shock, shows us the error of our ways, which demands a reallocation of resource—from subprime consumption via subprime mortgages, to a new allocation of savings. That reallocation takes time, failed experiments, innovation, etc. When the government spends money by fiat, it may temporarily sooth the pain of displaced workers, but only by slowing and postponing the reallocation process by diverting resource to yet another misallocation. Like so many economists, Mason only sees the economy statically, as if it merely needs to return to what it did before. Were that the case, most recession would never occur. He doesn’t see that we have to change quickly to stay in place. An underestimation of all the factors I have raised makes it seem as though borrowing a lot of money from offshore savers to buy their production for a one-time increase in our consumption today has less cost in the long run than it surely does. Policy decisions are largely the byproduct of mistaken analysis of a world too complex to analyze, and the overwhelming power of wishful thinking to justify the conclusions we seek. Surely that’s the case with the $1.9 T. Random mutation and survival of the fittest are the only processes likely to find optimal solutions in complex circumstances, like the economy.”

J.W. Mason, “It really does seem that on the big macroeconomic questions, our side is winning.”

Cochrane, “…I have noticed the same thing. Few Republicans mention the idea that today's spending has to be paid by tomorrow's taxes, and consequently today's stimulus must be repaid by tomorrow's prosperity. His "side" won. Until the well runs dry. (I also resist the assertion that economics must have political "sides," rather than an objective truth.)But my interest in this particular post is to think about what it says about how thinking about economic policy is shifting, and how those shifts might be projected back onto economic theory…”