Power & Market
I wrote five years ago about the growing threat of a wealth tax.
Some friends at the time told me I was being paranoid. The crowd in Washington, they assured me, would never be foolish enough to impose such a levy, especially when other nations such as Sweden have repealed wealth taxes because of their harmful impact.
But, to paraphrase H.L. Mencken, nobody ever went broke underestimating the foolishness of politicians.
I already wrote this year about how folks on the left are demonizing wealth in hopes of creating a receptive environment for this extra layer of tax.
And some masochistic rich people are peddling the same message. Here’s some of what the Washington Post reported.
A group of ultrarich Americans wants to pay more in taxes, saying the nation has a “moral, ethical and economic responsibility” to ensure that they do. In an open letter addressed to the 2020 presidential candidates and published Monday on Medium, the 18 signatories urged political leaders to support a wealth tax on the richest one-tenth of the richest 1 percent of Americans. “On us,” they wrote. …The letter, which emphasized that it was nonpartisan and not to be interpreted as an endorsement of anyone in 2020, noted that several presidential candidates, including Sen. Elizabeth Warren (D-Mass.), Pete Buttigieg and Beto O’Rourke, have already signaled interest in addressing the nation’s staggering wealth inequality through taxation.
I’m not sure a please-tax-us letter from a small handful of rich leftists merits so much news coverage.
Though, to be fair, they’re not the only masochistic rich people.
Another guilt-ridden rich guy wrote for the New York Times that he wants the government to have more of his money.
My parents watched me build two Fortune 500 companies and become one of the wealthiest people in the country. …It’s time to start talking seriously about a wealth tax. …Don’t get me wrong: I am not advocating an end to the capitalist system that’s yielded some of the greatest gains in prosperity and innovation in human history. I simply believe it’s time for those of us with great wealth to commit to reducing income inequality, starting with the demand to be taxed at a higher rate than everyone else. …let’s end this tired argument that we must delay fixing structural inequities until our government is running as efficiently as the most profitable companies. …we can’t waste any more time tinkering around the edges. …A wealth tax can start to address the economic inequality eroding the soul of our country’s strength. I can afford to pay more, and I know others can too.
When reading this kind of nonsense, my initial instinct is to tell this kind of person to go ahead and write a big check to the IRS (or, better yet, send the money to me as a personal form of redistribution to the less fortunate). After all, if he really thinks he shouldn’t have so much wealth, he should put his money where his mouth is.
But I don’t want to focus on hypocrisy.
Today’s column is about the destructive economics of wealth taxation.
A report from the Mercatus Center makes a very important point about how a wealth tax is really a tax on the creation of new wealth.
Wealth taxes have been historically plagued by “ultra-millionaire” mobility. …The Ultra-Millionaire Tax, therefore, contains “strong anti-evasion measures” like a 40 percent exit tax on any targeted household that attempts to emigrate, minimum audit rates, and increased funding for IRS enforcement. …Sen. Warren’s wealth tax would target the…households that met the threshold—around 75,000—would be required to value all of their assets, which would then be subject to a two or three percent tax every year. Sen. Warren’s team estimates that all of this would bring $2.75 trillion to the federal treasury over ten years… a wealth tax would almost certainly be anti-growth. …A wealth tax might not cause economic indicators to tumble immediately, but the American economy would eventually become less dynamic and competitive… If a household’s wealth grows at a normal rate—say, five percent—then the three percent annual tax on wealth would amount to a 60 percent tax on net wealth added.
Alan Viard of the American Enterprise Institute makes the same point in a columnfor the Hill.
Wealth taxes operate differently from income taxes because the same stock of money is taxed repeatedly year after year. …Under a 2 percent wealth tax, an investor pays taxes each year equal to 2 percent of his or her net worth, but in the end pays taxes each decade equal to a full 20 percent of his or her net worth. …Consider a taxpayer who holds a long term bond with a fixed interest rate of 3 percent each year. Because a 2 percent wealth tax captures 67 percent of the interest income of the bondholder makes each year, it is essentially identical to a 67 percent income tax. The proposed tax raises the same revenue and has the same economic effects, whether it is called a 2 percent wealth tax or a 67 percent income tax. …The 3 percent wealth tax that Warren has proposed for billionaires is still higher, equivalent to a 100 percent income tax rate in this example. The total tax burden is even greater because the wealth tax would be imposed on top of the 37 percent income tax rate. …Although the wealth tax would be less burdensome in years with high returns, it would be more burdensome in years with low or negative returns. …high rates make the tax a drain on the pool of American savings. That effect is troubling because savings finance the business investment that in turn drives future growth of the economy and living standards of workers.
Alan is absolutely correct (I made the same point back in 2012).
And the implicit marginal tax rate on saving and investment can be extremely punitive. Between 67 percent and 100 percent in Alan’s examples. And that’s in addition to regular income tax rates.
You don’t have to be a wild-eyed supply-side economist to recognize that this is crazy.
Which is one of the reasons why other nations have been repealing this class-warfare levy.
Here’s a chart from the Tax Foundation showing the number of developed nations with wealth taxes from1965-present.
And here’s a tweet with a chart making the same point.
A reminder that most of the OECD has moved away from wealth taxes. 12 countries had them in 1990, while only 4 levy them today. Most countries found that the tax has high administrative and compliance costs, and didn't meet the goal of redistribution. pic.twitter.com/pHs7Q5ehjL— Garrett Watson (@GS_Watson) January 24, 2019
Harvard has been a leader in the economics profession for better or worse. In recent years the economics department has been viewed as relatively free market oriented where human action is seen as rational, research is guided by economic theory, and where markets work most of the time. Symbolically, the introductory undergraduate course was taught for many years by conservative economist Martin Feldstein and since 2005 by Gregory Mankiw, who could be described as a middle of the road Republican. Mankiw is also the author of the leading textbook for principles of economics, a sign of Harvard's broader influence. The faculty has several noteworthy free-market-leaning members, including libertarian Jeffrey Miron.
However, there have been big signs that things are changing for Harvard economics and not for the better. In March, Markiw wrote that he would be stepping down from teaching the principles of economics course. There has been no official replacement announced, but Raj Chetty teaches a popular alternative course called Economics 1152: Using Big Data to Solve Economic and Social Problems.
This course provides an introduction to modern applied economics in a manner that does not require any prior background in economics or statistics. It is intended to complement traditional Principles of Economics (Econ 101) courses. Topics include equality of opportunity, education, health, the environment, and criminal justice. In the context of these topics, the course provides an introduction to basic statistical methods and data analysis techniques, including regression analysis, causal inference, quasi-experimental methods, and machine learning.
This data driven approach should rightly scare traditional economists because "data driven" often results in "personal viewpoint driven" conclusions, even by professional economists. In the hands of undergraduate students there is no telling how many more crackpot progressives might graduate from Harvard or how many economics departments might be influenced in this direction.
Different members of the ECB state that effects of monetary policy on banks’ profitability have been “broadly neutral”. Many also refer to papers defending that banks lend more under a negative rate scenario.
Here is a paper they use frequently trying to say that negative rates are good, do not hurt banks and makes them lend more: Why Have Negative Nominal Interest Rates Had Such a Small Effect on Bank Performance? (Lopez et al).
The paper ignores the collapse in net income margin and ROE and even dismisses ROTE (return on tangible equity) to try to defend the idea that banks earnings have not suffered from negative rates.
Looking at Bloomberg earnings from the Eurozone banks (SX7E Index) between 2014 and FY 2018:
- Net Income margin is down 29% on average since Quantitative Easing started
- Earnings per share is down an average of 12.3%
- Non-Performing Loans reduction has been moderate, and the figure remains elevated, at 3.3% of total banking assets, an important difference compared to other economies (the US is 1.1%) but also because eurozone bank assets are much larger relative to GDP than in other economies.
- The main beneficiaries of the sovereign and corporate bond purchase program have been deficit-spending countries that have all but abandoned any structural reform as borrowing costs fell, the automakers in Germany and semi-state owned utility conglomerates. As such, the ECB QE has increased the crowding-out effect, disproportionately benefiting the indebted and inefficient at the expense of savers.
The worrying part is that these statements ignore the fact that one of the main reasons why banks’ bottom line has not fallen more is they have almost stopped making provisions on bad loans.
There is no critical analysis of the rising risk in these central bank comments. The ECB and the above-mentioned paper assume a direct correlation between negative deposit rates and lending, without considering the risk of endless refinancing of zombie loans and the higher risk for a lower return embedded in the credit growth. Zombie companies have risen with low rates, and the ECB itself acknowledges the connection between weak banks and walking dead firms in this paper (Breaking the shackles: Zombie firms, weak banks and depressed restructuring in Europe).
It is also worrying that the ECB finds no problem seeing “high yield” companies borrow at an all-time low of 360 basis points spread or that bubbles are forming in the infrastructure and housing segments where multiples have soared in recent years despite the weak growth and modest salary and unemployment improvement.
What I find astonishing is that the ECB does not even show concern about the rise in malinvestment, whitewashing of populism by artificially lowering yields on the sovereign debt of deficit countries, misallocation of capital, and the abomination of charging for deposits to lend to almost bankrupt governments and firms at extremely low levels.
Originally published a Dlacalle.com
There is a lot of confusion about the term "free market economics." It is not a matter of advocacy, but a description of what's studied. Just like labor economics is not a matter of standing up for working class interests, but a study of how labor markets work.
So free market economics is a study of how free markets (would) work. It is a positive theoretical study, not ideology. So, for instance, Austrian economics is free market economics in this very positive sense, and for good reason: in order to understand how an economy (specifically, markets) functions, one must first establish which processes are innate to markets and how they work. Only after this has been established can one introduce (theoretically) exogenous influences such as institutions (including but not exclusively interventionism).
Whoever starts with the present economy as-is finds himself in a problematic situation, because it is impossible to then separate what effects, outcomes, and orders are due to markets per se and which are due to other influences.
Markets (actually, economies) are inherently endogenous (causes are human action, which are influenced by the effects). This is also why a study of markets and economies cannot be studied inductively, because the result is just one big blob of interrelated data points.
Economists have understood this for centuries, which is why economics proper has always been primarily a study of theory.
To put it differently, there are no pure market economies in the world that one can study empirically to establish economic regularities to then apply on mixed and control economies.
In this sense, ALL economic theories must to some sense be free market economics: in order to study how economies work — what the effects of added or removed influences will be, etc. — one must first understand the pure mechanisms of what 19th century scholars called the "economic organism" (the economic aspect of society).
One can perhaps criticize economics on the ground that there are no pure economic mechanisms, that there is no economic aspect to human behavior. But experience (my own as well as economics' more than quarter-millennium-old) shows that such critiques are predominantly ideological and not theoretical.
The fact that economics proper is "free market" in the positive sense is no stranger than natural sciences using controlled experiments to separate true causes. It's just that economics is more difficult, because there is no way of constructing such experiments to capture the true workings of a complete economy, including the profit-and-loss system, real entrepreneurship, accumulation of capital etc.
To criticize economics proper, one must do better than to use one's own ideological biases to create misinterpretation of theory as ideology.
Formatted from Twitter @PerBylund
The state and its evils are but the shadow cast by public opinion, and this is why advocates for freedom and free markets put so much emphasis on education. We focus on spreading the arguments about the workings of the profit motive versus bureaucratic management, state monopolies versus free competition, international trade versus protectionism and so forth. But we also know that a libertarian is not made overnight. Ask anyone, and the tale of how they became a libertarian usually involves reading numerous books, and often having long conversations with those who are already convinced of the value and virtue of liberty. In short, going through a months and years-long conversion process of learning, reading, and overturning previous convictions and beliefs one after another.
Therefore, as salespeople of liberty, our conversion process might literally take many years to come to fruition. That should give us a pause. This is because we cannot make strides towards a free society by relying solely on the ideological war through arguments. Once again, these arguments are indispensable for the deconstruction of any statist proposition, but they seem to be insufficient for a positive program for liberty, especially one that has the potential to win over a majority in any democratic election.
The solution for this, I believe, is to put much more emphasis on the cause of decentralization. In short, we do not push for political decentralization hard enough.
To reiterate the argument for decentralization in the shortest possible form: the greater the degree of political decentralization in a given territory, the easier it will be for the populace to move if one government becomes ever-increasingly tyrannical. And as governments seek to retain their tax base, decentralization imposes a natural limit on state power.
[RELATED: "What Must Be Done" by Hans-Hermann Hoppe]
Often, the basic premise here can be phrased as follows: you and I may have different ideas about how to organize society to achieve the best conditions for all its members. If you believe that your ideas will bring about the best, most livable system, and if I believe the same about my convictions, why not put both of them to test? Instead of a top-down system of politics, why not have a competition of free cities, communities, districts, states and counties, each of them free to implement the policies they deem to be the best, and the rest, seeing the resulting increase in living standards, will be incentivized by those who would vote with their feet to follow them.
To implement the political program of decentralization requires only one simple step — a mere constitutional amendment — that can be effected in every country of the world: If the majority of the inhabitants of a village, town, district or a city express in a freely conducted plebiscite their opposition to any given law ratified by local, state or federal governments, they are to be exempt from the jurisdiction of that law.
One need not be a libertarian to see the value of such a decentralist program. Indeed, this is arguably the only program which has the potential to unite just about everyone globally, whether they be left or right, capitalist or socialist or anything in between under a single worldwide decentralist movement of self-determination to liberate every community, so they may shape their society according to their own values, instead of those imposed on them by the might of the centralized, leviathan state.
Donald Trump has not had an easy, straight-forward relation with the Federal Reserve. He has both claimed to be a low-interest rate person and accused the Fed of keeping interest rates too low for political reasons. He has also expressed regret at appointing Jerome Powell and the White House has even explored the possibility of firing or demoting the Fed chairman . Apparently, President Trump’s intention was that Powell was to keep interest rates low, and he is not at all happy with the Fed’s policy of allowing them to increase. But why, since the Fed is not immune to political pressure , has the central bank allowed rates to rise in the face of presidential opposition?
In fact, it is likely that the market rate of interest is rising — for whatever reason — and the Fed has to respond in ways that keep a lid on credit creation so as to avoid bubbles. That is, in response to rising market rates, the Fed must raise rates on reserves lest its member banks flood the economy with new loans — and with money.
This is now a possibility because it looks like there is now an increased demand for loans. After the long years of the Great Recession, private companies are finally beginning to expand business again and demand more loans from the banks. What has caused this change is not an easy question to answer. It might be that there is now less regime uncertainty. The financial crisis of 2008 ushered in an era of increased interventionism on all fronts, which is hardly conducive to a good investment climate. Now, the current administration is perceived – rightly or wrongly – to be more friendly to free markets. Investors therefore feel more confident in expanding business. Furthermore, the many government interventions following the financial crisis kept alive businesses and maintained malinvestments that should have been liquidated at the outset of the Great Recession. So, instead of a short, sharp depression it took several years before capital goods were rearranged and markets adjusted to more realistic expectations of consumer demand. One of the main causes of uncertainty was the Fed’s many interventions in the economy, and it’s decision to normalize policy in 2014 — in spite of the fact this policy is only be carried out at extremely slow speed — is one of the main reasons the market is waking up again.
But whatever the causes may be, there is now more optimism in the market and an increased demand for loans. And since the money supply is so far not expanding at a particularly fast rate (see here for the Rothbard-Salerno money supply measure), and there is no increase in the savings rate to offset the increased demand for loans, private businesses are bidding up the price of credit.
Money-supply growth is relatively low:
U.S. personal saving rate 2008-2019:
The Fed Follows Along
In this environment, the Fed simply has to follow the developments in the market and raise its own rates unless it wants to start a new credit expansion.
Hayek described this mechanism in 1929 (p. 167ff): with a greater demand for loans on the part of business, the banks, operating on the fractional reserve principle, would have a choice: raise the interest rate to equilibrate the investment demand with the supply of savings, or issue new fiduciary media at the old rates — or at any rate, at interest rates lower than they would have been had they only been set by the demand for and supply of savings. So far, the banks have refrained from issuing fiduciary media, in large part because it is still a good deal to keep reserves at the Fed (and they are in any case not yet in a position to create new fiduciary media – see below).
The following chart illustrates the point: for the longest time both the market interest rate, illustrated by the 3-month LIBOR, and policy rates were virtually flat. Then in late 2015, LIBOR started rising ahead of the federal funds rate.
Market rate of interest versus policy rates:
There is a complicating factor: the amount of excess reserves has been steadily declining for two years now. Does this not mean that the Fed has failed in its attempt to neutralize the effects of its unconventional policies and that we’re in the midst of a huge credit expansion? After all, the amount of bank reserves with the federal reserve system has fallen from a high of nearly $2.7 trillion in August 2014 to about $1.5 trillion in May 2019. However, all demand deposits are still fully backed by reserves, if only barely so, and the reduction in excess reserves has therefore not caused a credit expansion. Rather, it should be seen in the same way as a private individual who has hitherto kept a large proportion of his wealth in the form of cash but then decides to invest it. Such behavior is precisely what we should expect when the economic environment is improving and business is picking up: During financial crises and depressions, people and businesses will pile up money balances because they are increasingly uncertain about the future. And when conditions improve again, and people begin to feel more certain, they will draw down their accumulated cash balances, and either consume more or invest their funds in the economy. . (For more on this, see Hoppe’s article "The Yield from Money Held.")
The banks function in precisely the same way, with excess reserves being the analogue of increased cash balances. So long as the banks operate at or above 100% coverage of demand deposits, their lending out excess reserves can no more be seen as credit expansion than can the decision of an individual to invest his accumulated cash balance.
Reserve balances (blue) and demand deposits (red):
Prospects for the Future
This does not mean that all is well. For example, a lot of businesses (e.g., Netflix) have been financed and refinanced when the interest rate was extremely low. Will they be able to transition to an environment where debt isn’t that cheap? And just how many zombie companies have been kept alive by artificially low interest rates?
More importantly, the market rate of interest has reversed its upward trend and is now falling again, which indicates that the budding boom of the last few years is already over. While the Fed appears to be oblivious to the possibility of an economic downturn, others are not so sanguine. The American trucking industry is in dire straits as demand for trucking has evaporated, suggesting in turn that there is significantly less business activity now than one year ago. Significantly, the Fed may inadvertently strengthen the downward trend, as the spread between the market rate of interest and the Fed’s policy rates has narrowed, while the Fed has chosen to maintain current rates . This means that it is now a better investment for banks to increase their balances at federal reserve banks than to loan out money, and the data seem to indicate that they have done so, as reserve balances have increased by about $125 billion from May 1 to June 12.
Far from being upset with his central bank, then, President Trump should recognize that the Fed's lack of dovishness has allowed more market freedom in setting the interest rate in a long time. This does not mean that God’s in his heaven and all’s right with the world. If the market interest rate continues to fall without any action by the Fed, we can expect liquidity to drain fast from the market, as the Fed rewards the banks for just sitting on their cash.
To pursue a more sustainable policy, the practice of paying interest on excess reserves must be ended. To do this without causing credit expansion, it is necessary to neutralize the reserves. This can perhaps be done by open market operations, as possible Fed nominee Judy Shelton has suggested, but a different approach is preferable: now is an excellent time to enforce a 100% reserve requirement on the banks and thereby prevent future credit expansion. While this may cause some disruption to the banking sector, the negative impact can be lessened by, for instance, at the same time liberalizing the financial sector, thereby significantly reducing compliance costs and increasing the possibilities for productive investment, or by shelving all talk of trade wars and tariff increases. Once that is done, there will be no reason to keep the Federal Reserve around and it will be a comparatively easy task to eliminate the central bank and finally remove the state entirely from the business of producing money.
ZeroHedge recently reported an interesting trend occurring in the United States.
A U.S. Census Bureau map details some interesting patterns. Areas highlighted in purple, where the population is growing, are located in the West and the South. Those in orange, areas where the population is dropping are situated in the North and East. Although the Sun Belt does have considerable allure because of its weather, there are other institutional and economic factors at play.
For example, seven of the ten counties with the largest population increases were in Texas or Florida . Of note, Florida and Texas don’t feature the kind of income tax boondoggle we see at the federal level and even some anti-growth states like California.
According to the Freedom in the 50 States Index , Florida and Texas are ranked first and tenth in terms of overall economic freedom, respectively. Interestingly, North Dakota has two of the fastest growing counties in the country, McKenzie and Williams County . In the same freedom index, North Dakota is ranked sixth.
On the other hand, there is evidence that some of America’s largest urban centers are shrinking. From 2017 to 2018, New York City has seen a decline in its population. The Wall Street Journal reports that “New York’s population dropped 0.47 percent to 8.4 million by July 2018, compared with the previous year.” Although small, this could be the beginning of a negative trend as the city is starting to embark on a new path of anti-growth policies such as the Green New Deal and its insistence on keeping big spending intact .
The Chicago metro area’s population dropped for four straight years according to the Census Bureau:
“There were 22,000 fewer residents in the 14-county metro area than in 2017, a drop of 0.2 percent, and the first time since 2010 that the area’s population has slipped below 9.5 million people. Cook County, which accounts for 55 percent of the population in the metro area, lost 24,000 residents.”
This is an interesting case study of a larger macro-trend taking place in America. People are fleeing coastal areas and solidly blue states with burdensome governments for the more sleek, affordable, and business-friendly Sun Belt and Great Plains states.
That’s the beauty of competitive federalism, which allows jurisdictions to compete for the best talent and citizens. This is what helped make America and Europe prosperous over the last 500 years.
This type of competitive decentralization should be embraced and expanded upon in order to ensure prosperity for future generations.
Perhaps the most destructive premise of modern, mainstream economics is that a central bank-induced monetary/credit expansion can cause an economy to grow without adverse consequences. Let's be perfectly clear from the start: this policy has been tried by many central banks many times and all such attempts have led to economic disaster. The latest victims are the poor citizens of Venezuela, a once prosperous nation. Furthermore, we Austrian economists have sound economic science to explain why it must be so, despite the fervently held wishes of mainstream economists, politicians, and the public at large.
Born of Depression Era Keynesian economic theory which elevated "aggregate demand" as the driving force of an economy, central banks have constructed a fallacious model of how an economy works. Repeated failures of this model have served only to embolden them to double down and double down again and again, driving interest rates in some countries below zero in order to force the world to conform to their dogmatic theory. The simplest explanation of this theory is that counterfeiting money will cause people to spend and it is a dearth of spending that holds back prosperity. If people won't spend enough themselves, then it is incumbent upon government to do it for them by paying people the equivalence of digging holes in the ground and filling them back up. No, I am not making this up. Keynes himself said it! (See: book 3, chapter 10, section 6, page 129 of The General Theory).
The theory of lack of aggregate demand fails to recognize two essential facets of how an economy really works. The first is that production must precede consumption. In other words, we cannot consume what we have not first produced, and one's production constitutes one's demand either through direct or indirect exchange. This is the essence of Say's Law, which Keynes unsuccessfully attempted to refute in developing his theory of an economy driven not by production but by aggregate demand.
The second is that the structure of production is determined by time preference: the structure of production is merely all the intermediate steps that constitute production. There are fewer steps taking less overall time in an economy with a high time preference, meaning that people wish to spend most of their production-borne income in the short term. Likewise there are more steps taking more overall time in an economy with a low time preference, meaning that people wish to save more of their current income in order to have more in the future.
A simple example is that one must plant seeds in order to grow vegetables for current consumption. (Please keep in mind that what I describe is applicable for all types and levels of production.) The steps in this process are the saving of seeds from previous crops, the tilling of the soil, the planting of the seeds, the watering and perhaps fertilizing of the seeds, the spraying or covering of the young plants from the predations of birds, insects, and bacteria. You get the idea. The "structure" is the steps and the amount of production that is involved in each step. In a high-time-preference economy in which people wish to consume almost all of their crop production, saving more seeds is a waste of resources. Likewise, producing more fertilizer than is necessary for the size of the crop is also a waste of resources. Time preference is the underlying guide. However, if people are more future oriented, they will save more from current production in order to plant more crops; they will clear and till more land for the extra seeds; they will buy more fertilizer, etc. The increase in crop yields spurs a new level of production in the preservation of excess production for future consumption. The refraining from current consumption — i.e., savings — is what funds this increase in the new level of production. The preservation process takes more time, but in the end there is more to consume in the future, especially in cases of future crop failure. Think of the children's story of the ant and the grasshopper.
Substituting Money For Real Savings
Keynes thought that an economy could bypass the savings process and substitute an increase in the medium of exchange for real savings. The obvious flaw in this argument is that counterfeit money is not a substitute for saving real, fungible production. Counterfeit money is simply a watered down medium of exchange. Think of the old adage of watering down the soup when uninvited guests show up for dinner. The cook can serve more bowls of soup, but the nutritional value per bowl is less.
But monetary/credit expansion does more than just reduce the value of each monetary unit. Because the counterfeit money appears no different than existing money, entrepreneurs are fooled into believing that something real has been set aside and that people have chosen a lower time preference. With a lower interest rate level their plans for expansion appear to be achievable. Canning and/or freeze-drying facilities, for example, are constructed over a longer period of time in anticipation of an increase in sales of vegetables that may be consumed much later. Eventually the entrepreneurs realize that no such longer-term demand really exists. They have wasted time and capital, neither of which may be recovered. The workers who left jobs in businesses that served the higher time preference economy for higher paying jobs in the vegetable preservation plants must find new work. This takes time, and the ranks of the unemployed grow until the economy has once again achieved a structure of production more in tune with the people's higher time preference. Businesses lose money; the owners may even go bankrupt. Stock prices collapse. Banks may fail. Such a transition is called a recession. It is inevitable and unavoidable.
Yet it is highly likely — in fact it is almost a certainty — that central banks will fight the latest economic slowdown with the same old money printing and lowering of the interest rate. This was the conclusion drawn by Thorsten Polleit in his latest essay, published on Mises Wire: "The Fed Has No Choice But to Return to Ultra-Low Interest Rates." The Keynesians at the Fed are baffled that the world won't conform to their theory of aggregate demand. Their theory is a straightjacket from which they cannot escape intellectually. Unfortunately we all will pay the price.
In November a year will have passed since the renegotiation of NAFTA. Although this version has new guidelines, for the most part its main principle prevails: free trade is beneficial for both parties. This is true with or without free trade agreements or the existence of "fair" trade. However, as a Parametria survey published in 2016 shows, most Mexicans still don't understand the multiple benefits that these opening policies entail.
Those benefits include:
- A greater diversification of brands and categories of consumer goods (According to IMCO)
- An increase of 21.154 billion dollars on foreign direct investment and of 339.244 billion dollars on Mexico's annual exports of goods and services since 1994 (According to the World Bank)
- Indirectly strengthening libertarian principles such as globalization (the free movement of ideas, people, capital and consumer goods) and property rights. As the liberal economist Frédéic Bastiat explained in his essay titled "Communism and Protection":
Every citizen who has produced or acquired a product should have the option of applying it immediately to his own use or of transferring it to whoever on the face of the earth agrees to give him in exchange the object of his desires. To deprive him of this option when he has committed no act contrary to public order and good morals, and solely to satisfy the convenience of another citizen, is to legitimize an act of plunder and to violate the law of justice .
- A possible contribution to the reduction of extreme poverty (measured as an income interval and not as inequality — less than half of the average national income — or access to specific consumer goods and services)
In "The Role of Trade in Ending Poverty," the World Bank estimates that between 1990 and 2010 the global percentage of people living under extreme poverty fell by half. In this report they use as a reference Kraay and Dollar's article titled "Growth is good for the poor" (in which they concluded that growth benefits the poor as much as it does the typical household) in order to explain the correlation, and possible causal relationship, of multiple economic variables. Their interpretation of the data establishes that GDP growth increases both the demand for labor and real wages for low skilled jobs:
It is the strong growth of the global economy over the past 10 years that has enabled the majority of the world’s working-age population to find employment. Real wages for low-skilled jobs have increased with GDP growth worldwide
In "The macroeconomy after tariffs," after studying the economic behavior of 151 countries from 1963 to 1914, its authors concluded that each increase of 3.6% on effective tariff rate produces a productivity reduction of 0.9% in 5 years. In some cases, this increase in average productivity is not only the result of the exit of less efficient companies from the market. As Nina Pavcinik shows in "Trade Liberalization, Exit, and Productivity Improvements: Evidence from Chilean Plants," companies that survive this trade opening also experience an increase in productivity.
A little known fact is that the percentage of people in Mexico who lived below the international line of extreme poverty in 2016 (income less than $1.90 dollars per day) is lower than in 1994: 4.1% less. In absolute numbers a similar scenario also occurs: 2.9 million people less. If the poverty line is used as a measure below $3.2 per day, we observe a reduction of 4.6 million people and of 9.3 in percentage points.
Due to the particular circumstances of the Mexican case (e.g., the 1994 financial crisis, social programs such as Oportunidades, among others), it is not possible to accurately determine if this commercial treaty contributed to the reduction of extreme poverty by only using global aggregates. Nevertheless, because of or despite trade liberalization, Mexico's extreme poverty has decreased since NAFTA.
The environment of persistently low interest rates is not going to last forever. But a recent drive to change European fiscal rules assumes low rates forever, and may have dangerous and unintended consequences. So far, after years of continuous growth, many European countries have not yet tackled the issue of debt: will they be able to do better with looser and less punitive rules?
In the aftermath of the European elections, the race to describe which (different) path the European Union should undertake has started. Among those who contributed with reform proposals, we find the IMF's Olivier Blanchard, in his column "Europe Must Fix Its Fiscal Rules," explained how Europe could better take advantage of the current low interest rate framework.
According to French economist Blanchard, Europe must begin to fix its rules about public debt and public deficit to align them with the current low-interest framework, which is different to the one the rules were initially written for. Admittedly, the fiscal-arm of the European economic-policy is surely something that can be improved. Nevertheless, Dr. Blanchard’s proposals would work as a shield for fiscally irresponsible policies put in place by countries now most in need of reform. These countries —especially Italy — have been putting off these needed reforms for years, and that have largely taken advantage of the east-money policies of crisis periods to do so.
A Closer Economic and Monetary Union?
Some parts of Dr. Blanchard’s proposal do indeed raise questions. The idea of creating a larger common European budget, in fact, is the notorious third pillar of an economic and monetary union which has been missing in the eurozone framework from its very beginning. One aspect of this are ongoing demands that the eurozone change the Growth and Stability Pact to abandon the 3% deficit cap and the 60% debt/GDP cap. Regarding the debt parameter, Dr. Blanchard argues that under a low interest rate regime, the need to have such a low debt/GDP ratio is questionable. Hence, Europe must allow its member states to coordinate and carry out a fiscal expansion, either at an individual level or with a common budget financed through the issuing of the often invoked eurobonds.
The Keynesian, centrist reading of the European reality, however, does not take into account any of the concerns about the moral hazard which is intrinsic to any monetary union. Moreover, it does not take into account the recent history of the debate over the budget proposals between the European Commission and the member states. In fact, Dr. Blanchard is of the view that “The eurozone has gone so far in piling up constraints, on the assumption that governments will always misbehave or try to cheat, that the result is sometimes incomprehensible.”
On the contrary, we are of the opinion that what the eurozone history can tell us, is that if the increase in debt was contained during recent times, that was exactly thanks to those constraints and rules, since southern member states (i.e., Italy and Greece, et al) have always pushed for more debt and never for less.
Moreover, we do not understand the need for a Keynesian fiscal stimulus to push the eurozone back to its "potential level." For example, the European Commission calculated for Italy (one of the countries which would benefit the most from a loosening of the eurozone fiscal rules) a -0,1% negative output-gap for 2018 and a -0,3% negative output-gap for 2019, which they predict will close again in 2020. That considered, to increase the fiscal room of a country like Italy would mean to permanently enlarge the public sector, since to boost GDP beyond its potential level the stimulus must be perpetrated indefinitely.
The path that has brought interest rates down to the zero lower-bound has not been coincidental either, but it has been a direct consequence of the policy carried out in these years by the ECB. Thanks to those policies, which have had a Cantillon-effect backlash that have modified the relative prices of government bonds for the sake of countries with larger debts. Those very member states with troubling and urgent issues have been able to “kick the can” and ignore the risk-pricing assessments made by the market because of the protection and the extended time granted to them by the quantitative easing.
All this contradicts what Dr. Blanchard implicitly argued about moral hazard: the expansive monetary policy and consequent lowering of the interest rates — which was meant to grant time and breathing room to the troubled countries to fix their numbers while allowing them at the same time to use fiscal policy as a cyclical tool — was instead used to put off the need for decisions and reforms that was already compelling years ago, worsening those structural problems that hold to the present disappointing level their potential GDP.
To remove those rules would allow a serious situation not to become far worse. The current interest rate scenario is not going to last forever, but it will indeed change as soon as the quantitative easing of the ECB comes to an end. Removing what few restraints exist strikes us as an unnecessary hazard.