To Spend Or To Save

Robert Shiller informs us that behavioral economists are beginning to study the psychology of spending and saving.

What makes people spend money and what makes them save it? What cultural and historical factors cause a group of people to value spending or to value saving?

Shiller recommends the preliminary study offered by Princeton historian Prof. Sheldon Garon, Its title is: Beyond Our Means: Why America Spends While the Rest of the World Saves.

Shiller summarizes Garon’s thesis: “Professor Garon says that our willingness to spend is driven most prominently by our reaction to major events in our collective memory, including wars and depressions, and that it also depends on national character, which differs across countries and through time. Spending, of course, is shaped by deliberate government policies. Notably, during wartime, governments all over the world often start huge public-information campaigns to promote saving.

“The United States, however, is something of an exception. More than any other country, Professor Garon argues, it elevates consumer spending to a virtue, sometimes minimizing saving. There is even an idea here that it is patriotic to spend, rather than to save.”

Shiller adds: “Professor Garon details an attitude that Americans, more than people in any other country, have usually had about spending: we tend to think it’s O.K. for people to go into debt to buy gadgets or take vacations. According to this view, such activity will stimulate everyone’s imaginations, and ensure a vibrant economy with plenty of fresh enterprises and innovations. Americans even tend to think that debt burdens may not be so bad — that people in debt work harder to pay it off, again keeping the economic engine humming. We are relatively forgiving of personal bankruptcies, too: they provide a fresh start to allow spending all over again.

“In much of the rest of the world, Professor Garon documents, this approach has traditionally seemed morally repugnant — though until the current crisis, many people worldwide were slowly coming around to the American view.”

It is fair to say that this attitude toward spending is relatively new in American culture.

If we think back to the origin of the republic we recall Benjamin Franklin’s well-known adage: “A penny saved is a penny earned.”

You may not recall another statement, equally germane to our discussion: “The way to wealth, if you desire it, is as plain as the way to market. It depends chiefly on two words, industry and frugality; i.e. waste neither time nor money, but make the best use of both. He that gets all he can honestly, and saves all he gets (necessary expenses excepted), will certainly become rich.”

If we seek clarity we should distinguish between the man who spends everything that he earns and the other man who spends more than he has earned.

Neither of them is thrifty. The first one, however, is more virtuous than the second. The second will accumulate more debt and, since he will be less industrious, will be less likely to pay it off.

Cultures may value thrift or spending. Shiller and Garon want to know that our attitude toward government spending significantly influences our attitude toward personal consumer spending.

If the government acts as though it has a divine right to spend more than it receives in tax revenues, not merely as a stopgap measure in time of crisis, but as a way of life, then citizens will also come to believe that it is better to consume today and let the next generation worry about paying off the debt.

Some economists, especially followers of Keynes, believe that massive government spending will cure an economic contraction. Others warn that a government might arrive at the point where it  is no longer able to borrow the money needed to fund its obligations.

Keynsians like Paul Krugman are horrified by the prospect of austerity. Of course, a government may choose austerity as a policy, but, if it runs out of money and credit, the markets will impose austerity, whether the people like it or not. 

Why do so many people believe in the virtue of government spending? The source seems to lie in the commonly held belief that the New Deal spent us out of the Great Depression.

For his part Shiller, a Democrat, wants to disabuse us of the notion that America spent its way out of the Great Depression.

He explains: “The truth is that stimulus packages never entirely lifted the economy out of the Great Depression. In the United States, unemployment didn’t drop below 12 percent until World War II changed the picture.”

By now the question has provoked some very serious debate among economists and historians.

Yet, for decades journalists and historians have spun out a narrative in which capitalism was nearly destroyed by the Hoover administration, only to be saved by liberal policies implemented by FDR.

Americans were sold the narrative that the New Deal worked and that Roosevelt was the greatest of presidents. Once that happened, New Deal-like policies—as in Lyndon Johnson’s Great Society—became the gold standard for American politicians.

When you ask its supporters why the Obama administration chose to fight the Great Recession with a gigantic stimulus bill in early 2009 they will tell you that Obama was merely following the example set by FDR. If it worked for FDR why wouldn’t it work for Obama.

In this historical narrative spending was a virtue. Herbert Hoover’s efforts to balance the budget were an error.

During a time of war, however, people were told to be thrifty, not to waste resources that could be used for the troops, and, to save their money… meaning, loan it to the government by buying government bonds.

After World War II it took time for America to rebuild what it had lost during the Great Depression. Once it did, and once it achieved prosperity, saving seemed to be less important.

When the country was no longer on a wartime footing it elected a younger, more charismatic president and began to address lingering social problems by using what had “worked” during the New Deal.

The Great Society was a massive government spending program. Many citizens joined the party by placing more and more value on consumption.

Thanks to the Vietnam era counterculture young people participated, not just by spending their parents’ money, but by spending their creative and rebellious energies in protest marches and free love.

If government spending is a good thing, then consumers could do their patriotic duty by buying as much as they could, regardless of whether or not they could afford it.

Spending could save the world. Thrift would destroy it.

If we want to broaden our perspective, we should point out that people are more likely to spend money they do not have when they expect inflation. If the Federal Reserve is implementing an easy money policy then most people will correctly see that it is trying to inflate the currency.

If people assume that prices will decline, as they have in the recent economic crisis, they will be less likely to spend and more likely to save.  

When an individual or a nation has accumulated a great deal of debt, inflation becomes highly desirable and deflation becomes a mortal threat.

If central banks are trying to save the world from the debt crisis by printing money they are saying that they dread deflation.

Since inflation makes prices and wages rise while your debt service remains the same it will make it easier pay down debt.

If prices and wages decline while your debt service remains constant, your hitherto manageable debt will become the monster that ate your paycheck.

Stable prices or deflationary expectations will promote the habit of thrift. Inflation will promote the habit of spending. If you expect that it will be more expensive tomorrow you will be more likely to but it today, even, or more especially, when you have to borrow to do so.

Not only does inflation make the shoes cheaper today, but the money you borrow to do it today will be devalued by the same inflation.

To fill out this outline of the way a culture values or devalues thrift, I want to show how the therapy culture has aggravated the problem.

Keep in mind that thrift involves discipline and self-control. It does not necessarily mean putting off until tomorrow what you want today. It concerns accumulating wealth more than deferring gratification.

In the world of therapy, especially as Freud set its foundations, thrift is bad. It is associated with repression, with the unhealthy effort to tamp down impulses.

Curiously, in Victorian England spending had a slightly different slang connotation.

When Victorian writers of erotic literature used the verb “to spend” they meant "having an orgasm. In their vocabulary, "spend" was the term that corresponded to our contemporary colloquialism: “to come.”

Strangely enough, saying that someone was spent by sex makes more sense than to say that he came.

If Freudian values make sex a good thing and orgasms a form of hygiene, then it is good to spend and bad to save. We will mention in passing, but only in passing, that Wilhelm Reich took this idea to an absurd extreme.

A culture that values hookups is opting for profligate spending. If you have to get drunk in order to hook up then obviously you are spending something that you do not have.

At some point you will have to pay it back.

If the culture makes sexual spending a virtue, and if it makes government spending a virtue, then clearly it will be encouraging consumers to spend. 

The New York Blues

We have noted, with little chagrin, that America’s great blue cities are disintegrating. Whether Los Angeles, San Francisco, Chicago or Baltimore… these cities are suffering from homeless encampments, high crime and drug epidemics. In Los Angeles, typhus seems to have made a comeback.

But, now, for those of us, like your humble blogger, who live in New York City, the bell seems to be tolling. New York City and New York State have gone deep blue, and the attendant social pathologies are beginning to make their presence known. 

For many years the city was well-enough led, by Rudy Giuliani and Michael Bloomberg. Now, under the aegis of Comrade Bill de Blasio, things are beginning to take a turn toward the worst.

Kristin Tate has the story for The Hill:

Dragging business practices, skyrocketing taxes, telecommuting, and loss of special status is a toxic mix for New York. Among young people, New York is becoming passe. During recent years, both the city and the state of New York have lost residents, as waves of educated and high earning millennials have fled. In fact, more than 46 percent of New Yorkers of all ages moving out of the state are in the bracket earning at least $150,000.

The Empire State budget is in near freefall, in no small part due to lower revenue from middle class and upper class workers, while growing states like Texas and Florida are in surplus. Governor Andrew Cuomo noted a $2.3 billion hole in the state budget earlier this year, caused largely by oppressive policies that have gutted the local population and economy. More than 450,000 people moved out of New York in the last year alone.

New York is filled with rich people, says Mayor de Blasio. They can afford to be taxed. Apparently, not so much any more:

In the Big Apple, the tax burden on high earners is onerous. The local government is reliant on the top 10 percent for over 70 percent of taxes paid, with the top 1 percent paying more than the bottom 90 percent combined. Any efforts to help the most needy citizens are heavily dependent on the city keeping its reputation as a driver of the national economy. The accelerating outflow of middle class and upper class residents will no doubt tarnish that. As steep declines in revenue hit, spending cuts will burden the urban poor rather than the bureaucrats.

The current spending levels are likely unsustainable for the Big Apple in the long term. The New York City Council passed a $93 billion budget, which includes spending hikes of 6 percent for salaries, 9 percent for other employee benefits, 9 percent for debt service, 11 percent for health insurance, 12 percent for public assistance funding, and more. This local budget also set aside a new line item for taxpayer funded abortions, an army of new social workers, and even a package for the Green New Deal.

If New York continues to lose taxpayers in droves, the city will not be able to fund its current initiatives, let alone new spending increases. As the exodus further dwindles local revenue, public programs will eventually require massive cuts. Meanwhile, increased pension spending will eat up any slack the city has left. The pension plans are already underfunded to the tune of tens of billions of dollars. Retirement spending comprises nearly a quarter of the annual budget and will only continue growing.

We have seen this picture before:

Whenever push came to shove in the past, cities like Chicago and Detroit prioritized bureaucratic spending and honoring pensions over funding public programs and infrastructure. If New York takes a similar route, the people most dependent on campaign promises will be left behind. The Big Apple has been down this path before with the struggling economy and massive spending hikes of the 1970s. New York leaders overpromised and underdelivered, while moderate mayors like Fiorello LaGuardia were unfortunately replaced by increasingly radical or incompetent politicians.

Democratic politicians talk about taxing the rich as though their wealth were a bottomless punch bowl. Apparently, such is not the case:

Those very same wealthy people that politicians have demonized to gain votes are the actual linchpins for the spending largesse of progressives. Once high earners are gone, soon followed by middle class taxpayers, the promises of democratic socialism by Mayor Bill de Blasio will also vanish. Many of those who remain in New York will be those without the means to leave.

Now that Bernie Sanders imagines that he is going to tax Wall Street trading, how long will it be before Wall Street banks move their trading operations off shore? I will conclude with a recent proposal: if we want to eliminate student loan debt why not tax university endowments? 

Consumption, Spending, and Happiness

In the 19th century "consumption" was the most commonly used term for what we now call tuberculosis. At the same time "spending" was the commonly used literary term for what we now call orgasm.

That being the case, no one was pondering the question of whether consumption would make you happy. And those who were thinking that they could spend their way to happiness were too discreet to discuss the issue.

Nowadays, the country is recovering from a decades long spending and consumption binge. People are pulling back, pulling in, spending less and saving more.

Not surprisingly, we are now seeing stories telling us that this forced downsizing will make us happier than did our previous free-spending ways, but, still and all, for most people it is not fun.

It is certainly not good for the economy. As Stephanie Rosenbloom explains in her New York Times article, people have been traumatized into making debt reduction a priority over spending, and this is going to impact a consumption-driven economy negatively. Link here.

The key, however, is that this new habit has been produced by  a severe trauma. While we can rejoice in how resilient people are, truth be told, we have all, to some extent, been traumatized by the recent financial crisis, and are not likely to resolve the problems it revealed any time soon.

Voluntary or involuntary, self-impoverishment is not necessarily a good thing. When people make sacrifices they usually expect to reap future rewards for their thrift. In fact, as research has shown, you feel better with a possession or an experience that you have saved for than one that you purchase on impulse.

When it dawns on people that cutting back is not just a new parlor game, but is a way of life... I wonder how happy they will be.
Take the couple Rosenbloom reports on, Lance Smith and Tammy Strobel. Having decided that they had too much they reduced their worldly possessions to something like the bare minimum. Two people living in 400 sq. ft. feels like a bare minimum to me.

Ms. Strobel is now happier with less. She is happier with her new work than she was with her previous job as a project manager with an investment firm.

But she is also happier because she has eliminated $30,000 worth of debt. On her previous salary of $40,000 that would have been a high level of debt.

And we must add that one reason the Smith-Strobels downsized is that Mr. Smith is pursuing a graduate degree.

Is this couple happier because they are no longer living large? One does not imagine that they were living very large on a $40,000 salary.

Are they happier because they are debt free? One does imagine that this would contribute to their quota of happiness. After all, it is one thing to spend money you have; quite another to spend someone else's money. If the all of those fine objects that occupy your mantelpiece are a permanent reminder of the payments you have to make to the credit card company, this would surely inhibit their ability to make you happy.

Appearing to be wealthy and being wealthy do not provide the same degree of happiness.

As everyone knows, conspicuous consumption has gotten a bad name. It has had one since Thorstein Veblen coined the phrase in his book, The Theory of the Leisure Class (Oxford World's Classics).

Conspicuous consumption can mean many different things. Let's examine a few.

It can refer to ostentatious displays of wealth by the nouveau riche. They are, after all, an easy target. Everyone seems empowered to laugh at those who are awkward for seeming to be out of place, for not having learned the local customs.

Yet, condemning those who started with little and ended with much has long been an aristocratic sport. It implies that those who earned their way and their success are not as admirable as those who have been, as they say, to the manner born.

But, if you had to choose between a status hierarchy based on blood and one based on achievement, which would you prefer? Keep in mind that aristocrats are generally conspicuous in their displays of wealth and privilege.

Admittedly, there is a degree of awkwardness in anyone who moves up the status hierarchy, but as long as we promote social mobility we are going to have such things, so why not show more generosity of spirit to those who have earned their way up the ladder.

The other reason why conspicuous consumption rubs people the wrong way is that it contradicts the ethical notion that people should only display their wealth discretely. One must mention that people who live well beneath their means are often known to be people of considerable means.

Anyone who follows the ethic of inconspicuous consumption is saying that displays of great wealth are likely to make those who have less feel like they are less. Such displays must be avoided as a gesture of respect for other people.

Veblen's point makes more sense if we consider that some people  feel compelled to consume the most and to spend the most because they feel that they must ensure that no one treats them as though they were of lesser status.

So far, so good. In principle they will finally feel sufficiently secure in their status to avoid grandiose public displays.

If they do not, they might fall into the pattern of making consumption and spending into ends into themselves.

Which means that they will be consumed by consumption, and spent by spending. Their behavior will look like an addiction; the more they do it the less satisfaction they get from it.

And anything that separates you from other people, and that undermines your social ties will make you unhappy

Happiness, as all the recent research has discovered, involves socialization. Develop more and better friendships and you will be happier. If you spend your money on vacations or dinner parties or trips to the theater-- that is, on shared experiences-- you will be happier than if you spend it on mere objects.

Of course, buying an object can involve investment and not spending. By definition, investing and spending are not the same thing. In principle, the object of your investment will have intrinsic value that might increase over time.

Why Are They Rioting in Turkey?

Once upon a time Turkey was the great Muslim hope. The Obama administration and many others saw Turkey as a role model. Its successes showed definitively that Islamist democracy could co-exist with capitalism.

Until recently, the Erdogan regime had presided over a rapidly growing economy.

The Obama administration has been notably friendly to Turkey because it expected that Mohamed Morsi in Egypt would follow the example set by Recep Tayyip Erdogan. Heck, it even prevailed on Israeli Prime Minister Netanyahu to apologize to the Turkish prime minister.

Today, young Turks are rioting against the Erdogan regime and the old narrative no longer seems to be quite as viable.

For decades a secularized Turkey has maintained a proud separation between mosque and state. Many commentators believed that Erdogan would maintain the separation, but they have found out that he meant it when he said that he would champion Sharia law.

The protest began over some trees in a park, but it is more important to note the symbolism. Taksim Park, the site of many protests, is a symbol of Turkish secularism. Underlying the violence is the fact that Erdogan wants to build a mosque there.

A liberal democratic Turkey has increasingly felt the jackboot of Islamist repression. The Erdogan regime has been systematically silencing the free press. Reporters Without Borders called Turkey: “… the world’s biggest prison for journalists.”

Most commentaries say that young people are rebelling against authoritarian repression. There is more to it.

David Goldman has put it all in economic context. He reports that the much-vaunted Turkish economic boom was more mirage than reality.

Goldman sets the stage:

The credulity that the mainstream media display towards Turkey continues to astonish. One reads today in the New York Times of Turkey’s “booming economy and a self-confidence expressed by the religiously conservative ruling elite,” at a moment when a mass uprising betrays the weakness of the Turkish economy and the bumbling of the ruling elite. As I report in the essay below cross-posted from Asia Times Online, employment in Turkey’s formal economy has shrunk by 5% in the past year (equivalent to the worst of the 2008 Great Recession in the US) and Turkish households are cutting spending under the weight of a crushing debt burden. Western reporters who turn up for a few days in Istanbul see a lot of construction activity, to be sure — that’s because Turkey’s Islamists are spending like drunken sailors on Islamic vanity projects while the private sector is shrinking. Two things have gone terribly wrong for Tayyip Erdogan. The first is his commitment to the Syrian quagmire, and the second (and ultimately more important) is the collapse of his consumer credit bubble.

As always, Goldman’s analysis deserves special attention. What everyone has been touting as a Turkish economic miracle has really been a credit bubble:

Erdogan did not preside over an economic miracle – contrary to the credulous estimates of many Western observes – but arranged, rather the usual sort of Third World credit bubble, which has left Turkish consumers to tighten their belts in response to a devastating debt burden. “Economic troubles will dominate the political agenda, and Erdogan’s claim to leadership of the Islamic world – let alone his own country – will look far less credible,” I warned in this space April 23 (see Turkey’s ticking debt time-bomb, Asia Times Online), just before Moody’s assigned Turkey an investment-grade rating, perhaps the poorest judgment by the rating agency since it put a “Aaa” stamp on securities backed by subprime mortgages.

Currently, the Turkish economy is on life support, that is, it is being sustained by government spending:

GDP growth is close to zero, propped by a 20% rate of growth in government consumption. With government spending dominating economic activity at the margin, it is not surprising that Turkey’s inflation rate stands at 7%.

Outsiders believe that Erdogan has managed the Turkish economy effectively. Insiders know better:

Consumer debt outstanding has risen nearly 10-fold since 2006, and jumped by 40% during the past year. As I noted in my April 23 essay, it is hard to reconcile a 40% annual increase in consumer debt with a 5% annual increase in nominal consumer spending (inflation is running at 7%, so real spending is down by 2%). The data imply that Turkish consumers are borrowing enormous amounts to refinance the interest they owe on their existing debt.

Erdogan’s spending spree of 2011 has left Turks with a horrendous hangover. Banks cannot balloon their consumer loan book by 40% a year indefinitely; when the music stops, Turkish households will have to reduce their consumption sharply. Debt-burdened consumers know that this must happen sooner rather than later, and this presentiment probably helps sour the national mood.

To say the least….

Austerity or Profligacy, or Neither

It is, in many ways, the most important debate of our time. Should governments adopt a policy of austerity or should they try to spend their way out of debt?

            Austerity or profligacy… that is the question.  It is a complicated and difficult question, one that goes largely beyond my own education and training.

         

Yet, the debate bears an eerie resemblance to another one with which I am more familiar.

That would be the debate between repression and expression. Those who see increased government spending as the proper therapy for the debt crisis echo the notion that complete self-expression will ultimately be good for your health.

Austerity feels like repression. Profligacy feels like expression. According to our culture, the first is bad and the second is good.

I think it fair to say that most people have only the fuzziest notion of the realities of the current fiscal crisis.

If so, that suggests that they form opinions based on other considerations, namely those that involve cultural values.

As a nation, we no longer value thrift; we value conspicuous consumption.

If we do not have the money, we spend anyway because we have a line of credit. We might not know how we are going to pay off the cheap credit that the bank has graciously given us, but we have a childlike faith that someone, somewhere, at some time is going to come along and pay off our debts for us.

If no one will pay off the debt, we can declare bankruptcy, or default on our loans. This entails being frozen out of the credit markets, thus, being forced to live within our means.

If your lifestyle depends on your access to credit and you suddenly cannot get credit you will be forced to reduce your spending habits, drastically.

At the very least, this is painful. It can also produce self-discipline and lead to a re-establishment of your good credit and a somewhat different lifestyle.

Since our culture values people to the extent that they spend money and since it recognizes their social value in terms of the spoils the accumulate on their trips to the mall, most of us feel that living within our means will alienate us from friends and family and will cause a loss of status and standing.

Obviously, when you default on a loan, whoever loaned you the money will lose his investment. And that will affect his personal balance sheet. If he had been using the interest on the money he loaned you to sustain his own lifestyle, he will have to spend less, thus diminishing economic activity.

If the bank loaned you the money, the bank will be forced to write off the bad loan, thus to take a loss. When the next person asks for a loan the bank will refuse because it does not have the money on hand. If you use a credit line to run a business, and the banks cuts off your credit, you will no longer be able to buy materials, meet payroll, and so on. Thus economic activity will come to a halt.

The issues are easier to grasp in personal terms. They are far more difficult to grasp in terms of the world financial system.

            On the side of profligacy we have Nobel laureate Paul Krugman and the voters of France. On the side of austerity we have Angela Merkel and famed Fed watcher James Grant.

            Krugman has argued that austerity will produce a depression. If governments stop spending money government employees will lose their jobs, they will reduce their spending, and the economy will grind to a halt.

            But, profligate spending only works as long as you can keep borrowing. The Krugmans of this world want rich governments to continue to ensure the liquidity of the credit markets, thus allowing poorer governments to avoid the dread austerity.

The alternative view says that profligate spending cannot last forever, that producing more worthless money will produce so much inflation that no one will want to lend money any more.

After all, why would you accept 5% interest over a year or two when you know that the currency will inflate at a 10% rate?

On April 28 James Grant went into the belly of an organization he has called “the vampire squid,” that is, the New York Fed, to offer his views on the dread deflation. Grant argued cogently that the alternatives are ill-defined. In truth, he said, profligate spending only produces a temporary inflation. In the end it produces the worst kind of deflation.

Anyone who thinks that the choice is between austerity and profligacy has gotten it grievously wrong.

Grant argued that profligacy was instrumental in producing the worst deflation, the deflation of asset prices.

Grant argued that there are two kinds of deflation. In the first, prices decline because business becomes more productive and efficient. Prices on computers and television sets, among other things, have become drastically cheaper over time.

And yet, since central bankers refuse to accept even this level of mild deflation, Grant adds, they “monetize assets and push down interest rates.”

This is like when the bank offers you money at 0% interest for a year. It feels like free money; you feel wealthier; you take the money and you buy something; you to pay up for your purchases because your enhanced credit line is making you feel especially flush.

Thus, merchants and other sellers can charge higher prices because people have access to cheaper credit.

Of course, the time will come—it always does—when the bills come due and the debt must be paid off. At that point, the consumer’s credit dries up and the bank is burdened with non-performing assets.

The result is a rush to sell everything and anything at the cheapest possible price… short sales, foreclosures. This produces the real deflation that Grant sees the Fed  engineering.

Instead of waiting to be rescued by another Fed-engineered asset bubble, we should live within our means. For Grant that means a return to the gold standard.

In Grant’s words:

For reasons you never exactly spell out, you pledge to resist "deflation." You won't put up with it, you keep on saying—something about Japan's lost decade or the Great Depression. But you never say what deflation really is. Let me attempt a definition. Deflation is a derangement of debt, a symptom of which is falling prices. In a credit crisis, when inventories become unfinanceable, merchandise is thrown on the market and prices fall. That's deflation.

What deflation is not is a drop in prices caused by a technology-enhanced decline in the costs of production. That's called progress. Between 1875 and 1896, according to Milton Friedman and Anna Schwartz, the American price level subsided at the average rate of 1.7% a year. And why not? As technology was advancing, costs were tumbling.

Long before Joseph Schumpeter coined the phrase "creative destruction," the American economist David A. Wells, writing in 1889, was explaining the consequences of disruptive innovation. "In the last analysis," Wells proposes, "it will appear that there is no such thing as fixed capital; there is nothing useful that is very old except the precious metals, and life consists in the conversion of forces. The only capital which is of permanent value is immaterial—the experience of generations and the development of science."

Much the same sentiments, and much the same circumstances, apply today, but with a difference. Digital technology and a globalized labor force have brought down production costs. But, the central bankers declare, prices must not fall. On the contrary, they must rise by 2% a year.

To engineer this up-creep, the Bernankes, the Kings, the Draghis—and yes, sadly, even the Dudleys—of the world monetize assets and push down interest rates. They do this to conquer deflation.

But note, please, that the suppression of interest rates and the conjuring of liquidity set in motion waves of speculative lending and borrowing. This artificially induced activity serves to lift the prices of a favored class of asset—houses, for instance, or Mitt Romney's portfolio of leveraged companies.

And when the central bank-financed bubble bursts, credit contracts, leveraged businesses teeter, inventories are liquidated and prices weaken. In short, a process is set in motion resembling a real deflation, which then calls forth a new bout of monetary intervention. By trying to forestall an imagined deflation, the Federal Reserve comes perilously close to instigating the real thing.

 

The Coming Inflation

For further edification on the state of the current economy we turn to Stanley Druckenmiller, notable hedge fund billionaire. A few days ago we looked at the views of money manager extraordinaire, Jeremy Grantham. Today, we can refer to a Zero Hedge report about a Druckenmiller appearance on MSNBC. 

He, like Grantham and Larry Summers, is most concerned about inflation. So much for modern monetary theory. Druck remarks that inflation is a tax on the poor. So, naturally, it makes sense that a Democratic president and Democratic Congress would be supporting it:

Moving on, Druck pointed out that the biggest economic crises of the last 100 years have largely been caused by asset bubbles and inflation. "Inflation is a tax the poor can't afford or avoid," Druck added.

Any further stimulus spending is intended to fix a problem that, in Druck's words, "doesn't exist anymore." 

So, the current Democratic infrastructure spending plan would do nothing more than-- hold your breath-- destroy the American economy. When the economy is doing very well, the worst thing you can do is to spend aggressively. Tell that to AOC. Keep in mind, the man leans left politically:

He added: "If I was Darth Vader and I wanted to destroy the US economy, I would do aggressive spending in the middle of an already hot economy."

"You usually get a bubble out of that, and you get inflation off of that. Frankly, we now have both. This is the biggest bubble I've seen in my career."

So, Druck wants Democrats to delay their infrastructure spending plan. 

When Druck added that he would prefer Dems postpone their infrastructure spending plans (even though he said he supports many of the provisions of the Demcoratic plan, including improving high-speed infrastructure access in rural areas), Ruhle interjected. Poor people don't care about bitcoin crashing, since they don't own that much bitcoin (or stocks) anyway. But the infrastructure plan will help all Americans, especially those with the fewest resources, Ruhle argued.

Stephanie Ruhle was the MSNBC interviewer. Clearly she was in way over her head.

Druck responded:

"I dont think we need to do anything, we need to take a step back, take a breath and see where we are...I think any net spending is a problem. I love a lot of stuff in the infrastructure plan particularly the investments in the digital infrastructure. There's a lot of other stuff im okay with."

As for Ruhle’s notion that only the rich would be impacted by a market crash, Druck corrected her poor understanding of economic history:

First of all, Druck argued that the growing retail exposure to equities means a market crash will impact main street even more quickly this time around.  And even if they own no financial securities or crypto assets, they will still be impacted by the economic declines, as Druck explains: "It's going to cause a financial crisis, it's going to cause inflation and nothing is going to hurt the poor more than that."

It’s worth your attention.

The Case against the Biden Tax Hikes

Having noticed that the government budget is running obscene deficits, that the national debt is expanding beyond our ability to pay, and that spending money on infrastructure is very popular, the Biden administration has proposed new tax levies-- on rich corporations.

It is part of the administration plan for a flood of new infrastructure spending-- almost as a way to pretend that we are going to be able to pay for it.

Other states and municipalities are also going into the tax raising business, though with slightly less fervor.

Taxing the rich, especially rich corporations, plays well politically. It is better than taxing the average Joe or Jane. And yet, how effective is it? How much will it really forestall the need to increase taxes on transactions that involve the middle class.

In principle, Republicans oppose tax hikes, because they are ineffective. And yet, the GOP seems barely to be capable of explaining why they are against tax hikes.

Since I posses no expertise in this area, I turn to David Rosenberg, Canadian market strategist extraordinaire. I posted about some of his views of the markets and readers seemed to be happy to read them. No one said that he or anyone else is always right, or always wrong, but he presents a more cogent argument against tax hikes than your average Republican has. And, of course, he is highly respected by Wall Street bankers-- for what that's worth.

Rosenberg begins with a comment on the Trump tax cuts, especially about where we were before the Tax Cuts and Jobs Act was passed. In short, we were not in a good place:

It helps to understand where things were before the 2017 Tax Cuts and Jobs Act (TCJA) was passed. At 35 per cent, the headline U.S. corporate tax rate was much higher than the Organisation for Economic Co-operation and Development average of 24.2 per cent. Just as important was the unique absence of an exemption for repatriated foreign business income: U.S. multinationals were keeping billions of foreign profits offshore.

You will recall that this was an important argument for lowering corporate taxes. Billions of dollars would be repatriated. You will note that Biden proposes to tax overseas funds, regardless of whether they are repatriated.

We know that following the Trump tax cuts year-over-year capital spending rose eight per cent in 2018, one of the best years of the past cycle for capital deepening. A reversal of the cuts could have the opposite effect.

Get it-- reversing the Trump tax cuts would diminish capital spending and investment.

And yet, the investment boom soon petered out. Some companies chose not to increase capital investment, but preferred to buy back their shares:

However, the impact of the TCJA was temporary (many tax planners knew even at the time that the 21-per-cent corporate rate was unsustainable), with capex fading the following year even before the onset of the pandemic, to just two per cent in 2019. Some of the windfall also went to share buybacks, which skyrocketed temporarily to a high of US$223 billion for the S&P 500 in Q4 2018 from US$137 billion in Q4 2017.

As for Biden plan, Rosenberg continues, raising corporate taxes will surely have an unwelcome side effect-- lower corporate investment. Businesses hate uncertainty and they are less likely to invest when they do not know what their future taxes will look like:

However, the problem with tinkering with corporate taxes is that it creates uncertainty for businesses embarking on multi-year projects. What business is going to embark on a major multi-year spending project without knowing what the after-tax rate of return on the capital invested is going to look like?

What would happen if the Biden plan goes into action. Not much that is very good. America would become the highest taxed country in the OECD, and this would decrease our competitiveness:

As well, the proposal, as it stands, would raise the U.S.’s combined corporate income tax rate to 32.3 per cent from 25.8 per cent, positioning the country as the highest tax jurisdiction among OECD countries and decreasing U.S. competitiveness. The impact could be a short-term freeze in capital expenditures, particularly as companies hold off during the months of negotiations that will no doubt ensue as G-20 countries work towards a harmonized tax plan.

Rosenberg explains that raising corporate taxes will not have much of an effect on the budget deficit. After all, corporate taxes contribute very little to the government’s budget:

There is still quite a bit of negotiating to be done on this file, even within the Democratic party, but the Treasury’s estimate of raising US$2 trillion from the final package of reforms seems far fetched and, of course, will be affected by unknown behavioral effects. It’s also important to remember that corporate income tax contributes a relatively tiny amount to governments’ bottom line — maybe five to 10 per cent at best. History shows that to be very stable whatever the rate and whatever the base. There is no way the corporate tax changes will pay for much in the way of infrastructure.

So, it’s a grand illusion. The Biden tax plan will not even come close to paying for the infrastructure spending it is proposing. In the end, Rosenberg concludes, America is going to be faced with the prospect of a new consumption tax or a value added tax-- tax that disproportionately hurts those of low and middle income. 

Of course, we can also deal with the debt by inflating the currency or simply by defaulting. 

Living in Deflationary Times

A parable for today: Imagine a teenager who borrows his father's credit card to go out and binge. He might binge at the mall or in a bar or in a house of ill repute. The next day he wakes up feeling awful and he swears he will never do it again.

Has he discovered the error of his ways? Has he taken a step on the road to virtue? Has he changed his attitude? Should we expect a new reign of discipline and thrift?

One is tempted to answer these questions in the negative. Before doing so, let us raise the most pertinent issue: who is going to pay for the binge?

Most likely, the burden will fall on his parents. Assuming that they can. But what happens if his parents cannot or will not pay for their son's profligate ways?

It had never crossed this teenager's mind that his behavior might have a price; now he has just discovered that it has a very high price, and that he is going to be saddled with the bill.

At that point, we can say that this youth will come face-to-face with the prospect of virtue. Not so much by choice, but by necessity.

If he is willing to pay for his irrational exuberance he might very well learn virtue. He may actually come to like it.

Unfortunately, that is not the end of the story. If this young man plans on paying for his binge by going to college and getting a job, he will be depending on the state of the job market. Not merely the availability of jobs but the prevailing wage level.

In a deflationary environment, when wages are decreasing, the burden of debt will become increasingly difficult to bear. Even with the best intentions, this teenager might well be spending most of his life, dedicating most of his labor, to pay off credit cards.

But that means that he will be spending less than is normal for someone his age. Less spending means lower prices. Lower prices mean falling wages. Deflation functions like a vicious circle, a circle that is feeding on itself.

Now this young man is going to spend a goodly amount of his time working to pay off old debts. Will this make him optimistic about his future? I think not. Perhaps he will learn to make do with less, to live more frugally and to lower his expectations, but these are adaptations, not reasons to rejoice.

I invented this example to offer something of an explanation for a major shift in the behavior of Americans. This shift is not coming from the depths of anyone's individual or collective psyche. It is being imposed by reality. It has nothing to do with bad parenting, childhood trauma, or repressed unconscious wishes.

And this does not describe recession economics. In a recession we hunker down and wait for the storm to pass. Once the storm passes things revert to normal.

In a depression, however, once the storm passes we have nothing left. With depression economics paying down debt is going to cause a severe economic contraction that will make the burden of the debt that much more onerous.

So says David Rosenberg.

While most people are comfortable calling our financial crisis the Great Recession, Rosenberg argues persuasively that we are at the beginning of another Depression.

Formerly at Merrill Lynch Rosenberg is now the Chief Strategist and Economist at the Canadian firm, Gluskin Sheff. From his perch up North he sends out eminently readable and sensible daily e-letters that give us his take on the economy and the markets. Here is a link to today's e-letter.

In today's letter it Rosenberg suggests that the current economic crisis is a "depression" that is producing a marked effect on behavior and attitude. It has produced a sea change in the way people relate to their spending and savings decisions.

But Rosenberg also cautions us not to be very optimistic about the political response to the crisis. In his view the increasingly parental state is trying its darndest to ensure that young teenagers who went on a binge-- or adults who simply assumed levels of debt, mortgage and other-- should not have to pay it all back.

Apparently they feel that if people do not have to face the consequences of their actions, if they still feel that there is some parental agency that is going to bail them out, they will not have to change their ways, and thus, will be more likely to vote for the politicians who have saved them from virtue.

And, why would they not? Several generations have absorbed the nostrums prescribed by the therapy culture. Surely an inflationary environment told people that it was smart to take on debt and to spend more today. In such an environment, wages always rise and prices always rise. If your debt burden stays constant, inflation will always bail you out.

But it is not just about spending money. Once the culture adapts an attitude, people apply it to other areas of their lives. People do not limit their spending to shopping sprees, but extended it to emotional and even sexual expenditures.

These were all considered to be supremely good things. The therapy culture encouraged them as contributing to good mental health. Unfortunately, no one really asked whether we could afford the binge, and what the price would be.

Swedes against Climate Change Spending

In Sweden, home of climate change truant Greta Thunberg, the government spends a goodly amount of money on climate change initiatives. One would hope that they get around to taxing the middle class to pay for their grandiose illusions. Then they could have yellow vested protesters marching in the streets.

Now, Breitbart reports that Swedes believe that climate change spending is the biggest waste of taxpayer money.

Another great lesson for our dewy-eyed politicians:

The Swedish public has voted that climate change spending has been the biggest waste of taxpayer money in 2019, according to a poll by the Swedish Taxpayers’ Association.

The Taxpayers’ Association released the results of their annual wasteful spending poll earlier this week, declaring that climate policy had been the biggest waste of money, largely due to the fact that despite the spending, emissions in Sweden had actually slightly increased.

In 2014, the Swedish national government spent 5.2 billion Swedish krona (£419 million/$547 million), a number that has more than doubled to 12.6 billion krona (£1 billion/$1.3 billion) for the planned 2020 budget.

“The government has more than doubled the appropriations for climate policy, but despite this, emissions no longer decrease. In 2018, emissions even increased. That is why climate policy has been voted the worst waste of the year,” Johan Gustafsson, Waste Ombudsman at the Taxpayers’ Association, said.