I posted a rather tongue-in-cheek item on the Irish situation yesterday. Anyway, a good friend, Peter M, sent the in following to illustrate both the complexity and, in the end, the delightful simplicity of the Irish bailout. Read on.
It is a slow day in a damp little Irish town. The rain is beating down and the streets are deserted. Times are tough, everybody is in debt, and everybody lives on credit.
On this particular day a rich German tourist is driving through the town, stops at the local hotel and lays a €100 note on the desk, telling the hotel owner he wants to inspect the rooms upstairs in order to pick one to spend the night.
The owner gives him some keys and, as soon as the visitor has walked upstairs, the hotelier grabs the €100 note and runs next door to pay his debt to the butcher. The butcher takes the €100 note and runs down the street to repay his debt to the pig farmer.
The pig farmer takes the €100 note and heads off to pay his bill at the supplier of feed and fuel. The guy at the Farmers’ Co-op takes the €100 note and runs to pay his drinks bill at the pub. The publican slips the money along to the local prostitute drinking at the bar, who has also been facing hard times and has had to offer him “services” on credit.
The hooker then rushes to the hotel and pays off her room bill to the hotel owner with the €100 note. The hotel proprietor then places the €100 note back on the counter so the rich traveler will not suspect anything.
At that moment the traveler comes down the stairs, picks up the €100 note, states that the rooms are not satisfactory, pockets the money, and leaves town!
No one produced anything. No one earned anything. However, the whole town is now out of debt and looking to the future with a lot more optimism.
And that, Ladies and Gentlemen, is how the bailout package works.
Ben Bernanke, Chairman of the U.S. Federal Reserve, announced that the Fed was likely to begin to sell some of the $1 trillion in mortgages, the so-called “toxic assets,” that it purchased over the last fifteen months to help stave off a total credit market meltdown. Those purchases essentially doubled the U.S. money supply, igniting fears of potential inflation should the underlying real economy recover before the money supply could be drawn back down. See earlier post.
Well, the process of tightening the money supply may be just around the corner. And increases in interest rates and the cost of everything purchased on credit – homes, cars, durable goods, and business capital expenditures – are not far behind. Increases in interest rates dampen economic activity, an unfortunate development given the current lethargic state of the U.S. economy. But it has to be done sometime – we cannot sustain such a huge increase in the money supply without paying an even higher price in terms of inflation and a weak dollar.
It will be interesting to see who buys the toxic assets and how much they will pay. Regardless, the sale will reduce the money supply which, if done in a slow, orderly manner, is a good thing for the economy. Getting the Fed out of the business of buying and selling private market securities will be an even better thing for the U.S. economy. Now more than ever we need a monetary authority that is focused on the best policies for our economy, not those that help Fannie Mae, the White House, or the Treasury Secretary save face.
On the 10th February, I wrote an article entitled Every Economist, Mr President? No Sir! The thrust of my argument was “that the unemployment rate would have been much lower today had the stimulus program never occurred.”
That post also appeared on my own Blog and there attracted a fascinating response from Rick Rutledge. Rick’s response is worthy of a separate article, as below, together with my reply.
Sherry,
The problem with your explanation here is that it states that “government spending is funded with taxes that WOULD HAVE BEEN invested by private industry” and that “the unemployment rate WOULD HAVE BEEN much lower today had the stimulus program never occurred.” (Emphasis mine.)
This argument, it seems to me, is predicated on the conceptual fiction of a two-dimensional relationship between government spending and business investment, with taxes as the lever. That model lacks a time vector, not so much from omitting it, as compressing it. The relationship between those factors can only be simplified to this level by compressing all time into the representational plane.
That is to say that, to fairly represent the relationship between government spending and business investment (via taxation), we have to compress three presumptions into one premise:
– Past government spending that resulted in increased taxes diminishes past, present, and/or future business investment resources;
– Increasing present taxes to fund present and future spending diminishes business’ investment resource pool.
– Past, present, and future government spending without matching funding WILL, EVENTUALLY result in increased taxation, diminishing future business investment resources. (And, consequently, MAY have a chilling effect on present business investment attitudes.)
However, unless NPR has let me down (it could happen), and I’ve missed a big, breaking story about an increase in business taxes, these stimulus programs have been wholly funded by deficit spending.
Of course, it could be argued that deficit spending generally COULD (nay, should) have a chilling effect on business investment. This, together with the third presumption of the aggregate premise above (that is to say, burgeoning national debt), does create a basis for the belief that the unemployment rate COULD have been much lower today, IF a number of things had been done differently. The French have a saying: “With enough ‘IFs,’ we could put Paris in a bottle.”
To simply state that “the unemployment rate would have been much lower today had the stimulus program never occurred” strikes me as conclusory, and the sort of reasoning on which our elected officials too often rely to justify partisan and ideological positions.
Too, and unfortunately, there is a great body of evidence to suggest that business leaders have historically taken a disappointingly short-sighted approach to management, so I would be reluctant to put too many eggs into the “chilling effect” arguments.
Rick Rutledge
As a person who teaches financial literacy, I’m fully aware that sometimes there are urgent needs that justify the use of leverage (and short-term deficit spending) to deal with near-term emergencies. Credit has its uses. I’m of the belief that short-term deficit spending is not the primary (and certainly is not in and of itself) the cause for our current woes. I’m more inclined to believe that short-sightedness, whether in the form of The Quick Buck on Wall Street, or a systemic refusal to acknowledge the looming problem of the national debt, is more to blame than any single short-term stimulus program. Government spending on stimulus, OUTSIDE THE CONTEXT OF DEFICIT SPENDING, wholly evades your argument.
(But then, there may be good reason I don’t claim to be an economist – through no fault of yours, to be sure!)
Rick Rutledge
This was my reply:
Hi Rick,
Goodness. Where to begin! I simply stated my conclusion because it’s a post, and I was responding directly to Obama’s claim about what “all” economists think or say. He was misinformed or stretching the truth, and I wanted to point out that fact. So, yes, there were a lot of unstated underlying assumptions and data and studies and research and theory that I did not specify. Apparently you’ve supplied some of your own to try to deconstruct the “reasoning” or “ideology” that I might have used to arrive at my conclusion! Creative and ambitious but, alas, wrong.
You’ve ignored or misunderstood the very essence of causality: the only thing one needs to know is that business profits are the ONLY source of tax revenues to the government, and when the government takes and spends those tax revenues, they are spending dollars that WOULD HAVE BEEN RETAINED AND INVESTED by the business that created those profits and those very tax revenues IN THE FIRST PLACE, and would have then caused further profits next period. CAUSED. And it doesn’t matter whether you talk one period or multiperiod or lags. This fundamental economic fact does not change.
You bring deficit spending (the relation between this period’s G and this period’s T) and the level of debt (cumulative deficits) into the picture, both of which are entirely irrelevant to the issue I am raising and, worse yet, are the accountant’s version of business profits.
You site “evidence” that business leaders have been short-sighted (do please share some of that evidence with me — cite the source and let me have at it — it will not hold up) and use that to conclude that government spending does not reduce economic wealth? And then literally blame our current woes on the short-sightedness of business? or on national debt? huh?
You say: “Government spending on stimulus, outside the context of deficit spending, wholly evades my argument.” Not so. My point is that when the government takes a dollar of tax revenues, whether the government is running a deficit or surplus, it reduces the economic wealth of the economy relative to what it would have been had the government not taken that dollar of business profits as taxes. Very simple. Very straightforward. The plain, simple, unadorned, incontrovertible truth.
Thanks for your interest and for taking the time to write such a thoughtful, thought-provoking comment!
Learning from Dogs 