Government Spending Cuts And Fallacious Keynesianism

As the so-called "fiscal cliff" approaches, can we count the number of articles foretelling grave economic harm from the impending cuts in government spending?  (Of course, the "fiscal cliff" involves much more of tax increases than spending cuts, but that's for other posts.)

Here's John Crudele in today's New York Post:  "[Either the Republican or Democratic prescription] will result in less spending.  And less spending -- no matter where it's cut from -- will tip an already fragile economy over the edge."

From MediaMatters in September:  "[E]conomic experts agree that cutting spending during weak economic growth damages recoveries and depresses employment."

From the [execreble] Paul Krugman of the New York Times in October:  "Recent spending cuts appear to have done even more harm than most analysts -- including those at the I.M.F. itself -- expected."  (Did you realize that the U.S. government had undertaken "recent spending cuts"?  From what possible set of data can that statement come?)

I could go on, but you get the point.

Those authors speak like they know what they are talking about, but they are completely, totally wrong.

What's the actual evidence in the U.S. economy from massive government spending cuts?  Perhaps you think that the U.S. government has never actually undertaken massive spending cuts within a short period of time.  You would be wrong.  It turns out that the Federal government cut its spending by around 50% or more within a short period twice in the twentieth century, once in 1944-48 and the other time in 1921.  The result both times was a spectacular boom.

Here's a great article from June 2012 by  economist David Henderson about what happened after World War II.  Key quote:

In a 2010 study for the Mercatus Center at George Mason University, I examined the four years from 1944, the peak of World War II spending, to 1948. Over those years, the U.S. government cut spending from a high of 44 percent of gross national product (GNP) in 1944 to only 8.9 percent in 1948, a drop of over 35 percentage points of GNP. The result was an astonishing boom. The unemployment rate, which was artificially low at the end of the war because many millions of workers had been drafted into the U.S. armed services, did increase. But between 1945 and 1948, it reached its peak at only 3.9 percent in 1946. From September 1945 to December 1948, the average unemployment rate was 3.5 percent.

Henderson points out how the disciples of Keynes, most notably Paul Samuelson, predicted disaster would occur when the war ended and were proved spectacularly wrong.  Henderson quotes this prediction of Samuelson from 1943:

[W]ere the war to end suddenly within the next 6 months, were we again planning to wind up our war effort in the greatest haste, to demobilize our armed forces, to liquidate price controls, to shift from astronomical deficits to even the large deficits of the thirties—then there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has ever faced.

The spending cuts of 1921 tell the same story.  Here is a good article from the Mises Institute in 2009.  Note that, unlike the post World War II cuts,  the 1921 spending cuts did not immediately follow World War I, which had ended in 1918.  But President Woodrow Wilson kept the government spending inflated at wartime levels.  By 1920, the economy was in depression, with 12% unemployment.  In 1921, new President Harding's prescription was to cut government spending in half.

Instead of "fiscal stimulus," Harding cut the government's budget nearly in half between 1920 and 1922. The rest of Harding's approach was equally laissez-faire. Tax rates were slashed for all income groups. The national debt was reduced by one-third.

Result:

By the late summer of 1921, signs of recovery were already visible. The following year, unemployment was back down to 6.7 percent and it was only 2.4 percent by 1923.

And then came the Roaring 20s!

What we have going on is a delusion that I call Fallacious Keynesianism, to be distinguished from real Keynesianism.  I have my disagreements with real Keynesianism too, but Fallacious Keynesianism is completely unsupportable, and, to his credit, Keynes himself recognized that and distinguished his theory from the Fallacious variety.  Nevertheless, essentially all of mainstream media, government, and the liberal commentariat has fallen completely for Fallacious Keynesianism.

The essence of Fallacious Keynesianism is that government spending increases the economy as measured by government GDP statistics, whereas cuts in government spending decrease the economy as measured by those statistics.   Therefore Fallacious Keynesians advocate increasing, or not decreasing, government spending in all circumstances.

To understand the fallacy of Fallacious Keynesianism, you must understand that the government economic statistics, such as the measure of GDP, do not have any good way of measuring the benefit or harm of government spending.  They simply assume that a dollar spent by the government is of equal value to a dollar spent in the private economy, theorizing that if the people choose to make this expenditure through the government they must find it to be of equivalent value to the private alternative.  This assumption is probably reasonable when the government is a small part of the economy.  When the government becomes a large part of the economy and spends vast amounts on wasteful things, the assumption breaks down completely.

Keynes himself in the General Theory considered the obvious example:  suppose the government pays everyone to dig holes and then fill them back in.  Everyone will work hard all the time but will starve.  Meanwhile the government GDP statistics will count the payments to the laborers as of equal value to what they could have produced in a private economy.  If the government cuts spending on the hole digging and filling, its GDP statistics will initially record a decline until the laid off workers find new employment in the private economy. But output of any real value has not declined, and only by cutting the wasteful spending can the resources of the economy be unlocked to produce real wealth in the private economy.

The simple lesson is that excessive and wasteful government spending is harmful, and if government GDP statistics do not initially show a benefit when the spending is cut, that is a defect in those statistics, and does not mean that the economy is not harmed by wasteful spending or benefited by cuts.

I was thinking of trying to explain real Keynesianism, but this post has gotten too long.  Try reading the General Theory.  It is really impenetrable.  My takeaway:  even if there is any real benefit from real Keynesian government spending, it can only work over the shortest term, in trivial amounts, and will always be co-opted into Fallacious Keynesianism by corruptocrats.

It's Good To Have An Infinite Credit Card

The alarming figure of $16 trillion for the debt of the United States has been much in the news.  That's the amount of actual bond debt outstanding, now somewhat exceeding the entire GDP and growing rapidly.  But aren't there also contingent liabilities out there?  For those who don't know that term, that is the amount that the Federal government has guaranteed, or insured, or otherwise put its credit behind, although not yet actually spent.  It's not so easy to come up with any kind of comprehensive numbers, but I'll make a start.  Also, I'll save the big ones (Medicare, Social Security) for last.

The Federal government insures almost all bank deposits through the FDIC.  In May 2012 the Wall Street Journal put the total amount of U.S. bank deposits at $10.26 trillion.  Could we ever have a systemic banking crisis where essentially all of the banks become insolvent at once?  We almost had one just a couple of years ago.  How about the S&L crisis in the 80s, where all the S&Ls became insolvent at once? And can we think of examples from other countries?  How about Japan in the 1990s?  Russia in 1998?  And don't even get started on Latin America!

What's the total of Federal housing guarantees?  According to Forbes a few days ago, the FHA (which has stepped into the breach to guarantee mortgages given the weakness of Fannie and Freddie) is up to $1.08 trillion.  Oh, and almost 10% of that is in default and they look to be needing a bailout soon.  But don't worry, they have an infinite right to just draw on the Treasury, so no need to go to Congress for an appropriation.  Here's an article in the American Thinker that puts the total of guarantees and debt of Fannie and Freddie at $7 trillion.  Supposedly the Treasury is ending its open checkbook to Fannie and Freddie as of December 31, 2012.  Do you believe it?

Do you know that the Federal government guarantees all private pensions?  The agency is called the Pension Benefit Guaranty Corporation, PBGC.  And by the way, what is the possibility that any private pension plan can meet its obligations when the Federal Reserve keeps interest rates at zero and nobody can make a dime on any investment?  So how is the PBGC doing?  Here's the latest from Fox News on November 16:  they just ran a $34 billion deficit for the year ended September 30, up from a mere $26 billion last year.  

If the trend continues, the agency could struggle to pay benefits without an infusion of taxpayer funds.

What a surprise!

How about flood insurance?  If you didn't know it before Sandy, you surely know now, that the Federal government issues essentially all flood insurance to those in the path of hurricanes.  Turns out that after Katrina the flood insurance program didn't have nearly enough money to pay its debts, so the Feds gave them a line of credit of $20 billion.  They then borrowed $18 billion to pay claims, and haven't repaid any meaningful amount.  Now we have Sandy.  Oops!  The cost of that is projected at $6 - 12 billion according to the Chicago Tribune.  So we are about to blow through the $20 billion cap by multiple billions.  Time for another bailout!  My idea is that we'll spend the money building bigger and better on the same barrier islands.  It's not a problem as long as you have the infinite credit card at your back.

Let's get away from these little numbers and back to something noticeable.  Virtually all student loan debt is backed by the government.  How much is that?  According to this from the New York Times, the total of student loan debt passed $1 trillion in 2011.  Likelihood of getting that back?  Remember, these borrowers are the same people who are supposed to pay for the retirement income and medical benefits of the baby boom generation.

Skipping over a few trivialities (crop insurance, terrorism insurance) let's get to some real numbers.  What is the unfunded liability of the Medicare program?   To be fair, Medicare is different from the other programs above in that the Federal government reserves the right to cut it.  But if you think it should be continued at least as is, or that it would be politically "impossible" to cut, then these numbers are highly relevant.  According to this from the Cato Institute, the Medicare trustees themselves put the number for the unfunded liabilities at $38.6 trillion.  Tanner of Cato thinks $90 trillion is more like it:

Let's try to put the ongoing debate over the future of Medicare into a little bit of context. Last year, Americans paid $274 billion in Medicare taxes and premiums. At the same time, the program paid out $564 billion in benefits. That amounts to a shortfall of roughly $290 billion. Looking into the future, even the most optimistic estimate by the program's trustees puts Medicare's future unfunded liabilities at more than $38.6 trillion. More realistic projections suggest the shortfall could easily top $90 trillion.

Faced with this ocean of red ink, the Obama and Romney campaigns are busy claiming that the other guy wants to cut Medicare. They, on the other hand, would never think for a moment about cutting anyone's Medicare benefits. Hello. Can anyone out there do math?

And yet one more:  Social Security's unfunded liability, according to this from Bloomberg News in July 2012, is $20.5 trillion.

Medicaid?  They don't even put out a number for that one, at least that I can find.  It may be the biggest of all!

The bottom line:  you either believe that it's possible for a big borrower with the infinite credit card to take on all the downside risk of life for everybody, or you don't.  I just predict, when this ends it's not going to be pretty.

The Poverty Deception, Part II

What is the biggest scam practiced by the U.S. government?  There are a lot to choose from.  But if the criterion is number of dollars stolen or wasted based on the scam, the winner has to be the so-called "poverty" rate, published by the Census Bureau. 

Today the reports on "poverty" put out by the Census Bureau are completely and thoroughly dishonest.  As Mary McCarthy famously said about Lillian Hellman, everything about them is a lie, including "and" and "the."

I do not think that the poverty measure began as a scam.  It was created in the 60s as a very crude way to get a handle on poverty in the sense of material deprivation.  The Census Bureau calculated the cost of a basic market-basket of food for a family of four, and multiplied by three to account for all other family expenses.  If a family did not have a level of income equal to three times the cost of the basic food budget, it was deemed to be "in poverty."  While the measure was crude, it was a bona fide attempt to get a handle on material deprivation.  Since then, the poverty threshold as originally set by this measure has been adjusted for inflation.   For 2011 the poverty threshold for a family of four with two children by this original measure was $22,881.

Over the succeeding years the government put in place numerous programs to alleviate material deprivation:  welfare, food stamps, public housing, Medicaid, school breakfast and lunch programs, etc., etc.  Means-tested anti-poverty programs today approach $1 trillion in annual spending.  Here is a report from the Heritage Foundation putting the total Federal, state and local spending on means-tested welfare programs for fiscal 2011 at $927 billion.  The report collects Federal data for some 79 programs.

For 2011 the Census Bureau reported 46.2 million, 15% of the population, in "poverty."  Both those figures are well up from the late 70s, when supposedly they were about 25 million and 12% of the population.

Wait a minute.  $927 billion of spending on 46.2 million people is over $20,000 per person, over $80,000 for a family of four.  That is higher than the median income for a family of four in the United States. and if simply distributed as cash would be nearly four times as much as necessary to get every single one of the 46.2 million out of material-deprivation poverty.  How could we possibly be spending all that money and the reported "poverty" goes up instead of down?

The answer is that the Census Bureau long ago decided that almost none of the government spending counts against the measure of poverty.   The measure of "poverty" turns only on "cash income."  All in kind benefits are excluded.  Just to give a few prominent examples of what is excluded:  food stamps, school lunch programs, Medicaid, all housing assistance.

There is nothing honest about the exclusion of in-kind benefits from the definition of poverty.  The main results of the exclusion are (1) the public thinks that the "poverty" rate is measuring something about material deprivation, but it is not, and (2) additional spending, even hundreds of billions of dollars of it, cannot ever make any dent in the poverty rate, even as the government spends more per family in poverty than the median income of a family of four in the entire country.

Even as the mainstream (and not so mainstream) media has fallen hook line and sinker for this scam, at least some scholars and think tanks have been onto it, and have been trying to demand from the bureaucracy some real numbers showing the impact of in kind benefits.  The GW Bush administration made at least some modest efforts to push for a new measure taking account of in kind benefits, but never actually implemented any reform.   Needless to say, the idea of honest numbers horrifies the poverty bureaucracy, not only in the Census Bureau but throughout the government, because of the potential to reveal the dishonesty and undermine the basis for the massive ineffectual spending.

But once the Obama administration came in, the bureaucrats knew that they had friends who would cover for them.  In January 2011 Obama's Census Bureau released information that they were considering various alternative measures, supposedly to take account of in kind benefits.  Then, last Wednesday (November 14) the Census Bureau released the results of their research on the "alternative measures".  Surprise!  Even with the inclusion of in kind benefits, the measure of poverty has increased!  Now the poverty rate is 16.1%

With the $927 billion of annual means tested anti-poverty spending, how can this possibly be?  Simple: the new measure of poverty is no longer even attempting to be an absolute measure of material deprivation, and now is explicitly a relative measure with respect to 33rd percentile of the population.  By the way, read their release and, for that matter, the full report, and try to figure that out.

They think they have dodged a bullet and have come up with something so impenetrable that no one will ever figure it out.  Now we can safely have a measure of "poverty" that has nothing to do with material deprivation, that can be used to sell the gullible public on ever more "anti-poverty" spending, and that can never go down no matter how much anti-poverty spending there is.

Mickey Kaus is onto the scam.  Is anyone else?

The SEC In Action

I went to a panel today discussing the JOBS Act. The Act itself is only tangentially related to jobs, and is rather intended to deregulate, somewhat, the cumbersome and expensive process of raising capital in the public markets. 

One of the panelists was a current SEC commissioner, Daniel Gallagher.  He reported on how they are doing at implementing the Act.  Part of the JOBS Act calls for deregulation of the process sometimes called "crowd funding." But in the way of Washington, it is not self-implementing, but rather provides that it will take effect only on the adopting of new rules by the SEC.  Unfortunately, the SEC is woefully backed up in drafting all the other rules that Congress has asked it to draft. 

So Gallagher started talking about where they are. There are some 100 or more rules called for by the Dodd-Frank law, all of which were suppposed to have been adopted by sometime in 2011, and all still in limbo without a projected date. The "crowd funding" rule is caught in this endless queue. Meanwhile, what rule is actually moving forward and has reached the desk of the Commissioner for review? Why, the Conflict Mineral Rule! What is that you ask? Not that I'm one to stand up for warlords attempting to profit from "blood" minerals, but let's just say that conflict minerals have absolutely nothing to do with raising money in the US capital markets, or with any conduct in the US at all. However, all of the business of the SEC is backed up behind this cause. And by the way, the Commissioner candidly admitted that the Blood Mineral Rule will be extremely expensive to comply with, maybe even more expensive than the entire benefit to be gained from the deregulation of the JOBS Act. 

That's how our government works. 

Hotel Lightbulbs

Here in Washington at the Federlist Society convention at the Mayflower hotel. It seems like a very nice hotel, but, like every other hotel I have stayed in for the past couple of years, the lighting is terrible. You turn on the lamp, and at first nothing happens; a second or two later, the light comes on with a pale, palid glow. You look under the shade. Sure enough, it's one of those squiggly compact fluorescents. 

So yet another person has been convinced that we can change the weather by changing our lightbulbs from ones that work to ones that don't work.  We may be annoying the customers, but at least we are saving the planet!  Not that anyone can actually articulate the causal mechanism by which non-functional lightbulbs can change the weather.  How did we get into the grip of this mass hysteria? 

Thankfully we don't allow these terrible lightbulbs into the Menton house. While they were still available, I went out and bought hundreds of incandescents. They should last until the Congress comes to its senses and makes them legal again.  

Meanwhile, not satisfied with merely ruining lighting, the administration is hard at work attempting to replace all energy that works with energy that doesn't work. Who needs 24/7 electricity when you can have electricity that goes on and off with the whims of the wind and the sun?  And as an added benefit it will be three or five times as expensive.

And we laugh at medieval people for thinking the earth was flat.

Governor Cuomo and LIPA

More than two weeks after the big storm, the lights are still out in big parts of Long Island.  Their utility out there is called LIPA -- the Long Island Power Authority, a New York State agency.  Not only has LIPA done a poor job of getting the power back on, but they are famous for having about the highest rates in the country, except for some remote places in Alaska and Hawaii.

Our Governor Andrew Cuomo has called for an investigation of the performance of the various utilities, and particularly LIPA.  He has appointed a commission to "investigate."  How could their rates be so high and their performance at the same time so bad?

Well, it's not too hard to figure out. There's a rather good summary on Wikipedia.

In the 1990s and before, Long Island had a utility called Long Island Lighting Company, LILCO. LILCO was private, not a state agency.  In the 70s and 80s LILCO got the idea to build a nuclear power plant at Shoreham on the North  Shore of Long Island.  They got a Federal permit and went out and built it, at a cost of about $6 billion.

By the time the plant was completed in about 1984, the post-Three Mile Island nuclear scare was in full swing. To open the plant, LILCO needed the participation of Suffolk County and New York State in just one thing -- an emergency evacuation plan.  Both flatly refused to cooperate. The then Governor, also Cuomo (first name Mario - father of the current Governor) ordered state officials not to  approve any plan.  (Full disclosure:  the elder Cuomo is Of Counsel at my law firm.)  LILCO gave up, and was left with a fully-completed, functional nuclear power plant that it could not open. 

The elder Cuomo came up with a plan to have a state agency, LIPA,take over LILCO and close down Shoreham.  Basically, LIPA would issue tax-exempt bonds to take out the LILCO debt on the power plant.  Those bonds would bear a lower interest rate because of their tax-exempt status.  Essentially, close to half the cost of the plant would be put to the Federal government through the tax exemption on the bonds, but the rest would be left to the Long Island ratepayers, even though they had no usable facility to show for the money.  The Republican congress of the 90s set out to stop this by making bonds issued to finance takeovers of utilities ineligible for tax exemption, but in congressional horse trading, New York got the LILCO takeover excluded.

The LIPA takeover of LILCO was not completed until the late 90s, by which time the elder Cuomo was out of office.  But I think he would be pleased to take credit for the result.

And the result is, LIPA ratepayers have to pay not only for the facilities that provide their electricity, but also for an entire nuclear power plant, fully built and discarded.  I'm sure there are other factors, but is it then any surprise that the Long Island ratepayers have about the highest rates in the country, and at the same time LIPA is always squeezed for funds and skimps on maintenance?

And by the way, since LIPA is a state agency, who is responsible for it?  The Governor is not the CEO, but he does appoint most of the Board.  So, Governor Cuomo, exactly who is the commission going to investigate?  I guess not you, because you appointed the commission and they know better.