Thought Experiment

One of our three commentators has asked me to engage in the following thought experiment.

A section of the country secedes, apparently peacefully and I am placed in charge of determining how the new country will pay for things.

The task is to address these questions (or if you think they are the wrong questions explain why);

What will be your currency? How will it be created? Will it have an exchange rate fixed to a commodity (gold?) or be free floating? What will you do with your new citizens "old" US$ ? How will you control inflation?

My responses:

First, the country doesn't pay for anything. And I don't mean this in a semantic sense - I mean that I (as Treasury secretary) would push for anarcho-capitalism and the dismantling of any national state. (This is why libertarians can't get into politics - the first thing we want to do is eliminate the state!) But, since that is probably a cop-out, I'll move forward with the questions.

There wouldn't be an official currency, and the state would not then be able to be the currency monopolist. Banking, including note issuance, would be entirely free. The empirical experience here is Scotland in the 18th century. I imagine that people would develop some matrix of exchange rates among the various currencies, much like exists today among national currencies. The currency, then, would be created by individual banks in a competitive market.

The commodity backing is an interesting question. Scottish banks has a gold backing, but they only held a 2% reserve. The only modern free banking experiment was Hong Kong (ended pretty much in the 1930s, but officially in 1965), but those banks were required to hold 100% foreign currency reserves. So it's not quite the same free banking situation as Scotland. That said, I don't see why the choice of commodity backing shouldn't also be competitive. Gold is obviously a good choice, but any precious metal would do, really. Some banks might try to back their currency fully with the lending on real assets. The problem with the latter is portability (I can't withdraw Jim's land, for example). So I think it would end up being some sort of portable, storable, commodity. Could be gold, silver, platinum.... And, the rate of redemption (one note = 0.01 oz of gold or something) would also be set by the individual banks.

There would be no, repeat no, central banking authority.

Old $ US would still be useful as long as the remaining U.S. had open trade with our new little operation. The rate of exchange to the new currencies issued by banks would, again, be set by the market. Some citizens might even want to be like Panama, and trade only in $US. Again, if the former U.S. maintained open trade with our new operation, people could work in the old US and get paid in $US. Ain't no thang.

Finally, the inflation question. Price inflation is a result of monetary inflation, so the root question is, how would you control money supply. This was the original concern with regard to free banking - that a bank could make money by overissuing its own currency. I won't present the whole refutation here (one can consult Vera Smith, or George Selgin, or Larry White on this issue). But the crux is the clearing process. If one bank overissues relative to its asset backing, as other banks clear more of the notes and the commodity (e.g. gold) is transferred from one bank's reserves to the other's, the overissuing bank will find its reserves becoming depleted. The value of the currency will decrease, as will trust in the bank's ability to refund commodity for currency. People will avoid using the bank's currency and it will lose market share and profit. So general money supply increases will be curtailed.

Note that there will remain one important source of price inflation, and that is an increase in the supply of the commodity that backs the currency. If a new gold mine, for example, is discovered, the value of current gold holdings must decrease if demand stays the same. This inflation can create problems, of course. This was the root cause of the Amsterdam tulip bubble (see Doug French's book at the Mises Institute on this issue.)

I'm sure there'll be questions, but that's my story.

More Bans

The US Department of Transportation is set to ban cell phones by truckers.  This ban would affect nearly 4 million truck drivers across the United States.  Secretary LaHood cited “lack of attention” in a number of crashes involving trucker drivers.  His solution: ban something.

If distracted driving, defined by Mr. LaHood as “taking your eye off the road for even a second”, is the culprit, let’s ban distracted driving.  This would mean no sneezing, as this can really disorient a driver, even if only for a moment.  Let’s also ban tuning the radio while driving.  That’s really bad.  Don’t think about blowing your nose either.  Also, no digging around for that pack of gum or cigarettes.  Too distracting.  No beverages either, lest you spill some and that distracts you.

Better yet, let’s empower the government to re-design the interior of today’s trucks.  No radio, no citizen band’s radios, and no knobs, switches, levers or handles.  Additionally, drivers shall wear a special head set to track their eye movements, monitored by the government for compliance, of course. 

 

If Mr. LaHood is serious about ending accidents cause by distracted drivers, I think he needs to go further than just cell phones.

Another Day, Another Ban

I learned just this morning the US Consumer Products safety commission voted to ban baby cribs with a sliding gate.  This gate allows easy access to the child, but also creates a safety hazard, allowing the child to get its noggin stuck in the sliding mechanism.  The government stated that 32 children have died over the last decade as a result.  So, in a totalitarian manner, the unelected and unaccountable consumer product safety commission banned the manufacture, sale, and resale of these cribs.  For the children, of course.

The estimated cost of the ban is $467 million, as day care centers and the like will have to replace their now-banned cribs and purchase government approved ones.  It’s unclear whether churches and other private organizations will be affected.  Private citizens are not required to replace their cribs.

Generally speaking, I’m against government banning anything, as it deprives me of a choice and my liberty.  As a parent, only I can make the best decision as to the type of crib for my child.  Suppose my wife is wheelchair bound and a sliding gate allows her easy access to the child.  What is she to do now?  Or suppose aging grandparents enjoy being able to comfort a baby because the gate slides down and out of the way.  What are they to do now?

Many children will die this year in car accidents or because their parents locked them inside the car during the summer months (and the kid is trapped in a car seat).  Should we ban cars?  Some kids will die playing football, soccer, and basketball.  Shouldn’t we ban these sports?  My point is: life is uncertain.  We shouldn’t expect (nor do we want!) the government to watch over us like a paranoid nanny, eager to deprive us of choice in the name of safety.  In my opinion, that’s more dangerous than any crib.

"Deficient Demand" and "Demand for Labor"

We can observe the unemployment rate is currently at a recent historical high in the U.S. We can also dig a little deeper into the employment numbers and discover that many are underemployed, meaning working at jobs for which they are overqualified; or, similarly, people are working less than they want to. Example: I would like to work 40 hours, but I can only find enough work to be employed for 20 hours. This is news to no one.

The question is, was, and will continue to be: why is unemployment high? David Andolfatto (see here:http://andolfatto.blogspot.com/2010/12/is-deficient-demand-hypothesis.html) is asking if the deficient demand hypothesis is a reasonable explanation for high unemployment given some turnover statistics. It is a very interesting discussion. I want, though, to take this issue back to general principles and approach this logically.

Empirical fact 1: Unemployment is high. Note, as a supporting fact, that industrial capacity usage is still pretty low, but climbing: http://research.stlouisfed.org/fred2/series/TCU?cid=3 .

The deficient demand hypothesis suggests that firms are not employing people at as high a rate as before (demand for labor is low) because the firms themselves are facing low demand for their products (revenue is down). This has much intuitive appeal, I dare say. Sales are down, so why do I need to produce as much stuff? This squares with high unemployment and low capacity utilization.

But, which demand is deficient? Personal consumption (mostly households; this is the C in the GDP identity of GDP = C + I + G + (X-M)) has returned to its peak: http://research.stlouisfed.org/fred2/series/PCECC96?cid=110. Note that is in real terms. In nominal terms it's a little bit higher than its previous peak. Government (of course) consumption and investment expenditure is increasing: http://research.stlouisfed.org/fred2/series/GCEC1?cid=107 again, in real terms. The deficient demand appears to be in private investment: http://research.stlouisfed.org/fred2/series/GPDIC1?cid=112 .

In other words, households and government are spending as much or more than before the recession, and definitely more than during, but investment remains far below recent history. Go back to 2003 and that's about where investment is. So clearly there is where the deficient demand is. Now, of this private investment, the item that has fallen off the most is housing. This again should be surprising to no one.

So let's say you are a company that sells construction materials. Clearly the demand for your products has fallen off, so you don't need as much labor and capital as when demand for your products was higher. Thus certain types of demand are deficient, but demand generally cannot be said to be deficient. As I have illustrated, spending is high from C and G.

What does this have to do with anything? Well, there is a strong correlation between lack of demand for new housing and lack of demand for housing construction workers. No amount of structural problems is required to explain that issue - in other words stuff like sticky wages aren't necessary here. Too many houses - that's the problem.

So the relevant question becomes manifold. First - specifically which industries are experiencing low demand? Second - why are those industries experiencing low demand? Those discussions are few and far between from what I can see.

Government Debt and Money Printing

That governments issue bonds to finance their activities is news to no one. That bonds represent a claim to future cash flows should also not be news, since that is the nature of a bond. A lends money today to B in exchange for periodic interest payments and eventual principal repayment. B's burden is to generate the cash flow necessary to make the payments. If B experiences a short fall at any time, then technically B is in default and A usually has some special privileges - like taking B's stuff. Or A and B can work together and restructure the bond such that B has a better chance of making interest payments.

In the case of governments, the future cash flows come from at least two sources: taxes or new borrowing. Taxes can be used to discharge the debt fully, but new borrowing would only change the structure of the debt, not discharge the debt. A may be paid back, but now B would be indebted to C. There's nothing inherently wrong with rolling over the debt in such a manner, provided C is willing to lend B money.

Now, if the government is the sole money producer for a nation, a third method of paying back debt is available: seignorage. Seignorage is the process of printing (physically or electronically) new money (which is zero-maturity debt in this case) for revenue purposes. Note that printing money for circulation purposes is not the same as seignorage.

Let us suppose we are at the point that B needs to pay back A, and B is not the money monopolist. If B has the free cash flow from taxes, no problem: B pays back A and the debt is discharged. If B hasn't the cash flow from taxes, but can roll over the debt (either with A or with a new creditor C) still no problem. However, if B is distressed and can't roll over the debt then B is in default and needs to restructure the debt. This typically has long-term consequences for B's growth, and so is rightly feared.

But, what if B is the money monopolist? Well then B can simply print up all the zero-maturity debt needed to discharge the debt owed to A. No need to worry about taxes or finding another creditor. What are the consequences of this action? At the time of debt maturity, B is swapping zero-maturity debt with zero-maturity debt. So it might look like the net effect is nothing. However, A was expecting to be paid dollars of a certain value - dollars from the current stock of money that has a certain purchasing power. But B has not done so - B has increased the stock of money by the amount of the debt owed to A and thus has reduced the purchasing power of money. A has been made worse off than expected because of this. We see also that the debt itself has not been discharged. Rather, the debt has been restructured in just the same way as issuing new bonds. The only difference is that the maturity structure of debt has been shortened, rather than maintained. That moves claims to real assets closer to the present and this is the source of price inflation.

If B does this once or twice, for relatively small amounts, the negative consequences are likely to be minimal. However if B does this frequently, present claims will come to dominate the maturity structure of the debt and one will observe quite a decline in the purchasing power of money. Furthermore, this will hamper B's ability to borrow since the As of the world do not want to lose money on their investments in real terms. Thus the political consequences of, say, the Weimar republic.

Wealth & Life Expectancy

Take a gander at this great little video, which shows a very strong correlation between wealth and life expectancy.  The technology to pull off this eye-dazzling stunt is rather amazing, and is simply another example of the power of free enterprise, individual liberty, and creative entrepreneurialism.  Okay, nuff said.  Just watch the video.  (Thanks to Russ Roberts over at Café Hayek)

A Mountain or Mole Hill

         

                                          Source: www.omb.gov

 I often visit the OMB website as part of my job, as there are loads of good budget data on the federal government.  After reading this quote by the Dear Leader, I couldn’t resist.  The President says to invest in our people without leaving them a “mountain” of debt.

Um, Mr. President, either your definition of “mountain of debt” differs from 99.9% of the population or your budget director is withholding information from you.

The chart below illustrates the CBO and WH estimates on the coming annual budget deficits.  These look like mountains to me.

 

                      Source: http://blog.heritage.org/2009/03/24/bush-deficit-vs-obama-deficit-in-pictures/

Either way, if the situation weren’t so grim, it would be funny.