The Rule of Law

I’m reading Road to Serfdom by Hayek and was struck by the chapter on Rule of Law.  While nearly every chapter could be applied to today, I found this chapter particularly applicable.

In a capitalist society, accurately predicting the future is necessary for firms and individuals to plan and deploy their capital and labor.  Uncertainty can easily become an impediment to growth (I think we’re seeing a lot of this happening now).  Of course, no one can predict the future with absolute precision, but in a free society, we have the Rule of Law as a guide.  The Rule of Law serves as a limit to the coercive actions of the state, denying it the authority to act arbitrarily against individuals or firms.  Without this limit, no firm or individual would risk resources fearing the state might act to defeat or confiscate their property.

I’m afraid, though, that over the past two years, the state (federal government) has marginalized this all important referee and encroached into dangerous territory.  The state has done this through a variety of avenues, including direct legislation and by federal rule making.

 

The several federal agencies, such as the EPA, DHS, and FCC, issue on a regular basis new rules affecting firms and individuals across major sections of the economy.  Think what you will of these new rules (which carry the effect of law), but they inject uncertainty into a once stable business model.  Just this week the FCC granted itself authority to enforce so-called “net neutrality”, despite calls from over 300 congressional representatives and a recent federal appeals court decision.  The action by the FCC will undoubtedly be challenged in court and most likely taken up in the next Congress, but it underscores the danger in allowing unaccountable and unelected bureaucrats to impose arbitrary regulation.

Additionally, this administration has expressed frustration in Congress for failing to adopt national “cap-and-trade” legislation (passed by the House, failed in Senate).  As a result, it has pledged to by-pass Congress and use the EPA to accomplish its climate-change agenda.  As firms sit idly by waiting for the EPA to act, consumers will face less choice, more unemployment, and higher prices.   This shouldn’t be.

As Congress and the administration continue to legislate and rule-make, they can expect firms and individuals to remain on the sideline, reluctant to make economic decisions for fear of state action.

How a Libertarian Rolls

I love Egg Nog. For me, it's the gastronomic pleasure of the season. I wait all year and enjoy it for just a few days around Christmas just to keep it special. Well, I went out this year to buy some 'Nog, but much to my chagrin, I could find only corn syrup-based 'Nog. I don't know what happened, here. Last year I was able to purchase egg-based 'Nog. Is this the corn lobby taking over the 'Nog industry? Not being in the mood to care, I had two choices. Go without 'Nog, or make my own. Actually, there's a third choice, but it would take awhile - lobby my local politicians to ban corn syrup from Egg Nog.

But I'm a libertarian, so I made my own. That's how I roll. If I can't find what I want, I find a way to make what I want, or I find somebody who can. I have yet to fail. Maybe I don't want complicated things. What I don't know, and would never do, is use political power to get my way. I know - I'm making a big deal over Egg Nog. Well, maybe Egg Nog is just that big of a deal. Or maybe metaphors are awesome.

Merry Christmas to all!

P.S. The 'Nog is awesome.

Government Debt as Private Savings

I've heard that Treasury debt (this is important) is akin to private savings. I'm pretty sure Greg (our most prolific commentator) has made this claim, but I've seen it elsewhere. If I'm not mistaken (and I hope Greg will clear up any misconceptions as I state the claim) this is the position of Modern Monetary Theorists, aka chartalists.

Note: I think they prefer MMT to chartalist since the latter easily translates to charlatanist. Hee hee!

So here is what I think the MMT position is: Treasury debt is private savings in the sense that, to place the debt people need to be willing to purchase the bonds. Thus Treasury debt is money owed to private individuals. This is 2/3rds true - of the 13.5 trillion debt outstanding (Sept. 2010, according to the Treasury bulletin), 9.1 trillion is held by "the public." The remainder is in "Securities held by Government Accounts," or inter-agency debts.

Let's focus on the debt to the public. For arguments' sake, I'm go to abstract away from the level of foreign holdings (e.g. China) of U.S. debt and assume that all debt is held by U.S. citizens. This avoids having to discuss trade issues, which are not part of the story.

So in this set up, every dollar of public debt issued by the Treasury is ultimately held by U.S. citizens. You can own Treasury debt directly, or through some agent (e.g. mutual fund). Thus Treasury debt is de facto private savings. So far, so good - I have no quarrel to this point.

One question that comes up is: why are people willing to hold Treasury debt? Well, it does promise a nominal return (or real, in the case of TIPS), so the interest induces people to hold the debt. Also, Treasury debt is default-free, so it is less risky than other similar types of debt (including municipal, corporate and foreign debt). So, as a finance guy, it makes sense to put some Treasury debt into your portfolio. This default-free feature becomes very important when people are more uncertain than usual about the future performance of other bond issuers in general.

Now bonds are debt, and so must be paid back eventually. Every bond issuer has two options to pay back existing debt: use cash on hand (from retained earnings in the case of corporations, or from taxes in the case of governments) or refinance the debt (issue new bonds and use the proceeds to pay off the old ones). Refis are pretty common - corporations for example like to target a certain cost of capital and also look to minimize cost of capital, so they may shorten or lengthen maturities using refis when the markets are favorable. Refis are also how the Treasury operates; it typically just rolls over the debt by issuing new bonds to pay off the old ones (in addition to new ones to pay for more spending).

But if you don't have cash, and can't refi, you're in default. The Treasury is default-free because of the third option: printing money (I've discussed this before). So as long as bonds are denominated in nominal terms, the Treasury can never default.

Well, enough with the institutional details. When the Treasury issues a new bond, some people decide to buy the bond. So in a realistic senses, Treasury debt is private savings.

But what if no one wants to buy the bond?

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.