Saturday, March 5, 2011

Economic Illiteracy: The Tyler Cowen Conundrum

Tyler Cowen, from what I can gather, is everyone’s favorite George Mason libertarian. His colleagues may be considered beyond redemption, but TC himself is provocative, interesting, worth a look. He throws in references to history and culture. He has a sense of humor. No doubt he is a nice guy and uncommonly smart. In spite of all that, shouldn’t it matter that he doesn’t understand the first thing about economics?

His column in today’s New York Times is a doozy. The subject is “fiscal illusion”, and here’s his example:

Say that you have $20,000 in Treasury bills. You probably believe that you own $20,000 in wealth. This will encourage you to spend and come up with ambitious plans. Yet someone — quite possibly you — will be taxed in the future to pay off the government debt. The $20,000 may be needed in order to do that.

The illusion is this: A government bond represents both a current asset and a future liability, yet for most people, those future tax payments feel less concrete and less real than the dollars they’re holding in a money market account.

What is lacking here is not a subtle grasp of cutting edge theory, but the sort of elementary knowledge my students are asked to learn in the first few weeks of introductory macro.

Except in unusual circumstances, government debt is not paid off. To pay off such a debt would mean running fiscal surpluses equal to deficits. No government anywhere does this. Our grandchildren will not be taxed to pay off the fiscal debt we are accruing today, any more than we are taxed to pay off the debt our grandparents ran up during WWII. Every country in the world has public debt, and there will never come a “year of reckoning” when the whole world has to start running budget surpluses to pay it off.

And suppose we decided to jack up our taxes like TC says we must, and we pay down the whole thing—what then? We would have no treasury bonds out there for people to stuff into their portfolios. The only assets you could buy would be the risky stuff: you know, stocks, commercial loans, mortgage-backed securities. People would be pleading with governments to please, please run deficits again so we can have at least a few low-yielding but safe assets.

You might be tempted to say at this point, isn’t there a limit to how much public debt we can ring up? The answer is a definite yes. We need to monitor the fiscal space available to our economy and avoid getting in over our head. There is a lot of economic analysis dedicated to figuring out what these limits are and how to detect them before it’s too late. The New York Times could perform a public service by publishing thoughtful pieces by economists that discuss these questions in an informed manner.

Alas, that has nothing to do with the column at hand. TC is not making an argument about fiscal space or debt sustainability. He is saying that our treasury bonds are illusory because we will have to be taxed in the future to remove them from circulation. We are not talking about shades of opinion here, but the difference between having a basic idea of how economies work and flat-out ignorance.

Sorry: someone has to say this.


sparc5 said...

Well said! The poor journalists have no idea who to believe, so end up publishing conventional wisdom.

Unknown said...

Peter - You probably know there is a long debate about whether government bonds are net wealth for the private sector. We owe it to ourselves, etc.

Not intending to rehash that one, but there is another way to go about a critique of TC's position, and others who hold it. The net saving the private sector has to do in order to net accumulate Treasury debt requires some other sector to deficit spend. Could be foreigner deficit spending (a US trade surplus) or fiscal deficit spending. And ultimately, since it takes US dollars to settle U.S. Treasury purchases, and foreigners cannot create U.S. dollars, then the private net saving used to purchase Treasuries must come from money created by fiscal deficit spending or by Fed balance sheet enlargement as it purchases financial assets from the private sector.

Turns TC types inside out when you point this out...but you have to go slowly, or they get lost. And this is not high theory, just an example of the tyranny of double entry book keeping.



Jazzbumpa said...

There is something far more insidious going on here. Cowan goes far beyond providing aid and comfort to those who claim that social security is nothing but a bunch of worthless I.O.U.'s.

His article is a naked assault on entitlement programs, and part of an orchestrated effort to roll back the new deal.

Lo siento,

Anonymous said...

We don't have to pay off WW2 because FDR financed the whole thing for 2% interest.

Ralph Musgrave said...

Good article by Peter Dorman above. Just one quibble. He says “Every country in the world has public debt, and there will never come a “year of reckoning” when the whole world has to start running budget surpluses to pay it off.”

That is going too far: I suggest that in a year or two it is quite possible that the private sector will want to reduce it’s holding of government debt (relative to GDP) to the level that existed prior to the credit crunch. But even that scenario would not make Tyler Cowen right. Reasons are as follows.

An attempt by the private sector to dissave cash and/or government debt could easily result in excess demand and inflation. Government would need to counter this with tax increases. But such a tax increase, strange as it may seem, would not constitute a loss in private sector wealth. It consists of removing tokens (money or bonds) from private sector pockets, which if they were spent, would cause inflation: i.e. tokens which in reality cannot be spent, and which are thus in a very real sense worthless. Put another way, the tax increase would cause no standard of living reduction for the private sector as a whole.

Don Levit said...

If the government is not even attempting to pay of its debt, I would think a lot of people would start to think of potential insolvency.
One way to look at this , other than to not even attempt to pay off its debt, is what are the consequences of attempting to do so?
For example, what would be the consequences of running a balanced budget, next year?
What makes deficit budgets so much better than balanced budgets?
If the government can't run a balanced budget, or dire consequences result, what does that tell you?
It tells me that we are in a heap of financial credibility, right now.
Right now, the interest is 10% of our budget.
What figure would it need to be for adjustments to be made, or is any figure okay with you guys?
Don Levit

Unknown said...

Don Levit said...

"If the government is not even attempting to pay of its debt, I would think a lot of people would start to think of potential insolvency."

And these would be gold bugs and "endogenous money" cranks. Both such crank cases believe that money has intrinsic value and must be borrowed from those who have it. Of course banks and governments create money all the time and the big mystery (for government) is why there would be any interest on this creation. Why don't you ask yourself where the 14 trillion in debt came from? The money (debt) did not exist until it was simply CREATED by the act of borrowing. Government should create money and spend it on Constitutionally ordained "public welfare" and tax to reclaim the created money when such reclamation is appropriate. It is appropriate when and if monetary inflation is the result of the spending and NOT UNTIL. And the people taxed would primarily be the people that have all the money. What part of this do you fail to understand?

John said...

...shouldn’t it matter that he doesn’t understand the first thing about economics?

Love it. That's in the I-wish-I'd-said-that category.

I'm reminded of how shocked I was the first time I came across some reading about banking referring to deposits on hand as "liabilities." Silly me, I always thought of my savings as assets.

On further reflection in a "d'oh" moment, I realized that leveraging those deposits was the main way banks generate profits. Accounts receivable are the reason bankers get up in the morning and deposits on hand are simply inventory, possibly with a short shelf life. Interest paid to depositors is simply lost revenue, along with staff wages, taxes and all the rest. Deposits on hand for bankers are what oil well owners call "wasting assets."

We all wear two hats. As citizen stewards we are tempted to see the national "debt" through the same lens as a mortgage or credit card balance. But as citizen bankers we should see at the same "debt" in terms of of wealth accumulation.

Jack said...

"One way or another, some of our savings will be taxed away to make good on governmental commitments, like future Medicare benefits, which we currently are framing as personal free lunches."

"Limiting Medicare and Social Security spending involves re-indexing benefits, adjusting eligibility ages, shifting the growth rates of costs and making other changes that have their full fiscal impact only over the longer run."

"Now that fiscal constraints are starting to bite, many politicians are afraid to reform or even to discuss changes in the largest problem areas: Medicare and Medicaid."

"He should include in that veto threat any deficit increases that arise from annual budgetary gimmicks like patches to the alternative minimum tax or the “doc fix” adjustment of Medicare reimbursement rates."

Prof Cowen offers us three primary areas of his concern in regards to budgetary reductions. He states categorically that SS and Medicare are the "largest problem areas." He makes no mention of military spending, nor does he discuss the costs of significant targeted tax reductions of the past decade. Cowen certainly seems to have a narrow view of budget issues. His only references to taxes focuses only on the AMT which adversely affects mostly the upper middle class rather than the wealthy. So I'm sitting and reading and wondering, why is his point of view so narrow minded? I tend to think that a man can be judged by the company he keeps. At least that is certainly true of a man's motives and prejudices. So who is it that Tyler hangs with.

Jack said...

Peter Does us a slight disservice by making reference only to Tyler's association with GMU. More specifically, "Tyler Cowen is the general director of Mercatus and the Holbert C. Harris Professor of Economics at George Mason University." That is very significant because it gives us a clue as to who it is that Prof Cowen actually works for. Always follow the money. Determining the funding stream for the endowed chair that he holds will take a little more time, but the Mercatus Center lets it all hang out. The money comes from foundations and individuals, as noted below.
"The Mercatus Center at George Mason University is a 501(c)3 not for profit organization and is supported by foundations (58%), individuals (40%), and businesses (2%) from across the country. Mercatus does not receive financial support from George Mason University or any federal, state, or local government."

Which businesses and individuals is not readily available information, but the members of the Board give one a reasonable clue.
"Richard Fink is an executive vice president and member of the board of directors of Koch Industries, Inc."

"From 1977 to 1994, Dr. Manuel Johnson was a professor of economics at the university, where he held the Koch Chair in International Economics. On the Board of Visitors"

Edwin Meese: Needs no explanation.

"Menlo Smith is CEO of Sunmark Capital Corp."

And most enlightening of all is Frank Atkinson. Talk about movers and shakers behind the scene. Lawyering, lobbying and banking&finance, all in one centralized organization.

"Frank Atkinson is a member of the Mercatus Center's Board of Directors. He is chairman of McGuireWoods Consulting, LLC, and a partner in McGuireWoods, LLP."

"McGuireWoods Consulting LLC offers a range of government and public relations services, business advisory services, and other non-legal consulting services."

"McGuireWoods Capital Group (MWCG) is a merger and acquisition advisory group that provides buy-side and sell-side transaction services for small- to middle-market businesses. Based in Charlotte, North Carolina, MWCG is a subsidiary of McGuireWoods LLP, one of the nation’s largest law firms."

Tyler Cowen is well connected and one can only guess at how well remunerated he is for his opinions. What one does know is that Tyler's place at GMU is in the company of the corporate and financial elite. His ideas seem to differ little from that association.

Don Levit said...

You talk about about government creating the debt, and ask why it should even pay interest on it?
And the author talks about why should we even consider paying off the debt when other countries don't?
It seems like you two don't even think this is real debt, yet the asset part is real, for we can use those assets to pay for current government expenses.
That is nonsensical thinking.
How can you have an asset without a corresponding liability?
And, it seems like rolling over the debt is just as prudent a tactic as paying it off, actually, even more prudent.
That way, we need not sacrifice, for we all get something for nothing.
Don Levit

Anonymous said...

Also, how is this any different from $20,000 in - say - IBM stock? When IBM pays out the dividend on it, that money has to come out of its cashflow, which means that it comes from someone else's spending, which means from someone else's income and possibly your own insofar as you buy IBM products or things with substantial IBM content (like, almost any industrial product). When you decide to sell, somebody else must buy. You've acquired a claim on future national income - how is this different from a government bond, in that sense?

It's like the mad myth that you can deal with demographically driven pension costs through privatisation. The government can do so, but society can't - all privatisation does is to move the bill from the public sector balance sheet to the private sector balance sheet. Paying out the pensions still requires that some of today's production is transferred to people who accumulated claims on it in the past. Only the terms of the transfer differ.

Unknown said...

Dear Don:

I talk about government creating money. Debt doesn't happen until some moron at Treasury sells T-Bills to "soak up" the money spent into existence by government. When government spends this created money into the world economy, the only way to get it back and prevent deterioration in the value of the money is to TAX it back out of the world economy. Yet, if this money is backed by real assets like bridges, roads, schools, or prisons, courts and cops, or needed military assets then there is no reason to reclaim the money. Interest (in the sense that you use the word) has nothing to do with it.

It is time that we all understood that T-Bills are like sponges that soak up the liquidity in the system and reduce velocity. T-Bills are interest paying forms of money. If there is no serious inflation problem then there is no reason for T-Bills. So long as the unemployment rate is high and inflation is low then T-Bills should not be offering a safe haven for money.

QE2 is redeeming inappropriately sold T-Bills, injecting liquidity, and reducing the actual debt.

What part of this still eludes you?

Anonymous said...

I think there are various sorts of economic illiteracy---maybe there is a TOE of econ so that literacy is possible, but there is no incentive to get it.

Cowan, besides his Mercatus/GMU connections, writes 'awful' books (which i havent read) on how what makes america great is that, as Hilary clinton pointed out recently, one is able to convert all of the appalachians into coal so Afghans can watch Wrestling and Barywatch, and people at GMU get good pay compared to Walmart.

But he has a point. Old classicl economics doesnt really need debt in the modern sense, but can be pure barter. Doesnt need government spending either (family can deal with social security).

Only in the modern sense does econ theory need debt and hedge funds. But vocabularies evolve---such that literacy in general is unnecesary. All you need is to publish or perish, whatevuha man (JYB).

widmerpool said...

Bill Mitchell has a nice takedown of the article.

ProGrowthLiberal said...

Rob is correct. I hope Tyler realizes he has dusted off the old Barro-Ricardian Equivalence proposition. And I trust he knows that this applies to at best households who are not borrowing constrained. There is an entire literature on this issue post Barro's infamous paper that Tyler's oped just sort of ignores.

Kaleberg said...

Don't you have the same problem with private debt? They're counting on selling you stuff at a profit in order to pay back their bonds. That's money you could have saved, spent elsewhere or paid in taxes.