It’s [xxxxx]… I left out that second i.

And redacted again. -FC

We did publish Olivier Strauch’s email address on an earlier thread. It’s olivier.strauch@gmail.com.

I wanted to err on the side of caution, so I apologize to you, Crowe, for redacting your comments.

Mr Smith, with his 1000+ page book in size 8 font, kicked my ass.

Before this fiscal year, US public debt stood at $6.3 trillion. Obama’s first year will increase it by almost a third.

The commonly-quoted $10 trillion figure is the US national debt. It includes the payroll tax surpluses that have accumulated since the mid-Eighties (“Social Security Trust Fund”). But this liability is meaningless because the government owes it to itself, so it never actually needs to be paid.

$6.3 trillion (40% of GDP), soon to be 60% of GDP, is the relevant figure to use. That’s money we actually have to pay back or roll over.

Inflation, by definition, is too many dollars chasing too few goods. You can respond to this by increasing the cost of money (raising interest rates), by raising taxes, or by reducing government spending.

Inflation happens a lot. We know a fair amount about how to deal with it.

Deflation is far more evil, and we have relatively less experience with it. In a time of deflation, the value of borrowing is strongly attenuated, because the real cost of money rises. Simultaneously, however, the value of all kinds of debt (except federal government debt) also falls, because the perceived default risk rises. (Federal debt is risk-free.)

We already have zero nominal interest rates, but due to deflation, real interest rates as experienced by the private economy are remarkably high. You’re stuck in a box at this point, with only non-traditional policy tools available. That’s where we are now.

I’m suggesting a 100% tax cut because it’s a radical way of injecting money into the economy.

A 100% tax cut WILL increase the money supply, but it will NOT cause inflation! This is a subtle and critical point.

Remember, inflation is not too much money. It’s too many dollars chasing too few goods. In a time of sharply reduced demand, as now, the dollars are going into savings accounts rather than chasing goods (or investments, which is the same thing).

In a time of deflation, saving money can be highly rational. In a time of inflation, saving money is not rational, and borrowing money for spending or investing is rational. In hyperinflation (Zimbabwe), nothing is rational.

I’m sure that people hear things like “The US government spends $3 trillion a year” and imagine that there is such a thing as $3 trillion somewhere. There isn’t.

The Treasury maintains accounts at commercial banks in which they receive tax revenues, and different accounts through which they pay for what they spend (including transfer payments like Social Security). These accounts have a special name that I forgot long ago.

But the last time I checked, the Treasury only has a total of about $50 billion in all of its accounts at any given moment in time. (For a few weeks every April, that amount balloons up, and then falls again.) Money changes hands as people execute transactions. Add up the value of all those transactions over a year, and you get the $14 trillion GDP figure. But there’s no actual reality to the money itself, it’s just units of account.

For the Fed, it’s all different. To the Fed, money is a liability rather than an asset. They used to keep about $42 billion in reserves in the accounts that every bank is required to keep with them. The Fed can increase or decrease these balances at will (they’re just numbers in computer files), and they can also manipulate the interest rates that banks charge each other to borrow reserves (which is the basic transaction that results in the generation of private credit). Since early November, reserve levels have been sitting at around $600 billion. No, I’m not kidding. It’s shocking.

You notice who’s near the top of the list? Japan, at 170%+. That’s because they tried to deal with their deflation crisis with fiscal stimulus. That’s where we’re headed.

The Japanese can deal with such a huge debt because they’re a surplus country. Most of the debtholders are Japanese. But we’re a deficit country. The ceiling is probably a lot lower for us.

I don’t think anyone has a really good yardstick for how to measure the effect of stimulus on GDP. The economics-101 answer is you multiply the amount of net spending by 1.5 and add that to GDP.

But there are problems. First, to what extent are you displacing private-sector spending or investment? This is a completely open question, and it will depend on how much of the stimulus borrowing will come from domestic or foreign sources.

For the foreign-sourced component, I think you can make a good case that there is no displacement. The Chinese aren’t doing anything with their reserves anyway.

For the domestic component, it’s a heck of a question. I think the twin facts that we’re in deflation and that we’ve returned to activist government both conspire to reduce domestic investment, a pattern that matches the early Thirties. So here too, there probably is no displacement.

Bottom line, the stimulus probably will increase GDP. But the multiplier will NOT be anything near 1.5. It’ll be much closer to 1.0, because there’s no significant private activity that is waiting for an incentive. People who make money from stimulus programs are NOT likely to spend it on.

And then there’s the fact that so much of the stimulus is programmatic spending rather than broad-based spending. It’s going to direct benefit only a small number of politically-favored people, and it won’t all be spent at once.

If I had to pull a number out of my backside, I’d guess that the net effect of the stimulus in calendar 2009 will be no better than 1 to 2 percent of GDP.