This sort of philosophy can, to a degree, be applied to nations as well as individuals.  A case with increasing relevance involves the People’s Republic of China and two of its “friends”, North Korea and Iran.  Where does each stand with respect to China?

North Korea: Clearly a friend that the PRC tolerates.  An economic basket case; its citizens use the PRC as a sanctuary from extreme poverty and repression – considering that China is one of world’s poorest and most repressive regimes, that is saying something.  It is ruled by a very possibly mentally unstable Stalinist dictator who appears to enjoy nothing more than stirring up trouble with South Korea, Japan, and the US into which China is dragged, like it or not.  It is furthermore a criminal regime with its involvement in illicit weapons and drug dealings.  China would have certainly thrown North Korea under the bus long ago if it were not a neighbor with whom there is a long history of alliance; to abandon which would make China appear as an unreliable ally.

Iran: A friend that the PRC genuinely likes.  Aspirational regional superpower in the Middle East; oil exporter (albeit an inefficient one).  Does not rely on China for economic or military support; while also arguably run by a possibly mentally unstable president there are checks on his authority not reliant on Chinese power.  China has been cultivating a relationship with Iran for some years now and has been reluctant (at best) to help block its nuclear weapons program.

These relationships have recently taken on immediate relevance.  The sinking of a South Korean naval vessel by North Korea, a clear act of war, and North Korea’s sabre-rattling in response to South Korea’s reaction, show that the North is most likely looking for a conflict with South Korea and the US.  Given North Korea’s reclusive nature it is nearly impossible to determine their goal with certainty; however, one can assume that a) anyone in the North with any sense knows that a Second Korean War most likely means the end of North Korea as a state, and b) in order to risk such a conflict, there is most likely an existential internal threat to the DPRK (perhaps the declining health of Kim Jong-Il along with the ascendancy of a pro-South faction? – Any thoughts are speculation…).

The PRC’s foreign policy apparatus undoubtedly sees this and sees an opportunity to help its “real” friend (Iran) while appearing to help its “tolerated” friend (N. Korea).  Although the Chinese leadership are making the de rigueur statement of being committed to peace and stability on the Korean peninsula, it’s not much of a stretch to see that this is, in reality, not the case.  I can easily see the Chinese leadership presenting the Obama administration with the following choice: The PRC will “keep a tight leash” on North Korea in return for the US stopping its pressure on China to support tough sanctions on Iran for its nuclear program.  In essence, China would sacrifice the friend it tolerates (either the friend’s prestige in backing down in this crisis or its existence in a war) to further the interest of the friend it likes.  An amateur response from the US administration (which I fear would be the case) would be to choose one of the two extreme choices – both of which are disastrous:

1. If we accept the prospective Chinese offer, Iran continues unfettered nuclear weapons development.  More importantly, the Iran-Syria-Hezbollah-Hamas unholy alliance is emboldened by the success of its Chinese patrons in relieving international pressure; Israel simultaneously sees the existential threat from this unholy alliance ratchet up.  While the Korean peninsula may (emphasis on may, as Kim is not entirely predictable) be stabilized, the prospect for war in the Middle East approaches near certainty.

2. If we decline the prospective Chinese offer, Kim (or whichever hard-liners are in charge in the North) are given free reign.  It is easy to see the situation spiraling out of control into a Second Korean War; while the outgunned North Korean regular army will eventually be defeated and the North Korean state terminated, the outset of the war would see massive Korean civilian and US military casualties at the hands of DPRK rockets, artillery, commando raids, and possibly nuclear weapons.  Furthermore, with the US tied up in a third war (remember Clinton’s “win-hold-win” strategy?  It’s overwhelmed here…), the Iran/Syria/Hezbollah/Hamas axis has a free hand – and both they and Israel know it, which again could easily lead to a Middle East war.

The best answer involves decoupling the Korean situation from Iran; the Chinese need to be convinced that under no circumstances does a Second Korean War benefit their interests while joining a sanctions regime on Iran does.  Does the Obama Administration have the wherewithal to accomplish this?  I say this not as a Conservative or as a Republican, but as an American – I sure as hell hope so.  The alternative is not pretty.

A fundamental identity of macroeconomics is called the National Income Identity which breaks out the components of the total economy that sum to the GDP.  It states that the GDP is equal to the sum of consumer spending, investment, government spending, and net income from international trade.  GDP is also equal to the sum of consumer spending, taxes, and savings.   Symbolically:

GDP = C + G + I + (X – IM) = C + S + T

Some simple algebra can recast this equation into two interesting forms.  First, we can see exactly from where the money for government spending comes:

G = T + (S – I) + (IM – X)

This tells us that government spending is funded from a) tax revenue (T), b) crowding out private investment by diverting savings to bond sales (S – I), and c) foreign entities reinvesting their dollars, which flow out of the US economy by way of a trade deficit, in bonds (IM – X).

The second form shows the investment potential of the economy – money available to invest in the private economy to replace depreciating assets, invest in technology, and, most importantly, hire new employees.  It is:

I = S + (IM – X) – (G – T)

This tells us that capital for investment comes from a) savings (S), b) reinvested dollar outflows (IM – X), and is diminished by governmental deficit spending (G – T).

Now the numbers: The GDP estimates are in the range of 14.5 trillion dollars.  The budget calls for 3.69 trillion in spending with 2.09 trillion in taxes (1.6 trillion dollar deficit).  The trade deficit runs generally 38 billion per month; that rate extrapolates to 456 billion annually.  The savings rate (percent of GDP minus taxes) is estimated to be in the 5% range; this gives 620 billion in savings.  How does this budget do?

I = S + (IM – X) – (G – T) = 600B + 456B – 1600B = -544 billion (-3.75% of GDP)

What does this mean?

1. Every dime of GDP which does not go to consumer spending and taxes will be diverted to fund the government – nothing for investment, zero to replace depreciated equipment, nada to invest in technology, and bupkis for new hiring.

2. Even after crowding out every bit of investment, the government STILL needs $544 billion more.  This is where the Fed starts printing money and debasing the currency.

The “Progressives” (who know so much better about what’s right for America than us – just ask them!) like to jump on President Reagan’s back about his deficits.  His biggest was 1986: $221.2 billion ($990.4 billion in spending with $769.2 billion in tax receipts) in a $4.428 trillion GDP; 3% trade deficit ($133 billion) and a savings rate of 8.5% (this is from St. Louis Fed data), making savings $311 billion.  So, how does this measure up?

I = S + (IM – X) – (G – T) = 311B + 133B – 221.2B = $222.8 billion (5% of GDP)

Five percent of GDP available to invest.  GDP grew 3.5-4% during that time.  By the way, if you want to have a 5% investment pool available in the current economy you’ll need to cut $1.221 trillion from the budget, leaving a deficit of “only” $379 billion (and I don’t want to hear a word about hiking taxes – those who do get an F and a lecture about how increasing marginal tax rates steepens the Investment-Savings curve and reduces total economic output).

So why do the “Progressives” run deficits which can never be sustained?  I have three ideas:

1. They have no clue about principles of macroeconomics which any first year economics student knows well (so what are Romer, Goolsbee, Summers, Bernstein, et al doing to earn their pay?).

2. They know about these macroeconomics principles, but don’t care.

3. They wish to “fundamentally transform the United States of America”, and this is a step in that process.

If anyone in the Administration reads this and wants to provide an answer you can find me on Twitter – @mikegesner.

Man-made climate change is a dubious cause?  You tell me – first, the simple fact is that global temperatures have been falling since 1998.  Eleven years and counting.  The environuts will tell you that this can be explained away by solar activity – and that argument in and of itself deflates their man-made warming claims, as it acknowledges that the sun is far and away the biggest driver of global climate.  Furthermore, the global climate models of which the followers of Algore are so fond are crude (even according to those who develop them), and those used to support man-made global warming have been found to be initialized with conditions orders of magnitude more pessimistic than reality.  In short, THEY MADE THE PROBLEM UP (and Algore is now a multimillionaire managing partner at Kleiner, Perkins, Caulfield and Byers, in the “green technology” space.  Hmmm…).

Their answer to the contrived problem is to make us more like the underdeveloped countries.  They know that the “carbon emissions” are a result of combustion, which fuels the majority of energy generation driving the economy.  Reducing carbon emissions back to some past level reduces the economy back to that same level – essentially a legislated recession.  Those who do not reduce will be taxed out of existence by Cap and Tax.  And, most insidious, there would be an annual transfer of wealth of many billions of dollars  from developed nations (read that “the USA”) to developing nations (you know, friendly ones like China) to help “bring them up to code” (Van Jones would be proud – “Give them the wealth!”).  So, what’s in this for us again?

I have a better idea.  While “climate change” is dubious, there are real environmental issues that need investigation and attention, and you don’t have to go far to find them.  So forget Copenhagen.  Here’s a candidate for where a portion of the attention should go – in central Palm Beach County there has been a statistically significant rate of a specific type of brain cancer concentrated in a relatively small geographic area (I’d call it a “cancer cluster” but that’s a loaded phrase – stick to the known facts instead).  The area is somewhat rural; the residents use wells for water.  That area is close to known sources of industrial waste products (sugar refineries and the Pratt and Whitney facility).  Given all of this it would seem that this could be a real environmental issue which needs attention.  By taking the time, and money, and effort from (excuse me…) crap like “climate change” and dealing with real issues, like this one and others throughout the country like it, facing real Americans, we’d be spending tax dollars to benefit taxpayers, solving real problems vs. contrived problems, putting people to work solving these real problems, and keeping American tax dollars in America.

Unless the goal is to turn the USA into a third world backwater, in which case forget everything I just said.

1. Anita Dunn is not helping.  Neither her Fox News bashing nor the old footage of her admiration of Mao (oh, right, she was being sarcastic…) is the public face that any Administration would want, and specifically not one that has been tagged in certain circles with words like “radical” and “socialist”.

2. Listen to Lamar Alexander – enemies list = badness.  He should know; remember he saw the Nixon Administration from within.

3. Some philosophy for you and your team to ponder: You work for us.  Even those of us who didn’t vote for you.  Your ridiculous spending which is being financed by a) our taxes, b) our domestic savings which could be investing in growing private sector businesses/employers but instead is diverted to government spending via bond purchases, c) our dollars being devalued by Quantitative Easing, and d) our national security as you sell bonds to our dear friends like China.  Basically, We the People (you know, the first three words from that document you call “imperfect”) are your bosses and it would behoove you to be nice to us, because we can add you and your cohorts (I’m was going to call them comrades, but…) to the ranks of the unemployed in due time.

By the way, hiring Anita Dunn’s husband as White House Counsel might give the impression that you support her “efforts”, so you may want to reconsider that as well.

Just some stuff to think about.

I take issue with two fundamental points of his thesis that a falling dollar is a good thing.  The first, that the falling dollar is a reflection of renewed confidence of investors who no longer see the need to take safe haven in the dollar, is flawed.  Other safe haven assets – gold and short term treasuries – are at crisis pricing levels.  Gold has broken above $1000/oz. (in no small part due to eroding confidence over the value of the dollar) while the three month treasury remains (as of the time of this piece being written) at a yield of 5 basis points (0.05%).

Secondly, he asserts that the falling dollar is good for US exporters.  This glib statement a) ignores some basic assumptions about the environment into which US exports are sold and b) is a overly simplistic application of the Marshall-Lerner Principle which governs the relationship between exchange rates and the trade balance.  It is true that devaluing the dollar will make goods whose price is denominated in dollars less expensive for those who are directly purchasing those goods from an American source using a foreign currency; however, that price is not necessarily passed along to the end consumer if the foreign entity reselling those goods is subject to trade restrictions such as high tariffs (priced in the local currency) on American products.  Furthermore, even in the absence of tariffs, the effects of a price reduction will be mitigated by an inelastic demand for the American made goods in question, such as in the case in which a third country can produce and sell its goods even more cheaply (China comes to mind immediately).  Additionally, the trade balance has two parts – exports and imports.  Improving the trade balance by reducing the American demand for foreign made goods by making them more expensive here is not a positive development.

So how did we get into this predicament?  The simplistic answer is that the supply of dollars in the international currency marketplace exceeds its demand and thus the value (price) of the dollar is depressed.  The underlying principle behind the supply and demand of dollars is interest rate parity.  In essence, when one nation’s aggregate interest rate is higher with respect to that of another, there will be a net inflow of money into the nation with the higher rate from that with the lower to take advantage of the better return.  This increases the demand on the currency associated with the higher rate and conversely reduces the demand for that associated with the lower rate.  The interest rate parity effect was clearly observed recently when the Australian central bank raised its target rate and the Australian Dollar immediately appreciated in value.

Where do we stand with respect to this effect?  We are at essentially a zero interest rate policy – both by Fed fiat (the Fed Funds target range of 0-0.25%) and by the dynamics of the market (for instance, the previously mentioned 5 basis point 3 month Treasury yield).  The marketplace effects are further magnified by the Quantitative Easing policy in which the Fed electronically prints money by taking government bonds onto its balance sheet, thereby a) inflating the supply of dollars by providing money for government spending and b) keeping interest rates artificially low by reducing the supply of government paper on the open market.  Thus the falling dollar.

The inflationary effects are apparent and are upon us.  In addition to making imported goods more expensive to the consumer, there is also an effect to the supply side which could be catastrophic.  When investors who are holding dollars see (or expect) a decline in the dollar’s value, their inclination is to purchase an asset which is denominated in those dollars and whose value is not likely to decline in the declining dollar environment.  One such commodity is crude oil (and it’s kind of an important one).  This currency-driven demand for crude oil (or, more specifically, crude oil futures, not necessarily spot crude for delivery)  is behind the recent run-up in the price of a barrel of oil past $80/bbl – not any supply shock, not demand, and not the “evil speculators” who “manipulate the market” (and my use of quotes should indicate my thoughts on those notions).  As we saw in the 1970s, the run-up in cost of basic materials (oil based energy products) needed by the supply side increases the aggregate cost of production, pushing the aggregate supply curve up/left.  This is classic cost-push inflation and results in a market clearing point at a higher aggregate price and lower aggregate output – or, to use the more common term, stagflation.  Prevention of stagflation is the fundamental reason to defend the dollar.

So what do we do to defend the dollar?  Given the current weak state of the economy, a step up in the Fed Funds target rate is probably a bad idea.  Quantitative Easing, on the other hand, can go away if accompanied by spending restraint on the part of the elected government.  The “stimulus” which the runaway spending was supposed to accomplish (you know, the spending that was supposed to keep unemployment under 8%, and that Christina Romer stated whose best effects were behind us) is better accomplished by way of a reduction in marginal tax rates, specifically aimed at the supply side of the economy.  A supply side tax cut has the opposite effect of increasing oil prices – reduce costs to suppliers, move the aggregate supply curve down/right, and produces a market clearing point at a lower aggregate price and higher aggregate output.

Now, by show of hands, who sees Paul Krugman recommending this course of action, or the Obama Administration doing this?  Didn’t think so.  Our economy is a short ride away from being known as “That 70s Show”.

The authors, Robert and Brenda Vale of New Zealand, are obviously and without question stuck on stupid.  Their idiotic assertions are exactly where the eco-insanity promoted by the likes of Al Gore has brought us.  The truly ironic (or maybe moronic) part of this is that the “problem” that they look to solve, that of man-made global warming, is at worst very overblown (due to the poor fidelity of the global climate models which were initialized with conditions in some cases orders of magnitude more pessimistic than reality) and at best non-existent (see the report which states that global warming came to a screeching halt in 1998 ).  I’m supposed to eat my dog, then go get a chicken for THAT?

In addition to the stupidity of their assertions and the underlying rationale, we also have the offensive part.  My dog is a part of my family.  He has been the one rock of sanity through an otherwise God-awful year (personal stuff, not just the Obamanuts taking over).  Furthermore, I am not alone in this “pet therapy” experience – the therapeutic effects of being with a dog are well documented and have become a common part of patient care (although Obamacare may put an end to that – maybe we can get therapy chickens instead?).  To “recycle” a pet is, as I see it, is at least as offensive as the whole Michael Vick affair, and is only one step down from “recycling” a human family member.  Ain’t gonna happen.

By the way, below is who the eco-freaks have me replace with a chicken.  The real “inconvenient truth” is that said eco-freaks can’t themselves be replaced by chickens. And yes, he’s in a Mustang. I’m not replacing that with a chicken either.

This report comes the day after Politico reports that Sarah Palin has broken with John McCain and supports continued F-22 production. In addition to lauding Sarah Palin for coming out of her “comfort zone” of issues like energy policy and making a foray into defense issues, I also applaud her recognition that this aircraft serves a role in defending America from threats such as Russia and China.

With all due respect to Secretary Gates, his decision to close out the F-22 production is short sighted and wrong.  It is true that the F-35, a smaller, less expensive aircraft which can be produced in greater numbers would have a decisive role in providing air support in areas in which air defenses are likely to be light or non-existent – Afghanistan in 2001, Iraq in 2003, and places like Somalia today are well suited for this multi-role fighter.  However, the “high-end”, strategic threats – Iran, China, Venezuela – which possess modern, dense air defenses would require suppression from a more capable platform, and which possess advanced fighters like the Russian built SU-30MK and which consistently beat the existing “high -end” F-15 in Air Force simulations, require a high end fifth generation fighter to ensure air supremacy .  Furthermore, stable allies such as Japan, Australia, and Israel have requested to purchase F-22 which would help the current account deficit and, more importantly, allow allies in “bad neighborhoods” (Japan with North Korea, Israel with most of its neighbors) deter aggression from some of the world’s most dangerous tyrants.

Unfortunately, Obama, Gates, McCain, et al are determining DoD procurement and Sarah Palin is not, so the F-22 production line is as good as shut down.  The air supremacy which this nation has enjoyed since World War II is most likely gone with it.  Remember this when a dictator goes on the march.

The Economic Bill of Rights has, at its core, the safeguarding of four freedoms: The freedom to work, the freedom to enjoy the fruits of one’s labors, the freedom to own and control one’s property, and the freedom to participate in a free market.  President Reagan further proposed specific measures to ensure these rights.  I think it would make an interesting study in contrast to look at some of those measures and how the activities of the Obama/Reid/Pelosi government fit in (or not).

- President Reagan proposed privatization of government programs which could be better run by the private sector, and productivity improvements for those which should remain in the public sector.  The crew in power today has brought us nationalized banks, Government Motors, and coming soon, the “public option” which will effectively crowd out any hope of a private health insurance industry, all run by a government which can’t even deliver the mail efficiently.

- The Task Force on Regulatory Relief had the task of cutting out unnecessary restrictions on the pursuit of one’s livelihood.  Today we have proposals to force every American to purchase government run health insurance under the guise of “taxing authority”, and a government which enforces its view of “green” by taxing the life out of any energy using activity (I may have gone off on that topic previously.)

- As he had throughout his time as President or Presidential candidate, President Reagan called for a balanced budget amendment and line item veto.  Today we have a $1.8 trillion deficit which guarantees that there can be no investment in the private economy (pardon my self-promotion, but I ran the numbers here which show how the deficit completely crowds out all private investment).

- Along with a balanced budget amendment President Reagan called for a supermajority vote as a requirement to raise taxes.  Today we have the Congressional Democrats looking to dictate its health care “reform” to the American people by rolling it into the Budget Reconciliation to get it passed with 51 votes and minimal discussion.

- President Reagan called for a Truth in Federal Spending law which required full disclosure of the spending impact, sources of funding, and ability to fulfill mandates of legislation.  Today we have esteemed legislators who don’t even take the time to read their own bills before passing them.

In the 1980s we had a President who sought to ensure individual liberty, both here and abroad, and took measures, such as his Economic Bill of Rights, to make it happen.  Today we have his successor and his Congressional associates about whom there are two inescapable conclusions:

1. They have no clue how to deal with the economy.

2. The rights of the individual are obstacles to be eliminated in their pursuit of their statist vision.

Makes regular, garden variety malaise seem pretty good by comparison.

To: flag@whitehouse.gov

Dear Big Brother Mr. President:

I would like to denounce myself as I have committed Thoughtcrime in the form of “fishy” information about your utter destruction reform of the healthcare system, which is at present the envy of the world profoundly unfair to the Proletariat.  Specifically, I have said and written that your abomination reforms would:

- Result in people losing the right to choose their own doctors.

- Require patients to wait for needed medical care while bureaucrats assessed individual cases.

- Erode confidence in the system of medical care as it would be run by a government that can’t even get mail delivery right.

- Cost jobs through higher taxes on businesses, especially small businesses which need to keep costs down to compete (oops, competition is a Thoughtcrime too…)

- Provide the end result of a “single payer system”, as advocated by Leading Party Member Barney Frank, which will end up with medical care having a higher cost and much lower quality.

I profusely apologize to Big Brother President Obama, The Party, and The Proletariat for my Thoughtcrime.  I will report to re-education a DNC sponsored pro-Obama rally immediately.

- Will be able to choose his own doctor.

- Will never need to stand in line to get care for any reason.

- Will be able to get the best care money can buy.

- Will still not be dependent on the government for paying for medical care.

- Will have no deductible.

Who is it?

A: This is him (because it sure as hell won’t be me):

If I were in his shoes I’d sit there with a puppy smile too.

Paying the interest on the debt is analogous to the minimum payment on a personal credit card – if it isn’t paid, the debt is considered to be in default; if this a regular event,  the card holder is well on the road to bankruptcy.  The “Banana Republics” are considered to be in default on their debt, and thus bankrupt, when this obligations goes unpaid.

I am by no means saying that the US Government is necessarily going to default (although would anyone be surprised…); however, I am saying that in order to avoid default, We The People are going to need to come up with $547 billion.  Let’s assume, for argument’s sake, that the means that I would recommend (cutting expenditures and reducing the marginal tax rate across the board to stimulate consumption and reduce the cost of doing business to stimulate hiring and capital investment) will be rejected by The Hope And Change Crew out of hand and we’ll be doing something else instead.

Obviously, The Big O would like nothing better than to raise marginal tax rates to “spread the wealth around”; however, since the shortfall is greater than 25% of existing tax revenues even he knows that this sort of tax hike would be economically ruinous (he does know this, right?).  So how do “We The People” stay out of Chapter 11?

1. Increase the domestic pool of capital.  This essentially means increasing the savings rate; the traditional means (outside of scaring the financial hell out of the populace which results in cash hoarding) is by making savings more attractive by raising interest rates.  Exactly what an economy in recession needs (not).

2.  Sell even more debt instruments to foreign entities.  Since we’ve expended allow of the dollars available in the capital account, we’ll need further dollar outflows via a larger trade deficit (the $547 billion shortfall represents about 80% of the expected 2009 trade deficit).  In addition to dollars, this sends jobs to provide the demanded goods and services overseas as well.  Again, exactly what an economy in recession needs (not).

3. Crank up the printing presses at the Bureau of Engraving and Printing, use the crisp new dollars to artificially inflate the GDP to “make the numbers work”, and wait for hyperinflation to kick in down the road (which will need to be cured with severe liquidity tightening).

There are other, more extreme measures, such as government assuming control of the means of production of goods and services and using the proceeds (whatever there may be) to fund expenditures (that’s socialism – they’d never do that, right?), but it appears Barry and Babbling Joe have chosen what’s behind door #3 for now?

I can’t wait for my first “Hope And Change Brewery” beer, which will cost $1000…

These pieces of news made me wonder as to just what effect these deficits are really going to have. Since I’m a quantitative sort of thinker, I started doing a little math. If anyone in the Obama Administration wants to follow along but has trouble with math, perhaps they can have Larry Summers recommend a tutor – after all, he fancies himself an expert on just who is and isn’t good at math. In any case, here’s what I came up with:

The means of accounting national income states that GDP can be expressed as one of two sums – the first is the sum of government spending, non-governmental spending, non-governmental investment, and net exports; the second is the sum of non-governmental spending, taxes, and savings. Put symbolically (this is where the Administration types may want to call Dr. Summers), they are respectively:

GDP = G + C + I + NX
GDP = C + T + S

Equating these two (as they are the definition of the same quantity) and canceling non-governmental spending (C) as it appears in both:

G + I + NX = T + S, or

(G – T) = (S – I) – NX

Put in words, this means that the deficit (government spending minus tax revenues) equals an amount diverted from domestic savings that could have been used for investment (S – I) plus the trade deficit (-NX). As a practical matter it means that the deficit is funded by domestic bond sales which take away from private investment that could be used for economic growth – adding employees or capital expenditures (either new technology or to accommodate depreciation) or by bond sales to foreign entities which are financed by dollar outflows to those entities’ nations.

Now let’s put some real numbers into action here (paging Dr. Summers…).  The US GDP is $14.1 trillion dollars.  The projected deficit is $1.841 trillion dollars on total spending of $3.997 trillion (CBO); meaning tax revenues are 3.997 – 1.841 =  $2.156 Trillion.  The savings rate (percentage of disposable income not spent) is expected to average about 5% over the course of this fiscal year (which started in October 2008), 5% of $11.944 trillion (GDP minus taxes – I know I left out state and local taxes and spending but including those shows the situation to be even worse) is $597.2 billion dollars.  The trade deficit is expected to run about 4.5-5% of GDP; let’s split the difference and cal it 4.75% of GDP = $669.75 billion.

Where does this leave us?  Since (G – T) = (S – I) – NX, the investment potential of the economy is:

I = S – (G – T) – NX = 597.2B – 1841B + 669.75B = -$547 Billion (or -3.9% of GDP).  That’s right – not only does Obama/Babbling Joe’s spending to avoid bankruptcy take every dime away from private investment (which is what is REALLY needed to pay the salaries of the potentially re-employed and fund new capital expenditures which will get the economy moving again), but we will STILL need to come up with $547 Billion even after we go hat in hand to “nice folks” like the Chinese.

Put bluntly, Babbling Joe’s spending to avoid bankruptcy ensures that there is NO WAY IN HELL that we can get out of this recession.

Since math is equal opportunity (Dr. Summers’ assertion not withstanding) – the left always liked to go after President Reagan’s deficits, so let’s subject his budget to the same sort of analysis.  The highest dollar amount deficit came in 1986 at $221.2 billion ($990.4 billion spending with $769.2 billion in tax revenue).  This was with a $4.428 trillion GDP, a savings rate of 8.5% for FY 1986 (St. Louis Fed data), and a trade deficit of 3% of GDP ($132.84 billion).  A savings rate of 8.5% on discretionary income of $3.6588 trillion (GDP – taxes) gives savings of $310.998 billion.  Plugging those numbers in:

I = S – (G – T) – NX = 310.998 – 221.2 + 132.84 = $222.64 billion, or an available investment “pool” of about 5% of GDP.  GDP growth during that time ran 3.5%-4%.

Maybe we should have some former Reagan people suggest a math tutor instead.

To be fair to Dr. Krugman, I will say that there are areas where we agree (and please, let me finish before brandishing the torches and pitchforks):

1. In other recessions, monetary policy was a sufficient tool to expand liquidity such that, after a lead time (generally two or three quarters), demanded output picked up and growth resumed.

2. In this recession, monetary policy ran out of gas when interest rates went to zero (the “liquidity trap”).

3. Porkulus I isn’t working and will not, in and of itself, work.

This is the end of the lovefest.  Dr. Krugman takes a big gulp of the left’s Kool-Aid and calls for Porkulus Round II.  I am of the view that when you’ve dug yourself deep into a hole, perhaps you might want to put the shovel down.

What, and more importantly who, isn’t working during this downturn is going to be the key to growth restarted.  I’m going to make a really, really radical suggestion to get unemployment down that will most likely get me sent to a re-education camp:

Supply-side tax cuts (insert gasp of horror from the left here…).

(In the interests of full disclosure, I’m actually a proponent of an economy-wide reduction in the marginal tax rate, but in light of this week’s release of a record high Continuing Claims number, I’ll talk about putting workers back to work vs. improving the discretionary income of those with jobs).

How does a supply-side tax cut put people to work?  Here’s how:

1. In the simplest incarnation of the business pricing model, the supply side sets aggregate pricing as wages paid multiplied by a markup factor.  The markup factor reflects the cost of doing business which includes taxes.  Put in another form, real wages (wages divided by aggregate prices) are the inverse of the markup factor – reduce costs (fiscal policy helps this by reducing taxes on the supply side) and real wages go up.

2. The wages demanded by workers is modeled by aggregate prices multiplied by a function of unemployment.  This function is a decreasing function of unemployment – when there are more workers competing for jobs, both job seekers and incumbents demand less pay to get and retain scarce jobs.  Real wages, as defined previously, are equal to this function.

The labor market clearing point is the point at which real wages determined by supplier pricing equals those determined by the labor market condition function.

So this is how a supply-side tax cut puts people to work: Reduce costs to business, and the real wages as affected by pricing increases, and will do so by reducing prices.  More employers can offer, and employees accept, lower nominal wages than they would at the higher cost/markup as a) employers have more capital to use to expand and b) lower prices gives these wages a higher real wage. Everybody wins (except for Pelosi’s mouse in San Francisco, but that’s another story…).

There are some assumptions here – the biggest of which is that “government” (both the fiscal and monetary sides) doesn’t set off hyperinflation by creating and/or monetizing huge debt.  Perform that act of stupidity (by maybe, uh, passing Porkulus Round II) and the “reduce unemployment by increasing real wages” task becomes an impossibility.

But far be it from me to argue with the esteemed Dr. Krugman.

Or is Babbling Joe just babbling again?

Or maybe both?

http://www.foxnews.com/politics/2009/07/05/biden-misread-bad-economy/

Understanding the problem will help in defining the solution.  The US economy had been in a credit crunch since 2007 – the TED spread (difference between 3 month LIBOR and the 3 month Treasury bill) went above it’s typical upper range of about 50 basis points in mid 2007 and remained there until recently (and, as for you “green shoots” fans – it came down due to lack of demand – the 3 month LIBOR is at a ridiculously low level of 50-60 basis points, rather than an increase in the supply of credit, as evidenced by the 3 month Treasury remaining in the 15 basis point area).  The situation came to a head with the Lehman bankruptcy; at this point consumers and investors all took their money and put it in their pockets.  The net effects:

1. The velocity of money (the rate at which money changes hands to pay for the goods and services comprising the GDP) slowed.  To use the macroeconomics jargon this steepened and moved the liquidity-money (LM) curve left – less money to purchase goods and services, and interest rates more sensitive to the supply of liquidity (if you want money, it’s going to cost you – in this environment it was referred to as the risk premium).

2. The consumers’ marginal propensity to consume (the portion of discretionary income – income after taxes and transfers – spent as opposed to saved) dropped.  While there is long-term upside to this – a higher savings rate provides capital for business investment for an expanding workforce, improvements in technology, and dealing with depreciation (as long as it isn’t crowded out by high government deficits – are you listening Barry O.?) – the immediate term was a reduction in demand for goods and services.

These two factors resulted in the post-Lehman market clearing demand point being at a lower output level (read that “recession”) and sharply reduced interest rates (the three month Treasury briefly went to a negative rate).  The (essentially) zero interest rate produced a liquidity trap – the FOMC had no room to buy treasuries to lower rates, and any additional liquidity the Federal Reserve might have provided would sit on the sidelines.  The result was leftward/downward shift of aggregate supply brought the supply/demand market clearing point to a lower output at a lower pricing point – deflation.

So how does Steve Moore’s suggestion help?

1. The consumer gets more discretionary income.  Even if the split between consumption and savings remains at the post-Lehman levels (and I for one hope it does) this improves demand and shifts the aggregate demand curve back up/right.

2. The dollar strengthens.  Assuming no change in monetary policy, the resulting increase in consumer spending will cause the equilibrium demand point to not only be at a higher output quantity but also at a higher interest rate as a natural result of economic growth – money goes for goods and services as opposed to interest bearing instruments, so those instruments pay higher rates to become more attractive.  The concept of interest rate parity indicates that as the aggregate interest rate associated with one currency rises vs. others the net inflows into the higher interest rate economy will raise demand for that currency and thus make it stronger.

3. The cost of producing goods and services drops across the economy.  Since all suppliers get this cost reduction competition will cause them to pass along the savings vs. pocketing it.  This moves the supply curve right and down; this and the demand curve shift result in a market clearing point that is at a higher output and lower prices than those that would be seen with a demand shift alone – growth with non-inflationary pricing power (didn’t some former actor from California successfully do this about 25 years ago?).

These effects would be as instantaneous from the time the tax holiday became effective – help when the help is needed.

It is true that government spending will need to be reduced during the tax holiday to keep deficits from crowding out investment, and that this reduced spending will somewhat reduce aggregate demand; however the combination of positive effects on higher demand from increased discretionary income, more cost-effective supply side, and a stronger dollar will outweigh the negative effects of reduced government spending.  (And, I’d be remiss as a conservative if I didn’t state that the government spends too much as it is – the question of whether to spend should start with “does the Constitution specify this as a role of government?”)

My only argument with the tax holiday is that it would sunset and this would reverse some (or all) of the positive effects.  I would propose a permanent reduction in the overall marginal tax rate on individuals and businesses.  Yes, the effects would come in more gradually than the large step change associated with the tax holiday, but they would be permanent (at least until the liberals can repeal it…).

But did Barry O. do that?  Nope – all we got were hope, change, and a mess of government spending programs.  The effects:

1. Immediate (as in when the help is needed) effect on demand in the real economy = bupkis.  There is no stated intention to have an effect on aggregate supply; as for immediate aggregate demand, government programs have a lead time – bidding contracts, hiring workers, obtaining materials (yeah, right – shovel ready…).  And, since bureaucratic inertia is at play, it’s a looooong lead time.  But in the meantime…

2. The money to pay for all these programs has to be raised to get the ball rolling; so far it’s been by issuing a whole pile of bonds.  If the Federal Reserve doesn’t step in to put these on their balance sheet we get higher interest rates without growth; since they have done so to keep rates down in the recessionary environment we get…

3. The Federal Reserve printing money to pay for these government programs which have done nothing in the immediate term when the boost is needed.

We’ve seen the printing presses crank up to pay for government spending in the past.  It’s how we paid for the Great Society and the Vietnam War.  It’s the reason Nixon took us away from Bretton Woods.  And it’s one of the factors that brought us the inflation of the 1970s.  And this time it’s buying us NOTHING.

Someday a future Fed Chairman will need to massively tighten the Fed Funds rate, a la Paul Volcker, to clean up Barry, Harry and Nancy’s mess.  We can trace the roots of that future recession to this.

We can only hope for a change in 2010 and 2012.

One of the lamest arguments in favor of the passage of Cap and Tax was that it was good “energy policy”.  Rep. John Larson (D-CT 1), among others, went off at length in this direction.  You might suspect from the title that I may take exception with this assessment.

Before we go further, a couple of definitions:

Policy: A governmental plan (contrast with “program”), generally formulated within the executive branch which has the purpose of solving a particular problem facing the nation.

Elasticity: The percent change of the quantity of a good/service supplied or demanded for a unit percent change of price.  This definition can be confirmed in any undergrad microeconomics text.

So we see “energy policy” thrown out there as an argument.  What problem facing the nation does are we trying to solve?  In this case, it is the inelastic demand for fossil fuels (primarily oil) combined with the inelastic supply of the same fossil fuels.  The supply is inelastic in that the nation imports a sizable percent of its oil and thus does not have direct control over supply quantity.

Given the definition of the problem, it seems that there is a two part solution: