A substantial minority of libertarians, and fellow-travelers on the right, view this crisis as just desserts. America has borrowed prosperity from the future, and now the bill has come due. We need to "work the rot out of the system" (an idea that originated with Andrew Mellon, the US treasury secretary whose dealt so ably with the onset of the Great Depression by sailing off to Europe to negotiate over the debts we were owed from World War I).
This does not, to me, make much sense. Sure, monetary expansion can
cause the economy to produce above its natural level of output
temporarily. As the supply of money (i.e. bank credit) rises, firms
expand. They bid up the price of labor. More labor is lured into the
labor market by this money. But of course, it takes labor some time to
produce more goods, and some of those goods are probably combination
flashlight/nose trimmers that no one wants to buy. Workers lured in by
higher wages bid up the price of existing goods. That means that the
money wasn't worth nearly as much as they thought it would be, a
monetary phenomenon you can observe at will by finding someone who is
about to transfer from the Oklahoma City office to New York.
Disappointed, some of the marginal workers who were lured into the
labor force cut back on their hours, or leave the labor force, or at
least spend more time playing computer solitaire because who wants this
lousy job anyway? The ultimate result is higher prices and about the
same level of output. That process of boom and mean reversion takes
about eighteen months to work its way through the system.
But I don't see how it is possible, over the long term, to have a
bubble that consists of "borrowing from our future". We can't get
money from the future--their financial system isn't integrated with
ours. We can commit some people in the future to give others money,
and in that sense our current political happiness with various old-age
entitlements might be said to be borrowed from the future. But we
cannot, ourselves, spend the actual cash that rightfully belongs to
them.
Well, actually we can. We can borrow from foreigners. But America borrows in her own currency, and at pretty low interest rates. Our current account deficit is certainly worrisome, but not "the economy needs to contract by 1/3 to fix it" worrisome. Moreover, we still do most of our borrowing from good old US citizens.
Credit markets don't expand our wealth by borrowing from the future's
precious prosperity reserves. They increase production by vastly
increasing the efficiency of individual savings, funneling them into
long term investments that require larger sums than most individuals
can amass. They do so both by aggregating investments, and by
transforming the duration of the investments--allowing people who want
to lend for six months or seven years, to lend money to people who want
to borrow for fifteen or thirty. This increases the supply of savings,
and hence the supply of investment. But at the end of the day, the
size of the economy is, to a first approximation, the amount of goods
that a society can produce with the available supply of capital and
labor. The composition of these two factors is always changing, of
course, but thanks to the magic of prices, and the law of large
numbers, those changes mostly smooth out in the big picture.
The future being uncertain, that aggregation can result in some
spectacular misallocation of resources between productive sectors. But
even those misallocations aren't that big in the grand scheme of
things. Most of the houses in America, even the new ones, are being
lived in. Maybe their owners would rather have had a new Mercedes, a
rototiller, and a week in Maui. But the utility loss just isn't that
big.
Copyright © 2009 by The Atlantic Monthly Group. All rights reserved.
A substantial minority of libertarians, and fellow-travelers on the right...
Not just on the right. Or even primarily on the right. In fact, I'd say that the notions that 'America is living beyond its means' and that 'America's way of life is unsustainable' and that, in general, 'America must now atone for its sins' seem considerably more prevalent on the left than right.
But we cannot, ourselves, spend the actual cash that rightfully belongs to them.
Yes, absolutely right. And the idea that we need a recession to 'cleanse the system' (sort of like an enema) is a terrible idea that needs to die an unlamented death.
Thank you Megan. You get it.
Fundamentally, the health of an economy is determined by its ability to produce which is determined by its physical capital stock, the skills of its workers (human capital stock) and, perhaps, its organizational capital stock (its networks of relationships). Regardless of what happens to the market price of various pieces of paper or the promises written on them, at the end of every day, the physical capital stock and human capital stock are the same. Liquidation of a firm might destroy some organizational capital, but if a firm went bankrupt, it was probably not that good organizational capital anyway.
What is scribbled on various pieces of paper isn't fundamental.
...some of those goods are probably combination flashlight/nose trimmers that no one wants to buy.
I agree with you, but demand for combination flashlight/nose hair trimmers might be greater. But that's an empirical question.
I don't think it's a good idea for this conversation to get too metaphysically far down into the weeds of the nature of value. For one thing, I don't have enough weed for that conversation to be a good one. But also I am kind of unsure as to whether you are really expressing some kind of pure naive materialism or whether you have something else in mind when you talk about what is "fundamental" and what is not.
I mean, the claim that the misallocations are not that great in the grand scheme of things and that physical productive capacities and talent are far more important determinants of wealth than paper/intangibles like money and contracts is something one might have heard being argued by a "convergence theory" economist in the '70s as part of a claim that the USSR wasn't much poorer than the US or Western Europe. So I'm kind of surprised to see it here. The reason why, as it turned out, Russia was much, much poorer than the US or Western Europe was that nobody actually wanted the things it was making. In other words, those things had no value. But there was no way to see this lack of value until you reordered the "slips of paper" and the intangibles, like contracts and forms of ownership, to see more clearly what was desired by whom.
The unwinding of mortgage-backed securities is in some ways the same kind of reordering of intangibles to reveal more clearly who actually desires what, and how much, and what it reveals is that fundamentally a whole lot of houses are not worth what people thought they were worth in comparison to other goods. People will still live in them, rather than on the street, given a choice, but they are not willing to exchange them for 10 Lexuses; they may be worth only 7 Lexuses. And so a whole lot of promises to buy 3 Lexuses go up in smoke. A lot of jobs producing Lexuses go up in smoke. And so forth.
I mean, I make a living producing stuff that is itself intangible. As do you. There are no "Megan McArdle articles" sitting out there to be worth a certain amount of money or not. But if a desire for more Megan McArdle articles is shown and a promise made to pay $10,000 for them, I suppose a few articles will come into being shortly. What is key here is the existence of the demand and the credit to pay for those articles. The world will be wealthier once the articles come into being. But the question of whether or not they come into being hinges on a bunch of intangible things about the way society is structured and what the people in society desire. In an advanced postindustrial capitalist economy, the potential capacity to produce is so vast that the way of structuring and expressing demand for goods is at least as important as the capacity to produce. And that's what gets totally screwed up when there's a financial crisis.
Today's money and tomorrow's may not be fungible.
However, I'm not so sure the principle holds for oil, other natural resources, or deferred maintenance.
Megan,
A question from an interested non-economist. Can you (or anything else) evaluate this for any shred of validity:
For many year, US has imported more than it has exported. Wether the boogie man was oil, or china or whatever isn't important, but rather the result was that there were more dollars flowing out of the country, than there were coming back in.
This means that the rest of the world, would have an increase in the supply of dollars, without an increase in demand, since only so many could be sold back. This should cause the value of the dollar to come down (which it did). However, even after the value adjustment, all these foreign countries still need some use for all these dollars they have.
You mentioned that USA borrows at its own currency. Americans may not want to buy back all those dollars, but they will borrow them. You also mentioned, that one of the causes of the real estate bubble is the plentiful supply of foreign credit, which artificially inflated prices. Can this too be related to the long standing trade imbalance?
"America borrows in her own currency, and at pretty low interest rates."
Yup; but there is still a mountainous position of debt and payments deficit to work out of. Now the dollar is down and the euro up it could make good sense to start issuing some US government euro bonds at, say, 5 or 10 year maturities. Overseas holders of US dollar debt have lost when the dollar fell: no reason why they should not also lose when the dollar rises again.
We are willing to prop up the supply of capital with these bailouts, but that's only half the problem. The other is the supply of labor -- and I would argue that we aren't investing enough in it.
Today, from my perch in Maine, I'd tell you there are too many investment-bankers and a shortage of plumbers. Too many lawyers and a shortage of machinists. Too may retail-workers and a shortage of farmers.
And the market won't correct; for even though a plumber can earn $40/hour, that will never compare to what the banker earns. Same for the machinist and lawyer. And the farmer doesn't get paid by the hour; her income is subject to the weather, the fluctuations in fuel costs, the latest food scare to hit the news, the latest piece of over-regulation out of the Congress.
If we want to work our way out of this crisis, we need to understand that there is real value in producing real products with integrity; products that consumers can trust. Real value in investing in the skills workers need to be productive; investing in those skills is an investment, it isn't socialism. But every time I hear either a conservative or a libertarian blovate out loud, they just have to put in the dig, don't spend tax-payer money on the common man.
If it's okay to squander the wealth of the labor force on bad paper, then maybe it's time to invest in those laborers, so they can keep their houses, pay for their children's college and their family's health care. Because every one I know has been pushed to the brink. They aren't buying shoes, cars, couches or lipstick. They're buying wood pellet stoves and insulation; alternative medicine and cheap food. Their risk of foreclosure isn't because they couldn't afford their mortgage five years ago, it's because they can't afford the heat and healthcare on top of the mortgage this year. They're the other side of the coin at the bottom of the financial crisis.
From all I read of your work, this is the underpinning of the economy you consistently fail to identify -- folks don't get "skilled" by accident. It requires serous investment in schools and not the 4-year MBA schools, an attitude that "blue-collar" work is honorable, and an economy where blue-collar jobs can provide for a family. It also requires an investment in public infrastructure (roads, schools, bridges, railways) so that there is a certain level of wage competition; increasing the standard of living. High unemployment and low wages are an investment bankers dream; it's time to start dreaming of the economics that the plumber, machinist, and farmer need to succeed. It's time to view the an economy that's successful from the bottom up, not from the top down.
I'm with Carrington Ward.
You definitely can borrow from the future, at least if that means consuming more today and less tomorrow and not literally borrow money to consume today.
Just remember the fable of the ant and the grasshopper. When people demand more consumption goods relative to investment goods they change the production mix of the economy. When the economy produces less capital and innovation and more services and consumption it is consuming more today at the expense of future consumption.
"some of the marginal workers who were lured into the labor force cut back on their hours"
LOL
How about some specifics?
1. You mentioned debts to foreigners. What are they? What is the percent of future GDP that will be required to pay for it? How does it compare to obligations in the past.
2. The fact that foreign debt is priced in dollars is great for us, but raises the problem of inflation, a tax on the future.
3. How many empty homes are there? What level of misallocation are we talking about? And what if those misallocated funds had been placed into improved transportation and energy systems. I think you provide examples that prove your thesis rather than considering all alternatives.
Finally, if the credit markets are locked up, then why doesn't the federal government start providing credit where credit is needed and provide insurance to depositers when banks fail? Why bail out the financial firms themselves. Seems wrong to me.
While there is some argument about whether we need a bailout or not, the consenus in Washington and Wall Street is that it is needed and will happen. The real argument is what form the bailout will take.
If we are going to spend taxpayer money on the bailout, the taxpayers should get the assets and not just the obligations. These firms need to be dismantled and their executives fired and possibly prosecuted. There is no way that middle class taxpayers and our decendents should buy up worthless paper and hope that it will eventually appreciate in value.
The government should acquire the assets at a market rate which means the assets should be auctioned off so that relatively strong financial institutions can purchase as much of the assets as possible and so that the government only pays current fair market value.
Finally, the government should NOT borrow all of the money necessary for the bailout. Congress needs to make the income generated by hedge funds taxable as ordinary income and not capital gains. Congress needs to repeal the Bush tax cuts on individuals earning more than $250k per year and Congress needs to enact a small transaction tax on all equity trades.
These measures plus increased regulation of the financial services industry will help prevent the next financial disaster and place the burden for this bailout on those that caused it and benefited most from the loose rules.
brooksfoe - Good point about how the financial markets, and other intangibles are relevant to figuring out real demand, so problems and distortions in them can reflect distortions of how demand is perceived and what is produced, but I think Megan's post already recognizes that. Also the example of the USSR, while a good example to illustrate the general concept, is one that doesn't resemble our current situation in any very important way. In the USSR, the issue wasn't primarily distortions in contracts and finances, it was a lack of real markets (except the black market), with production decisions being based on government plans. We get distortions that sort themselves out, if sometimes with some pain. The USSR had no real signal of demand to distort in the first place.
OneEyedMan - The grasshopper didn't borrow from the future, it just failed to save for the future. That's a similar idea, and might have similar results, but it isn't the same thing.
Megan: But at the end of the day, the size of the economy is, to a first approximation, the amount of goods that a society can produce with the available supply of capital and labor.
Just so. One should distinguish between two sorts of failures/problems: the first moves wealth from A to B, the second destroys goods. The former may be inequitable and unfair, but it is not a net loss to the economy.
For example, the "housing crisis": If all that happens is that A cannot keep up the payments on a house, the bank forecloses, and B buys the house, then A is worse-off, B is better-off, and the total "goods" of society did not drop. Contrast with the house burning down -- or a hurricane -- or massive unemployment thus less production.
Shorter Megan McArdle: (To Congress and the American public) Just fork over the damn money and act grateful for the privilege of doing so.
"As the supply of money (i.e. bank credit) rises, firms expand. They bid up the price of labor. More labor is lured into the labor market by this money."
Except that's not really what happens in real life. In real life most of the increase flows to the people that have the most and they want to do something with it so a bubble is formed, which then causes average people to jump on the bubble near the end only to see it collapse.
The problem with economic theory is that it acts like people are all detached consciousnesses without any worldly needs. Sure in theory it should work like you describe (not accounting for outsourcing etc.) but in reality people have to eat, get medical care and take care of their kids, so working isn't optional and they can't bid up the price of labor.
Also Alan Greenspan has said many times that productivity increases are limited to at most 3% a year, and our debt is rising much faster than that for a lot longer than a couple years...so even with maximum theoretical efficiency a huge part of the present is unsustainable.
This analysis is so shockingly flawed as to amount to rank disinformation. Nearly every assertion you make at the outset of your argument is simply contradicted by facts.
Number 1: Firms didn't "bid up the price of labor." The cost of labor, in real terms, has gone down since 2000 -- as real wages for Americans have contracted and as corporations have outsourced jobs overseas (where labor is cheaper.)Unit labor costs in the U.S. (excluding the savings from outsourcing manufacturing jobs) fell nearly half a percent so far this year. (http://www.bls.gov/news.release/prod2.nr0.htm)
Number 2: Far from "playing solitaire" -- are you serious??? -- productivity of American workers has *increased* roughly 18% since 2000. So far this year, business productivity increased 4.4% from the 1st to 2nd quarter. (See link above.) The idea that people are paying more because of lower productivity is simply and demonstrably false -- and a kind of slander on the American worker.
Number 3: The U.S. has not seen an "increase in the supply of savings." Savings in the U.S. as a percentage of GDP are at their lowest level since the Great Depression, and in fact, are now NEGATIVE. (http://www.cbc.ca/money/story/2007/02/01/ussavings.html) In other words, we're spending more than we have as a nation -- again, contradicting the entire premise of your post.
But perhaps the biggest laugher is your "nose trimmers and flashlights" line. First, instead of nose trimmers -- workers are now producing things like, oh, automobiles, that are now beyond the reach of most Americans because of point C above (having no savings, Americans aren't in a position to make large purchases like cars -- even though most could probably scrounge together enough money for a nose trimmer) and because the supply of credit, which allowed people to live and spend despite negative savings, has now been cut off. Secondly, chances are, most nose-trimmers and flashlights are made in China these days anyway and are hence totally irrelevant to a discussion about American workers' wages.
Jeez. I'm all for a contrarian take on the news, but what to make of a post based on so many blatant errors?
This post shows something is really wrong in Denmark, and when you look at the Debt to GDP ratio of 350% graph I think it's impossible to argue that we haven't been living on borrowed prosperity or that things correct themselves within a couple years from excess.
Some of these posts highlight why some people are so smart when it comes to theory, they're just dumb as nails when it comes to reality. It's the same phenomenon that lead the Wall St geniuses to come to the edge of financial disaster despite Ph D's, Ivy League MBA's and all the "evidence" in the world that what they were doing wasn't risky.
We require $2 billion a day in foreign borrowings just to stay afloat. How is the US borrowing from "good ole US Citizens" when we barely save? Why do you think the Fannie and Freddie bailout was done? For the "good ole US citizen" vs the Chinese Central Bank? LOL yeah...
We have upwards of $50 trillion in unfunded liabilities going forward. Of course this assumes no more bailout packages or wars to fund.
We have several roads out of this dilemma:
- cut spending, benefits, SS for future generations etc
- raise taxes on future generations to meet these obligations
- do neither of the above and print money to the point where a $1 today is worth 25 cents tomorrow while at the same time, food and gas doubles or triples in price. See Zimbabwe or Weimar Germany for an extreme example of what happens when this occurs.
if you don't see all 3 of the above as "borrowing from the future to finance the present" I just don't know what to say...If I spend all my savings on booze and partying but not save it for my kids' college education and leave it up to them to pay for it on their own, sure it's not their cash I'm spending but you're going to seriously argue that I'm not "borrowing" from them? Huh???
Of course, since you want to interpret the term literally, we can't "borrow" from people that dont even exist yet. Yet we can "borrow" from their standard of living to increase ours today.
I think it's been more than obvious that's what the term was meant to reflect and any attempt to spin it another way is just another example of free market/raw capitalism apologists at work.
America has borrowed prosperity from the future, and now the bill has come due.
__________________
Before today, I had literally NEVER heard the phrase "the bill had come due"... and now I've heard/seen it TWICE in about five hours. I'm stunned. It sounds so foreign to me...
I say this even though I know it adds nothing to the discussion, which is pretty much over anyway.
"We have upwards of $50 trillion in unfunded liabilities going forward. Of course this assumes no more bailout packages or wars to fund.
We have several roads out of this dilemma:
- cut spending, benefits, SS for future generations etc
- raise taxes on future generations to meet these obligations..."
In the case of Social Security, we literally have been "borrowing from the future" in that we have been spending Social Security payroll tax surpluses for close to 25 years now, a practice that will have to stop when Social Security's cash-flow starts going negative around 2018.
A reader - Re: "The cost of labor, in real terms, has gone down since 2000"
"Wages" does not equal" "total compensation". Also 2000 is a rather arbitrary date with higher real wages than the years around it. Your data is apparently correct (ignoring disputes about the proper size of inflation adjustments), but also apparently meaningless.
Re: Savings - Stock market investment, even home equity is a form of savings broadly understood. Very risky savings. But traditional bank deposits are just ways for you to indirectly invest (getting greater security in return for giving the vast majority of the potential profit), and "savings" under mattresses aren't very meaningful.
re: "automobiles, that are now beyond the reach of most Americans"
Automobiles are most certainly NOT beyond the reach of most Americans.
Jim - Re: "If I spend all my savings on booze and partying but not save it for my kids' college education and leave it up to them to pay for it on their own, sure it's not their cash I'm spending but you're going to seriously argue that I'm not "borrowing" from them?"
Yes. As you say its not their cash that your spending. You are not borrowing from them. Are you making things worse for them in a way similar to what would happen had you actually borrowed from them (and then not been able to pay it back)? Perhaps. But that still doesn't mean you are actually borrowing from them.
Bulworth - Re: "In the case of Social Security, we literally have been "borrowing from the future" in that we have been spending Social Security payroll tax surpluses for close to 25 years now"
No, you have been figuratively borrowing from the future, but not literally. The government is one entity. The SS payroll tax is income to the government. Spending it on other things isn't borrowing anything, not even from the present. Or if you want to consider the parts in isolation, than its one part of the government borrowing in the present, from another.
Sure the "lending part" has made all sorts of promises about giving out money in the future, but those promises aren't loans or in any way borrowing.
Spending money you may need tomorrow, today, isn't borrowing from the future in any but the most figurative sense, and spending Social Security taxes on programs other than Social Security isn't any different in this regard.