MONEY-A Quick Thought On Obama's Call for a Raise in the Minimum Wage [192*8]

MINIMUM WAGE ACROSS THE NATION

GREEN - States with Min Wage Higher; BLUE - States with Min Wage the Same; YELLOW - States with No Min Wage; Remainder have a Lower Min Wage
GREEN - States with Min Wage Higher; BLUE - States with Min Wage the Same; YELLOW - States with No Min Wage; Remainder have a Lower Min Wage | Source

AN INCREASE IN THE MINIMUM WAGE ISN'T THE BEST WAY TO GO

THIS IS JUST A QUIKIE HUB regarding President Obama's call for 1) increasing the minimum wage to $9/hr and 2) tying it to the cost of living. No, Democrats, I haven't forsaken you, I am still an "active-state" liberal, my new, more correct name for progressive (it differentiates philosophically from socialist); nevertheless I do not think the minimum wage is the best way to go, if fact I think it should be abolished because it has the same drawbacks of say, rent control; the effect is to distort normal economic activity.

While the minimum wage does not have the devastating depressing effect on hiring the other side ("limited or minimal-state" liberal and conservatives, two entirely different species) wants you to believe, it does have some, if only in perception, limiting impact. I strongly believe it is a necessary function of a government formed under the concept of Lockean Liberalism of individual rights where those same individuals contract with government to give up some of those rights in order for the government to be able to prevent harm to its citizens from systemic issues beyond their control or from each other. The negative side-effect of grossly unequal distribution of income from unregulated capitalism is one of them. So, the question is, if a minimum wage is not the best idea because it does have anti-growth aspects, what is the better way to do it?

Based on the convincing logic of an economics lecture I recently listened to, the answer is ... "something we are already doing"! And, that is expanding the earned income tax credit. Where the minimum wage has the drawbacks of any artificial floor or ceiling placed on economic activity, the earned income tax credit does not; yet it accomplishes the same goal of providing a livable wage for those who work. It may have other advantages as well such as increasing economic growth as business will at least feel they have more opportunity to expand now that they can pay lower wages.

BUT WON'T BUSINESS STOP PAYING WORKERS?

THOSE ON THE LEFT MAY ARGUE, however, that without a minimum wage, businesses will revert to the conditions that existed in the "Gilded Age" in the 1800s and pay subsistence wages while pocketing the difference for themselves. They will probably be right, some businesses will try to do just that. But, let's consider some things.

First, take the absurd case that all business stop paying anybody anything since the "gov't will take care of it" with the EITC. Well that can't work because to get an EITC, one must earn a wage and wages aren't being paid. OK, then let's suppose the next absurd case, employers pay all of their employees one dollar a day in wages and letting EITC pick up the rest. Now, theory would have it that the employers could live high-on-the-hog and the rest of the nation can survive on subsistence assistance. The problem with this scenario is look who is paying the taxes that fund the EITC ... the employers, of course. They are the only ones earning enough money to be taxed. Further, they also have to shoulder the entire burden for the cost of rest government. Not likely!

So, what is likely? What is likely is that employers will pay wages consistent with the skill level of the job, the scarcity of employees, and any demands unions might bargain for. Does that mean wages will go down for many low end jobs? It probably does, but it also suggests economic growth as more employers enter the market because labor became cheaper. This, in turn, will drive up demand for labor which has the potential for driving up wages as employers compete for employees.

The EITC offers a significant advantage to help this process along. In the Gilded Age, employees were locked into their jobs at slave wages because they literally had no alternatives; it was accept the wage or die, for there was no government support system; a limited-state government enthusiast heaven. Companies went so far as to set up company stores and company towns, paying their employees in company script that could only be used in the company stores ... that was life in America in the early 1800s.

America in the 21st century would be very much different, IF employees have options. With EITC, employees aren't tied to the employer any longer, they can be mobile. They won't necessarily starve to death if they leave intolerable conditions to seek better ones elsewhere. They could find a lower paying job for a while and still be insured of their family surviving while they try to move up the latter somewhere else. This, in and of itself limits how despicable companies can choose to become, simply out of self-interest.

And where is the incentive for someone receiving EITC to "move up the ladder"? In the program itself. Unlike many assistance programs, EITC has a sliding scale that rewards you for doing better, it does not punish you, thereby locking you into the assistance roller-coaster. With EITC, for each additional dollar you earn, you only lose a portion, say fifty cents, of your assistance; consequently, your net position is better than it otherwise would be, you are incentivized to improve.

The EITC is society helping itself. Yes, it is a tax on everybody who pays taxes, but everybody benefits because it does two things, 1) encourages growth by letting the economy work the way it is supposed to work without artificial ceilings and floors getting in the way and 2) keeps people employed and productive rather than on the welfare and a drag, either willingly or unwillingly on society. This is the way I think we should go.

UPDATES

8/9/13: THE BATTLE OVER MINIMUM WAGE seems to be heating up again with an ad war between President Obama and the billionaire Koch brothers. President Obama is using his bully pulpit to push for a higher minimum wage (he should be pushing for a lower minimum wage and higher EITC, IMO) while the Koch brothers are spending millions on ad campaigns keep the minimum wage where it is, or lower it. SOLUTION: Write your Representatives and tell him to Increase the EITC and Lower the Minimum Wage!

HERE ARE A FEW QUESTIONS TO MULL OVER

DO YOU THINK THERE SHOULD BE A MINIMUM WAGE?

  • YES
  • NO
  • NOT SURE
See results without voting

DO YOU THINK THERE SHOULD BE AN EARNED INCOME TAX CREDIT?

  • YES
  • NO
  • NOT SURE
See results without voting

DO YOU THINK THE EARNED INCOME TAX CREDIT SHOULD REPLACE THE MINIMUM WAGE?

  • YES
  • NO
  • NOT SURE
See results without voting

DEMOGRAPHIC QUESTION

DO YOU CONSIDER YOURSELF MOST CLOSELY ALIGNED WITH

  • CONERVATIVE OR "LIMITED-STATE" LIBERALS
  • PROGRESSIVE OR "ACTIVE-STATE" LIBERALS
  • SOMEWHERE BETWEEN LIMITED-STATE AND ACTIVE-STATE LIBERALISM
  • OTHER
See results without voting

AMAZON ON EARNED INCOME TAX CREDIT

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Comments 38 comments

JohnfrmCleveland profile image

JohnfrmCleveland 3 years ago from Cleveland, OH

Good topic, M.E. -

My initial thought on this is that, in essence, using the govt. to subsidize worker salaries is basically subsidizing industry. We would be lowering their labor costs, which would just increase their profit margins. But none of that increased profit would benefit labor at all, because labor still has no leverage to demand more. If we are going to use government to float workers (a place I think we are inevitably headed), why not just expand the public sector? The private sector has always been very efficient at putting stuff on the shelves and making money - they need no help in these endeavors. But a well-paid public sector - teachers, cops, firemen, researchers, etc. - not only have a positive impact on society, they also have money to spend. They could be the middle class that is no longer coming from the private sector.


My Esoteric profile image

My Esoteric 3 years ago from Keystone Heights, FL Author

Thanks for you comment John. You make good points. One issue with the examples you used, although the idea is still certainly valid for other jobs, is most of those jobs are 1) skilled and 2) state centered jobs. The ones that EITC support are mostly the unskilled and semi-skilled workforce. So the jobs we would consider must 1) be intrinsitically federal, 2) require unskilled or semi-skilled workers, and 3) not be "make-work" but actually beneficial to society as a whole; something the government would spend money on, if it had it. In any case, I think that is a great alternative.


JohnfrmCleveland profile image

JohnfrmCleveland 3 years ago from Cleveland, OH

On another debate board, I once made the argument that it is not important whether or not these govt. jobs are beneficial - the important thing is to, basically, distribute money to those who need it. The classic American example of make-work is the bridge to nowhere, but we were discussing the Chinese phenomenon of building whole cities (with the expectation that they will fill up, I guess) that often end up as ghost towns. My point was that, as long as there is no shortage of material (labor, cement, steel, etc.) that would drive up prices, and you are paying for this with new (deficit) money, the government would be employing people who otherwise would be unemployed, and buying materials and services that would otherwise not have been used. Everybody from contractors to steel mills to cement companies wins, plus there are that many more workers who have money to spend. What difference does it really make if that city gets used or not?


My Esoteric profile image

My Esoteric 3 years ago from Keystone Heights, FL Author

I'll have to think about that one for a bit, but it has something to do with the trade-off between deficit and capital available for investment. It goes something like this: first assume as a starting point there is X number of $$ in the economy and the gon't isn't printing anymore. Then, the amount of capital available for investment is simply the sum of the amount of capital held in private savings, the amount of capital invested by foreign markets, AND MINUS the amount of gov't borrowing (deficit spending).

On the flip side, the measure of growth, the GDP, is equal to Household Conmsuption plus Business Domestic Investment plus Gov't Spending plus the amount Exports exceed Imports.

So, in the one case, deficit spending henders growth by reducing the amount of capital available for private investment, therefore reducing GDP; but in the other, it helps GDP through its own expenditures. The question is, which scenario provides more overall value, more private investment or more deficit spending, especially if that spending leads to waste; which would incease GDP more?


JohnfrmCleveland profile image

JohnfrmCleveland 3 years ago from Cleveland, OH

That's classical, gold-standard thinking. Try this: there is not a limited amount of capital in a fiat currency economy. The government can create all the money it wants to. The only real limit is an economy's ability to produce and meet the demand of the new money - as long as an economy can produce enough goods to meet that demand, prices have no reason to go up.

This, by the way, is why interest rates do not go up based on demand. Banks are never "reserve-constrained," meaning they are not limited by the amount of capital they have when making loans. If a bank wants to make a loan and does not have the necessary reserves on hand, it first goes to the interbank market to borrow another bank's excess reserves. If there are no excess reserves in the system, the bank can always go to the Fed's discount window to borrow reserves. So a bank can always get the necessary reserves to make a loan. Hence, there is always capital available for investment. The only thing that holds banks back from loaning out credit is the borrower's prospective ability to repay the loan. No matter how bad the economy is, a bank will be happy to loan money to a profitable business, and no matter how good things are going, a bank won't loan money to a bad risk.

So - assuming you don't print so much that you outstrip your economy's ability to meet the new demand - new money (as long as it is spent) should induce production that otherwise would not have occured. More people with more money means more people buying food, homes, utitilites, cars, etc.


JohnfrmCleveland profile image

JohnfrmCleveland 3 years ago from Cleveland, OH

On what scenario creates more value - I don't think it matters, really. The private sector is very efficient at sucking up all available dollars, and it will be able to meet just about any demand. No matter where dollars start out, they always end up in the same place - with the rich, the people who own the means of production. Whether you give money to people on welfare, pay them directly to do public sector work, or contract out to private sector companies to build cities, dollars flow through labor up to the rich.


My Esoteric profile image

My Esoteric 3 years ago from Keystone Heights, FL Author

That is a different issue with different resolutions. What you describe is occuring now and occured in 1800s and early 1900s; but not so much in from 1933 - 1980 when active-state government was in place. (there were flashes of it with Abraham Lincoln and Teddy Roosevelt as well)

The issue we were talking about can exist whether you have a fair distribution of wealth like we use to, or the grossly unequal one we are faced with today.


JohnfrmCleveland profile image

JohnfrmCleveland 3 years ago from Cleveland, OH

I'm sorry M.E., I'm not following you. Could you please explain your point in more detail?


My Esoteric profile image

My Esoteric 3 years ago from Keystone Heights, FL Author

Sorry, I do that a lot. We started with a proposed alternative to the minimum wage, which was an expanded EITC; both designed to provide low paid employees with a so-called living wage. My thought was that the EITC is better because it 1) allows the economics of the labor market to work as it should and 2) remove barriers to investment. You proposed rather than providing EITC, hiring them off the private sector and employing them instead in the public sector at jobs that may or may not have value; but at higher wages. (one effect of that, which I didn't think of, is it would drive up wages in the private sector because of the reduced labor force, reducing investment).

In you last comment though, you switched gears and began discussing unequal distributions of wealth; the rich getting richer while poor get poorer kind of thing. While this is quite real, it is a different topic altogether from one about workers getting a living wage. That was all I was trying to say.


JohnfrmCleveland profile image

JohnfrmCleveland 3 years ago from Cleveland, OH

Thanks for clarifying that. I actually wasn't trying to rant about unequal distribution of wealth there (but it's an understandable mistake, since I have been known to do that ;) ). I was trying to say that I don't think one can really affect capital formation much with these kinds of policies. I also don't think that the rich do all that much job creation. (When I say "the rich," I'm also talking abour corporations and banks - whoever is holding money.)

You can give money to the rich (basically, by lowering their taxes), or you can give money to the poor (by giving them jobs, welfare, etc.) - but how long does it really take for the poor's money/wages to end up in the hands of the rich anyway? Since most on the low end have no savings at all, I'd say "not very long." You get a paycheck, and it's pretty much all gone by the time you get the next one. The dollars cycle through the economy for a while, but only to the extent that labor can attract them. After some number of cycles through the economy, those dollars end up in the hands of ownership. It is inevitable. I'm not saying that it's a bad thing, but I am saying that money is always going to find it's way home, so no matter where or how the government spends it, it all ends up in the same place. It just ends up there faster when we have a large income disparity between rich and poor. (That's also why I was cool on the idea of government subsidizing the paychecks of the working poor in the private sector.) So in the end, I don't see how capital formation is affected either way.

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You are correct in saying that government jobs would affect the cost of labor. The theory is that the lowest government job (I like to use highway trash-pickers as my example) would set the wage floor. If you can't flip burgers, you can always get a job picking up trash. Until you approach 100% employment, you are not going to force up the cost of labor across the board, since there would always be an available pool of workers at the low end. But when you do approach 100% employment, all the private sector has to do is make flipping burgers a little bit more attractive than picking up litter, and they will have no trouble finding labor.

I just want to reiterate that American businesses, for all their complaining, are having no trouble making money. Overall, this country is making more than ever. It just feels bad because so many people are out of work, and many more of us are running in place, nervous about our jobs, or both. It is not a production problem, but a distribution problem, so my solutions don't include too many fixes for the private sector's sake (like lowering the cost of labor). My solution is to allow the private sector to continue to make money, then redistribute some of those profits for the benefit of all. Labor used to be strong enough to do this on its own, but, I think, those days are over.


My Esoteric profile image

My Esoteric 3 years ago from Keystone Heights, FL Author

There isn't much you say that I can disagree with excet that about capital formation. Unfortunately, in the short-term, it is a zero-sum game with government spending being a negative force; more gov't spending means less capital formation, everything else being equal.

Also, it isn't that removing the minimum wages fixes the problems for existing employers, as you say, it just lets them get richer. What it does do is lower the barrier for others to create new jobs in new enterprises with the multiplier effect that has, it broadens the base of employment opportunities, where increasing the minimum wage does anything, it narrows it.

Effectively, and theoretically, this new workforce would produce goods and services that would be consumed, causing a growth in GDP from the private sector, rather than the gov't sector in your schema, thereby raising tax revenue and lowering the deficit, which in turn frees up money for more capital formation and investment. I'm dizzy.


JohnfrmCleveland profile image

JohnfrmCleveland 3 years ago from Cleveland, OH

"Unfortunately, in the short-term, it is a zero-sum game with government spending being a negative force; more gov't spending means less capital formation, everything else being equal."

Do you mean that, short-term, taxing companies means less money for them to invest? Or does government spending itself have some kind of negative effect?

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"Effectively, and theoretically, this new workforce would produce goods and services that would be consumed, causing a growth in GDP from the private sector, rather than the gov't sector in your schema, thereby raising tax revenue and lowering the deficit..."

One of the tenets of my schema (basically, MMT) is that all dollars come from the government. Not all value, and not all growth, but all dollars. So to grow an economy in dollar terms, you of course need to grow the number of dollars in an economy. Working against that end, you have savings (not the kind of savings that most of us do, which eventually gets spent, but dynastic savings, which just piles up). So, keeping the number of dollars and the number of people equal: our economy produces, say, $15 trillion worth of products and services/year, and $15 trillion is earned overall. If the whole $15 trillion is spent to buy those goods, everything stays stable. But there are always savings - money piles up in the coffers of businesses, banks, China, Japan, and other rich guys - so the government must add at least that much to keep production from contracting. And if you want the GDP to grow in nominal dollars, you need to add new dollars to the economy (deficit spending). So you need that government money to grow.

Also, the distribution of that $15 trillion worth of production matters, because the rich save much of their money, while the poor spend all of theirs. If you allow the cost of labor to go down, less of that $15 trillion is going to go to labor and get spent, more will go to ownership and be saved, and the government will have to make up the difference. You might grow the economy with cheap labor, but the growth is going to ownership, not labor (this has been the trend for the past 30 years). And we are left with the same problem.


My Esoteric profile image

My Esoteric 3 years ago from Keystone Heights, FL Author

Government deficit spending has the negative effect. The formula is I = PS + FI - GDS where I is private investment, PS is private savings, FI is foreign investment and GDS is gov't deficit spending (gov't borrowing), which is to say "sources" of capital must equal "uses" of capital because the interest rate on borrowing and saving money varies such that the two stay in near equilbrium most of the time. It is times like these when nice theories go all to hell, though.

Now, on the flip side, you have GDP = CS + GS + BS + NE or consumer spending+ government spending + business spending + net exports (which today is a negative number, making the FI above a positive number) Now, "spending" is a bit tricky. It is only counted if it is on the end product, so most of CS and GS goes toward GDP but not all BS does as it buy intermediate products that wind up in the end product.

Further, I think your wrong to a degree in your statement the government has to print money to make the economy grow. Actually it can grow, as can the supply of money, naturally because of the nature of credit and the banking laws. Because banks do not have to keep 100 % of their deposits in reserve to cover the loans they make, they in effect create money each time they make a loan. So, in a booming, expanding economy, the money supply is increasing without government action.

I am going to have to write a hub on this, my response was getting that long, lol. Anyway, examples are needed.


JohnfrmCleveland profile image

JohnfrmCleveland 3 years ago from Cleveland, OH

MMT uses a completely different equation for investment. Investment is just treated as spending, really. GDP is the same, though.

I'm goint to attempt to change your mind on the govt. money thing, so bear with me. The government supplies what is sometimes called High-Powered Money (HPM) - these dollars have no attached liability. When the government prints up money, there is no need to pay anybody back. The only liability on a dollar is another dollar.

Banks, on the other hand, can only create credit. You borrow $1000 from a bank, and you are not richer for it, because you owe them $1000 (plus interest). The bank, assuming you repay the loan, only makes the bit of interest. When the loan is extinguished, no net money has been created. The only net change is that a bit of HPM (the interest) has moved from your hands to the bank. Also, banks have to use HPM to settle up at the end of the day with the Fed - their credit will not do.

It was a banker friend of mine that changed my mind on this stuff. He explained why the "money multiplier" theory was incorrect (I went over this in one of my hubs, so I won't bother you with it here). But in short, the government will loan a bank reserves at the discount window of the Fed, so there is, in practice, an unlimited amount of bank reserves available. This allows banks to create all the credit they can sell, but as explained above, this does not increase the number of actual dollars in the economy. It is more accurate to say that banks do a good job of leveraging HPM, and their credit allows for more economic activity. But nothing a bank does can increase a country's net position as measured in dollars. In a bank transaction, the assets will always equal the liabilities.

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Now, if you accept that, government spending takes on a whole new meaning. So do capital markets, because there is no fixed pile of capital, and no corresponding interest rate adjustment that reflects competition for those funds. As MMT explains it, the government sets the (overnight) interest rate by the controlled sale of govt. bonds. And as we have seen in real life, interest rates do not behave as classical economics would predict; rather, they follow govt. bond yields.


My Esoteric profile image

My Esoteric 3 years ago from Keystone Heights, FL Author

Thanks for joining in Walt, I appreciate it. Bottom up.

EITC is currently paid out as part of an employees pay check and the employer passes on the cost to the gov't, although I need to check that out as I never looked to see how that exactly worked in my company. In any case, the employee receives constant income at some level of "living" wage, which is not much, let me tell you; at least not based on what I added to this ladies paycheck.

The employer picks up a portion of the EITC only by virtue that they pay taxes, like everybody else does; there is no specific tax increase levied on them just for this.

Besides going through how minimum wage distorts the economic cycle, the lecturer also covered rent controls, farm subsidies, and other forms of support that work directly at the economic level. In each case, he suggest alternative approaches which achieve the same result, but lets the economy work without putting a boulder in the stream of its normal flow.

I am trying to think of what features of Obamacare perturb the normal economic activity. I have no doubt there are some. Its major feature is requiring all citizens to have insurance. So, what does that do? 1) It certainly impacts demand, doesn't it, but only to the degree that it makes it more stable and predictable where suppliers can plan production better with less hiccups. 2) It subsidizes people who can't afford insurance rather than making suppliers reduce their prices, which is exactly the solution the instructor suggests, 3) it increases excise taxes in certain businesses who profit, in most cases grossly, on sick people, but again, it isn't sufficient to change business decisions, 5) it levies a special tax on the wealthy, again, something needed as the tax cuts beginning in the 1980s is responsible for the unconsciencable and growing disparity between "haves" and everybody else; nevertheless it doesn't have an effect on economics of delivering medical care. I don't understand enough of the pools or the requirement of certain businesses to provide insurance to make a comment on that, however. I think the pools are probably safe, I am not so sure about the latter, however.

But, to the first part of that paragraph, yes, that would be a good idea.


My Esoteric profile image

My Esoteric 3 years ago from Keystone Heights, FL Author

John, I went back to look for your first mention of MMT and pondered it. Now, I answered it based on what I thought it meant, but I am thinking I may have missed your point. Can you expand on MMT, starting with what it is an acronym for? Thanks.


JohnfrmCleveland profile image

JohnfrmCleveland 3 years ago from Cleveland, OH

MMT stands for Modern Monetary Theory, which is just fiat currency economics, or chartalism. It is basically a description of how our system actually operates, along with Japan, Canada, Australia, the U.K., and other fiat currency economies. The big revelation, in my opinion, is that the government does not borrow or raise money through bonds sales; even though they still offer bonds, they are used to control interest rates. Since the government can (and does) print up dollars at will without any gold-based or debt-based constraints, the true (and only) limiting factor to government spending is just inflation (printing too much).

Another important thing is how the Fed interacts with banks. Since the Fed will always lend banks more reserves at the discount window, banks are never reserve-constrained - therefore there is no finite pile of capital to compete for, therefore there is no upward pressure on interest rates. (i.e., interest rates are not market-driven.)

Finally, it is important to distinguish between government-created dollars and bank-created credit, and understand that banks cannot increase the number of real dollars in the economy. So all dollars emanate from the government, and enter the economy through deficit spending. If the government ever stopped adding new dollars to the economy, dollars would be sucked out of circulation by saving/hoarding.

I hope that was clear. My hubs are all attempts to explain MMT, or parts of it, but they are pretty poorly written. There is probably more to be gleaned from the comments. MMT is completely compatible with Keynesian principles - the big difference really comes from the fact that most applications of those principles, even today, are based on outdated, gold-standard assumptions concerning debt, dollar creation, interest rates and capital markets.


My Esoteric profile image

My Esoteric 3 years ago from Keystone Heights, FL Author

I must go puruse your hubs, but a question regarding this statement, "So all dollars emanate from the government, and enter the economy through deficit spending"

The last couple of years of the Clinton administration they were running a budget surplus. If Bush hadn't botched it, even with 9/11 and Afghanistan, the 2000 downturn would have probably have ended without a recession and the surplus most likely would have continued since it had some strength.

The question is, what does that mean to MMT?


JohnfrmCleveland profile image

JohnfrmCleveland 3 years ago from Cleveland, OH

By MMT reasoning, budget surpluses are almost always bad, because they permanently remove dollars from the economy. The only time you want to do that is when you have more dollars in play (and more demand) than your economy can meet. In fact, many MMT people blame the surpluses for the ensuing downturn. Keep in mind that those surpluses were the government's, not ours.

As much as I dislike Bush and his policies, I can't really argue with his dismantling of the government surplus, nor his increased deficit spending.


My Esoteric profile image

My Esoteric 3 years ago from Keystone Heights, FL Author

Hmmm, how interesting. I don't see how that agrees with Keynesian economics. The formulas I gave come straight out of it.


JohnfrmCleveland profile image

JohnfrmCleveland 3 years ago from Cleveland, OH

Well, the difference I see in the equations is that yours treats government spending as debt - dollars coming out of the economy. Otherwise, countercyclical government spending is the main policy from both schools.

What is investment if not spending?


My Esoteric profile image

My Esoteric 3 years ago from Keystone Heights, FL Author

It does, you see. I haven't gotten to it in my Economics for the Political Junkie series, but it will say. as I have alluded to above, that both Austrians and Keynesians agree that Savings and Investments always find an equilbrium at the 50/50 point and that interest rates somehow play a role in it; they disagree on the how. It will also say that all monetary policy of the economy is vested in the independent federal agency, the Federal Reserve while the political side of government retains oversight over the fiscal policy. In its charter, the Feds have just two principal goals they were established to meet, 1) keep unemployment low and 2) keep inflation in check. To do this, they were given a few tools, 1) to set certain basic interest rates, 2) issue and buy bonds, 3) print money, 4) regulate nationally charted banks, and 4) some others I forget at the moment; but those were some of the biggies.

It is through the Print Money capability where gov't, meaning the Fed, can itself create inflation; I don't believe any of the other tools do that, becauase all inflation is, is more dollars chasing a disproportionaltely less value in goods and services, artificially pushing the price of those goods and services up.

Raising foundational interest rates have a different and opposite effect. And when those rates change, it naturally effects all other rates in one way or another. The Fed can also effect interest rates and also raise money by buying or selling bonds.

None of those activities change the money supply, except the phyisical printing of money. The only other activities that I can think of where the Fed can effect money supply is the reserve rate they require banks to maintain, reducing the number of loans they can make or, if big enough, making them recall loans.

Now, back to deficit spending. as to the savings-investment formula, this can be restated as the savings-borrowing formula. When private business invests, it borrows money from domestic or foreign savings, including their own. Likewise, when the governemt borrows money, the Fed sells more bonds, it doesn't print more money, which also comes from peoples or foreign savings.

If I understand what you are saying about MMT, the Fed is printing money, inflating the economy, and not buying bonds.


JohnfrmCleveland profile image

JohnfrmCleveland 3 years ago from Cleveland, OH

Here is how MMT explains dollar creation, in the most basic terms: the government creates dollars by spending, and destroys them by taxing. Bonds are not even necessary. But the creation of new dollars is necessary due to people's (and businesses') desire to save/hoard money.

Bonds today are used to control the overnight rate, but this could also be done by adjusting the interest rate paid on reserves. Bonds are not used to borrow dollars, as there is no need to do so, but I think it all works out the same in the end either way you look at it. By MMT thinking, govt. bonds are just savings. Large piles of amassed dollars are converted into bonds when people/banks/businesses wish to hold cash risk-free instead of investing in something more profitable and riskier. America has created about $15 trillion dollars over our history (the net of all deficits and surpluses); about $14 trillion of that has been converted into bonds, and about $1 trillion remains in play. And the pile of bonds never gets any smaller, so those dollars do not affect the economy. Even if we bought up all of those bonds, exchanging new dollars for them, the thinking goes, there would not be much of an effect, because govt. bondholders want a risk-free way to store dollars, not risky investments. So, that's the cycle - the govt. creates dollars, spends them, and they work their way up through the economy until they are lost to savings (dynastic savings, the kind that doesn't get invested in anything else) held as bonds by the usual suspects - banks, corporations, China, Japan, Saudi Arabia, etc.

If you consider bonds to be the near-equivalent of dollars, it works out the same as "borrowing" dollars for spending - either way, the government has merely exchanged bonds for dollars, and neither party's financial position is any different.

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On savings and investment: If you hold dollars, you have a few options.

*You can exchange them directly for govt. bonds. The dollars that find their way to bonds are, to my thinking, out of play. They might change hands, but since the net number of bonds doesn't decrease (although it could), those dollars never get used again.

*You can save money in a bank. That money is added to the bank's pile of reserves. But since banks are not reserve-constrained, the amount of reserves they presently hold does not affect their willingness or ability to make loans. If your savings cannot immediately be used by that bank (or another bank) for a loan, it will be used to buy govt. bonds, as all excess reserves do.

*You can invest in stock. If you buy a company's stock offering, they get your dollars, and they will presumably spend those dollars on equipment, construction, labor, etc. (If you buy secondhand stock, you are just trading cash positions with the previous owner.)

*You can invest directly in your business, in which case you will be spending dollars on equipment, construction, labor, etc.

So in sum - either dollars are sitting around waiting to be spent, or they are being spent. If you break down investment, all you find is spending.

***********************

On inflation: the thinking goes that new money can elicit more production without serioius inflation, as long as you don't encounter shortages of materials (including labor). A couple of policy precriptions follow from this, though there is some disagreement - the government should be able to spend enough to employ everybody. Some think we should pump up the private sector to do this, while others (myself included) think we should expand the public sector. Some want to lower taxes, while others want to let the government do the spending.


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JohnfrmCleveland 3 years ago from Cleveland, OH

Since my edit was timed out, let me just add this: the official MMT equation on savings and investment is S = I + (S - I), but I find this more confusing than helpful. I prefer to think of these things in real terms.


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My Esoteric 3 years ago from Keystone Heights, FL Author

It shouldn't be confusing because that formula reduces to S=I, which economist believes is the equlibrium point in the relationship between savings and investing. Which is to say the source of capital for investing is savings. Well savings is also the source for deficit spending, unless the government prints money. Consequently, deficit spending and investing compete for the same savings dollar. I will provide some examples when I get back from work.


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JohnfrmCleveland 3 years ago from Cleveland, OH

When I reduce it, I get S = S. Which is why I stopped trying to understand things in terms of this equation. :)


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My Esoteric 3 years ago from Keystone Heights, FL Author

Well, actually you get 0=0 because you can simply remove the parentheses and subtract S from each side leaving S - S = I - I , so, regardless of the values S and I take on, it reduces to the identity zero = zero (my S = I was wrong except in the cases where S and I take on the same value)


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JohnfrmCleveland 3 years ago from Cleveland, OH

No matter how you break it down, it seems that there is no meaningful relationship between S and I, which isn't very enlightening. But I have read long essays on all of the implications of this little equation, so somebody thinks they have meaning. (I don't, but my opinion hardly carries any weight in the MMT blogosphere.)


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My Esoteric 3 years ago from Keystone Heights, FL Author

Now, back to MMT. If the economy had $1o in circulation and nothing in savings today, nor in the Treasury, and then the government spent a dollar, your theory says there will be $11 in circulation tomorrow. Where did that dollar come from for it clearly is a "created", it wasn't there yesterday. In this scanario, it could only come from one place, the gov't printing press. Why? Because there is no place to borrow it from, there are no savings anywhere, the initial assumption; it fits your theory perfectly, I think.

Let's change the scenario a bit and say there is a dollar in savings and $9 in float or $10 in the total money supply. Now when the gov't spends the dollar, it has choices. It can print the dollar, inflating the economy and "creating" a dollar of money supply. Or, it can now borrow the dollar by issuing a short, medium, or long-term bond for a dollar and spend that. Where did that dollar come from? The dollar in savings of course, so the money supply stays the same, $10.

Now what about the effect on inflation, investment, money supply, and GDP in those two scenario's? In the first case, clearly "inflation must increase", that is what necessarily must happen because of the pressures it causes on demand and supply that is not caused by natural growth. "Investment"? Well, I suppose that it could result in some increase with a corresponding increase in savings. Money supply? It grew $1 dollar because there is now $11 in circulation rather than $10. Finally, GDP, it increaseed $1 also from the gov't spending.

How about the second scenario. Here, there is no inflation, there was no artificial increase in demand. Investment didn't increase either, in fact it had to decrease because the gov't borrowed the dollar in savings that could have been used for investment and savings didn't increase, according to the standard model anyway. Money supply remained constant at $10 and GDP increased $1.

So, what do we have? On the one hand, inflation, maybe inflation and savings, money supply, and GDP all increase; while on the other, GDP increases and investment decreases, there is no inflation and money supply remains unchanged.

What would MMT say would happen to inflation, money supply, investment, and GDP under those two scenarios?


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JohnfrmCleveland 3 years ago from Cleveland, OH

Under scenario one, as you said, there is now $11 in circulation. GDP should increase, because of the extra $1 demand, which was spent at least once (by the government). (How much GDP really goes up, I believe, would depend on velocity. What if it was spent once/month? But for simplicity, let's call it an $11 output economy.) Inflation should not occur as long as there are no shortages - if demand in your bakery goes up 5%, you should be able to meet that increase without raising prices, assuming there are no shortages of raw materials and no shortage of labor.

Under scenario two, with $9 in circulation and $1 in savings, that would depend on your definition of savings. In a steady-state economy, with $10 of output and $10 of earnings, $1 of hoarded money would lead to deflation or a contracting economy. $1 "invested" though is $1 spent, and the economy stays at a steady $10 output.

If the government taxes away that $1 of would-be savings and spends it, you still have a $10 output economy, because all $10 is spent on production. If the government taxes away that $1 and runs a surplus, you have deflation or a contracting economy, with only $9 of financial assets left.

if the government "borrows" that $1 and exchanges it for a bond, the economy stays at $10 output as long as the government spends that dollar (which would be deficit spending). Net financial assets in the public sector now = $11 ($10 in dollars and $1 in bonds). This is close to our economy today, if there was zero growth - the government just deficit spends in the dollars that were lost to savings. Money invested in govt. bonds was never going to be spent again anyway.


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My Esoteric 3 years ago from Keystone Heights, FL Author

Ah ha, we moved a little closer, methinks.

First paragraph - Agreed, actual GDP growth would depend on velocity and actual inflation would depend on how many zeros followed the one, but at some point, one of those shortages you mention will occur, at least temporarity as demand surges, and inflation increases. Prices tend to stay higher, as do wages, once they get there because economists have found that they tend to be a bit "sticky" and defy the natural downward pressures.

Paragraph two - that was the steady-state condition so there was only $9 in output and earnings, the $1 was in a personal savings account in a bank. Consequently, the economy wouldn't contract, not yet anyway.

In reading you answer, however, I see I did leave out an assumption which changes a couple of things a little bit. I need to assume the reserve requirement is 50%. That implies in scenario 1, there is $.50 of capital available for investment and in scenario two, there would be zero dollars available (explaining my decrease comment) because it was used by the owner to buy the bond.

Third paragraph, first sentence - I agree

Third paragraph, second sentece - I would argue that you would only have a contracting economy if the surplus, meaning a negative national debt, is effective reducing the velocity of money that consumers, busintesses, or gov't are using to buy end products, the measure of GDP. The depletion of savings means a reduction in investment, potentially leading to lower growth, but not contraction.

The last sentence in the last paragraph is quite true, expecially with the real world assumption I added in this reply that there is a 50% reserve requirement on the bank. That means $.50 was available for investment if the gov't hadn't borrowed it. Some of that fifty cents would have ended up in GDP.


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JohnfrmCleveland 3 years ago from Cleveland, OH

Probably the most difficult thing for people to accept is the notion that inflation will not necessarily occur when the government prints more money. But I have become a believer, for the most part. A lot depends on where the money goes. Print up the money and don't distribute it, and nothing happens. Print up money and distribute it to the lower end, and 99% of that money will be spent. Give it to the rich, and much of it gets saved. Print it up and use it for quantitative easing, and not much happens.

The actual distribution would happen over time, which will be less of a shock, and business will probably have some time to respond to the increase in demand. But I truly can't think of a realistic scenario where we would have a shortage. Were government to spend by bumping up employment, for example, there is plenty of food on the shelves (everybody eats now anyway), plenty of empty housing stock, no shortage of utitilities. I doubt we would face a shortage of cars anytime soon. Business would be good, but I don't see it being stressed.

**

On the economy contracting or deflating... if savings (hoarded savings, specifically) were allowed to continue for a number of years without replacing any dollars, do you not agree that we would eventually see a contraction?

**

On savings and investment - simply having savings does not guarantee that there will be investment. We could put a ton of personal savings in the bank, and without creditworthy borrowers looking to borrow money, nothing would happen, and the banks would simply buy bonds with those excess reserves. This is what we saw with quantitative easing - the government made banks incredibly cash-rich by buying up their bonds and/or junk assets, but this didn't lead to the hoped-for increase in lending. And interest rates couldn't have been any lower. QE has been a miserable failure every time it has been tried. Business was lousy, so loans were a bad idea on both sides.

I'm not sure where the reserve requirement comes into play here, either. In practice, the govt. will always loan a bank more reserves, so their ability to make loans is not really limited. And some countries have no reserve requirement at all.


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My Esoteric 3 years ago from Keystone Heights, FL Author

There have been a few times in our history, I will have to go find them, where the gov't purposely flooded the economy with newly printed money for the sole purpose of inflating the dollar to help farmers. They have also played with the exchange rate of the dollar for gold or changed back and forth from bi-metalism to single-metalism for the same purpose, to inflate or deflate the economy; all of this took place in the 1800s.

I would agree that if savings contined to grow, reducing money for purchasing AND none of it went to investment in the form of loans, they yes, the economy would contract; but at no time in history has that ever been the case.

As to the quantitative easing, blame Congress for that. The Fed is inventing new ways to keep the economy going while Congress lets Rome burn buy not compromising and showing business gov't has finally settled on a fiscal policy with which they can make long-term planning decisions on. Until that happens, they are going to sit on their hoards of savings and not invest, thereby killing growth, making the economy clunk (a technical economic term) along.


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JohnfrmCleveland 3 years ago from Cleveland, OH

QE was not Congress' idea. QE is purely monetary policy. Japan tries it, but it doesn't do anything in Japan, either. I just threw it in there as some evidence that capital markets and interest rates do not operate the way classical economics predicts they should.

I would also suggest that the Fed is pretty powerless to help the economy - there is not much you can do with monetary policy besides tweak things. You can screw things up by jacking up interest rates, of course, but you can't really add new financial assets to the economy without government spending, and fiscal policy is Congress' area.

**

"I would agree that if savings contined to grow, reducing money for purchasing AND none of it went to investment in the form of loans, they yes, the economy would contract; but at no time in history has that ever been the case."

This is exactly what happens with the dollars that China, Japan, and Saudi Arabia are amassing. They have large piles of dollars from their trade surpluses with us, and they just stick those dollars in U.S. bonds. They could cash them in and buy dollar-denominated goods, but they don't want to, because their economies are built around being exporters. There is no reason to think that those dollars, or the interest they are accruing, are ever going to be spent.


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My Esoteric 3 years ago from Keystone Heights, FL Author

Yes, they have huge trade surpluses, but net exports is equivalent to investing in America, if it is coming from foriegn firms. If foriegn countries or companies are buying US debt, then they are infusing dollars into the US Treasury to pay down debt (or meet interest payments).

If American debt gets too big, then that is when foriegn investors may get worried and slow down buying debt or demand higher rates.

I didn't say QE was Congress' idea, I said it was a result of Congress' inability to compromise and devise a stable fiscal policy that big business can use to make long-term plans with.

I do agree, at this point, about all the Fed can do is keep things from getting worse, their tool box is empty for stimulating the economy if business refuses to be goosed into moving.

I am getting closer every day to thinking the best overall thing that could happen is for the sequester to take place - maybe THEN, Congress will get off their butt and act like legislatures who care about this country.


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JohnfrmCleveland 3 years ago from Cleveland, OH

"Yes, they have huge trade surpluses, but net exports is equivalent to investing in America, if it is coming from foriegn firms. If foriegn countries or companies are buying US debt, then they are infusing dollars into the US Treasury to pay down debt (or meet interest payments)."

I can't agree with this. Using debt to pay down debt is circular. Plus, those dollars (from bond sales) would go to the government, not toward investment.

I think that foreign firms just don't have that many options. If they want to sell goods to the U.S., they have to accept dollars. And if China wants to pursue an export economy, not all of those dollars are going to be coming back to us. If the world settled up in gold, then China and Japan would collect the largest piles of gold. But the world now settles up in dollars, euros, yen, etc., and all net exporters can do is collect piles of those currencies (or their corresponding bonds). They are more than welcome to spend those riches, but they choose not to.

**

I don't think anybody is worried about U.S. bonds, either. After our most recent downgrade, short-term bonds were auctioning off at a 0% yield. Per MMT, bonds are not even necessary. Our current legal requirement to issue bonds in the same amount as deficit spending is seen as a holdover from the gold standard days, when you couldn't print up more dollars without the gold to back them up, and you really did have to borrow dollars sometimes.

If the MMT version is correct, bond sales are not needed to raise dollars, and it would not matter if investors were nervous about our bonds. Many of the MMT guys happen to be bond traders and others in the financial markets, and they operate on the assumption that the U.S. government can always meet its dollar-denominated obligations, so U.S. bonds are as safe as it gets. The only thing that prevents this from being a 100% certainty is the political issue of the debt ceiling, which is a self-imposed restraint, and an operationally unnecessary law.


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My Esoteric 3 years ago from Keystone Heights, FL Author

First paragraph. We are talking about two different sources of money. In the first case, foreign companies investing in America, that is the result of American Imports exceeding Exports leading to a net out-flow of U.S. dollars. Some, or a lot, of those dollars are reivested by their owners back into American companies. That is one inflow of capital back into America.

The other is excess foreign capital, be it in terms of dollars or any other currency that a foreign company or country has accumulated in their bank or treasury that they want to spend. In the instant case, they want to spend it on U.S. bonds, infusing dollars into the U.S. Treasury; tey could have done something else with that money, say buy an airhplane or a 1000, but they chose to buy U.S. bonds as an investment.

In neither case is it using debt to buy debt, the way I see it. But, yes, the dollars used to buy bonds effectively buy down debt, or more properly reduce its growth over the projected baseline.

I disagree about foreign firms choosing not to spend their accumulated wealth in America. While Obama was touting Apple for planning to bring back 200 manufacturing jobs to American soil, he forgot to mention a competing Chinese firm already was in the process of building a plant in GA to employ 170 American workers. European and Japanese car makers, for another example, have built dozens of plants all over the mid-West and South employing 1000s of Americans; there is a large list of these.

Selling bonds at zero percent interest is news to me, do you have some sources on that? It is inconcievable anyone would buy such a losing proposition. Bonds always have to pay a rate of interest that equals or exceed the ROR the investment could have earned through an alternative use over the same time period, either in terms money or satifaction (utility); I can't bring myself to believe in that type of altruism.

Your last statement is an absolute truism.


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JohnfrmCleveland 3 years ago from Cleveland, OH

Well, there is a net outflow of dollars, and that's really all I am concerned with. And those dollars wind up being converted into U.S. bonds, where they just sit. Why do you assume that dollars return to America in the form of investment? I always figured that some dollars were merely spent on American goods and services, and the rest (the amount of our trade deficit) were not. I don't doubt that there is *some* investment, but I don't see any direct correlation between our trade deficit and investment. Not when there are net dollars piling up in the hands of our trade partners.

****

Here is the MMT sectoral balances equation, which might help explain our reasoning:

(I-S)+(G-T)+(X-M)=0 where:

(I-S)=the private domestic balance; positive if in deficit, negative if in surplus

(G-T)=the government balance; positive if in deficit, negative if in surplus

(X-M)=the current account balance (net exports); positive if in surplus, negative if in deficit

G=government spending (printing money)

T=income taxes (un-printing money)

I=investment spending

S=savings

X=exports

M=Imports

You can probably make more out of (I-S) than I ever could. To me, investment spending is just spending.

****

Short-term (1 month and 3 month) bonds were going for little or no yield for much of 2011. We were downgraded in early August of that year. http://www.treasury.gov/resource-center/data-chart...

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