You must control debt before it controls you

If a country goes into debt, no one gets sent to debtors’ prison, no one is declared bankrupt, the furniture is not sold off to recover the money. It’s more subtle, but in the end the country is forced to draw down on its capital and over time living standards fall. If you have debts you want to pay off you divert income into repayment and cut expenditure. One way or the other, those are the choices.

The picture below is not Australia’s debt, it is the timeline for American debt stretched out to 2024. It’s the same kind of picture we have here but in Australia we have a government that is intending to do something. And the picture comes with a story about Janet Yellen, the new Chair of the Fed in the United States.

yellin us federal debt

The only bit that is ridiculous in the story is that the timeframe is projected into the future, Fed Chair: ‘Deficits Will Rise to Unsustainable Levels’. What do they think happens when the government diverts output down various plug holes, that the entire country disappears into thin air? What happens is that over so slowly real incomes begin to fall and the communal environment begins to crumble. There will certainly still be many wealthy people, but the average will move in only one direction. Detroit becomes the national future.

In the US they pretend that time is on their side but it isn’t. Things are long past being just line ball. There will be a fall in living standards, in fact, it is already happening. The only question is whether there will be a recovery and if so when. Personally I do not see the slightest evidence of a will to change things around in the US.

But at least here we do have just that chance. We are dealing with a junior version of just this debt problem ourselves. The ALP talks about what geniuses they had been since debt-to-GDP was only about 37% when they left office. They never dwell on the figure when they came into office – ZERO – nor where debt levels are likely to go if nothing is done about the legacy they left.

This stuff is hard and generally uninteresting for most people. Just gimmee the loot or I’ll bring in the other mob who will. We here may not quite be at that stage but perhaps we are. What Janet really would like to say is what Joe Hockey’s been saying: THE HOUSE IS ON FIRE! THE HOUSE IS ON FIRE! but she can’t because she does not wish to bite the hand that fed her. But she knows. Keynesian though she is, she knows perfectly well that debt is a problem, and it is pure sophistry to argue that it’s not a problem because we owe it to ourselves. And when it comes to Australia, I can only hope that enough of us here know it as well. And looking at our own debt projections, it is certainly not an argument to say that that fire’s not all that big at the moment so why worry?

Depression economics

If you want further reason to be depressed about our economic future, this article Janet Yellen and the Phillips Curve will supply it. If you believe this thing called the Phillips Curve relationship works, then you believe that higher inflation can bring faster growth and lower unemployment along with it. It is exactly this that Janet Yellen apparently believes. This is a direct quote:

“Each percentage point reduction in inflation costs on the order of 4.4 percent of gross domestic product, which is about $300 billion, and entails about 2.2 percentage-point-years of unemployment in excess of the natural rate.”

That is, reducing inflation slows growth and raises unemployment. If you want growth, inflation is therefore the way to go.

Yellen believes that the central bank should maintain enough inflation to prop up business activity, because ‘uncertainty about sales impedes business planning and could harm capital formation just as much as uncertainty about inflation can create uncertainty about relative prices and harm business planning.’ This approach extends the Fed’s mission beyond even the dual mandate of Humphrey-Hawkins and into the sphere of American corporate activity, a place that the business economist Greenspan was reluctant to go. Yellen, a disciple of predictive modeling, dismisses the notion that the Fed could go too far. To her the record shows that ‘tuning works even if it is not “fine.”‘

Here’s the article’s conclusion:

It isn’t just the 1970s, but the last few years, that show how money creation does not produce permanent employment gains. This was raised time and time again at Yellen’s recent Senate Banking Committee hearing, when several Democrats bemoaned the absence of any ‘trickle down’ effect from quantitative easing. Do we want the Fed to double-down on that folly with Janet Yellen at the helm?

This is not going to end well.

Classical economists – there are still a few of us around

A quite instructive article by Peter Boettke on The Great Disruption in Economic Thought. Addressed in particular towards Janet Yellen but more generally to anyone capable of listening, you are encouraged to read it all but let me provide the first para so that you can decide if you would like to continue after that:

Roughly speaking classical political economy, or economic orthodoxy, taught the following: private property, freedom of contract and trade, sound money, and fiscal responsibility. For our purposes we refer to this set of policies as the laissez-faire principle. Of course throughout the history of economic ideas there were always subtle differences of opinion within orthodoxy, and fine points of disagreement in method and methodology. But these paled in comparison with the broad consensus on matters concerning the nature and signficance of economics and political economy. Yes, John Stuart Mill had exceptions to the laissez-faire principle that one could drive an intellectual truck through, but re-read how he sents up that discussion and the importance he places on the laissez-faire presumption.

I will only add that anyone who thinks they can drive an intellectual truck through the ideas of John Stuart Mill has their work cut out for them. But since for most people, someone’s views on John Stuart Mill are not apt to be an obstacle, let me encourage you to read the rest.

And if you do, let me mention that I specifically classify myself as a classical economist a label which Peter is also willing to use. Indeed, I go further. I think of my own book on economic theory as a twenty-first century version of Mill’s 1848 Principles. We have learned a lot since then it is true, but we have forgotten even more.

Right questions wrong answers

Thomas Sowell and I have many things in common most importantly of which was that we both did our PhDs on Say’s Law and for both of us this was the subject of our first books: here’s his and this is mine. And once you understand Say’s Law, you will never again think of economics in the same way. Rather than Keynes having disproved this law, he made it unfashionable, and thus it has remained for the past three-quarters of a century. But unfashionable or not, it is the indispensable core of economic reasoning which is why its original name was the law of markets. If you want to understand how a market economy works, you must understand Say’s Law.

Anyway. Sowell has put together a column on the nomination of Janet Yellen as the next Chairman of the Federal Reserve (found here) and structures his comments around her incorrigible Keynesian approach to matters economic in much the same way I did myself the other day. This is from Sowell.

The Keynesian economists have staged a political comeback during the Obama administration. Janet Yellen’s nomination to head the Federal Reserve is the crowning example of that comeback.

Ms. Yellen asks: ‘Do policy-makers have the knowledge and ability to improve macroeconomic outcomes rather than making matters worse?’ And she answers: ‘Yes.’

The former economics professor is certainly asking the right questions — and giving the wrong answers.

The amazing part of the way Thomas Sowell writes is how much he can pack into a few hundred words. If you can read what he writes and still not at least start to think that maybe, just maybe, there is something to that classical economic theory after all then you are as incorrigible as Janet Yellen and about as clueless on how to manage an economy as well.