Monday, December 23, 2019

A rising cost that can turn expansion into recession

Couple quotes from Arthur Burns and Inflation (PDF) by Robert L. Hetzel.

Burns was the protégé of the American institutionalist and founder of the NBER, Wesley Clair Mitchell... In 1946, they published a comprehensive study of the business cycle, Measuring Business Cycles... Both achieved worldwide recognition as preeminent scholars of the business cycle.
Hetzel on Burns's view of the business cycle:
During expansion phases “firms will find their profit margins rising handsomely” and “people [have] a feeling of confidence about the economic future—a mood that may gradually change from optimism to exuberance. . . . The new spirit of enterprise fosters more new projects”. However, rising costs erode profit margins and eventually turn expansion into contraction.
That sounded right to me, at first: Rising costs eventually turn expansion into contraction.

But how can it happen? Doesn't a rising tide lift all boats? Unless we have something like an oil shock or, as in more recent times, a package of wrong-headed policies that create imbalances in the economy... Unless we have something like that to create imbalances, doesn't the rising tide lift all boats?

Suppose the rising cost is wages. Don't rising wages boost aggregate demand? And doesn't rising demand boost profit? If the rising cost of wages leads to rising profit, doesn't the problem solve itself? Granted, we could get inflation this way. But that's not the question. The question is whether rising cost turns expansion into contraction.

Certainly the situation is different if, as in 1973, the price of oil increases extraordinarily. That shock drew money out of the domestic economy, and within the domestic economy it created an imbalance favoring the oil industry. The oil shock created a cost imbalance in the economy. The imbalance caused the recession.

The oil shock is not a good example. Burns offers an explanation of the typical cause of the typical business cycle recession. What imbalance could cause that?

Surely not every recession is generated by a supply shock the equivalent of the 1973 oil shock. Few are. I'm looking for an example of rising cost that fails to boost demand and fails to boost profit and therefore results in recession. I'm looking for an example where imbalance is created.

In a normal economy, in a normal business cycle, what are the rising costs that do not lead to rising profit? At Chron, they offer the bleeding obvious:
Production costs are expenses, such as materials and labor, that your company incurs in the course of producing the product that you sell to consumers. In general, the lower your production cost, the higher your profit, or the amount you have left over after you subtract your expenses from your sales revenue.
Other things equal, any rising cost would reduce profit. Sure, the same way writing a check would reduce the balance in your checking account. But that's a micro example, and one so extraordinarily micro that it considers only the one check and its immediate effect on the balance in your account. Similarly, the Chron quote considers only the one situation, and considers nothing beyond the one consequence that immediately follows. These are two examples of what Henry Hazlitt called "the fallacy of overlooking secondary consequences."

Henry Ford thought that if he paid his workers enough, they'd buy cars from him. Ford was not one to overlook secondary consequences.

In general, as I see it, the lower our production costs, the less money our customers have, that they can use to purchase our products. This is just the opposite of Burns's view that, as a rule, rising costs bring on recession.

That reminds me...

Jeez, from ten years ago! Sometimes my memory is surprisingly good. My dad gave me an advertisement he'd received, a magazine-size flyer from Investment Rarities Incorporated.

In the flyer was an interview with Dr. Kurt Richebacher. Richebacher's first answer is the reason I kept Dad's flyer:
Q: Give us the cause of the profits problem.

A: Corporate cost cutting, for one. The widespread measures that individual firms take to improve their own profits have, in the aggregate, the opposite effect on the profits of other firms. Business spending is the key source of business revenues, not consumer spending. A retrenchment in business spending cuts business revenues. Higher profits and higher prosperity cannot possibly come out of general cost cutting.

Again, Richebacher says:
Business spending is the key source of business revenues... A retrenchment in business spending cuts business revenues. Higher profits and higher prosperity cannot possibly come out of general cost cutting.
Richebacher is saying what I said. I'm saying what he said. In general, the lower our production costs, the less money our customers will have, that they can use to purchase our products. Higher profits and higher prosperity cannot possibly come out of general cost cutting.

This is the opposite of Burns's view that rising costs bring on recession. Thanks, Dad!

Rising costs, Hetzel's Burns says, turn expansion into contraction. But Kurt Richebacher says general cost cutting cannot possibly lead to higher profits and higher prosperity. I'm with Richebacher. And Henry Ford. And, by god, Henry Hazlitt, and this is the first time I ever said that.

So the question remains: What causes recessions? Curses! It still makes sense, what Burns said: Rising costs cause recession. But then, don't we also have rising costs during the expansion? You can't expand if you don't spend more. So it's not a sure thing that rising costs lead to recession.

Is there a way we might have rising costs that don't lead to rising profit? Well yes, you have the oil thing, where everyone saw cost increases but only oil producers saw profit increases.

In general, it is not likely that everyone's profit will increase more than their costs. Some businesses, some industries, will do better than others. Some of the unlucky will go out of business. Some of the others will pick up the slack. Small imbalances like that can work themselves out without causing a recession.

Okay. But we're talking about recessions, lots of recessions, one or two or three of them in every decade. And we're talking about some unidentified cost we are trying to find, a cost not offset by rising profit. A cost that typically leads to recession. And it would have to be something like the oil shock, where the one industry benefits at the expense of all the rest.

I know.

I know what it is. It's finance.

In The Wealth of Nations, Book 1 Chapter 6, Of the Component Parts of the Price of Commodities, Adam Smith wrote:
The interest of money is always a derivative revenue, which, if it is not paid from the profit which is made by the use of the money, must be paid from some other source of revenue... All taxes, and all the revenue which is founded upon them, all salaries, pensions, and annuities of every kind, are ultimately derived from some one or other of those three original sources of revenue, and are paid either immediately or mediately from the wages of labour, the profits of stock, or the rent of land.

When those three different sorts of revenue belong to different persons, they are readily distinguished; but when they belong to the same they are sometimes confounded with one another, at least in common language.
That confusion still exists, as Timothy Taylor points out:
The calculation of labor share involve adding compensation received by employees to "proprietor income," which is the labor income received by those who run their own business. However, proprietor income is conceptually tough to measure, because someone who owns their own business can receive both "labor income," as if the person was an employee of their own business, and "capital income," as the owner of the business. In the real world, these two types of payments are jumbled together.
The difficulty distinguishing between "labor income" and "capital income" is exactly the confusion described by Adam Smith. Another example, one that gets less attention, arises in the confusion of interest with profit, or rent with profit. Bezemer and Hudson would say it is confusion of the financial economy with the real economy. Now we're talkin.

In the real sector, you work for your money. In the financial sector, your money works for you. Or look at it this way: Real-sector business makes and services things. Financial-sector business makes and services money.

When real profit and financial profit are confused together, the difference between profit and interest is blurred. The difference between productive business and financial business is blurred. This confusion allows imbalances to develop: In our economy, before the crisis, the growth industry was finance. The crisis, when it came, was financial crisis.

In our economy, the confusion is so deep that productive business is called "non-financial".

Most of us have real-sector jobs. (Even people who work in finance are in this group. They work for their money, too.) And most of us have, or want to have, money in the bank. So we're in both worlds, real and financial, or at least we want to be.

The whole goal of having financial income (as with any income) is to increase it. So a big portion of the income that goes into the financial sector stays in the financial sector. Little comes out. This is what made finance a growth industry. It also creates imbalance. When you have money going into finance and not coming out, it is very much like when you have money going to the oil-producing nations and not coming out.

Oh, it comes out, yes, but it's not drinkin' money. It's on a leash. The oil producers' money comes out to buy up our assets. The money that comes out of finance, most of it, comes out in the form of loans, loans which bring interest back with them to the financial sector as the debt is repaid. This assures that there's more money in finance when a loan is paid off than there was before the loan was taken out.

Unlike rising wages, growing financial costs do little to increase aggregate demand, except in the financial sector. And the rising demand it does create, does little to boost profit except in the financial sector. One industry benefits at the expense of all the rest. Imbalances arise.

You want to see a rising cost that can turn an economic expansion into recession? Finance is that cost.

Saturday, December 21, 2019

I don't remember looking at this before

I got RGDP growth rate data from FRED and put a Hodrick-Prescott on it. Then I put a linear trend on it. Two linear trend lines, actually: one based on start-of-data thru 1980, the other based on the post-1980 period:

Both linear trend lines run from start to finish on the graph. But the lower one is based on the data from 1947 to 1980. The upper one, the dashed black line that starts at or above the 5% level, is based on data that starts in 1981 and runs to 2019.

The dashed line is higher at the start. But this doesn't mean growth was better under post-1980 policies. It means growth was going downhill faster under the post-1980 policies than under the pre-1980 policies.

What I find interesting on this graph? Two points:
  1. Growth was slowing in the early period, almost as much as it was slowing in the latter period.
  2. Both trend lines end up in the same place. Same result either way.
I won't dwell on these points, but you might want to think about them.

Thursday, December 19, 2019

The Art of Deduction

I can get Individual Income Tax Filing: Total Deductions from FRED.

I can get it broken down as Individual Income Tax Filing: Standard Deductions and Individual Income Tax Filing: Itemized Deductions.

I can even get it broken down further, showing
  • Individual Income Tax Filing: Statutory Adjustments: Student Loan Interest Deduction
  • Individual Income Tax Filing: Itemized Deductions: Charitable Contributions
  • Individual Income Tax Filing: Itemized Deductions: Home Mortgage Interest Paid
and such. But that's not what I want. I want corporate deductions. Specifically, I want the deduction for corporate compensation of employees. The data must be available, because
Most payments you make to employees and employee benefits are deductible business expenses to your company.
I want to see corporate compensation of employees (including wages, salaries, commissions, and bonuses, and "retirement plans, health insurance, life insurance, disability insurance, vacation, employee stock ownership plans, etc.") as a percent of total corporate deductions.

I want to see if employee compensation was rising (as a share of total corporate costs, or of deductible costs at least) during the time of the Great Inflation. I want to know what was happening in the 1960s and '70s when inflation was called "wage push".

Anyway, here's what I get from FRED. They all start out the same:
  • Corporate profits: Total receipts less total deductions, IRS
  • Corporate profits: Total receipts less total deductions, IRS: Bad debt expense
  • Corporate profits: Total receipts less total deductions, IRS: Interest payments of regulated investment companies
  • Corporate profits: Total receipts less total deductions, IRS: Income of organizations not filing corporation income tax returns: Federal Reserve banks
  • Corporate profits: Total receipts less total deductions, IRS: Income of organizations not filing corporation income tax returns: Federally sponsored credit agencies
  • Corporate profits: Total receipts less total deductions, IRS: Adjustment to depreciate expenditures for mining exploration, shafts, and wells
  • Corporate profits: Total receipts less total deductions, IRS: State and local taxes on corporate income
  • Corporate profits: Total receipts less total deductions, IRS: Posttabulation amendments and revisions
  • Corporate profits: Total receipts less total deductions, IRS: Disaster adjustments (net)
  • Corporate profits: Total receipts less total deductions, IRS: Income of organizations not filing corporation income tax returns
  • Corporate profits: Total receipts less total deductions, IRS: Depletion on domestic minerals
  • Corporate profits: Total receipts less total deductions, IRS: Adjustment for misreporting on income tax returns
  • Corporate profits: Total receipts less total deductions, IRS: Income of organizations not filing corporation income tax returns: Other
All of them subtract the deductions. None of them tell me what the numbers are, that they are subtracting. (And none of the titles say compensation of employees)

Not useful.

I did manage to find corporate compensation of employees at FRED. But for total deductions I'll have to go fishing.

Tuesday, December 17, 2019

Problem solved. Sort of.

I solved the problem of not being able to find a few quarter-inch nuts for a little project I'm doing, by at last finding the nuts. I was ecstatic, but only for a moment. Then I realized I didn't solve the problem by becoming better organized. It's like solving the economic problem by raising somebody else's taxes or by having the government hand out money like we all won the lottery, or some other "feels good" solution. It doesn't solve the problem by figuring out what's really causing the problem, and solving that prior problem.

Sunday, December 15, 2019

What economists may or may not have said

Were I to mention that economists used to say our economy's post-WWII "golden age" ended in 1974, and that these days they act as if that golden age never existed, would you think me crazy?

Surely on this evidence, you would:

This does not show what economists think, but what everyone thinks whose opinion ended up in any book Google could get its virtual hands on. It's not even about the golden age of our economy, but just about the words "golden age".

Nonetheless, I cannot help but point out the increase in the 1950s and the high plateau in the 1960s, during the golden age, and the decline in the 1970s. And the relative low since then, with however a little bump during the "macroeconomic miracle" of the mid-to-late 1990s. The ups and downs of the graph match perfectly the ups and downs of the US economy, despite the real or imagined irrelevance of the ngram data and the real or imagined relevance of economic performance to discussion of a golden age.

Saturday, December 14, 2019

Premise: You can't pay down debt by using credit.

I want to look at the amount of interest we pay relative to the quantity of money we have "readily accessible for spending".


It's a measure of how much we rely on credit, and whether we can afford to do that.

Before 1966 or so (when Minsky and Keen say the golden age ended) interest paid was less than half the size of M1 money. By 1974 (when everyone else says the golden age ended, if they even admit there was one)  interest paid was more than all of M1 money. And from 1980 to 2010 (when economists were learning the lie that there never was a golden age) interest paid was on average twice the size of M1 money.

And that's just the interest.

Thursday, December 12, 2019

what the hell?

Two notes at  on 3 december:
And then this morning M1 Money Multiplier turned up in search results. (I didn't even know they had that series.) I laughed, because some people have such tantrums about the multiplier, then went to have a look.

What struck me is this, from the notes:
Updates of this series will be ceased on December 19, 2019. There is no direct replacement to this seasonally adjusted series. Interested users can construct a proxy ...
Change is upsetting.

The really strange one is the discontinuance of base and reserves data. That sounds more like an overhaul of Fed doctrine than a perchance budget-related matter.

Tuesday, December 10, 2019

The "we owe it to ourselves" theory strikes again

FRED Blog, 9 December 2019:
The federal debt reached 103% of GDP in second quarter 2019. These numbers, however, don’t properly reflect the amount owed by the federal government to private bondholders, since certain federal agencies (primarily, the Social Security trust funds) also hold federal debt. These agency bond holdings are liabilities the federal government owes to itself and therefore should be netted out.
The premise -- that the numbers don't "properly" reflect the amount owed by the federal government to private bondholders -- assumes the conclusion.

Sunday, December 1, 2019

"started by over-indebtedness."

From mine of 10 June of this year:
Debt-to-GDP? Really?? GDP is highly unstable, and probably affects the ratio more than debt does. I'm reminded of something Scott Sumner said. In comments on Debt surges don’t cause recessions, Vivian Darkbloom "ran across another [debt-to-GDP] chart", one that goes "back to 1920". Vivian provided a link to an old Steve Keen site but the link no longer works, so I can't show the graph.

But based on Scott Sumner's response, I'm pretty sure the outstanding feature of that graph was the massive spike associated with the Great Depression:
Vivian, Thanks for that graph. Here’s my prediction: 99% of people will misread that graph. Most will think it shows a debt bubble before the Great Depression. In fact it shows there was no debt bubble before the Depression. Rather the debt ratio rose DURING the Depression, but only because the denominator (NGDP) fell.
I agreed with Sumner that the debt ratio rose sharply "DURING the Depression" and that it rose because the denominator fell. Again, GDP is highly unstable, and probably affects the ratio more than debt does. But I didn't just agree with Sumner and let it go; I said "Agreed. But ..."
Agreed. But if you were around in 1910 or 1920, the Roaring 20s probably looked very much like a debt bubble. It's not that "there was no debt bubble before the Depression", but that in hindsight the bubble is insignificant when compared to the debt spike of 1929-1933.
And when compared to the debt we've accumulated since that time.

This comes up because I was reading Irving Fisher, writing in 1933:
36. The depression out of which we are now (I trust) emerging is an example of a debt-deflation depression of the most serious sort. The debts of 1929 were the greatest known, both nominally and really, up to that time.
Sumner can say what he wants about "no debt bubble before the Depression" but I'm going with Irving Fisher, who said the debt before the Great Depression was the most debt ever accumulated -- up to that time.

Also from my June post, this graph from Martin Wolf:

The vertical line just before 1930 shows the start of the Great Depression. The sharp increase after that, just to the right of that line, is the debt ratio rising because GDP fell, as Sumner says.

To the left of that vertical, we see what happened leading up to the Great Depression. Debt was a little high in the 1870s, about 150% of GDP. Then it fell to around 125%. From that low, debt increased persistently for 50 years, reaching almost 200% of GDP; this happened before the Great Depression.

That persistent increase from 125% to 200% produced what Fisher called the "greatest known" debt. It looks low on the graph today because debt has gone so much higher since that time. But that 50-year increase in the debt ratio paved the way for the Great Depression. As Fisher has it:

19. I venture the opinion, subject to correction on submission of future evidence, that, in the great booms and depressions, each of the above-named factors has played a subordinate role as compared with two dominant factors, namely over-indebtedness to start with and deflation following soon after...
Over-indebtedness, to start with. Couldn't be more clear on the cause of the troubles. Couldn't be more clear. On the cause of the troubles.
21. Disturbances in these two factors—debt and the purchasing power of the monetary unit—will set up serious disturbances in all, or nearly all, other economic variables. On the other hand, if debt and deflation are absent, other disturbances are powerless to bring on crises comparable in severity to those of 1837,1873, or 1929-33.
Yes, and we can now add 2008-09 to that list. The "future evidence" is in. Fisher was right.
22. No exhaustive list can be given of the secondary variables affected by the two primary ones, debt and deflation; but they include especially seven, making in all at least nine variables, as follows: debts, circulating media, their velocity of circulation, price levels, net worths, profits, trade, business confidence, interest rates.
23. The chief interrelations between the nine chief factors may be derived deductively, assuming, to start with, that general economic equilibrium is disturbed by only the one factor of over-indebtedness...
The conclusion to that last sentence is other things equal, the perspective commonly employed by economists.

And then, this:
Paragraph 24 above gives a logical, and paragraph 27 a chronological, order of the chief variables put out of joint in a depression when once started by over-indebtedness.
"started by over-indebtedness."