US economic policy encourages inequality of wealth

My topic today: US economic policy encourages inequality of wealth. 

In the Melania post, I quoted from Michael Wood's book Domesday: A Search for the Roots of England, on ancient Rome:

The long-term effect of Roman government, then, may well have been to concentrate land in the hands of the governing aristocracy at the expense of the mass of the population at large.

We do the same thing. And it will end the same way, decline and fall, if we let it continue.

 

In the Homelessness post, I quoted from HUD on the Housing Choice Voucher program. The main points are:

• "The housing choice voucher program is the federal government's major program" for housing assistance;
• "A family that is issued a housing voucher is responsible for finding a suitable housing unit"; and
  
• "A housing subsidy is paid to the landlord directly".

The wealthy are paid by the government to provide housing for the poor. That's a generalization, yes, but it's not an incorrect assessment. The long-term effect of the US government, then, may well be to concentrate wealth in the hands of a governing aristocracy at the expense of the mass of the population at large. Just as Michael Wood said of ancient Rome.

As if by the force of gravity, wealth attracts wealth. Policymakers make use of this principle to get things done. But their method is not a good one, because it accelerates the concentration of wealth. It moves the economy closer to the event horizon. It turns the trajectory of society directly toward the black hole.

Left to its own devices, the concentration of wealth would ultimately bring a Dark Age upon us. But we don't let nature take its course. No. And we don't do what we must: We don't create policies that undermine the natural process and keep capitalism at an early stage of development. No. Instead, our politicians create policies that accelerate the concentration of wealth. 

Civilizations die by suicide.

The housing voucher program is just one example of the bad method politicians use to solve our problems. (But let me stress that their method does not solve these problems. It only lets us cope with them. It helps us cope with what people see as problems (such as homelessness, unemployment, and financial crisis), but it does not solve the problems within the economic system that give rise to what people call problems. The economic system, could it speak, would say that what people see as "problems" are its solutions to imbalances in the system, primarily monetary imbalances like extreme inequality and excessive debt. If we would fix the imbalances, the economic system would have far less tendency to produce results that people see as problems.)

(And isn't that the whole point and purpose of policy.)

The housing voucher program is just one example. Another is the TARP program. The "Troubled Asset Relief Program" was created in response to the 2008 financial crisis. Investopedia says "TARP stabilized the financial system by having the government buy mortgage-backed securities and bank stocks." In other words, the government bought up financial assets that were failing to produce the expected income. 

Ordinarily, when the income from an asset falls, the selling price of the asset falls to minimize the change in the "return on investment" ratio. (I think I'm right about that.) The government must have been over-paying to buy these assets, so that the investors selling them could minimiize the losses that would have made the crisis worse. (I think I'm right about that, too. Otherwise, there would have been no reason for the government to get involved. They could have let asset prices fall until other private investors thought those assets were a good deal.)

To minimize the damage to the economy, the government overpaid to buy "troubled" assets from the people who were wealthy enough to have them. The government paid high prices to buy bad assets from wealthy people. Nothing wrong with that, huh?

The "mortgage-backed securities" that Investopedia mentions went bad because homeowners were having trouble making the mortgage payments. An alternative to TARP would have been for the government to make the debt go away by paying down the mortgages for the homeowners. In other words, pay the people who were too poor to pay their own mortgages instead of paying the people who are so rich that when they get in trouble the whole economy goes down.

Those mortgages were bad only because the payments were not being made. If the government started making the payments, the mortgages would no longer have been bad. The troubled assets would no longer have been troubled. See what I'm saying here? And the wealthy people would have ended up with the money anyway, just like they did under TARP. So where's the problem?

"It's just wrong for the government to pay off mortgages for people."

There is merit in the objection to the government making mortgage payments for people. There is also merit in the objection to the government buying bad assets at high prices from wealthy people. Together, these objections mean that the government must never again let such a situation arise, where all the solutions are objectionable.

It means tighter regulation of the finance industry is required, and immediate response when financial "innovation" creates financial "products" that escape the scrutiny and reach of regulators. The rule of thumb is obvious: Financial innovation is always intended to make more money for somebody in finance. More money going to people in finance means more money coming out of the nonfinancial sector, which is the productive sector where output is created.

We also need less government policy that encourages borrowing. The encouragement of borrowing is good policy for a low-debt economy like the US in the 1950s, but not for a high-debt economy like the US since the 1970s .

Also, the regulators should not be people from banking and finance. Regulators who think like bankers are a big part of the problem.

Hey, maybe homeless people should be hired to regulate finance. They need jobs right?

 

The economy cannot speak. At least, it doesn't speak English. But you know, if you pay attention to your dogs you can learn to understand their way of telling you what they want. It's no different with the economy. But you have to listen.

They think like bankers, that's the problem

I focus on cost, the cost of credit versus the cost of money. If you want to use credit, you're gonna have to pay interest on the money you borrow. If you want to use money, you may have to work to get it, but once you have it, you have it and you don't have to pay interest on it.

I distinguish credit from money by whether or not you have to pay interest on it. Some people reject this idea, but there is no thought more important in our economy: Credit is money we have borrowed.

And what is debt? Debt is the money we pay interest on. Debt is the amount of money we have borrowed and not yet repaid. Debt is the measure of credit in use.

Suppose the interest rate is 3%.

Suppose credit-in-use in the US is about 3¾ times the size of the quantity of money. That means, for every dollar of money, we're paying about 11 cents in interest charges. This was the situation in 1946.

Suppose credit in use in the US is about 38 times the size of the quantity of money. At an interest rate of 3%, for every dollar of money, we're paying about $1.14 in interest charges. This was the situation in 2007 (except the interest rate was like 5% in 2007).

The average cost of interest per dollar in 1946 was 11 cents. The average cost of interest per dollar in 2007 was more than a dollar more than 11 cents. (And that's assuming an interest rate of 3%.)

That's why I distinguish between money and credit: So I can see this cost.

If you say "this is the result of economic policy" then I say yes, you are absolutely right. But I will also say policymakers have it wrong. I don't think they look at "the average cost of interest per dollar of money" at all. How else could they let interest cost increase so much? How else could they fail to notice that the high cost of interest is a problem?

They think like bankers, that's how. For them, more borrowing means more business. That kind of thinking creates problems for the economy.

Policymakers think using credit is good for economic growth. It is. But debt's a killer. Using credit creates debt, and the debt's a killer.

By the way, using money does not create debt. But you knew that.

Policymakers think using credit is good for economic growth. So they create policies that make it easier for us to use credit. Okay, but using credit creates debt. Our debt increases because of their policies. And policymakers don't create policies to help us reduce our debt. 

Take the tax deduction for mortgage interest, for example. You don't pay tax on the interest you pay. This is to encourage people to get mortgages. And wouldn't you know it, when the financial crisis arose, 2007-2008, mortgage debt was the big part of the problem.

We should scrap the tax deduction for mortgage interest, and replace it with a different policy that creates an equivalent tax break for homeowners. Instead of getting a tax break for paying interest, we should be getting a tax break for making extra payments on the mortgage. Instead of getting a tax break for having a mortgage, you'd be getting a tax break for paying it off early.

When you take out a loan, you get the money along with an obligation to pay it back, with interest. That's what credit is: money, plus the obligation to pay it back. 

If I borrow a dollar and spend it, I'm spending credit. But only the "money" part of the credit changes hands. The obligation to pay it back stays with me. The "debt" part of credit stays with the borrower. The "money" part of credit is the part that changes hands when we spend it. And the person who receives it receives money, not credit, because she didn't borrow it. I did. (Read that again.)

There is a problem with paying debt back early. If policymakers change the tax deduction so it encourages us to pay off our debt early, by making those payments we will be reducing the quantity of money in the economy. This undermines the whole concept of using credit: Using credit doesn't help the economy grow if we pay back the money too soon. When we pay it back, it's not in the economy anymore, being spent. That's the problem with paying debt back early.

There is a simple solution. Let the Fed keep an eye on the "average cost of interest per dollar". Let them increase the quantity of money -- that's money, not credit -- in the economy, increase it enough to offset the effect of us paying back our debt early. One way to do it? Let our paychecks grow a little faster. It's not rocket science.

By the way, the money I'm talking about is the money that changes hands. M1 money. That's the money we receive as income, the money we spend, the money that's "readily accessible for spending".

But maybe you don't like the idea of letting our paychecks grow a little faster. I admire your altruism. And you are right: We have to prevent the inflation that might be induced by rising pay. No problem.

Instead of suppressing the increase of money, policy should be suppressing the increase of credit. We went over this already. Tax breaks for home mortgages have to change. Tax breaks for business use of credit have to change. The "bankers' mindset" of policymakers has to change: Stop encouraging the growth of finance!

If we do it right, the increased growth of money is offset by decreased growth of credit-use, so our improving paychecks create no inflationary pressure. At the same time, the increase of money and the decrease of credit-use reduces the average cost of interest per dollar. It reduces the cost of finance. It relieves the cost pressure created by the rising cost of finance.

And you know what? Relieving the cost pressure created by finance improves living standards, lifts profits and improves economic growth.

Let us begin.

How did we get so much private debt, and why was nothing done to prevent it?

How we got all that debt is simple: Policy didn't prevent it. In fact, policy encouraged it. But what's done is done. There is a better question: Why? Why was nothing done to prevent it?

Cecchetti, Mohanty, and Zampolli:

"For a macroeconomist working to construct a theoretical structure for understanding the economy as a whole, debt is either trivial or intractable. Trivial because (in a closed economy) it is net zero—the liabilities of all borrowers always exactly match the assets of all lenders."

I'm leaving out the part about "intractable" because they've already answered my question: "net zero". It comes to nothing.

Steve Keen:

"conventional economists ... ignore private debt as just a “pure redistribution”, to quote Ben Bernanke."

Pure redistribution: For every dollar my debt costs me, somebody else earns a dollar. It's the net-zero thing again.

Paul Krugman:

This is how you want to think about debt: it’s not a burden on the nation’s resources, because it’s mainly money we owe to ourselves, and it’s a problem not because we have to tighten our belt but because debt is currently leading to spending that’s less than we need to maintain full employment.

Krugman at least acknowledges that excessive debt reduces aggregate demand. But really, he's only changing the subject.

Debt's "not a burden," he says, "because it’s mainly money we owe to ourselves". Again, the net-zero thing. He enhanced the story, but he can't let go of net-zero.


Asymptosis summarized such explanations with exceptional clarity:

"Economists will tell you that gross debt levels don’t matter because one person’s debt is another’s holdings. (Net: zero.) They ignore it."

Yeah, I know: Net zero. But isn't it a weak argument? I mean, really. That's the whole story? Are we doing economics here, or are we just jerking off?

The "net-zero" argument is absurd. It's like balancing your checkbook (remember those days?), getting the errors to zero out, and then saying the zero means you didn't spend any money last month.

There's gotta be a better explanation. I need a better explanation.

I kept an eye open for a long time, and finally found a different story, from Patrizio Lainà:

"Interestingly, mainstream economists have given warnings about the public debt to GDP ratio (see e.g. Sargent & Wallace 1981), but at the same time they have almost completely neglected the private debt to GDP ratio. This might be due to Fama's (1965 & 1970) widely used efficient market hypothesis, which simply implies that private debt does not matter because it is always on the “right” level and no economic imbalances, such as bubbles, should occur. This, in turn, indicates that there is no need to study private or total debt."

The efficient market hypothesis. At least it's not net-zero again. And if the EMH has been debunked, that's good: It just means the "private debt does not matter" argument has no solid foundation.

Beyond that, something finally clicked for me, and now I have my own explanation, apart from net-zero and the efficient markets thing. My explanation is simple: As long as economists think credit-use is good for growth, they cannot see private debt as a problem.

I think mine is the strongest argument.