Fed raising interest rates 0.25% and setting a goal of "normal" 2% by 2018 means little to nothing. Market already priced the miniscule rate hike in as the move was widely expected, and move did nothing to assure markets that the Fed is in control, or set credible, measurable goals for future hikes.
Fed can continue to push on the supply side of money at the bank/institutional level all it wants. We need the Federal government to stimulate aggregate demand at the consumer level. How? Investing tax dollars in a smarter manner. Not raising the interest paid out on short term bonds so that institutions are incentivized to keep even more money in bonds rather than putting them to work in the economy.
Monetary policy needs to work hand in hand w/ fiscal policy. I feel bad for the Fed...its decisions are largely restricted and inconsequential when gov spending is broken, yet it receives all the attention and the blame.
If you want to stimulate aggregate demand at the consumer level, you need more people to have good jobs, so they can make money, so they can spend money. This would represent a reversal of the trend since 1970 towards greater income inequality.
It is not clear to me that anyone is doing anything about that (except, of course, in the negative sense.)
The Federal Reserve has the knobs and levers to create asset bubbles, but not to stoke consumer demand.
Only Congress can do that with legislation increasing the minimum wage, changing corporate taxes so it behooves companies to pay employees more, or legislation increasing entitlements such as social security. Those in lower and middle classes are the ones who govern the velocity of money through the economy, not the most wealthy.
> changing corporate taxes so it behooves companies to pay employees more
"Corporate" is perhaps too restrictive, but shifting the relative tax burden from labor to capital, without changing the overall share of the economy represented by taxes or government spending, would probably be pretty powerful here.
There are, to say the least, political difficulties involved.
legislation increasing entitlements such as social security
Expected to run structural deficits by a certain point. Theoretically speaking, an endogenously determined fiat money system doesn't really have "government debt" what with it being the sovereign issuer of debt to begin with, but in reality politics and the economy don't exist in frictionless vacuums and there are political costs to pork barreling, logrolling, unsound investments and so forth.
tl;dr if you raise the minimum wage imperceptibly, poverty reduction is affected imperceptibly and prices are affected imperceptibly.
In general if something will have a negative effect on corporate profits (minimum wage hikes have an outsized effect on corporate profits) you will be able to find a legion of economists who will lie to you about what it really does.
The reason many economists are unsure or against the minimum wage is not because they're some agents of bourgeoisie capitalists, but because arguments in favor of it tend to be moral, not economic.
It's pretty weak. The first two are very flimsy normative/moral arguments that, even if true, do not at all imply minimum wage is the solution over say, basic income, unionization, community-based mutual credit or a variety of other initiatives.
The third one is a can opener assumption. "Oh, minimum wage might work, but only in the case of Post-Keynesian full employment with buffer stocks of labor." You might as well speak of spherical cows in a vacuum. Followed by an unsourced claim about post-WWII prosperity being strictly due to Keynesian policies, when there's no consensus what factors exactly caused it.
> The reason many economists are unsure or against the minimum wage is not because they're some agents of bourgeoisie capitalists, but because arguments in favor of it tend to be moral, not economic.
All policy arguments are moral. Economics (to the extent it is a useful, predictive, empirical science) can tell you what outcomes to expect from what actions, but not tell which actions should be preferred, without first assuming some moral values.
(OTOH, some of what passes for economics is itself not a predictive, empirical science but a form of moral advocacy in itself; but in that sense, you can't distinguish "moral" from "economic".)
People who agree about objectives can still have (non-moral) policy arguments. That may be due to a misunderstanding or a lack of knowledge by some of the parties, or simply because society (and hence the economy as part of it) is an extremely complex dynamic system that we only understand in broad strokes. That's when the good kind of economics happens. (Unfortunately, most economics that you see in public is the bad kind perpetuated by "think tanks".)
All policy arguments are political, but not necessarily emanating from a moral philosophy. To the extent morality can be reduced to cause-effect propositions, it can also be subject to analysis.
> All policy arguments are political, but not necessarily emanating from a moral philosophy.
Insofar as they can be called arguments at all, they rest on moral -- or at least, "subjective value", which some would see "moral" as a subset of, with other subsets including "aesthetic" and probably some others; these distinctions are not well-defined and, ultimately, I don't think actually meaningful -- bases.
> To the extent morality can be reduced to cause-effect propositions, it can also be subject to analysis
To the extent something can be reduced to cause-effect proposition, it is a fact question, not a value question. Morality consists of the space of value questions. It may be necessary to answer a fact question to address a value question in a particular value framework, but ultimately a question that can be reduced to cause-effect propositions is not a moral question, but a fact question (which may also have utility in addressing a moral question.)
I agree that they should not tell what outcomes should be preferred, but they absolutely should tell what policies should be preferred in order to achieve a given outcome.
I'm not at all concerned about economists who are "for" or "against" the minimum wage. They can hold whatever opinions they want if they don't lie.
It's the economists who poorly design studies with the intent of demonstrating that it either causes prices to rise uncontrollably (which it doesn't), causes unemployment to rise (which it also doesn't) and who pointedly never, ever, ever look at the effect it has on profits (it is savage towards profits, which is why the marketing budgets for stuff like this gets approved: http://kron4.com/2014/07/18/new-sf-billboard-says-workers-wi...).
They all know where the money is in their profession: it's at ideological corporate think tanks. If you can tread the fine line between not lying and saying things which they really like you've got a good career ahead of you.
As it happens, 'moral' arguments that say that you shouldn't raise the minimum wage work better when you can claim that it will hurt the people it is designed to help. Those arguments fall flat on their face when it becomes apparent that raising the minimum wage just transfers profits into workers' pockets directly.
It sounds like you've dismissed any economist who doesn't agree with you.
You claim raising the minimum wage would never raise prices nor cause unemployment to rise. Ok, let's set it to $1000 a hr. Do you really think that would have no effect on either of those? Maybe there's some range on increase where the effects are offset by other effects but it's not lying to believe those effects will become real at some point.
It hits profits first and hardest. Raise it significantly and it also causes prices to rise. Raise it to stupendous levels (in the US probably > $40-50 hr) and it eventually causes unemployment.
Realistically speaking, though, most arguments are over minimum wage hikes that only affect profits and won't even have a minimal effect on prices. $10 -> $12 isn't even going to cause prices to rise, let alone have an effect on employment. It'll go straight from profits to paychecks.
I can think of only one instance where raising the minimum wage actually affected employment, actually, and that was because it was set at first world levels in a third world environment.
If something is going to have an effect on profits, you can bet on the fact that a company will fight against it, hard. Because SHOCKER the point of a business is to generate PROFITS.
I think you're wrong in thinking that businesses will just give up, and take lower profits. No. They're going to cut hours, fire anyone they can, etc. to maintain their existing profit levels.
If you have a laser like focus on maximizing profit (and supposedly most businesses do), you've already fired everybody you can and cut all the hours you're able to already.
But no, they don't just sit there and take it. They pile money into think tanks and advertising campaigns in order to try to sway public opinion (see above).
One of my favorite tactics is when they pretend that robots that do minimum wage jobs all cost $minimum wage + $1 and raising wages is simply going to make them all go out and buy those magical robots.
What else is there to say about the GP's blanket assertions of opinion being bought out by corporate think tanks and a link to an article about labor-related strife? It's a predetermined conclusion.
Raising the minimum wage WILL increase unemployment. That's Economics 101. Companies are going to find ways to fire people, or give them fewer hours. Raising the minimum wage to something like $15 would be ludicrous.
Econ 101 is "look at what happened in Australia". The commenter addresses that actually but his response is really lame. "Things are just different there". Uh huh.
Actually this is pretty much a model for what would happen to McDonalds in the US:
I don't wonder about the sincerity of most economists
I do wonder if there are selection pressures to becoming an economist that prevent a diversity of viewpoints on certain issues
sometimes those neatly line up with the bourgeoisie capitalists (who just coincidentally disproportionately have their names on university building and have levers on which university departments get generous funding)
Would you like a socialist society? Do you want a welfare state? I don't. Why shouldn't some people be able to afford luxuries like names on buildings?
Minimum wage has been around for a long time, and there are plenty of counter examples like restaurant workers and soldiers who could be studied who often get paid less than the minimum wage that has been around for decades.
You also cannot ignore that when the social safety net exceeds the value of working wages, particularly for women, there's a strong incentive to not work. Given the unavailability or high cost of health insurance, Medicaid makes that a no brainier for any woman with one or more children.
> You also cannot ignore that when the social safety net exceeds the value of working wages, particularly for women, there's a strong incentive to not work. Given the unavailability or high cost of health insurance, Medicaid makes that a no brainier for any woman with one or more children.
Which is why basic income, single-payer health insurance, and free college are such compelling ideas.
There is obviously an economic impact from not paying workers a living wage, irrespective of how certain arguments can be parsed. There is also obviously an economic cost associated with paying a living wage.
The alternatives to the minimum wage that you listed are pretty much variations on the mimimum wage in that they seek to achieve the same goals and also have attendant costs. They are, essentially, no more or less moral vs. economic in nature than is the minimum wage, though their invocation may be less charged at present.
The latter point is evidenced by your juxtaposition of the "moral" minimum wage with its presumably amoral (and thus economics-based) alternatives. But, in truth, if any of these have valid economic arguments, then so does the minimum wage.
That's why he said basically, it's pretty much the upper half which yes, includes middle class families and billionaires and is a silly bucket to put in one group.
"Unlike most public income support programs, increased earnings from the minimum wage are taxable. Over 25 percent of the increased earnings are collected back as income and payroll taxes"
Is that a problem? The minimum wage should be the minimum needed to live on, that includes taking taxes into consideration.
" Adopting this empirical scenario, the analysis demonstrates that an increase in the national minimum wage produces a value-added tax effect on consumer prices that is more regressive than a typical state sales tax and allocates benefits as higher earnings nearly evenly across the income distribution."
So the argument is that raising the minimum wage increases prices, thereby negating the potential benefits. Here's the thing, competition drives prices down, but if low wage earners have limited options to shop around (because they look towards the big chains to get low prices), then competition can't fulfil this function. This quote would seem to support this view:
"Even after taxes, 27.6 percent of increased earnings go to families in the top 40 percent of the income distribution."
Competition drives prices down, but chances are people with limited options to shop around and who disproportionately head towards mass retailers already, by example, live in areas with imperfect competition and in the worst case, food deserts. As such, a minimum wage would seem to negate itself again.
You've missed the point of what I'm saying. I'm suggesting that minimum wage increases aren't detrimental on their own, they're detrimental when combined with reduced competition. A minimum wage increase in an area with strong competition for consumers is likely to be a net win.
Right wing thinkers don't believe reality exists for the most part. We've come into an age where we can't agree on basic facts; in that environment, there is no real thinking.
The competition in Google and Facebook's case isn't "programmers", but "exceptionally skilled programmers," which is a different good, a much scarcer one and with less diminishing returns than the former.
I'm not aware of the real estate situation in London to make a comment.
I argue my ideas only need to hold water for another 10-30 years, depending on if technology advancement keeps up.
Japan's been running structural deficits for decades, and still has a very high quality of life.
> but in reality politics and the economy don't exist in frictionless vacuums and there are political costs to pork barreling, logrolling, unsound investments and so forth.
As basic minimum income solves this without the messy politics surrounding it.
I argue my ideas only need to hold water for another 10-30 years, depending on if technology advancement keeps up.
Given that the AI community's prediction making skills have been just slightly better than those of Nostradamus, that's a very tough gambit to rely on.
Japan's been running structural deficits for decades, and still has a very high quality of life.
Except for the aftermath of the whole Lost Decade thing and aging population taking tolls on aggregate productivity. I'm not qualified enough to say whether causes were monetary, fiscal, sociological or some combination thereof, but listing Japan as a positive example here doesn't strike me as wise.
As basic minimum income solves this without the messy politics surrounding it.
UBI would theoretically handle a minimum transfer of purchasing power for every individual. We're talking about public programs and initiatives unrelated to that.
Though, if you're idealistic enough to think the UBI is a prospect soon realizable, I wonder why you're advocating minimum wage increases over say, stronger collective bargaining? Denmark for instance has never had a minimum wage law.
> > I argue my ideas only need to hold water for another 10-30 years, depending on if technology advancement keeps up.
> Given that the AI community's prediction making skills have been just slightly better than those of Nostradamus, that's a very tough gambit to rely on.
That's a weird comment; "technology" is a lot broader than "AI".
I made some perhaps overly hasty generalizations. HN is a community that is heavily skewed towards a belief in transhumanism (especially that AGI will be coming very soon) and moreover that high rates of technological unemployment are upon us, necessitating a UBI or stronger reforms to make sure the general-purpose labor saving of AGI doesn't cause social unrest from crowding humans out of the labor market.
I can't imagine what else could the GP have been referring to other than mass automatized labor for most sectors, hence either AGI or lots of narrow AI.
I think you accurately characterize a fringe of HN, but I think support for UBI, etc., isn't all (or even mostly) about imminent AI singularity (though certainly some is based in that belief), much of it is a belief that the Band-Aid over traditional capitalist economic relations provided by the modern mixed economy, particularly as implemented in the US, which remains heavily based on the assumption of steady wage labor with one primary employer (which, itself, is almost a pre-capitalist, feudal/manorial model) as the normal means for people to earn income, is fraying given present levels of automation and preferences for ad hoc interactions, necessitating a more efficient model of support to cushion the blows of long-term and short-term dislocation in an increasingly automated and increasingly fluid market, a need which will only get more acute with increasing automation (even fairly mundane automation that falls well short of AGI.)
> I can't imagine what else could the GP have been referring to other than mass automatized labor for most sectors, hence either AGI or lots of narrow AI.
* Renewables generating the majority of power consumed world wide
Second is a real possibility during the next 20-30 years. First and third are significantly more doubtful.
Even assuming all three come in place soon, I don't understand how they'll fix public choice. If anything, at least autonomous electric vehicles will be a boon on private enterprise, which I don't think is what you had in mind.
I have made a comment or two recently about how unlikely AGI/superintelligence is in the next 50+ years. Those comments received a net positive response. I don't think HN is as biased toward AGI as you might think. Then again automation in labor tasks doesn't require AGI --just specialized programs that work well. Advanced automation is very likely to have an impact in the next 5-10 years.
Advancing automation in labor has been having a progressive effect for several decades, and will to all evidence keep doing so for the foreseeable future.
That's a good point. I should have said "a more significant impact". It could be argued that the impact of the last decades were offset by increased support role and tech jobs. I think in 5-10 will be when a lot of the current tech and support jobs also get filled by automation. Or where its an "automation of creativity" where you don't have a broad general intelligence, but you do have programs that present a few good options that could be considered creative depending on the domain.
As someone who has lived in Japan for 6 of the last 8 years (with 2 in the UK in the middle) -- I'll take Japan any day. Especially when I compare what's happening in real estate in Japan vs what's happening in the UK, I've got a pretty good feeling that one of the two has got it right (hint: not the UK).
However, not sure if Japan will survive "Abenomics" (just as sensible as Reaganomics, but with a dash added corruption ;-) ).
> Though, if you're idealistic enough to think the UBI is a prospect soon realizable, I wonder why you're advocating minimum wage increases over say, stronger collective bargaining?
Why not both? Seriously I am very much in favour of e.g. working time restrictions, but "union" is a dirty word in the US (indeed you carefully avoided saying it), so I don't think advocating stronger collective bargaining rights would help me achieve my policy goals.
How does a negative income tax subsidize any of that? If anything, it's much more neutral regarding wage labor (since it's based on the broader definition of income in tax codes) than, obviously, minimum wage mandates.
Not all other prices are set by competition. There's much manipulation through things like subsidies, tariffs, tax incentives, and bailouts.
Also, having lived in Singapore for years, it's a wonderful city and I love it, but the wage story isn't necessarily one to mimic. It might look grand as a foreigner, but your cleaning lady is probably sharing a 3 bedroom apartment with 16+ other women and doesn't see her family more than a few times a year.
Singapore wages aren't zero but they are really low for the non-managerial classes (i.e. the people who do all the work) and oversized for the managerial classes.
It's about 3x the size of San Francisco and clearly has aspirations of becoming a similar center for startups but with the prevailing wages for the people who do all the actual work so low the quality of what is produced is usually shitty.
I question the assumption that "job creation" is the necessary prerequisite for money creation especially in an age of automative ephemeralization and surplus. Large demand for money already exists among the poor whether or not they have a job.
>In technology's "invisible" world, inventors continually increase the quantity and quality of performed work per each volume or pound of material, erg of energy, and unit of worker and "overhead" time invested in each given increment of attained functional performance. This complex process we call progressive ephemeralization. In 1970, the sum total of increases in overall technological know-how and their comprehensive integration took humanity across the epochal but invisible threshold into a state of technically realizable and economically feasible universal success for all humanity.
Consumer demand is meaningless. Trying to push it is like trying to push a string. Demand is an artefact of production. Unless your economy is producing, you won't increase quality of life and wealth for all citizens. This point is obvious, but gets completely lost in all the frenzy around 'stimulating demand'.
To buy something, first you have to produce something worthy of exchange. Everyone has to start from this point.
Supply and demand are entwined in a perpetual dance, and "if you build it they will come" only goes so far. A product has to find a market capable of making the purchase. Opening a Whole Foods supermarket in rural Tanzania isn't going to boost sales of Tom's of Maine Wicked Cool Toothpaste -- a product apparently worthy of exchange among sufficiently wealthy consumers in a different context.
Malinvestment in incorrect production is part of the process. The person who produces unwanted goods and services must gain the feedback that they have, so they can switch production to what is desired. This is a very important reason why crony capitalism, protectionism and secession regulation hurts everyone.
I have never stated that 'if you build it they will come', because that is patently false. This is a common straw man erected by the true 'aggregate demand is all' believer (I don't know if this is your position or not). If you build it, they will come is as absurd as 'if we just gave everyone a bit more money, the economy would grow'.
You're arguing that a glut is due to producing what is not desired, instead of what is desired. So when there is a glut in one area, there must be corresponding shortages in other areas. This is easy to debunk.
Look at the labor market. The US unemployment rate went from ~4.5% in 2007 to 10% in 2010: a big labor glut. The "malinvestment" theory predicts unfulfilled demand comparable in size to the unemployment. Large sectors of the economy should have had millions of unfilled job listings, spiraling wages, etc. But this did not happen.
The right explanation is simply that total labor supply exceeded demand.
I don't agree with the statement that a glut in one area must equal a surplus elsewhere. You've added at interpretation to my statement.
If a person produces hot pink sweaters and finds nobody wants them, that doesn't mean there is a shortage of blue sweaters, or even sweaters in general.
Additionally, it might mean that people might want hot pink sweaters, but not at the price being asked.
Taking this back to labor markets, surplus labor (unemployment) is indeed oversupply, that much we are agreed. But you must break this down further - it is an oversupply of specific types of labor at specific rates. You could clear that labor oversupply by switching the supply by changing the type of labor being offered, and also by changing the price. For example I'd happily pay someone to do work for me at lower rates than currently offered, but that market doesn't usually clear. Changing the price doesn't happen often for regulatory reasons or stickiness, but changing the nature of labor supply often does. It's just that the timescales involved involve a lot of problems.
The solution to that is to identify reason why mal investment occurs and to avoid anything that contributes to it. I don't think it can be totally avoided due to human nature - hubris, mistakes and misfortune - but you can certainly avoid some of the obvious ones, like rigging credit markets and trying to centrally plan economies.
You wrote "The person who produces unwanted goods and services must...switch production to what is desired," which presupposes that there is something else desired, i.e. there is no general glut.
For example, we Americans demand less oil today than we did 10 years ago. This contributes to the oil glut, which has turned many drill sites into malinvestments and caused layoffs in the petroleum industry. How can you say that that consumer demand is irrelevant here? Isn't it obvious that if there was a nationwide ad campaign to buy gas guzzlers and take them on road trips, it would increase oil prices and improve the state of the petroleum industry?
And if it can happen in the petroleum sector, why not at the scale of the entire economy?
Unpacking that slightly. First, an oil glut is not a general glut, so it's possible that the demand for oil has shifted elsewhere. I don't agree that an ad campaign for national gas guzzler travel would increase oil prices, because it's very unlikely that such a campaign would work, and even if it did, it would be a poor choice of resource spend.
Going back to a general glut - and I hate the term - of course it is possible to have an economy-wide contraction where production overwhelms demand temporarily. This is possible from external shocks (eg war, disaster) or persistent interference (eg Venezuela). Such a scenario is generally best resolved by solving the cause of the shock and doing everything to let the market clear. Most of the time this will be temporary and conditions will resolve, if not at the speed at which makes everything happy. I think the key thing here is that while there will be demand for other production at some point, it's necessarily a case of timing and there is likely to be a lag before new preferences are developed. The key here for future prosperity is not to borrow and spend on what is already not wanted, or to borrow and spend on pointless spending just for the sake of making money move.
The alternative is if an economy dropped to a new, lower level of production by choice, such as if everyone decided to lower their production and consumption and consciously not increase it again. You'd then get reversing economic growth, but then that would be the intention as results from people choosing less.
> Such a scenario is generally best resolved by solving the cause of the shock and doing everything to let the market clear. Most of the time this will be temporary and conditions will resolve, if not at the speed at which makes everything happy.
Maybe waiting would work, but that's no reason not to intervene if we think that intervention can bring us faster growth (even if this will only be temporarily faster growth until we "catch up" to currently unused production capacity). If consumption stimulus will help recovery (and I think it will, on Keynesian grounds) we should do it.
> To buy something, first you have to produce something worthy of exchange. Everyone has to start from this point.
But so many people from the Marxist-leaning schools just don't and refuse to, because at its core this belief destroys pretty much every argument they make about moving from a market-based system to a collective one.
Sure. The Marxism school of thought is one of fantasies, of free lunches from artful arrangement of resources. The problem is that this persistent belief stretches from hard core far-left socialist/communists right up to the centre right of political thought (though I despise the left/right denomination, I use it here to illustrate fashionable thinking).
Eventually, beliefs will have to change - anything that can't go on, won't - but I don't expect it in my lifetime. Human nature is unchanging and economics is simply the study of human choice when it comes to limited resources. At some point understanding must come back to this simple point - you've got to produce something to trade for something - but magical thinking and hoping has a way of persisting for a long, long time.
Edit: you'll see that most of my comments in this topic are being systematically down voted. This is because it is contrary thinking to what gets fed in higher education in the past few decades. I know, because I consumed the same content, and had to continue my own further education to realise why the concepts never sat right with what I observed going on. And that results in a lot of a-ha moments when you start reading pre-Marxian and pre-Keynesian thought. I hold no ill-will or malice to the down voters, perhaps one day they'll come to realise the dry, barren road current macro thinking finds itself.
>The Marxism school of thought is one of fantasies, of free lunches from artful arrangement of resources.
Actually the Marxist school of thought is one of economic self-determination.
That ideal went badly wrong with the concept of the dictatorship of the proletariat.
Even so. Economic freedom - specifically the moral right of the working classes to benefit from the economic value of their labour - is the bedrock concept of both Marxism and Socialism.
And the bedrock moral value of American corporate capitalism is the elimination of that right in favour of distribution of value exclusively to a social conceit called "capital".
Now - in fact both are oversimplified and wrong-headed, and both lead to disaster in different ways.
A useful synthesis may be possible, perhaps. But it's going to take a much more insightful analysis than anything that appeared in previous centuries.
I've never, ever seen a credible argument that saya capitalism is based on the elimination of a persons right to their labour value. That sounds terribly like some undergraduate student publication or occupy chant.
Capitalism is about the freedom to control and own capital - it's not a 'social conceit', capital refers to assets, whether physical in the for,s of factories and farms, or others, such as inventions and savings. The ability to freely allocate capital and follow ones free economic agency is the greatest engine for eliminating poverty the world has ever known, despite its obvious and some,times major flaws.
Well, that depends if you want to reinforce existing beliefs or challenge them with new ones.
After much reading from Smith to Marx to Keynes, it's my personal beliefs that the classical economists had it right and much of the 20th century thinking was wrong. To my mind, the experiences of the 20th century pretty much lay out that case, particularly with the twin a/b test of East/west Germany.
If you want a complete history of economic thought according to he Austrian school, then 'An Austrian Perspective on the History of Economic Thought' gives a thorough background from Ancient times to now on the evolution of economic thought and how people came up with the answers to puzzles like why is water essentially valueless as compared to gold when one is life and death and the other essentially useless. Going back deep into the original philosophers and coming forward helps to understand why thinking is the way it is.
The other book I recommend for people is 'The road to serfdom' by F.A. Hayek. This gives a thorough and as-yet unanswered critique as to why socialism in all its forms fails, and why it is an inherently unstable system that always leads to dictatorships and loss of wealth (hint: feature not bug)
But these speak to my own beliefs which are decidedly no longer mainstream. Like many I studied this in undergraduate and masters courses but the explanations never really settled with me so I kept on reading. If you want to understand what the mainstream economic thinking is, just pick up a Krugmsn article and keep reading because most mainstream publications are wedded to the idea that governments can plan and manipulate economies into prosperity.
Why would you produce something for what there is not demand? Is not this the first lesson for start ups? searching for a market-product fit?
Do you agree that the goal of a business is profit?
Ergo, is the prediction of profits what create production. This is the core of the capitalist system, isn't it?
If a business don't see profit in its future, the rational thing to do is decrease production and, more important, stop new investments. That means lay offs, no new hires, etc..
Less people with jobs, less people with money, less demand, less future estimation of profits. Feedback loop.
Then come the creative destruction, that is supposedly a good thing. People is more desperate, accept worse conditions, business not 'efficient' enough close, this create less competence in the market and people ready to work for less. The survivors can accumulate more claims in the economy, what means concentration of capital in less hands. Rise and repeat.
I'll reiterate:
'To buy something, first you have to produce something worthy of exchange'.
To understand this, don't immediately jump to the business level, think of it at the individual level. If I want to buy something, first I have to produce something worthwhile, so I can exchange that thing for the other. It's unlikely that the exchange is going to be direct (barter) and it will take place using the medium of currency.
I think your understanding of demand is slightly askew from the economic definition of demand.
Entrepreneurism is precisely what you have described - the creation of new products where future consumption is uncertain. It is vitally important as an agent of change in any economy - and incidentally is the first victim to central planning.
But that is incidental to the issue of requiring production before consumption. If I want something, first I have to make/do something which has value for someone else, then they can trade the thing that they made/did and that I value. We are both better off, wealth has grown. The issue here is that people think that just giving currency to one of us so we buy the thing off the other is the key to growth. When it is patently obvious that 'stimulating demand' by giving someone money can't possibly grow wealth (and the economy in the same way).
"When it is patently obvious that 'stimulating demand' by giving someone money can't possibly grow wealth"
But this is not the claim. The claim is somebody trying to buy something with money create demand. We all agree that money is different of real wealth.
Even in an alleged two persons barter economy I could buy from you with a promise of something in the future. If the promise is good enough you could even start producing more.
And this is not even the correct framework, because what we are talking are systemic problems in modern economies that don't map well to hypothetical two persons barter economies.
Sort of.... you want more stuff if you have more money, but if you have little money, at one point, your propensity to save increases to avoid poverty, whereas below some point I imagine you spend everything you have (not much) as fast as it comes in.
I don't think that's a valid statement. There is only so much 'stuff' that you can use. Beyond a certain level more money does not translate into a better quality of life or more 'stuff' for most people, there are a few outliers but lots of very wealthy people are actually quite modest. They're so modest you won't read about them in the newspapers.
I don't think GP is saying that the demand you add to the economy increases linearly with income. I think the point is that it's essential to have lots of people with a healthy amount of discretionary income, because non-discretionary income can't really be reallocated no matter how compelling your wares are.
Yea, it's more important because there are more (or should be more in this era) people in that range as a percentage of population than strikingly wealthy people.
Demand is not want. Demand is standing at a cash register with cash, asking for a product.
Although demand in the economic sense sort-of-sounds like want - certainly I'd like a new Lamborghini - I have zero effect on the demand for lamborghinis.
The level of spending (poverty vs wealth) is mostly irrelevant because that's a value line someone draws on a graph somewhere. Poverty in the Midwest is not the same as poverty in Sub-Saharan Africa. Absolute Poverty (in which a person has insufficient resources to survive) has a wide variety of causes but essentially reduces down to the inability of an individual or family to produce enough to exchange for what they need.
Savings are just postponed consumption in the same way as debt is the promise to hand over your future production.
Err... I guess I used the word want loosely. I meant demand.
Savings are just postponed consumption, but if the consumptions of multiple people never align (you could save until you're dead) the aggregate demand will never rise to a high level.
Well, that's still not true. Savings are put to use by investing - either by the saver or someone else on their behalf (capital markets/banks). The savings further production by being used by someone else.
Keynes had to kill the idea that production is the foundation of growth in an economy. He did this by implanting the idea that production is irrelevant, all you needed as spending (the fantasy of aggregate demand). This was further pushed by the universal declaration that savings were a problem because it was postponed - rather than transferred.
Once this foundation was laid, the idea that throwing more money at people would increase wealth was created, and enthusiastically adopted by politicians who could use it as an excuse to throw money around in good times and bad.
Savings are the foundation of future production, and future production is the foundation of future wealth. This is so self evident it takes a high level of internal contradictions to believe it not to be so.
Hmm, I think you're mostly right, but here's the thing. If you put consumer money in the bank, then it goes to investment in additional production. Loans to businesses allow them to staff up and/or purchase capital equipment. However, if in the aggregate, the base consumer purchasers don't have any cash, they won't be buying things from those businesses.
What you are saying sounds so easy, but if it were, there wouldn't be recessions or liquidity traps. You're right that production is key, but if the monetary system becomes friction in between producers and consumers, then problems can arise even if production is okay. I don't really see a contradiction here. Savings are the foundation of future wealth, but if nobody spends any money, businesses crumble, and capacity is lost. When people decide to spend again, it takes time for the economy to recover.
I don't think recessions can be avoided. Irrational actions and malinvestment by unskilled capital allocators virtually guarantees ups and downs in industries. Fiat currencies with fixed pricing (centrally set interest rates) exacerbate the problem by allowing mispricing of money leading to misallocation of resources. My belief is that the approach of fixing interest rates leads to overswings in the business cycle which are bigger than otherwise would be.
The issue is you'd have to - and get everyone else to - understand that periods of high interest rates and periods of low wages would periodically happen. But people expect wages to never fall and are conditioned to fixed interest rates. As lowering wages is unacceptable the solution is to cut positions, which arguably makes things worse as no job is worse than a lower payment on an existing job. So we are doomed to business cycles for the foreseeable future.
The key thing I believe most people miss is that they believe that 'economic stimulus' in terms of under priced interest rates, government borrowing and foolish spending and other tricks comes at no cost. But there is a very real cost, and that is misallocated production - building value-destroying 'bridges to nowhere' and burdening of future income with excess taxation to repay debt.
There are those who say that a sclerotic economy - such as most countries have had for going on 7 years now - is better than a short, sharp contraction. You can compare the experiences of Japan - flat growth for two decades - or countries like Estonia and Latvia which had massive contractions but bounced back to strong growth relatively quickly. How much that impacts the safety and stability of society may be related to social cohesion and personal savings.
Probably the best answer is that governments keep a rainy-day-fund, and when credit contracts due to external shocks, the government gives a temporary tax receipts holiday and spends the savings. Such a strategy would allow people to have confidence going into an economic contraction but wouldn't indebt the government to the future. But it is fantasy-land to expect any politician to design such a scheme and resist the temptation to raid it for votes.
Income equality has jack-all to do with absolute income levels. The richest getting richer at a pace greater than others doesn't mean that others aren't making money. Real income is up for all quintiles since the 1970s, as are consumption expenditures. Real income is up quite a lot more for the upper quintiles, but since we don't operate in a zero-sum economy, that doesn't require that it be down for other people.
> It is not clear to me that anyone is doing anything about that (except, of course, in the negative sense.)
Precisely - monetary policy in the English-speaking world has, since the 80s, been focused on avoiding inflationary pressures via avoiding "too much" growth. Anything that would lead to upward income pressure outside the executive suite is "too much".
> We need the Federal government to stimulate aggregate demand at the consumer level. How? Investing tax dollars in a smarter manner.
How do you get 535 people (congress) to spend $3 trillion smarter? It's an impossible task. A fools errand. Even if we elected the 500 smartest people to congress, the results wouldn't be much better.
We need less of the economy flowing thru the federal government, not more.
The Federal Government's expenditures needs to be a lot lower than it is across the board. It needs a serious dose of efficiency. The borrowing alone impacts all business and individuals simply because it removes money from individuals directly and indirectly which slows the economy, puts pressure on future governments to raise taxes furthering the loss of spending by individuals, and lastly leads to uncertainty in the future.
The truly sad part is they could balance the budget and operate with a surplus by doing two simple things, getting rid of baseline budgeting and keeping spending increases under inflation. Some projections put doing those two items as righting the budget in less than 10 years
Look up the term dead weight losses to get an idea of how bad government spending is for the economy versus private spending.
We have indeed seen it in action since 2008, to horrific results.
$9+ trillion in new public debt added in eight years, to go with ~$11 trillion in additional government spending, boosting federal spending by nearly 1/2, to achieve the slowest average growth in non-recessionary times in US history, and the slowest employment recovery in US history.
More typically you get examples like the governments of Japan and China, which over-spent by the trillions of dollars and misallocated resources on purpose to fake economic prosperity that doesn't really exist so their citizens don't get upset. To say nothing of the favor and bribe based system large governments always operate by - so eloquently demonstrated by the entirely worthless American Recovery and Reinvest Act - in which they choose to allocate resources to their favorite causes (or to build things that aren't even needed) instead of to the most productive outcomes.
China is providing an amazing example of how incompetent command spending always is in an economy. Inevitably when the tide goes out, the fraud begins to reek. In the case of China, they've been busy arresting people to make it look like they're doing something about the vast corruption they've caused through distorting the economy to a truly massive degree. They caused the problems, and then arrest people for their own incompetence. The big difference with the US, is the US doesn't arrest its executives based on the mistakes the Fed made in intentionally creating asset bubbles that inevitably collapsed.
>$9+ trillion in new public debt added in eight years, to go with ~$11 trillion in additional government spending, boosting federal spending by nearly 1/2, to achieve the slowest average growth in non-recessionary times in US history, and the slowest employment recovery in US history.
While I agree with the general outlines of your point, this really doesn't make the case. It's impossible to know what would have happened in the absence of whatever policy you want to discuss. You can say "We spent X and as a result our recession was the longest ever." But you could also say "We spent X, and despite that our recession was the longest ever." It's impossible to prove one way or another.
China has many serious problems, but its situation simply does not prove what you are suggesting here.
China is a once heavily communist country that has been transitioning its economy for awhile now, and it has been quite successful at it. The idea that it is a fake prosperity ignores the changes in quality of life that have happened.
The problems it faces now are not insurmountable. It is easy to list off everything China should do and point out the corruption, but it doesn't really prove anything about fiscal stimulus in the USA.
Dismissing the government stimulus/intervention without considering what would have alternatively happened, a long and deep depression, is disingenuous. That would have been a horrific result, and we would all be worse off.
Balancing the budget is not important. Increasing utility per dollar spent (the dollar is conjured by the govt, it isn't a real resource) can easily be achieving by cutting back on all the productivity wasted by paying people to blow stuff up and maim each other.
The 500 smartest people? They simply delegate and entrust a small committee of the five most qualified people with the resources they need to get the job done.
Five people controlling the collective spending of the world's 1st or 2nd largest economy... that sounds like a scary amount of power for any small number of individuals. No thanks.
Nah, it's actually pretty easy. The 535 people just need to assign general priorities, like spend a third our country's money on health care and education, a third of it on infrastructure, a little bit on funding pure research, and whatever's left over, the military can have.
They're not in charge of deciding how each individual dollar is spent, and they shouldn't be.
This is super naive. For much of the past decade, congress could have removed the entire discretionary budget (yes, including the military) and still had a deficit.
The deficit is driven by social security, medicare, and medicaid. If you want to balance the budget, you have to reform those.
> For much of the past decade, congress could have removed the entire discretionary budget (yes, including the military) and still had a deficit.
Two fiscal years in the past decade (2010 and 2011) had deficit exceeding discretionary spending. That's not "much of the past decade". (The highest deficit was in 2009, but discretionary spending was actually higher.)
> The deficit is driven by social security, medicare, and medicaid. If you want to balance the budget, you have to reform those.
The deficit is driven by a shortfall of revenue vs. spending. Even if your portrayal of the spending side was accurate, ignoring the revenue side is not. If you want to balance the budget [0], you probably shouldn't ignore one side of the balance.
[0] The question of whether you should want to is one which is rarely addressed directly, merely assumed.
> Or increase taxes? Social security taxation is limited to the first ~$120K of someone's income. Why?
The theory, I believe, is that this is tied to the maximum amount of income that is counted in the benefits formula for SS. OTOH, there's no reason you couldn't count more income toward benefits (there's already at least one bend point where the amount of benefits for each additional dollar of lifetime qualifying income/contributions is reduced, so if you are concerned with the distribution of benefits if more income is counted, you could also add additional bend points.)
If you wanted to go further, you could include personal capital income (perhaps with some limit, or perhaps open ended, with additional bend points, as necessary, as discussed above for increasing/removing the limit on labor income) as SS taxable (and in SS benefit calculations). Given that at least some capital returns are a result of active personal management that can become less practical with age or disability for the same reason that labor can, it makes as much sense to preserve a safety-net retirement for those retiring from such active management as for those retiring from wage labor.
Because taxing those people won't solve the real issue? I pay more in taxes every year on my income than many millionaires do because my income is primarily salary instead of stocks, etc.
120k may seem like a lot, but it isn't in several parts of the US now (e.g
SF Bay Area, New York).
> Because taxing those people won't solve the real issue? I pay more in taxes every year on my income than many millionaires do because my income is primarily salary instead of stocks, etc.
Taxing capital income like other income is another possible solution.
Yes. The shareholders are rent-seeking. They should be taxed as if it was normal income. They don't provide an real value to the company, its output or consumers. For the most part, they are a determent to all outside themselves (specifically their holdings).
Shareholders do not provide value. They provide a 1 time infusion of cash in exchange for a future return of either increased value of their stock or dividends. They only infuse cash when the stocks are released either at IPO or later offering of new stock.
The reason stocks are sold is due to cost of capital. A company can make money in a few ways. First is they make a product or service and receive money from customers. Second, they can IPO or some other form of shareholder investments. Third they could finance their needs either with a direct loan or through bond issuance.
Now, most bonds are considered junk if they are from a small company, especially one where people are working out of their garage. This means the debt has a rather high rate (because people think you're going to default). So now you've got to find a buyer (requires middlemen and their costs) that's will to bet on you. Good luck (no seriously I'd prefer this over opening my company to an IPO).
Bank financing is hard to get for pretty much the same reason that bonds are junk. Unless you can show positive cash flow for a few years (you know with your just formed startup and a dream), you probably not going to get a loan. It is due to this that often people, including Elon Musk, self-debt finance via credit cards. Again, ridiculously expensive lending terms.
Let's say you are making money. That's great, you're in the top 40% of startups. You are now constrained by the amount of money you make. If you make 100k a year, but need 1mil to bring a new product to market, we'll see you in 10 years (probably more like 13 with taxes removed over those years).
This brings us to stocks. Find people that are a) suckers, b) chumps or, and good luck o' bearer of dreams, c) actual believers in your product/service. They buy at the IPO price. Your company gets a percentage because the financial house that offered your stock takes a chunk. VCs might cash out after their sale moratorium ends. But after all of this you have a pile of money. That 1mil product is probably doable now. So is an office complex with open floors, and a coffee machine and free lunches and a dog kennel for when your employees just need to feel something that proves they're alive.
You also have an asset to back bonds. So you can, after a small period of time, issue bonds.
At no point did the shareholders add a penny in value to your product directly. They are just there hoping to the FSM that they can leave your stock at some point with a gain. They DO GET TO BITCH. They can have you legally removed from your own company because you have a long view that says in 10 years doing X, Y, Z will increase this companies value 100 fold, but it won't help (probably will hurt) the next 3 quarters.
As a stock holder I can say this about other stock holders. Fuck'em. They get 10-50% return for literally parking their money. As they have more capital related income, they should be taxed as income (outside of reasonably tax-protected vehicles like retirement plans).
> As a stock holder I can say this about other stock holders. Fuck'em. They get 10-50% return for literally parking their money. As they have more capital related income, they should be taxed as income (outside of reasonably tax-protected vehicles like retirement plans).
Word. As a TSLA stockholder with >10K shares, I couldn't care less if it went to 0. It was a gamble, and only because I believed in what Elon was trying to do.
> 120k may seem like a lot, but it isn't in several parts of the US now (e.g SF Bay Area, New York).
And national tax policy shouldn't be dictated by ~2 major urban metros.
I agree that tax policy needs to encompass more than just the salary of the working class, but let's not joke ourselves. Medicare already taxes your entire wage base, there's no reason Social Security shouldn't.
We keep kicking the can down the road, and its time to own up to the liabilities we've created.
>We keep kicking the can down the road, and its time to own up to the liabilities we've created.
I'm afraid it's quite impossible to 'own up' to those liabilities. Look at the debt clock:
http://www.usdebtclock.org/
The GAAP liabilities of USG amount to $100 trillion, yet the net assets of the entire US are only $116 trillion. Nearly all of the assets in the entire country would need to be sold to pay for the liability to be incurred.
I'm afraid the only solution is to reduce benefits, primarily reducing social security payments (particularly when most of the boomers are drawing on them) and cutting medical spending - probably by instituting controls on what the government will pay for in terms of end-of-life care.
> Or increase taxes? Social security taxation is limited to the first ~$120K of someone's income. Why?
Because social security is billed as a retirement scheme, not a wealth transfer scheme. The idea being that you get back out approximately what you get in.
Since benefits are capped, payments necessarily are. If you want to change social security into an explicit wealth transfer scheme, expect heavy resistance.
> Since benefits are capped, payments necessarily are. If you want to change social security into an explicit wealth transfer scheme, expect heavy resistance.
Increasing taxes and redistribution for "quality of life" necessarily decreases savings and investment. investment is where long term quality of life is determined.
> ...move did nothing to assure markets that the Fed is in control, or set credible, measurable goals for future hikes
Markets respectfully disagree, see the uptick across all indices since the announcement.
As you point out, there is only so much Fed can do and they are taking a measured, responsible stance, well within expectations. The fact that Fed's actions are fully aligned with expectations is kind of the point - the last thing they want to do is spook the markets, so messaging and signaling is key.
A huge percentage of net market moves happen on the days around fed announcements. Your interpretation of the reaction needs to be rebased onto that history. Today only looks like a big move compared to an average day in a week without a fed announcement. You can see this here: http://slopeofhope.com/socialtrade/item/19476?__share=52402
> We need the Federal government to stimulate aggregate demand at the consumer level. How?
Simply put by distributing cash to the people directly. Why do only rich people on Wall St. get subsidies and bailouts where the Fed purchase their worthless papers with hefty sum of money and push on their balance sheet on the taxpayer's dime?
Not only this but they are also engaged with them in destroying the labor market by bankrolling Wall St greed and their endless chase of efficiency at the expense of people's jobs as they get more aggressive with M&A activity evading taxes and expanding robotics & automation to eliminate labor costs.
This can't be going this way forever and something has to be done to stop this madness.
> We need the Federal government to stimulate aggregate demand at the consumer level. Investing tax dollars in a smarter manner.
Isn't it highly unlikely that tax dollars will be spent or invested more wisely than the original owners of those dollars would have spent or invested them, since no-one would have known the owners' preferences as well as the owners themselves?
Keynesian pump-priming ends up thinking it makes economic sense to tax people for money to fill up jars, tax people to pay for workers to fill jars with cash, tax people to pay for workers to bury the jars, and tax people to pay for workers to dig the jars up. Although I think there is a very valuable insight about velocities and derivatives rather than simply values-at-times, I think that government spending in general is essentially a drag on the economy: a necessary and inevitable malinvestment, but one to be avoided where possible.
I'd argue government spending on things like infrastructure moves goods and people to more places thus stimulating the economy.
Government spending on research results in new drugs and medications which improve peoples qualities of life.
Government investment in clean energy promises to reduce the tens of thousands of people adversely affected by pollution in our nation annually and also provide us with a hugely viable export technology.
Government spending on bureaus like the FDA, EPA, and BBB give consumers and citizens access to outlets for complaints against dirty businesses and give us a decent amount of protection against those who would harm us to gain more of those dollars you think they'd rather have in their own pocket.
Meanwhile, the original owner might buy a boat while thousands of people have shoddy products and no recourse. Or they might buy a nice car while people deal with the pollution from their industry.
In the end, I believe it to be about balance but lets not pretend that a lot of the research that goes into the vast majority of the technologically advanced products doesn't come from tax dollars and lets start ensuring that we as citizens benefit just as much as the owner of these big businesses which can (and should) capitalize on these investments made by society for the good of society.
Then we can all go back to our enjoyable lives of digging up and reburying jars of money.
Government spending on bureaus like the FDA, EPA, and BBB give consumers and citizens access to outlets for complaints against dirty businesses and give us a decent amount of protection against those who would harm us to gain more of those dollars you think they'd rather have in their own pocket.
> Government spending on bureaus like the FDA, EPA, and BBB give consumers and citizens access to outlets for complaints against dirty businesses and give us a decent amount of protection against those who would harm us to gain more of those dollars you think they'd rather have in their own pocket.
Well, that's clearly not the case for the BBB (which is a private nonprofit), unless you are counting granting tax exempt status to an organization as a form of "government spending". I tend to agree with regard to the FDA and EPA, most of the time, but its not exactly a non-controversial claim and regulatory capture is always a concern.
It's not about 'wisely' in terms of returns to the individual who invested, it's about 'wisely' in terms of creating aggregate demand.
For example, funding a bunch of national infrastructure projects would have horrible returns, being a 100% loss to the person who spent the money. But that money circulates in the economy, creating demand, and we get the infrastructure afterwards as well.
That's speculation, of course, but we can look back to the New Deal to see that it's worked at least once before, and look at current-day corporate balance sheets and their underwhelming investment in demand-creating ventures to see that what we're doing now is not working. If the goal was to generate novel tax-avoidance schemes like the double-irish, though, we'd be a rousing success, so there's that.
There are very respected economists and historians on all sides of debate as to whether the New Deal programs were effective, not effective, or if they actually prolonged the depression. Also, the New Deal was multi-faceted, so any analysis of its effectiveness needs to be specific. What parts were effective? Giving legal privileges to labour unions? Infrastructure investment? Social Security? Tax changes? You also have to consider the political side. Some of the New Deal proponents claimed that they saved capitalism, by preventing the crisis from boiling over to revolution. If they're right, there's certainly value in that. Now apply any lessons learned to today, a very different set of economic, social, and political circumstances.
Also, beware of the broken window fallacy. Unproductive make-work is of no net benefit to society, and if foregone productive work is the opportunity cost, it's a net loss. Obviously, infrastructure investment is ideally productive, but the government has a pretty terrible track record for effectively spending money.
Many smart people argue that the New Deal prolonged the Great Depression due to the government's incessant meddling in the market with price controls and new regulations.
Maybe nobody who is all of honest, aware of the relevant documented facts, and sufficiently intelligent does. Maybe.
But there are certainly people who are smart, people who are honest, and even people who are smart and honest that believe that the New Deal exacerbated the Depression in the way described.
(Note that I very much do not endorse the idea that these beliefs are correct.)
Your paragraph on Keynes is a very common misrepresentation of his policies. Keynes was very clear that he wanted the government to offset the private sector. So if the economy was strong he expected the government to reduce spending least they lead to overheating. If the private sector was weak he expected the government to step in and try and offset that weakness. So it's nigh impossible for government spending to be a drag on the economy because it's only there in force due to the absence of private investment.
There are a vast number of situations where the individual decisions about how to spend money/take action may be the best for the individual, but bad for the society overall. For each and every one of those, it's better for society to act as a unit to make the optimal decision.
> For each and every one of those, it's better for society to act as a unit to make the optimal decision.
Depends on how you define "better". Who is to say that "better for society" trumps "better for the individual". There's no particular objective reason to take that position over the one favoring individual choice.
> If everybody owns something, then nobody owns it. We should probably rethink our notion of what "the commons" means, vis-a-vis property rights.
Good point. Of course, that rethink might go in either way, moving more things from public to private or from private to public. It's a good idea to periodically review what we consider public property and try to make it more consistent with the idea of privatizing externalities.
> more wisely than the original owners ... would have invested
It depends. If the original owners were a handful of wealthy oligarchs, that's likely to be worse (ie. more centralized) than as spent by a large, distributed bureaucracy. If the original owners were a large population of mostly middle-income and poor, that's likely to be better (ie. more decentralized) than government spending/investment.
> government spending in general is essentially a drag
If government is a centralizing force, then yes. If government is a decentralizing force -- improving the mechanism of the free market -- then it's increasing efficiency.
How do you categorise a set of 'wealthy oligarchs' as having 'worse' spending than a monolithic government, which we all know has terrible spending patterns and priorities.
Politicians spend money on vain projects to get themselves popular and re-elected- how is that not worse than a wealthy oligarch spending money on a gold plated fountain? At least the gold plated fountain would not be built on promises that the future (unborn) taxpayers will make up the tab.
The point here is that people tend to see the government as a relatively benign spender who sometimes gives money to others, while they automatically see a rich person spending money as terribly misdirected. When you impugn a government with perfect morals and individuals with terrible morals the thinking that results simply has to be wrong.
You're missing his point; he's saying whomever happens to be the larger group in a given scenario will be the better spender of the money. Which is a point, given your stances, that you should be agreeing with unless you're just purely anti-government. He's saying the government is a better spender than the 'wealthy oligarchs' precisely because that's such a small group and the government is the bigger group but that the poor and middle class are better spenders than the government because they're the bigger group..
'Good' and 'bad' spending are pretty loose concepts. Sure, building weapons is worse than building tractors in terms of human impact, but when you get down to incessant government intervention in everyday spending, it's not clear that governments spend money better than individuals of any wealth level. Only a minority of citizens waste their money; while a majority of governments waste theirs.
I don't care how you define good and bad; that's not the topic. You asked how he categorized wealthy as worse spenders than government, the answer is the size of the group. More people equals better spending decisions because it's less centralized. So are you anti-government, or anti-central planning? Because you can have defacto central planning without a government; that's what extreme wealth is, defacto central planning. Sometimes giving the government the money to spend is the more decentralized option.
But it would seem like a 2% rate would still have pretty bad consequences. The average interest rate on federal debt is 2.4%. [2], and interest on that debt is about 7 percent of outlays. [1] (Yes, I looked up those figures for my previous HN comment, not trying to plagiarize myself.)
I couldn't find data on average maturity, but if it's slanted toward shor-term debt, then that average could go to more like ~3.5%, which would be a ~40% increase in interest spending, and (assuming no increase in revenues) a 3-4% cut from the federal budget, when pretty much anything is hard to cut.
Debt at these low interest rates makes spending very vulnerable to even small (point-wise) increases.
Isn't investing in bonds putting money to work in the economy? And how does the government really stimulate demand? Nobody demanded an IPhone before it existed. Good products stimulate demand.
production creates demand. Not because people want to buy it, but because the act of production gives you something to trade.
The people who build iPhones (Apple employees) produce something valuable (iPhones). Everyone else has to produce something to trade for an iPhone - a bushel of wheat, a written work, a clean window, a haircut, a night of entertainment.
The act of production and trade is what creates wealth and economic growth.
People get lost and separated from this basic understanding because if you create and give everyone money, then everyone can go and trade the money with Apple employees for an iPhone. But this is not long term sustainable, and you actually cheated the Apple employees because the money they are getting is worth slightly less than when they set out to build phones. And it's clear that the extra money has not made the world as rich as it would have been from people actually producing something else to trade. This is patently true even though the mythical gdp number went up, giving the illusion of an increase in wealth.
> production creates demand. Not because people want to buy it, but because the act of production gives you something to trade
What are you describing is called Say's Law. There's various ways it can be false, and the US economy experienced lots of them.
An example of how production does not create demand: people can save money for the future. A person who wants to save more will produce more (work harder) and reduce their spending. If everyone does this simultaneously, we get a glut: supply exceeds demand, and real production will fall.
Note the simple remedy: give everyone money, everyone can increase their savings, and resume their old level of demand. Here money did increase real output. And (even in your example) everyone got money, so the Apple employees were not cheated. Lost real income from iPhone sales is compensated by the additional money they received.
Of course I know it is Say's Law. My purpose here is to post it for people to understand the principle.
Giving everyone money does not work. You can only increase the size of the economy and wealth of the people within by producing more. That much is self evident, yet people have been bamboozled by muddied thinking that aggregate demand is all. I don't try and convince the hardened Keynesian thinker with Krugman in their favourites, but merely to explain to people who instinctively know that current macro thinking is broken, but haven't worked out why.
I'm not sure where you're going with that. Ok, so we become wealthier if we produce more. The next question is, how do we shape public policy so that our economy produces more?
If you tug on that rope, you find that supply is connected to demand, and demand is connected to things like the money supply. So choosing the correct money supply can increase real output.
I think you're arguing against a strawman, something like "if you give everyone money then we'll all be richer because we have more money." But nobody's saying that.
Here is the mechanism that will fully elaborate brc's point.
Elderly consume more than they produce. The young produce more than they consume to save for retirement.
A lowering of interest temporarily induces additional borrowings which will be invested in capital in the short run. Inefficient companies that were going to go bankrupt and release their physical capital for more efficient use, will be kept alive, staving off job losses.
In the long run, low interest reduce elderly's income on their savings. Reducing elder's income reduces demand for the goods the young produce. Since the young cannot produce at a loss, they produce less and have less income to save with. The causes reduced savings, which in turn means reduced investment, and thus even less spending, less income, which means deflation. This deflation is further enhanced from the increased supply caused by the increased investment in capital when interest was first lowered. And if you keep lending to companies at near zero interest rate with money from nowhere, increasing inefficiency in capital means lower yields in stock markets general, also lowering income in the long run, and lower job growth.
The Fisher equation[1]: Nominal interest rate = Real interest rate + Inflation.
The initial thrust of lowering interest will boost the economy temporarily. Keep down nominal interest rate long enough, and the economists will get the deflation they so dread.
Now you know why the EU and the U.S. has trouble with lack of inflation "even though" interest rate is so low for the past so many years.
The whole point of Keynesian theory is that, in times of economic contraction ('a glut' in the old money), you should borrow from the future and buy things - any things - now.
You could make the argument that buying worthwhile things - like dams or power stations - makes this true. But for two things : if it's worth building a dam for positive return, you should do it at any time, as soon as you can. The second is that governments do not spend money on buying good things. In 2008/9 they spent money buying and crushing old cars, which is about as close to paying people to dig holes and fill them in as you can get.
The believers in 'aggregate demand is all' absolutely do believe that giving people money makes us all richer. They may not say it like that, but that's what they mean.
Bonds are government debt. When you buy a bond, you are giving the government your money now in order to receive a return on that money later, with the expectation that the government will do something useful with the money in the meantime. So if the government is allocating its budget well, then yes, purchasing bonds is a good thing. If it is not, you are making a bad loan to someone who may not be able to pay you back in the future.
Government stimulates demand by investing in sectors that have huge up-front costs but large positive social externalities over time because the lifespan of a gov is much greater than that of an individual or corporation. It invests in infrastructure - the national grid, highways, roads, prisons, the post office, mortgage lending, insurance - most importantly though, wars, education, and healthcare. Many of these industries have become increasingly privatized over the past 30 years. This is not inherently bad, but it changes the profit time horizon and shifts incentives away from long-term investment towards short-term profit maximization.
iPhone would not exist without the development of the internet during the cold war on gov grants, the affordability and draw of public UC Berkley where Jobs and Wozniaki met, people alive and well-fed enough to buy it, etc. You can't point to a single innovation without looking at the entire fabric of the society that produced it. Gov spending has huge impact on social fabric. iPhone is also only one half of equation. If no one has the disposable income to buy one, it doesn't matter how good it is.
> iPhone would not exist without the development of the internet during the cold war on gov grant
Isn't that a bit of a broken-window fallacy, though? We can see that the iPhone exists, and we can see that it exists in part as a result of the State grants which funded the development of the Internet, but we can't see what that money might have funded had it not been spent on those grants. We have no way of knowing what the original earners of those dollars might have chosen to invest them in, and what the world would now look like had they been free to do so.
We do know from history that while socialist economies like the USSR and its satellites did indeed tend to improve their economies measurably over their pre-socialist levels, freer governments tended to improve their economies to an even greater degree, leading to exponential quality-of-life differences over the decades. The average Russian was better off in 1989 than he would have been in 1913, as was the average American, but that average American was so much better off than the very best-off Russians that Boris Yeltsin was converted simply by seeing a Houston grocery store[1].
I love the Internet deeply, and I'm glad that government grants financed the research which led to it, but I wonder what else I might have had if those grants had been spent otherwise, just as a Russian in 1989 was no doubt glad for what he had — and amazed when he saw what he could have had.
People who actually believe that wouldn't say "politicians", they'd use some other euphemism, because they believe in some abstract trustworthy organization that's always being hampered by those damn politicians.
Statists love their euphemisms:
“investment” instead of “government spending”
“shared sacrifices” instead of "wealth redistribution"
"government officials" instead of "un-elected bureaucrat"
and lastly,
"public sector" instead of "The State".
My irony detector has just exploded. Can you direct me to a completely-unregulated minarchist free-for-all market where I can buy one that merely poisons me and everyone in a hundred-mile radius? Because at least it would actually work.
The poisonous version was cheaper to make than the non-poisonous one, last I heard. So the company decided to go with poisonous ones in order to meet Q4 financial goals.
I didn't claim my language was "straightforward", any term we use will carry bias. That's how political language works.
"Investment" automatically biases you to think that said spending must have a net-good result. Calling it "Government spending" predisposes you to think about the price of said action.
Biased language is always annoying to the other side. When I hear the liberal euphemisms I groan as strongly as I suspect most liberals groan to my dysphemisms.
If you said libertarians love their dysphemisms I wouldn't hold it against you.
Hah. Someone should write a bot that evaluates trite simplistic aphorisms (regardless of sarcastic or whatever) and replies with something like "real life is more complex" or something of that ilk.
> And how does the government really stimulate demand?
Building things (roads, spaceships, bridges, etc), funding things (medical research, education, etc) and other obvious things. Low interest rates make longer term projects much more viable.
So maybe the industry might have to take some risks on younger businesses, rather than piling on yet another zillion dollars for the Series Q round of Unicorn Inc along with the timid institutional investors?
> Fed raising interest rates 0.25% and setting a goal of "normal" 2% by 2018 means little to nothing. Market already priced the miniscule rate hike in as the move was widely expected
The second part is true, but doesn't support the first. The fact that move was expected and priced in doesn't make it meaningless, since if it didn't occur as expected, the fact that it was priced in would mean that the market would then have to adjust to the inaccurate expectation that had been priced in.
Fed raising interest rates 0.25% and setting a goal of "normal" 2% by 2018 means little to nothing. Market already priced the miniscule rate hike in as the move was widely expected, and move did nothing to assure markets that the Fed is in control, or set credible, measurable goals for future hikes.
I'm pretty sure it doesn't mean nothing and that it actually is more than just symbolic.
>We need the Federal government to stimulate aggregate demand at the consumer level. How? Investing tax dollars in a smarter manner
Everyone - and I do mean everyone - would be better off if the fed government (and state and local) invested those tax dollars smarter by leaving the majority of them in the hands of those that earnt them.
"There are four ways in which you can spend money. You can spend your own money on yourself. When you do that, why then you really watch out what you’re doing, and you try to get the most for your money. Then you can spend your own money on somebody else. For example, I buy a birthday present for someone. Well, then I’m not so careful about the content of the present, but I’m very careful about the cost. Then, I can spend somebody else’s money on myself. And if I spend somebody else’s money on myself, then I’m sure going to have a good lunch! Finally, I can spend somebody else’s money on somebody else. And if I spend somebody else’s money on somebody else, I’m not concerned about how much it is, and I’m not concerned about what I get. And that’s government. And that’s close to 40% of our national income.” - Milton Friedman
In terms of stimulating aggregate demand, transfers to people who will spend the money are more effective than transfers to people who spend less (i.e. save more). In practice that means food stamps, unemployment benefits, etc. are more effective than tax cuts directed at high earners.
This seems like a common point in this thread with which I respectfully disagree.
While I'm sure we all support the notion that there is social good in reducing income inequality in the U.S. and improving quality of life for all, consumers in lower tax brackets will tend to spend additional income on staples, marginal quality-of-life improvements and servicing past debt. While this spending (increased aggregate demand) can't be bad, it doesn't necessarily distribute the capital _efficiently_.
Meanwhile, as you put, the high earners who "save" (read: invest) their excess income are precisely those who stimulate the economy effectively, as they are typically more able to efficiently allocate investments. I make this broad-brush assumption based on personal experience and some research I read years ago I don't have the time to look up right now. But basically think about this: if you had $100 to invest, would you rather ask a hobo on the street or Bill Gates (let alone Ray Dalio)? This "sophistication factor" is relevant, I believe. Add in the fact that lower-income consumers are almost certain to spend the excess capital in a predictable but not necessarily efficient way, and it's fairly easy to make the argument that aggregate demand would best be created by a.) efficiently distributing capital to b.) create new and profitable enterprises that c.) create demand both domestically and internationally, and d.) purchases are made (demand is created) for those innovative new products/services using e.) the money earned by workers paid by the companies that just created them. (f. what a mouthful.)
Now we've not only increased demand but added to the whole pie via foreign trade. And gets us back to the point mentioned above that the quality of what we create directly impacts demand for it -- and you can't really get around that fact either.
I agree with most of your points just that I'd tweak it slightly and say that Bill Gates vs the Hobo are better at producing, rather than saying that Bill Gates is better at creating demand. It's a very slight shift but it's important to recognise that it is the very act of producing that enables trade and the wealth that comes.
Gates and the Hobo have the same ability to spend (ie demand) with the money you give them, but Bill Gates and the Hobo do not have the same ability to produce. That is why Gates is Gates and the Hobo is the Hobo. It is the fact that Gates has a propensity and skill to take the $100 and create value (production) from it that gives Gates the ability to grow the pie for everyone.
It's great if they work together. But it's also rarely the case historically. Don't feel bad for the Fed. They actually have very real power to influence the economy _indirectly_ History will judge Ben Bernanke as preventing the country (globe?) from a depression via aggressive monetary policy.
>Not raising the interest paid out on short term bonds so that institutions are incentivized to keep even more money in bonds rather than putting them to work in the economy.
There's plenty of money around. Oceans of it. The problem is a lack of demand.
Right, it would help to put $ directly into consumers hands versus buy bonds and putting it back on to bank balance sheets who will not necessarily lend it back out.
Analysis from TD on how banks (Wells Fargo, US Bankcorp, JPMorgan, M&T, PNC, Citi) rushed to hike the prime rate to 3.50%, and forgot to increase the deposit rate:
As CNBC reported [1], "a change in the federal funds rate will have no impact on the interest rates on existing fixed-rate mortgage and other fixed-rate consumer loans, a Wells Fargo representative told CNBC. Existing home equity lines of credit, credit cards and other consumer loans with variable interest rates tied to the prime rate will be impacted if the prime rate rises, the person said."
The good news: the rates on mortgages, auto loans or college tuition aren't expected to jump anytime soon, according to AP, although in time those will rise as well unless the long-end of the curve flattens even more than the 25 bps increase on the short end.
What about the other end of the question: the interest banks pay on deposits? Well, no rush there:
"We won't automatically change deposit rates because they aren't tied directly to the prime," a JPMorgan Chase spokesperson told CNBC. "We'll continue to monitor the market to make sure we stay competitive."
Bottom line: for those who carry a balance on their credit cards, their interest payment is about to increase. Meanwhile, those who have savings at US banks, please don't hold your breath to see any increase on the meager interest said deposits earn: after all banks are still flooded with about $2.5 trillion in excess reserves, which means that the last thing banks care about is being competitive when attracting deposits.
> Existing home equity lines of credit, credit cards and other consumer loans with variable interest rates tied to the prime rate will be impacted if the prime rate rises, the person said.
> "We won't automatically change deposit rates because they aren't tied directly to the prime," a JPMorgan Chase spokesperson told CNBC. "We'll continue to monitor the market to make sure we stay competitive."
Does it matter though? 21st Century, everyone with savings can open a Vanguard mutual fund account with the risk/reward profile of their choosing, that's almost as convenient wrt withdrawals.
What I'm curious about is what effect this move will have on stock prices. Historically, when interest rates rise, stock prices decline. That's because fixed-income becomes relatively more attractive with higher interest rates; owners of capital move out of old low-interest securities (hence why bond prices fall when interest rates go up), into newer high-interest securities. A portion of that capital also comes from the stock market, in the form of the most risk-averse equity holders, and so usually stock prices fall. Remember that stock prices are set on the margin of buyers & sellers; it doesn't take much change in the relative balance between them before you can start seeing big price jumps.
I have yet to be convinced there's no downside to everyone piling into ETFs in Vanguard. Also, funds are traditionally not FDIC insured as checking and savings accounts.
Money market funds have broken the buck before. Its rare, but can happen.
The downside of everyone piling into index funds isn't something systemic that'll bring down the financial system the way the real estate bubble did. Rather, it's that the capital market as a whole becomes less efficient. All the money parked in index funds is money whose owners did no due-diligence about where they put it; it means that if reality changes and the value of the underlying businesses goes up or down, the index fund will be the last to profit from it, and we can expect price changes in the stock market to lag fundamental changes in the businesses by a greater time period.
The effect of this is basically that returns for active smart-money investors go up, as there's less competition amongst folks actively trying to discover new relevant business facts. We see this already - a lot of the wealth-creation in Silicon Valley is because folks who have an information advantage can invest in new private businesses before the general public is willing or able to invest in them, creating large private fortunes. But because the price mechanism lags the business reality in this case, you don't have crises where a large number of people suddenly find out that they are poorer than they expected, like the 2008 housing bust and 2001 dot-com crash. Rather, you end up with chronic societal inequality where a small number of people end up with fortunes that everyone else thinks are implausibly large.
The problem is that Wall Street fund managers who beat the market almost never do so consistently, i.e. there is insufficient evidence to reject the null hypothesis "all actively managed funds have a roughly equal (low) chance of beating the market" in favor of "this fund knows how to beat the market consistently and will probably do so next year."
So a rational personal investor, who does not have insider information, is best off not trying to beat the market. Even though the market as a whole may be best off with everyone trying to beat it.
Yeah, I know the rationale behind why index funds exist. The majority of my wealth is in them, after all.
The parent poster, however, is asking "What's the catch? Where's the trade-off to investing in index funds, and what sort of new systemic risks does widespread adoption of them bring to the financial system?" He's right to ask that: there is always a catch, because the financial system is about distributing & incentivizing the wealth of society and doesn't directly produce any wealth itself.
I'm saying that the catch is in diminishing returns from the index itself. A well-subscribed index fund, by definition, will always give you the median return of the market it tracks. I'm saying that the effect of large amounts of capital pouring into index funds is that the mean and median returns will diverge. Market inefficiencies become more prevalent as fewer eyes are on each business; as a result, people who successfully exploit them become richer than they would otherwise. Wealth becomes increasingly more concentrated in the few people that actively invest (usually with insider information) and do so successfully. Passive investors continue to make the median return, but the median return falls further behind the mean return.
We're seeing exactly this phenomena right now. I haven't seen anyone else who has explicitly linked it to the rise of index funds & passive investing, but I wouldn't be surprised if it's related.
Index funds (whether exchange-traded or not) have exactly the volatility of the bundle of stocks they track; of course they aren't FDIC-insured, because they're investments and not savings accounts. But for index funds diverse enough and time horizons long enough they have really nice risk/reward characteristics that suit most people. If you go to Fidelity or Vanguard's website you can use automated tools to calculate the distribution of index funds, bonds, and cash equivalents that best suit your risk appetite and time horizon for growing a nest egg.
There is a sticky price effect, but interest rates on savings accounts will inevitably rise as the prime rate increases, as banks compete with each other for customer business. Yes there will be lag time, but it will happen.
I'm not sure if the Fed pulled back the trillions it pumped into the banks during the crisis, but until that happens, banks don't have a real incentive to compete for deposits.
And isn't that how it should work? The extra money around is supposed to make people do something with their money apart from depositing it with a bank.
The reason the Fed issued the money to banks is so they don't collapse.
Why would they collapse? Banks use deposits as collateral to make investments. During the crisis, a lot people and institutions were panicking and withdrawing whatever they had in the market.
So the Fed issued a bunch of money and loaned it to banks on generous terms to prevent a Domino effect where institutions fail one by one.
It's probably what prevented a giant meltdown of the economy.
It also changed the dynamic for the banks. They were loaned trillions by the Fed for next to nothing -- much better deal than fighting over people's deposits. So we won't see deposit interest rise until some of that money is taken away. (My understanding is that hasn't happened.)
A couple years ago, the Fed paid the banks to sit on that money and not use it, but I'm not sure if that's related. Somebody more informed might be able to fill that gap.
>a change in the federal funds rate will have no impact on the interest rates on existing fixed-rate mortgage and other fixed-rate consumer loans
>Existing home equity lines of credit, credit cards and other consumer loans with variable interest rates tied to the prime rate will be impacted if the prime rate rises, the person said
That is literally what fixed and variable rates mean, so I hope it isn't surprising to anyone.
Nanex, an account that follow market micro-structure, had an interesting tweet that showed how the liquidity on 10 year Treasuries just dried up prior to the announcement.
I'm surprised this story has gotten so many votes so fast. This rate hike was widely predicted, as intentionally as the fed could by law so that they don't impact the markets too much.
Alot of people think this is the first of a few small rate hikes we'll see in the next 12 months.
IMHO, this is good news for the US economy,
- it will help give the the fed some wiggle room/ammunition to soften the fall when the next recession hits
- a slowly raising rate could stimulate the economy by convincing companies to spend now on large projects rather than wait, ditto for housing/consumers
Having said all that, keep in mind the rate hike is only 0.25% upping the overnight rate to 0.3% so this is likely to have an almost negligible impact on the every day consumer.
In other words, the price of liquidity is much higher when impacting news (for any given security) is expected during market hours. To me this seems like a desired feature of properly functioning markets.
I'm home shopping at the moment, and my mortgage broker told me that he noticed a large hike in mortgage rates, is that due to this announcement and that I should wait a few weeks before locking in a rate?
(1) Liquidity always dries up prior to the announcements. If you're a market maker, you don't want to get run over by someone moving the price on new information.
(2) It's a myth that raising rates will give the Fed more ammunition. That's like saying you should exercise less now so that if you gain weight in the future you'll be able to make a bigger change in the amount you exercise. (Not the perfect analogy, but I hope you get the idea.) The fallacy comes from thinking that the change in interest rates is what stimulates the economy, not the interest itself.
A second issue with raising rates to 'increase ammunition' is that if you choose a rate path that is too high, you'll depress economic growth, pushing rates down, counteracting your goal of higher rates. Monetary economist Scott Sumner writes: "Fed funds target rate increases tend to reduce the Wicksellian equilibrium interest rate, and hence give them less ammunition for the future. The ECB in 2011 is now the classic example, but you can cite Sweden, or Japan (2000 and 2006) or the US (1937) as well."
And here's a blog post that argues that while rate hikes might not give you monetary ammunition, they still might give you reputational ammunition: http://www.themoneyillusion.com/?p=31361
I agree with your first point. Most people don't follow the markets so I thought it might be interesting to them.
As to your second point, we will have to agree to disagree. You might be right, I'm not a macro economist, but your opinion is a minority one and its definitely not the mainstream opinion.
Which is fine, it might be right, but I'd rather have the fed have room to cut rates than not have that option on the table.
Worth noting that the mainstream macroeconomic wisdom has been completely disconnected from what we've observed in reality the past 10 years or so -- having rates this low for this long is supposed to spur demand and create inflation, according to mainstream macro, right?
I think mainstream macro acknowledges that negative rates can be needed to spur demand even though there isn't a good mechanism for achieving negative rates. The zero bound is pretty much a 'natural' restriction that doesn't have anything to do with just how much people want to hang on to their capital in times of uncertainty.
This could have wide implications for the startup community. A lot of people think that the current really high late-stage startup valuations, and the money pouring into the seed stage is an effect of the low interest rates. With no way to get any decent yields with these rates; it incentivizes institutional money to chase returns in alternative investment classes.
Not sure how much it will impact startups with saner valuations, but yes I do suspect we might see a unicorn apocalypse at some point in the future.
If it happens it will unroll more slowly than a public market crash since these markets are mostly illiquid and private. What you'll see is former unicorns raising down rounds and a general regression of other valuations in proportion to how over-inflated they might be.
I wonder if it might even help the other "99% of startups" by making their saner valuations seem... well... sane.
Tangential but I've wanted to ask around here for a long time:
WHY would a founder seek such insane valuations? I feel like there must be something I don't get. I understand wanting a higher valuation to raise more money with less dilution to a point, but insane valuations strike me as very dangerous. If these valuations fall then the effect is not terribly unlike a full ratchet and multiple liquidation preference and other founder-hostile terms.
You are not clueless. It's just nearly impossible to draw an actionable line in the sand where on one side your valuation is sane and on the other it isn't.
You certainly can't do that in any kind of general sense. Every startup is by definition unique. And there's almost always a way to justify a higher or lower valuation for any given company.
Oh sure, it's a judgement call. I would say as a founder that it's best to seek a high but not insane valuation, and of course the definition thereof depends on multiple factors: what I think a reasonable growth estimate is (while not under the influence of drugs), what the market is currently paying for capital (average, not outliers), etc.
If every living multicellular organism on Earth would have to create an account on your service for it to be worth X, X is probably insane. If you have no meaningful revenue, then in most cases a valuation more than one standard deviation among the mean for your sector and maturity is probably nutty.
> This could have wide implications for the startup community.
More like a tempest in a teacup. I wouldn't qualify a meagre 0,25% interest rate increase as huge or potentially having wide implications on the market.
Curious if anyone knows what is the average VC fund return for the time-span of 2010-2015 for the past five years?
Suppose if Fed plan to gradually raise interest rates to 2.0% to 2016 year's end; and with that corporate investment bonds, municipal bonds yield also rising to match and go beyond that baseline.
Then, how attractive would VC funds be for mutual and pension funds in relation to other investment alternatives: a) bonds, b) publicly-traded companies following general market trends, c) REITs, d) commodities and precious metals?
For comparison, major Internet IPO's since inception:
GRPN (-87.97%)
TWTR (-42.23%)
FB (+176.6%)
BABA (-10.02%)
ETF Tracking since ETF inception:
SOCL (ETF for Global X Social Media) (-38.8%) vs. SPY (+62.93%) vs.TLT (+1.85%);
FDN (ETF for DJIA Internet Fund, but distorted to contain established Internet companies; GOOG) (+267%) vs. SPY(+65.62%) vs. TLT (+44.18%)
This will have an impact on the flow of money to VC's, which will have an impact on the flow of burnable cash to unprofitable startups. No more $1.5 million rounds for apps like Yo [1] (the investor community should be embarrassed and horrified that this kind of thing was getting financed anyway).
Winter is indeed coming for those that don't have a business model, and that's a good thing.
I wonder how big an impact this will have though. As much as there are apps without business models, there are many solid products solving real problems that already have real revenue and customers behind them contrary to the dotcom bubble.
Sure some tightening of the belt might happen, but is there really any way to say how much?
No, the institutions who allocate money to VC typically do so as part of a long (> 30 year) horizon plan based upon portfolio theory. There are no institutional investors for whom a 25 bp change in a short term interest rate will materially alter their allocation to VC (typically a tiny sub-portion of a minor portion allocated to "private equity," the lion's share of which goes to later-stage buyout).
Private equity and, in particular, venture capital, are part of that allocation precisely because their outcomes are relatively uncorrelated to, say, public stocks and bonds -- which are very correlated to interest rates.
The flow of easy money to VC's has dramatically increased because of zero/negative interest rates - not just in the US but around the world. That flow of money will slow in a positive interest rate environment, which means less money for low quality startups.
Winter comes when exits dry up. After all, the exit is where the VCs make their money. Valuations don't mean anything until a VC can get out of his equity position and into cash or another liquid asset.
We are starting to see valuation corrections with large funds writing down investments in startups in later rounds, and IPOs proving to be very tricky to sell correctly to the market.
A recent example: Square IPOd at $11.20 for a market cap of $3.5b (was valued at $5bn in 2014) and, more importantly, only floated 8% of its stock on the IPO. This means that supply was so low that they essentially guaranteed a pop in price as there was bound to be more demand at this lower price and for such a limited number of shares. This is not how an aggressive, confident IPO is structured.
So once the exit round starts to gum up, it will have a chain reaction on all earlier rounds as people re-evaluate the likelihood and size of an exit. The crash will be swift.
This was very much in line with expectations, ergo the muted reaction in the markets. It's worth noting that the Fed used gradual in lieu of measured to describe the increase. Measured implies a steady series of increases (announced every few meetings until the target rate is reached) versus a gradual approach in which there's a long term number in mind but no strict mandate on getting there - a dovish tone.
Agreed. Judging from the price action in emerging market currencies, which have been particularly sensitive to the Fed lately, it seems the statement was interpreted as being slightly more on the dovish end of expectations.
Would this end up being the pivotal moment of this decade? There is already speculation of recession in the 12-18 month time frame[0] and the energy sector [1] is going downhill since April. I'm seeing some cities and suburbs expanding unlike anything in a while but how much of that could be sustained?
To word it differently, did the Fed blink or are the underlying indicators where they want it to be?
[0] Given the cyclic nature of recessions, we seem to have artificially delayed it a bit.
Not sure I understand your question. Are you saying the fed is wrong here and raising rates into the teeth of a likely recession?
If that's your question, good luck finding someone who knows the answer, but I will note that when the energy sector goes downhill because energy is cheap, that helps, not hurts, a lot of the rest of the economy--energy is an input.
I've been understanding the energy market problems in terms of OPEC manipulations (both artificially high and low prices) more than anything else. I think renewable energy is possibly bubbling, but still doing well?
The fed interest rate is the foundation for pretty much all loans, cars, mortgages, whatever.
Low interest rates are good for borrowers. I want a car, or a house, or a power plant, or a jet, or whatever. I want to spend some money that i don't actually have. This changes the economy because more money is moving around.
High interest rates are good for lenders. I've got this pile of cash that isn't doing anything. The higher the rate, the more likely i am to loan it to someone who wants to do something with it.
The higher the rate, the more sure the borrower needs to be that they can actually put that money to good use. Not only do i have to get you your money back, i have to get you all the interest as well. Lower rates mean more activity, more people borrowing and buying stuff. Higher rates slow things down, but bring more investors out.
Say the fed rate went up 5%. Yesterday i could give you a home loan for 5%, today i could give you a loan and make 10% instead. Since that rate is the foundation of everything, my risk stays the same, but it's much tougher for you, because you have to come up with a bunch more money. They made a tiny, probably imperceptible change to you and I, unless you're actively looking to take out a loan.
Anyway, that's the gist. Borowers need to be a tiny bit more sure they can pay the interest.
One way this might affect ordinary people is the choice between investing or paying down a mortgage. The day you get the mortgage, it probably feels like a good risk-adjusted return to pay it down. "Risk-free 5% return!"[0] But if you have a low 30-year rate and interest rates rise enough, there might be low-risk investments that pay better than extra mortgage payments.
This is one doubt I've always had about Dave Ramsey-esque advice to aggressively pay down your mortgage: In every analysis I see the rate on investment is static, but we know that's not true, and for a long time it's seemed inevitable for rates to go up eventually.
[0] Not strictly risk-free if you wind up needing the cash or your house tanks in value, but that's the pitch.
I think if you don't make a whole lot of money (like retirement is going to be kinda scary) and you're living in the house you're planning on dying in, paying it down makes sense. it's a very easy way to hold on to some wealth and get to the point that you don't have house payments anymore. maxing out 401k is better, you'll end up with more money, but there's some real security in outright ownership.
Paying down the mortgage with the rates we have now, aside from personal security, don't make much sense to me. If you're in an ARM and the payment keeps creeping up, then yeah, it's a better move to pay down early.
> Paying down the mortgage with the rates we have now, aside from personal security, don't make much sense to me.
You must be quite young. The 25-30 year window most people are now taking mortgages out can cover dramatic economic swings. Thirty years ago mortgages in my neck of the woods were up around 20%.
Assuming that rates will be this low forever is like believing we were in a "long boom" in 1999.
Rising interest rates also mean that house prices should drop (or deaccelerate), right? If you figure a buyer has a fixed budget, the more they are paying in interest the less they can pay in principal. Not saying 0.25% will have much effect, but in principle don't they have that relationship?
My feeling is over the next 12-18 months, at least in markets that are already hot (SF, NYC, Boston, etc), you'll actually see house prices rise as the buyers who have been on the side lines are given a kick in the butt to get in the game for fear of losing out on the low interest rates.
> Rising interest rates also mean that house prices should drop (or deaccelerate), right?
Compared to without the policy change (not necessarily compared to before the policy change, though implications of the latter type are frequently treated as if they were of the former type) higher interest rates should mean (with the common assumptions about the dynamics of the rest of the market) both lower prices and fewer sales (buyers can afford less, but there's no reason for sellers to seek less, so the best any property can sell for will be lower and there will be fewer cases where any buyer will be able to offer what a seller would accept.)
I think the big question though is that in super hot markets like SF and the Peninsula, will the demand actually go down enough to slow things? There's a LOT of all cash offers still coming in from overseas. Sure they might have less competition, but I feel like the aggregate demand is so massive and available supply is so restricted (in large part due to Prop 13) that even higher interest rates wouldn't put a big damper on things.
> There's a LOT of all cash offers still coming in from overseas.
Not as many as you think. Saw this the other day:
The San Francisco and San Jose metro areas ranked ninth and sixth from the bottom, with all-cash deals representing only 28 and 24 percent of purchases, respectively. All-cash sales in San Francisco peaked at 36 percent in the first quarter of 2010, Zillow said.
That's really interesting, thanks for sharing your source. I wonder if that accounts for "offers" vs. "buyers." If you have the assets, you can make an all cash offer and come across as much competitive, and then switch things out after your offer is accepted to finance whatever percentage you want without the seller ever knowing. That's a fairly common tactic I've heard about and could definitely skew these numbers depending on what the data represents.
But the broader point of demand is obviously the bigger concern. What are your thoughts on the factors that would impact that? Personally, I see a place to live that has great weather, schools, people, food, culture, jobs, tech, and things to do. It also has proximity to eastern countries which makes it desirable to them. Given the finite land, building restrictions and Prop 13, I really wonder what it would take to have a significant long term hit to prices.
Right, but 25 basis points is such a miniscule increase that it's not really going to do much. It's only a few hundred dollars to buy that amount in discount points.
Eventually. Today, of the many houses sold, there's going to be .25% more people who can't get the loan they want. They're going to move down market, and buy a slightly cheaper house. The more expensive houses might lower their price, or take it off market or whatever.
It's like a distributed system. There's a bunch of complicated moving parts that all react to each other. There aren't that many knobs and levers to pull on. The fed can't tell home sellers to lower their prices, they can just fiddle with interest rates.
It's a mental model to highlight a point. if there were infinite mortgage applicants, and the fed change was the only change in the whole universe, there would be a 1-1 correlation. Lots of other stuff is going on, which pushes back.
No, that's wrong too. I have no idea why you think there would be a relationship like that. The two things you're trying to relate aren't even on the same scale.
Where else are you going to stash your cash? The likelihood of you losing it when your bank goes under is perceived to be higher than the US government defaulting on their debt obligations. US treasuries are the least risky assets out there, even more so that your bank account deposits for large amounts of cash.
For lenders, low rates make it easy to borrow money to in turn lend to consumers. As the rate increases, lenders will pass the higher rate along to consumers, which in turn leads to lower borrowing by consumers due to higher rates.
My personal economist-on-twitter of choice to tune into around fed and other news is Justin Wolfers[1]. Your mileage may vary, but he's certainly willing to express an opinion in what I consider a pretty clear manner (not to say he isn't opinionated, I just find his prognostications and commentary generally compelling).
If they have a variable-rate credit card that has a balance on it, they might want to start paying it down to reduce their interest costs (a good idea in any case).
If they have an ARM for their house they might want to look at what the lifetime interest rate cap is on the loan. Add that to the margin rate to find out what the payment could potentially go to. If they're not comfortable with those numbers, they might want to refinance now into a fixed-rate loan, or see how long they plan to be in the house.
There will be hidden changes as well, as businesses will be paying more for operating loans, and this increase will be passed onto their customers. So food, entertainment, etc. costs will all go up.
In short, pretty much everything you could buy just got a little more expensive.
Realistically, not much for a while. The FED still doesn't think inflation will hit its target until 2018, so low rates are here for the time being.
The two things you might notice:
- Slight increase in rates on CDs, money market accounts, and other short-term savings
- Slight increase on car loan rates, mortgages, and other long-term consumer borrowing
Also, harder to raise capital for startups. Though that's probably a good thing that the bar is raised -- will be better in the long term for everyone.
Not really, any long term fixed rate loan had this priced in for months. In fact, the FNMA 30 year interest estimate is slightly lower now than when it opened, opened at 3.040% and is currently at 3.019% (sorry, no internet source available for that or I'd link it). The question this morning was if they were going to raise the rates today or next quarter and by how much, not if they were going to.
Edit: It's now moved up to 3.048%, but either way, my point is that whether you closed on a long term fixed rate loan yesterday or today doesn't really matter.
I was being a bit generous with the we bit since I am Australian, but the same thing applies to our government too. My state just sold off a hugely productive piece of infrastructure (electricity poles and wires) to pay down debt. The crazy thing is the infrastructure returned twice as much per year in dividends than the interest on the debt retired.
Yes and no. Yes because the monthly payment on a new mortgage for a given purchase price just went up. No because that payment went up for everyone by the same amount at the same time, so purchase prices will (theoretically) adjust downward.
Keep in mind that today's news means a bak will lend you money at 4% instead of 3.75%, so the effect is minimal.
Other factors that influence the housing market such as strength of the local economy and availability & quality of financing won't be affected unless we see substantial rise in rates.
> No because that payment went up for everyone by the same amount at the same time
The rate is more significant the more you borrow, and not everyone has to borrow the same amount to buy the same hypothetical home. Buyers who have to borrow more are less attractive to sellers, ceteris paribus, since there's a greater chance of the deal falling through.
But if we're talking about a .25% difference, it won't have a real measurable effect.
No, likely easier. Think of it this way. Borrowing money costs you more, but makes the lender more money in interest. Lenders now have more of an incentive to loan out money, because they'll actually be earning more (eventually) on it.
An oversimplification: Interest rates are going up over the long run in an effort to keep inflation from getting out of hand (very generally, asset prices go down when interest rates go up). The risk is that it will worsen unemployment before we're ready for it.
Woohoo, that means that less people will be able to afford the highest prices, which means the bubbling up sales prices will go down, and those of us who have been saving up for a home will have a better shot instead of getting priced out by folks willing to take on extreme loans because of low interest rates.
It will also be interesting to see how much of the FED Assets [1] will need to be sold directly or indirectly in open market action to get to their target rate.
In the full text of their announcement, they said they will not be selling any for the time being. They will continue to reinvest the principal as well. They will be using other mechanisms to achieve their target.
I believe it is reverse repos [1] they are referring to.
"When the Desk conducts an overnight RRP, as in the current ON RRP exercise, it is selling an asset held in the System Open Market Account (SOMA) with an agreement to buy it back on the next business day. This leaves the SOMA portfolio the same size, as securities sold temporarily under repurchase agreements continue to be shown as assets held by the SOMA in accordance with generally accepted accounting principles, but the transaction changes some of the liabilities on the Federal Reserve’s balance sheet from deposits to reverse repos while the trade is outstanding."
They released their implementation note here [1].
The Fed completely uncapped the ON RRP program, along with pushing IOER up to 50 basis points as expected. Fed is sending a signal that they will use RRP to keep the FF rate near their target by any means necessary.
From the FOMC statement, it doesn't sound like the low rate environment will disappear too suddenly:
"The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run."
Looks like the stock market reacts positively to the rate hike. But its effect on the general population remains to be seen, specially in the mortgage industry. Will more people shun buying houses? Banks are more willing to lend money with higher interest rate.
I would imagine that housing will stay flat. New mortgages and new rentals will both increase in cost as lending costs rise. IIRC, generally, a higher interest rate environment will incentivize people to go from renting to home ownership as rents increase due to increase lending costs & lowered/flatter housing costs.
Each 1% hike in interest reduces the leveraged buying power of all buyers about ~$21k per $1000 mortgage payment.
The maximum monthly payments for a mortgage are capped at 36-44% Debt-to-Income (DTI) ratio. At the 36% DTI, a hypothetical Joe with no debt making 10k/mo, will be approved for about $2000/mo mortgage. Today's market at 4% means Joe can get a $418k loan. By 2018, with interest rates moved up 2%, he would only be able to get a $334k loan with that same $2k.
Banks make money on the rate arbitrage. Currently, they get money at .25% and loan it out at around 4%. I'm guessing they will be borrowing from the fed at 2% and loaning it out for around 5.75-6% if we stick to the 2% rate by 2018. But I think long-term mortgages are tied to treasury bonds.
If it causes enough people to affect the lending volume, the mortgage lenders may be willing to take a small hit to their margins and try to make up for it in volume.
I guess we will see. People generally aren't willing to sell their homes for a loss, so I'd imagine that realestate will stay relatively flat for a little bit.
Additionally, you can buy discount points to reduce the mortgage interest rate. So it's either a reduction of $21k as you said, or $3000 more due at closing to buy the discount.
I was thinking about this earlier and I have a question about inflation. Could increasing the interest rate cause inflation to rise a bit in the near term?
My reasoning for this is that given that banks were borrowing at near zero, could they have had no real reason to put all the borrowed money to work since it wasn't costing them anything to hold it in reserve for later when the rates did increase? Now that the rates are increasing would they not have to use the money a bit to ensure they stay ahead of the interest rates. I was also thinking that there is a threshold at which banks wouldn't have any more money that is just sitting there and having to borrow at higher rates reduces their demand for new funds from the fed thus undoing this initial effect to the hike.
Hopefully this isn't completely naive. Please let me know if I'm misunderstanding how the fed and banks relationship works.
Holding bonds to maturity vs. selling them and buying new bonds doesn't actually change the financial result. You could equally say "just sell them and buy new higher-yielding bonds and there's no issue," since the resulting yield over the whole period would be equal.
Whether or not there's an issue depends whether your investment horizon matches your bond duration, or alternatively, whether you're comfortable with (or even aware of) the amount of rate risk you're taking compared with the return you're getting.
What is this going to do to interest payments on the national debt? Will this put a squeeze on spending? Cause tax increases? Or will it be business as usual and the fed buy as many bonds as needed?
In the latter case, I think that will cause inflation to pick up unless we can export it all out the trade deficit.
> What is this going to do to interest payments on the national debt? Will this put a squeeze on spending? Cause tax increases?
Spending and taxes are driven by political decisions which can remain extremely distant from any clear relation to the market for quite a long time, so the effect a rate hike like this has on fiscal policy is (even after the fact) murky at best -- even once we know future policy, there will be as many theories as observers as to the contribution of monetary circumstances to those policies.
Need is the construction of the world order; satiety is the universal conflagration. (Kahn translating Heraclitus) If you want to stoke consumer demand in a country where the poor have massive televisions and cable, maybe notch up the bullying of people wearing cheaper brands and carrying fake designer brands and charge 30 grand for VR headsets but advertise them during the Super Bowl? I dunno. I've never even had a real job and there aren't any gadgets I want and I want to get more crap out of my house than I want to add. Eliting schooling for hypothetical kids I'll probably never have is the only big ticket purchase I can seem to summon strong desire for.
Because as soon as you can get a risk free rate of return, (savings) then why would someone invest in a half brained start up that has a low probability of any return, when you could get a risk free return.
The FED has reduced interest rates to drive spending in startups, lending, housing market, and the stock market.
But don't worry, .5% is only a start, we have a ways to go before Unicorns start to starve.
> Because as soon as you can get a risk free rate of return, (savings) then why would someone invest in a half brained start up that has a low probability of any return, when you could get a risk free return.
Because startups, while they may have a low probability of return, have a high potential upside, whereas low-risk (and essentially zero-risk, like US government debt) investments have fairly locked-in maximums as well as minimums.
Sure, the higher returns in low-risk investments, the better returns have to be in high-risk investments to justify choosing the latter over the former with the same risk sensitivity.
You should look into the probability of those high returns. The media likes to remind you of the Facebook / twitters/ google, but those are just one in thousands.
So you have a one in ten chance. If you pick a startup that fails, I doubt you will be able to reclaim any of your investment. It's not like you can get liquid, when things start to go in the wrong direction.
Fed => Wall St. Bankers => Private Eguity/Venture Capital => Silicon Valley => Start-ups (disruption in labor market & layoffs) => leaner corporations and more profits $$$ => Wall St. Bankers => PE/VC ad infinitum
You get the picture by now where's the Fed's loyalty lies in this reverse Robin Hood wealth redistribution scheme. Isn't capitalism wonderful?
With all due respect, just ask any fat cat on Wall St. about the Fed or the role of central banks in the economy and he would assert that those institutions are essential for the global economy to function correctly and they are really upapologitically capitalists and they wear the label as a badge of honor.
The USD is about as free market as a currency can be reasonably obtain. The Fed allows the market to drive the money supply through lending. Institutional banks can effectively create an unlimited supply of money on demand through lending; they just ask the Fed for money and pay the discount rate.
So it's largely the market that drives short and medium term inflation through borrowing. The Fed uses treasury bonds to balance the money supply.
It's not a perfect system, but it's the best system we know of.
> The USD is about as free market as a currency can be reasonably obtain.
Nothing about the USD is free market.
The USD is shored up by the petro dollar standard and its status as a reserve currency esp. in the commodities market and its supply and management is governed by a quasi-private institution that is in bed with Wall St.
Not only did you ignore what the guy said, but you don't even seem to understand the points you are trying to make. The reason why the dollar is a reserve currency, and why so many oil contracts are made out in USD is because both parties have a reasonable expectation that it will retain its relative value over a reasonable time period. This means that it is a reserve currency because no one group can manipulate its value. If it was subject to as much political machination as you seem to imply, then no one would want to use it.
Apparently you ignored conveniently the petrodollar part and the Fed being non federal or public institution and just focused on its status of reserve currency to discredit me. Maybe you need to get acquainted more with these points before writing your counterargument.
Fed can continue to push on the supply side of money at the bank/institutional level all it wants. We need the Federal government to stimulate aggregate demand at the consumer level. How? Investing tax dollars in a smarter manner. Not raising the interest paid out on short term bonds so that institutions are incentivized to keep even more money in bonds rather than putting them to work in the economy.
Monetary policy needs to work hand in hand w/ fiscal policy. I feel bad for the Fed...its decisions are largely restricted and inconsequential when gov spending is broken, yet it receives all the attention and the blame.