Month: May 2008

This is the final part of my series on the economic stimulus package. Part 1 was a critique of the federal stimulus program and Part 2 looked at one industry that, given a relaxation of restrictions currently impeding it, could help pull the country out of its economic doldrums practically single-handedly.

Back in Part 1 I promised to talk about the fluctuating dollar so I’ll lead off with that discussion. While much of who does well in the world economy depends on the freedom of their economic system, the value of their currency also plays a role. At present the dollar is near a historic low against the euro (granted, the euro’s only been around for a short time compared to the dollar) but the weak dollar affects the price of items that are imported, making them more expensive to us. It’s a factor that’s increasing the price of oil because exporters demand more of a weaker dollar in order to maintain the same purchasing power they could get with other currencies like the euro.

On the other hand, a strong dollar makes our exports more expensive and gives a leg up to other suppliers, particularly China. A happy medium between the two extremes generally serves us best, so we need to take measures to build confidence in our economy and give those currency traders a reason to bring the dollar up against other world currencies.

One knock on the American economy is the amount of deficit spending that takes place by our federal government. Because revenues rarely exceed or even come close to matching our spending, each year the American taxpayer is forced to pay more and more in interest payments to those who hold our debt – and if those debtholders ever called in the debt our economy would likely go into a death spiral. Nor have I even accounted for all of the unfunded liability that our federal government would owe to future generations, all thanks to what I consider the Twin Towers of social programs, Social Security and Medicare.

In addition, government spending tends to be woefully inefficient when you compare it to the private sector. I used the example yesterday of a windfall profits tax being slapped on oil companies and what could well happen to all of that capital – rather than being invested in proven energy solutions (with some set aside for research where the companies felt it best to develop new technologies) much of it would go to the overhead of a brand new bureaucracy and the rest could be frittered away on new, unproven products that one or a small group of companies maintain as their own and drive competitors who could provide innovation for these products out of the market via regulation – to refresh your memory, that’s known as rent-seeking.

Contrast that to what could happen if markets were opened up and the beneficial effects circulated through the economy. While some would naturally thrive more than others, the overall effect would be one of prosperity.

So it is with driving down government spending. On the one hand, the dollar could become stronger against other currencies, making imports like oil less expensive. (Even if we did completely open up oil exploration in this country, there would still be a period where imported product dominates but the share would become less and less as domestic oil began to flow.) Secondly, because government does little to create wealth, getting the vast majority of its monetary capital from the taxation of your monetary capital, a cut in their spending would result in more monetary capital staying in your pocket, which you can use on those goods and services you desire to purchase. Rather than sending the money to Washington and seeing a portion of it sent back to be spent on things the bureaucrats want the money to pay for after they take their cut, wouldn’t it be simple common sense to cut out the middleman?

Let’s return to the stimulus check idea. The main flaw I saw in the program was that it wasn’t completely inclusive. If you accept the premise offered by the commenter St4rbux on Part 1 that these checks are simply an advance payment on your 2008 tax refund that you’d otherwise not receive before 2009, that still doesn’t explain why many people who would normally have little to no tax liability still receive checks. Even more oppressive is the fact that those who do pay the lion’s share of the taxes in this country, people in and above the upper-middle income bracket, receive no stimulus check at all. Someone arbitrarily decided that this group, primarily comprised of white-collar workers and job-creating small businessmen, didn’t deserve the same refund as everyone else and since they’re not a large number of voters overall no one paid mind to their concerns.

If there’s one thing I’m about, it’s fairness. And while I’m on record as endorsing the idea of a national sales tax (like the FairTax) its adoption is years away, if ever – meanwhile we seem to keep running into a situation where those inside the Beltway decide that the government needs to do something to pick up the economy and we get programs like the one currently underway as people keep looking at their bank account and wait for that deposit from the United States Treasury to magically appear. When mine shows up it shows up (yeah, I’m getting one and I think I’m the last in line to do so based on my Social Security number).

When this stimulus program was first announced, I thought a much better solution – one which benefits the people who actually pay taxes – would be to simply suspend backup withholding for a period of time. This way, the money would be almost immediately available and there would be no checks to send out. Perhaps a small stipend check could have been provided to those without jobs (I’ve never gotten a welfare check and it’s been years since I received unemployment so I don’t recall if taxes are withheld from either) but the effects would have been spread among more people. And even if St4rbux is correct, doing a stimulus in this manner would have the same effect of taking away from whatever tax refund those who work their finances to assure a big check each spring would have received.

In distilling the arguments I made in a three-part series down to a couple closing paragraphs, my economic philosophy involves allowing the fewest market restrictions possible while at the same time government at all levels takes the least amount of money out of people’s pockets as they can. I believe the advantages to this philosophy are manifold and it’s a system that has allowed our society to become the most prosperous on our planet. Imagine if we waited on a government program to invent the automobile, the airplane, or the telephone – inventions that revolutionized cultures around the world.

On the other hand, government does have its uses but on the federal level those duties they have are spelled out by our Constitution. While the Declaration of Independence plainly states we have the right to “Life, Liberty, and the pursuit of Happiness” the possible pursuit of happiness we may receive by the transfer of monetary capital from the federal government to your wallet comes at a steep cost in the Liberty we would otherwise enjoy.

Yesterday I discussed some basic economics to support the theory I’m going to expand in this part and critiqued the stimulus check program currently being undertaken by the federal government. Today’s installment looks at who has the capital to truly stimulate the economy.

If you go under the assumption that capital flows from those who have more of it to those who have less of it, you may be scratching your head about who’s doing well in these subpar economic times. Certainly it’s not mortgage lenders or real estate agents; on the other hand those who make their fortune by buying the debt written off by lenders and other creditors for pennies on the dollar and aggressively making their own attempts to collect might not be doing too poorly right now.

And while the federal government is attempting to place monetary capital back into the economy by sending out all of these stimulus checks, the reality is that much of that capital will simply bail out the creditors who made the mistake of allowing underqualified borrowers and pure speculators to use their service capital and provided them monetary capital to purchase overvalued real estate – in other words, excessive capital invested in a good.

There are a number of goods (or commodities) that are doing well and holding their value, though. While housing is not one of them, those who have some of their capital tied up in precious metals are faring quite well these days – particularly those who invested in gold. But there is another commodity that is at a record high price, and while most of us can live without gold for the most part (it does prove useful in the electronics field and there may be a tiny fraction of an ounce of gold in the computer you read this on) not many of us can live without oil. Oil is one good that has a lot of capital potential, and the major oil companies have the monetary capital to show for it.

Unfortunately, while the federal government was quick to place itself into debt and send out millions of stimulus checks with only their good name to back them up, they also see these oil company profits as a quick source of additional monetary capital. And what makes this even more appealing to the federal government is that they don’t have to make any investment in the company to coerce a profit for themselves. Simply pass a few new tax regulations and voila! a new stream of monetary capital is born, ready for redistribution.

One may contend that, because the government provides necessary services and the oil companies make more profit than they need, that a windfall profits tax like the ones proposed by both Democrats in the running for the White House is only fair. After all, they opine, the government will take that capital and invest it in companies who research alternative forms of energy, sources that will wean us off our thirst for oil.

So let’s say that the windfall profits tax becomes law. I’m going to leave aside the logical argument that oil companies will not actually pay this tax because they’ll simply do what any business does with its costs and pass them on to the consumer; rather I’ll concentrate on what happens to the monetary capital that is transferred from the oil company’s coffers to Washington’s.

For starters, getting this new source of capital will require hiring a number of people in some new bureau or agency to oversee who gets the government largesse. They will dictate to whom the newfound capital flows, and in order to increase someone’s chances it may be worth sending some of their own monetary capital to a particular politician or a lobbyist just to let that new bureau or agency know that person or company has a REAL interest in acquiring some of that monetary capital from the oil company windfall profit tax. Thus, a percentage of the windfall gets spent and not one watt of new energy has been converted to a useful form yet.

And when the federal government sends out this monetary capital, there’s no guarantee of results nor is there a real incentive for results to occur – after all, it’s not really the beneficiaries’ capital that is at risk. A company who receives this monetary capital may simply be using it to assist their efforts at a practice called rent-seeking, where companies or groups of companies use lobbyists, elected officials, and bureaucrats to set the rules and regulations in a market for their own benefit and close the market to competitors.

Thus, if a windfall profits tax approach is tried, it has little chance of actually creating opportunities to use the monetary capital to exploit goods and services, creating further monetary capital. That cash would create some jobs, but the end result of most of these positions will be the same as what you accomplish by shuffling papers from one end of the desk to the other.

Instead, I favor an approach which will allow those companies who have that huge pile of monetary capital to better position themselves in securing the product that has allowed them to collect it in the first place. And in that effort, they will spend their monetary capital on a myriad of goods and services, each creating the prospect for unlocking the capital in other goods and services.

As an example, let’s go back to the trip to the gas station I spoke of yesterday. (Yes, I picked the analogy for a reason!) Currently, the chances are very good that the tankful of gasoline you purchased predominantly came from an oil field outside of our borders and was refined in a refinery that is over thirty years old. For the privilege of using offshore resources and possibly outmoded technology to refine those resources, you paid about $3.60 per gallon – of that, maybe a nickel or two a gallon actually accrued to the oil company (monetary capital in exchange for its refining and/or distribution service) while much larger proportions of that price went to a foreign supplier (the exchange of monetary capital for the capital locked up in the commodity) and to state and federal government in the form of taxes (also monetary capital in exchange for services, but not those which necessarily assisted you at the gas station). For this example we’ll disregard the much smaller portions of monetary capital you exchange for the myriad other services provided like the pumps, the credit card, electricity to run the pump, and so forth.

If we were to allow the oil companies more leeway to invest the huge amounts of monetary capital into tasks like tapping those sources we’ve already confirmed have a huge amount of oil and natural gas, building new refineries to handle the increased supply that will begin flowing from within our borders and coastal waters, laying pipelines or securing other means to transport their product, and researching the possibilities of alternative forms of energy (yes, oil companies indeed do that) imagine all of the people who would be able to use their service capital to acquire a portion of the monetary capital the oil companies are sitting on along with all of the capital locked up in the various goods that all parties to these transactions need to complete their tasks.

And while the federal government wouldn’t necessarily receive as much of the profit that the oil companies make as they might with a windfall profits tax, they will still get their healthy cut they’ve received for the last several years. Moreover, they’ll also see the monetary capital from all those who secured or enhanced their employment because of all this oil company activity – not just from the people directly benefitted like those who constructed the pipelines or worked second shift at the refinery, but those people like the car dealer who saw his sales jump through the roof because of the new oil company facility that came to town or the truck driver who cleared more income after expenses because the price of diesel dropped significantly.

Some have argued that the oil in ANWR would be easier to export than to use domestically. Even if that’s the case, certainly we could use less expensive oil to assist our allies around the Pacific Rim like Japan or South Korea and create trade imbalances in our favor for a change. OPEC could use a little competition, and many jobs would still be created; mostly in Alaska but others around the country would secure new and better jobs as well.

Because it weighs so heavily in our day-to-day lives, I felt the oil industry was the perfect entree into making the argument that, rather than attempting to regulate and shape markets, government does better for both itself and our citizens at-large by allowing markets to become more free rather than less so. Tomorrow I’m going to extend that argument into individual situations and talk about what we can do to strengthen the dollar as well.

This is the first of a three-part series critiquing the ongoing economic stimulus plan and suggesting some better alternatives in my view. Today I’ll go over some economic assumptions I’m basing my argument on and discuss how all those checks going out impact our economy in the longer term.

For many of you reading this, May will be the month that you receive an economic stimulus payment from the federal government. Created as a way to goose the economy through a rough patch, these checks will generally range from $600 for a single taxpayer up to $1,800 for a family of four. Even those who owed no tax liability but made $3,000 or more in income share in the largesse by receiving a $300 stimulus check.

The idea behind sending out all of this money is to place more capital in the economy. For the sake of my argument, I’m defining capital as an object or action which has value. While I’m not trained as an economist (so perhaps capital isn’t exactly the right term; however most people understand what the word means), hopefully I make some sense when I assert that there are three different types of capital:

• You have the obvious and common meaning of the word, where capital means cash or money. Because barter is not always practical, most transactions in this day and age involve the exchange of money for a good or service. Due to this fact, I can also consider goods and services as a type of capital as well.
• I consider goods a type of capital because they have a value that’s determined generally by a free exchange. The obvious examples are commodities like grain, gold, or oil which are bought and sold for cash and thus maintain a fluctuating value depending on their supply and demand. In all three examples I cite, their value as expressed in dollars has increased dramatically in recent years. (But dollars fluctuate as well, a point I’ll get to in part 3.)
• You also have capital expressed in services. In exchange for monetary capital, I provide a service to my employer – thus, the skills and knowledge I have acquired and put to use as my labor have a value to him. In turn, he combines the talents of those he employs to sell as an overall service to those who come to our company seeking that type of service when it needs to be done. Because it’s a specialized service, there is a niche in the market for providers that I exploit to acquire my own monetary capital to buy other goods and services.

With all this as the basis for my theory, I’m going to argue during this series that capital nearly always flows from those who have more to those who have less. (I think it’s loosely known as “trickle-down” economics.) Of course you may say, “Michael, how is that possible when I spend my hard-earned dollars at the gas station giving the filthy rich oil companies more profit?” Stick with me on this.

Here is where the free market comes in. Oil companies have much of their capital tied up in goods, while the station where you buy the fuel has its capital tied up in services. Neither of those are useful in that form to purchase other goods or services they may need in the course of doing business, so they depend on someone (the consumer) who has more capital in a form they can use (i.e. money) to purchase those items (or potential capital) that they sell.

But then one can ask, “well, what did I get out of the deal? I spent my capital to get these things which aren’t useful for me to sell.” That capital you previously had which was expressed in monetary terms was exchanged at an agreed-on rate for a good that is useful for your personal needs (gasoline), using a number of services that made acquiring the commodity much easier (the pump at the service station, the debit card you swiped to pay for it, etc.) For many, purchasing that good enables them to travel to an employer or client, one who provides them with more monetary capital that they can exchange for other goods and services at a rate agreeable to all parties.

While it’s far from a complete example, I wanted to create a simple illustration of how private-sector economics works. You’ll notice that I didn’t include the governmental aspect in my example of filling up the gas tank. Obviously there’s a degree of taxation on many transactions, and it can be argued that you’re also paying for services every time you drop an extra six cents or so on the dollar for sales tax. After all, someone has to maintain the roads, provide police protection, and so forth.

It’s also your tax dollars that are being paid to write, send out, and back up all of these checks. Unfortunately, with all that the federal government spends our tax money on there’s nowhere near the amount needed in the bank to physically back these stimulus checks, so the federal government turns to entities who are willing to invest their own monetary capital with the understanding that the loan will be repaid at a later date, with an agreed-upon fee to the lender for providing the service of purchasing the debt. Come to think of it, that same action by millions of homeowners and others got us into this mess to begin with.

Our current economic situation primarily stemmed from an imbalance between the capital that is expressed in the value of goods (particularly homes) against the potential capital from services provided by those who agreed to borrow against the capital tied up in their homes (i.e. equity) as collateral to borrow monetary capital from those willing to provide it. To provide that service, lenders charged a fee designed to assure them a good return on their investment and, in many cases, took a short-term loss to provide an incentive for borrowers to use their service, with an increased fee in later years recouping their return on investment. (In other words, adjustable-rate mortgages with short-term “teaser” rates.)

All of this worked fine and dandy until the inevitable point came where borrowers didn’t have enough monetary capital to continue to pay for the service capital they were provided. As more people couldn’t pay, the lenders found themselves short on monetary capital and also found that the capital they assumed to be in the value of the goods used as collateral (the homes) fell short of making them whole. Furthermore, as the number of homes that were foreclosed on increased, it lessened the value of all other homes and the market correction placed many lenders in a situation where they in turn couldn’t provide monetary capital for services they had received. Add in being squeezed by the increased monetary capital required to purchase other goods, like food and the aforementioned gasoline, and you create a situation where both homeowners and lenders screamed for some solution – any solution – to fix the problem.

So the idea of stimulus payments was rehatched after a similar program was tried a few years ago. The theory was that putting more monetary capital in peoples’ hands would unlock the potential capital in the goods and services they would purchase, which in turn would allow those entities who sold the goods and services to turn over the monetary capital they gained for those goods and services they needed, ad nauseum until the economy was healthy again. Unfortunately, they didn’t think about two basic problems with this theory, one of which I touched on earlier and will now delve into further.

Because the money wasn’t actually there to pay for these stimulus checks, it has to come from someplace, that “someplace” being entities who lent our treasury the money to send out. At some distant (or maybe not-so-distant) point that money needs to be paid back to those lenders, with interest. In “solving” the problem created by people borrowing against goods which didn’t have enough collateral in them to backstop the amount borrowed, the federal government made the exact same mistake. Sure, the federal government could print enough money to repay the loans but by doing that would make each dollar worth less because all a dollar’s value is tied to are other currencies. We have that problem now as the dollar is near an all-time low against the euro, among others.

Furthermore, this also leads to the potential for ruinous inflation – maybe not on the scale of the Weimar Republic, but certainly enough to chill the economy to a deep freeze. The potential capital of people’s services wouldn’t be able to keep up with the capital required to purchase other goods and services; meanwhile banks and other lenders would be stung as the market for lending their excess monetary capital would dry up. All this would be a replay of the conditions Americans endured most recently under President Carter in the late 1970’s, the era of the “misery index.”

More damning to me about the stimulus check idea is how it perpetuates the mindset that it’s only the government who can provide a solution by handing out money – cash which they don’t even have. Moreover, while our tax dollars will eventually pay for this, many of the beneficiaries of these checks pay little or nothing in income taxes to begin with. (Originally, they weren’t part of the plan but it was amended to include lower-income recipients.) On the other hand, a large number of people who were deemed to be too successful based on their high incomes were excluded from the plan. Unfortunately, they’re not excluded from paying taxes or the higher prices we are enduring for necessary items like gasoline and groceries. Instead, they’ll eventually be forced to curb their spending and since they’re the real producers in this country their cutbacks (combined with a push to punish their achievement through higher tax rates, such as Maryland’s new “millionaire’s tax”) will trickle down and affect everyone else, defeating the purpose of the stimulus program. When these cutbacks which will surely occur actually take place, the call will be put out for yet another stimulus program and the vicious cycle will begin anew.

Tomorrow I’m going to suggest how those who actually have a lot of monetary capital to spend right now (and there are some who do) can be encouraged to use their assets to truly give the economy a boost.