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.
it’s a matter of semantics (isn’t everything), but the stimulus is not a cash handout (aka Transfer Payment, or Welfare), but a Tax Rebate for 2008. it is a one-time reduction on the taxes you will owe next April 15th. whether or not the government can afford tax cuts with the federal budget the way it is is a legitimate debate, but that’s how the debate should be framed.
I haven’t read enough of your site to be sure, but if you’re Republican, you’re likely in favor of lower taxes. if that’s true, you should have no argument against that aspect of the stimulus.
the twist with the stimulus is that you don’t have to wait until April 2009 to get the tax cut as a refund (or reduction to your amount owed) — you get it today! lucky you! actually, considering time value of money, inflation, and the declining value of the US dollar, the $600 you get today might be worth a good deal more today than in 365 days (so don’t go stuffing it under the mattress)
“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.)”
I don’t think there is any evidence that capital flows from those who have more to those who have less — I think that is borrowingly very liberally from the process of osmosis (high density disperses into low density). If capital flowed the way you theorize, there would be no ‘cycle of poverty’ as the mass of wealth in this country would become distributed among the lower classes. instead, a small percentage of the most wealthy people in America (and indeed, the world) control the majority of the wealth/capital. (not that there is anything wrong with that…)
“trickle-down economics” implies that tax cuts for the wealthy result in increased investment (capital to create businesses and jobs, therefore employement; and/or innovations which lower the cost of goods for all) and/or increased consumption (the rich buy a yatch, which employs boat builders, who buy McDonalds, who hire minimum wage employees, etc). see http://en.wikipedia.org/wiki/Trickle-down_economics
“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.”
I’m not sure what you mean by the “potential capital” tied up in goods and services — I thought you said at the outset that in your model goods and services are a type of capital. if they are a type of capital, how is potential capital unlocked from them?
your description of the turn-over of money for goods, for more money and more goods is well established — see Velocity of Money (http://en.wikipedia.org/wiki/Velocity_of_money). I tried to find current estimates for this velocity, but it doesn’t seem to be something that economists track (probably because there are too many measures of “money” in the economy — M1 (currency), M2, M3, etc.)
last thing — the printing of money doesn’t really affect anything. minted currency is just one measure of money in the economy (M0: http://en.wikipedia.org/wiki/M1_%28economics%29).
the fed does most of their dirty work with Open Market Operations (http://money.howstuffworks.com/fed10.htm), where they buy and sell government securities in order to achieve a target interest rate. when you hear the “Fed lowers rates by 0.25%”, they’re really purchasing securities (creating more money supply) such that the Fed Funds Rate drops by about 0.25% (http://www.federalreserve.gov/fomc/fundsrate.htm).
On comment #1:
In the original form of the stimulus program, your assertion was relatively true – however, once seniors and others who had no tax liability were included, at least that aspect indeed became a government handout.
Comment #3 and #4:
The point was that there is potential monetary capital in goods and services. If you go to Wal-Mart, they have thousands and thousands of dollars worth of potential capital sitting on its shelves in the form of goods. They also employ pharmacists, opticians, mechanics, etc. who have potential capital in their services. Thus, Wal-Mart has more capital in goods and services but less monetary capital while you, the shopper, have fewer goods and services but more monetary capital that you’ll use in a fair exchange at an agreed-upon price.
Comment #5:
In most cases, you are correct but that also assumes that the economy grows at a rate which keeps the value of a dollar constant. But if the economy were to shrink radically yet the money supply kept the same or even increased, each dollar would be worth far less and inflation would become rampant (unless the currency was backed by something else of value, most people think of gold as an example.) Think of the Carter Administration and how inflation ravaged the country then.
I enjoy the discourse and the chance to explain my thinking further.