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Philip Mause
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My name is Phil Mause. I am a Senior Advisor with the Pacific Economics Group, focusing on energy, regulatory and valuation issues. I retired from 40 years of law practice earlier this year. I am a yield oriented investor and in the last two years, I have done reasonably well in junk bonds,... More
  • A Modest "Thought Experiment" - The "Two Americas" Problem  22 comments
    Mar 12, 2012 12:59 AM
    Some experiments are too expensive or too impractical or too time consuming to perform and so we have to try to think through "what if" scenarios in order to evaluate various courses of conduct or more basically various hypotheses about how things work. One of the constant refrains I hear is that the United States is heading toward ruin because of the National Debt. I have written about this already and I tend to be in the "deficits don't matter" camp and many people view me the same way that they would view a nutrionist who recommended junk food.

    One way to think about this problem is to do a thought experiment which I will call the "two Americas" experiment. It will seem a bit far fetched but bear with me. I am assuming we are put in a time capsule and sent forward 10 years and wake up right where we are in Washington D.C. (I would love to check real estate listings and stock prices but there will be no time for that). We do the experiment twice and wake up in two different countries. The two counries are absolutely identical in every respect down to the last blade of grass except for one very important difference. Each country is prosperous, an investment in infrastructure has been made and our roads, airports, bridges etc. are in reasonably good shape. The education level of the population has improved over the past 10 years and we have a workforce which matches the demands of the job market. We have attracted lots of talented and energetic immigrants and the population has increased. There is only one big difference. In the first instance, the national debt is a small number and the Treasury does not owe any money to the Federal Reserve. In the second instance, the national debt is that first small number plus $25 trillion dollars and the $25 trillion is owed by the Treasury to the Federal Reserve.

    Of course, in the second America the Treasury must pay a lot of interest to the Federal Reserve and one would think that this interest would "crowd out" other worthy federal projects. But since the interest would be earned by the Federal Reserve, it would be periodically remitted to the Treasury so that the "net interest" cost of the $25 trillion would be close to zero.

    What difference would the $25 trillion debt make in the relative strength, happiness, productivity, prosperity, or other relevant factors with respect to the "two Americas"? I have thought this through as best I can and I cannot see any relevant difference at all. Of course, on the way to piling up this debt, we may - indeed, probably will - generate more inflation. But that identifies the relevant problem with more precision than a generalized concern about the National Debt. We addressed inflation very effectively in the 1980s while we were running big deficits and we can do that again. If inflation is the only real downside here, it also means that deflation can be countered with deficit spending until it is brought under control and inflation actually materializes.

    I now want to talk about a third America. This is the America which we are likely to see if Eurozone type austerity is put into effect. Young people find it increasingly difficult to find jobs and so they postpone family formation. The birthrate goes down, suicides increase, and we start to see net out migration in search of jobs. Infrastructure decays as state and local governments cannot afford upkeep. More and more public schools lay off teachers and go to four day weeks. College enrollment declines and the employability of our population deteriorates. China gets further and further ahead in scientific education and technical training and skilled jobs start to leave the country. Many Americans spend decades burdened with unsustainable student loan debt and the mortgage mess never really goes away because real estate prices keep declining. But - hey - that's just one side of the picture. There is also some very good news. The Treasury does not owe the Federal Reserve one red cent.

    Does anyone in his right mind want to live in the third America rather than the second 10 years from now?

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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Comments (22)
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  • Leftfield
    , contributor
    Comments (3895) | Send Message
     
    My 25 $trillion debt scenario includes mostly more payoffs and bailouts for plutocrats and ever-increasing government waste, fraud and abuse with precious little to counter the declining circumstances of American families.

     

    Government programs, left unhinged from any reality, will continue to make college and healthcare even more unaffordable while causing the rest of family budgets to crater in a their vain attempt to chase skyrocketing costs of living as the dollar disappears.

     

    Meanwhile, hacks from academia, MSM and in government will continue to chirp happy thoughts about "recovery."
    12 Mar 2012, 08:13 AM Reply Like
  • Philip Mause
    , contributor
    Comments (3806) | Send Message
     
    Author’s reply » I think it is important to separate two issues here - 1. the nature of government spending and 2. the degree to which government spending is funding by taxation rather than the creation of new money. I am opposed to wasteful spending whether it is funded by taxes or by debt. Even if the budget were balanced, it would still be imperative to cut wasteful spending in order to be able to reduce taxes.
    In order to separate these separate issues - think of the two scenarios this way. In both cases, the government spends exactly the same amount of money the same way - in one case, the money is raised by higher taxes and in the other case the money is raised by borrowing from the Fed. Both situations have the same amount of fraud, waste abuse etc. on the spending side. But in the higher taxes scenario the private sector is starved for resources, family finances deteriorate and business moves out of the country because of the tax burden.
    There is a legitimate answer to this and it is that a requirement that we "balance the budget" might discipline spending. However, that is not really what the population wants. The population wants lower gasoline taxes, no spending cuts, lower income taxes, no "death" tax, and more and more deductions targeted at special projects. The public wants to spend more than it pays in taxes but it also doesn't want the national debt to go up. The politicians spend a lot of money polling the public to determine what they want to hear and then they simply tell the public what the pollsters tell them the public wants to hear.
    Someone has to tell people the truth here about the significance of the "national debt" - what it is and what it isn't - so that we can begin to have an honest dialogue about where we are heading.
    12 Mar 2012, 10:40 AM Reply Like
  • jhooper
    , contributor
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    For you, what are some examples of wasteful spending and why? Also, if all gov spending were wasteful, then, would deficits matter?
    12 Mar 2012, 11:25 AM Reply Like
  • Leftfield
    , contributor
    Comments (3895) | Send Message
     
    "...think of the two scenarios this way. In both cases, the government spends exactly the same amount of money the same way - in one case, the money is raised by higher taxes and in the other case the money is raised by borrowing from the Fed."

     

    I have trouble with that since the borrowing option seems to have left us with government spending beyond what neither George Orwell nor Louis XIV could even imagine, but government spending limited by taxes raised would be vastly slashed and prioritization would at long last finally be forced upon our public servants.
    12 Mar 2012, 11:27 AM Reply Like
  • Philip Mause
    , contributor
    Comments (3806) | Send Message
     
    Author’s reply » Federal spending as a percentage of GDP has remained pretty constant. There definitely has been a federalization of things like education, criminal law, etc. that were previously left to local and state government but it is often in the form of mandates rather than spending.
    12 Mar 2012, 12:11 PM Reply Like
  • Philip Mause
    , contributor
    Comments (3806) | Send Message
     
    Author’s reply » The War on Drugs - imprisoning hundreds of thousands of our own people and still not being able to stop drug use and then embarking on an effort to prevent the production of drugs anywhere in the World because of the danger that they might be smuggled into the United States. The Iraq War - the net effect was to empower Iran by removing an important counterweight. Multiple "bridges to nowhere" = public works projects whose costs outweigh their benefits. All sorts of waste - unfortunately Senator Proxmire is not around anymore to give out "golden fleece" awards every month.
    12 Mar 2012, 12:16 PM Reply Like
  • Leftfield
    , contributor
    Comments (3895) | Send Message
     
    "Percentage of Federal spending/GDP was Research shows that from the founding of our nation, 1787-1849 (63 years) federal spending averaged 1.7% of GDP. For the next 51 years, 1850-1900 (including fighting the Civil War) spending averaged only 3.1%. From 1901 till 1930 (including fighting WWI) it never reached 8%, and averaged approximately 3.2%.

     

    At the height of the progressive movement (including FDR's New Deal) federal spending as a percentage of GDP never went above the 1934 level of 10.7%. Even after the historic 1944 (WWII) level of 43.6%, spending had fallen by 1948 to 11.6% of GDP.

     

    In short, for the first 130 years of the U.S.'s 224 year existence, federal spending as a percentage of GDP averaged around 2.5%!

     

    So why is the 18-25% solution offered? At best politicians might be misusing or misrepresenting data, or using only a couple of decades for determining what's "historical" and "average" spending. In all honestly, heuristic ignorance and the need for political capital is probably driving the rhetoric. What's important is to realize the "parroting" we are hearing should be our canary in the mineshaft, warning us of the impending decline of our economy caused by excessive federal spending."

     

    Source: Real Clear Markets.
    12 Mar 2012, 12:18 PM Reply Like
  • jhooper
    , contributor
    Comments (6166) | Send Message
     
    OK, and now the why? How do you identify what is waste and what is not?
    12 Mar 2012, 01:16 PM Reply Like
  • Philip Mause
    , contributor
    Comments (3806) | Send Message
     
    Author’s reply » This is a little bit of a different issue from the one my piece addresses. I am just addressing the delta between spending and tax revenue and arguing that the delta doesn't really matter unless inflation becomes a danger. So we could have exactly the same debate about the delta at a much lower level of spending because we could cut taxes(theoretically to or even below zero) and so the differential between spending and revenue would remain the same at a much lower level of spending.
    12 Mar 2012, 02:20 PM Reply Like
  • Jacob Teague
    , contributor
    Comments (109) | Send Message
     
    The united states does not run a deficit because it is investing in its people, it runs a deficit because it is continually bailing out wall street investment banks. The Eurozone is imposing austerity on the middle class to bail out the banks, and we impose deficits on the middle class to bail out the banks. Inflation is raging out of control for the middle class right now, as a result of America's large deficits. Just because the Fed says there is no inflation does not make it true.
    12 Mar 2012, 10:27 AM Reply Like
  • Philip Mause
    , contributor
    Comments (3806) | Send Message
     
    Author’s reply » We had very large deficits in the 1980s and at the same time we had lower and lower inflation. I am not sure what the evidence is that inflation is currently raging out of control but it is not supported by any of the generally accepted statistical measures. Some prices are always going up and some are always going down. I also think that the net cost of the bailout was not really a significant part of the huge deficit we have be running. I would admit that a lot of federal spending is wasteful and I would rather see tax cuts and money remitting to state and local governments so that they can stop firing teachers.
    12 Mar 2012, 10:44 AM Reply Like
  • Leftfield
    , contributor
    Comments (3895) | Send Message
     
    Large deficits in the 1980's came from a much lower level of debt and the economy wasn't yet nearly as distorted and distended by Washington mandate creep, coercion and overreach.

     

    Furthermore, let's eliminate a catastrophic source of educational and fiscal dysfunction by ending the Federal Department of Education and throw in the Department of Energy for good measure to give the economy a good kick start into recovery.
    12 Mar 2012, 11:31 AM Reply Like
  • Philip Mause
    , contributor
    Comments (3806) | Send Message
     
    Author’s reply » As to the Department of Education - I think block grants to states with no strings attached except that the money be remitted to local school districts might be a good idea. I am not in favor of cutting net spending on education. Federal spending as a percentage of GDP has remained pretty constant except for the impact of wars. What has really created a big deficit is lower tax receipts.
    12 Mar 2012, 12:09 PM Reply Like
  • Jacob Teague
    , contributor
    Comments (109) | Send Message
     
    Health Care, Education, and Energy are rising at over 10% a year, clothing costs are steady. Which items have a bigger affect on the average person's bank account? When the Fed measures inflation it measures clothing costs as a larger percentage of the input than Health or education. Until we end the lie that there is no inflation we will never have sound monetary policy.
    12 Mar 2012, 12:29 PM Reply Like
  • jhooper
    , contributor
    Comments (6166) | Send Message
     
    Is it possible for spending on education to ever be wasteful?
    12 Mar 2012, 01:30 PM Reply Like
  • jhooper
    , contributor
    Comments (6166) | Send Message
     
    How would you ever really know that prices in general were rising? You would have to be able to measure every single transaction in an economy to be certain. The best measure of all would be reductions in the standard of living, but if you cut out the things that really matter to people's spending, then you can do all sorts of horrible things to them and dismiss their protests because your measurements show that they shouldn't be protesting.
    12 Mar 2012, 01:33 PM Reply Like
  • Philip Mause
    , contributor
    Comments (3806) | Send Message
     
    Author’s reply » Of course it is possible. But the fact that there is some waste is not necessarily an argument for cutting back the level of spending. There is waste in the Defense budget and there was probably huge wasteful spending along the way in the process of fighting World War 2 but that does not mean that those projects should be abandoned.
    12 Mar 2012, 02:23 PM Reply Like
  • jhooper
    , contributor
    Comments (6166) | Send Message
     
    How do you determine waste?
    12 Mar 2012, 02:24 PM Reply Like
  • Philip Mause
    , contributor
    Comments (3806) | Send Message
     
    Author’s reply » You are suggesting an agnostic approach to inflation - that it is simply unknowable. While that may be true if the goal is to precisely quantify it, there are reasonable methods for estimating inflation and if we don't try then the attitude will be that it doesn't matter because you can't measure it.
    12 Mar 2012, 02:24 PM Reply Like
  • jhooper
    , contributor
    Comments (6166) | Send Message
     
    But you can't measure it, thus any attempts will just give results that require faith. Faith isn't a bad thing, but faith without reason is blind fanaticism. This is why it is argued that a gov shouldn't measure an economy, because it creates the implication that a gov can actually do something if an economy isn't growing to make it grow.

     

    The only thing that makes an economy grow is knowledge about production. Knowledge about production comes from mistakes that lead to learning about how to produce better. Gov has force. Force has only two uses. It can be used as either to steal or as a deterent against stealing. Neither of these alternatives creates new production knowledge. In fact, force makes gov blind to learning from mistakes, because if gov makes mistakes, its guns require others to bear the costs for those mistakes. This is why gov needs a population to support it, because gov blindness precludes it from creating capital. If gov could create its own capital it wouldn't be blind to prices and it wouldn't need a populace to tax.

     

    However, when force is used as a deterent against theft, people are then free to increase their production because they don't have to spend time in defense of their production. It is Smithosnian specialization. Have gov do the only thing it can, deter force, and leave price discovery to those that are sensitive to price. Only when people are sensitive to price can they discover waste. Gov never knows waste, because sight is required in order to discover, and gov force makes gov blind to discovery.
    12 Mar 2012, 02:40 PM Reply Like
  • Leftfield
    , contributor
    Comments (3895) | Send Message
     
    jhooper - Another fine distillation of fundamental issues: Government force which can be used as theft from the productive, which has been increasingly it's focus for a very long time now, hence the miserable state of US finances and vanishing freedom, and the legitimate use of force government should be limited to: As deterrent AGAINST theft.
    12 Mar 2012, 03:17 PM Reply Like
  • Jacob Teague
    , contributor
    Comments (109) | Send Message
     
    I appreciate your effort to create a thought experiment. It helps everyone clarify the issues.
    12 Mar 2012, 04:08 PM Reply Like
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