U.S. Government "Debt Limit" to be Raised-Again

U.S. Treasury Secretary John Snow now urges Congress to raise the legal debt limit for the U.S. government-again. The debt limit is now set at $8,184 billion (This refers to the gross debt and includes bonds held by the Social Security Trust Fund and other government agencies). It was last raised as late as November 2004, with $800 billion to its current level and Snow warned that this level would be reached as soon as mid-February 2006.

I have 2 observations here:
1. What's the point of having a "debt limit" if it is raised whenever it is reached? None at all. The point of debt limits is to limit debts, but if it can and are raised whenever debts reaches that level than the situation is no different from what it would have been without a formal debt limit.

2. If debts increase by a full $800 billion in just a little over a year, then the fiscal position of the U.S. government is anything but sound, notwithstanding the absurd assertions from John Snow in other contexts.

Answering the Arguments of a Greenspan-Fan

I have received more e-mail than usual after my article on the mess that Greenspan created and virtually all have been positive, apart from a few which pointed out a typo which initally appeared. Jeffrey Tucker at the Mises Institute however forwarded a e-mail where someone called Paul Nathan attacks the article. Apparently he is to much of a coward to post it on the article's blog entry or on my blog entry below or even to e-mail it directly to me. Yet I shall still reply to his arguments as I believe this increases people's understanding of the issue. Here is what he wrote-and my replies:

>Subject: Re: Response to Greenspans Legacy
>
>on 12/27/05 2:02 PM, Paulnathan2000@aol.com at Paulnathan2000@aol.com wrote:
>
>It is very disappointing to read an article in the name of Ludwig Von
>Misses, that so corrupts the truth. If you read the article you have to
>notice that most of it is opinion.

Oh really. Well, I guess I didn't provide any facts apart from far more statistics than most mises.org articles, theoretical reasoning about the moral hazard created by Greenspan's rescue operation (economic truths are facts, not opinions), Greenspan's background as a Randian gold standard advocate and his role in promoting the rescue operations and the "New Economy" nonsense.

The few facts offered, are twisted to
>make the Authors point. For example he criticizes Greenspan for increasing
>the money supply by rates that he virtually cut in half during his term in
>office.

No he didn't. While money supply growth was below the peaks of the 1970s and early 1980s, it was higher (both the average of Greenspan's whole term and during the latest year) than during Paul Volcker's last year.

Moreover, it is hardly clear that Greenspan deserves credit for holding money supply growth lower than in the 1970s. Sometimes central bankers try to inflate yet fail because the public isn't willing to borrow more. A good example is Japan which have had price deflation and only modest money supply growth for the latest decade despite the fact that the Bank of Japan have tried hard to inflate by reducing nominal short-term interest rates to zero and by rapidly expanding the monetary base. But as bank lending have fallen because the Japanese public have been unwilling to borrow, money supply growth have been modest.

And we can see how Greenspan have done his best to inflate by holding down interest rates far below the natural level and increasing the monetary base even faster than total money supply.

>It is my opinion that anyone that cuts money supply growth, as does anyone
>who cuts taxes, is adding to the freedom of individuals -- but not this guy.
>He simply wants to make a point: That because Greenspan did not take us to
>a Gold Standard he is evil. The fact that it is impossible for Greenspan to
>impose a Gold Standard on this country is evidently irrelevant to the
>writer.

Hu? Yes, Greenspan could hardly have single-handedly given us the gold standard. But he most definetly could have once -at least just once- publicly during the latest 18 years publicly proclaimed that his institution, the Fed, should be abolished and replaced with a gold standard. He could have proclaimed the evils of monetary inflation and that he can and will do everything he can to halt monetary inflation. In short, he could have repeated the arguments he made in 1966 and he could have voted against inflation on the Fed board. But he didn't. In fact, as I point out he was often
a leading advocate of dicretionary Fed board actions for more inflation.

Then there's this:
>
>"When Congressman Ron Paul reminded Greenspan of "Gold and Economic
>Freedom," Greenspan said he now realizes he had been wrong, and that as Fed
>Chairman he was able to pursue policies that mimic the gold standard."
>This is totally false. Greenspan never said he was wrong about his past
>writings, on the contrary, he said that he recently re-read his writings on
>gold, and was surprised that there was nothing he would change, today. He
>is also on the record many times as saying that he favors a Gold Standard,
>and wished more of his peers, agreed. He usually goes out of his way to
>cite the Gold Standard in his writings. Now who is the "dishonest one"?

Didn't this guy read the link to Ron Paul's LRC-article that I had in my article? There Ron Paul writes:

http://www.lewrockwell.com/paul/paul236.html

" In short, he claimed he was wrong about his predictions of calamity for the fiat U.S. dollar, that the Federal Reserve does a good job of essentially mimicking a gold standard, and that inflation is well under control. He even made the preposterous assertion that the Fed does not facilitate government expansion and deficit spending. In other words, he utterly repudiated the arguments he made 40 years ago. "

The fact that Greenspan in another conversation with Ron Paul claim to still believe in the gold standard even as he pursues inflationist policies hardly makes him less of a liar and a fraud.

>"Alan Greenspan has a record of repeated rescue operations during times of
>financial distress. From the stock market crash of 1987(if the market
>crashed how did he rescue it?) to the S&L crisis of the early 1990's (that
>was in the 80's under volker) to the Asian crisis and the collapse of
>LTCM...(this one really gets me. Greenspan brought the parties involved
>together at long term capital, and sat them down in one room and explained
>to them why it was to their interest to put up capital to refinance ltcm's
>bad loans. Not one penny of Government money was used as a bail out.
>Greenspan is the only Government official I know of to use a voluntary
>approach to a crisis.) to the feared Y2K crisis to the bursting of the tech
>stock bubble, Greenspan has proven himself more than willing to bail out
>failed investors (tell that to all the investors that lost fortunes in the
>tech crash) with additional doses of "liquidity" (the popular inflationist
>euphemism for inflation). (What a terrible misrepresentation!)

Hu? Government created fiat money is a "voluntary method"? Puh-lease.......
And this guys considers himself a misesian? Only in cloud-cooko land.

>Fortunately, the world thinks, much better of Alan Greenspan, and his legacy
>will be to have governed during the most prosperous and stable times in the
>history of the United States. He will be remembered for lowering inflation
>rates, and hence, interest rates to the lowest level in modern times. While
>his detractors will continue to wait for the collapse of the monetary
>system, the system he helped improve will serve us well for years to come.

He seem to have missed all of the statistics I provided about the imbalances created by Greenspan I provided.

>I know nothing about the man that wrote this terrible article, but I do know
>something about Walter Williams. He is one of the most outspoken advocates
>of Capitalism, and say's he thinks Alan Greenspan has done an excellent job.
>Williams is also a Missian Economist.

Walter Williams is a misesian economist? That's news to me. He can arguably be refered to as broadly pro-free market and pro-capitalist, but misesian? I've never read him argue for ABCT or any other distinctly misesian theories. And I think the mere fact that he thinks Greenspan have done a great job disqualifies him from being considered a misesian.

The Mess That Greenspan Leaves

New article by me on the Ludwig von Mises Institute web page.

Tony Blair's Fascist Struggle Against Freedom

Just unbelievable, Tony Blair's government will impose a new electronic survey of all car traffic in Britain. Apparently, it was not enough to have camera surveillance of the streets of cities and have the secret police monitor all internet traffic. Now hardly any zone of privacy will remain outside homes. It seems that George Orwell should have called his novel "2006" rather than "1984", as his nightmare vision of the police recording your every move and every action seem to have been nearly completely implemeted in his home country, Britain.

Some people claim that 9/11 was motivated by al-Quaida's hatred of freedom. In that case, they have succeded beyond expectations as Tony Blair have been very willing to appease them in their struggle against freedom.

John Snow's Bubble-Budget Hypocricy

Bush's Treasury Secretary John Snow recently came with the most ludicruos statement since Bush's own claim of having imposed "spending restraints" , namely that "the president's legacy will be one of having significantly reduced the deficit in his time" .

Say what???? "Significantly reduced the deficit"? Bush inherited a surplus from Clinton which have enabled him and his supporters gloss over the full extent of Bush's fiscal recklessness.

Snow being prepared to the objection that Bush inherited a large surplus from Clinton argues that the surplus was "a mirage" and "wasn't a real surplus". The argument was that the surplus was the result of the tech stock bubble. But while Snow actually does have a point on this issue, as the Clinton surplus was largely a result of windfall capital gains tax revenues from the tech stock bubble as well as the temporary economic boom associated, he is highly hypocritical.

The temporary decline in the budget deficit in fiscal year 2005 was a result of the housing bubble as well as a unsustainable rate of asset price inflation in other areas too something which in turn have contributed to a temporary capital gains tax revenue windfall as well as having created a unsustainable cyclical boom. If you are going to [rightly so, at least partially] dismiss the Clinton surplus as a result of a bubble, then you must also adjust the current budget deficit to a far higher level as it would have been far higher without the current housing bubble.

Japan's Population Shrinks

Because of a plummeting birth rate (down nearly 4% in 2005 alone to 1,067,000) and a rising number of deaths as the population rapidly ages, Japan's population is expected to shrink this year for the first time ever during the time there have been official population statistics in Japan. Earlier forecasters thought the year when the number of deaths would surpass the number of births would be next year, but as the birth rate have fallen faster than expected it seems to happen already this year. And as the number of women in fertile age will fall rapidly in the coming years while the number of old people rises, the rate of population decline is likely to accelarate even if the fertility rate do not fall further.

One implication of this is that the relative importance of Japan in the world economy is likely to fall as a falling population level all other things being equal will slow GDP growth.

However, a smaller population need not lower GDP per capita as the lower GDP will have to be shared by fewer people. But as this population decline is accompanied by a aging population structure with more and more people leaving the work force to retire, the aging of the population structure will lower GDP per capita.

For GDP per capita -and government pension systems- it is far less of a problem if a low birth rate is associated with direct population decline due to a low life expectancy, like in Russia, than if it is associated with a rising number of old age retirees like in Japan, Germany and Italy.

This however presupposes that the average retirement age will not rise along with the median age.

And Japan have actually been better at keeping old people in the work force than many European countries with similar demographic structures like Germany and Italy. One sign of this better attitude towards making old people work is revealed in how statistics Japan defines "working age population". Whereas in the west it is defined as the population aged 20 to 64 or 18 to 64 or even 15 to 64, in Japan it is defined as the population aged 15 or older, with no upper age limit. In Japan it seems, old people are considered potential workers, something which in turn means that Japan won't have as great problems with the country's aging demographic structure as for example Italy will.

The U.S. Senate's Struggle For Higher Oil Prices

The idiots in the U.S. Senate tonight decided to block further oil drilling in Alaska. Great news for the governments of Saudia Arabia, Iran, Norway and Russia who will continue to receive large "windfall profits", but bad news for the rest of the world who will see their economies damaged by high oil prices. Whether through monetary inflation by the central banks or through agricultural subsidies or by blocking oil drilling you can apparently always trust governments to make the things we buy more expensive for us.

The Dire Fiscal Outlook in America

Conservative maverick Bruce Bartlett have a interesting column in the Washington Times (Thanks Greg Ransom for the link) about the dire fiscal outlook for America. An excerpt:

"According to CBO, spending for Medicare and Medicaid will more than double from 4.1 percent of the gross domestic product to 9.2 percent over the next 25 years and more than triple to 12.6 percent by 2050. But this assumes Congress will show some restraint and keep these programs from rising as rapidly as they have in the past. Under CBO's high-spending alternative -- which I find more likely -- spending for Medicare and Medicaid triples by 2030 and rises to 21.9 percent of GDP by 2050. Total federal spending on all programs is now 20.2 percent of GDP.

By contrast, Social Security, on which President Bush concentrated so much effort, is no problem at all. Its spending only rises from 4.3 percent of GDP this year to 6.6 percent by 2050 even under the high-spending scenario. Rather than waste so much time on a futile effort to reform this program, he should have spent all his time on reducing Medicare's spending growth. Instead, he vastly worsened its problem.

If revenues are held constant at their current 18.3 percent of GDP, the debt explodes, causing the government's interest expense to rise from 11/2 percent of GDP to 4.6 percent by 2030 and 12.4 percent by 2050 under the lower-spending scenario. Under the high-spending option, interest payments rise to 21.4 percent of GDP by 2050.

Under another scenario, CBO assumes that taxes will rise by allowing the Bush tax cuts to expire and Congress enacts no offsets to the growing alternative minimum tax or bracket-creep. This would raise revenues by 6.2 percent of GDP by 2050. Although this mitigates the rise in debt considerably, interest costs still rise to 4.7 percent of GDP by 2050 with lower spending and 13.6 percent with higher spending.

Moreover, allowing taxes to rise this way lowers economic growth. And because indebtedness still rises, more and more of the national income must be send abroad to pay foreign holders of Treasury securities. The result is lower standards of living for all Americans."

Japanese Government Budget to be Reduced

It now appears that Prime Minister Koizumi will actually go through with his election promises to reduce government spending. At least the government's budget plans for 2006 says they will spend 3% less than the current year. While budget forecasts are not always completely reliable, this means that actual spending is certainly more likely than not to fall.

As I've already told you, government spending in Hong Kong have also fallen. Why is it that the Asian governments can reduce government spending in absolute terms -not just relative to GDP- while most Western -including the Swedish and American- governments seemingly can't?

Binyamin Netanyahu New Likud Leader

Former Israeli Prime Minister and Finance Minister Binyamin Netanyahu appears to become the new leader of Israel's main right-wing party, Likud, after Ariel Sharon left the party to form a new centrist party called Kadima. After Sharon's departure, Likud have fallen back to third place after Kadima and the Labor Party.

While some of my libertarian friends may disagree with Netanyahu's "hard-line" policies towards the Palestinians, his economic program is , while not consistently libertarian, the by far most free market oriented in Israeli politics as is shown in this 2002 article called "Restoring Israel's Prosperity".

Apart from his call for more government "investments", his plan for strengthening Israel's economy is all about making the Israeli economy freer, with large spending cuts, large tax cuts and privatizations.

During his past terms as Prime Minister and Finance Minister, he made some progress on these areas, although these reforms were not radical enough. Right now, these limited reforms have together with a global recovery in the tech sector and a improved security situation produced a strong recovery in the Israeli economy, now growing at a 6% rate. But for this recovery to be sustainable, further free market reforms must be implemented.

The Economic Fallacies of Nuder

Swedish Social Democratic Finance Minister Par Nuder (It's pronounced "Neuter". Not that I want to imply anything about him.....) wrote a article in yesterday's Svenska Dagbladet. For those of my readers that don't understand Swedish, I can summarize what he wrote:

1. The Swedish economy is going great.
2. It's going great because the Social Democrats pursue so great policies.
3. To keep it great, they will increase the level of fiscal stimulus.
4. The tax cut proposals from the centre-right opposition cannot be motivated on economic grounds, and is motivated by the circular argument that taxes must be cut because taxes must be cut.
5. A extensive welfare state is necessary to make people feel secure, and the feeling of security is necessary to secure Swedish competitiveness.

Regarding point 1 and 2 , I refer to my previous post on the subject. Nuder makes a big deal of the by Western European standards strong third quarter growth number, but this reflects not high underlying growth but is a purely cyclical phenonema, reflecting the combination of fiscal stimulus, interest rate cuts and the falling exchange rate of the krona. The effects of these will probably last for a few more quarters, conveniently enough for the Social Democrats for next year's election, but once they wear off, growth will slow sharply, down to its long-term sluggish trend.

As for number 3, that is a rather curious argument given the fact that the Social Democrats traditionally have been Keynesians and since Keynesians usually teach that you should pursue countercyclical policies, that is loosen during downturns and tighten during booms. And since this is a cyclical peak, it seems strange to loosen then. Does this mean that Nuder will propose to tighten fiscal policy during the next downturn? If the fact that the government sector (including the pension system) now have a surplus is a argument for loosening, then surely this would imply tightening during the coming downturn.

As for number 4, I have previously demonstrated the negative economic effects of high tax rates both on a theoretical and empirical level.

Moreover, there is a strong non-economic case for lower taxes, a case which contrary to Nuder is not circular. While this may seem incomprehensible for a Social Democratic Finance Minister, some of us have a desire to keep our income and dispose of it as we see fit, rather than being robbed of it by arrogant Social Democrats. Taxes should be cut, not because taxes should be cut but because we want more freedom from arrogant politicans like you.

As for number 5, I find the argument that the feeling of security supposedly created by "generous" welfare state benefits is necessary for Swedish competiveness to be invalid on at least two grounds.

First of all because these have -together with high taxes and high union-imposed mimimum wages- created Sweden's employment crisis where the level of employment have been falling under the last few decades and where now some 20-25% of the population is unemployed (including those hidden in various hidden unemployment schemes from the government), a number which is more than 50% for non-western immigrants.

Secondly, Nuder claims that "security" is necessary because otherwise people won't agree to necessary structural changes. Presumably, he by that means that in the absense of the welfare state, people would demand protectionism and employment regulations. But this is first of all a political argument, not a economic one. Unless he can come up with some other arguments even he is implicitly admitting that the ideal state of affairs is a free market economy with free trade and little or no taxes and regulations, like in Hong Kong and Latvia and Estonia . It's just that he finds it inevitable that the political process will produce either a extensive welfare state or heavy regulations and protectionism. Yet, there is little evidence for such inevitability, as we see many examples like the aforementioned Hong Kong and the Baltic states which have little or no welfare state yet have even less of regulations and protectionism than Sweden. Meanwhile we see that in the case of France, whose welfare states is as extensive as Sweden, that there is strong support for protectionism and destructive regulations.

The Social Democrats may think they have repealed the laws of economics, but in reality they cannot escape the basic economic truth that if you punish productive behaviorand subsidize people who do not engage in productive behavior, you will get less of productive behavior.

Mixed Economic Reports

The U.S. Economy continue to deliver mixed economic reports. On the one hand, the trade deficit rose sharply during October to a new record of $68.9 billion, contrary to the expectations from most economic analysts -including me- that it would fall. Given the fact that the trade deficit is a full $11 billion higher than in July and $8 billion higher than the third quarter average, this means that even if the deficit falls back (as is likely) in November, trade will generate (in purely statistical terms) substantial subtraction to GDP for the fourth quarter.

On the other hand, consumer prices fell more than expected as a result of sharply falling gas prices. That in turn means that even the likely weak nominal growth in consumer spending will amount to a very strong real spending growth number. That in turn means that consumer spending might just make it above the zero level.

Together with a build-up in inventories,continued strong investment growth and rapidly growing government spending this means that despite the statistical drag from the rising trade deficit, the U.S. economy will certainly grow during the fourth quarter, although clearly far below the third quarter number. This view is also supported by a number of unexpectedly strong reports today on the maunfacturing sector. While U.S. growth have very shaky foundations, it have not ended yet.

My Kind of "Sacrifice"

The WTO negotiations in Hong Kong have now started. It is widely expected to be a big failure. Why? Because the poor countries of the world demands that the United States and the European Union must end or sharply reduce its fram subsidies and abolish tariffs on imported food in order for them to reduce barriers on goods from the US and the EU.

One would have thought this would be a no-brainer. Let's see, if we do away with farm subsidies then taxpayers save a lot of money and we can cut taxes and we get much lower food prices . That is a "sacrifice" ? A "sacrifice" so terrible that we cannot agree to this in exchange for receiving higher export revenues? What the hell kind of twisted thinking is that?

But unfortunately, the farmers lobby is so strong that it have been able to get the French government on its side, who have been able to prevent the EU to agree to these "concessions". We are because of that held hostage to a system which reduces our income, raises our food prices and our taxes.

China's GDP 15-18% Bigger Than Previously Thought?

Financial Times reports (Thanks Johan Norberg for the link )that China will next week announce a large upward revision of its GDP at between 2,000 and 2,400 billion yuan ($250-300 billion) for 2004, raising it with 15-18% from the previously estimated 13,650 billion yuan level. It will mostly be in the form of a bigger private service sector.

All statistics in all countries contains potential errors and should thus be taken with a grain of salts, although I for practical purposes still use them as errors can be in either way and accordingly the published numbers are therefore the best middling estimate so to speak.

China's statistics are widely considered more unreliable than that of western countries. However, this certainly does not mean that the Chinese economic boom is a statistical fraud. Quite to the contrary, Chinese statistics likely underestimate economic growth and the size of its economy. As I pointed out in my speech on the outlook for the world economy, various indirect indicators of production levels, like coal, oil and steel consumption or foreign trade indicates that production levels are in fact much higher than the official GDP numbers indicate. That is to some extent a result of the fact that the price level in China is much lower, but it is probably also a result of much business activity being neglected, as this revision show. And as Professor Song Guoqing points out in the article, more upwards revisions is likely needed.

This revision will also mean that China's dependence of its trade surplus with the U.S. is somewhat smaller than previously thought, although it is still dangerously high. It also means that the share of the economy going to private consumption rises, at the expence of the share going to the trade surplus, investments and government consumption.

UPDATE: Today, this rumour was officially confirmed, with the upward revision landing at 16.8%, to 16 trillion yuan in 2004 or slightly less than $2 trillion at current exchange rates. This means that even at current exchange rates, China surpassed Italy in economic size in 2004, and will surpass Britain and France this year (2005). Eventually, barring extraordinary events like nuclear war or a reversal to communism , China will surpass first Germany, then Japan and finally even the United States in economic size.

Stagflation With a Vengeance

BBC Business News reports that Zimbabwe's consumer price inflation rate rose above 500%. But don't worry. I'm sure some Mugabe apologist can say that if you exclude food, fuel, home rentals, bicycles and maybe some more rapidly rising items, then we come up with some "core" rate of inflation which aren't really that bad.

Given the fact that Zimbabwe have at least 60% unemployment (Some argue its more like 70-75%) and a rapidly falling GDP it would be interesting to hear how all the pundits who argue that the ECB pursues a "tight" monetary policy would charactarise Zimbabwe's monetary policy. After all, despite the fact that the Euro-zone have rapid money supply and credit growth, rapidly rising house prices and a consumer price inflation rate firmly above the ECB:s supposed ceiling, 2%, they still regard it as tight , using as evidence the high unemployment rate and sluggish growth. This they argue is evidence of "slack" in the European economy. But in Zimbabwe where GDP is collapsing rather than growing slowly, and unemployment is 60-75% rather than 8.3%, there is arguably a abundance of "slack". Given this, should Zimbabwe's monetary policy be regarded as "tight"? If money supply and price growth is irrelevant in the Euro zone, shouldn't this hold true for Zimbabwe too?

In Zimbabwe's economic collapse is of course the result of the disastrous policies of black racist dictator Robert Mugabe, most notably his policy of stealing the lands of productive white farmers and giving it to his in agriculture obviously incompetent cronies. Zimbabwe's combination of 500% inflation and 60-75% unemployment is what one might call stagflation with a vengeance. EU policies are of course far less destructive, but it is still they who are responsible for the high unemployment and sluggish growth, and any attempt to substitute market reforms with inflation will only worsen EU problems .

The Myth of the Importance of R&D Spending for Growth

One myth that is widely accepted is the idea that spending on research and development (R&D) is more important for economic growth than other forms of investment and that R&D should thus be subsidized by the government. Thus, in the strategy plan of the European Union for making the EU the most competitive economy in the world, raising R&D spending to 3% of GDP is one of the most important parts.

Yet, what evidence exists that R&D spending will have a greater impact than other forms of investment spending. None.

A comparison of different EU countries illustrates this. The two fastest growing economies, Latvia and Estonia , have R&D spending levels far below average, as have all the other relatively rapid growing Eastern European countries. And even if you exclude the Eastern Europeans, largely the same pattern of negative correlation between growth and R&D spending exists. The four fastest growing of the old 15 member countries are Ireland, Luxembourg, Spain and Greece, all of whom have R&D spending below the European average.

This negative empirical correlation between growth and R&D spending should in my view not really be interpreted as R&D spending really having a negative impact on growth. This empirical pattern instead reflect that countries with low R&D spending by coincidence have a better policy in other areas. This is illustrated by the fact that one country with low R&D spending, Italy, have low growth as they pursue bad economic policies. Indeed, I think R&D spending is probably better for growth than pure consumption. However, as the empirical facts illustrate, there is no reason to believe that it will yield higher returns than other forms of investments, so there is certainly no reason for governments to subsidize it.

The Flow of Funds Report

This Thursday, the Fed released the "Flow of Funds" report for the third quarter. It shows that the trend of the last few years of asset price inflation and a higher debt burden continues . At $11 trillion, household debt is now at a record high of 121% of disposable income, up from 77% when Alan Greenspan became Fed Chairman in 1987. Mortgage debt alone have risen to 91% of disposable income, versus 52% in 1987.

On the other hand, household assets have also risen and while relative to disposable income they are still below the peak after the bursting of the tech stock bubble in early 2000, they are risen from 1987 (albeit not as fast as debt).

Some Administration pundits try to reassure us by telling those that worry about debt being based on a house price bubble that it is not just housing values that have risen, but that financial assets have risen too. But given that financial assets like stocks or mutual fund or pension fund shares are actually even more likely to see outright falls in value (That is what they did after the tech stock bubble bursted) than real estate, this hardly is very reassuring.

If current asset prices can be sustained then current debt levels can certainly be justified (at least on a aggregate level). But since the underlying value of assets must ultimately be derived from national income and since asset values relative to national income are at recorde levels, this means that there is a substantial risk that asset prices could fall again just like they did after the tech stock bubble bursted.

Observations About the Gold Price Rally

New blog post at the Mises blog.

U.S. Budget Deficit Increases Again

The latest report from the Congressional Budget Office shows that the U.S. budget deficit have again started to increase. During the first two months ( October and November ) of fiscal year 2006, the budget deficit increased to $130 billion from $115 billion the same two months in fiscal year 2005.

This is both because revenue growth have slowed significantly, from 14.6% for fiscal year 2005 as a whole to "only" 6.1%, while spending growth have soared, from 7.3% to 11.4% (Adjusted for calendar effects).

To some extent the increase is due to temporary factors. Katrina have meant the payments of a few (not specified in the report) billions of dollars in disaster relief, while revenue growth would have been $5 billion more hadn't last years numbers been artificially boosted by the fact that corporations normally due for September 2004 to October 2004. But even adjusting for those factors, the budget deficit increased.

It remains to be seen whether this trend will continue. That depends largely on the outlook for the economy and asset prices. Assuming they slow, which I think they will, the trend will continue. The current high rate of inflation have boosted nominal revenue growth, but on the other hand it have boosted the cost of government purchases and the cost of interest payments to holders of inflation-protected securities. And next year it will also increase the cost of social security payments, which are indexed for inflation.

European Monetary Policy Analyzed

I have a article discussing the monetary policy of the ECB on the German web site Der Invest Informant. After the recent small quarter point interest rate hike the ECB was again accused by EU politicians of not inflating enough. But I point out that contrary to the general perception, ECB policy have been highly inflationary and this have caused great distortions, distortions that will become even greater if the EU politician's call for even more inflation would be granted.

Currency Manipulation in China and Japan

New blog post at the Mises blog.

Empirical Evidence For the Negative Effect of Taxes

"Austrians" often maintain that it is both impossible and unnnecessary to conclusively prove economic theories with statistical evidence. Impossible because there are so many different factors -many of which is extremely difficult or impossible to quantify- working to produce a single phenonema like say GDP including for example tax rates, regulatory burden, trade policy, natural resources, cultural factors, demography, monetary policy, relative preference for non-economic priorities, innovativeness of the population etc. almost ad infinitum that there will never be a perfect empirical correlation between any sigle one factor and the phenonema it contributes to, despite the fact a causal relationship really exists. Unnecessary because we can really conclude the causal relationships with so-called aprioristic reasoning.

Like in the case of taxes, we can conclude that it will certainly lower economic activity based on the fact that 1) People desire more money 2) Taxation of productive activities means that they will get less money from productive activities. From thiose two premises we can conclude that taxes will make people less willing to engage in productive activities from which in turn we can conclude that taxes will reduce the level of productive activities.

The counter-argument sometimes used against the above reasoning is that taxes through the so-called income effect might stimulate productive activities, but this argument was refuted by me in this article.

But nevertheless, while we can conclude through aprioristic reasoning that taxes will damage the economy, we cannot conclude how much it will damage it. To find that out, statistical analysis might be necessary after all. And while for the above stated reasons, any such analysis should be taken with a grain of salt, it is still likely to give us some hint of how big the effects are.

One such study was made by Nobel Laurate Edward Prescott, and it concluded that marginal tax rate changes accounted for nearly all the differences in hours worked between the G7 countries (the United States, Japan, [West] Germany, Britain, France, Italy and Canada). A surprisingly strong finding, as I had expected working hours laws to play a bigger role, but possibly support for such laws could have correlated with tax rate changes. I presented this study already last year in a blog post at the Mises blog.

Now in a comment thread at Angrybear, the signature "Teller" presents 5 more links to empirical studies that all show how labor supply is increased if taxes are cut. The exact magnitude of the estimated effect differ somewhat, but they are all significant:

Study Nr. 1
Study Nr. 2
Study Nr. 3
Study Nr. 4
Study Nr. 5

Bush Claims to Have Implemented "Spending Restraints"

Commenting on Friday's employment report, President Bush, claims to have implemented "spending restraints"

As I've detailed before (see here and here)this is a completely absurd claim.

An increasing number at traditionally loyal Republican institutions aren't fooled however, with Veronique de Rugy, even going so far as to say that "Congressional Republicans Make French Socialists Look Like Ronald Reagan". And as you know, to many American conservatives, being called French is the worst possible insult.

Here is a funny picture on the subject of Republican deficit spending (Thanks Greg Ransom for the link).

Fourth Quarter U.S. Production Growth To Slow-But Income Growth Strengthen

I discussed the "advance" estimate of third quarter GDP about a month ago. In it I highlighted the paradox that it showed strong GDP growth-but falling real income and falling NDP (Net Domestic Product). The reason for this was that Katrina sharply increased the level of capital consumption, and capital consumption is deducted from Net Domestic Product and National Income (and Household Disposable Income to the extent it effects property owned by them)-but not from Gross Domestic Product.

The first revision have only increased this paradox with GDP being revised up (A large upward revision of domestic demand owerwhelming the higher than expected trade deficit) while household disposable income have been revised down.

As the basic analysis of the third quarter I made a month ago still stands, despite the revisions in some details I am not going to comment this issue further.

Instead I am going to turn to the issue of the outlook for the third quarter. This is likely to be a partial reversal of roles with production growth likely to slow sharply even as income growth turns positive.

The main reason why production growth is likely to slow sharply is because private consumption is likely to show barely any growth at all. Indeed, it is set to fall unless we see really strong growth in November and December. As we can see in today's report on personal income and spending, third quarter consumption growth was based almost entirely on the temporary surge of car sales in June and July due to the discounts from GM and Ford. Both August and September by contrast saw significant monthly declines in real consumption. And this means that despite the marginal 0.1% monthly increase in October, October spending was in real terms 1.2% lower than in July. Because of this, we'd have to see 0.5% real monthly gains to even have a unchanged quarterly number-and that is highly unlikely given the negative savings rate.

But while personal consumpton is likely to fall, this doesn't mean that overall GDP will fall. Business investments will likely continue to expand strongly, residential investments will likely continue to expand albeit at a slower rate and government spending will likely continue to soar. Moreover, inventories will also likely give a positive contribution. More uncertain is the outlook for the trade gap, but even though the monthly deficit will likely fall from the September peak, the fourth quarter deficit will probably still be greater than the third quarter gap and that will lower GDP growth. All in all, we are likely to see a significant sowdown in growth, certainly well below 3%, but likely still well above zero.

Because capital consumption will fall from the third quarter peak caused by Katrina (althoug it will certainly be higher than in the second quarter), income growth will likely rebound and be higher than the likely low production growth.

All Fiat Currencies Are Manipulated

Good article today on LRC from Paul Hein on the hysteria in Washington D.C. led by New York Senator Charles Schumer over China's "currency manipulation" . I particularly like this quote: "To bemoan the manipulation of fiat currencies is to bemoan the fact that north is opposite of south. How could it be otherwise?".