To Sequester or Not to Sequester, That is Sequestion

Federal government budget deficits, per se, don't matter. They matter only to the extent that if aggregate demand in the economy is too high (deficits too high), unwanted inflation results, and if aggregate demand in the economy is too low (deficits too low), unwanted excess capacity (e.g. unemployment) results. Thus, demanding spending cuts simply to reduce the deficit is illogical.  If there is no inflation, there is no problem.

That being said, I think the sequester is a good thing.  It's really an interesting experiment to see whether government spending can be cut arbitrarily by a small percentage without anybody really noticing except the bureaucrats whose livelihood depends on growing government. It's an exercise, really, and even though many lament the "obvious" idiocy of doing across-the-board cuts, I think it's a useful one. I submit there is not a single federal program that doesn't have at least 10% easy-to-remove waste. There has to be.  Bureaucrats have been thoroughly trained to pad their budgets by at least this amount, compounded each and every year, until a mandate from on high comes to implement severe cuts.  And that mandate simply has not issued for as long as I can remember, and certainly not in the last 15 years.

What makes the looming sequester particularly interesting (and delicious) is that the Obama administration has been running around like Chicken Little claiming that the sky will fall because of a 2.3% cut to the budget, which admittedly is a 5-10% cut to discretionary programs because the entitlement programs are immune (on a side note, is this why it's called a sequester - that discretionary programs are isolated from the budget and subject to cuts?).  As George Will pointed out, Obama's theory is that the size of federal government is so finely tuned that just a few % points in spending is what's separating us from chaos and economic collapse. And the fact is, this is a time-honored trick of bureaucrats, used at all levels of government. I've seen it referred to as the Washington Monument strategy. The bureaucrats threaten to close the Washington Monument to visitors if their budget requests aren't met. That is, they threaten to make the cuts to spending in those areas which are most painful and most highly visible to the public. In fact, our embarrassing Secretary of Transportation has threatened air travelers with significant flight delays if the sequester cuts are passed through to the FAA.

Every time I have seen the Washington Monument strategy threatened, it has been a bluff. I saw it here in my own city, where the mayor asked for a $12MM property tax override to increase spending on the schools. The school board (and teachers' union) threatened parents with much larger class sizes if the override was defeated. Opponents of the override claimed that the school board was bluffing - that the money simply was not needed and there was plenty of money in various slush funds. I was actually a proponent of the override, but when it was defeated, and class sizes remained the same, and news articles came out about money being shifted around from various slush funds and new cost savings miraculously being found, I had to admit the override opponents were absolutely right.

I suspect that Obama will play hardball and will try to make the most painful cuts to the military possible, but there will be room for compromise with House Republicans because Obama will also realize that the cuts to other programs will go unnoticed by the public (a very dangerous development for someone whose main goal is growing government). So my prediction is that they'll compromise on a half a sequester, with a more detailed list of things that will be cut and things that will be spared.

The Real Lesson of the Newtown Shooting

The law of large numbers means that horrific, improbable events will happen from time to time in a country of >310MM people.

There are actually two mortality risks Americans face that I find shockingly low.  One is the risk of dying in a commercial plane crash.  It is absolutely remarkable that a plane carrying thousands of gallons of jet fuel, with engines the size of automobiles, can travel at 150mph on the ground, rise tens of thousands of feet into the air at speeds reaching 600mph, travel thousands of miles, and then land on a narrow strip of asphalt less than two miles long, all while being controlled by a human being, and still have less than a 1 in 10MM chance of crashing.

The other risk I find to be surprisingly low is the risk of dying in a random mass shooting.  There are over 200MM privately owned firerms in the US, and over 50MM households have at least one firearm.  And yet random mass shootings occur at the rate of fewer than 5 per year, and those involving children are much, much less frequent.  If we define an opportunity for a mass shooting as one year of access to a firearm in the home, then the probability of one such opportunity turning into a mass shooting is comparable to the probability of a plane crash.  That is, if you lived next to a gun owner, and you somehow managed to convince him that if he were to go on a random murderous rampage with his gun during the next year, that he should shoot you dead first, just as a courtesy, then your increased risk of dying over the next year would be equivalent to the risk of taking a one-way trip on a commercial plane.

I think it almost goes without saying that the risk of dying in a random mass shooting (or any shooting actually, as long as you’re not a criminal or suicidal) is so small as to be negligible compared to other risks in life, and we should waste no more time or resources on the problem unless evidence arises that the risk is increasing by orders of magnitude.  In fact, the statistics show that the risk is actually decreasing.  Despite the increase in US population, the frequency of mass shootings has stayed relatively constant, and the rate of shootings at schools has actually declined.

The real lesson of the Newtown massacre is that we should not let statistically insignificant events be blown out of proportion by the media and by our own emotions.  The coming push to enact new laws to restrict our liberties, whether they involve the right to own and carry a gun, the right to have a weird personality, or the right to produce and consume media with violent content, should be opposed vigorously.  If media focus on exceedingly rare (but statistically inevitable) tragedies allows the ratchet of liberty-reducing law-making to progress with each event, then we will become less free over time.  At times like this, it is worth recalling Benjamin Franklin’s famous maxim, usually paraphrased for dramatic effect as:  “Any society that would give up a little liberty to gain a little security will deserve neither and lose both.”

The Politics of the Tucson Shootings

My immediate reaction to the shooting of Congressman Gabrielle Giffords was "Crap, I hope she wasn't a liberal." There are two reasons for that: if she was, then 1) I wouldn't be able to watch or read the news for several weeks without being inundated by stupid commentary about the "irresponsible vitriol" directed at liberals from the political right; and 2) this random, despicable crime, committed by an obvious lunatic, could significantly impede the new Republican House majority's agenda to curb the growth of government control over the economy. It turns out Giffords was/is not particularly liberal, but because she was a Democrat, it looks like many on the left will try to coopt this tragedy for political gain anyway.

It almost goes without saying (at least for the half-dozen people who read this blog from time to time), but I'll say it anyway, that it is idiotic to blame our political discourse for such a tragedy. Besides the fact that political speech is probably more polite and "PC" than at any time in US history, especially when it comes to very emotional and significant political issues, it's unclear that the use of violent imagery and harsh criticism is even positively correlated with political violence, let alone materially so. And any causal relationship is even less clear. Finally, even if colorful political rhetoric could be proven to increase political violence, I think that's just something we have to accept as a society. In a country of 310MM people, the level of political violence is so low that the threat of violence simply doesn't have the intended effect (assuming of course the perpetrator of the threat is not thinking one level deeper and attempting to sabotage the opponents of his target).

I'll end this post by pointing out what a jackass Pima County Sheriff Clarence Dupnik is. Without any evidence (the shooter is not talking), he implied strongly that recent political fights in Arizona, which he equates to prejudice and bigotry, would have a motivating effect on unbalanced people like the shooter to commit violence.

His implication of course is logically inconsistent with the facts concerning the shooting. If the political environment in Arizona is so toxic that unbalanced people could be incited to commit violence, why was there zero security at a campaign event for a sitting congressman? Literally zero -- there wasn't even a security guard on duty at the shopping mall. If the sheriff really believed that political violence was caused by vitriolic rhetoric, and that Arizona was the "capital" and the "Mecca" of such rhetoric, then he was completely negligent in carrying out his duties.

The fact that congressmen generally do not receive security at public events, even liberal congressman who are the targets of Tea Party ire, undermines the credibility of after-the-fact accusations like those of the sheriff's. To be clear, I think it's amazing that important public officials like congressmen do not routinely have security. That's pretty good evidence that the real professionals in the law enforcement establishment do not take political rhetoric seriously.

Fiat money, part 3

(Follow-up to part 1 and part 2.)

Let’s clear up some potentially confusing points about fiat money on our island:

We said that when the government spends, it increases net dollar wealth, and that when it taxes, it decreases net dollar wealth.

So you can think of the total government debt as the “national savings account”. But it is important to note that when we say "savings", we are really referring to savings in the form of dollars (or Treasuries, which we’ll get to later).

If I chop up some wood and build a bird house for my pet woodpecker, I've created wealth and my net worth (assuming that other people are interested in buying the bird house) has gone up. But my dollar wealth is unchanged. Since the total number of dollars out there is the same but there are more goods it can buy (because that spectacular bird house has been built), overall prices might have to come down. So you could argue that the government has to issue more dollars to keep pace with the amount of “real wealth” that is created.

Where does the extra money "come from"? Is the government racking up a bunch of debt?

You might be confused at this point as to where the money used for deficit spending comes from. There are two possible answers: the government can "print" the money, or it can "borrow" the money.

Let’s start with borrowing, since that’s the case most familiar to a lot of us.

In order to borrow money, the government has to print up a bunch of IOUs and sell them. We'll call the island IOU's "Treasuries" to match the U.S. terminology. So the government prints some Treasuries and exchanges them for cash with "regular" civilians. For now, those civilians represent island citizens, but later we'll consider what happens if they are foreigners.

For instance, if the government collected $500,000 in taxes but wants to spend $520,000, it could issue $20,000 worth of Treasuries and sell them to island residents. In the process, the government has $20,000 worth of cash, and it can proceed to spend or give away the money. If Lenny the Lender purchased $100 worth of government Treasuries, then he's just as wealthy now as he was before. His cash has been reduced by $100 but he now has $100 worth of Treasuries.

So now when we refer to "dollar savings" we'll be referring to cash or Treasuries. Both are a form of dollars; the difference is the Treasuries are scheduled to "turn into" regular cash at a future date. Alternatively, you could say that cash is just a "zero maturity" Treasury, i.e. a Treasury that gets paid back by the government right now.

So how does “printing” money work?

Well, on the island, we can literally print it and spend it. It is our imaginary island after all.

But does the U.S. actually just print money and spend it?

This is a minor point, but the U.S. Treasury works slightly differently. (Thanks to ESM for spelling this out for me.) If the U.S. Treasury wants to "print money", the Treasury issues bonds to the Federal Reserve, and the Fed pays cash to the Treasury. Now the Treasury has cash to spend, and the Fed is holding onto a bunch of bonds. The Fed can either hold the bonds, sell them on the open market, or tear them up. In the last case (which is quite common), we can say that the Treasury effectively printed money, and for some reason, the amount that it printed is not added to the U.S. debt. This is horribly inconsistent, but it’s the way it is. It's as the government periodically get loans and the bank keeps forgetting to collect debt payments.

Intro to Fiat Money Part 2

To review the ideas from part 1:

1. All the island dollars that people have came from government spending at one time or another.

2. When the government spends, it increases the net dollar wealth of the world. You can think of government spending as the government printing green pieces of paper and exchanging them for good and services.

3. When the government taxes, it decreases net dollar wealth. You might think of taxation as the government collecting money and dumping it into a shredder.

4. Fiat money has value because it’s the only form of payment accepted for island taxes.

A lot of this probably sounds odd if you're used to thinking about gold backed currency. The goal here isn't to attack or defend fiat currency; rather I just want to explain how it works and how these ideas might affect policy decisions.

As Bob and ESM pointed out in the comments to part 1, in year 1 the government has to spend (or give away) at least as much money as it wants to collect in taxes each year; otherwise people won't have money with which to pay their taxes. ESM went further and said that the government has to spend enough for people to pay their taxes and satisfy their demand for dollar savings.

If the government spends or gives away $6000 per person per year and collects $5000, then people will be able to save $1000/person on average. Some people might save more or less (and some could end up in debt), but $1000 has to be the average.

You should also note that in this example, the government ran a deficit of $1000/person. So each year, the government deficit matches the change in private dollar savings. If the government runs a deficit, then total dollar savings must rise, and if the government runs a surplus, total dollar savings must fall. (This might be the opposite of what you thought previously.)

For this reason, some people (though admittedly, not many) refer to the national debt as "the national savings account". People's total accumulated dollar savings must match the government's accumulated dollar debt. It's a closed system after all.

A few other interesting points about this system:

• The purpose of taxation is not to raise revenue, at least not on the federal level. The island government prints and destroys its own currency, so it can spend however much it wants.
  
  
• Of course, printing a lot of money and not destroying very much money can cause the dollar to lose value and trigger inflation. So the real reason for taxation is to reduce the number of dollars floating around to "make room" for the dollars that the government wants to deploy. Another way to say it is that the government taxes in order to reduce aggregate demand and keep prices under control. A second purpose of taxation is to give dollars value in the first place!
  
  
• Not everyone has to pay taxes for this set-up to work. Even if only people whose last names began with "A" had to pay taxes, dollars would still have value to Mr. Aaronson. But Mr. Bozo would still value dollars since he knows that Mr. Aaronson values them. In other words, Mr. Bozo is happy to accept dollars as payment for calculus tutoring, since Bozo can then use those dollars to buy stuff from Aaronson. So they'll both value dollars. To pick a more realistic example, U.S. dollars have value to Canadians even though they (typically) don't have to pay U.S. taxes.
  

Next time: How does government borrowing work? Is printing money the same as borrowing?

Intro to fiat money part 1

The mysterious Bob requested a short "course" on how fiat money works. Considering that our economy runs on fiat money and probably less than 1% of Americans understand it, it's probably important to come up with a simple way to wrap one's head around it.

Imagine we all live on an island, isolated from the rest of the world. (This keeps things simple; we'll talk about international trade later.) People on the island obtain goods and services by trading with each other. Whatever merits this system has, it can be very tedious to enter into a transaction. For example, if you're a calculus tutor and you want some salmon, you have to find someone who has a bunch of salmon and wants calculus tutoring. What are the odds of finding that person in a reasonable amount of time?

So the government of the island issues green pieces of paper called "dollars" and lets people trade with dollars. There's just one problem: These pieces of paper have no intrinsic value, so there's no way I'm giving you some of my stuff in exchange for dollars.

Now let's add one more kink that will actually make these dollars valuable. At the end of each year, every island resident (government worker or otherwise) has to pay a tax of $5000. These pieces of paper will be collected and tossed into a shredder. [Alternately, the taxpayer can simply submit a YouTube video of himself shredding the money he owed.] If anyone fails to turn in $5000, he'll be put out to sea in a raft with nothing but a DVD player with Britney Spears videos and "What's Happening!!" reruns.

Now no matter what you think of the idea of having a "head tax", you have to agree that dollars now have some serious value. They're the only form of payment that the government will accept for tax liabilities.

So now dollars have value and people can use dollars for trade. I can buy fish in exchange for dollars because either the fisherman needs the dollars to pay his taxes, or he knows that somebody else needs them for taxes (and thus that guy will trade for them).

One last problem we have to address: Where do people get dollars from? They need to accumulate dollars in order to pay taxes each year, after all. Saying that they get dollars from trading with other people is a cop out, because those people need to get dollars from somewhere. Even if somehow people "started out" with a certain number of dollars floating around, they will eventually be destroyed at a rate of $5000/resident/year.

The answer is that dollars can only come from one place: the government. The government can create and destroy dollar bills and they're the only ones who can do it.

So the island government decides to hire people to do various jobs around the island such as cleaning seaweed off the beach, maintaining the roads, and running a tropical counter-terrorism unit. The employees are paid in dollars. If the government wants to, it could even supplement the supply of dollars by dropping them from a helicopter and letting people find them.

So dollars "start" in the hands of people who sell their services (or goods) to the government, the dollars are used for trade, and they eventually end up in the hands of people who need to pay taxes (government workers or private sector workers alike.)

Now here's a good question to think about: How much does the government "need" to spend each year? As a follow-up, what happens if they spend more or less than that amount?

Don't you hate traffic? Part 3

Ok, one last note about charging people to use the road. It's easy to draw the wrong conclusion from my posts. When people hear about these ideas, some of the ideas that pop into their heads are:

1. "Thank goodness there's a huge tax on parking in some places." Manhattan charges an unbelievable 18.375% tax on parking! (Incidentally, residents can get much of it rebated, but out-of-towners are stuck paying the whole thing. I'm not sure if this has been challenged in court yet). Anyway, taxing parking is totally backwards! What's crazy is that if there's one thing I want people to do with their cars, it's to keep them parked in garages. I don't want those things on the roads during busy times. In other words, road space during rush hour is the scarce resource that needs to be rationed via prices; room in parking garages already is rationed by the owner (since he charges for them).

2. "That's why we have a gas tax." A gas tax is not the stupidest thing on earth. As ESM has pointed out to me in the past, the government spends considerable resources keeping the waters safe for oil shipping, and it makes sense to charge the consumers of the oil. There are other externalities associated with gasoline use, so a tax might make sense. But a gas tax doesn't address the traffic problem very well. The guy driving through Nevada at 2 a.m. might be using a lot of gas but he's creating no traffic congestion. But Marginal Matt, who's driving in Manhattan rush hour traffic uses only a litle gas and creates all sorts of delays and aggravation. That's the guy you want to charge.

3. "God bless the DMV. They charge registration fees for cars." Again, cars aren't the problem; using road space when it's scarce is the problem. There may be good reasons to charge a small fee for having a car (the police now have to track it down if it's stolen, etc.), but rationing road space isn't one of them.