Do You Believe In Fairy Tales?

It Seems that for the first time in four years, the senate has passed a budget. Republicans are bleating that it “has zero real deficit reduction” and “never balances.”…which is probably all true, but as I discussed a few weeks back, neither does Paul Ryan’s Path to Prosperity. You see, any monkey with a free copy of Google Spreadsheets can make a lot of bogus assumptions about revenue growth and cost cutting and squeeze the “projected” deficit down to zero in 10 or 20 years…Just ask the Congressional Budget Office, who in 2000 projected to much acclaim that the US would be more or less debt free by 2010.
In any case, we now have affirmation by both political parties that one of three things is true about each of them.
  1. They are a bunch of Lying SOB’s…
  2. They aren’t lying, they are just incredibly incompetent.
  3. Or…they believe in fairy tales.
I really don’t know which it is…all seem feasible to me. However, it is time for you to decide if you believe in Fairy Tales…or not. The fairy tale they want you to believe…written by the economic high priests of the last century is quite simple. First…deficits don’t matter. Government, led by the infinite wisdom of elected politicians and an army of bureaucrats can borrow and print an infinite amount of money with no consequences. They will save your job, care for you when you are sick, educate your children, and even manage your retirement for you…all you have to do is believe….and maybe tap your shoes together 3 times.
For comparison, let’s think about what might make sense for a typical family budget. It is generally accepted that an ideal state is a surplus…you should be saving, let’s just say 10% of income…. for rainy days, paydown of debt, and hopefully accumulation of enough wealth for the rather modern invention we call “retirement.” We could have a debate over the specifics, I think we can all agree that more or less, this is a pretty good prescription for success.
Imagine if instead of following the above, our family, with a household income of $80k/year, decides to take the prescription advised by modern economic theory. At this point in time, our family, has accumulated debt approaching $500k….not mortgage debt…unsecured credit card debt. Further, they are accumulating debt at the rate of about $40k per year, with no realistic plan to address the annual deficit, much less actually pay down debt accumulated so far. At this point,  really should be bankrupt, but fortunately for them, their credit card company keeps increasing their credit limit, and at this point has actually removed the limit altogether.
Do you see this ending well? Is it possible that a financial policy that would so obviously asinine for a household makes sense for a nation? Ben Bernanke, Tim Geithner, Republicans, Democrats, and most modern economic theory thinks it will. That’s what’s in the Fairy Tale, so it must be true…right? You need to decide for yourself what you believe. Is infinite deficit spending the right medicine to heal a sick economy, or is it just another line of cocaine….inching closer to bankruptcy and ultimately…death?


How Paul Krugman and the Economic Witch Doctors accumulated $16.7 Trillion of Debt

This is kind of long, and a bit of a diversion…but I hope you enjoy:
The first thing you learn in accounting school…after you find your stapler that is.. Is that there are two sides to every entry…a debit, and a credit. If you are still awake, let me explain…. Let’s say you go to the store and buy a new computer for $500. The accounting entry would be to debit assets…+500, credit cash -500. Or…if you put it on the plastic…the credit would be to liabilities -500. In total, the transaction itself has no net effect on the balance sheet as a whole. It’s just an even exchange of one type of asset-cash, for another type of asset…the computer. Simple stuff right…Hey you in the back…WAKEUP!!.. Seriously..I’m getting to something very important.
This concept doesn’t only apply to transactions within organizations or individual’s balance sheets…it also applies to all transactions between them. For example…a cell phone bill. AT&T sends you a bill for $100. To them…this represents revenue… a credit. To you, this is an expense…a debit. Got that? It is extremely important. Every dollar of GDP….every dollar of revenue has an evil accounting twin… completely and utterly ignored by economists and politicians….cost. If you need a heart transplant…GDP +2M. Wrecked your car? +$30k. House blown down by a tornado? $+250k. Paid $75 to turbo tax because the tax laws are flippin ridiculous??+75 Had to hire an army of accountants to comply with government SOX laws that do absolutely nothing to protect investors??+$∞. Mow your own grass..+$40 wait…better make that $+0. Still think GDP measures…well anything…much less the lifeblood of the economy?
And yet…I think it would be fair to say that all modern economic theory is GDP-centric. The primary goal of all governments and economists is to Increase GDP…which they believe will solve all of our problems. This is in my opinion false…and therefore, at its core, all modern economic theory is fundamentally flawed, and all economic policies based on these theories are doomed to fail in one way or another.
Long story short…for nearly 100 years, countries and their leaders have been judged by their ability to increase GDP…never mind that GDP is a fundamentally flawed concept. And so…over the years, our leaders have learned to play the game better and better…forgetting to ask whether the spoils of the game were even worth playing for. At some point… our leaders, with the help of their trusty economic advisors found a cheat code they could use to increase GDP at their will. All they had to do was borrow (or print) money, and spend it. It didn’t really matter on what. It could be a dam, a school, a bridge to nowhere, a building full of bureaucrats, or even a new welfare program.  From there, since they get to define GDP, the process for accounting for GDP(don’t get me started), and ultimately report GDP….the rest of the puzzle just fell into place… It started taking off in the 80’s and had hit full steam by 2008, when for a moment…it looked like maybe the magic donkey was starting to choke. So we doubled down…increasing our deficits from hundreds of billions per year…to over a trillion per year…now going on 5 years in a row.
This is all a completely rational outcome. If you believe that GDP is the elixir of life…and that even a tiny drop in growth, much less an actual decrease of a few % has consequences that are so terrible they will almost certainly bring on a “greater depression”…and of course impair your re-election hopes…then you will do whatever your economic witch doctor says…even if it sounds absolutely ridiculous….like running a trillion dollar deficit for 5 years running, then pretending like there isn’t a problem.
And that brings us to today. Governments around the globe are scared as hell of a drop in GDP, and willing to do anything…ANYTHING… to make sure that it doesn’t happen on their watch. Unfortunately, modern economics is pretty much a one trick pony…just ask Nobel Prize winner Paul Krugman, probably the most famous Witch Doctor economist in the world. According to him, the problem is that we simply didn’t spend enough, and to fix it, all we have to do is spend more. In other words…well, 2 leaches didn’t work….and 15 leaches didn’t work…what the hell…let’s try 200.
I think that the time has come to throw all of the witch doctors out, and the reason lies in some relatively simple accounting. Let’s imagine a simple transaction between a buyer and a seller. Each comes to the table with very different goals in mind. Our buyer would like to be able to purchase an infinite quantity of goods…for zero price. Our seller, on the other hand, would like to sell one unit…for an infinite price…and then retire. Just for fun, let’s say that the product in mind is a 1 hour massage (ok…50 minutes). At the beginning of the negotiation, we know that there are only two possible outcomes….a transaction occurs, or it doesn’t. Let’s say they haggle and agree at a price of $75. The buyer exchanges $75, for 50 minutes of the seller’s time, and GDP increases by $75.(assuming the seller reports it) Hooray right…parades in the street…all hail GDP. But…don’t forget about the evil twin…let’s think for a second about the other outcome. After haggling for a bit, the buyer is at $25, and the seller is still at $75….no transaction occurs. Oh no…GDP is crashing…prepare the soup kitchens right? Well…no. You see, the buyer has determined that the value of a massage to him is only $25. Spending $75, would mean taking a loss….which he won’t do, because he can take his $75, and get something he personally values at greater than $75…even if that something is nothing at all. On the other side of the transaction, the seller values his time at greater than $25. He would rather call it a day and spend the extra time with his kids…or watching TV, or sleeping….all things he may personally value more than the marginal $25. In this case, a non-transaction is the optimal economic outcome…even though the economist is incapable of measuring it. In the real world….like dark matter in the universe, non-transactions make up the majority of all transactions. But even though economists can’t see them, the value is real. This is Dark GDP, which I believe is one of the economic “missing links”…more on that some other day.
Let’s go back to our non-transaction, but instead, apply some modern economic theory and see what happens. The economist sees the potential to create GDP…the seller does want to give a massage, and the buyer does actually want a massage, they are just too far apart on price. So the economist has a great idea…first, the government borrows $50. Then, they create a “massage for clunkers” program, which pays buyers $25 to get a massage and sellers $25 to give a massage. Thus…the $50 gap is bridged, and Dark GDP is converted to “Real” GDP…targets are met, and all is right with the world….except that they forgot to mention that in 10 years….the buyer and seller will each have to repay the $25+ interest…..or, and this is more likely….the government will just default on the $50 loan, leaving the lender out in the cold. Also….dark GDP has been destroyed in the process. Were proper accounting possible, the losses of forcing this transaction through would be quite apparent, but economists, I suspect, are even worse accountants than most…so they conveniently forget the moral of our story, which is that for every debit…there is a credit….even if you ignore it.
So what does all of this mean? What it means is that every $ of deficit spending overrides an optimal economic solution…the perfectly legitimate decision not to transact.  The result is higher GDP…and an economy that has been transformed from the body of an Olympian, into a sick, frail, and bedridden 500 pound man. The economist/witch doctor has achieved his singular goal….growth…which is the only vital sign he is even aware of.
It means that our quest for infinite growth  is foolish and misguided….that we need to develop different tools, other than the simple scale, to measure our  economic wellbeing. Or better yet…accept, as Einstein did, that “not everything that can be counted counts, and not everything that counts can be counted”
And now for a personal story of GDP destruction. It wasn’t so long ago, that both my wife and I were working…two college educated professionals, mid-career…you do the math….we weren’t high rollers by any stretch, but for two kids from a small town, we were doing all right. Then…we started having kids, and realized, as many people do, that some things are more important than GDP. I crunched the numbers, and shortly thereafter, my wife left her job to take on a new career on the Dark GDP side of town…as a stay at home mom. As such…our families recorded GDP was nearly cut in half…and yet, despite a statistical depression…I can assure you that all is quite fine. We have less money, but more time, and we have absolutely no regrets. Just like the massage therapist in our example….we decided that our time was more valuable than the market wages being offered, and that the optimal economic solution was simply not to transact. My family survived a massive cut in GDP, and the truth is, so will our country.
And you can be assured that GDP will shrink. GDP has become dependent upon these trillion dollar deficits and when our government stops deficit spending…either voluntarily or by force…GDP is going to shrink. Period… and probably by a lot. When the government is no longer there to pay buyers to buy and sellers to sell….the market…disfigured and mutated by decades of bad medicine…will start to gravitate to a new equilibrium that will look nothing like the current economic landscape. Entire industries and infrastructures have sprung up and been built based on the existing false assumptions. (our entire medical system for example) They will first collapse, but then rise from the ashes built anew by willing buyers and willing sellers. It will be stronger, it will be healthier, and most importantly, it will be sustainable not just for a few decades….but indefinitely, or at least until we  invite the witch doctors back in.