Now let’s apply these issues to another one close to your life. Savings and retirement. Savings also follow an exponential process, albeit one neither as rapid nor as certain as those involving viruses. The same principles apply, however. But in this case instead of wanting to avoid the gains at the end you want to start saving early in order to capture the big gains in your 50s and 60s as you approach retirement. You don’t get many attempts at retirement so you need to use theory rather than experience. And because you don’t get many attempts you need to learn from other people, including other people’s mistakes, to guide your savings decisions today.
Economists usually look at saving for retirement as a decision that will be based on “rational, forward-looking behavior.” I think that Alex is much more realistic. He points out that people learn best from repeated personal experience. If you mess up the decision to save for retirement, you don’t find out the consequences until it is too late. To make good decisions, you have to learn from theory and from the experiences of others.
A related issue is deficit spending by the government. We have no personal experience of deficits leading to bad outcomes. People like me point out that in theory the government has to stop piling on debt at some point. But if people need to learn that lesson from experience, it will be too late.
Alex’s advice isn’t really theory. It’s more a repeat of classical wisdom on savings.
Theory isn’t what people should learn from because theories change all the time and are eventually replaced with new theories. We should learn from classical wisdom (which is more robust) and experience.
“Alex’s advice isn’t really theory. It’s more a repeat of classical wisdom on savings. We should learn from classical wisdom (which is more robust)“
+1 – very well said
(To this, I would add herd mentality…what your friends and family decide uponfor a retirement strategy has an impact on your retirement strategy)
This reminds me of the creationist accusation that, “It’s called the theory of evolution. It’s only a theory.” Where they are using “theory” to mean a story with a diploma, something that’s not definite, just a sophisticated guess. When theories grow up, they become “laws” but most of them die in childhood.
But lots of things are called “theories” that under that definition are laws: Newton’s theory of universal gravitation, Einstein’s theory of relativity (both the special and general), the kinetic theory of matter. They are not intuitively obvious but if you act as if they are not true, you may get burned. I think Tabarrok and Kling are using theory in that sense.
Call it what you wish… but your point is really nothing more than an uninteresting meta discussion about the difference between a theory and a non-theory. Except, you also decided to introduce the creationist accusation into the mix.
I can’t speak for the Dawit, but I interpreted his post as demonstrating that herd knowledge passed down from generation to generation is probably more influential than any academic “theory” (however defined).
Thank you, Tobias. That’s exactly what I was saying.
Even when it comes time to “experience” the negative consequences of deficit spending, they won’t be borne evenly. Just like every other economic problem, it will hit some very hard, and others will profit and move ahead at the same time. And, lots of other causes will be proposed. Thus, it takes a really overwhelming consequence to ingrain it as a consequence of a specific action in most people.
What looks like a consequence of “deficit spending” to you and me will come across as a “failure to implement a wealth tax” to others.
Just stumbled on this:
I cannot check the validity of the hypothesis, but maybe a stimulus needs to be this forceful and this prolonged to create a societal and cultural learning effect:
“The members of a successful family could maintain their economic position over time only if in each generation large amounts of additional wealth were extracted from their land and their neighbors through high intelligence, sharp business sense, hard work, and great diligence. The penalty for major business miscalculations or lack of sufficient effort was either personal or reproductive extinction.”
https://www.unz.com/runz/how-social-darwinism-made-modern-china-248/
When I was a kid, it was common to hear stories from the old timers about successes of regrets of investments they made (or failed to make) over a long period, often with initial memories when they were just 18 and earning their first pay. If they retired at, say, 63, they had an investment history of 45 years, which is a long time to learn and to experience all kinds of ups and downs.
Today, it’s common for professional couples to not get into the black (with the exception of their mortgages), for a long time, after their education and low-pay “prove yourself” years, and after a lot of debt is paid off. With the high rent, there may not be a lot left to invest anyway, and a lot of people don’t pay much attention to what’s going on in the investment-relevant world when they don’t have a lot on the line yet.
I figure folks like that today are losing 10 – maybe even 20 – years of investment experience vs. their predecessors. Maybe other kinds of experience too. With less personal learning, learning from the wisdom and experience of others who came before is more important that ever, but I think the typical esteem and regard for that kind of knowledge is also about as low as ever.
“A related issue is deficit spending by the government. We have no personal experience of deficits leading to bad outcomes. People like me point out that in theory the government has to stop piling on debt at some point. But if people need to learn that lesson from experience, it will be too late.”
So prescient, but seems so out of touch for some strange reason. Remember the halcyon days of the 1990s when such conversations were still in the mainstream.
In any event, here is a link to an ASK classic (not just self-recommending, it’s basically required reading)
https://www.heartland.org/news-opinion/news/lenders-and-spenders-confronting-the-political-reality-of-debt?source=policybot
Steve Sailer today links to a Town and Country piece entitled “No One Retires Anymore.” Retirement is a privilege of the entitled few encumbering bureaucratic positions in government.
The notion that federal government spending will ever be managed by the indoctrinated classes is laughable. In the next decade government will begin to directly plunder any retirement savings that remain after inflation and the higher education industry have swindled away their shares. The USA is devolving into Chinese-style state capitalism except without an overclass of competent elites that China has. The safe bet for people trapped in the USA is to, as the song goes, move to the country (preferably an unincorporated area) and plant a garden.
Victor David Hanson’s piece yesterday entitled “Thin Façade of Authority” at American Greatness sheds a glimmer of hope that the competence of the unindoctrinated will cushion the fall.
However, that the spiral downward is out of control is made irrefutable in Scott Yenor’s “Higher Ed Is Crumbling” at Law & Liberty, a review of John Ellis’s magisterial book The Breakdown of Higher Education. Tenor writes:
“Another canary in the coalmine is the quality of education as measured by skills and general knowledge. On this, universities graduate people “who know little and can’t think,” as Ellis relates in study after study. Arum and Roska, authors of Academically Adrift, find “no statistically significant gains in critical thinking, complex reasoning, or writing skills” for nearly half of students. The National Center for Education Statistics sees a “sharp decline” in literacy between 1992 and 2003. The numbers are astounding: nearly 70 percent of college graduates cannot read reasonably complex materials (we’re not talking about Shakespeare, but something like an FDR speech) and explain what it means. Depending on the question wording, somewhere between 40 and 70 percent of college professors think their students are unprepared to think, write, and speak clearly. (And judging from much academic writing, the professors are not overly prepared themselves!)”
And yet the unindoctrinated bear the punishing incidence of taxation while the tax-exempt and government subsidized merrily feast away. Perhaps the single worst provision in the CARE was the $300 “charitable” contribution deduction it created for non-itemizers, a sure net negative multiplier tax expenditure if ever there was one.
If children want to learn from examples, let them study the history of the pacifist Anabaptist sects. You survive by not accumulating a lot of wealth that attracts the attention of government expropriators, and when they finally have you in their sights, you must move quickly.
You write that “in theory the government has to stop piling on debt at some point.” But, actually, the government can run deficits forever, so long as the country is growing economically and the deficits are not too big. And what does theory say is the optimum size of the public debt? That is a rather obscure question. Even if we wanted to be guided by theory (I’m all for it, though it seems not to be popular), we would like to have theory deliver a clearer result.
I think “piling on” suggests “too big” rather than “not too big”.
Government interest charges must remain as uncertain an any other budget item in a stable value chain. Government goes from DC down to the county, they all need that same uncertainty in budget to avoid chain collapse.
Just curious.
Has there ever been a case of country that only ever spent or borrowed in its own fiat currency ever having a catastrophic economic event that could be provably traced to deficit spending and little else?
I know there are history books that keep a list, but you judge the accuracy.
Since you asked…
a good recent history of decline is _Balance_ by Glenn Hubbard and Tim Kane. It’s not a waste of time to read it.
https://glennhubbard.net/books/balance
I’m guessing the deficit spending is a sign of something deeper. It’s syndromal. Whatever the syndrome is, it’s bad. It’s storing up problems for the future.
It’s always a sign of something deeper and it’s always a sign of something bad. Inflation is probably waiting in the wings.
Inflation these days (post WWII) is kind of similar–thus the statement (who said it?) that “Serious countries do not have high inflation rates.” After the 1970s price shocks and stagflation, “serious” countries got inflation back down to a “tolerable” level again. France was a more serious country than Brazil or Argentina. Italy was a more serious country than Greece. Germany was very serious. Very serious indeed.
For the converse, see the history of inflation in Latin America since independence. Albert Hirschman, who spent some time in Colombia, once asserted that inflation was a symptom of unresolved conflict, a sort of sub-clinical half-way house to civil war. He wrote a lot–where he said it I’m not sure. Probably either _Strategy of Economic Developement_ or _Exit voice and loyalty_.
= – = – = – = –
As a final note, I am reminded of an assertion periodically made by Deirdre McCloskey. To paraphrase, in the economic history of modern economic growth “The Essential Question” isn’t what made the UK different from Italy so that Northern Italy eventually caught up and overtake the UK, or most of it.
“The Essential Question” is why didn’t Argentina become as rich as Canada. If Argentina is such a smart country, why isn’t it as rich as Canada? Riddle me that!
Methinks part of the answer is that a good bout of hyper-inflation might be enough to help knock a country off its growth path to sustained opulence.
= – = – = – =
Final stream of consciousness simile. If you meet someone who wants to become part of your life and he doesn’t have any friends, that’s a red flag. You don’t know why he doesn’t have any friends when you initially meet him, but you should continually be asking yourself what’s up with the guy. If he’s such a great guy, why doesn’t he have any friends?
For some reason, excessive deficits and high inflation is like that–it’s a similar red flag when it comes to countries. There might be exceptions–I can’t think of many.
” People like me point out that in theory the government has to stop piling on debt at some point.”
The government does not determine the fiscal balance. In a closed economy, the fiscal balance is determined by the private sector’s saving intentions. Here is the accounting math:
GDP = C + I + G
GDP = C + S + T
Equating, we get the sectoral balances equation (the private sector and the government sector):
(S – I) = (G – T)
Since the private sector typically desires to net save, i.e., save in excess of investment (S > I), then the government must run the corresponding deficit (G > T). If the government fails to run the deficit, then saving will still balance investment but it will do so with higher inventories due to unsold goods. That means layoffs and a recession. A recession means that welfare payments rise and tax revenues fall, and the government deficit rises that way. Either way you end up with a deficit.
Bear in mind that these are accounting identities which means they are true by definition and not contestable.
If the government has no deficit and no debt, the private sector can produce and purchase canned food, shelter, and machinery. These are all forms of saving that do not depend upon a government deficit. I will leave it to you to revise your equations if you feel inclined.
If there is no population growth they won’t produce much shelter. The canned food and machinery mean more leisure can be planned for. That’s not the same as unemployment resulting in welfare payments.
“These are all forms of saving that do not depend upon a government deficit.”
Actually, most saving does not depend on a government deficit, only net saving. (The “net saving” is not the “S” in the sectoral balances equation, but the difference between “S” and “I”). Since saving always equals investment, the net saving is balanced on the other side of the equation by government dissaving, such that saving equals investment for the whole economy. For an open economy, saving balances investment at the global level.
Absent a government deficit, the (S – I) equation goes to zero which is another way of saying that saving equals investment, in the way that you described. “Net saving” means the saving that takes place above that, comes from the government deficit, and is net financial assets.
Example:
If the private sector produced $100 of capital goods, and the private sector wanted to save $120, then the government would supply the extra $20, as net financial assets.
(S – I) in this case would be ($120 – $100), the extra $20 is net saving and is supplied by the government deficit, i.e., (G – T) is also ($120 – $100).
If the government did not supply that extra $20, then the private sector earned $20 which was not used for consumption. Here, the $20 becomes unintended investment in inventories, businesses than cut back on production which leads to unemployment.
Because saving is the excess of production over consumption, and the unemployed do not produce but continue to consume, i.e., dissave, then the unemployed are the ones supplying that extra saving.
So either the government dissaves, or the unemployed do.
Please assume when I said savings I meant net savings by the private sector. I think that’s obvious from the context.
Your wrote: “If the government has no deficit and no debt”
Net saving is not possible without a government deficit, only saving. Also, there would be no money in the economy.
If the government spends $100 into the economy and taxes back $80, the $20 is net financial assets and base money. Commercial banks can create loans and deposits because of that base money thus expanding the money supply.
Currency and reserves, created by deficit spending, is what underpins the money supply.
Those identities are never perfectly equal,, they track each other.
When tany sector bets more on the future, they do so at the margin in a stable system and the savers adapt.
“the savers adapt”
Saving is non-volitional. The amount of saving in a community is determined by the amount of investment in a community.
Saving is the excess of income over consumption. If you decided to save an extra $100, the income of the community, and by extension its saving, would fall by the same $100, leaving saving unchanged. The effort to save, in the aggregate, defeats itself. This is Keynes’ Paradox of Thrift.
If the business community decided to invest zero in a given time period, the amount of saving in that time period would be exactly zero.
No.
There is a liquidity reserve that absorbs some of the imbalance. When borrowing increased on the margin, we get congestion, folks trying to buy more than expected. This happens first, and the balance has some reserve inventory to handle the crush.
This is absolutely essential, this is why Walmart keeps inventory in reserve. Eventually savings will adapt. In the visa versa it is borrowing that will adapt, but the adaption is not instantaneous. Pricing happens after the adjustment, pricing does not even work well until the adjustment. So it is a few steps after the change in S/L that firms adjust pricing back toward balance.
This is the mistake of assuming complete markets, there are no complete markets. And you find that savings and loans never balance, they are constantly discovering each other. There is no Godot, no mysterious force keeping balance, it is a discovery process.
I anticipate a response that so what, at least savings and loans eventually reach balance, so the identity holds within a bounded error.
Good, but does this always hold true? Under what conditions to they diverge? And that is the thousand dollar question, that is the question a world of mathematicians are, at this very moment, trying to decide.
Borrowing for consumption goods does not add to saving. Only borrowing for capital goods adds to saving.
Say you go to a bank and get a loan for $100. The bank creates a matching deposit liability of $100. When you spend that $100 on a CONSUMPTION GOOD, it travels through the economy with each person retaining a small part of it according to their marginal propensity to save. The sum of all this saving is $100.
For you however, you have a loan for $100 which means that your savings fell by $100, i.e., you dissaved $100.
Saving for the community in the aggregate remains unchanged.
Say you go to a bank and get a loan for $100. The bank creates a matching deposit liability of $100. When you spend that $100 to construct a CAPITAL GOOD, the worker you pay lays a claim to that $100 deposit. Like before, the $100 ends up scattered through the community as saving.
For you however, you have a loan for $100, and you have a capital good worth $100. For you, this transaction nets to zero and your net worth has not changed, only the composition of your assets. Your savings remain the same.
However, there is still that $100 of additional saving in the community, which is exactly matched by that the addition of that $100 capital good to the capital stock of the community.
Saving equals investment. S = I.
“Bear in mind that these are accounting identities which means they are true by definition and not contestable.”
Bear in mind that an accounting identity is nothing more than a simplified model.
(Unless it actually works in practice, including for tail events, then it doesn’t really do much to undermine the analysis stated here on debt and deficits.)
There are no simplifying assumptions in these accounting identities and they continue to hold true for tail events.
There are two sectors in a closed economy, the private sector and the government sector. In a tail event, there are two sectors in the economy, the private sector and the government sector.
An economy produces two types of goods, capital goods and consumption goods. In a tail event, an economy produces two types of goods, capital goods and consumption goods.
And so on. While the numbers may change, the accounting identities don’t.
“There are no simplifying assumptions in these accounting identities and they continue to hold true for tail events.”
Good luck to you then, but don’t drink too much of the Kool-Aid while you are trying solving for the equilibrium.
Income statements and expense statements are never perfectly known. Pricing does not happen instantaneously, remember backward GDP revisions?
There are primitive societies that don’t know how to count. Even there, the accounting identities hold true.
A closed economy is about as simple an assumption as you can make. Not much on a scale smaller than the Earth itself can claim that closed status, and if you add up the trade numbers for the planet, apparently there is loss there too.
Further, you are also assuming that the transactions costs for government expenditures are the same as private. Studies vary in this, but most estimate between 1.25 to 1.67$ of cost to raise 1$ of government revenue. Assuming instead that the source of spending is equivalent in an accounting sense is going to get you into trouble, just as saying paying people to dig ditches and fill them in is as good as producing what people want.
Lastly, just because something is an accounting identity doesn’t mean it has relevance to the real world. We can define RDI as the sum of eggs eaten, temperature of Saturn, and Keynes’ bank account. We can also define it as the weight of Bengal tigers, the universal constant and the population of Tripoli. We can set them equal. So what? Changing the number of eggs we eat won’t imply a change in the rest. Changing the units for temperature and weight will not change the components ‘ underlying behavior either. Nor should we expect it; accounting identities are not relationships in nature, just conventions.
Talk to an accountant sometime about activity based costing vs cost based. In theory they should be the same, but good luck with that.
For the sake of controlling the deficit we can only hope that the Tea Party Movement will return. It will happen as soon as a Democrat is elected POTUS, natch.
I believed every economist who guaranteed that the 2008-2009 financial crisis government deficit spending would inevitably lead to rampant inflation and then I watched as those same economists rationalized its failure to happen. I honestly don’t know what to believe now, but I appreciate humility in making any economic forecast.
“We have no personal experience of deficits leading to bad outcomes. ”
—
Half remember the Nixon Shock.
This banking nonsense.
But wait, is not there an exact deposit for every loan? Isn’t the number exact?
The loan and deposit queues are semi independent, folk. So in this standard view, I go through and get my loan based on load conditions, then my deposit is made right away. I did not get to look at the deposit queue, others have, and my loan has already been repriced by the market.
But my money is monopoly government money, it has to enter an account! But that account is being repriced from nominal because I am trading on that account unknown to the regulated bankers. So there is a long process, sometime decades long, to make the official accounting identity more accurate than before. That process is what contains the force, the process that moves us to equalize loans to deposits. The reason for the delay is simple, we never know the current state of congestion in the value nets, pricing is always pending an a bit late getting set.
I hope you’re not saying that deposits fund loans because that’s not how banking works.
“The loan and deposit queues are semi independent, folk.”
I’m not too clear on what you’re saying here. When you go into a bank and get a loan, the bank creates a matching deposit liability. That is a new deposit created ex nihilo, i.e., out of thin air. It has nothing to do with any other deposits the bank has on its balance sheet. Here, right from the mouth of someone who has spent years in the banking industry.
“As many of you know, I have spent much of the last seven years explaining to anyone who will listen that banks do not “lend out” deposits or reserves. Rather, they create both loan assets and matching deposit liabilities “from nothing” by means of double entry accounting entries. Creating money with a stroke of the pen (or a few taps on a computer keyboard) is what banks do.” —Frances Coppola
Here is Frances’ bio from Forbes:
“I used to work for banks. Now I write about them, and about finance and economics generally. Although I originally trained as a musician and singer, I worked in banking for 17 years and did an MBA at Cass Business School in London, where I specialized in financial risk management. I’m the author of the Coppola Comment finance & economics blog, which is a regular feature on the Financial Times’s Alphaville blog and has been quoted in The Economist, the Wall Street Journal, The New York Times and The Guardian. I am also a frequent commentator on financial matters for the BBC. And I still sing, and teach. After all, there is more to life than finance.”
As an aside, I’ve been analyzing banks for thirty years now as an investor. That means reading 200 page annual reports and following the transactions in detail on the financial statements. That and analyzing other businesses is what I do for a living full time. I can confirm for you that the description that Frances gives of banking is accurate.
As Bismarck said, or may have,
“Any idiot can learn from his own mistakes. A wise man learns from watching the mistakes of others.”
Joseph Henrich would concur.
Thanks–I’ll put him on my reading list.