A Solution Exists…I Can Quit Any Time

Tyler Cowen writes,

Unfortunately, longer-lasting solutions require coordinated agreement among many euro-zone nations and, possibly, the broader European Union. That would include significant debt write-offs (as the International Monetary Fund is suggesting), quick moves toward better-integrated European banking institutions, and a general agreement that the European Central Bank unconditionally support troubled debt securities without trying to manipulate home governments’ policies.

I would say that a longer-lasting solution has to include adopting sustainable fiscal policies. Read the whole column. Another excerpt:

Unfortunately, the relevant governments — and their citizens — still don’t seem close to accepting the onerous financial burdens they need to face. And when those burdens are unjust to mostly innocent voters, no matter whose particular story you endorse, acceptance becomes that much tougher.

Still, we shouldn’t forget that a solution exists.

Meanwhile, back in the United States, Jonah Goldberg writes,

You could confiscate 100 percent of income over $1 million, and it would cover about a third of the deficit (and crush the economy in the process). You’d still have to deal with spending, particularly entitlement spending.

But the Democrats want to do . . . nothing. Or at least that’s the position they seemed to be taking this week.

I want to caution readers not to commit the Fundamental Attribution Error. That is, do not attribute the current political strife and apparent short-termism to the personalities of politicians. Instead, these characteristics are structural defects of a system without a hard constitutional brake against deficit spending. Absent an effective constitutional brake, deficit spending is like smoking. In theory, the politicians can quit at any time. In practice, in many cases we end up with cancer.

That is the import of Lenders and Spenders, an essay that I expect I will be linking to regularly. The point of that essay is that debt crises are easy to slide into and very difficult to get out of.

At the end of the second World War, the United States was fortunate in that (a) running deficits in peacetime was still taboo and (b) Social Security was running surpluses that the politicians had not yet put their hands on, because it was considered a separate account. Unfortunately, both of those taboos went away in the 1960s, when Keynesianism became orthodox and President Lyndon Johnson got his hands on the Social Security surpluses by changing to a “unified budget”.

Eventually, some smokers get cancer. And some deficit-spending countries succumb to the fiscal equivalent. I used to think that Europe was going to get there before the United States, because I thought that in this country we had a stronger political will to restrain deficit spending.

I am starting to change my position. The mainstream views in the United States on deficit spending now lie somewhere in between, “We can quit at any time, but now is not the time” and “We never have to quit.”

Have a nice day.

Home Ownership and Wealth

According to Edward Wolff,

median wealth plummeted over the years 2007 to 2010, and by 2010 was at its lowest level since 1969.

I see this as a result of the policy of encouraging the middle class to take a highly levered position in housing. I had just been looking at an earlier paper by Wolff, which looked at the wealth data through 2007. In that paper, if you looked at the middle 60 percent of the wealth distribution, the gross value of their homes accounted for 65 percent of their wealth (because of mortgage debt, their net equity in homes was less than 40 percent of their wealth).

In my opinion, households would be better off if their savings were in diversified asset portfolios, including shares in funds that invest in stocks and real estate. Instead of making a mortgage payment, you should use that money for a combination of paying rent and saving in a diversified portfolio.

I think that the main reason that debt-financed home purchases are the standard savings channel for most households is that it is a mechanism for pre-commitment. Most households will not have the discipline to put money into savings every month. Moreover, of those that have the discipline, many will shy away from higher-yielding assets because of loss aversion. Taking on a mortgage is a way of pre-committing to sinking money into a risky investment (housing is indeed risky in real terms, even though nominal house prices typically rise), rather than spending the money or putting it into low-yielding safe assets.

If public policy wants to take a paternalistic approach to incent savings, we should be looking to create pre-commitment mechanisms that encourage people to set aside money that they invest in diversified mutual funds, rather than highly levered investments in their homes. Of course, such a policy would have to run the formidable gauntlet of the housing lobby.

Note that I would be rather uncomfortable with the idea that the government should take on this paternalistic role at a time when it is engaged in such heavy deficit spending. Politicians would be saying to households, in effect, “Save more so that we can do the spending.”

Deficit Spending and Political Conflict

In Lenders and Spenders, I recently wrote,

this sets the political system up for conflict and strife in year two, when the burden of paying the debt has to be apportioned. As we have seen, it could be divided any number of ways. However, consider this: Lois is expecting three bushels of corn, based on what she produces and her expectation of having her loan repaid. Meanwhile, Sammy is expecting two bushels of corn, based on what he produces. There are only four bushels of corn available, and there will be a political battle over who gets disappointed the most.

This is one of my favorite essays.

Inflation and the U.S. Debt Problem

Timothy Taylor wrote,

if federal deficits are first definitively placed on a diminishing path, then a quiet surge of unexpected inflation could help in reducing the past debts. But on the current U.S. trajectory of a steadily-rising debt/GDP ratio over the next few decades, inflation isn’t the answer–and could end up just being another part of the problem.

He links to analyses that support this conclusion.

Reviewing John Allison

I reviewed John A. Allison’s The Financial Crisis and the Free Market Cure for Reasonpapers. I think that one can learn from reading it. I agree with much of his analysis and I share many of his opinions. However, in my judgment the book fails to live up to the standard of argument that I want to encourage. That is, I want people to constantly consider, “What would someone who disagrees with me think about this issue? What might be the unpleasant consequences of the solutions that I am proposing?” etc.