Payroll tax holiday

Depressions. There are people today, mostly in their nineties, who experienced the last one that commenced in 1929 and ultimately ended because of huge government expenses and deficits to fight the second world war. There is no one alive today who can remember the other one that was also precipitated by a monetary crisis in the mid 1890's. While the cause for both can be traced to liquidity, the availability of loans, the underlying reasons are different.

In the 1890s the money supply was gold. For fifty years the country had increasing amounts of this commodity from California, Alaskan and Yukon gold mines. The supply of new gold began to dry up in the 90s, but not the need for it to fund expansion.

The capricious spending of the 1920s came to an abrupt end when speculators realized that the value of the stocks they owned was ethereal. The banks that lent money on what they thought was market value, suddenly found that their collateral had no substance. They could not lend and business could not find funds to continue growth.

In 2008 the basis for growth was not gold nor stocks, but the consumer's appetite for big houses funded by what was perceived to be a never-ending increase in value of their investment. Americans began to use their homes as ATMs. Again, the banks went along with this fantasy, fueled by the guru of the Federal Reserve, Alan Greenspan.

Consumers could not afford their mortgages and cut back on spending. Business saw inventories increasing and cut back on both hiring and making additional product. Banks stopped wild loans of 100% or more of value. While the basis was different (houses as collateral versus stocks as collateral) the problem was the same. Loss of liquidity.

In 1935 along came John Maynard Keynes who wrote The General Theory of Employment, Interest and Money. He basically said that there are three components of any economy: What consumers spend, what business invests, and what Government spends (or invests). These three items comprise the Gross Domestic Product (GDP). Reduce any one of them and GDP decreases.

The deficits caused by our participation in World War II brought an end to the Great Depression and convinced some that Keynes was right, that government must step in when the other elements of GDP are not viable.

A moratorium on the Employment Tax (FICA) that funds Social Security is now being considered. In fact, Senator Scott Brown (R. Mass) had indicated his support of this idea in January. This tax goes into a Trust Fund that is then borrowed by the Government to fund deficit spending and may be the largest lender to the General Revenue. Stopping this tax does not add to the general deficit. It is not part of the federal budget.

What does a moratorium do? First, we do not have a problem for funding Social Security until about 2037 under current actuarial calculations. By allowing current employees to use these funds that would otherwise be a tax, consumer spending will increase immediately. Secondly, business who will save their portion of FICA will have funds to both increase investment and incentive to hire additional workers since the cost of wages will be reduced by the elimination of the FICA tax.

The placement of funds in the hands of consumers and business will be the fastest way to improve the GDP. Keynes would be smiling.

Economics 101

There are two ways to look at macroeconomics, one called Keynesian (government spending to prop up the economy) and one most recently related to Milton Friedman (monetary policy as the best way to manipulate the economy). From an accounting perspective, both yield the same answer (GNP), but they diverge in how each leads to its result.

Keynesians view GNP as the equation of the sum of income (what consumers earn for consumption, C, and what they save, S) and what the government earns in taxes (T). This side equates with expenditures, what consumers spend for consumer goods (about 70 percent of the total), private investment (I) and government expenditures (G).

The formula, C+S+T=C+I+G, symbolizes the basic model — the left side is income, the right side is expenditure. In today’s economic scenario, consumer expenditure (C) and private investment (I) have slumped to depression levels. The only salvation under the Keynesian model is for G, government expenditures, to make up the difference. The gap in the last quarter was over 6 percent, a reduction in C and I expenditures.

C and I are about 80 percent of GNP. They are so large that increasing G must be so massive to bring GNP back to equilibrium. GNP should be about $15 trillion. The 6 percent reduction would require about $1 trillion in immediate increase in G, and possibly a continuation for one or two years.

Monetary theory also has a formula for national income: M, the money supply and V, the velocity of turnover. GNP equivalent to the Keynesian would be M times V.

In our current circumstance, V has been slowed because it is the banking system that controls it. The Bush administration operated from the perspective of “juicing” the banks, getting them to lend funds so the economic system would regain its foundation and money would flow from buyers to producers to workers in an endless cycle. Nothing wrong with the thinking, it just did not happen.

Now, there is another measure of GNP I will call micro/macro. National income is the sum of all quantities bought (Q) times their price (P). In order to clear markets (Q), P must be such that there is enough money (MV). If the money supply is curtailed by a slow down in V, P must fall, a deflation — something to be avoided at all costs — it is a psychological killer.

Conclusion. If you are a Keynesian, increasing G is your chosen route. The amounts would have to be so substantial as to be impossible to comprehend.

If you are a monetarist, finding a way to increase either M (printing press) or V (getting the banks to lend) is your answer. Our first attempt was to increase V (lending by banks). It was a failure. Printing money is a possibility, but very dangerous.

The long run solution is that liquidity must be restored, that government deficits cannot be maintained at the trillion-dollar level. The real need is to restore confidence in the money supply and those who run it, the banks and the Fed.

Steamboat Springs Today March 11, 2009