Out of touch, anyone?

President Obama announced yesterday that any senior executives who receive a federal bailout will have their pay capped at
$500 000/year. Expense accounts, stock options, and other benefits don't count, so they can still earn millions. Wow. Even for a symbolic gesture, that's unbelievably timid. Let's review the score: failing corporation X will get a billion dollars in free money, and in return the senior management needs to tighten their belts down to a million dollars a year. Does the president realize that hundreds of thousands of non-incompetent Americans lost their jobs and savings and can't pay for food and rent?

I shouldn't have to point this out, but there are real problems with their economy which brought us this pass. Among other things:

1. Out-of-control deficit spending by some individuals, corporations, and governments caused a massive debt bubble, an economic house built on sand. We still don’t know how much of their apparent wealth is bad debt. They need transparency and lending reform before the bubble bursts.

2. A lack of oversight of the financial system led to billions of dollars of fraud. This isn't new, but it gets worse every year.

3. Creation of credit is entirely in private hands, so when bankers panic en masse as they did last fall, they cause major economic damage (”credit crunch”). Capitalism has a gun to our head. There should be a public body which can also lend money and keep commerce running smoothly in such situations.

4. North America's productive economy is linked to an unproductive and volatile speculative economy and an equally unproductive war industry. We should invest more in things which are durable and improve quality of life.

5. There is deep and persistent wealth inequality, which distorts political decisions and causes unnecessary suffering for "the rest of us". For a start, billionaires need to start paying taxes so we can fix our health care, EI, and pension systems.

I don’t want to see anyone punished “as an example”--I want to see financial criminals put on trial and systemic reform so this doesn’t happen again.

Ergo inflation

I was still wondering how these mind-boggling bailouts will affect the value of money. So to find out more, I picked up a 10-year-old book called Paper Boom, a critique of the Canadian financial system. The author makes some interesting points*, but there is something he mentions in passing that really caught my eye.

When talking about the value of money, we're really talking about inflation. In theory, inflation occurs when the money supply expands faster than the amount of real goods and services (or shrinks more slowly). With more dollars in circulation for the same number of goods, the price per good goes up. Nobody wants that** because it means the purchasing power of our salaries and savings shrinks every year. We can't just keep the money supply artificially low because then there is a shortage of currency, which leads to an inefficient barter economy. Since we can't easily control the total amount of goods and services, we control the money supply to avoid inflation.

I thought that the government controlled the money supply by minting, physically or electronically, any money used in commercial transactions. Loans or bonds wouldn't change the total money supply since they are simply a transfer from one person to another. In fact, that's quite false. Only about 5% of wealth created is issued by the government. The rest comes from a special power that banks have called "creation of credit". By law, banks can lend more money than they actually have. So if they have $1 million in liquid assets, they can lend $10 million and thereby increase the total money supply. That sounds like a bad thing--I have visions of 1929 bank runs--but as I explained above, the money supply does need to expand*** in order to keep up with the increase in goods and services, and bank loans are an efficient way of doing that. It would be difficult for a central planner to accurately match monetary and economic expansion, but since banks lend (newly created) money to purchase newly created goods, there is a close match. That being said, there is a logical consequence: the interest charged on this created credit leads inevitably to inflation. I'll illustrate what I mean below.

Suppose a community produces 100 units per year of real goods and services at $1 apiece, say food and music, and that increases by 5 units per year. That's the real economy. We'll neglect government wealth creation by assuming old currency wears out as quickly as new coins are minted. Each year, citizens take out loans (since the money doesn't exist yet) to buy the additional goods. The economy expands by 5 units/year and the money supply expands by $5/year; therefore the goods will still cost 1 $/unit the next year and there is zero inflation. However, banks don't lend for free: they will charge interest on the $5 loan. This extra dollar or partial dollar means that the money supply is now larger than the real economy, so there must be inflation to compensate. Ergo, any interest charged on bank loans causes inflation.

The next question is, how much does this contribute to real-world inflation? Canada's real economy was valued at $1150 billion in 2007 with yearly economic growth of about 1.5% and 2.5% inflation. Interest on bank loans was about 5%. So inflation from bank lending is

(economic growth)x(loan interest rate)/(size of economy)=(1.5%x$1150 billion)x(5%)/($1150 billion)=0.075%

Which is only a tiny fraction of the actual inflation. So I guess it isn't a major factor.


I realize that there are several important factors I've neglected in this analysis--I was just so astonished that banks create wealth that I had to write this down. For the sake of brevity, I'll just mention one of them. We know that human industry and commerce are damaging our planet's life support system and depleting natural resources. Expansion of goods and services, which mainstream economists take as their goal, is a central cause of this degradation. Therefore it would be preferable to halt inflation by freezing economic growth and minting a constant amount of currency. That is, to invest in reduced waste rather than growth for its own sake. I don't know the best way to achieve that, but there will need to be public analysis and control of resource exploitation and pollution rates to safeguard our environment's life-support capabilities and allow continued prosperity.


*Author Jim Stanford mostly tells us what we already know--our financial system is hyperactive, mostly pointless, heavily subsidized, unfair, detached from reality, and prone to catastrophic crashes--but he goes into depth and lucidly explains how and why this is so. A few things he said were surprising:
First, although theoretically its whole purpose is to channel savings into productive investments, the financial sector only handles about 3% of real investment. The rest is performed via retained earnings by companies, individuals, or governments. That productive investment accounts for about 5% of financial activity, and the rest is entirely casino capitalism.
Second, most successful companies in Canada are insulated from the destructiveness of the stock market through majority ownership by a family or individual.
Third, mutual funds are for suckers: they nearly always underperform the stock market as a whole. Mutual fund brokers do so well because they spend hundreds of millions of dollars on advertising and because they get large subsidies through the RRSP system.

**Some argue that inflation is really only a problem for those who are already wealthy. In Canada, the poorest 30% (family income < $30 000) have such a low income that they never accumulate any savings. The middle 60% ($30 000-$250 000) usually invest any surplus income in paying off their mortgage, so as long as their wage keeps pace, they actually benefit from inflation. The richest 10% (family income > $250 000), whose assets and real estate are paid-for, invest their surplus income in the financial system, and that is where inflation is a big problem. So for 90% of Canadians, high employment and wages is much more important for their financial well-being than low inflation. I agree with that under normal conditions, but what I'm worried about is hyperinflation, which is very harmful to the poorest 90%.

***For commerce to function, the money supply needs to keep pace with the expansion of the real economy. However, banks are given the power to create wealth but not a mandate to do so. This can lead to serious problems when, for one reason or another, banks refuse to create wealth (ie lend money). That's exactly what happened last fall; bankers panicked over the collapse of the stock market and caused a paralyzing "credit crunch" until they were bribed to lend money again.

"The Strong are strongest alone"

US Congress enraged the Canadian government this week by adding a clause that any bailout money (in the trillions now) must be spent on American firms only. We've been NAFTA partners for 20 years, and they still treat us like an unwelcome houseguest. Is this the start of another 1971-style trade war between Washington and Ottawa? Considering they import 20% of their oil from us compared to less than 5% in 1971, plus a lot of their electricity and raw materials, that might not be a good idea.

Either way, this halfhearted protectionism seems so puny compared to the scale of the problem. The US has an $800 billion per year trade deficit; they can't produce enough to satisfy themselves, and no-one wants to buy their shoddy goods. They've been coasting for decades, using their military dominance to rewrite the international rulebook in their favour and letting their civilian and industrial infrastructure decay. They can't fix that just by giving mad cash to the largest corporations--there needs to be real investment and real restructuring to become productive and self-sufficient again.


When the news becomes too depressing, I sometimes play a little game I call "stupid or evil?" For instance, Hurricane Katrina killed thousands and wiped most of New Orleans off the map before help arrived days later. President Bush said afterwards that no-one could have predicted that the New Orleans levees would break, yet the week before he was explicitly told that that was a major risk.

Despite his reputation, I think that is a clear case of "evil" not "stupid". Why did the US Justice Department allow torture and suspend habeas corpus and Geneva Convention rights? Why did Clinton force single mothers to get a job and pay for childcare to get welfare benefits? Why did Reagan "not recall" the Iran-Contra affair? The list goes on.

Likewise, it seems obvious that these trillions of dollars of bailouts will only make economic collapse worse if and when it does come by inflating the debt bubble and exacerbating financial inequality. So either (a) the White House and Congress have terrible economic advisors or are ignoring good advice or (b) senior decision-makers will personally benefit from their decisions. (Or (c) their decisions are right and I'm wrong.) There is no way to be sure unless there is transparency and investigation.

Update: the White House weighed in and modified the "buy American" clause to specify that it would abide by NAFTA and WTO rules. So no trade war for now.

Deficit saving

(StatsCan, 2008)

In the past federal election, all parties including the NDP and Greens promised to run a balanced budget no matter what. 3 months later, the Conservatives' budget does indeed have a deficit, and they are roundly criticized for it.

We know from "governing" our own affairs that running a long-term deficit is bad because sooner or later debt payments grow out of control and force us to make painful spending cuts. It is OK to keep a certain level of debt--in fact, nearly everyone does--but too much is a recipe for disaster. The same logic should be applied to governments... or should it?

1. Just like businesses, governments take on debt to pay for profitable projects. Such a deficit is worthwhile if the profits from the project are larger than the interest payments. In some cases, the deficits and profits are within the same organization, such as the now-privatized Ontario Hydro; in other cases, a different department or the citizenry itself benefits, such as treatment of raw sewage to prevent an expensive epidemic of waterborne disease. Water treatment plants will always run a deficit, but it is silly to say that we shouldn't treat our water because of that. Many academic, social, and cultural projects have no financial benefit whatsoever but are still worthwhile.

2. When interest rates are lower than inflation, as they were for decades, the real value of the debt shrinks by itself. In other words, government revenues rise naturally with time as the money supply increases, and as long as the deficit is smaller than that rise, there is no problem. So if a government really wants to reduce its debt, it should have a low-interest macroeconomic policy. Perversely, since the mid-80's our government has had both balanced-budget and high-interest-rate policies. Interest payments went way up, and the debt still grew despite painful cuts to social programs.

3. The government is also concerned with encouraging investment. That way, unproductive capital can be put to good use. Government bonds are an excellent investment: in return for regular (and 100% guaranteed) interest payments, the rich lend their cash to fund public programs. Without government debt, there would be no government bonds, and investors would turn to speculative "investment" like that which lately shattered the global economy. Government could also tax the rich directly to finance its public programs, but acquiring debt is considered less intrusive. From that point of view, the only problem with a large debt is that tax dollars from the working class are being continuously given to the rich with nothing in return.

4. The government is also concerned with the well-being of its citizens and with the productivity of the overall economy. There are social and financial benefits when citizens have good jobs, and sometimes it's worth it for the government to step in and provide such jobs in sectors or regions too unprofitable for private corporations.

5. Another pertinent question is to whom the interest payments are paid. In most of the 20th century, government departments borrowed from the Bank of Canada, which meant that there was no net cost to the public. When they borrow from private banks, they are paying for the privilege of creating their own currency.


With that said, it should be clear that running a government deficit is not automatically a bad thing.

Vicarious vitriol

As a rule, I don't reprint the words of others on this site; too many blogs do that, and taken together it often turns the Internet into an echo chamber dominated by one or two narrow viewpoints. I'll make an exception this time because the polemic below is both well-reasoned and entertaining... and because its target is someone who has annoyed me for years--Thomas Friedman. (Lately he reinvented himself as a Green, which I definitely can't take lying down.)

Flat N All That by Matt Taibbi

For those who don't know the man, he is a famous author and New York Times columnist. Not because he is insightful or talented or diligent or knowledgeable; his only qualifications seem to be an unwavering support of whatever the New York establishment wants at the time (electricity and banking deregulation, the invasion of Iraq, tax cuts for the rich, lavish corporate subsidies without oversight) and his marriage to a multibillionaire. His analysis, predictions, and advice are almost always catastrophically wrong. His artless writing and baffling logic would be funny if it weren't so horrifying. For instance, here is his view on the Gaza attack:

"Israel’s counterstrategy [in 2006] was to use its Air Force to pummel Hezbollah and, while not directly targeting the Lebanese civilians with whom Hezbollah was intertwined, to inflict substantial property damage and collateral casualties on Lebanon at large. It was not pretty, but it was logical. Israel basically said that when dealing with a nonstate actor, Hezbollah, nested among civilians, the only long-term source of deterrence was to exact enough pain on the civilians — the families and employers of the militants — to restrain Hezbollah in the future. […] In Gaza, I still can’t tell if Israel is trying to eradicate Hamas or trying to educate Hamas, by inflicting a heavy death toll on Hamas militants and heavy pain on the Gaza population…If it is out to educate Hamas, Israel may have achieved its aims."

Truly chilling. This man can justify anything. I could go on, but I think I've made my point.

I should add that Friedman is not by any means writing alone. For example, during the buildup to the Iraq war in 2003, the New York Times played fast and loose with the facts in its news section, which gave more weight to Friedman's pro-war arguments. (Remember Ahmed Chalabi's insider account, the White House's secret WMD evidence, "Saddam gassed his own people", "Iraq can strike within 45 minutes", "Saddam kicked out UN inspectors"?) Throughout America's TV and radio networks, newspapers, and magazines, there were similar pundits and journalists who repeated the same arguments and half-truths enough times that they seemed self-evident. As with Friedman, they bent logic and facts to the breaking point to stay on message. And six years later, 25% of Iraqis were killed or displaced and America threw trillions of dollars into a hole in the ground (mass grave?), which could have paid for universal high-quality health care and education in both countries.

Friedman &co are not a sign of American stupidity, callousness, or ignorance. Friedman, especially, has little in common with real Americans, those who buy their own groceries, worry about their jobs, or drive an aging car on their yearly vacation. They are a symptom of concentrated private media ownership, witting or unwitting agents in a concerted effort to shape public opinion in the desired direction. I can't say that for a fact, but it seems more likely than the alternative, which is that American journalists and editors are exceptionally sloppy, illogical, and credulous.


Bonus reading: There are some places which do offer intelligent commentary and debate, such as the Manchester Guardian Online, ZNet (see also here), Informed Comment, or TomDispatch. They clarified a lot of things which mystified me as a young man, eg. how someone like Friedman can be a famous and respected commentator. These articles from Noam Chomsky and Justin Podur are the some of the ones I read back in the day, but there are many articles, lectures, and books on these and other issues out there.