Author: Lawrence Marsh

Lawrence C. Marsh is professor emeritus in the Department of Economics.  He taught graduate and undergraduate economics in the department for 30 years beginning in 1975. Marsh's "Optimal Money Flow" book was released on June 16, 2020. His latest book "Money Flow in a Dynamic Economy" was released on July 4, 2023. In 1990 he co-founded the Midwest Econometrics Group (MEG), which he directed for 15 years.  He served as the director of the graduate program in economics for 13 years. He served in 2010 as visiting professor of econometrics and statistics at the University of Chicago's Booth School of Business and in 2016-2017 at Avila University in statistics and research methods in psychology. In teaching he won the James A. Burns award for excellence in graduate teaching in 1990-1991 and was an O’Malley Award Nominee for undergraduate teaching in 1995-1996.    In 2002-2003 he was selected as a Kaneb Faculty Teaching Fellow for excellence in teaching. He has served on 80 Ph.D. dissertation committees and has given several thousand lectures in graduate and undergraduate statistics, econometrics, mathematical economics, microeconomic theory and research methods in psychology. In quasi-retirement he spends his time writing and editing a variety of articles, books and newspaper columns.  His book "Optimal Money Flow: How a Dynamic-Growth Economy Can Work for Everyone" was published by Avila University Press.  Professor Marsh will forgo author royalties and donate the entire book price to student scholarships.

Winning as a Team Takes Us Beyond Individual Identity

Posted on by Lawrence Marsh

We all love the story of the rugged individual — hard-working, self-reliant, and through the magic of Adam Smith’s invisible hand, inadvertently helping others while pursuing one’s own self-interest. An entire world of economics has been built around this story. There is a lot of truth to the idea that this country was built on the frontier spirit of individual efforts overcoming difficult challenges to get ahead.

The problem with this story is that it ignores, or at least relegates to the background, the idea of each of us being part of a larger entity — be it our family, our neighborhood, our work team, or our country as a whole. Yes, we are out for ourselves to some extent, but we are also very likely to sacrifice our own interests to help others. Few people totally ignore the best interests of their family or community in their day-to-day choices. Our community identity can be as strong, and sometimes stronger, than our individual identity. Think of the basketball player who passes up the chance for glory in making the long shot and, instead, passes to a teammate closer to the basket. Think of the medic in combat who puts his or her own life at risk to save others. We thank our soldiers, police and firemen for their service knowing that they are risking their lives on a day-to-day basis to help protect us.

In some ways we are so interconnected that it is not clear that an intelligent alien entity from elsewhere in the universe would see us as separate individuals at all. To such an entity, we might be seen as the mass of humanity spread out across the globe. The dangers of world war, asteroid strikes, and irreversible climate change bind us together in a way not fully appreciated by Adam Smith’s invisible hand.

In displaying and waving the American flag, we are revealing and relishing in our larger identity as Americans. We are proud to be part of the greater team. Hopefully, we feel that same about our family. Some explore their genealogy to better appreciate their family heritage. But what about our work team. For some, there is great pride in the team’s efforts and achievements. For others, not so much.

If each individual is directly and completely responsible for a specific output or outcome, it is easy to provide incentives to reward their work. But what if your work team is producing and selling a product or service where the quality of the work in production and the marketing of the product in advertising is combined to produce sales. Are those sales the direct result of better quality or better advertising? It is sometimes hard to tell.

Moreover, the outcome of a team effort might only be determined by the interaction of team members in supporting and enhancing the efforts of the individuals on the team. This interaction and support is enhanced when the team as a whole is rewarded. For sports teams, the glory comes in winning as a team. Each member of the team understands that the others must do their part to enable the team to win. Rewarding the team as a whole can sometimes be just as important as rewarding each individual team member.

Going to one extreme or another in this regard can lead us astray. To the extent that it is possible to identity and measure an individual’s contribution that individual should be rewarded to that extent. However, it is also important to recognize and reward the team as a whole so that each team member will have an incentive to encourage, and sometimes cajole, other team members to do their best for the team. Success often requires team cohesion and coordination that cannot be achieved by each member just doing their own thing. We have our individual identity, but we also have our collective identity. Only rewarding individual identity misses the importance of our group identity in enabling good outcomes for the team.

On the other hand, if we only reward the team, as a team, and ignore the extent to which a particular individual has contributed to the team’s success, we run the risk of encouraging free riders who make little effort with the hope that their teammates will make up the difference. This was the fundamental mistake of communism — simply dividing up the team’s profits equally without regard to individual efforts. Clearly, maximizing economic productivity requires just the right combination of rewarding the team as a whole and rewarding individuals according to their individual contributions. Every enterprise may be different in this regard so broad oversimplifications of this complicated challenge are likely to be misleading. Too much emphasis on individual effort alone can be just as foolish as simply rewarding the team as a whole without regard to each member’s contribution.

Disequilibrium Economics and Adam Smith’s Two Invisible Hands

Posted on by Lawrence Marsh

In competitive markets with sufficient elasticity, equilibrium is established and maintained relatively easily. Consumer demand and supply respond quickly to the mantra: “The solution to high prices is high prices; and the solution to low prices is low prices.” Obviously, the point is that in the face of high prices, consumers cut back demand and suppliers increase supply to bring down prices. Conversely, in the face of low prices, consumers increase demand and suppliers cut back supply to raise prices. We achieve equilibrium quickly and efficiently.

Except this doesn’t work very well or very quickly in the financial markets and in the economy overall. The problem is that traditional equilibrium economics assumes rational, independent decision makers with full information and sufficient mental energy to compute and re-compute their optimal behavior in complex situations that can quickly change and invoke emotional responses. Contagion effects in financial markets can drive prices dramatically higher in irrational exuberance as higher prices cause people to jump in and follow the crowd to purchase even more in the face of those higher prices instead of less. Conversely, a downward price spiral can be hard to stop when fear overtakes hope and prices fall precipitously. Dan Ariely’s book “Predictably Irrational” reveals a problem that economists have tried to ignore and marketers have profited by exploiting. An irrational herd effect can quickly overwhelm market participants to leave markets in disequilibrium for an extended period. It is hard to understand why economists have taken so long to catch on to consumer irrationality when the people in marketing have understood consumer irrationality and have been exploiting it for hundreds of years.

Moreover, too many people confuse optimal microeconomic behavior with optimal macroeconomic outcomes. The aggregate economy does not converge toward equilibrium when microeconomic incentives do not lead to the intended desirable macroeconomic effects. The classic example is the paradox of thrift where during a recession, when people see friends and neighbors losing their jobs, they try to save a larger share of their earnings in case they might lose their jobs, but the total amount of savings falls because the drop in spending causes more cutbacks in working hours and jobs as consumer demand and prices fall causing businesses to cut back production of goods and services. The microeconomic incentive to save more leads to less total savings at the macroeconomic level. My spending contributing to your earnings and your spending contributing to my earnings can sometimes lead to greater disequilibrium instead of a convergence toward an overall equilibrium for the economy as a whole.

It would be nice to have a world that even in primitive times would have allowed individuals to compete freely and fairly with perfect competition resulting in a natural, efficient and dynamic equilibrium being established in every market. But that is far from reality. In most primitive and many modern societies, the big guy gets what he wants. The equal opportunity and competitive environment is not the natural state. Far from it. It takes a strong and active government to enforce freedom with equal opportunity and competitive markets. In his book “The Myth of Capitalism” Jonathan Tepper has revealed the surprising extent of reduced competition and increased concentration in most major industries in the United States.

For example, consider the market for eyeglasses. Glass and plastic should be very cheap. After all, we throw a lot of glass and plastic into recycling bins every week. But instead of two or three dollars, eyeglasses typically cost about one-hundred and thirty dollars or more. In reality eyeglass manufacturing is basically a duopoly with only two eyeglass manufacturers dominating the market. In the eyeglass market, Adam Smith’s first invisible hand of competition has been suppressed by Adam Smith’s second invisible hand of market power where he said: “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the publick, or in some contrivance to raise prices.”

Moreover, government can interfere with freedom and competition by imposing patents, copyrights and licensing requirements, among other restrictions such as child labor laws and government sponsored monopolies. Sometimes government intervention is good in solving problems that the free market is incapable of solving on its own. At other times, government intervention can create problems or make problems worse, so it is important to distinguish between good government intervention and bad government intervention. With limited mental energy, we have a natural tendency to think in all-or-nothing terms, but reality requires careful analysis to devise effective and efficient policies to fix free market problems without introducing significant other inadvertent difficulties. For a better understanding of the role of government in our economy see Mariana Mazzucato’s three books: “The Entrepreneurial State,” “The Value of Everything,” and “Mission Economy.”

Adam Smith’s explicit invisible hand of competition suggested that we just need to focus on maximizing our own personal utility function or profits, and others will benefit from our self-centered behavior. But Adam Smith wrote implicitly about a second invisible hand where competitors conspired together to block competition and exploit consumers. While the invisible hand of competition led to lower prices with a focus on quality, the second invisible hand led to higher prices with less concern for quality. Assuming that the first invisible hand will always dominate is naive at best. The rules and regulations set by government play an important role in determining the balance of power between these two invisible hands.

As of May 1st, I-Bonds now offer 9.62 percent interest

Posted on by Lawrence Marsh

Great news!!! As of May 1st, I-Bonds offer a 9.62 percent interest rate. But for most middle-class Americans, there is nothing here to celebrate. As currently structured, I-Bonds are not designed for lower or middle-class people.

I-Bonds were presumably created to try to get middle-class people to save more money and spend less. In theory I-Bonds should be especially helpful in times of inflation to reduce overall consumer demand as well as in recessions in providing savings to draw upon to keep consumer demand from falling too abruptly. The I-Bond savings limit of $10,000 per person was supposed to benefit the middle class without giving the wealthy another way of leveraging their wealth to further exacerbate economic inequality.

We all like to think of ourselves as being in the middle class. But remember that two-thirds of Americans do not have a college degree and forty percent of Americans could not come up with $400 in an emergency without having to borrow money. Most of the wealth of the sixty-six percent of Americans who own their own home is tied up in the value of that home. Still, getting people to save more money is a worthy goal.

However, the other features of an I-Bond limit its usefulness to the very people that I-Bonds were created to benefit.  Money invested in I-Bonds may not be withdrawn for one year. Money withdrawn after a year, but before five years, is subject to a loss of three months of interest payments. Wealthy people have very low marginal propensities to consume because giving them a little bit more or less money has virtually no effect on their spending patterns. However, poor and middle-class people have high marginal propensities to consume in that they adjust their spending up or down significantly as they get more or less money at the margin. Consequently, for I-Bonds to serve as an automatic stabilizer in times of inflation and recession, the poor and middle-class should be the primary beneficiaries of I-Bonds, but they are not.

The challenge is to design an attractive flexible investment that will work for poor and middle-class people and to make sure that they know about it and how to access it easily even if they are currently unbanked or underbanked.

People with little money need access to their money whenever an unexpected expense arises. For example, an automobile accident may require the repair or replacement of their vehicle. A medical problem may require unexpected expenditures. An unanticipated increase in rent may mean withdrawing money from savings while looking for a cheaper place to live. I-Bonds just don’t work well for people who would like to save more but can’t afford to tie up their money for extended periods.

Since most people in the middle-class are not familiar with the bond market anyway, they probably don’t know about I-Bonds to begin with so they may not feel left out of this opportunity to try to stay ahead of inflation.

Unfortunately, what at first appears to be a great wealth-building opportunity for the middle-class, turns out to be just another snack for the wealthy (or at least for those wealthy who want to bother with such a small amount of money ($10,000)).

Inflation from multiple causes requires multiple cures

Posted on by Lawrence Marsh

Consider all the relevant and important factors that have generated our current inflation.

First, the pandemic has played an important role in interfering with our unexpectedly fragile supply chain. Other commentators have already pointed out that too much emphasis on efficiency created our rather unstable “just-in-time” system. This needs to be replaced with a more secure “just-in-case” system that is robust and resilient to disruptions.

Second, many economists have reported that COVID-19 also caused people to cut way back on services (e.g., travel and dining) and to use those savings to increase demand for durable goods such as automobiles. This occurred just as the vehicle computer chips were in short supply. There has also been a significant increase in demand for housing driving up prices partially due to a new, widespread effort by some Wall Street investors to buy up single family homes around the country and turn them into rental units. Perhaps you have received a phone call recently from one of them offering to buy your home.

Third, consider the stimulus packages. Larry Summers was among the first to point out that the Biden stimulus package was too big and would result in too strong consumer demand. Ironically, President Obama had made the opposite mistake in 2009 in trying to compromise with Republicans who sought to minimize the stimulus to minimize the role of government in recovering from the Great Recession. Ultimately, Obama failed to gain bipartisan support for his stimulus package anyway. Obama’s stimulus bill was too small, but President Biden went too far in the other direction and produced a stimulus that was too big.

The pandemic also discouraged some people from going to work so the workforce was reduced just when more supply was needed to meet an increase in demand. At the same time demand increased for medical and other essential workers. The surge in demand led to a shortage of workers in general and truck drivers in particular who are needed to provide the corresponding increase in supply. The increase in wages due to the shortage of workers helped raise prices of many commodities including food and fuel. President Trump had better relations with the OPEC countries, especially Saudi Arabia, than President Biden, due, in part, to their different reactions to the murder of Jamal Khashoggi, which didn’t seem to bother Trump, but deeply upset Biden. Biden’s pleas to the OPEC countries to increase the supply of oil have gone largely unanswered. Obviously, the war in Ukraine will only make things worse so expect prices (especially food and oil prices) to continue to rise substantially.

On top of all this is an economy dominated by less than fully competitive firms which took advantage of the new inflationary environment to raise their prices even if not justified by supply shortages or excessive demand. Jonathan Tepper wrote “The Myth of Capitalism” to reveal the amazing amount of concentration in American industries. For example, our patent laws have allowed the production of eye glasses to be dominated by just two companies. You would think that a small amount of glass and plastic would cost just a few dollars, but glasses typically cost close to 100 dollars or more. Patent laws originally were intended to encourage innovation, but in many cases have suppressed both competition and innovation. Adam Smith actually provided us with two invisible hands: (1) the explicit invisible hand of competition to increase quality and lower prices, and (2) the implicit invisible hand of economic power where firms conspired together to suppress competition and raise prices. It is this second invisible hand that has become so active in our current inflationary economy. To restore competition and reduce prices patent laws must be severely limited in their application and large dominant firms must be broken up. Some import duties may be necessary to avoid excessive dependence on production in overseas countries. 

Our politicians have been reluctant to take responsibility for all this and have instead relied on the Federal Reserve to stop excessive inflation. The Fed, in turn, has emphasized the need to ‘’stay in its lane” by limiting its action to cutting back or even reversing its purchases of securities and raising interest rates. This means increasing the cost of borrowing. Unfortunately the Fed’s restrictive policies suppress both supply and demand. To meet excessive demand for its products, a firm may want to add another line of production. This requires investment. Borrowing the money to invest in another line of production may turn out to be too expensive after the Federal  Reserve raises interest rates to suppress borrowing. This approach to stopping inflation slows the economy to the point of causing a recession.

It would be much better if the Fed could target demand by those people with the highest marginal propensities to consume (hundreds of millions of poor and middle class Americans). The whole point of the existence of interest rates is to pay someone to delay consumption. Private banks cannot afford to offer a higher interest rate on savings than the interest rate they charge on borrowing. But the Federal Reserve could offer a high interest rate on savings if it was limited to relatively small balances aimed at reducing consumer demand by those most likely to spend any extra dollars. Such small balances would not have much effect on private banks or the rates that they set for borrowing and saving. Most of the money in our banking system is owned by a few thousand wealthy families who have very low marginal propensities to consume and would probably not bother taking the time to move such a relatively small amount of money. However, the total increase in savings by hundreds of millions of Americans could amount to billions of dollars in reduced spending. Most prices would stabilize in the face of such a substantial reduction in consumer demand.

Too often policy is devised by politicians, who interact with the bankers, doctors, and lawyers who represent the small minority of Americans who are exceptionally wealthy. Instead we need to target middle class families who would save more money and spend less if offered a high enough interest rate on relatively small amounts of savings. This could be done by creating Federal Reserve digital currency bank accounts for every American. To combat excessive inflation very high interest rates could be offered on small balances for only one account per Social Security number. Anyone else in the world would be allowed to have a digital currency account with the Federal Reserve (unless sanctioned by Congress) but they would not be allowed to earn interest on their account balance. The Federal Reserve is currently considering the possibility of offering such digital currency bank accounts, and I have answered the 22 questions they have asked on how this new policy tool could be implemented. Going forward we will see if they follow my never-too-humble advice.

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Stock Market: Prudent Investment or Gambling Casino?

Posted on by Lawrence Marsh

My father, Edward Cady Marsh, was a Wall Street investment banker. He took the train in to Wall Street each morning from Westfield, New Jersey and returned in the late afternoon. He specialized in industries such as the automobile industry, the steel industry, and the grocery industry. His compensation was based in part on his recommendations to the board, regardless of whether the board accepted and acted on his recommendations. As someone who lived through the stock market exuberance of the late 1920s and the crash and depression thereafter, he was very aware of the downside of stock market investing.

I learned early on that the profitability of a company was only one aspect to consider. The stock’s price was of equal importance. Overpaying for a very profitable company’s stock could be just as big a mistake as buying a cheap stock that had poor profitability prospects. Another factor that retail investors often overlook is the time horizon of stock market pricing. My own experience suggests that the typical stock is evaluated on a six month return basis. In other words, on average the market appears to be pricing stocks on the basis of how well they are expected to perform in six months. After the Great Recession the stock market bottomed out in March of 2009, but the economy took about six months before it was clearly heading up again.

If you get into a great stock too early, your investment may just flounder around rising and falling without much direction before it finally takes off, whenever that might be. Getting in to a good stock too early can be just as bad as getting in too late after its price to earnings ratio has reached unrealistic levels.

Another common mistake made by retail investors is sitting on too much cash and not investing for fear of short term losses. The general pattern of the stock market is to fluctuate up and down for some time and occasionally slip into a bear market, but, more importantly, suddenly move upward to establish a new level. It is these sudden upward moves, when you have too much of your investable funds in cash, that can make stock investing unprofitable. Many studies have pointed out that missing out on just of couple days of extraordinary gains in a very profitable year can eliminate most of the profit.

For the retail investor, investing in individual stocks can be very dangerous. Although most stocks tend to move up and down with the market over the short run, individual stocks can drop dramatically or move up unexpectedly. For the retail investor, investing in individual stocks is more akin to gambling that investing. As a retail investor, I have benefited from investing in broad market index funds with very low expense fees. Professional investors are much better positioned to determine which stocks are best to invest in at a particular price and time. However, sorting out the good professional investors from the bad and overcoming the fees charged by professional investors might not be worth the time and trouble. Index funds with low fees can sometimes be more cost effective and efficient than actively managed funds.

Clearly there are trends that may signal substantial increases in profitability going forward. A professional investor might consider whether the time is right to invest in stocks of companies producing lithium in anticipation of a big increase in the sales of electric vehicles that require lithium batteries. But what if there is a breakthrough in battery technology that replaces lithium with some other ingredient? In that case, the value of lithium stocks could drop dramatically.

Individualized medicine is another area ripe for expansion in coming years. Most of our doctors do not even have a sample of our DNA. Moreover, the randomized trials compare the average person’s response in the experimental condition with the average person’s response in the control condition to determine the statistical significance of the average person’s response to a drug or other medical intervention. But if the distribution is bimodal with half the people at one end and the other half at the other end, the average person may not exist. With more and more individualized data becoming more widely available, a professional investor may want to consider investing in companies with personalized medical data (e.g., DNA) that are able to zoom in to subsets of individuals sharing common characteristics to get closer to the uniqueness of an individual patient in order to provide individualized diagnosis and prognosis. For the retail investor these potential breakthroughs may introduce too much uncertainly and potential volatility but may be of interest to the professional investor.

Finally, one might consider the use of leveraged funds. Such funds provide multiples of the price movements of their corresponding indices either in the same direction (leveraged longs, UDOW) or in the opposite direction (leveraged shorts, SDOW). The opposite strategy would be to seek out the least volatile stock indices which tend to the ones that emphasize dividends. One approach might be to move from a broad based stock index fund into a fund emphasizing dividends when the stock market seems overextended in an irrational exuberance phase. If one is really into gambling, substituting broad-market leveraged shorts would be an alternative strategy at such times. On the other hand, when the stock prices have fallen significantly, one could move into broad-market leveraged longs, which could dramatically increase yields when (and if) the market recovers. Note that the expense ratios for these leveraged funds tend to be quite high and may be restricted to accredited investors.

In general, successful stock market investing requires being reasonably cautious and very patient. Most importantly, the investors style and strategy must match their personality. What works for one person may be entirely inappropriate for someone else. If you become distraught and tear your hair out when your portfolio’s value drops with a market decline, including a bear market that lasts for some time, then your style and strategy do not match your personality.

( Note none of the above commentary should be considered professional investment advice. This commentator does not accept any responsibility for losses incurred as a result of reading this commentary. Investors who want professional advice should seek out a professional investment advisor.)

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Why Punish the Poor to Stop Inflation and Make It Harder for Firms to Increase Supply?

Posted on by Lawrence Marsh

Why Punish the Poor to Stop Inflation and Make it Harder for Firms to Increase Supply?

When the Federal Reserve raises interest rates in New York financial markets, it becomes harder for businesses to borrow, which causes businesses to cut hours, lay off workers and close outlets. This is an indirect and rather brutal way to reduce demand for goods and services that also reduces supply. The effect is to make it harder for firms to increase supply and harder for people working paycheck-to-paycheck to handle medical emergencies, automobile accidents and other situations where they need a small loan just to get by.

But trashing the economy to stop inflation is not necessary. A more direct, more efficient and more effective way to stop inflation is possible. When the demand for goods and services exceeds the supply, prices rise. Demand can be reduced with either a carrot or stick approach. Why use the stick of raising interest rates on loans that punishes poor people facing a personal crisis and businesses that want to supply more, and instead offer the carrot of higher interest rates on savings to get people to voluntarily put off unnecessary spending and save some money?

In 2018 Senator Kirsten Gillibrand introduced Senate bill S.2755 as “The Postal Banking Act” as a way to use post offices to restore the “The Postal Savings Act” of 1910 which allowed people to cash checks and set up savings accounts in the over 30,000 post offices throughout the United States from 1911 to 1966. Senator Gillibrand sought to use our local post offices as a venue for the poor to get small loans to deal with various crises without becoming prey to loan sharks, pawn shops, payday loan dealers, or “cash now” providers who typically charge exorbitant interest rates.

The Federal Reserve is already considering creating a central bank digital currency (CBDC) as China and several other countries have already done. The Federal Reserve could use post offices as physical locations to access individual CBDC savings accounts. People could also register their smartphones at post offices for more direct and immediate access to their CBDC accounts. When excessive inflation threatens, these CBDC accounts could offer a high interest rate on savings. Encouraging people to save money and spend less will reduce the excess demand where too much money is chasing too few goods and driving up prices.

Ordinarily, to make a profit a bank must charge a higher interest rate on loans than it pays on savings. But as the creator of money, the Federal Reserve is in a unique position. To reduce demand for goods and services, the Fed can offer a higher interest rate on savings. However, in line with “The Postal Savings Act” of 1910 and in order to avoid disrupting commercial banking, the Fed will need to set a limit on the size of savings accounts. With one account per Social Security number and a limit of $10,000 per account, the Fed can avoid competing with private banks for the large savings of wealthy investors.

Encouraging people to build up their savings will also serve as an automatic stabilizer for the economy. Whenever an economic downturn threatens, people with savings do not have to cut their expenditures so dramatically. This avoids a sudden drop in expenditures which would just make economic downturns more severe. A larger pool of savings would shorten and lessen the severity of recessions.

If everyone had a Federal Reserve bank account accessible from their computer or smartphone, it would become easier to transfer money. If someone cuts your grass, rakes your leaves or shovels your snow, you can pay them easily with a smartphone-to-smartphone transfer between your individual Federal Reserve accounts.

Alternatively, when inflation is low and unemployment rises, the Fed could lower the interest rates on both savings and loans to help stimulate the economy. This new tool would give the Fed much tighter control in meeting its mandate of maintaining full employment with stable prices.

Large banks already have bank accounts with the Federal Reserve. There is no reason why the rest of us couldn’t also have bank accounts with the Fed. The rise of digital currencies, especially stablecoins, threaten the Federal Reserve’s dominance and control over our currency. By setting up digital currency smartphone postal savings accounts for every American, the Fed can reestablish its control over our currency and gain a much better way of dealing with the challenge of excessive inflation on one hand and high levels of unemployment on the other.

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Distorted Money Flow Creates Chronic Disequilibrium in our Economy

Posted on by Lawrence Marsh

January 7 – 9  is the American Economic Association Conference with 115,000 economists attending virtually where I present a rough draft of my new book in a poster session, followed later by a presentation at the Midwest Economics Association meeting in Minneapolis. Instead of emailing you my 70+ page research paper, I am providing below the content of the PowerPoint slides that summarize the paper.  

 “The Public Banking Act ” Should Allow for Individual Federal Reserve CBDC Bank Accounts (“FedAccounts”) To Transform Monetary Policy.  Adjusting interest rates on Wall Street is ineffective in stimulating and too brutal in slowing the economy, but injecting stimulus money and adjusting interest rates on small individual consumer Federal Reserve bank accounts could impact consumer demand more effectively and more immediately.  Note the author’s  proposal for stopping inflation using “FedAccounts” at: https://www.youtube.com/watch?v=nnMT7DVyK0g This follows from the money flow paradigm in the author’s book “Optimal Money Flow” which also considers the case of deflation where aggregate demand is inadequate to match aggregate supply which is summarized on YouTube at: https://www.youtube.com/watch?v=-hqBD3ZEhIM  

Digital Currency Threat => Will Central Banks lose control of money?  Banks creating their own money caused bank panics that continued even after adopting a common currency (dollars).  Wide use of private digital currencies could cause excessive volatility, tax avoidance, and criminal activities. Central Banks need to create their own digital currencies.

STOP  INFLATION without causing a RECESSION. The supply-side tool of raising interest rates in New York financial markets causes layoffs as businesses cut back. Don’t trash the economy to stop inflation. A demand-side tool can be created to stop inflation more effectively and more efficiently.  

Control demand to avoid economic downturns. NYC financial markets already have more money than can be put to work. Lowering interest rates further and supplying more money is just “pushing on a string.” A demand-side tool can be created to stimulate economy more directly using much less money. 

Velocity of Money Falls => Milton Friedman  M V = P Q  inflation always a monetary phenomenon with V (velocity) constant, and P (prices) constant only if M (quantity of money) rises at same rate as Q (economic output) rises. But V falls as population ages. And V falls as economic inequality increases. To keep Q growing at full employment, M must rise faster than V is falling so P can be constant.

Adam Smith =>  Two  Invisible  Hands: 1. Economic competition (lower prices). 2. Economic concentration (higher prices). USA economy has become less competitive with greater oligopoly and monopoly (as well as oligopsony and monopsony) power. See Jonathan Tepper’s book: “The Myth of Capitalism” about the dramatic drop in competition in the USA economy.

Pure Profits at Zero Marginal Cost => The explosion of information on the Internet has produced a commodity with essentially zero marginal cost. For example, with premium access you can gain access to extra information that already exists but only requires changing a zero to a one in computer code for you to access, which is done automatically when you make your payment for premium access. See book by Jeremy Rifkin: The Zero Marginal Cost Society. New York: St. Martin’s Press, 1014.

Profits rise as labor and capital shares fall => Barkai (2020) calculated the capital costs for the U.S. non-financial corporate sector over the period 1984 to 2014 and found that while labor’s share has dropped by 11 percent, the share of real capital has declined 22 percent with a corresponding increase in pure profits. Barkai, Simcha. “Declining Labor and Capital Shares.” The Journal of Finance, 75(5), pp. 2421-2463. 2020.  https://doi.org/10.1111/jofi.12909 

Distorted Money Flow => extreme wealth inequality leads to instability. Most of the money flows to the already wealthy who put it into the New York financial markets (stocks and bonds). The money flow has become so distorted the middle class can no longer afford to buy back the value it creates. Individuals go deep into debt while the government runs large deficits to keep the economy from sliding into recession. However, recently a combination of a large stimulus and COVID related supply shortages temporarily disrupted this chronic problem of inadequate demand relative to extensive global supply.

Disequilibrium Economics => Hyman Minsky explained that while most markets for well-defined goods and services move toward equilibrium, the economy as a whole and especially the financial markets are prone to swing between an upward irrational exuberance and a downward recessionary spiral. As John Maynard Keynes said: “In the long run we are all dead. Economists set themselves too easy, too useless a task if, in tempestuous seasons, they can only tell us that when the storm is long past the ocean is flat again.”

Darwinian Natural Selection Paradox => As countries reach about $6,000 per capita, birth rates drop like a rock, eventually falling below the 2.1 replacement rate. Wealthy and well-educated countries and families have fewer and fewer children in recent decades. Instead of success in education and wealth breeding bigger populations, human populations fall dramatically. As world population shrinks to zero, last one remember to “turn off the lights.”

Private and Public Debt => Decline of unions and Citizens United’s one dollar = one vote cuts workers’ real pay. Middle class unable to buy back the value of the goods and services it produces. Low pay and low interest rates drive people on Main Street deep into debt as more and more money flows to Wall Street. Government debt needed to fill in for the money flow going to Wall Street to maintain full employment.

Financial vs. real economy => Money flow to wealthy goes mainly into stock and bond markets on Wall Street driving down interest rates and inflating stock prices. Large amount of money not used for real investment (physical and intellectual) but goes into financial investments (dividends and stock buybacks). Consequently, the middle class is unable to purchase the value of the goods and services it is capable of producing at full employment.

Money Flow Paradigm => George Cooper in “Fixing Economics” identified key problem of too much money flowing to Wall Street and not enough money flowing to Main Street. Government sets the rules and regulations, and provides the money for free enterprise system. Government investment in common property resources is key to economic efficiency and growth. See Mariana Mazzucato’s 3 books: The Entrepreneurial State, The Value of Everything, and Mission Economy. 

The Age of Oversupply => Globalization and the collapse of communism. Cheap labor makes large quantities of high quality products available at very low prices and leads to deflation in prices of goods and services when demand is inadequate relative to enormous global supply. Read Daniel Alpert’s book: “The Age of Oversupply.”

Policy Driven Excess Supply => Chinese take resources and work hard to make products for USA in return for pieces of paper with George Washington’s picture on it. To keep Chinese products inexpensive for USA and Chinese workers employed, China collects USA dollars and buys U.S. Treasury securities in New York financial markets instead of driving down value of dollar in foreign exchange markets.

Antithesis of Say’s Law => population growth > food supply  reversed!!! Global supply exceeds demand when too much money flows to Wall Street and too little money left on Main Street. Supply-side economics replaced with demand-side economics. “Supply creates its own demand” replaced with “Demand creates it own supply.”

Distorted Money Flow => extreme wealth inequality leads to instability. To understand how “Distorted Money Flow” can become “Optimal Money Flow” visit the following website: https://optimal-money-flow.website/  For more information on the author visit the author’s public website at: https://sites.nd.edu/lawrence-c-marsh/home/ 

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Please provide your insights and comments on “Distorted Money Flow Creates Chronic Disequilibrium in our Economy” by scrolling down to the bottom of this page and writing your comments in the textbox “Comment.”
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Lawrence C. Marsh is Professor Emeritus in Economics at the University of Notre Dame and author of the 2020 book: Optimal Money Flow: A New Vision on How a Dynamic-Growth Economy Can Work for Everyone. 
_______________________________________________
You can donate the entire purchase price of the book to student scholarships by buying a hard-bound copy of the Optimal Money Flow book at the Avila University Press website at:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh with no charge for shipping and handling.  
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Economic theory must change to accommodate irrational, inconsistent and altruistic behavior

Posted on by Lawrence Marsh

Traditional economics is based on three key assumptions: (1) rationality, (2) consistency, and (3) self-interest. It assumes a cold, calculating, rational choice by each individual based on a stable set of preferences. It frequently doesn’t work out to be that simple, because social factors intervene.

We are all highly interdependent. Automobiles, cell phones, even breakfast cereals are created collectively. Stock market and housing bubbles are evidence of important contagion effects. Aliens from outer space may not see us as individuals at all, but rather as cells in a collective body that is spreading across the face of our planet. Economic theory needs drastic revision to better incorporate our collective interdependence.

Economists tried to devise methods of aggregating individual preference functions into a community-wide preference function, but finally had to accept economics Nobel prize laureate Kenneth Arrow’s Impossibility Theorem that said that under somewhat general circumstances no such aggregation of individual preferences could produce a legitimate community-wide preference function. Thus, no formal, mathematical proof has been forthcoming of Adam Smith’s idea that our collective, economic well-being as a nation can be improved from each individual pursuing their own economic self-interest, as expressed in his 1776 book An Inquiry into the Nature and Causes of the Wealth of Nations.

Instead economics detoured into game theory which provides many interesting results but does not solve the fundamental problem. Moreover, the outcome of any particular game tends to be sensitive to its own, game-specific assumptions. A more general economic theory is needed that is robust to a wider range of assumptions in general and allows for our collective interdependence in particular.

A good beginning for thinking about developing an economic theory of our collective interdependence is the 1976 book by Fred Hirsch called Social Limits to Growth published by Harvard University Press.

A new branch of economics called behavioral economics tests these assumptions by performing scientific experiments to determine how people actually behave. Behavioral economists have recorded numerous situations where people do not behave rationally.

For example, advertisers have long understood that people will go to great expense to get something for “free.” One professor set up an auction system that caused his students to bid more than $20 for a $20 bill. An irrational sense of commitment leads people to tenaciously hold on to stocks they already own, but otherwise would not be willing to purchase. These are not just trivial irregularities. There are a wide-range of situations where people behave irrationally from the point of view of traditional economics.

From its beginning, economics has had to fend off evidence of irrationality. Giffen goods that defy the law of demand by responding positively to price increases and negatively to price cuts were dismissed as special cases with little importance for overall economic policy. When some individual consumers and investors made foolish choices, economists employed the law of averages to try to reaffirm rational market outcomes. The term rational expectations was coined when this was extended to the behavior of monetary and fiscal policy makers.

Is it enough to simply dismiss irrationality by throwing it into the error term, or could it sometimes be the main effect? Bounded rationality depicts decision making in a restricted context where information is incomplete and available choices are limited. Such analysis provides the dismal science with a new basis for moving away from excessively optimistic forecasts.

The hedge fund Long Term Capital Management collapsed in 2000 when the market did not move back toward equilibrium in a reasonable amount of time. Such unexpected events are described by Nassim Taleb in his book The Black Swan: The Impact of the Highly Improbable.  Are markets ultimately efficient in the long run or is the long run just too far off? After all, it was John Maynard Keynes, the father of macroeconomics, who pointed out that “in the long run we’re all dead.”

The Achilles heel of traditional economics was uncovered when researchers found that irrationality is often predictable. Dan Ariely’s 2008 book Predictably Irrational is a recent popular contribution while the 2004 compendium volume Advances in Behavioral Economics provides a more extensive coverage from the professional literature. Also see The Paradox of Choice by Barry Schwartz, Sway by Ori and Rom Brafman, and Free Market Madness by Peter Ubel.

Economists such as Nobel prize laureate Gary Becker led the extension of economics into the social realm in studying such things as the economics of marriage and drug addiction. Becker and his followers showed how economics can influence social behavior. The new economics is showing how social considerations can impact economics. The Nobel prize in economics was won in 2009 by Elinor Ostrom and Oliver Williamson for research that showed how organizational factors can affect economic outcomes. Social factors can have an even bigger impact on the day-to-day decisions of all of us.

For example, if you ask a friend to help you move, she may be willing to sacrifice a few of her precious Saturday hours to help out. If instead, you offer her $10 a hour to help you, she may turn you down flat. How can it make sense to be willing to work for nothing, but not be willing to do that same work for money? The answer is that social relationships are quite different from economic relationships. As soon as you make it a monetary transaction, you have changed the nature of the relationship.

An important irrational distortion occurs when a person takes possession of an item. A study randomly sorted an equal number of people into two groups. In one group each person was given a coffee mug. In the other group everyone got a candy bar. They were immediately given an opportunity to exchange the item they received for the other item. Since membership in the two groups was random, on average the ratio of people with candy bars to coffee mugs should turn out to be the same in the two groups after the final exchange. To the surprise of the researchers, the proportion of candy to mug lovers turned out to be quite different in the two groups. Each group tended to hold on to its initial gift much more than traditional economics would predict.

Decision making is more than just taking into account time and money. We also must consider the mental energy necessary to make decisions. Behavioral economists have unearthed substantial evidence of omission bias in economics. The stock market provides a perfect example. Researchers have found that people who own stock A which turns out to be a loser but could have purchased stock B which ultimately turns out to be a winner have much less regret than a person who initially owned stock B and then sold it to buy stock A. Even though both people end up with the losing stock A, they feel much different about it. A recent decision to hold onto a loser is not considered anywhere near as bad as the decision to buy that loser even when the monetary loss turns out to be exactly the same.

The desire to be a winner frequently distorts economic outcomes and not just when an item is offered for “free.” A study offered people either $100 for sure or, alternatively, a chance to win $200 or nothing with a fifty-fifty probability. Since the expected value of the two alternative offers is the same, researchers expected about half of the people would take the $100 and the other half would try the gamble. A large proportion of the people chose the $100 with certainty. The $100 is enough to make the person a winner while the chance to get an additional $100 was not as important as the possibility of getting $0 and losing the winner status. The opposite was found when people were given a choice to lose $100 with certainty or lose $200 or $0 with a fifty-fifty probability. Most people chose the gamble since a loss of $0 was the only way to avoid being a loser.  Traditional economics does not provide a mechanism for understanding such an irrational inconsistency.

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Please provide your insights and comments on “Economic theory must change to accommodate irrational, inconsistent and altruistic behavior” at the bottom of this page.
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Lawrence C. Marsh is Professor Emeritus in Economics at the University of Notre Dame and author of the 2020 book: Optimal Money Flow: A New Vision on How a Dynamic-Growth Economy Can Work for Everyone. 
_______________________________________________
You can donate the entire purchase price of the book to student scholarships by buying a hard-bound copy of the Optimal Money Flow book at the Avila University Press website at:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh with no charge for shipping and handling.  
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International Trade – U.S. dollars flowing around the world

Posted on by Lawrence Marsh

What are the implications of the U.S. importing lots of products from abroad? Does our trade deficit imply that we are getting ripped off and need to impose trade restrictions? For example, consider our trade with China. China takes its resources, and its people work hard producing products for us. In return, instead of sending lots of our products to China, we send them pieces of paper with George Washington’s picture on them (U.S. dollars). Ordinarily, all those U.S. dollars would find their way into the international currency exchange markets driving down the value of the U.S. dollar and raising the price of the Chinese yuan. That would make Chinese products more expensive for us to purchase and U.S. products cheaper for China to purchase.

You would think that making U.S. products less expensive for the Chinese people to purchase would be good for China. But traditionally most Chinese have been very poor and not able to afford even lower priced U.S. products. A more immediate problem for China’s government has been the flow of peasants from rural areas into the urban centers where products are produced for export. China needed a way to avoid high levels of unemployment and keep its citizens employed through the manufacture of products for export. Instead of allowing those U.S. dollars to go into the currency exchange markets, China used those U.S. dollars to buy U.S. Treasury securities. In other words, China gave us products, we gave China U.S. dollars, and China gave us our money back again by investing money in U.S. financial markets by buying U.S. Treasury securities. Who is getting ripped off here? (Hint: it is not us.)

Issuing a lot of U.S. Treasury securities attracts U.S. dollars situated abroad that would otherwise drive down the value of the U.S. dollar in international currency exchange markets. This makes it more difficult for the Federal Reserve to suppress inflation through the supply-side. Overseas investors, especially sovereign wealth funds, may move U.S. dollars into New York financial markets leaving a stronger U.S. dollar in international currency exchange markets than would otherwise be the case. Japan and China have purchased large quantities of U.S. Treasury securities with U.S. dollars that would otherwise have gone to drive down the value of the dollar, which would have lowered the price of U.S. exports and increased the price of imports into the U.S. helping move toward a better balance in tradable commodities and services.       

However, some foreign governments (e.g., China) may have motives for investing in U.S. Treasury securities other than seeking an attractive return on investment in the form of interest payments. China requires that Chinese exporters turn in U.S. dollars to the Chinese government in return for renminbi (yuan) to keep those dollars out of foreign exchange markets. China’s return on investment in U.S. Treasury securities may be less in the form of interest payments and more in keeping its population fully employed to maintain both economic and political stability by maintaining either a low value for the yuan in international exchange markets or, somewhat equivalently, a high value for the U.S. dollar. 

It is important to consider the underlying cause of trade imbalances, especially those that have kept the U.S. dollar strong.  China and several European countries, for example, have highly unequal internal wealth distributions such that an insufficient amount of money is flowing to their average people to sustain full employment without substantial exports. In other words, United States consumers and other foreign consumers make up for the lack of adequate demand by China’s domestic consumers. The extreme wealth inequality in China and those European countries mean that the people in those countries cannot afford to buy back the value of the goods and services they are producing, but the wealth of those countries has gone to wealthy elites who are eager to invest their money in the United States financial markets. 

Even elites in poor, developing countries are often eager to invest their money in the New York financial markets instead of investing in industrial development in their own country. This phenomenon can be viewed as another form of colonial exploitation, with the development of poorer countries held back in favor of providing more wealth to the already wealthy by driving up prices in the U.S. stock market. The U.S. stock market, and stock markets in general, have become alternatives or substitutes for real investment in the productive capacity of economies throughout the world.  Simcha Barkai published a carefully researched paper that revealed that business revenues were going increasingly to profits (financial capital) as opposed to the cost of labor or real capital (e.g. physical or intellectual capital).

This distorted money flow has created a financial economy that is more and more separated from the real economy. Ironically, it has been restraining and undermining productivity and economic growth rather than supporting and encouraging it. Yes, money is cheap for businesses to borrow, but demand is chronically inadequate without extraordinary stimulus from governments. Businesses have no incentive to expand their operations, but instead they buy up or undercut smaller competitors to increase their market share and prices.

Another major reason for the strength of the U.S. dollar in foreign exchange markets is the role of the U.S. dollar as the world’s primary reserve currency. In order to avoid the instability and risk associated with fluctuations in the value of trading one country’s currency for another, some major entities purchase imports with U.S. dollars and sell exports denoted in U.S. dollars to avoid the ups and downs of the foreign exchange markets. Trade in crude oil and other major commodities is traditionally done in terms of U.S. dollars. Consequently, as international trade continues to increase over time, the demand for U.S. dollars increases to keep the U.S. dollar highly valued in foreign exchange markets. 

In other words, a country whose currency serves as a major reserve currency is in basically the same boat as a country that suffers from the natural resource curse, otherwise known as the Dutch Disease, a term coined by The Economist to refer specifically to how the value of the Dutch guilder was driven up when the Netherlands discovered massive amounts of natural gas within its territory, and generally to any country selling large quantities of a natural resource in high demand.  A reserve currency country and a country suffering from the natural resource curse have great difficulty selling their exports because of the high price of those exports in that country’s currency in the foreign exchange markets. In other words, under these circumstances the exports of the United States and the Netherlands would be basically priced out of international markets. The Dutch escaped the Dutch Disease by dropping the guilder and joining the Euro currency union where their natural gas exports were much less impactful with little effect on the strength of the Euro overall. As a reserve currency it is not only desirable, but necessary, for the country with the reserve currency to run a current account deficit to increase the amount of their currency in foreign exchange markets to keep from being completely priced out of the markets for its exports or see its exporting industries shrink as a result of its reserve currency status and the ever increasing demand for its currency in international markets.

On the other hand, the advantage of a strong currency are low prices for imports which save consumers money and helps make up for extreme income and wealth inequality within the United States. This is particularly helpful for retired elderly people who are on fixed incomes. In real terms the Chinese and other foreign producers are taking their natural resources and working hard to produce products for us, but instead of sending comparable products to them, we are sending them pieces of paper with George Washington’s picture on it (U.S. dollars). For the most part, tariffs on Chinese goods entering the United States are not paid by China. Walmart, in competition with other businesses around the world, buys goods in China and ships them to the United States. When those goods arrive in Long Beach, California, the Federal government requires that Walmart pay a tariff on those goods from China. Walmart can compensate itself to some extent by passing along the cost of the tariff to Walmart customers. Since many of the items Walmart buys from China are relatively inexpensive to begin with, the elasticity of demand for those items may be relatively high relative to the elasticity of supply so Walmart is able to get away with passing along most of the cost of the tariff to Walmart customers without suffering a significant drop in demand for those particular items. When the price of a great pair of Chinese memory foam sneakers rises from $9.98 to $12.48, it is still a great deal relative to alternatives.

The world works for us and we work for ourselves, yet we are told that we are being exploited by others by importing actual physical goods and services and paying for them with pieces of paper (U.S. dollars). The actual truth is the exact opposite of what those U.S. citizens who see themselves as “victims” tell us, the world is working hard and sacrificing their resources to keep us fat and happy!  In reality, we are the ones in the dominant and exploitative position in foreign trade. The absence of tariffs works to our advantage. The lumber and steel tariffs we placed on Canada only increased the cost of housing, automobiles and appliances in the United States. We need to remove those tariffs so we can get Canadian lumber and steel for less.

Yes, the overseas competition for the dollars of U.S. consumers means that the wages and jobs of U.S. workers are suppressed. Tariffs do not necessarily solve this problem since they would raise prices without guaranteeing that the money from the higher prices would go to workers in the form of higher wages and more jobs. Both the flow of dollars from abroad into U.S. financial markets in New York and the role of the U.S. dollar as a reserve currency in foreign trade have kept the value of the U.S. dollar strong in foreign exchange markets. The high value of the U.S. dollar makes U.S. exports expensive for people in other countries to purchase. A strong dollar means that we export less than we would otherwise and end up primarily producing our own goods and services for our own citizens.

The idea that there are a limited number of jobs in this world, and we must fight over them is what economists call The Lump of Labor Fallacy. The number and quality of jobs in the United States is not fixed. Fiscal and monetary policies can create as many jobs as we need. The current shortage of workers is in part due to stimulus policies that have been implemented in response to the COVID-19 pandemic. We should not raise prices in Walmart, Target, Amazon and many other low cost venues by imposing tariffs on imports coming from abroad. A better approach is to gain a tighter control over the number and quality of jobs here in the U.S. to keep our workers fully employed while still enjoying the low prices offered by imports from abroad.

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Lawrence C. Marsh (http://sites.nd.edu/lawrence-c-marsh/home/) is Professor Emeritus in Economics at the University of Notre Dame and author of the 2020 book: Optimal Money Flow: A New Vision on How a Dynamic-Growth Economy Can Work for Everyone (https://emeritipublishing.com/) .
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You can donate the entire purchase price of the book to student scholarships by buying a hard-bound copy of the Optimal Money Flow book at the Avila University Press website at:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh
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To sign up for this free monthly Money Flow Newsletter =>  click here. (https://emeritipublishing.us4.list-manage.com/subscribe?u=9f045b890bf0da60df9208ec5&id=c656af03b6)
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For additional details see the Optimal Money Flow book website at:
http://optimal-money-flow.website (http://optimal-money-flow.website/)
or the 2018 "Money Flow in a Dynamic Economy" paper presented at 2019 American Economic Association conference in Atlanta, GA:
https://www.aeaweb.org/conference/2019/preliminary/paper/FT7A95eS
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The full purchase price will go into the student scholarship fund when purchased through Avila University Press at the link:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh
Link to my Notre Dame webpage (http://sites.nd.edu/lawrence-c-marsh/home/)

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Stop Inflation Without Causing Recession

Posted on by Lawrence Marsh

Don’t repeat our historically dysfunctional approach to stopping excessive price inflation. The Federal Reserve uses a supply-side tool to stop excessive inflation by raising interest rates that works by constraining business enough to cause a cutback in working hours and layoffs that suppresses consumer demand. But postal bank accounts could be created to provide the Federal Reserve with a demand-side tool to directly reduce demand pressure to stop inflation without throwing the economy into recession.

When the Federal Reserve raises interest rates, it suppresses supply for seasonal, cyclical and other businesses that depend on short term liquidity to maintain and establish inventory and cash flow.  It suppresses business.  For example, farmers borrow money from the financial system to pay for seed, fertilizer and irrigation in the spring and to pay workers to harvest the crop in the fall, and pay it back after the harvest is sold. 

But production is cut back when borrowing costs increase as interest rates rise. This traditional approach suppresses both supply and demand as workers find less work and their incomes fall. High interest rates also cause businesses to put off long-term investments in plant and equipment that would increase supply. The economy slides into recession.

Inflation occurs when too much demand for goods and services is chasing too little supply. The financial markets exist to offer liquidity to businesses to maintain or expand the supply of goods and services. Countering the rapidly rising prices requires increasing supply while reducing demand. Current supply shortages call for encouraging supply. But the traditional Federal Reserve policy approach will do the opposite of what is needed.

Sure, suppressing business to lay off workers to reduce demand will work if you slam on the brakes hard enough. But trashing our economy to stop inflation is not necessary. What the Federal Reserve is missing is a demand-side tool to ratchet down demand when markets for goods and services become overheated.  

Under the Postal Savings Act of 1910, our post offices served as banks for 56 years from 1911 to 1966. You could go to any of our 34,000 post offices to cash a check or set up a savings account. The Public Banking Act, which was recently introduced in the Congress to create postal bank accounts, could be modified to provide the Federal Reserve with a demand-side tool to curb excessive inflation without throwing our economy into a recession.

Demand can be tamped down and supply encouraged by recreating the postal savings accounts and offering high interest rates in those savings accounts on balances up to some specified limit, such as $10,000 (with no interest earned on amounts above that limit), while leaving the rates in the New York financial markets relatively low to stimulate, not suppress, supply. 

Higher interest rates will encourage savings. Saving more and spending less is obviously what is needed when too much money is chasing too few goods. If we offer high enough interest rates in postal bank accounts dispersed in our 34,000 post offices around the country, excess demand can be reduced enough to stop inflation without forcing the economy into an unnecessary recession. This approach withdraws money from the economy by offering a return on investment, not by taxation. People will still be able to purchase their necessities, but will be motivated to delay or cut back on luxuries until the economy cools off and postal bank interest rates return to normal. 

This will especially benefit the elderly who need a good return on their savings to help finance their retirement. Having more people save more money will also serve as an automatic stabilizer by providing people with the savings they need to ride out economic downturns, which, in turn, will make such downturns shorter and less extreme.

Note that the Federal Reserve is independently financed from its bank fees and investments, which produce enough revenue such that the Federal Reserve donates more than $80 billion to the U.S Treasury each year. The Federal Reserve, not the taxpayers, can pay for setting up and operating the postal banks. The Federal Reserve could also help pay for postal employee pensions. This will reduce, not increase, the overall tax burden. 

With reasonable limits on the savings and loan amounts restricted to one account per person or small business, these postal banks can avoid interfering with the normal functioning of the commercial banking industry. Of course, banks will oppose any intrusion onto their turf, but the broader benefit to the country as a whole must be taken into account.

When the opposite conditions develop with low demand, high unemployment, and the start of a deflationary cycle, postal banks could offer small loans at relatively low interest rates to individuals and small businesses. Such a loan program has already been proposed in bills formulated in both the Senate and the House in the last few years such as Senator Kirsten Gillibrand’s Postal Banking Act as Senate bill S.2755 or Representative Rashida Tlaib’s Public Banking Act as House bill H.R.8721. These bills are aimed at helping unbanked and underbanked people who live paycheck to paycheck and suddenly face job loss, a medical emergency, an automobile accident, or some other event that forces them to go to loan sharks, pawn shops, payday loan dealers, or “cash now” providers who typically charge exorbitant interest rates.

Postal bank savings accounts offering high interest rates could attract middle-class and working-class people, and those with high marginal propensities to consume who tend to spend most of their income except when offered an exceptionally high interest rate on savings. This will provide the Federal Reserve with a demand-side tool to directly impact Main Street instead of relying on indirectly influencing demand through a supply-side tool aimed at Wall Street.  Targeting demand through postal bank accounts to stop excessive inflation or, alternatively, to stimulate demand in a weak economy will be much more cost effective in offering more bang for the buck, will be more direct and have a more immediate impact, use less money and be less disruptive of our economy than current Federal Reserve supply-side stabilization strategies. 

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Use More Creativity in Funding Government

Posted on by Lawrence Marsh

USE MORE CREATIVITY IN FUNDING GOVERNMENT
Get your name on buildings, streets, programs and positions.

How did America create and pay for the best teaching and research universities in the world? What can government learn from this success story? When both carrots and sticks are known to motivate, why restrict funding to sticks (tuition or taxes) when carrots (donations and endowed chairs) could also provide money?

In my recent book (“Optimal Money Flow”) I proposed the taxpayer appreciation program (TAP), which would allow the naming of a taxpayer supported institution or edifice after those who pay an especially high estate tax. For example, at some point in the future, and with the approval of the appropriate board, a primary school in Omaha, Nebraska might be named “The Warren Buffett Elementary School.” Of course, you only get to die once so under TAP you could only get one institution or edifice named in your honor.

However, there is no reason that such naming should be limited to estate taxes or taxes in general. Universities allow donors to have their names attached to campus buildings, programs, scholarships and professorships. Whatever people are willing and able to fund might be considered for approval. Why shouldn’t the public sector explore this approach as well? Voters or their representatives could approve a particular donor to have their name attached to a building or road. You might be able to pay to have “Union” in Union Station or “Country” in Country Lane replaced with your name.

But what about funding actual government positions as endowed chairs? A donor named John Smith could donate a few million dollars to make Mayor Bill de Blasio the John Smith Mayor of New York City. If several wealthy people want to bid for naming an official government position, the naming of the position could be auctioned off. Of course the funding for these positions need to be large enough to pay both the future salaries and operating expenses of the named position. This would free up tax money to pay other expenses, or that tax money could be earmarked for a reserve fund to be used in an economic downturn instead of cutting back services or going into the red.

If having individual donors pay to have their names associated with key positions seems unseemly, with the approval of her family and next of kin why not create a “Go Fund Me” page to create a Ruth Bader Ginsburg Justice of the Supreme Court? The nation as a whole could show their respect and appreciation along with that of her important and wealthy friends and colleagues by funding a Supreme Court position in her honor. One of Georgia’s senators could be named the John R. Lewis Senator of Georgia. Endowed positions could eventually be created for every position in the Congress of the United States.

As the wealthiest Americans accumulate more and more money, they may wish to use their money more creatively than just investing it all in the stock market. Not every wealthy person has the ability and ambition to create an Amazon or a Tesla so offering them another way to get their name out there may be just what they were looking for. Alternatively, a “Go Fund Me” page for honoring our fallen heroes may be exactly what we need to reestablish our sense of commitment and unity as a nation. Let’s hope that our leaders will have the courage to give it a try. It has got to be more popular than raising taxes or running up the national debt.

Ranked-Choice Voting Blocks Extremists From Power

Posted on by Lawrence Marsh

New York City has joined Maine in recognizing the danger of traditional plurality voting methods and has embraced ranked-choice voting. Ranked-choice voting is not new. Australia started using it in state elections in 1918, and Ireland started using it in presidential elections in 1937. Commentators have frequently pointed out that ranked-choice voting eliminates extremist candidates who are not favored by a majority of the electorate and allows a more moderate candidate to get elected. But the best way to understand the pitfalls of our traditional plurality voting system and the advantages of ranked-choice voting is with some simple examples.

Suppose that there are only three candidates. Candidate A gets 35 percent of the vote, Candidate B gets 33 percent, and Candidate C gets 32 percent. Without a runoff election, Candidate A wins even if most of those who voted for Candidate C would have preferred candidate B. In the extreme case, Candidate A was preferred by only 35 percent of the voters with 65 percent opposed, yet Candidate A wins, while a majority of the voters favor Candidate B. With Ross Perot running as a third party candidate in 1996, neither Bill Clinton nor Bob Dole was able to get a majority of the votes. We will never know who would have won if Ross Perot had not been in the race.

A runoff election could solve the problem, but only with an expense that would be unnecessary if the original ballots had allowed each voter to rank the candidates as first choice, second choice, and third choice. In a three-candidate race under ranked-choice voting, if none of the candidates received 50 percent or more of the votes in the first round, the third-choice candidate would be eliminated and the ballots of all those who had ranked that candidate as their first choice would be recounted, moving their second choice candidate up to first place. In the extreme example above, this ranked-choice voting procedure would enable Candidate B to win with 65 percent of the vote without requiring an expensive runoff election.

In the 2000 election both in Florida and nationally, George Bush beat Al Gore, but failed to get a majority of the votes, with Ralph Nader as the spoiler candidate. If ranked-choice voting or a runoff election had been used in Florida in 2000, Al Gore might have won the presidential election, but we will never know. In November of 2018 in the Australian state of Victoria in a race with several candidates, a Green’s party candidate, who came in third in the first round of voting, won the election under the ranked-choice voting system. In other words, ranked-choice voting can sometimes make a dramatic difference in an election outcome.

Now consider an election with 13 candidates as in the June 22 Democratic primary for New York City mayor where ranked-choice voting was used with voters ranking up to five candidates. First suppose that the traditional plurality voting method was followed. Imagine that an extreme left-wing candidate got 17 percent of the vote and an extreme right-wing candidate got 17 percent of the vote, and each of the 11 moderate candidates got 6 percent. Even in a runoff election between those top two extremist candidates, the winner might be truly favored by only 17 percent of the electorate with a majority of the voters preferring any of the more moderate candidates. In other words, in the extreme case, a candidate with just over 17 percent of the vote could get elected under traditional plurality voting even with almost 83 percent of the electorate strongly opposed to that candidate. If ranked-choice voting had been used instead, the most likely outcome would be the election of one of the more moderate candidates. In other words, under traditional plurality voting, even in the case of a runoff election between the top two candidates, one of the extreme candidates would win, but under ranked-choice voting, a more moderate candidate, preferred by a majority of the electorate, would ultimately win.

Maine is the first state to mandate ranked-choice voting in federal elections. Losing Republican incumbent Bruce Poliquin from Maine’s Second Congressional District challenged the use of ranked-choice voting in federal court. He was in the lead in the first round, but lost after the votes of third-party candidates were reassigned under the ranked-choice voting procedure. After losing the recount and after a federal judge rejected the claim that ranked-choice voting was unconstitutional, Poliquin ceased his challenges to the outcome of the election.

In Maine and several cities throughout the United States, ranked-choice voting has been successfully implemented without much confusion or disruption. Once the voters get used to it, they will see how easy it is and the advantages of ensuring that only candidates with widespread support get elected. The delay in the New York City tabulation is not due to the use of ranked-choice voting, but because of the need to wait until all the votes, including all those mailed-in ballots, are received. Once all the votes are in, it only takes a few nanoseconds for the computer to determine the winner under ranked-choice voting.

We like to think of the United States as that “shining city on a hill” as President Reagan said, yet our democracy has serious drawbacks and disadvantages. A combination of our traditional plurality voting system, especially as used in primary elections to defeat more moderate candidates, along with gerrymandering, influencing politicians through massive campaign contributions, and other aspects of partisan politics, has produced a much less attractive version of democracy. The widespread use of ranked-choice voting could be one step in the right direction toward correcting these deficiencies.

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High Oil Prices Aid Anti-American Regimes in Russia, Iran, and Venezuela.

Posted on by Lawrence Marsh

Some key anti-American governments are highly dependent on oil revenues. A large portion of the budgets of Russia, Iran, and Venezuela depend on money from oil and natural gas. The United States consumes the most oil of any country in the world. If demand for oil and other fossil fuels in the United States were cut dramatically, their prices would fall, and that would sharply curtail the activities of our adversaries. Should we send more troops overseas to curb the bad behavior of these regimes, or, instead spend that money on switching our economy from fossil fuel dependency toward an economy built on renewable energy, and thereby deprive these regimes of a substantial part of the revenues they need to continue their anti-American activities?

Transitioning the American vehicle fleet from using fossil fuels to electricity will be a major step in that direction. Ford made news last month when it announced it will begin production next year of the F-150 Lightning, all-electric truck. As an added plus, the truck’s batteries will be able to power your house during an electric outage. There are also plans to integrate its Intelligent Backup Power system with a solar company to provide solar power to both charge the truck as well as your home.

At the moment, one of the drawbacks of an electric vehicle is the limited range of its batteries, which typically provide a range of 250 miles on a single charge. One solution already under way is the creation of a network of fast-charging vehicle battery stations by Tesla, local utilities (such as Evergy in Kansas City) and a growing number of private providers such as EVgo.

Another solution is to buy the electric vehicle, but rent the batteries. This significantly reduces the price of the car, but requires a rental payment. The advantage is that when your battery power runs low, you just stop at the highway service station for ten minutes to swap out the low-power batteries for renewed fully-charged ones. This greatly extends the driving range of your electric vehicle. This battery rental plan has worked well in Israel and other countries that have tried it. It may work even better in the USA where we often drive great distances, especially on holidays.

Economists generally tend to oppose most tariffs in favor of free trade. However, in matters of national defense some tariffs may play an important role. In particular, a tariff on imports of crude oil and gasoline could substantially reduce American demand for these commodities. This would drive down their prices on world markets and deny our adversaries the revenues they need to continue their anti-American campaigns. It would also increase the demand for electric vehicles in the United States.

Even if you believe that global warming is a hoax, but care about national defense, taking advantage of our adversaries’ weakness is just common sense. A tariff on crude oil and gasoline imports would be a good start. Tax breaks for wind, solar and other renewables could create new, higher-paying jobs and contribute to economic growth, instead of sending more soldiers to fight in those never-ending Middle Eastern conflicts. Vladimir Putin doesn’t want you driving an electric vehicle. He needs you to keep driving your gas-guzzling car or truck. Putin will be very annoyed and disappointed with you if you purchase one of those recently announced electric Ford F-150 Lightning trucks or any other fully-electric vehicle.

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Exactly what would happen if federal debt got very big?

Posted on by Lawrence Marsh

The cash in your wallet used to be government debt. What the government owed you before 1971 was an ounce of gold for $35.  In 1971 President Richard Nixon took the United States off of the gold standard. Now the government owes you absolutely nothing for $35 or any amount of money. If you are nervous about using money that is backed by nothing, don’t use it.

Question: But what about US Treasury bills and bonds? Doesn’t the government owe you for the principal and the interest on those bills and bonds?  Answer: they owe you the interest payment, but if you want to redeem any of those bills and bonds, you go into the New York financial markets and sell them for whatever price they are currently selling for.

Question: Does that mean that the government never has to pay back the debt that it has issued?  The answer: as long as there is a market for government bills and bonds, the government doesn’t have to worry about it. As long as there is someone else willing to buy the debt, then it isn’t a problem.

Question: How do we know when a government debt problem might be developing? Answer: when people start losing faith in government debt, the interest rates on government debt will begin to rise.  Safe and secure debt offers a low interest rate. Risky debt requires that the issuer pay a high interest rate. If the interest rate on government debt starts rising above that offered on corporate bonds, then it would be time to start worrying, mainly because the government would need to sell more and more debt to get the money to pay the interest rate on the increasing debt load. It is very unlikely that the government would let this get to the point where they couldn’t keep up. In an emergency the Federal Reserve would monetize some of the debt (buy up enough of it to alleviate the crisis) to bail out the government just as it bailed out the banks on Wall Street in 2008-2009.

Question: What if there was a situation (such as the current situation) where wealthy people and wealthy corporations had a huge amount of money in the financial markets and there were no reasonable real investment opportunities (except maybe overseas) so the money just drove up stock and bond prices and drove down interest rates? Answer: Yes, this is the current situation. There is a huge amount of money in the financial markets that is sitting idle. Corporations are using the money they get to issue stock buybacks and increased dividends and driving up stock and bond prices. Right now the chances that the interest rates on government debt are going to spike are next to none. It is definitely not an immediate problem. The inflation that has resulted is primarily in stock and bonds, which are not well represented in the market basket of goods and services that the government uses to generate the consumer price index (CPI), because most consumers don’t own many stocks and bonds.

Question: But what if the government went wild by issuing a huge amount of government debt? Answer: that would be a problem, because eventually all market interest rates would start to rise and private investment would be choked off. This is what is sometimes referred to as “crowding out.” But a moderate amount of “crowding out” is not a bad thing if the money is being used for important public investments such as infrastructure repair and other important priorities that voters have determined are more important than what the private sector would spend the money on. The term “crowding out” is prejudicial in that it implies that private spending is good and government spending is bad, but that is not always the case. Some reasonable amount of government spending is needed.

Question: What if the government issued the debt but didn’t spend the money?  Answer: Although the chance that this would happen is absolutely zero, it is an interesting question. It would mean that the government was reducing the money supply. Controlling the money supply is supposed to be the responsibility of the Federal Reserve. But if the treasury department did it the effect would be the same as the Fed purchasing securities in the financial markets. It would reduce the money in the economy and slow the economy, and, if extreme enough, cause a recession.

The real question is how much money is flowing through our economy and where is that money going? Right now, there is too much money flowing into Wall Street and too little money flowing to the people on Main Street. The people on Main Street don’t have enough money to buy back and goods and services they are creating so the federal government has to use deficit spending to make up the difference to keep the economy from falling into a recession. The problem is that the wealthiest one percent don’t spend enough of their enormous fortunes, and they put so much money into the stock and bond markets in New York City that there aren’t enough investment projects to use all that money. In others words, the wealthy have a low marginal propensity to consume and make financial investments that trigger increased dividends and stock buybacks, but not enough real investment in the real (Main Street) economy. The Wall Street economy has become more and more separated from the Main Street economy. Deficit spending is here to stay until we correct the money flow problem where too much money is flowing to the wealthiest people and biggest corporations on Wall Street and too little money is going to everyone else back on Main Street. Of course, if too much money flowed to Main Street, it could trigger real inflation in the real economy and not just stock and bond inflation on Wall Street. I will leave the inflation discussion for another column.

Lawrence C. Marsh is professor emeritus in economics at the University of Notre Dame and author of the 2020 book “Optimal Money Flow: A New Vision on How a Dynamic-Growth Economy Can Work for Everyone.”

The “Inflation Dilemma” and How to Solve It

Posted on by Lawrence Marsh
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Fiscal conservatives claim that President Biden’s $1.9 trillion stimulus proposal surely will lead to excessive inflation. However, in Congress the recently proposed Public Banking Act opens the door to a new policy tool that could quickly and painlessly stop excessive inflation in its tracks were it to develop. 

Economists such as Stephanie Kelton in her book “The Deficit Myth” argue that although we must avoid excessive inflation, deficit spending is not inherently a problem. The key point in her argument is that interest rates have remained low.  Low interest rates make larger deficits manageable because they keep interest payments on the debt low.  Moreover, low interest rates are a sign that investors have not lost faith in the soundness of U.S. Treasury securities. Although the interest rate on 10-year government bonds has risen to around 1.5 percent, it has not yet approached levels that would be of any real concern.

But already we have seen the prices of gasoline, lumber and some foods rising significantly. What if President Biden’s $1.9 trillion COVID stimulus package were to push us into an upward inflationary spiral? Biden supporters argue that this is unlikely, but what if it did?  Would the Federal Reserve have the policy tools to stop excessive inflation quickly without throwing the economy into recession?

In the past the Federal Reserve has stopped inflation by significantly raising interest rates in the New York financial markets. Most notably in the early 1980s after inflation soared to 13.5 percent, Chairman Paul Volker led the Federal Reserve to raise rates and throw the economy into a deep recession. Could the Biden stimulus bring this upon us once again?

The key to solving this problem is in understanding “The Inflation Dilemma.”  The fundamental cause of excessive inflation is when too much money is chasing too few goods which drives up prices. In the face of excessive inflation, high interest rates are needed to encourage consumers to divert more of their money to savings to earn the higher interest rate and, therefore, cut back on unnecessary expenditures.  This reduces the demand for goods and services.

However, at the same time, low interest rates are needed to encourage producers to supply more goods and services to help drive prices back down. Businesses would like to respond to excessive demand by supplying more. But high interest rates discourage them from borrowing the money they need to add another line of production. 

When faced with rising prices, we need to cut back on demand and raise supply.  Raising interest rates enables the former, but discourages the latter. This inflation dilemma can be overcome only by providing high interest rates for consumers, motivating them to increase their savings and reduce demand, and at the same time providing low interest rate to companies to increase supply.  

The Public Banking Act opens up the opportunity to solve this inflation dilemma.  From 1910 to 1966 the post offices throughout the United States offered banking services. You could go to any post office to cash a check or set up a savings account.  A resumption of these services as currently proposed in the Public Banking Act would be particularly beneficial to low-income, disadvantaged people, who, after a job loss, car accident or uninsured medical emergency, need to borrow money but have to go to loan sharks, pawn shops or “cash now” opportunists and end up paying high interest rates. Under the Public Banking Act they could apply for a small loan at a relatively low interest rate at any post office. 

But the Public Banking Act could also serve to defeat the threat of excessive inflation and solve the inflation dilemma. Limiting postal savings accounts to individuals based on their Social Security numbers and placing a limit on how much of the savings in their accounts could earn interest, the accounts could offer a high interest rate when excessive inflation threatened. Limiting interest payments to accounts with $10,000 or less would keep wealthy individuals from transferring large amounts of money to these savings accounts from the private banking system. At the same time, the Federal Reserve could keep interest rates low in the New York financial markets enabling both the payments on the federal deficit to remain low and encouraging businesses to employ more workers, not less, as they expanded supply in the face of rising prices. Thus, the inflation dilemma would be solved by offering consumers high interest rates to reduce demand and businesses low interest rates to increase supply. The combination of less demand and more supply could slow or stop price increases without entering a recession.

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Please provide your insights and comments on The Inflation Dilemma and How to Solve It.
Lawrence C. Marsh is Professor Emeritus in Economics at the University of Notre Dame and author of the 2020 book: Optimal Money Flow: A New Vision on How a Dynamic-Growth Economy Can Work for Everyone. 
_______________________________________________
You can donate the entire purchase price of the book to student scholarships by buying a hard-bound copy of the Optimal Money Flow book at the Avila University Press website at:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh  
_______________________________________________
For a limited time (21 days) listen to Optimal Money Flow for free on your smartphone or computer courtesy of your local public library via Hoopla at:  https://www.hoopladigital.com/artist/7090137015 
_________________________________________________
Please provide your insights and comments on “The Inflation Dilemma and How to Solve It” at:
https://sites.nd.edu/lawrence-c-marsh/ 
_________________________________________________
To sign up for this free monthly Money Flow Newsletter =>  click here.
_________________________________________________
For additional details see the Optimal Money Flow book website at:
http://optimal-money-flow.website or my 2018 paper presented at 2019 American Economic Association conference in Atlanta, GA:
https://www.aeaweb.org/conference/2019/preliminary/paper/FT7A95eS___________________________________The full purchase price ($24.95) will go into the student scholarship fund when purchased through Avila University Press at the link:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh
Link to my Notre Dame webpage

Minimum Wage Promise and Pitfalls

Posted on by Lawrence Marsh

One aspect of the minimum wage that has been widely ignored is not the impact on overall employment, but on the actual low-wage workers themselves. The question that has been largely ignored is what happens to low-wage workers who are not as good as alternative workers who do not enter the labor force to displace the low-wage workers until the minimum wage is raised?  

Think of a local McDonald’s where at a low minimum wage the workers may not be those with the best social skills. They may not get along well with their colleagues or be very nice to the customers. They do only the minimum required to keep their jobs. Not all low-wage workers have poor social skills, but for obvious reasons workers with poor social skills are over-represented in low-wage jobs. 

Then the minimum wage is raised. A stay-at-home parent may decide that the increased pay makes it worthwhile for them to work when their children are at school. Elderly retired workers may be willing to come back to work when offered higher pay. A college student may decide that the wage is high enough to make it worthwhile to take that McDonald’s job after all. Workers with better social skills may get along better with one another and with the customers, and they may be more willing to pick up trash in the parking lot and keep the restaurant looking nice by cleaning and straightening chairs, etc.  

What the debate about the minimum wage is missing is an analysis of what happens to the original, low-quality workers when better workers show up? With the higher minimum wage, it may be worth the while of the higher-quality workers to enter the labor force and take the jobs away from the low-quality workers. But the low-quality workers are the very ones that need the most help.  

We are fooled into thinking that the minimum wage has no effect when the level of employment does not fall. McDonald’s may employ just as many people for just as many hours as before. But the low-quality workers may have lost their jobs nonetheless. Yet these are the workers who typically are the poorest and need the most help.  

The problem is that we tend to analyze one economics policy tool at a time. But there are times when two tools need to be used in concert with one another to solve a problem. When you try to tighten a bolt and it just goes around and around without tightening, you take a wrench to hold the nut while you use the screwdriver to screw in the bolt. In the same way it is sometimes necessary in economics to use more than one tool at a time. Raising the minimum wage may work well if at the same time unemployment insurance is increased to help the lowest-quality workers.  

From the supply-side point of view, giving money to unemployed workers just encourages them to remain unemployed. But demand-side economics sees workers differently. From the demand-side point of view, more money going to unemployed workers is a good thing, especially if it causes them to hold back on taking a job until a higher wage is offered. The unemployment insurance check helps ensure that workers will not sell out for too low a wage. Even in the absence of a union, a higher unemployment insurance payment can lead to higher wages relative to profits.  

When aggregate demand is too weak relative to aggregate supply, higher unemployment payments will help divert the money flow from the financial markets where it piles up inflating stock and bond prices and depressing interest rates to money flowing to workers who have higher marginal propensities to consume than the investors on Wall Street. When demand is weak, Wall Street investors can’t find real business projects to invest in. In such circumstances diverting profits to worker paychecks through a combination of a minimum wage increase and an increase in unemployment insurance helps create real business opportunities by increasing the demand for goods and services. This produces a healthier economy with greater economic growth from which we all benefit. 

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Listen to audiobooks for free via University or Public Library via Hoopla

Posted on by Lawrence Marsh

Public libraries now allow free 21-day access to audiobooks via Hoopla. Now you can listen to “Optimal Money Flow: How a Dynamic-Growth Economy Can Work for Everyone” on your smartphone for free when you exercise, drive or just hang out. Here is the Hoopla link for free audiobook (click on book image for book description): https://www.hoopladigital.com/title/13557352

The Deadweight Loss of Christmas (revisited)

Posted on by Lawrence Marsh
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Economics is about the efficient allocation of resources. But gift giving is anything but efficient. From a purely transactional point of view, wouldn’t Uncle Jim be better off if you just handed him $50 than spending that $50 on another ugly sweater for him?  Why guess what the other person wants?  Perhaps a $50 gift card from Walmart might work, but what if what Uncle Jim really wants is not sold at Walmart?  Instead, what if you just give him $50 and he gives you $50?  Wouldn’t that be the most efficient gift exchange of all? 

Joel Waldfogel presented and analyzed this problem in the December 1993 issue of The American Economic Review in an article entitled: “The Deadweight Loss of Christmas.” For close relationships such as a good friend or significant other, the loss of efficiency from gift giving may average about one-tenth of the value of the gift; whereas, for more distant relatives or friends, the loss of efficiency may average closer to a third of the value of the gift. 

It is clear that social relationships are different from economic relationships. The problem is that economics students are taught to view the world from a purely transactional point of view. This doesn’t mean that we don’t care about other people, but just that economists don’t generally consider “intent” as important. But it is important. Meaning may be imbued into a gift by virtue of the fact that the gift-giver meant well, even if the gift was not optimal to the recipient given the amount paid for the gift. Gift giving is associated with good intent, but behavior can also be distorted by bad intent. Having your car dented in a hail storm is much less upsetting that someone denting it with a hammer. 

How about all those great Thanksgiving dinners your mother-in-law made in years past? As you left, did you give her a tip, or pull $50 out of your wallet to pay her for the great meal? People who are trying to build or strengthen a relationship don’t want to be simply paid off for their efforts in some sort of quid pro quo manner. Social (noncognitive) skills are often more important than technical (cognitive) skills in navigating the real world. Unfortunately, most economic textbooks in the past have tended to ignore such considerations.

Economists create a fantasy world where everything is about money and market relationships. In the past economics professors have tended to ignore aspects of life that cannot be measured or understood in terms of money. But this ignores the most important relationships of all. The problem boils down to prediction. Neurologists frequently point out that the primary purpose of the human brain is prediction. In primitive times knowing what to expect in different circumstances was often a matter of life or death. Even today, accurate prediction is often the key to success or failure. If people are motivated by things other than money, then an economic prediction methodology based primarily on money may lead us seriously astray if people tend to deviate from gaining the highest monetary return because they are willing to sacrifice money for other less tangible and less measurable objectives. 

Remember over this holiday season, that it is not the gift that counts, but the thought behind it that matters. (And that there is sometimes more truth in old cliches, than in that Principles of Economics textbook.)

______________________________________________
Lawrence C. Marsh is Professor Emeritus in Economics at the University of Notre Dame and author of the 2020 book: Optimal Money Flow: A New Vision on How a Dynamic-Growth Economy Can Work for Everyone. 
_______________________________________________
You can donate the entire purchase price of the book to student scholarships by buying a hard-bound copy of the Optimal Money Flow book at the Avila University Press website at:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh  
_______________________________________________
For a limited time (21 days) listen to Optimal Money Flow for free on your smartphone or computer from here:  https://www.hoopladigital.com/artist/7090137015 
_________________________________________________
Please provide your insights and comments on the Deadweight Loss of Christmas (revisited) at:
https://sites.nd.edu/lawrence-c-marsh/ 
_________________________________________________
To sign up for this free monthly Money Flow Newsletter =>  click here.
_________________________________________________
For additional details see the Optimal Money Flow book website at:
http://optimal-money-flow.website or my 2018 paper presented at 2019 American Economic Association conference in Atlanta, GA:
https://www.aeaweb.org/conference/2019/preliminary/paper/FT7A95eS___________________________________The full purchase price ($24.95) will go into the student scholarship fund when purchased through Avila University Press at the link:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh

Should the income tax be replaced with a progressive consumption tax?

Posted on by Lawrence Marsh

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Conservatives love to complain about the income tax. They say that taxing income undermines incentives and suppresses innovation and economic growth. Why should you work hard if the government is just going to take away a substantial portion of your hard-earned income? 

Instead, some propose the so-called “Fair Tax” which replaces all personal federal taxes with a national sales tax. To raise comparable revenue such a tax would need to be about 30 percent of the pre-tax price. Such a tax would be very regressive. In other words, it would take a much higher percentage of income from low income people than from high income people. Such a tax would be certain to draw the ire of the working class and middle class and be a nonstarter politically. So forget about the “Fair Tax” which imposes tax on purchases directly.

But what about a progressive consumption tax?  This tax would allow all earned income to be nontaxable as long as it went directly into savings and stayed in savings. It would be essentially an unlimited traditional individual retirement account (IRA). In other words, you could put your earned income directly into a savings account, buy certificates of deposit or stocks and bonds without paying income tax.  However, any withdrawal of money from any of these forms of savings would be progressively taxed annually at rates higher than the current income tax rates. Basically, as under the current income tax, you could probably cover a modest monthly rent and essential food expenditures while paying little or no tax. However, a high flying life style of buying exclusive properties, frequently eating out at the most expensive restaurants, and traveling around the world on costly vacations would cost you an arm and a leg in tax payments, because it would require withdrawing a lot of money from your savings. 

In theory there could be some real advantages to a progressive consumption tax. First, it would not undermine work incentives as much as the income tax, at least not directly. It would encourage frugality. You could earn a lot of money and not pay a penny in tax as long as you saved most of it. Since wealthy people have more money than necessary to meet basic needs, they often purchase items that do not involve producing more goods, such as in buying exclusive real estate or rare artifacts such as famous paintings. Their motivation is more in displaying their relative wealth and in accumulating more wealth than other wealthy people. A consistently and evenly applied progressive consumption tax would reduce absolute wealth but not relative wealth so their incentives would not be undermined by a progressive consumption tax. A progressive consumption tax would not bump anyone from their position on the Forbes list of wealthiest people unless they consumed relatively more than their peers. 

Second, a progressive consumption tax would encourage savings. Certainly, getting people to save more would help reduce the severity of recessions. Instead of cutting back dramatically on expenditures with a reduction in overtime pay, a reduction in work hours generally, or a temporary layoff, people could draw on their savings to maintain their basic expenditures when the economy slowed.  Moreover, with more money saved, they would have a more secure retirement. Overall, this would certainly serve as an automatic stabilizer and keep the economy from experiencing deep recessions.  

All this sounds good. If a progressive consumption tax was applied in the decades after World War II when interest rates on savings were higher and consumer demand was very strong relative to aggregate supply, it might have worked, although higher estate and inheritance taxes might have had to be added to maintain adequate revenues.

But there are some serious difficulties with implementing a progressive consumption tax during the current period. In recent decades our money flow has become so distorted that huge amounts of money are being diverted to the financial markets as the wealthy get ever wealthier. In the face of weak consumer demand, most of this money is not going into real investments in our economy, but is instead used to increase dividends and stock buy-backs. So little money is being retained by consumers that they can no longer afford to buy back the value of the goods and services they are producing. The government has had to step in with deficit spending to make up the difference. Stock and bond prices have been driven up, while interest rates have fallen so low that it is hardly worth bothering with a savings account. Under current rates, even a modest level of inflation could significantly reduce the real value of your savings over time. 

What this all boils down to is that to create and maintain a healthy economy, we need to eliminate the tax loopholes and distortions that enable wealthy individuals and corporations from shifting the burden of taxation onto the middle class and pouring huge amounts of money into the financial markets. Instead we need to direct money to working class and middle class people who will actually spend that money on the goods and services they are producing. Higher tax revenues from either a progressive income or consumption tax would enable us to cut back and ultimately eliminate the federal deficit spending. With less money in financial markets, interest rates would rise, which, along with a progressive consumption tax, would encourage people to save more money, which in turn would strengthen our automatic stabilizers in keeping our economy healthy.  

Please add your insights and comments on the potential advantages and disadvantages of the progressive consumption tax below in the comment box.

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___________________________________________________________________________

Lawrence C. Marsh is Professor Emeritus in Economics at the University of Notre Dame
and author of the 2020 book: Optimal Money Flow: A New Vision on How a Dynamic-Growth Economy Can Work for Everyone. You can donate the entire purchase price of the book to student scholarships by buying a hard-bound copy of the Optimal Money Flow book at the Avila University Press website at:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh  
For a limited time (21 days) listen to Optimal Money Flow for free on your smartphone or computer from here: https://www.hoopladigital.com/artist/7090137015 

How to get on Bernie Sanders’ list of millionaires and billionaires

Posted on by Lawrence Marsh

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You used to be able to afford a good retirement from a guaranteed pension earned on the job. In the decades following World War II there was a strong demand for workers in industrial jobs and the building trades. Unions were strong representing as much as 35 percent of our workforce. Unions had countered the power of companies to control block of jobs and drive down wages. By unionizing workers, wages moved back up closer to what would have been the equilibrium wage under free and fair competition. Under the Theory of the Second Best, union power countered company power to restore relatively efficient allocation of labor resources in our economy. Our economy’s productivity was rising and wages rose at about the same rate as productivity rose.

But then starting around 1975 all that changed. After the government brought in the military to break the air traffic controllers’ strike, unions began to decline. As revealed in “Optimal Money Flow” the second invisible hand of market power overcame Adam Smith’s first invisible hand of free and fair competition.  Union representation dropped to less than 10 percent of the workforce. Productivity continued to rise, but wages flattened out in real terms after adjusting for inflation. The money that would have gone to workers on Main Street was increasingly being diverted to the financial markets on Wall Street.

You are asking: What does this money flow distortion have to do with becoming really wealthy?  If you are already old, not much. But if you have young children or grandchildren, it is crucial to understanding the system, how it works, and how they could easily make a fortune over time.

It is hard to get rich the easy way (win the lottery), but easy to get rich the hard way (saving and investing every penny you can in the stock market). Capitalism won’t work very well for you if you don’t have any capital. But people have been discouraged from saving money because the flood of money into the financial markets has driven down interest rates. What is the point of saving money if you can’t earn much on your savings? The low interest rates have caused many people to go deep into debt with almost no savings at all. 

It is true that bonds and certificates of deposit, not to mention savings accounts, pay so little that it is hardly worth bothering with them. But what if you save every penny you can and put it into a broad-based stock index fund?  The difference is rather dramatic. With dividends and the rise in stock valuations, it is easy to average around 7 percent per year which allows you to double your money approximately every 10 years. Compound interest comes into play in using your wealth to build even more wealth all by itself. 

But won’t you feel guilty if you have millions of dollars while so many others are struggling to get by with many elderly having to taking jobs at hair salons or fast food joints to get by?  No doubt, you will. Bill Gates and Warren Buffett are suffering from this sense of guilt and have been giving away a lot of money through the Gates Foundation. You may suffer the same fate if you carefully and consistently follow the “get rich game plan” and actually become wealthy yourself.

As long as the wealthy cannot find more lucrative places to put all their ever increasing wealth, the stock market will continue to rise over time. This does not mean a smooth and continual increase in valuations. What is most interesting about the stock market is that it will fluctuate for a while or even drift upward or downward a bit, before making a sudden and unexpected move upward to a new higher trading range. What this means is that trying to play the ups and downs of the market is generally a fool’s errand. Just keep putting money in month after month, year after year regardless of where the market is at, and in the long run you will get an enormous return. 

What does this tell us about capitalism?  After all, in primitive times everything was thought to be owned by God so no one other than God owned anything. For native Americans, the spirit world owned everything. In reality, without the rule of law, the big guy owned everything. If you had a chicken, it was the big guy’s chicken. If you had a pear tree, those were the big guy’s pears. The King, the Pharaoh, the Emperor or the Czar then told us that God had granted them dominion over everything. You could not hunt deer in the forest or take fish from the stream without the approval of the King. 

The direct ownership of capital came about under John Locke’s conception of private property.  Locke’s idea was that you owned your own body so you could gain sweat equity over some resource from the woods by putting your work into cutting a tree branch into a spear and shaping a spear head from a stone. Your work with an object translated into the ownership of capital through sweat equity. This implied that hard work paid off. The incentives drove you to work harder to earn more capital. 

This worked great for a while as long as the craftsmen and craftswomen could afford to create their own tools which became their property as a result of their sweat equity in creating them and working with them. Land on the frontier in America became the farmer’s property through the sweat equity of working that land. But then bigger machines were needed that required more money to obtain than could be justified with one person’s sweat equity. The nobility or aristocracy stepped in to supply the water wheel or factory equipment. The ownership of capital then became separated from the sweat equity of using that capital. You could drive a truck for 40 years and gain no ownership stake in that truck or in the corporation that owned that truck no matter how hard you worked. The incentive structure broke down with no acquisition of capital through sweat equity.

What is the situation today?  You work hard in production, services, retail or delivery and earn no capital and get a rather modest return for your efforts. Those with capital (large portfolio of stocks) might spend a few minutes adjusting their stock portfolio each day, before heading out to the golf course. They are eager for you to work hard every day, so that their stocks will pay higher dividends and rise in value. After all, they have to be able to pay for their yacht, private jet or many vacation homes. Whether you are part of the rich getting richer or poor getting poorer really depends a lot on how little debt (if any) you have and how much stock (hopefully lots of stock) you own.    
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This Excel Spreadsheet shows how your money grows.
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To sign up for this monthly Money Flow Newsletter, go to:  https://optimal-money-flow.website/  Lawrence C. Marsh is Professor Emeritus in Economics at the University of Notre Dame and author of the 2020 book: “Optimal Money Flow: A New Vision on How a Dynamic-Growth Economy Can Work for Everyone.”   
You can donate the entire purchase price of the book to student scholarships by buying a printed hard-bound copy of the book at the Avila University Press website at:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh  
For additional details see the Optimal Money Flow book website at:
http://optimal-money-flow.website

or my 2018 paper presented at 2019 American Economic Association conference in Atlanta, GA:
https://www.aeaweb.org/conference/2019/preliminary/paper/FT7A95eS


The full purchase price ($24.95) will go into the student scholarship fund when purchased through Avila University Press at the link:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh