Arnold Kling  

Social Security Privatization Debated

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Here is Peter Ferrara's comeback to me on Social Security privatization and stock market scenarios.


The views advanced by Kling, however, are not peculiar to him. They reflect what personal account reformers are calling these days the "pain caucus" approach to Social Security reform. The pain caucus thinks that the Social Security reform debate is all about the program's long term deficit and closing it as quickly as possible. They fail to appreciate the true and complete argument for personal accounts, which would by themselves provide broad and powerful economic and social benefits beyond just eliminating the long term Social Security deficits.

He argues that my proposals to cut future benefits are unnecessarily painful. He suggests that privatization would increase national saving, thereby raising the capital stock and future output.

My response is this that if we eliminated some or all of the payroll tax in order to allow workers to put money into their own accounts, then we confront the issue of how to pay current benefits. If we cut wasteful government spending to pay current benefits (which is one of Ferrara's suggestions), then of course it's a win-win. On the other hand, if the government borrows to pay current benefits (another of Ferrara's suggestions), then national saving does not increase.

We also disagree about the long-run return to capital, which he says can be "rationally" expected to exceed the growth rate of the economy by a large amount. Let P be the market value of the stock market. Let E be the earnings of the stock market. Let Y be GDP. Then my argument is this:

P/Y = (P/E)(E/Y)

If the market value of stocks is going to outgrow the economy, then either the price-earnings ratio has to rise or the earnings-to-GDP ratio has to rise. The P/E ratio, which accounts for much of the historical rise in stock prices relative to GDP, is inversely related to the risk premium. In order to believe that P/Y will rise without bound, then you have to believe either that the risk premium has no lower bound (not even zero) or that the earnings-to-GDP ratio has no upper bound (not even 100 percent).

If you concede that the ratio of stock market value to GDP cannot increase without bound, that does not mean that it cannot increase for several years. However, the farther into the future that one projects an increase stock market value that is larger than the growth rate of the economy, the more implausible such a forecast becomes.

For Discussion. I think that there are two separate issues. One issue is dealing with the long-term deficit in Social Security. The other issue is swapping the government program for a private savings program. Is it better to think of those issues as separate or linked?


Comments and Sharing


CATEGORIES: Social Security



COMMENTS (128 to date)
dsquared writes:

Just to note that (obviously, ignoring all issues of vintaged capital):

GDPt = GDPt-1 + (GDPt-1 x [Savings ratet-1 - Depreciationt-1] x Return on investmentt-1)

A fairly straightforward difference equation expressing the accounting identity that next period's GDP is determined by the proportion of this period's GDP which is invested rather than consumed, and by the return on that investment.

Dividing both sides by GDPt-1 and subtracting 1 from each side, we get the accounting identity:

Growth rate in GDP = Net savings rate x Return on capital

Since the net savings rate has to be below 100% (simply because depreciation is non-negative), we can see that as an accounting identity, the rate of return on capital has to be bigger than the rate of growth of GDP.

But, as Jim Glass pointed out in previous comments (although this shouldn't be taken as an endorsement of other points he made), this is a one-period "simple" return, not a compound return. Ferrara's argument is bogus because it (implicitly) relies on comparing a rate of return on capital "well in excess of GDP growth" with the compound rate of return you earn on stocks and bonds. That rate of return assumes that the proceeds of the investment are reinvested in the same asset, and the model above clearly shows that this assumption is not valid at the level of the whole economy; the "rate of return on capital" is higher than the growth of GDP precisely because they're *not* all reinvested (the savings rate is less than 100%). Assuming that simple-interest returns can be compounded is exactly the confusion which led to Glassman's notorious "Dow 36,000", by the way.

This confusion can be seen clearly in the following paragraph, which I hope for its author's sake Paul Krugman never reads:

"The total capital stock in the economy will earn each year on average the before tax real return to capital determined by these factors. That return will constitute the portion of national income that goes to capital for the year. If there is no economic growth for a year, and the national income consequently remains the same as the previous year, that does not mean the capital stock will earn a zero return for the year. It will continue to earn the full, real, before tax return to capital, again as determined by the above factors.""

In the context of the model above, it is clear that this is nonsense. If the capital stock was returning its "full, real, before tax [but presumably after depreciation -d^2] return", why would economic growth be zero? It is easiest to see this in a two-period model of the economy, as in a two-period model, the capital invested in T1 has to return the amount spent on it in T0 plus a bit more. In a more realistic model with vintaged and long-lived capital it's a bit more confusing, but the result holds.

Ferrara also plays fast and loose by switching in the next paragraph from "capital" in the context of the national income accounts to "capital markets", but this is a minor error compared with the big one (though still big enough to make his argument incoherent independently). Bond traders would also possibly take issue with his assertion that "Rationally, we can only assume that capital market returns, including stock and bond returns, will be the same over the next 75 years as they have been over the last 75 years" given the current yield curve.

I actually have a certain degree of sympathy with Ferrara's position that we should consider the macroeconomic effects of dismantling Social Security and chucking the money in the stock market. I happen to think that these effects would be disastrous, but there you go. But it is quite clear that the article linked is based on equivocation and ambiguous meanings of important terms. It is far more rewarding to have the discussion about privatising retirement insurance with someone like Arnold who can usually be relied upon to characterise the actual economic issues in a coherent and rigorous manner.

My abject apologies, by the way, if this weblog does not support the "sub" HTML tag and my subscripts above come out garbled ....

Don Lloyd writes:

When Ferrara states - "...Rationally, we can only assume that capital market returns, including stock and bond returns, will be the same over the next 75 years as they have been over the last 75 years. They may turn out to be lower, or higher, but we have no sound basis for assuming change in either direction today....", his assumption is clearly backwards. He is saying that because the future returns may be either higher or lower, we can assume that they will be the same. This is nonsense, as there may be NO rational assumption.

Regarding the question of privatization of SS, it should be clear that retaining a coercive factor in new private accounts is highly likely to lead to a far higher level of investment than was present in the previous 75 year period. This fact alone should send up a warning flag that the history of previous investment rates of return, earned at far lower levels of investment, cannot simply be expected to be repeated, or even approached. Rates of return on both specific and general investments, generally vary inversely with their popularity, at least eventually as investment levels are increased without limit.

Regards, Don

Eric Krieg writes:

>>This fact alone should send up a warning flag that the history of previous investment rates of return, earned at far lower levels of investment, cannot simply be expected to be repeated, or even approached.

Don Lloyd writes:

Eric,

If SS were to be switched to mandatory individual accounts in which every wage earner was effectively required to invest up to 15% of his wages in the stock market, this would be such a different environment that the 75 year historical returns on investment would have little or no predictive power.

Contrary to common belief, increased investment levels can easily reduce overall profits, by increasing the level of competition and also reduce the rates of return by spreading the remaining profits over a wider investment base, as well as bidding up initial investment entry points.

Regards, Don

Eric Krieg writes:

>>Contrary to common belief, increased investment levels can easily reduce overall profits, by increasing the level of competition and also reduce the rates of return by spreading the remaining profits over a wider investment base, as well as bidding up initial investment entry points.

Paul Jaminet writes:

Eric -

The expected long-term ROR on investments is equal to the nominal growth rate of the economy. So, with an inflation rate of 6% and real growth of 3% -- characteristic of much of the 20th century -- you get roughly 9% returns. With inflation of 3% and real growth of 4%, you can expect 7% returns. With inflation of -2% and real growth of 2%, you can expect 0% returns. This is why few 19th century investors, under the gold standard, invested in stocks.

Patrick R. Sullivan writes:

" increased investment levels can easily reduce overall profits, by increasing the level of competition '

Feldstein has estimated that it would only be by about 15%, which would still dramatically outperform the current system. And, btw, that lost 15% to capital would be labors' gain.

Patrick R. Sullivan writes:

"If the capital stock was returning its "full, real, before tax [but presumably after depreciation -d^2] return", why would economic growth be zero? "

Well, let's see how it would work with our old friends Crusoe and Friday. Suppose Crusoe comes ashore in a rowboat, with a fishing pole, and discovers the island's labor force. Management and labor cut the following deal; Friday uses the only capital now on the island to go fishing, and they split the catch 50-50.

Friday proceeds to catch one fish each day, and the two share it equally. This goes on for two days, two weeks, two months, two years.... No growth in the economy, but returns to both labor and capital.

dsquared writes:

>>Suppose Crusoe comes ashore in a rowboat, with a fishing pole

Well no. Don't suppose that. If you're going to model anything with relevance to the economy, you can't suppose that capital washes up on the shore.

>>This goes on for two days, two weeks, two months, two years....

Nor can you suppose zero depreciation

rvman writes:

From the perspective of now, does it matter whether capital was built or "washed up on the shore"? It exists. To eliminate depreciation, have Friday fish for 8 hours, and then spend a couple of hours butchering and cooking the fish, repairing the boat and fishing pole, etc. As long as he doesn't build a new boat, pole, etc - that is, new capital - there is no growth. And yet Crusoe is getting a return on his capital - his half a fish. His net assets stay the same: value of boat - depreciation + repairs = value of boat. Total GDP = 1 prepared fish + repairs. For all periods. Presumably, after the initial shock of landing, the boat retains its "price", so P/E stays the same. E/Y is constant. But capital is STILL EARNING ITS RETURN > GDP!!!

What is happening is that that return isn't being completely reinvested. Well, neither will it be completely reinvested in a privatised SS scheme. People will be retiring, and pulling money out. Ultimately, if population and GDP were to stablize, net influxes + returns would stablize to withdrawals + depreciation, just like above. (Won't happen, since GDP continues growing, but to simplify the example, lets assume it does.) Which will be higher, the GDP where this system is based on return off of a bunch of savings, and thus capital, or this same equilibrium based on "Pay as you go", and thus a lower level of capital.? Will capital's "return" be zero? Growth is.

I do not doubt that long run capital return will be somewhere between what it is now and growth rate. It will be higher than growth rate, though. And the economy as a whole - GDP - would be better off. It is getting from here to there that is the trick. (My suggestion - slowly ramp up the percentage of payroll taxes retained, for those under a certain age. Guarantee a level of benefits for those over that age, and phase out the program as necessary over the younger folk. (If the cutoff for full benefitsis 55, allow 50 year olds a 80% benefit + return on savings, 45 year olds a 60%, etc. These percentages are for example only - real numbers may vary.) Pay for deficits out of general revenue - we'll have to anyway, when the system goes into deficit.

Will this "save" Social Security from the ignominious fate of general revenue funding? No, of course not. The only way to do that is raise payroll taxes a lot, or lower eligibility. Everyone here, not a libertarian, who wants to do that, raise your hand. The above, I believe, will have lower cost than the current system, and be much better for the economy.

dsquared writes:

Repairing a boat is investment, not consumption. I really do suggest that we stick to simple two-period models in which capital is created in T0 and destroyed in T1 in order to get the stylised facts right before trying anything more complicated.

dsquared writes:

(Forestalling any criticism from Austrians) I realise that static models are limited and agree that the dynamic issues have to be taken into account, but we need to establish things like the rate of return identity before moving on.

The answer to Patrick's question is that you have to break up the time periods differently. Dividing up production into arbitrary periods based on calendar time is the only way to do national income accounting, but it's a surefire way to get confused when you're doing capital theory.

There are only two periods in the Crusoe example described. In period 1 (Before Fishing Rod), the size of the economy is the value of one fishing rod, consumption is zero and savings are 100%.

In period 2 (the period between Fishing Rod Day and the day when the Rod breaks), the size of the economy is the total amount of fish caught during that period, which it is assumed are all eaten and nothing saved. So the "growth" in the GDP of the island is the difference between nothing and the fish caught. This is also the return on the investment in making the fishing rod

In period 3 (after the rod breaks), the capital asset is fully depreciated, production, consumption and saving are all zero and Crusoe and Friday all starve to death.

If you break it up in this manner, fitting the "returns" to the life of the capital asset, you reach the accounting identity above. If you subdivide period 2 into calendar time, you get Patrick's result, but this is an arbitrary way to divide it up, which only makes sense if you're already in hell capital theory-wise because you're trying to do growth accounting for an already existing and heterogeneous capital stock.

If you think that this is contorted thinking, try reading Bohm-Bawerk one day ....

Eric Krieg writes:

From Ferrera:

>>The problem is worsened because the baby boom generation had much lower fertility than previous generations, a point that Kling did not mention. So the working generation that is supposed to fund the benefits of the baby boomers through taxes in the pay-as-you-go system is relatively small.

Patrick R. Sullivan writes:

" >>Suppose Crusoe comes ashore in a rowboat, with a fishing pole

" Well no. Don't suppose that. If you're going to model anything with relevance to the economy, you can't suppose that capital washes up on the shore."

Oh c'mon, you've heard of Nike? It's foreign investment.

" >>This goes on for two days, two weeks, two months, two years....

" Nor can you suppose zero depreciation"

Sure you can, easier than you can assume a can opener. Part of Friday's job is to maintain the boat, he get's nothing beyond his half of the fish for doing so. There is no addition to the capital stock for maintenance.

Patrick R. Sullivan writes:

" There are only two periods in the Crusoe example described. In period 1 (Before Fishing Rod), the size of the economy is the value of one fishing rod, consumption is zero and savings are 100%."

I guess you missed the import of my saying: "This goes on for two days, two weeks, two months, two years....".

dsquared writes:

Patrick, maintenance spending on a capital asset is investment. If you're maintaining a boat, your consumption is reduced.

>>I guess you missed the import of my saying: "This goes on for two days, two weeks, two months, two years....".

I thought I said quite clearly why I thought it was a red herring.

Patrick R. Sullivan writes:

" >>I guess you missed the import of my saying: "This goes on for two days, two weeks, two months, two years....".

" I thought I said quite clearly why I thought it was a red herring."

Still don't see it, huh? Period 1 is the day after the contract is agreed to and the fishing begins, period 2 is the next day, period 3 the day after that....

"Depreciation" is so small as to be zero. Further, as I said, Friday is responsible for any maintenance and repair, not Crusoe. Any reduction in consumption comes from Friday's leisure time. I.e. it does not effect GDP. So, your question:

"If the capital stock was returning its 'full, real, before tax [but presumably after depreciation -d^2] return', why would economic growth be zero? "

Is answered by my simple example. Also, GDP growth could easily be negative and be an answer too. Suppose Crusoe strikes a bargain that fixes his return at 1/2 fish per day. Friday could meet that obligation by going without eating a day or two per week. In which case, GDP would decline while capital received its "full real return".

dsquared writes:

Patrick, you're doing exactly what I said; confusing the issue by trying to run before you walk. You need to get things sorted out in simple, capital-life-cycle time before moving onto what happens in calendar time.

Bernard Yomtov writes:

"Any reduction in consumption comes from Friday's leisure time. I.e. it does not effect GDP. "

That doesn't sound right. Maintenance time has to come from somewhere. You're lowering Friday's wage to cover depreciation. Either that or you're investing output, that is, part of his portion of fish is pay for his maintenance work. He gets 40% of a fish for fishing, and 10% for fixing the boat, say. Isn't the 10% being invested?

rvman writes:

Yes, the repairs on the boat are gross investment. Depreciation is gross negative investment. Net investment = 0. Capital Stock growth = 0. GDP Growth = 0.

dsquared - the question being answered is "can capital returns outperform GDP growth?" Both of those concepts are meaningful only in calendar time. So if we are going to answer them, we have to build a model which works in calendar time.

I think what we are hanging on is that capital return doesn't occupy the same space as GDP Growth. Let's say return to capital is 5% - that is, firms have 5% of the value of their capital left over at the end of the day, once revenues are collected, depreciation offset, and expenses paid. They can either reinvest that money or pay it as dividends. If we use a REALLY simplified theory of stock prices, the price of the stock should be the present value of future returns. If dividends are paid, then that 5% is paid out and stock price remains the same over time. If the company buys back shares, then the stock price rises 5%. Or they can buy out someone else's capital(normally shares), in which case their own stock rises 5%, because it now represents the original capital plus the new capital. All of these cases represent forms of dividend distribution. Only if they "reinvest" by purchasing additional new capital does this 5% capital return result in a 5% increase in capital stock, and thus in GDP.

Two of these can be done more or less "forever" - Dividend distribution and reinvestment. In either event, the return to capital is 5%. Only in the latter case can GDP growth approach 5%. If ONLY reinvestment were occuring, then yes, in the long run GDP growth would match capital return per period.

Part of the problem is that our host is trying to assume that changes in stock prices are the same as return to capital. They aren't. Maybe today dividends are out of favor, but THAT can't hold forever. Returns to capital in a competitive market won't outperform the long run real interest rate, adjusted for risk, but that only equals GDP growth if reinvestment is the only outlet for returns. In fact, in the long run if real interest rates = rate of time preference = returns on capital, then GDP growth will probably be zero - people will consume dividend distributions.

In Robinson Crusoe terms, GDP Growth will equal capital return only if the 1/2 fish per day is used to build a new boat. (GDP growth is a percentage of overall GDP. Capital return is net payment to capital stock. Why would they have to equalize, if returns can be used for something other than new capital?)

Jim Glass writes:

Ferrara is right that the *real* problem with SS is that it is a *very bad deal* for today's young workers compared to the alternatives readily available to them. Just as SS became very popular when it was a very good deal, better than available alternatives, so being a bad deal will make the status quo unpopular in the future -- it's already started, as we can all see. And being that SS is a political creature, political unpopularity will doom the status quo, one way or another.

The "funding crisis" is relevant only in that solving it must of necessity make the deal for today's young workers even *worse*. Closing the funding gap is easy -- trivial even. Just increase taxes or reduce benefits or both. It's no more difficult than closing a funding gap at the Agriculture Department or Pentagon or wherever.

That our politicians are so loathe to do such a simple thing -- in spite of the endless warnings of SS's trustees that "sooner is much better than later" in doing so -- shows the fact that it is *not* the funding gap per se that is the real problem.

The real problem is political -- that closing the 25% funding gap by either raising taxes or lowering benefits will *visibly* further reduce the return on contributions to today's young workers, from the current miserable 2%-to-negative, to 25% below that, giving today's young workers a much worse deal than prior generations had. Today's politicians don't want to take the heat for that, they want to leave that heat for tomorrow's politicians, who will face a gap larger than 25% as a result.

But when the cash flow on SS goes negative in a time of large overall deficits, around 2018, the politicians won't be able to dodge any more. Most likely means testing for Bill Gates and all those Boskin IRA millionaires then will become a cost-cutter so that the national deficit won't be run up to provide extra spending cash to billionaires and millionaires. But that still won't provide positive returns to SS participants, which is *the* problem.

The *only* way to give meaningfully positive average returns to participants on their SS contributions, which is the political necessity to save SS, is by some form or other of private savings -- like the Swedes have done. I mean, the Swedes of all people have faced up to all this and found 2% private accounts the way to go. Something like that really is inevitable. The work to do now is to examine the alternative possibilities and their consequences to make the best choice as to how to do it.

** "I think that there are two separate issues. One issue is dealing with the long-term deficit in Social Security. The other issue is swapping the government program for a private savings program." **

They have to be looked at together for the reasons above -- closing the deficit is fiscally trivial but politically impossible (see today's politicians) unless some counter is presented to the fact that doing so will give all workers seriously negative returns from SS on 12.4% of pay when they could get positive returns on that same money ... well, anywhere. In a money market fund, even. People just aren't going to be happy to have Social Security impoverish them.

** " ...if we eliminated some or all of the payroll tax in order to allow workers to put money into their own accounts, then we confront the issue of how to pay current benefits." **

Friedman has pointed out that this argument is a red herring because the liability to retirees is a sunk cost. We have to pay it from taxes anyhow, whatever we do. Thus the net change in cost from putting in a funded "real savings" system for today's young workers is exactly $0. We'd pay the current benefits from taxes just exactly as we would anyhow -- only we could shift them to income taxes, much more progressively, with a lower tax rate over a much larger tax base. Net change in cost $0, with big improvements in both efficiency and equity. And even Krugman has admitted that a funded retirement system would be better for workers if we had set SS up that way. So going forward for young workers, let's make him happy and set it up that way!

** "We also disagree about the long-run return to capital.... **

I find this whole running argument something of a red herring too.
[] First, as to "stocks" carrying the whole load of privatization, they wouldn't any more than they do in corporate pension plans and other retirement accounts. There's a whole world of investments available. Government bonds by *direct* ownership in private accounts would be a big improvement over the SS status quo.
[] Second, re the tie between the return to capital and the US economy, it is the world economy that matters. It is payroll taxes that are tied to the US economy.
[] Third, this whole argument sounds like it could have been made decades ago against corporate pension plans, IRAs, 401(k)s, etc. "There can't be trillions of dollars of new private retirement savings without driving down the return to capital, etc." Well, here we are and it hasn't so far that anybody's noticed. If SS could have been a funded program to begin with, then it can be one now.
[] Fourth, some increase in private savings must result -- however much that is, a lot or a little, it's got to be a good thing. (How are we going to pay for Medicare, which is a *real* problem?)
[] Fifth, as long as return to capital is *positive* private accounts will be better than what today's SS will provide to most young workers. Anything positive beats a negative.
[] Sixth, in political reality we are talking only about 2% private accounts, like the Swedes have, or something on that scale -- not privatizing all of SS (even if we should). It's not that big a deal.

dsquared writes:

Rvman wrote:

"dsquared - the question being answered is "can capital returns outperform GDP growth?" Both of those concepts are meaningful only in calendar time. So if we are going to answer them, we have to build a model which works in calendar time. "

Good objection. But we want to be thinking about steady state, long term equilibrium answers to these questions, which to me means sorting out our model in capital time first and then extending it. I have to confess that I don't understand your company example, which just goes to show that this is a difficult subject. I'll have another cup of coffee and come back to it.

Jim: The "poor return" on Social Security for young people is a result of their reduced numbers compared to the number of expected future claimants.

Given that private savings accounts will neither create more young people nor exterminate old people, I'm assuming that the underlying demographic problem will be unchanged. So how can the economic problem be solved?

The *only* way that you can assume that private accounts are a solution is either to assume that the simple act of privatisation will improve the productive capacity of the USA dramatically, or to assume that the rate of return on capital outside the USA is dramatically higher than the rate of return on capital in the USA. Otherwise, you're pushing a problem that used to be called "taxes" into a problem called "dividends and coupon payments", and young people still end up getting the raw end of the deal.

Don Lloyd writes:

dsquared,

"...The *only* way that you can assume that private accounts are a solution is either to assume that the simple act of privatisation will improve the productive capacity of the USA dramatically, or to assume that the rate of return on capital outside the USA is dramatically higher than the rate of return on capital in the USA. Otherwise, you're pushing a problem that used to be called "taxes" into a problem called "dividends and coupon payments", and young people still end up getting the raw end of the deal...."

This seems to be substantially correct.

The returns on financial assets cannot, overall and in the long run, exceed the profits that can be realized from the actual real investments that result from the use of the financial assets to produce goods and services.

In the long run, in a closed economy with neither imports nor exports, the total real financial returns and profits cannot grow faster than the population.

When additional marginal investment funds become available, either through increased saving and investment, or through artificial credit expansion, they will eventually increasingly reduce and eliminate profits due to higher levels of competition that overwhelm the carrying capacity of the finite consumption markets.

While there is no limit on the standard of living benefits that can result from increased productivity and lower consumer prices (assuming no monetary expansion that mistakenly attempts to stabilise prices and prevents broad distribution of those benefits), financial returns will stop increasing as the economy fills up all available niches through specialization and the division of labor, and starts to become zero sum as new niches must destroy old ones.

Regards, Don

Eric Krieg writes:

>>We'd pay the current benefits from taxes just exactly as we would anyhow -- only we could shift them to income taxes, much more progressively, with a lower tax rate over a much larger tax base.

Eric Krieg writes:

>>The *only* way that you can assume that private accounts are a solution is either to assume that the simple act of privatisation will improve the productive capacity of the USA dramatically

Don Lloyd writes:

Eric,

"...The act of privatization raises economic growth rates by 3 POINTS over what it otherwise would be...."

It would be only a slightly caricatured model to say that the private accounts might be required to invest 10% of income in 'safe' investments, say IBM and MSFT stock only. Is there any reason to assume that this would raise economic growth rates, or yield high returns in the long run?

Regards, Don

Eric Krieg writes:

I would assume that the accounts could invest in any mutual fund. I wouldn't assume that these only would be stock funds. Bond funds, cash funds, just about any fund that is available to a 401(k) should be assumed to be available to a fully funded national pension system.

And as Larry Kudlow would tell you, a nation of stockholders is going to act differently than a nation of people betting their retirement on a government enforced ponzi scheme.

For example, if we had your system where everyone held IBM and Microsoft, do you think that the Feds would have taken anti-trust actions against MS? I don't think so.

Patrick R. Sullivan writes:

" I have to confess that I don't understand your company example, which just goes to show that this is a difficult subject."

It isn't as difficult as some people are trying to make it out to be.

"Jim: The 'poor return' on Social Security for young people is a result of their reduced numbers compared to the number of expected future claimants.

" Given that private savings accounts will neither create more young people nor exterminate old people, I'm assuming that the underlying demographic problem will be unchanged. So how can the economic problem be solved?"

As you have been told an uncountable number of times, allowing Americans to invest OUTSIDE the U.S. will increase the number of people supporting American retirees. The other mechanism is by increasing the capital available, thereby making a given workforce more productive.

Don Lloyd writes:

Eric,

If more people holding more stock resulted in the elimination of the FED, the income tax, and government schools, you might have a point. -grin-

No matter what the investment vehicle, the last marginal investment is far less effective than the first.

If you buy a million dollars of IBM stock, how does this result in increased economic growth or increased business profits?

First of all your investment does nothing for IBM unless it makes a secondary stock offering at a price that has been temporarily bid up by your purchase. For most intents and purposes, stock buyers and sellers on the public markets are merely gambling among themselves while pushing the stock price up and down and varying the actual results that the inside owners produce as they cash out their holdings. There is nothing wrong with this. But it is the existence of the liquid market that motivated them to make initial investments in the past, not the price gyrations in the present, and not in any significant way your decision to buy stock. The effect of your stock purchase depends on the investment decisions of whoever sold you your stock.

But even if your investment were to directly go to IBM for its internal investments, it would be of little or uncertain effect. IBM at any one time has thousands of potential investments under consideration. They will be ranked from best to worst depending on their potential returns and degree of risk. As more investment funds are made available to IBM, they will be sequentially invested in the highest ranked investment. What this likely means is that your late arriving million dollars can only be used by IBM for a relatively low ranked investment, with weak potential returns and high risk. Thus there is little certainty that your million dollar investment will result in increased business profits by IBM or anyone else.

The only way your million dollar investment is likely to help the economy is if you can invest it in something about which you have correct and rare knowledge, possibly your brother-in-law's small business which needs your money.

The idea that simple, dumb increases in investment levels result in a more productive and profitable economy is unlikely to be anywhere near as true as expected, if at all.

Regards, Don

dsquared writes:

>>As you have been told an uncountable number of times, allowing Americans to invest OUTSIDE the U.S. will increase the number of people supporting American retirees.

As I have pointed out a countable number of times, this implicitly assumes that the rate of return on capital is higher outside the USA than inside it, and also requires under most reasonable assumptions that the USA will run a substantial current account surplus for the next several years. I do not see how merely privatising Social Security will affect this.

In any case, money is fungible; the government borrowing implied by Social Security ought to be crowding out exactly that amount of private capital and sending it overseas. If people aren't investing overseas now, why would they under a different regime?

>>The other mechanism is by increasing the capital available, thereby making a given workforce more productive.

Hahahaha. Privatising Social Security will increase the capital stock of the United States of America? How? Will it cause trucks and lathes to magically wash up on the beaches? Will the French send machine tools as a birthday gift in celebration?

If you send an email to Arnold, he might delete your post for you.

Bernard Yomtov writes:

"What this likely means is that your late arriving million dollars can only be used by IBM for a relatively low ranked investment, with weak potential returns and high risk. Thus there is little certainty that your million dollar investment will result in increased business profits by IBM or anyone else."

Don,

You are correct up to this point. Remember that IBM is not obliged to accept the million dollars, and will normally do so only if they expect the return on the project they finance with it to exceed its capital cost.

Eric, after all, is unlikely to provide IBM with a million dollars without demanding something in return, most probably a quantity of stock.

Jim Glass writes:

"Jim: The 'poor return' on Social Security for young people is a result of their reduced numbers compared to the number of expected future claimants...."

Not so. It's due to the continuous increase of backloaded benefits to one prior generation after another over 60 years, until we've now reached the point that payroll taxes finally no longer can be increased to give the younger generation a positive return.

Note that with a funded system -- even one like FDR's original Social Security, funded by investments only in gov't bonds -- the "demographic" problem you are talking about never arises, no matter what happens to the worker/retiree ratio, because each worker's benefits are funded in advance. The worker/retiree ratio is a non-issue.

FDR's Social Security Act of 1935 was designed to give positive returns of a real 3% annually to everyone forever. "Actuarially sound and out of the Treasury forever" in FDR's words. Of course, it wasn't going to pay full benefits to retirees until some decades passed, as benefits became funded.

Private savings accounts are funded. So they don't incur the demographic problem of SS.

Unless, of course, you think global capital markets are incapable of absorbing a modest portion of US savings -- 2% savings accounts would represent really a quite modest net addition to total US savings (and we here so often that an increase in the US savings rate is badly needed). You really believe global capital markets couldn't handle it?

"Given that private savings accounts will neither create more young people nor exterminate old people, I'm assuming that the underlying demographic problem will be unchanged. So how can the economic problem be solved?"

You haven't noticed that there are rather more workers in the world than there are in the US? And that their demographic profile is rather different?

"The *only* way that you can assume that private accounts are a solution is either to assume that the simple act of privatisation will improve the productive capacity of the USA dramatically, or to assume that the rate of return on capital outside the USA is dramatically higher than the rate of return on capital in the USA... "

Huh?

"Otherwise, you're pushing a problem that used to be called "taxes" into a problem called "dividends and coupon payments", and young people still end up getting the raw end of the deal"

Well, that sure must leave the Swedes befuddled about how their 2% private accounts are going to provide a positive return to anyone -- what with Sweden's SS financing situation being worse than the US's by every measure.

So when Sweden's young workers tap the world's capital markets with their private accounts, they are just screwing themselves because, what?, as a result they must receive less in "dividends and coupon payments" in Sweden in the future compared to what they save, just as they'd get less in benefits compared to the taxes they paid in a paygo transfer system?

The Swedes' 2% investments in international markets are going to drive down global investment returns to the return they'd get on taxes in Sweden's tax and transfer system?

You know what, as long as global returns on capital >0%, they don't think that's gonna happen. ;-)

BTW, why shouldn't all these same arguments have been made a few decades ago against the rise of corporate pension plans and then IRAs, 401(k)s, etc.? Don't they all imply that we should have just added a bunch more to payroll taxes to substitute for all those private savings, since private savings can't provide any real benefit compared to a tax-and-transfer tax system? But then why does even Krugman say SS *would* have been better as a funded system?

Jim Glass writes:

" 'As you have been told an uncountable number of times, allowing Americans to invest OUTSIDE the U.S. will increase the number of people supporting American retirees. ' "

"As I have pointed out a countable number of times, this implicitly assumes that the rate of return on capital is higher outside the USA than inside it..."

Nonsense.

"... and also requires under most reasonable assumptions that the USA will run a substantial current account surplus for the next several years."

So you are saying that I haven't been able to get the international capital markets' rate of return in my IRA for the last 20 years because the US has been running trade deficits all that time?

Or are you saying that while I can and will continue to do so in my IRA, some mystical reason of dark magic would keep me from doing so in a comparable 'SS IRA'?

"I do not see how merely privatising Social Security will affect this."

Well, it would increase the domestic savings rate by some amount. And that would tend to improve the current account. So it would help.
Though that obviously is hardly necessary for one to get a market rate of return in global investment markets.

Don Lloyd writes:

Bernard,

It WAS IBM stock that Eric would have been buying with his million dollars. My point is that simply buying stock on a public exchange doesn't generally improve either the profitability or the productivity of the economy as a whole OR the company itself. For Eric to profit himself, he either needs a proverbial 'greater fool' to buy his stock at a higher price and/or dividends.

Regards, Don

Jim Glass writes:

"In the long run, in a closed economy with neither imports nor exports, the total real financial returns and profits cannot grow faster than the population."

Which nicely illustrates the problem with a tax-and-transfer social security system financed solely by payroll taxes imposed on the domestic economy. And why so many nations are adding private investment options to their SS system to escape this limitation.

Sweden has overpromised past benefits relative to the payroll it will have available to tax in the future in its local "closed" economy, so Swedish workers can't get positive returns on their contributions via such taxes.

But Swedish workers can get positive returns in their privatized 2% SS investment accounts that they invest in companies that are investing in China (and India, and the rest of Asia, and South America, and North America, etc.)

Bernard Yomtov writes:

Don,

I understand your point. I was referring, not too clearly I see upon rereading my post, to the case where money goes directly to IBM for internal investments.

In that instance IBM is free to reject the investment, and wise to do so, if it lacks sufficiently profitable projects.

Don Lloyd writes:

Bernard,

"...I understand your point. I was referring, not too clearly I see upon rereading my post, to the case where money goes directly to IBM for internal investments.

In that instance IBM is free to reject the investment, and wise to do so, if it lacks sufficiently profitable projects."

There's no question that IBM will not undertake known negative investments.

However, there is a wide range of projected results and risk involved in the universe of possible positive investments that IBM perceives as available to it. ALL of the investments actually made will tend to produce all of the undesirable consequences of any investment, i.e additional competition for both markets and resources. In large part the last marginal investment that IBM undertakes MAY depend on the investment capital available to it. IBM is probably a bad example in the sense that it probably has virtually unlimited access to capital, if it is willing to pay the price.

However, for smaller companies with limited credit, the marginal ones are more likely to become real drags on profitability as they are actually funded by banks desperate to loan against their fractional rserves.

Regards, Don

Bernard Yomtov writes:

Sorry Don, I don't understand. You seem to be saying firms will knowingly make bad investments for no other reason than that someone will supply the capital.

Patrick R. Sullivan writes:

Why do I suspect d squared has just returned from one of those three-wines-meals paid for on someone else's expense account.

" >>As you have been told an uncountable number of times, allowing Americans to invest OUTSIDE the U.S. will increase the number of people supporting American retirees.

" As I have pointed out a countable number of times, this implicitly assumes that the rate of return on capital is higher outside the USA than inside it..."

Pretty obviously not. The question you asked was about the demographics. I gave you the answer (there's a whole wide world out there to exploit), and you are now blindingly thrashing about for a rejoinder. The rate of return on foreign investment could be LOWER than the R of R on domestic investment, and it would still INCREASE the number of workers available to American retirees. Don't blame me that you asked a stupid question.

Think back to Crusoe and Friday; suppose Crusoe spends his days building a second boat and fishing pole. It's useless on that island (assuming Crusoe doesn't want to fish) as Friday can't use both boats at the same time. But if Crusoe rows it over to East Islandia and contracts with Saturday he's got another hand feeding him. Even if Saturday catches fewer or smaller fish (i.e. the R of R is lower), Crusoe has solved the "demographics problem" and has more to eat.

[snip]

" Hahahaha. Privatising Social Security will increase the capital stock of the United States of America? How? Will it cause trucks and lathes to magically wash up on the beaches? Will the French send machine tools as a birthday gift in celebration?"

I see you have a keen grasp of the world of commerce. Offer them money, and they will produce.

"If you send an email to Arnold, he might delete your post for you."

Oh, I wouldn't think of spoiling my fun.

Don Lloyd writes:

Bernard,

"... You seem to be saying firms will knowingly make bad investments for no other reason than that someone will supply the capital...."

Not at all. Investments must be judged good or bad twice, once before investing, and once after the investment has been made.

I can invest in a perfectly good looking investment in a corner gas station, but it may turn out to be bad if three additional stations are subsequently built on the other three corners of the intersection. The availability of business loans may well be the determining factor as to whether 1,2,3 or 4 stations are actually built.

Regards, Don

dsquared writes:

Jim, there are still a number of fallacies of composition in your argument:

>>Note that with a funded system -- even one like FDR's original Social Security, funded by investments only in gov't bonds -- the "demographic" problem you are talking about never arises, no matter what happens to the worker/retiree ratio, because each worker's benefits are funded in advance. The worker/retiree ratio is a non-issue.

It is still an issue. In the simple model you look at here, the young end up getting a high tax burden because the government has to pay the interest on the government bonds in the fund. Funding arrangements don't change the fundamental fact that if some people are going to consume without producing, others must produce more than they consume.

For an individual, it's a sensible simplifying assumption to just regard a treasury bond as a black box that produces money in ten years time in exchange for money now. When you're looking at the point of view of the whole economy, you can't make this assumption.

>>So you are saying that I haven't been able to get the international capital markets' rate of return in my IRA for the last 20 years because the US has been running trade deficits all that time?

No, I'm saying that *the* *entire* *US* *economy* can't be a net investor overseas (rather than a net borrower from overseas) without also running a current account surplus, and I'm getting quite cross that you keep injecting these silly remarks about the investments of a single person.

Sweden is much smaller than the USA.

Patrick: Your example does not illustrate your problem, although it does demonstrate (again) that you're determined to be confused about capital.

>>It's useless on that island (assuming Crusoe doesn't want to fish) as Friday can't use both boats at the same time. But if Crusoe rows it over to East Islandia and contracts with Saturday he's got another hand feeding him. Even if Saturday catches fewer or smaller fish (i.e. the R of R is lower)

Patrick R. Sullivan writes:

Gee, d squared appeals to his own authority, and on the other side I have Milton Friedman, Martin Feldstein, and Tom Sargent saying I'm right. What to do? What to do?

But I hope d squared also enjoyed the cognac that must have induced him to produce this howler:

" >>It's useless on that island (assuming Crusoe doesn't want to fish) as Friday can't use both boats at the same time. But if Crusoe rows it over to East Islandia and contracts with Saturday he's got another hand feeding him. Even if Saturday catches fewer or smaller fish (i.e. the R of R is lower)

dsquared writes:

>>and on the other side I have Milton Friedman, Martin Feldstein, and Tom Sargent saying I'm right. What to do? What to do?

As I've told you before, take a bit more tobacco with it.

If the marginal rate of return on capital is higher outside the USA than inside, why is the US private sector not a massive net exporter of capital?

>>Anyway, what does d squared have to say to Tom Sargent

I'd say "Tom, there's this odd bloke on the internet who's taking your work in vain to support some pretty weird statements about social security privatisation. I think that the problem is that he's forgotten that total saving equals private saving plus government saving, but have a look".

Patrick R. Sullivan writes:

d squared apparently believes the best response to finding oneself over a barrel, is to ask an irrelevant and silly question. Such as:

" If the marginal rate of return on capital is higher outside the USA than inside, why is the US private sector not a massive net exporter of capital?"

Well, MARGINAL means on the next dollar invested. So why there would not be "a massive" export of capital should be obvious. However, d squared is desperately trying to change the subject from his original claim that there is soon going to be a "demographic problem" that can't be solved.

IN THE FUTURE, when baby boomers start to retire. Not today, when baby boomers are working and overpaying SS taxes. Whatever the situation of export vs. import of capital TODAY, it is irrelevant to the situation that d squared professes to be worried about in the future.

And it is a fact that Americans do invest overseas in physical assets right now, and can increase that investment if circumstances warrant. And surely, d squared isn't so foolish to think that American retirees will ever constitute the entire U.S. economy.

And I note the full and headlong retreat on the Sargent argument, as well.

Patrick R. Sullivan writes:

Since some are having trouble with their tenses, I'll illustrate with another example. At present the worker to retiree ratio on the desert island is 1:1 (Friday to Crusoe).

In the future, Friday can die before Crusoe, reducing the ratio to 0:1. Leaving Crusoe with a demographic problem. One that he can solve by taking the boat and fishing pole over to Saturday's island, and restoring the ratio to 1:1.

That Crusoe doesn't engage in "a massive net export" of capital today, doesn't mean he can't if circumstances change. Which is d squared's bogeyman.

Jim Glass writes:

"Jim, there are still a number of fallacies of composition in your argument..."

Again with the 'fallacies of composition'. Geeze ;-)

"In the simple model you look at here, the young end up getting a high tax burden because the government has to pay the interest on the government bonds in the fund. Funding arrangements don't change the fundamental fact that if some people are going to consume without producing..."

You keep imagining that the constraint on returns on SS for the young is the future productivity and wealth of the world in some meaningful way, when the real-world data -- which have been totally absent in this thread -- show that it is *not*, in *no* meaningful way.

The constraint is simply the *formula* in the administrated program of SS that has been politically manipulated over the years so that it is now mathematically impossible to deliver what the politicians have promised, which will piss off future voters. That is *all*, it is a *political* problem.

Note well that these are two different things: A resources constraint and a formula constraint. And the resources contstraing is not meaningful, so fuhgettaboutit.

In the future there is going to be more than ample real wealth even in the US alone (forget the rest of the world) to make *everybody* happily wealthier than they are today. Unless a comet hits the earth. That's *not* the problem.

The problem of SS is the formula constraint that that politicians have made specific promises to voters of what would be delivered through a particular administrative system that it is now mathematically impossible to keep. That's the problem, a *political* problem.

>>So you are saying that I haven't been able to get the international capital markets' rate of return in my IRA for the last 20 years because the US has been running trade deficits all that time?

"No, I'm saying that *the* *entire* *US* *economy* can't be a net investor overseas (rather than a net borrower from overseas) without also running a current account surplus...."

*The* *entire* *US* *economy* doesn't have to run a capital surplus for individual investors to benefit from investment opportunities they didn't have before, any more than *the* *entire* *US* *economy* must run a trade surplus for people in the US to benefit from trade.

"... and I'm getting quite cross that you keep injecting these silly remarks about the investments of a single person."

I hate to break this to you, but SS investors are all single persons -- and in the aggregate their total potential SS investments don't amount to much of either the US or world economies. While you seem to imagine the world's entire future production will be bound over to them. Tain't so, no matter how much they might want it. ;-)

Remember when I observed that even an insured money market fund beats the return on SS to many, and you answered with the 'fallacy of composition'...

"I think you're assuming far too readily that investment options which are available for individuals are necessarily available for the economy as a whole (this fallacy of composition...)"

... just *as if* Social Security is "the economy as a whole"!? (And as if money funds would be more than one of many options in private SS accounts.) Well, you still seem to be thinking that way.

And I'm getting quite cross that you keep injecting these silly 'fallacy of composition' objections at every turn. Try thinking of today's SS participants as the individuals they are, partaking in a much, much larger scheme of things, as they are.

"Sweden is much smaller than the USA."

And today's young SS participants are much smaller than the world. Much smaller than the USA, even.

BTW, you didn't answer my question as to why your points haven't argued against all private retirement plans from the first corporate pensions plan onward.

"I also note that it is currently legal for Americans to invest overseas and therefore the fact that the USA runs a substantial capital account surplus is decent evidence that they don't want to."

Geeze.... No Americans want to invest overseas? Or all those many, many who do don't want to and are forced to against their will? Or they aren't really Americans since they want to? What does this mean???

Would you also note...

" ...it is currently legal for Americans to sell their goods overseas through trade, and therefore the fact that the USA runs a substantial trade deficit is decent evidence that they don't want to." ?

You've got to try de-aggregatize your thinking, please. All economic actors are individuals. It's individuals who count. Aggregates are just the sum of individual actions.

And the "aggregate bounds" for individual action that you seem to imagine apply to SS just simply *don't*.

Jim Glass writes:

Regarding all the arguments along the lines that private accounts in SS "must reduce the rate of return on capital", or will merely shift the problem from return on "'taxes' into a problem called 'dividends and coupon payments', with young people still end up getting the raw end of the deal", it occurred to me that looking at some actual, realistic numbers might give some perspective. Being that they've been totally absent so far.

First, let's imagine that 2% private savings accounts are created in SS, as per the Swedish example, the Moynihan and Feldstein proposals, etc.

If the 2% savings are mandatory and there is zero portfolio shifting (i.e., people saving less elsewhere due to the increase in savings here) this implies an increase in private savings of about $115 billion a year. (SS collects about $700 billion in taxes annually at a 12.4% flat rate, 2/12.4= .161 x $700b ~ $115b)

How much is that? Well, it would increase the personal savings rate from 3.5% to 5%, still well below the historic norm and a rate many economists would think still too low. It would offset just a *small fraction* of the decline in national savings that's occurred during the last year alone due the swing in the government's fiscal position. It compares to total net securitized wealth in the US of about $20 trillion and in the world of about $60 trillion, being about 0.0056 and 0.0019 of them respectively. And this full annual increase would occur for only a limited number of years, until people started cashing in their investments.

*This* is supposed to drive down the rate of return on capital in US and world capital markets, and make it impossible for the young to get positive returns from investments?? I am skeptical! ;-)

OK, so next let's go whole hog and do an Extreme Friedman, repealing SS fully and replacing it entirely with private savings. Let's be conservative and require everyone to save 10%, and while there surely will be portfolio shifting here, let's say 66% of these savings are real additions to savings.

Now savings increase by 3.3 times as much, $345 billion a year. The personal savings rate goes to 8%, which is about the historic norm. The increase still does *not* come close to covering the decline in national savings in just the past year due to the deficit. The annual increase is about 1.68% of securitized wealth in the US and about 0.56% of world securitized wealth, again for a limited number of years.

OK, *this* is supposed to drive returns on US and global investment markets downward significantly?? I remain skeptical. Quite.

Social Security provides a very bad, low return to the young for one reason and one reason only: the tax-and-benefit *formulas* legislated and repeatedly re-legislated by Congress over time now make it mathematically impossible for it to do anything else.

But there is nothing in economics to prevent the young of the world from expecting to receive healthy positive returns on their real economic investments over their entire lives, whether those investments be in privatized SS accounts or elsewhere.

Bernard Yomtov writes:

But Saturday will not catch as many fish as Friday, so the return drops.

Don Lloyd writes:

Jim,

"...How much is that? Well, it would increase the personal savings rate from 3.5% to 5%, still well below the historic norm and a rate many economists would think still too low...."

I need some help in believing that the personal saving rate has any inherent necessary relevence in and of itself for the economy other than assuring that the individual doing the saving is likelier to be able to eat better in the future by sacrificing in the present.

Assume that the government has outlawed the import, export and mining of gold. Nor can gold jewelry be melted down.

Is there any way that an increase in the personal savings rate implemented exclusively by the buying and holding of gold can possibly benefit the economy as a whole?

Regards, Don

Patrick R. Sullivan writes:

" But Saturday will not catch as many fish as Friday, so the return drops."

The point is that after Friday dies he catches no fish at all, the return to Crusoe is 0%. So, now that the demographics have changed, Saturday's "foreign" labor is more attractive.

Bernard Yomtov writes:

Don,

What you are saying is that if savings are stuffed into mattresses they do the economy no good. True. But financial markets exist to make savings available for real investment, so the economy benefits.

If I use my savings to buy a bond, the issuing company then uses the money to buy equipment, etc. They will not do this unless the retrun they expect exceeds the interest they pay me on the bond. The economy comes out ahead.

Jim Glass writes:

Don,

I'll match your gold construct there with the idea of people keeping their savings exclusively in currency that they bury in the basement or back yard for years at a time until needed. Or which they maybe leave buried for their grandchildren to find. Then savings wouldn't help the general economy.

But these unrealistic theoretical constructions of ours don't refute the importance of savings in the way the real economy normally operates any more than the theoretical construction of Giffen Good refutes the real world operation of the law of supply and demand.

Regards,

Don Lloyd writes:

Bernard and Jim,

My question is why buying shares of IBM or Intel or shares in a SP500 index fund is any better for the economy than buying gold. All of these investments share the possibility of returning a capital gain for the individual investor, but this does not necessarily mean that the overall economy is any better off, as it may just mean that someone else has suffered a capital loss.

With the FED effectively expanding credit at will, is it really logical to expect that new savings will improve the economy, rather than further damage it?

My conjecture is that the economy can only be improved by investments that actually generate business profits and/or reduce the final prices of products by using less of labor and other factor inputs. No segment of business or industry can remain profitable if it is subjected to an increase of investment, and competition, without limit.

Regards, Don

Jim Glass writes:

Don:

When you buy IBM stock you are participating in the secondary market for stocks, and secondary markets provide very large real benefits to the economy.

Take the mortgage market. Before the development of secondary markets in which mortgages are repackaged and resold, all mortgage lending was direct between lender and borrower. That meant there were limited funds available for lending with high risk on both sides. So down payments were large (like 40%) and terms were short, like five-year balloons. And still either side could get screwed. The Bailey Savings & Loan could still go under due to no fault of its own, and because George Bailey was having a hard time all his borrowers could have their loans called rather than rolled over at the end of the five years.

With the rise of secondary markets for mortgages all this changed. The lender sells off mortgages right away for a safe return, eliminating most risk and getting the money to make more loans right away if desired. The millions of new lenders who buy in the secondary market to reap high rates of mortgage interest provide liquidity for mortgages and make it much easier for primary lenders to obtain funds, from them or others. Risk is further reduced to lenders because investing $100,000 in a portfolio of 100 different mortgages in the secondary market is much, much less risky than George Bailey investing $100,000 in one mortgage.

The growth of the secondary mortgage market is the direct cause of mortgage terms becoming much less costly -- zero down, 30-year, low real rates now being common. The much lower cost greatly increases the volume of mortgages, which helps everybody: many more people can buy homes, banks get much more business, investors have a whole new range of investments available to them, home builders employ more workers, home building supply stores sell more supplies, etc.

Plus, the greatly increased amount of competition in the mortgage market drives terms in favor of consumers -- you get much better terms now than you would having to reach a deal with mean old Mr. Potter or nobody.

It's the same for all secondary markets, for stocks, bonds, insurance, orange juice, pork bellies, whatever. They are beneficial, and so is their growth.

Corporations raise capital by selling stock to investment bankers who resell it. If there was no secondary market for them to resell into, they couldn't do that and couldn't get the money from the resale to fund the next company. So there'd be much less capital invested in corporations. Plus, what capital there was would be much more under the control of the bankers, increasing its cost to both corporations that seek to obtain capital and to investors who want to invest in corporations though the bankers, since they'd both have to meet the bankers' terms. (This is real-life history, btw. Think back to the days when J.P. Morgan or one of his small group of partners, or one of the very small group of their banker competitors, the "bankers' trust", held a key seat on the board of almost every major US corporation.)

Price valuations of corporate stock also go right to the "equity" line on the corporate balance sheet, of course, and thus directly affect the corporation's ability to borrow to finance direct investments.

So there are many real benefits to the real economy from secondary markets, and from the growth of participation in them, and growth of the amount of finance and savings flowing through them. So increased saving invested through them, including the stock market, may safely be deemed beneficial to the economy.

It's burying savings in tins in the back yard instead of investing them in secondary markets that leads to bad things.

Regards,

Jim Glass writes:

Don,

Or, in a rather shorter response, I could say that the statement ...

"No segment of business or industry can remain profitable if it is subjected to an increase of investment, and competition, without limit."

... does not even imply that an increase in the personal savings rate from 3.5% to 5% (or even 8%) would not be beneficial as per the textbooks, since it is a long, long, way from being "without limit".

Regards

Don Lloyd writes:

Jim,

"...When you buy IBM stock you are participating in the secondary market for stocks, and secondary markets provide very large real benefits to the economy...."

Everything you say is true, but you've misidentified where the benefits come from.

Every share of IBM stock that I buy has to be sold by someone else. Which of us is increasing overall economic profits and productivity of businesses?

The overall economic benefits of a secondary market generally come from the very fact of its existence, not its individual transactions. It is because there exists the possibility of a future public stock offering into a large and liquid market that the founders and venture capitalists can startup a company with large amounts of money at high risk, and have a hope of high rewards IF their knowledge and skills can be accurately applied to an uncertain future.

Regards, Don

PS --

There is an argument about the exchange value of money which has a similar feel.

Although money serves three purposes, as a medium of exchange, a unit of account, and as a store of future purchasing power, its entire exchange value is structurally encapsulated in its function as a store of future purchasing power, although the actual value can be influenced by its role as a medium of exchange making it more popular to hold. You effectively pay for money's ability to buy future goods when you acquire it to hold, but the functions of medium of exchange and unit of account come along for free.

Jim Glass writes:

"The overall economic benefits of a secondary market generally come from the very fact of its existence, not its individual transactions. "

It would have a hard time existing without the individual transactions.

And while growth in the numbers of individual transactions within them have brought us many good things, significant declines in the numbers of such transactions generally are associated with "not good" things.

Regards

Don Lloyd writes:

Jim,

"...... does not even imply that an increase in the personal savings rate from 3.5% to 5% (or even 8%) would not be beneficial as per the textbooks, since it is a long, long, way from being "without limit"...."

All I am saying is that is inevitable that at some sufficiently large level of investment for every separate business or industrial segment, business profits must be destroyed, unless the investment itself is self limiting before that point for a given segment. While it is entirely possible that those levels are well above realistic levels, many segments HAVE been suffering from severe overcapacity, especially telecom, destroying not only its own profitability, but that of much of its supplier base.

Regards, Don

Don Lloyd writes:

Jim,

"...And while growth in the numbers of individual transactions within them have brought us many good things, significant declines in the numbers of such transactions generally are associated with "not good" things...."

The volume of transactions in IBM or any other stock DOES result in profits for financial services companies in the form of commissions, for example, but I have my doubts as to whether financial services should be considered productive or parasitic.

Regards, Don

Bernard Yomtov writes:

"All I am saying is that is inevitable that at some sufficiently large level of investment for every separate business or industrial segment, business profits must be destroyed, unless the investment itself is self limiting before that point for a given segment"

Don,

Yes but.

As I tried to point out earlier, the investment IS self-limiting in the sense that investments do not just appear. They are the result of presumably rational judgments by someone that they will prove profitable. Not all do, of course, but the point is that this is not simply an uncontrolled process.

Similarly, the amount of savings is not uncontrolled. It is regulated by available returns and individuals' time preference.

Investments are profitable if they return more than their cost of capital. In a society that saves a lot, savers are willing, by definition, to accept relatively low returns on their savings, and the cost of capital drops. hence more investments become profitable. But no one will provide funds for a negative return.

Think of "the" interest rate as the price of capital. As it rises more is supplied (more savings), and less demanded (less investment). At some point an equilibrium is reached.

Don Lloyd writes:

Bernard,

"...As I tried to point out earlier, the investment IS self-limiting in the sense that investments do not just appear. They are the result of presumably rational judgments by someone that they will prove profitable. Not all do, of course, but the point is that this is not simply an uncontrolled process...."

Investments are self-limiting largely because at some point it becomes undeniable that expected profits will NOT, in fact, occur. This, in turn will restrict the availability of investment funds as a business will sooner or later cease operations and eliminate the returns to labor and other production factors that could have been invested if there had been a profitable operating business.

Rational judgements aren't enough as they must be made in advance simultaneously with the judgements of other potential competitors.

Business profits are seldom truly controllable, and are a highly sensitive residual result of many effects.

As investment funds increase in quantity, there are several effects that reduce or eliminate returns.

First, in a finite economy, profits are limited, and often transitory. More investment dollars must share those limited profits, with lower rates of return.

Business investments for productivity enhancement are seldom restricted to a single competitor. Rather than increasing profits, investments in productivity enhancements are often less sources of increased profits than they are a cost of business survival.

Major business problems are seldom the result of minor miscalculations or moderate variations in the cost of capital. Instead major business problems are often the result of three competitors fighting for market share in a market that is only large enough for two. The resulting price collapse quickly turns normal profit levels into enormous losses.

New potential competitors are seldom discouraged by cost of capital considerations, but rather by the availability of capital for their specific use. The cost of capital is primarily an effect, not a cause, of the availability of capital.

Regards, Don

Jim Glass writes:

Don,

"All I am saying is that is inevitable that at some sufficiently large level of investment for every separate business or industrial segment, business profits must be destroyed,..."

It is a truism that there are always individual business sectors that have "too much" invested in them -- not only supposedly hot rising businesses like Worldcom but also old declining ones like the buggy makers. The essence of the "creative destruction" of capitalism is the market's movement of capital away from those sectors to others where it is most useful.

But it is D^2's favorite "fallacy of composition" to take what may be true of an individual business as something that may be true of an economy as a whole. I am not aware of any economies as a whole that have suffered fates anything at all like that of Worldcom or the buggy makers solely as the result of voluntary excess domestic personal savings.

But even if one wants to make this dubious "dangerous excess personal savings" argument, I don't really see its practical relevance to a SS proposal that even at its most extreme still wouldn't get the savings rate up to even its 50-year post WWII average.

"The volume of transactions in IBM or any other stock DOES result in profits for financial services companies in the form of commissions, for example, but I have my doubts as to whether financial services should be considered productive or parasitic."

Well, that's mindful of the old, old, argument that middlemen who move goods from the farms and factories to the cities are non-productive profiteers and exploiters of consumers, although city dwelling consumers would have a hard time eating food that never leaves the farm and using goods that never leave the factory.

Secondary financial markets provide many more benefits to the economy than just providing fees and commissions to those who work in them. We went over the list before. And as far as commissions go, as noted before, the growth of secondary markets increases competition to drive them down for the benefit of consumers at the cost of the parasites.

If you want to invest in a corporation, you'll pay a lot less in commissions to the parasites at Charles Schwab today than you would have to the parasites at Merrill Lynch 50 years ago, and you'd have paid a lot less to the parasites at Merrill back then than you would have to JP Morgan and his partners a hundred years back.

Now as the conversation is drifting rather far from the subject line of Social Security, I think I'll bail out of it here (barring further typical character weakness).

Regards,

Don Lloyd writes:

Jim,

"...But even if one wants to make this dubious "dangerous excess personal savings" argument, I don't really see its practical relevance to a SS proposal that even at its most extreme still wouldn't get the savings rate up to even its 50-year post WWII average...."

These, of course, are your words, not mine. I am content to merely claim that that expecting to earn the same rate of return as has been experienced over the last 75 years in the face of substantial (by any standard) new mandated savings and investment and a substantial reduction in the rate of population growth is likely to be wishful thinking.

Thanks, Don

Don Lloyd writes:

Jim et al,

This may be of interest --

http://www.mises.org/fullarticle.asp?record=985&month=45

Will Savings Save Us?

by Antony P. Mueller

[Posted June 24, 2002]

The subject of financing the needs of an increasing portion of elderly people is a matter of growing concern in many countries. Given the current demographic trends, the established systems of social security are no longer viable to guarantee the standards of the past. -------more-------

Regards, Don

dsquared writes:

Patrick: You have ignored my substantial point in order to make a fairly silly debating point (your sentence about "marginal" only meaning "the next dollar" is embarrassing). Also you ought to remember that I don't believe that there *is* a demographic problem; only that privatisation doesn't change demographics.

You haven't understood my response to your comment on Sargent if you think I was conceding anything; I regarded your misuse of
Sargent's point (which independently, I disagree with anyway) as "not even wrong". Total saving equals private saving plus government saving. The implict debt of the government to the SS system has been invested in real capital assets (interstate highways and the like), and changing the balance between private and governmental saving would have very little effect on the capital stock. Unless, of course, you believe that government-owned capital assets aren't productive, which I suppose is your right.

Your desert island example actually works in its own terms, but to make it analogous to the current USA, you would have to have Crusoe spending most of period 1 building up massive net external liabilities to the inhabitants of Saturday Island. Which makes the whole thing less credible.

Jim: Since you have now decided, on the fourth time of asking, to pretend that the fallacy of composition isn't a fallacy, and that everyone can buy claims on the future with nobody selling them, I don't really see much point continuing.

Eric Krieg writes:

Don,

>>Capital without entrepreneurial activity is an empty concept.

Patrick R. Sullivan writes:

d squared takes time from Appealing to his Own Authority, to finally concede the obvious:

" Your desert island example actually works in its own terms"

Which is to say THEY answer your confused objections about how capital can't get its return with there being no GDP growth, and the even sillier one about foreign investment not bringing more hands to the matter of feeding more mouths.

Though you throw in an irrelevant smoke screen to save face: " you would have to have Crusoe spending most of period 1 building up massive net external liabilities to the inhabitants of Saturday Island".

You would have to do no such thing to change the mix between domestic and foreign investment. Did Nike build up "massive net external liabilities" before opening all those factories in Asia?

But since you now profess no belief in a demographic problem, which is odd in that not too long ago you wrote:

"Given that private savings accounts will neither create more young people nor exterminate old people, I'm assuming that the underlying demographic problem will be unchanged. So how can the economic problem be solved?"

and also:

"Jim: The 'poor return' on Social Security for young people is a result of their reduced numbers compared to the number of expected future claimants...."

I think we have something like total and unconditional surrender. A least we do after we dispose of this disingenuous claim:

" The implict debt of the government to the SS system has been invested in real capital assets (interstate highways and the like)...."

Some of it may have been, but a lot more has been SPENT on consumption. And you know it.

Don Lloyd writes:

Eric,

"...But entreprenurial activity is something that we have in excess, and is something that can be fostered...."

I can't agree with this, at least as far as successful entrepreneurial activity goes.

Regards, Don

Bernard Yomtov writes:

Sorry, I don't see exactly what the desert island example shows other than that, if net savings are zero there is no GDP growth. This is perfectly consistent with d^2's equation.

In the initial case there is no saving at all, hence no GDP growth.

Now introduce depreciation and have Friday spend time bringing the boat back to its original condition. There is still no net savings.

You've lost fishing time, but Friday still gets his wage, so return to capital drops as does GDP.

The only way to increase GDP is to have Friday do more work on the boat than is needed to overcome depreciation. Then returns will rise, and so will GDP.

So what?

Jim Glass writes:

"Jim: Since you have now decided, on the fourth time of asking, to pretend that the fallacy of composition isn't a fallacy...."

D^2: Oh, c'mon. As you very well know, I have never once said the "fallacy of composition" isn't a fallacy -- and if you've paid attention you've even seen me invoke it myself in this very thread.

What I've *asked* you to do is stop abusing and torturing it so relentlessly: I say SS participants might have insured money market investments in private accounts, you invoke the "fallacy of composition" because the entire economy can't be financed with insured money market funds. ;-) I talk of 2% funded private SS accounts that would involve 1% of national income, you invoke "fallacy of composition".

Please, cease this. You must invoke the fallacy of composition in reference to the composition of 100% of the economy -- you can't invoke it in reference to 1% of national income except as the most heartless abuse. If you are going to keep abusing the fallacy over and over like this you may indeed do best not to continue, as you say, lest the Society for the Prevention of Cruelty to Analytical Concepts come after you.

"....and that everyone can buy claims on the future with nobody selling them, I don't really see much point continuing."

Also, D^2, try to grasp the *empirical reality* that Social Security isn't "everyone" and the amount of money we are talking about is *small* ... even *very small*, relative to the capital and investment markets and to future national income -- as I've pointed out with actual numbers above.

Moreover, everybody who sells an investment to an investor in a private savings account -- through SS, a 401(k), Charles Schwab, whatever -- *obviously* is selling a claim on the future, so how do you figure I'm calling them "nobody"??

It's just that these claims for SS wouldn't be *nearly as large* relative to future wealth and income as you insist on fantasizing when you keep thinking of SS as the "entire economy", as with those insured money funds and all.

Empirical reality: The claims on the future to privatized SS accounts would be *small*. The *temporary* annual additions to US financial capital on the order of 0.0056, to world financial capital 0.0019. That's the size of the claims on the future: SMALL. Deal with it.

So this whole line of argument of yours is *empirically* no more than a red herring that you are throwing out to confuse others, or maybe that others have thrown out to confuse you.

Unless, that is, you believe that your same argument applies to all other funded retirement plans as well, starting with the first corporate pension plans and on through all the IRAs, Keoghs, 401(k)s, etc., that all the Boskin future millionaires have been piling up for decades.

I've asked you this twice before but you haven't answered, so I'll ask again -- does your same argument also refute the benefits to savers (and from saving) purportedly provided by all those funded savings programs as you claim it refutes the purported benefits to would-be savers (and from would-be saving) in funded 2% private SS accounts?

Eric Krieg writes:

If a ponzi scheme is no better than an investment, or vice versa, then why should ponzi schemes be illegal?

SS has great scale, and is mandatory. But it is a ponzi scheme nonetheless. Why should it work where all others have failed?

Jim Glass writes:

Don,

"I am content to merely claim that that expecting to earn the same rate of return as has been experienced over the last 75 years in the face of substantial (by any standard) new mandated savings and investment and a substantial reduction in the rate of population growth is likely to be wishful thinking."

And I am content merely to claim that as long as the return to capital is positive, it will provide more to SS participants than SS's benefit formula, which is going negative.

(You aren't claiming the rate of return on capital in global investment markets is going to go negative are you? If so, I'd think we should be worrying about some things other than Social Security!)

Although I might also wonder what one means by ... "in the face of substantial (by any standard) new mandated savings" ... in the light of the numbers I gave above. I mean, by *my* standard, adding 1.5 points to the national savings rate, leaving it still far below the historic norm, and adding just a small fraction of one percent to total securitized investments annually for a limited period of years, isn't all *that* substantial as to self-evidently be expected to drive down the rate of return on capital.

And I might also wonder about the meaning of ...

"...and a substantial reduction in the rate of population growth ..."

What? Are we expecting a capital glut soon in China, India, the rest of Asia, South America ... even in the USA with its 5% of GDP annual capital imports?

Is the globe running out of investment opportunities while 5 billion people, most in rapidly developing countries, still have incomes only a fraction of that of the fully developed countries? And while those 5 billion have a demographic profile that puts the bulk of their non-workers among the *young* group, with their working and adult years ahead of them?

I think it might be a little premature to make that call.

(And, yes, I have a weak character. But I shall try again now.)

Patrick R. Sullivan writes:

Bernard, the desert island example destroys this claim of d squared's

" If the capital stock was returning its "full, real, before tax [but presumably after depreciation -d^2] return", why would economic growth be zero?"

d squared is conflating two different things, 1. RoR on capital, and 2. economic growth. As are you.

" Now introduce depreciation and have Friday spend time bringing the boat back to its original condition. There is still no net savings.

" You've lost fishing time, but Friday still gets his wage, so return to capital drops as does GDP."

Not true. Fishing time does not drop, only Friday's leisure (and as I said that's not in GDP). GDP is still one fish per day, and RoR is one half fish. BTW, you can have GDP growth without any savings and investment at all.

Bernard Yomtov writes:

If you want Friday to work longer hours, surrendering some leisure, so he can still spend as much time fishing as before, you have to raise his wage. So Crusoe ends up with less than half a fish.

Otherwise, you could insist that he work around the clock and catch not one but two or three fish.

Certainly GDP can grow with no investment if everyone decides to work harder, but "preferences change" does not lead to strong arguments.

Jawan writes:

Bottom line is that SS is a "tax" and that privitization of SS is a tax cut and I love tax cuts.

Bernard Yomtov writes:

To clarify, you don't necessarily have to raise Friday's wage rate. What I meant was you have to pay him more in total, since he will be working more hours.

Don Lloyd writes:

Jim,

"...(You aren't claiming the rate of return on capital in global investment markets is going to go negative are you? If so, I'd think we should be worrying about some things other than Social Security!)..."

I wasn't planning on claiming that, but it would seem to me that the majority of US dollars exported are consumption dollars, and the return flow into the US has to be investment dollars. Assuming positive returns, the net profit flow may well be out of the US.

It is rather shocking to realize that current nominal money market yields are about 0.5% at best, and real returns are certainly negative when believeable inflation figures are used. Stock market valuations are generally still so high that earnings yields overall are often in the 3% range when there are earnings, and we know that both inflation and interest rates' next moves will be higher. Looking forward, real total returns on money market funds, bonds and stocks are all likely to be negative for some time even without private SS accounts and independent of any 401K crowding effects.

Regards, Don

dsquared writes:

>>I say SS participants might have insured money market investments in private accounts, you invoke the "fallacy of composition" because the entire economy can't be financed with insured money market funds. ;-)

Who would provide the insurance? Insurance transfers risk from one party to another. If the party which assumes the risk is the state, then all you've done is shift around the counters.

Eric Krieg writes:

Don will like this:

What This Country Needs Is Higher Savings.
I am sure you have heard more than one economist or politician bemoan low savings rates in the U.S. as if higher savings rates would somehow help the economy. I guess these guys think that increased savings means more capital for business investment. How silly is that! In aggregate, one person’s savings is another person’s income. If I decide to spend less and save more, then someone else won’t have that income. The economy slows as a result and there is less need for capital investment. And banks can lend money unconstrained by the size of their checkbooks, so if businesses want to borrow to increase capital expenditures, there doesn’t have to be a higher level of savings to accomplish that end. However, the most important aspect of savings is deficit spending by the government. When the government runs a budget deficit it creates private sector savings. Or, when the government runs a surplus (another term for government saving) then the non-government or private sector runs a deficit, i.e. less saving. So if the politicians want greater savings, they will have to run a bigger deficit.

http://www.nationalreview.com/nrof_nugent/nugent071503.asp

Patrick R. Sullivan writes:

"To clarify, you don't necessarily have to raise Friday's wage rate. What I meant was you have to pay him more in total, since he will be working more hours."

No you don't. He's a "commission fisherman".

Bernard Yomtov writes:

The quote Eric cites cements NRO's reputation as a purveyor of economic idiocy. It's so bad it's not worth taking apart.

Bernard Yomtov writes:

Patrick,

Doesn't matter. Crusoe is hiring him, presumably, in a competitive labor market, so his expected income has to be at a certain level. If he's at all risk-averse, and is put on commission, it has to go higher.

If you think desert islands don't have competeitive labor markets, think of how Friday can do without the boat, by hunting, gathering, or farming as the competition.

Is Crusoe going to insist he work full-time fishing, even if fishing prospects are poor? Then up goes the commission. If not, then the boat will be idle part of the time. In either case, down goes return.

Jim Glass writes:

>>I say SS participants might have insured money market investments in private accounts, you invoke the "fallacy of composition" because the entire economy can't be financed with insured money market funds. ;-)

"Who would provide the insurance? Insurance transfers risk from one party to another. If the party which assumes the risk is the state, then all you've done is shift around the counters."
~~~~

Who provides the insurance now? Does the "fallacy of composition" prevent such insurance from existing? Has the "fallacy of composition" prevented such accounts from growing to their existing size? Will it prevent them from growing a little more?

Will the "fallacy of compostion" really prevent people with private SS accounts from having insured money market accounts as one of many investment options available to them, as owners of IRA, Keoghs, 401(k)s do? And as everyone who has a taxable savings account at Citibank does?

Why hasn't it stopped everyone else from having such accounts already? Because ... they are only a SMALL part of a VERY BIG marketplace. And Social Security is only a modest part of a VERY BIG U.S. economy, and a teeny part of the world economy.

So give the "fallacy of composition" arguments re SS a break. They deserve the rest.

And you still haven't answered the question I asked you three times.

Bernard Yomtov writes:

I wasn't aware money market funds were insured. If they are, why are there MM funds that invest only in treasury securities?

Jim Glass writes:

"I wasn't aware money market funds were insured"

Some are. Not all. That's just one investment option, for ones that invest in commercial paper. It's not like they're the whole economy or anything like that. ;-)

Eric Krieg writes:

>>The quote Eric cites cements NRO's reputation as a purveyor of economic idiocy. It's so bad it's not worth taking apart.

Jim Glass writes:

Ah, Nugent, one of Warren Mosler's good buddies: try www.mosler.org for more entertainment from both!

"I guess these guys think that increased savings means more capital for business investment. How silly is that! In aggregate, one person's savings is another person's income"

Freudian slip! He means: one person's spending is another person's income, but as it happens....

"If I decide to spend less and save more, then someone else won't have that income. The economy slows as a result and there is less need for capital investment."

Unless the savings are lent out by the bank to, say, finance some capital investment, and so become the *income* of somebody in a capital asset-providing industry while increasing investment in capital goods too. See, he was right!

"And banks can lend money unconstrained by the size of their checkbooks..."

For the three days until the Fed requires them to meet their reserve requirement. ;-)

"However, the most important aspect of savings is deficit spending by the government. When the government runs a budget deficit it creates private sector savings. Or, when the government runs a surplus (another term for government saving) then the non-government or private sector runs a deficit, i.e. less saving. So if the politicians want greater savings, they will have to run a bigger deficit."

For fun, find the coyote pack sized howler in this "most important" part! Obviously the statement is flat wrong, as it is refuted by the national accounts of so many nations year in and year out. But there's no fun in checking our own keen insights that make us smarter than all the textbook writers against mere facts.

Mosler explains it this way:

"the Washington elite have forgotten (or never knew?) the fundamental economics 101 accounting identity: a government surplus is NECESSARILY equal to the (same period) private sector deficit (including domestic business and individuals, and any foreigners dealing in $US). Therefore, the U.S. surplus of $250 billion reduces private sector savings EXACTLY by the same amount."
http://www.mosler.org/docs/docs/ten_trillion_tax_cut.htm

See, there's only a public and private sector -- so if one runs a surplus it must be at the expense of the other's deficit. So public savings can only be increased by a deficit in private savings that reduces them by like amount. QED.

As a friend of Mosler explained it to me once....
E.g: We start with the private sector owning $2X of cash and X$ of gov't bonds, total private savings = $3x while gov't debt = $X. But if we redeem the gov't debt by running a surplus we must tax $X from holders of cash and transfer it to the bondholders while the bonds "go away". This leaves us with still $2X of cash in private savings but no bonds. So total private savings have dropped from $3X to $2X while the govt's saving of $X has eliminated the debt. So private and public savings are inverse -- an "identity" even.

And this "101 accounting identity" is so simple that the Federal Reserve and Nobel prize economists don't know about it -- because they aren't as smart as our geniuses Mosler and Nugent at figuring out simple identities!

Ah, but what have our geniuses overlooked???

A: INCOME. They've overlooked a mere $8.5 trillion in annual national income, which is what the feds in fact tax a portion of when paying down the debt to run a surplus, while the private sector saves another portion of it to increase total private savings *at the same time*. Taxes collected to pay down the national debt come out of income taxes collected on *income*, not on pre-existing private savings.

Duh.

So the reality is, if the private savings rate is 10% of disposable income, and the gov't collects $X of that income to pay down $X of bonds, savings grow by $0.1X less than they would have without the tax -- but as long as savings rate is positive they *still* grow. And since $0.1X > $X private savings certainly are not reduced by "EXACTLY" $X as an "identity", and total national savings increase by $0.9X on net.

Why does the National Review have to damage the credibility of conservatives everywhere by publishing such dimwittedness? Couldn't they pay a few bucks each issue to a real economist of conservative bent for a little fact checking, howler prevention and, if necessary, coyote shooting?

And I wouldn't be in a hurry to invest my money through PlanMember Financial Corporation.

Eric Krieg writes:

>>Why does the National Review have to damage the credibility of conservatives everywhere by publishing such dimwittedness?

Eric Krieg writes:

After all, I posted the link because I though that the argument parralleled that of Don. Is Don a conservative?

Don Lloyd writes:

Eric,

"After all, I posted the link because I though that the argument parralleled that of Don. Is Don a conservative?"

Don is an Austrian, economically speaking. All Austrians are at least broadly small-l libertarian, unless they're confused.

I appreciate the post, but have no interest in the opinions there expressed. Surpluses and deficits are beside the point. Every dollar spent, taxed, or created by government damages the economy, even if the expenditures happen to be necessary for non-economic reasons. All economic activities not driven by a self-interested, broadly defined, profit and loss motivation, whether monetary or subjective or both, distort the economy.

Regards, Don

David Thomson writes:

“Every dollar spent, taxed, or created by government damages the economy, even if the expenditures happen to be necessary for non-economic reasons. All economic activities not driven by a self-interested, broadly defined, profit and loss motivation, whether monetary or subjective or both, distort the economy.”

Alas, a viable nation must be willing to sometimes “distort the economy.” We regretfully have to make this sacrifice if a greater need arises. I don’t think we really disagree in principle, but my guess is that I’m more favorably inclined toward the public sector than you are.

Jim Glass writes:

"There is no party line when it comes to economics in National Review, outside of, say, supply side effects of tax cuts. This is just one perspective, as wrong or right as it may be..."
~~~

Well, perhaps I over-reacted a bit because of my past close encounters with the Moslerites and the upset it causes to see them get space in publications where serious people go to learn something and risk learning Moslerism instead.

But this in not "just one perspective" -- it is dressed up crankery. And it does not serve the editors of NR any better than presenting any other crankery (flat-earthism, astrology, UFO stories, alchemy) in a serious mode. Not if they want to be taken seriously on economic affairs.

We have a cultural problem in that the general population is scientifically literate on at least an ABCs level, but near totally illiterate on economics. I'm not against scientific literacy, but for human welfare it would seem economic literacy is more important. I mean, people don't vote on whether they should follow the laws of physics, but do vote all the time on whether they should follow the laws of economics and often vote to defy them.

People are scientifically literate enough so that a serious proposal to use alchemy to turn lead into gold to solve a budget problem would *not* be taken as "just one perspective" to consider, it would be ridiculed into oblivion. But when they hear a proposal to solve a purported housing shortage in NYC with rent controls, they think that's one view that deserves fair consideration, and actually vote for it for 60 years.

This is a pet peeve of mine and off topic so I won't push it any more -- except to note the editors of NR don't help matters any when they publish cranks rather than credible economic perspectives, and they don't do their own credibility any good either.

Patrick R. Sullivan writes:

" Doesn't matter. Crusoe is hiring him, presumably, in a competitive labor market, so his expected income has to be at a certain level. If he's at all risk-averse, and is put on commission, it has to go higher."

This is becoming silly. If half a fish a day is better than the nuts and berries Friday can gather for himself, then that is all his pay has to be. And, since he TOOK THE FISHING JOB, he has revealed his preference already.

" Is Crusoe going to insist he work full-time fishing, even if fishing prospects are poor? Then up goes the commission. If not, then the boat will be idle part of the time. In either case, down goes return."

All Friday has to do is catch a fish a day. Whether he rows two hours to find a school of fish or four hours (for which he won't be paid extra either). He's getting paid for his results, not for his time. You've never had a "commission" job, have you.

Jim Glass writes:

Oh, my, Brad DeLong just read the Nugent exercise in crankery and trashed the NR for publishing such, um, hooey...

"As I've said before, there are many, many, many very smart and thoughtful people -- academics, investors, Wall Streeters, and others -- who are conservative in belief and would love to write economics coverage for National Review. So why is the quality of what we get so very, very low? "
http://www.j-bradford-delong.net/movable_type/2003_archives/001773.html

dsquared writes:

>>Who provides the insurance now?

In the final analysis, other parts of the personal sector who are willing to provide the capital backing the insurance. That's why the personal sector *as a whole* can't be insured against the risks of the economy *as a whole*. And stop pretending that you raised this investment class in a context where it was meant to be "a small part of the economy"; I quite clearly remember that exchange and you were presenting it as an asset that could give *everybody* a positive return *for certain*.

If I haven't responded to a question of yours, it's probably because I thought you were pulling some sort of trick like that one.

dsquared writes:

Going back to the tape ...

>>Which brings to mind the other thing to remember -- what we are comparing against. The SS benefit formula promises negative-to-minimal returns for those entering the work force in the 1990s -- and even that promise is 25% underfunded and can't possibly be met. You don't need much of a return to beat that -- for a lot of people an insured money market fund would do. *Anything* beats a negative return.

I didn't assume that Jim meant by "a lot of people" here that "a lot of people could have insured money market accounts and the rest of them could be saddled with the entire investment risk", because that would have been pointless. Instead, I assumed that the scope of quantification of this sentence was given by "those entering the workforce in the 1990s", making the implicit claim that everyone born between 1972 and 1982 could carry out their retirement saving on a risk-free basis via purely privately provided insurance. Which just isn't true for any credible assumptions about the financial system. In other words, why doesn't everybody just put their money in the stock market and hedge their returns by buying put options? Because *everyone* can't buy put options. There is a massive difference between things that *anyone* can do and things that *everyone* can do, and if you're talking about replacing Social Security, you need to be considering the latter.

Eric Krieg writes:

Jim, not to be Clintonian, but it depends on your definition of credible perspective. Who gets to decide what is credible?

It is a serious question. For example, if you read Scientific American, you know that they believe that the only credible perspective is that global warming is real. They will have you believe that anyone arguing against global warming, for any reason whatsoever, is a crank or worse.

Of course, this is not the case. Global warming has not been proved beyond a shadow of a doubt. There are plenty of credible, contrary perspectives that need to be dealt with honestly and fairly. That is something that SA does not do, for political reasons.

If science can be politically manipulated, anything can be.

I like National Review because it isn't afraid to publish a contrary perspective on something as even well agreed upon as evolution. They know that their readers AREN'T economically, scientifically, mathematically or whatever illiterate. We conservatives can process any perspective, we don't need editorial training wheels, like the liberals do.

Eric Krieg writes:

>>Don is an Austrian, economically speaking. All Austrians are at least broadly small-l libertarian, unless they're confused.

Patrick R. Sullivan writes:

Curioser and curioser:

" the implicit claim that everyone born between 1972 and 1982 could carry out their retirement saving on a risk-free basis via purely privately provided insurance. Which just isn't true for any credible assumptions about the financial system. In other words, why doesn't everybody just put their money in the stock market and hedge their returns by buying put options? Because *everyone* can't buy put options."

Why not?

Bernard Yomtov writes:

"Because *everyone* can't buy put options.

Why not?"

Because somebody has to sell the put options.

Unless you want Friday to do it, along with everything else you've burdened him with. Logic doen't work? Just ignore it and pound your chest about "working on commission."

Bernard Yomtov writes:

Eric,

I don't claim that Nugent's article is typical of "conservative" economic thinking. It's just total idiocy.

But what it does suggest is that the people at NRO, especially Kudlow, who I think is their economics editor, are unable to identify economic idiocy when it bites them on the nose.

And it raises again the question DeLong has asked before and JIm now repeats: why can't they find someone who knows something to handle their economics section?

dsquared writes:

In the interests of completeness, and before we get another trip to that blessed desert island, it is in principle possible that the population of the USA could buy put options from foreigners. Try and say it out loud without laughing.

Jim Glass writes:

"Jim, not to be Clintonian, but it depends on your definition of credible perspective. Who gets to decide what is credible? It is a serious question"

Well, who decides if alchemy is credible? Flat-earthism? Astrology? Is somebody undemocratically repressing these credible perspectives on how the world works? Is that why they can't get into Scientific American *or* Nature *or* Science *or* Popular Mechanics *or* the New Ask Mr. Wizard ...?

No, as I said, it's just a matter of basic cultural literacy about reality -- which, relative to the sciences, is sorely lacking regarding economics.

"For example, if you read Scientific American, you know that they believe that the only credible perspective is that global warming is real."

Though there is no shortage of other respectable forums where reputable scientists present differing ideas. But you miss the point. This isn't at all like global warming, about which the scientifically literate may differ -- it is like alchemy and flat-earthism. Nugent, Mosler & Co. are economic cranks.

You don't even have to know any economics to recognize the crankery here. The warning signs of "crankhood" are well-publicized on the web (such as at www.crank.net) because it is so full of them.

Here's a basic one: The crank says he knows more than all the experts, *not* because he actually knows more than them, which would be very difficult, but because they are so *stupid* that they don't see what he does. He's smarter than all of them!! If he says so himself.

Now let's go back to the explanation of Nugent's theory of savings as explained by his co-author and collaborator...

"the Washington elite have forgotten (or never knew?) the fundamental economics 101 accounting identity: a government surplus is NECESSARILY equal to the (same period) private sector deficit (including domestic business and individuals, and any foreigners dealing in $US)..."

See? Washington's elite at the Federal Reserve don't know a basic 101-accounting identity -- they are stupid! -- but we know it, so we are smarter than the elite!! (Even though in reality there is no such identity, which is why the elite don't know it, of course.)

Here's another basic one: Cranks ignore facts anyone could look up in the almanac. So, continuing:

".... Therefore, the U.S. surplus of $250 billion reduces private sector savings EXACTLY by the same amount."

Which is *factually wrong*, you can look it up. But they don't care about facts.

The editors of the NR wouldn't publish contributors seriously promoting alchemy or flat-earthism or claiming as a *fact* that water runs uphill, as "credible perspectives", because they are scientifically literate enough to know that doing so would damage the NRs basic credibility. It's too bad they aren't literate enough about economics to realize that publishing economic crankery does the same thing.

Of course, on a larger scale it's too bad that the general population isn't literate enough about economics even to realize that price controls don't cure shortages. (See 60 years of rent controls in NYC). That's the *real* problem.

Eric Krieg writes:

Jim, you just keep opening more and more worm cans!

You reminded me of something that Arnold wrote about a little while back...

http://econlog.econlib.org/archives/000067.html

...which ties right back into my quote from the Roosevelt University Economics Department Web Site.

Are any alternate schools of thought on economics credible? For example, how can a school get away with teaching Marxism (the ultimate crank theory)? In fact, not even get away with it, but BOAST of it on their website. Conceivably, they are an accredited department.

Is Krugnman credible? I think some of the crank-ness you bring up in the NR column is just hyperbole used to make the article a little more interesting, something I think that Krugman routinely does in his columns (and to which NR takes him to task for regularly, admitadely).

Also, what constitutes economic literacy? I'm sure the NR folks have as much economics training as I have had (an undergraduate minor (with a 4.0 GPA in economics!!!), regular reading of business publications like the Wall Street Journal and Forbes). Yet I'm not deconstructing that NR column to the level that any of you are (although I freely admit that I wasn't reading into it very much, other than noting that his views on the futility of increased savings being in line with those of Don's).

I'm literate, yet I find it difficult to read Shakesphere. I think that the level of economic literacy that you are looking for is quite advanced, and is not going to happen when there are as many people with 75 IQs as 125. I think that is what is going on in NYC, where the average IQ is below 100. Far below, thanks to tax policy that taxes the successful (and thus, intelligent) right out of the state.

dsquared writes:

>>Are any alternate schools of thought on economics credible? For example, how can a school get away with teaching Marxism (the ultimate crank theory)? In fact, not even get away with it, but BOAST of it on their website. Conceivably, they are an accredited department.

However cranky you believe Marxism to be, it adds up mathematically (mainly because much of it is surprisingly orthodox Ricardianism) and is thus far less cranky than the Mosler and Nugent paper.

In fairness to Mosler, he has done some useful work on the Real Bills doctrine and his paper in the Journal of Post-Keynesian Economics was really quite good (after severe editing from Paul Davidson) but he doesn't express himself very well, lending himself to misinterpretations, and his choice of co-authors is often unfortunate.

Jim Glass writes:

"Are any alternate schools of thought on economics credible?"

Of course.

But not any that say the Federal Reserve doesn't know a 101 accounting identity, or that "numerous Nobel prize winners" fail to grasp my undestanding of fiat money, as Mosler says.

Are there any any alternate schools of thought on economics that are *not* credible?

How would you identify them? This is important too.

Personally, when an amateur says "all textbooks disagree with me -- but that's only because all the PhD professionals don't know what freshmen know, and numerous Nobel Prize winnners don't understand what I understand", my crank detector gets triggered.

What triggers your crank detector?

Jim Glass writes:

"Also, what constitutes economic literacy?"

Well, you can tell us in a moment.

"I'm sure the NR folks have as much economics training as I have had (an undergraduate minor (with a 4.0 GPA in economics!!!)"

If you have that much, I really doubt that they do.

And if you had a 4.0 in econ then you know what an "identity" is. Not a "theory", which people may differ about, but an *identity* -- it's hard to differ about an identity. I mean, like the textbook identity for savings is Savings = Income - Taxes - Consumption.

How likely is it that the "elite" in the Federal Reserve and Treasury and such don't know an *identity* for savings that Mosler and Nugent know? ... and that YOU know!!

Yes, you. For they tell us their's is an "economics 101 accounting identity", and with your 4.0 in econ you certainly took 101 and must have aced the test on those! So here's your pop refresher literacy quiz...

Is the 101 accounting identity for private savings that *you* remember from school:

(a) Savings = Income - Taxes - Consumption, or

(b) Savings is the inverse of the government fiscal surplus, "a government surplus is NECESSARILY equal to the (same period) private sector deficit", or

(c) "What is Truth?", as per Pontius Pilate and the deconstructionists.

If you remember (a) from school then Nugent's claim in NR that we need to increase the gov't deficit to increase private savings should have caught your attention like a thumb in your eye -- and you've also caught Mosler, um, fibbing about the 101 identity that is taught in school, and your crank detector should be buzzing.

If you remember (b) I'll be surprised and ask for a reference to the textbook you used.

If (c), well, I'll just go on my way quietly.

Eric Krieg writes:

>>What triggers your crank detector?

Eric Krieg writes:

>>Savings = Income - Taxes - Consumption

Eric Krieg writes:

>>(c) "What is Truth?", as per Pontius Pilate and the deconstructionists.

Bernard Yomtov writes:

"We conservatives can process any perspective, we don't need editorial training wheels, like the liberals do."

Eric, Eric, Eric,

You're doing it again. Kill that reflex.

And do you really think highly of a magazine that considers creationism a legitimate point of view, rather than a crank theory?

And you claim a low tolerance for BS!

Eric Krieg writes:

>>And do you really think highly of a magazine that considers creationism a legitimate point of view, rather than a crank theory?

Bernard Yomtov writes:

Eric,

Let me make two points:

1. Your assertion that liberals need "editorial training wheels" is plain silly. It's just a random insult that has no basis in anything other than your own prejudices, and your notion that those who disagree with you are fools.

2. When NR publishes differing ideas, no matter how foolish, you praise them for presenting different perspectives. But you avoided history, etc., in college (not such a good idea, Ithink, but never mind) because you have a "low tolerance for BS.") In other words, the silly ideas you imagine you might have heard in an anthropology class are BS to be avoided. The silly ideas in NR are food for thought. And since you don't know any anthropology , history, etc, how exactly do you know which ideas are BS?

dsquared writes:

>>How can you separate political Marxism from economic Marxism? Stalin wasn't an economist, was he? As such, the entire subject is tainted.

Bad news for the theory of evolution by natural selection, which has also been put to bad use ...

Jim: I would say that b) is a bastardised version of something that is an accounting identity; the open market operations identity that the change in private holdings of money is equal to net sales of bonds by the government plus net sales of bonds by the central bank. Mosler believes some funny things about money balances which I don't clearly remember what they are, but the passage you're having fun with has this identity at its root. The problem is that Mosler is addicted to his hyperbolic invective; he doesn't really believe that nobody knows about this identity, he's just castigating them for not putting it at the heart of their model of the economy like he does.

Eric Krieg writes:

>>Bad news for the theory of evolution by natural selection, which has also been put to bad use ...

Eric Krieg writes:

Bernard, there are ways to education outside of the formal, bureaucratic, regimented, time consuming academy. Steven Ambrose did more to promote history than entire university academic departments, for example. Just because one has not taken a history class does not mean one is ignorant of history. I can't say I know much about anthropology. I'm SURE that it is my loss (yeah right).

>>Your assertion that liberals need "editorial training wheels" is plain silly. It's just a random insult that has no basis in anything other than your own prejudices, and your notion that those who disagree with you are fools

Eric Krieg writes:

Just wondering, does anyone OTHER than D^2 think that Marxism is a vallid ECONOMIC point of view? Bernard? Jim? Don? I'm just interested in where you all are comming from.

Eric Krieg writes:

I asked you guys to put evolution to the side, briefly. I ask you to take it up now.

NR is not creationist, as Derb explains:

http://www.nationalreview.com/derbyshire/derbyshire050803.asp

Eric Krieg writes:

Bernard and Jim, I just thought of something else.

While I avoid postmodernism like the plauge, it is in vogue among the academic subjects that I don't like. But doesn't postmodernism teach that what is "credible" is a function of political power, not what is truthful? The politically powerful decide what is credible.

So creationism is not credible because the power elite does not make it so, not because it is wrong, or so the postmodernist would have you think.

Bernard Yomtov writes:

Eric,

You were the one praising NR for publishing a "contrary perspective" on evolution. In other words, for publishing crank science articles to go along with their crank economics articles.

In any case, this is tedious. You've clearly swallowed the brainless claims of conservatism hook line and sinker. The ravings about media, "training wheels," blackballed conservatives, IQ levels in NY, etc., are sad symptoms.

I see no point in further exchanges with you.

Eric Krieg writes:

>>You've clearly swallowed the brainless claims of conservatism hook line and sinker. The ravings about media, "training wheels," blackballed conservatives, IQ levels in NY, etc., are sad symptoms

Eric Krieg writes:

BIAS!

Read the eigth paragraph and the headline, and tell me how they have ANY relation to one another.

http://www.nytimes.com/2003/07/17/national/17VOIC.html?pagewanted=all

Patrick R. Sullivan writes:

-------quote___________
"Because *everyone* can't buy put options.

Why not?"

Because somebody has to sell the put options.

Unless you want Friday to do it, along with everything else you've burdened him with. Logic doen't work? Just ignore it and pound your chest about "working on commission."
-------endquote-------

Oh c'mon Bernard, you snipped the part of d squared's quote that clearly indicates this was directed at "everybody" in their SS accounts. Even d squared sorta, kinda got the point (he's been told enough times that SS is only a subset of the American economy as well as the world economy), but I'm wondering if he's going to be laughing when I point out that Americans investing in privatized SS accounts can very easily buy options from American investors OUTSIDE SS, as well as from foreigners.

Don Lloyd writes:

I haven't read this yet as the print is too small, but it looks like it should be pertinent.

http://www.mises.org/blogdetail.asp?control=459

Why Social Security Can't Work
Robert Blumen 7/17/2003

"This article by financial analyst Robert Arnott uses logic and demographic statistics to show that the social security system as presently constituted must go broke. It is not a financial problem - lack of funds, or lack of real savings - but an issue of how many working people will support how many non-working people. (The article starts on page 3 of the PDF)."

Regards, Don

dsquared writes:

Eric wrote:

>>D^2, the death toll of Communism just during the 20th Century has been estimated to be around 100 million (Black Book of Communism).

Have you read the Black Book of Communism, Eric? I have. It estimates the death toll between 60 and 100 million. That's "around" 80 million, not 100.

Patrick: there are no natural buyers of the risk faced by Social Security investors. Therefore, you're assuming that the speculative capital available to the USA to take on this risk could be vastly expanded. It's just not credible.

Patrick R. Sullivan writes:

d squared decides to redouble his efforts at Appealing to His Own Authority:

"Patrick: there are no natural buyers of the risk faced by Social Security investors. Therefore, you're assuming that the speculative capital available to the USA to take on this risk could be vastly expanded. It's just not credible."

Why not?

Eric Krieg writes:

>>Have you read the Black Book of Communism, Eric? I have. It estimates the death toll between 60 and 100 million. That's "around" 80 million, not 100.

Eric Krieg writes:

Don, thanks for the link. It pretty much hit EVERYTHING we have been talking about.

A a "Baby Buster", I like that the article hit upon the fact that we will be buying into a declining marktet. This is a good thing. Ideally, you'd like asset prices to be low or fall throughout your working years, and then grow during your retirement. If the entire demographic crisis is entirely because of the Boomers, once that pig moves through the python, we will have a more sustainable demographic and economic situation. Maybe we busters will make out in the end.

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