BSR

I think that is a bit of a misnomer. If the free market were to set taxes they would set them to zero. I think what you mean is that government sets taxes in reaction to the free market which really is just Keynesian economics.

As for raising taxes there really is no debating that taxes pulls money out of an economy. The Keynesian models that recommend using tax hikes would argue that the tax is offset by the spending that you are doing on the other end. The problem in this case is that we aren't talking about spending on anything that will have an economic impact, but rather paying off debt. That is a direct drain on the economy.

Patters

It would not be zero because we are getting services. The problem is those services are only sold to the American public at large, so the only way for the American public to buy them is through taxes. Most Americans vote for the politicians they think are best for the economy. It really is a free market mechanism that regulates our taxes, IMHO.

Well, the stimulus bill contains a lot of spending and tax cuts, but you're right about the bailout. I think it's anyone's guess how things will play out, especially since the economic policies abroad are such a huge variable.

BSR

The only problem with that is that the debt holders understand this and don't really appreciate haivng their trillion dollars of debt devalued. So what if they start selling off their debt and you can no longer sell your treasuries? Well you can always start printing money, but then you have what happened in Brazil and have a period of hyper inflation. That is certaily not the type fo inflation you want.

True if done in reason.

Well, I guess that would be true if rich people kept their money under the matress. But something tells me they don't and that their money will grow with inflation.

BSR

I know what you are saying but that is a really loose use of the term "free market". Under that definition, everything is estabished by the free market, and that is just not how the term is used. Free market, by definition, means without government intervention.

I was more refering to how we pay off our larger debt. And remember there are differing schools of thought about how effective tax and spend really is. The neo-classical model believes that the government process reduces the efficiency of the free market system as there is a lag between the taxing process and spending process and that there is also a matter of waste.

PatriotsReign

Inflation may or may not happen and if it does, we don't know what level it will be. But we need to think this through for a minute. "Too many dollars chasing to few or a similar amount of goods" is a typical description of an inflationary environment. But, although it "appears" the money supply is being increased, the fact is, it really hasn't been increased.

When we print money to cover toxic assets of banks to the tune of billions, it has no net effect on the money supply. It is in reality, just money to cover balance sheets. That money will never get into circulation and has zero impact on consumers. If our government spends 100's of millions on the stimulus package to create jobs, all they are doing is replacing LOST jobs. So once again, it has zero impact on the money supply.

Now, if we consider the 10's of TRILLIONS of lost private sector wealth, how in world is demand (or too many dollars) going to come about? In fact, what the gov't has been spending is a minute fraction of the wealth that has been lost. So demand isn't going anywhere fast anytime in the foreseeable future. One website (which I don't put a lot of trust in) says that the world has lost $45 trillion dollars in wealth.

http://peakoil.com/forums/viewtopic.php?f=33&t=51701

In addition, Americans are in no mood to spend money foolishly after what we've experienced. It is widely believed that our citizens have now entered into a new "age of frugality" like nothing we've seen since the days of the great depression.

Finally, although inflation is great in reducing private and public debt, our income structure in the U.S. can't support further increases. We are already at a huge competitive disadvantage for jobs on a world wide level. If we have our incomes increased to meet heavy inflation, US companies will flock to other nations. And if our incomes are NOT increased to meet inflation, we'll have a nation of destitute citizens.

I would not worry about inflation for a long time.

Patters

The concept I think is important to those who argue taxes on the basis of fairness. In my view, taxes can't really be fair. There are too many variables, and even the flat tax has someone earning $1 mil paying 10x as much as someone earning $100k for essentially the same services. The economy, though, through normal free market mechanisms affects our political systems to assign taxes according to what's good for the economy. It's sort of circular, but I think that's how it work.

I don't think the neo-classical model carries a lot of weight these days, especially once you get out of political circles. It's my impression that most straight economists do see that government as the only entity that can pull an economy out of a funk (and the argument is over taxes and spending). In addition, if you believe government is fundamentally charged with protecting its people, government must act when millions of people are in crisis. My view is that pure capitalism is no better than pure communism as an economic system; economies need to be very fluid because they must adjust to the biggest variables there are: human behavior and attitudes.

PatsFanInVa

PR, as to the mood of America, from all recent reports and of course the Sage of Omaha's recent declaration, we have suddenly all become converted to the world's greatest savers (rather than spenders.) This aligns w/generational analyses, btw. It's the wacky, no-rules, it all turns out okay cuz it's US Baby Boomers, and the "Screw it all wahhhh why even try to save" Gen Xers. So, unless this is a momentary phenomenon, the saving/debt paying tendency will continue to be an exacerbating factor in this conversation.

As to the larger question, which could be recast as, are we in fact creating pent-up demand? Are there in fact people on the sidelines waiting for bottoms, waiting for shakeouts, so they can buy that new car they can (as it turns out,) afford, so long as they are sure the company will be there in a year? Or so they can buy that first house, or trade up, once they feel they will have appreciation in value on it, or at least not lose money? Are there people with busted toilets in a 2-bathroom house for that matter, that haven't bought the new one? Yeah, there are. Are there families where daddy lost his job so they had lean Christmases, but will have different ones when daddy gets a new job? Yeah I think so.

8% unemployment is 92% employment (not really but we'll use these numbers... about which more in my next parenthetical). But for the 2% of people who would actually lose their jobs on the march to double digits (using todays definitions, so we don't go off on a discussion of how the counting methodology distorts things,) there are five times that number thinking they MIGHT be next, and the entire society responds to the "general situation" through osmosis. My own personal circumstances have not changed that much; but the number representing my future 401K earnings -- though always notional -- looks terrible. I better not spend. I better pay off that damn credit card. Etc.

And around and around we go. Now thrifty is chic, now cheap is in, now we repair instead of dispose. These are all very solid values, and part of me says screw it, all our indicators would be down, but it might not be such a bad thing if we were to get used to such a way of life. It's why you can see 50 year old cars in the streets of Havana -- they fix 'em. Plus, no salt on the roads.

But this crisis hasn't turned us into Cubans. It hasn't even turned us into Europeans. It's turned us into slightly chastened gluttons, who still consider 10 years old a pretty old car, and still think some things are not worth the time and effort of "sweat equity."

If we sell fewer than 10 million autos this year, that does not mean that it's impossible that we'll be back at 14 mill next year or the year after.

I notice that I've seen 2 responses, one of them saying "but it's not inflationary because someone else holds the debt," and another saying "what if they don't want to hold our debt," which sort of balance one another out.

Then they just stop buying treasuries. Then we print money to pay obligations. Or, they say "pay up" on what they already have. Same outcome, just faster.

The objection that money is not actually in anybody's hands to spend is a shortsighted view, in my opinion. It relies on the current recession to be an infinite L curve, as opposed to a V, a U, or a bathtub. It's an interesting question. But insofar as the actual mood of the country has turned around for both the 8% and the 92% (or 18% and 82%, or whatever, depending on methodological issues,) the 92% (or 82%) are applying a psychology to their own circumstances that will likely fade. Then the L goes back to those more common curve geometries, albeit slowly, consumer and business spending being the key (and businesses would spend in a heartbeat to make payroll, etc., if they could; they just can't get credit.)

So yeah, I think the connections to reality all say there is pent-up demand, and yeah, I think the cash will flow -- some of it from bond sales, some of it from hiring a third shift where they print the money.

PFnV

PatriotsReign

To "some" extent, of course there is pent up demand, but very little of it. You're forgetting about the millions of idiots who leveraged everything to buy "stuff". That won't and can't happen again because home values won't rise much at all for years & years. in addition, all those people now owe HUGE mortgages and have suddenly realized they can't depend upon their home for retirement savings.

Frugality is in for a long, long time. When people start to buy again, it won't be extravagantly at all. And the turn around is not next year like some are saying. Maybe the bottom, but certainly not a turn around.

There are people PANICKING that they haven't saved enough for retirement and that panic is not going to go away because good times return. So even "if" there is some pent-up demand, the main thing is that our money supply has not increased one iota and that's the main thing that drives inflation.

BSR

This also means that many people are going to need to work longer because good portions of their nest eggs have disappeared. Thats a good thing in a growing economy but just adds to the unemployment pressure in a shrinking economy.

PatsFanInVa

We have a number of assumptions that all circle back on themselves:

Assumption 1 - people in China don't ever want to spend anything, ever. (If they do, global demand increases; even if this is only demand on Chinese goods, that is good for American industry on a competitiveness basis.... if there still is American industry.)

Assumption 2 - The PRC sees itself wedded to the "Chimerica" model, in which the production happens in China, and the consumption happens in the U.S. The poor guys revised down their estimate to 8% growth this year ... and brace yourself, it could go lower. The point is, both national economies are getting by without the fulcrum of sustainable growth, a middle class that makes things and consumes things at something like comparable rates. China makes but doesn't consume; we consume but don't make. Chinese consumption would do for China what American production does for America; i.e., get all the eggs out of a single basket.

Assumption 3 - the PRC wants to buy our debt forever. If they simply stop buying... not cash in their markers, but just reduce the pace at which they bet on America's future... we end up printing, not borrowing money.

Assumption 4 - "not one dollar is finding its way into a consumer's hands." Patently false; stimulus spending on tax breaks is a perfect example. This is specifically designed to go into the consumer's hands, with very little perceived savings value. A great deal of such a stimulus will be spent, i.e., circulated through the economy. Infrastructure investments create or "swap off" jobs, primarily at the lower end. (nobody's stumping for pencil-ready and spreadsheet-ready projects.) Again, that puts money into pockets. The only counter is that this is, for now, simply an exercise in keeping money in pockets, or putting it into some pockets while others empty out. Again, that is true only insofar as we have negative or zero growth.

Assumption 5 - in the purely notional world of asset valuation, today's down values are the "real" values, and yesterday's inflated values were purely imaginary. That cuts both ways; value is what someone will pay for a product or service. Today's values are correct for today. Witness last weeks momentary buying spasm on Wall Street.

Assumption 6 - Stuff doesn't wear out. Stuff still wears out. You fix it, you get a car repaired, you don't buy without a very good reason... but yes, sooner or later stuff wears out, and you do have to replace it. Can you do without a lot of stuff say, from September last year to March of this year? Yep, pretty much everything except food and shelter. Would you rather buy if you're feeling secure in your job etc.? Oh yeah.

Uber-Assumption (7) - However bad the economy really is, it's worse. We'll see as time goes by whether (7) is correct or not. I thought when I first heard it that an 09 turnaround is optimistic. I don't have much hope that last week's rally will be the beginning of the big uptick, but I am also not absolutely certain of my guess that early '10 is the turnaround. You on the other hand seem to take the L curve literally; as in, all economics have now changed and there will be zero growth forever. A no-inflation guess is tantamount to a zero-growth guess.

So not to turn it all into another blind "bottom-search," our favorite sport of late hereabouts, but my guess is there will be a turnaround. Obviously it won't be as dramatic as the crash itself. But with the turnaround will come spending... and the "stuff" you spend on will be in short supply. (i.e., what if people started trying to replace those old beaters right now, in the auto industry, at the pace we once bought cars? You would have a shortage. Prices would increase.) Hopefully we get serious and get electric and hybrid production up to speed by then, and make the tax credits for them substantial; but I digress.

Oil is obviously held down by a slump in demand, and will bounce right back up when all the oil-eating deisel machinery is back online. Oil prices will affect food prices, all by their lonesome, and non-staple foods (i.e., other than pasta, rice, potatoes, bread, eggs, etc.) will probably increase disproportionately, given that they will be in that much more demand. For everybody that puts meat on the table 1 less day per week, when there's money to do so, that pulls on meat prices. Ditto all the way up the "food chain" in terms of pricing.

Sure people will be pizzed that they finally feel like their job is safe, and now the Safeway isn't, but as inflation becomes a recognized phenomenon and demand increases, the labor market eventually reverses, and firms are competing for workers. At that point wages begin to follow prices.

We have Buffet's word for it that everybody has changed behavior, and your word on it that the change in behavior is lasting. Fair enough; now ask yourself -- dollar for dollar, how deep does that go? Don't you still pick up McDonald's (or your favorite bottled health concoction, for the obnoxiously body-conscious) on occasion, if you haven't lost some hours? Don't you still every now and then wonder whether you'll be able to swing a new car and take advantage of the ridiculous level of incentives, if you time it right, once you see whether there will be a company behind the car? Hell, I have debt and this has crossed my mind... I may be able to get great value by unloading a used car's trade-in value, pick up a brand-spanking new one I want more and like more, and pay very little actual cash for the exchange. I don't think I will, but there will be those who do.

At some point these pathetic corporate attempts to tease us into buying again will actually have an effect (for what companies are left out there alive.) If the liquidity is there, they will come.

But that's the $64 million question (to vastly undervalue it): When and how does consumer liquidity return?

PFnV