–The low interest rate/GDP growth fallacy

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The Fed raises interest rates to fight inflation. To fight recession, the Fed does the opposite. It cuts interest rates.

This may sound logical except for one, very small detail. The opposite of inflation is not recession. The opposite of inflation is deflation. So doing the opposite of what you would do to counter inflation makes no sense when trying to counter a recession.

We could have a recession with deflation. We could have a recession with inflation, which is called “stagflation.” The history of Fed rate cuts, as a way to stimulate the economy, is not a good one. The Fed, under Chairman Greenspan, instituted numerous rate cuts. The result: A recession that President Bush’s tax cuts cured.

The Fed, under Chairman Bernanke, instituted numerous rate cuts. The result: The 2008 recession.

Why does popular faith hold that cutting interest rates stimulates the economy? Because popular faith views only one side of the equation. But, for each dollar borrowed a dollar is lent. $B = $L.

Cutting interest rates does cost borrowers less. A business needing $100 million might be more likely to borrow if interest rates are low than when they are high. Further, consumers are more likely to spend when borrowing is less costly. So making borrowing less costly stimulates business growth and consumer buying. At least, that is the theory.

What seems to be ignored is the lending side of the equation. When interest rates are low, lenders receive less money. And who are the lenders? Businesses and consumers.

You are a lender when you buy a CD or a bond, or put money into your savings account. When interest rates are low, you receive less money, which means you have less money to spend on goods and service — which means less stimulus for the economy.

In short, interest rates flow through the economy, with some people and businesses paying and some receiving. Domestically, it’s a zero-sum game — except for the federal government.*

A growing economy requires a growing supply of money. Cutting interest rates does not add money to the economy. That is why there is no historical correlation between interest rates and economic growth. During periods of high rates, GDP growth is not inhibited. During periods of low rates, GDP growth is not stimulated.

Please review the following graph:

Blue is interest rates. Red is GDP growth. Not only are low interest rates not associated with high economic growth, but the opposite seems to be true. There seems to be a correlation between high interest rates and high GDP growth. How can this be?

*When interest rates are high, the federal government pays more interest on T-securities, which pumps more money into the economy. This additional money stimulates the economy.

This shows why the Fed’s repeated rate cuts do not seem to stimulate the economy. The action has been shown, time and again, to be counter-productive. Cutting interest rates to stimulate the economy is like pouring water on a drowning man.

Do you remember these headlines: “Employers slashed 80,000 jobs in March.” “The U.S. central bank has lowered rates by 3 percentage points since mid-September” “The loss of jobs signals another interest rate cut by the Federal Reserve later this month.” “Federal Reserve Chairman Ben Bernanke acknowledged Wednesday that the country could be heading toward a recession, saying federal policymakers are ‘fighting against the wind’ in combating it.”

Rate cut after rate cut did nothing. So what was the Fed’s plan? More rate cuts. During the previous recession, the Fed also attempted rate cut after rate cut, also to no avail. The recession, finally ended with the Bush tax cuts. The Fed has not learned from experience, but stubbornly adheres to the popular faith that interest rate cuts stimulate the economy.

Rate cuts do not stimulate the economy. They never have. They never will.

“Stimulating” an economy means making it larger. A large economy requires more money than does a smaller economy. Therefore, the only thing that stimulates the economy is the addition of money.

Rate cuts, by reducing the amount of interest the federal government pays, actually reduce growth of the money supply. We are on the edge of a recession, because the economy is starved for money. The coming “stimulus” checks will help, but they are too little and too late. This should have been done months ago, and the amounts should be far larger.

The only way to prevent or cure a recession: Federal deficit spending. There is no excuse for recession or inflation. These problems are not economic failures. They are leadership failures.

Rodger Malcolm Mitchell

For more information, see http://www.rodgermitchell.com

-Does taxing the rich help the poor?

The debt hawks are to economics as the creationists are to biology. Those, who do not understand monetary sovereignty, do not understand economics. Cutting the federal deficit is the most ignorant and damaging step the federal government could take. It ranks ahead of the Hawley-Smoot Tariff.
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President Obama wants us to believe that increasing taxes on the rich allows him to give more to the poor, ala Robin Hood. However, there is no historical relationship between federal spending and federal tax rates, which despite massive deficits and debt, have remained level or declined for the past fifty years.

Yes, raising the tax rate on the wealthiest Americans may address a psychological need to punish the rich for being rich. But, if this tax increase succeeds in collecting more taxes from any group, rich or poor, it will hurt poor people. All taxes remove money from the economy, which slows or reverses economic growth. Even now, with so many unemployed, the poor remain slow to understand that their jobs depend on the financial health of the rich, the spending they do and the businesses they own.

The economy runs on money. Among the government’s most important jobs are to create money and to spend it. In 1971 we went off the gold standard specifically to give the government the unlimited ability to create and spend money. When the government fails to do that job, the economy falters. Every depression in U.S. history and every recession in the past 40 years followed periods of reduced federal deficit growth, and every recovery as been associated with increased federal deficit growth.

The media and the politicians suffer from federal debt paranoia, which is responsible for more misery in America than all the crime and illness combined. Federal debt paranoia keeps us from providing universal health care, fully funded Social Security and improved education, military, infrastructure, energy and policing.

I call it “paranoia,” because, history indicates large federal deficits do not cause inflation, recession or any other negative economic effect. On the contrary, large and growing deficits stimulate the economy. We keep falling back into recessions because of federal debt paranoia.

Although President Obama wants to redistribute wealth, increasing any taxes will reduce overall economic growth, taking from the rich and from the poor.

Rodger Malcolm Mitchell
For more information, see http://www.rodgermitchell.com Continue reading “-Does taxing the rich help the poor?” →

-Ten Reasons to Eliminate FICA

11/5/08: The dual needs to stimulate the economy and to provide more health care and retirement funds, provide us with the rare opportunity to do both at one stroke. I recommend we eliminate the FICA tax and instead, fund Social Security and Medicare the same way we fund the military and every other federal agency. Recognizing this is a controversial and counter-intuitive suggestion, I offer ten rationales for discussion:

1. The Social Security part of FICA is a severely regressive tax, unfairly impacting the salaried middle classes far more than the non-salaried or upper income classes. Currently, salaries above $102,000 do not pay FICA for Social Security. Non-salaried people pay nothing.

2. The Social Security part of FICA is a double tax. Salaried workers pay taxes on their FICA contributions and again pay taxes when they receive benefits. Although Social Security is quasi-insurance, no other insurance collects taxes on premiums and on benefits.

3. Eliminating FICA would put more money in the pockets of salaried consumers, stimulating consumer buying and saving – exactly what the economy needs now.

4. Eliminating FICA would give business more money for investment and payroll – the other thing the economy needs now.

5. There are 400+ federal agencies, including all the military agencies, all the Departments, and dozens you never have heard of. When the military needs money to pursue the wars in Iraq and Afghanistan, Congress quickly votes hundreds of billions of dollars to this effort. No tax covers this budget. When the economy needed a stimulus, Congress quickly voted $150 billion to this effort. No earmarked tax was passed. When Freddie Mac and Fannie Mae ran into financial difficulties, the Treasury immediately gave them a blank check. Recently, another $700 billion was voted, and again, no new taxes were levied to cover this government expenditure. The current, annual cost of Social Security and Medicare totals about $1 trillion, well within the government’s proven spending range.

6. The government neither needs nor uses FICA money. In 1971, President Nixon eliminated the final connection between gold and U.S. money. His purpose: To give the government the unlimited power to create money. Even with the current trillion dollar bailout, no additional taxes have been levied. In fact, both presidential candidates promise to reduce taxes, and no federal check ever has or will bounce. There literally is no limit to the amount of money the federal government can create, and no limit to the size of the debt it can support.

7. There is no historical data to demonstrate that deficit spending inhibits gross domestic product, causes inflation or limits any other indicator of economic productivity, nor must federal debt be paid by taxpayers. President Carter oversaw modest deficits with high inflation and low economic growth. President Reagan oversaw huge deficits – the largest in American history – with low inflation and high economic growth. History shows deficits correspond with economic growth, and the larger the deficit, the healthier the economy. To date, the government has spent $10 trillion that has not cost taxpayers a cent.

8. Relying on FICA restricts Social Security benefits, which are too low to support even a modest lifestyle, and are received by too few people. The belief that Social Security and Medicare, uniquely among federal agencies, must be self-funding, causes political leadership to search for impossible “fixes,” something akin to searching for two quarts of water in a one quart bottle. Inevitably, these fixes involve higher taxes and/or reduced benefits, both of which hurt our citizens, our businesses and our economy. The world’s wealthiest country needs to, and can afford to, eliminate FICA taxes while supporting more people with higher benefits.

9. Funding Medicare through FICA limits the number of people covered, now mostly older people. But 40 million Americans do not have health insurance. Either they can’t afford it or have pre-existing conditions. Medicare coverage for these other groups would solve that serious, national problem and stimulate the economy for all.

10. Funding Medicare through FICA limits the size of Medicare payments. America has a severe shortage of doctors and nurses. But limiting the size of benefits has the unintended consequence of discouraging our best and our brightest from entering medicine or from participating in Medicare. A growing number of “boutique” doctors, who do not accept Medicare payments, charge fees only wealthier patients can afford. Federal funding of Medicare could provide better health coverage for Americans.

I first recommended this in my 1995 book, The Ultimate America.

Rodger Malcolm Mitchell
For more information, see http://www.rodgermitchell.com

-How to Eliminate All Federal Debt and Interest Payments — if we want to

AP: August 12, 2009:
“The Obama administration is projecting that when the current budget year ends on Sept. 30, the (deficit) will total $1.84 trillion. The soaring deficits have raised worries among foreign owners of U.S. Treasury securities including the Chinese, the largest holder of such debt.”

Perhaps no subject has caused more controversy than the federal debt and deficit. The deficit includes interest payments, which this year are projected to be $260 billion, a substantial amount, even with today’s low interest rates. Interest payments will continue to grow as the debt and interest rates rise.

So we deal with three related worries: We worry about paying for the large and growing federal debt. We worry about our creditors buying our debt. And we worry about the growing amount of interest the government must pay.

Every one of these issues could be solved with one stroke of the pen.

The federal government borrows by creating Treasury securities (T-bills, T-notes and T-bonds) from thin air, backed only by “full faith and credit.” It then trades these securities for dollars it previously created. When the securities mature, the government trades them back, plus interest.

“Full faith and credit” is an intangible collateral. The government has an unlimited supply. This gives the government the power to create unlimited amounts of T-securities. Finding buyers for these T-securities is addressed by offering interest rates high enough to attract investors.

While the government currently creates T-securities from thin air, it just as easily creates dollars from thin air – similarly backed only by full faith and credit – and can eliminate the borrowing step. No longer would we be troubled by federal debt, federal deficits, concerns about China et al or interest payments. The same controls over T-security creation would apply to money creation. We merely would eliminate the one step that causes so much controversy.

Why does the U.S. government create T-securities ostensibly to obtain U.S. dollars? Borrowing is a relic from the gold-standard days, which ended in 1971. Prior to that, U.S. dollars were backed in part by gold, a tangible product in limited supply. This limit prevented the government from creating as many U.S. dollars as it needed, so it had to borrow these dollars.

When you think about it, the notion of the U.S. government “borrowing” U.S. dollars – dollars it alone has the power to create – is ironic. The government can eliminate debt, along with all the controversy these subjects cause.

Rodger Malcolm Mitchell
For more information, see http://www.rodgermitchell.com

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