Posted by: graemebird | December 10, 2008

Why Increasing Savings And Retained Earnings Is The Key To Ending A Recession.

The economics profession has taken leave of its senses, and has lifted to the top a lot of Keynesian stupidity. With the exception of Michael Stutchbury of the Australian, all of our economics commentators  in the mainstream, are either silent on this idiocy, or they are participating in it.

YOU DO NOT SPEND YOUR WAY OUT OF RECESSIONS. This is the opposite of what must be done. You do not ask people to spend on consumer goods. You do not want the government spending more for this purpose. Rather you want them to cut, cut, cut, cut ,cut. Its always good to cut government spending. But its even more important to find cuts when you have fallen into recession. It may seem paternalistic for government to ask individuals to save more and pay off their debt. Well yes it is a bit paternalistic at that. But this is what they ought to do if we want to be quits with this recession.

So yes Nick Gruen is an dummy. Or at least he doesn’t understand economics. And neither does anyone else pushing this stupidity. Summers, Bernanke, Paulson. Idiots one and all. No-one who thinks that you spend (ie consumer spending and government spending) your way out of a recession understands economics. This is the wrong direction entirely. Save and cut. Cut and save. Thats the way you deal with recessions.

It is a little bit hard to try and get your head around this when you have been brought up on beguiling nonsense like the Keynesian spending multiplier. One of the most stupid ideas known to man. But once its in your head its hard to be quits with it. Below we will try and make that sort of analysis a bit more useful and realistic. A bit more of the Reisman and a bit less of the Keynes.

We want to set up a series of steps a little bit like the narrative that goes into the Keynesian multiplier. But we want to take out any of the sleight of hand. So think of the following as a series of freeze-frames. Where we move economic activity forward one frame at a time and freeze it, so we can subject it to some sort of analysis.

Lets look at the components of spending that make up Gross Domestic Revenue.

Gross Domestic Revenue = Government spending plus Gross Investment (Business To Business Spending) plus Consumer Spending +Exports minus Imports.

Supposing we could freeze GDR in nominal terms. Leaving net exports aside that would mean that if government spending or consumption spending went up, business to business spending would be damaged. This is a straightforward mathematical relationship. But also consider that there are only so many resources and the question is WHERE ARE WE GOING TO DIRECT RESOURCES TO END THE RECESSION.

What you are trying to do with monetary policy is to not allow GDR to fall. But you don’t want it to grow too fast either. Since that is inflationary. But you need a greater proportion of GDR to be in that category above that is private business-to-business spending. Else you do not have the resources you need going into business improvement and productivity improvement.
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

Look at it from the point of view of if we were a nation of primarily small businessmen. Supposing if people have cash-balances they like to keep on average, but the rest of the money they will spend. Hence we can analyze this question from the point of view of some amount of money that is always moving in discrete steps. We will assume 100% backing and assume also that any saved money is immediately automatically spent by a borrower WITHIN BUSINESS. So we don’t have this Keynesian sleight-of-hand where savings are considered leakage.

Now going with this analysis we imagine you get some revenue. Lets say it is ten ounces of silver. Your small business spends the money, not on consumption, but on something for the business. Pays some wages and does some maintenance. Gets the place painted. Fixes up the leaky roof. Leases a small hand fork. Puts in some racking. Gets a new cash register. Pays for some advertising. 

The next small businessman gets some of that revenue. He has a fundamental choice. He can spend the money on consumption or he can spend that money on something for his business. We might say he can spend internally or externally. He can consume the resources or his business can. And then when that money goes to the next small business. same basic choice. Does he spend on himself or on his business? Or rather WHAT PROPORTION gets consumed by his business, or by himself, in each discrete step that we are talking about.

(There is some more that can be said about that proportion going to wages. But I won’t further complicate things at this point and to follow the money going to wages doesn’t change in principle what we are saying here.)

The thing is that wages are paid out of the money that you spend WITHIN your business. Not on the money that you spend on yourself. Wages are paid out of the money spent WITHIN and not WITHOUT of your business.

We made an assumption about savings above so we would not lose track of it. We see that WAGES ARE PAID OUT OF SAVINGS as well.  Wages are NOT paid out of consumer spending. Wages are paid out of retained earnings and savings.  We can see this because we have made some specific assumptions above that allow us to view the effect of savings consistently.We said that savings lead to spending by borrowers within business. Whereas spending on consumer goods does not contain spending on wages going with this discrete step methodology.

>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

Now we see that from an accounting point of view, if we have people spending money on themselves (ie consumer spending), then that spending becomes someone elses revenue in the next discrete step. But in that first instance, this consumer spending becomes revenue, without spending of the sort that one day will become cost of goods sold. Hence consumer spending is the sort of spending that lifts profit rates. Since profit is revenue less cost of goods sold. But we see that the sort of spending WITHIN the business is spending that doesn’t lift profit rates. Since it is revenue, but it is also the sort of spending that will be one day be classified under cost of goods sold. So the policy that our government and Paulson and the others are pushing…… well all this extra spending on consumer goods and government spending, that our dumb-economists are trying to bring about, will indeed lift pre-tax profit rates. There is no doubt about that. There will be a cosmetic effect as government spending and extra-consumer-spending will lift the profit share. This may make people imagine that the recession is less bad then it is.

But this sort of change to spending cannot make the businesses themselves more productive in real terms. And it cannot lead to a recovery of employment and real wages in total. Only the spending WITHIN the business can do that. The new machinery, the new stock, the extra maintenance, the hiring of new staff, the new computer system, the new basement, and so forth.

*I may add to this further explanations over time down the bottom. The example is likely hard to visualize whereas the misleading examples associated with the Keynesian multiplier are easy to visualise and therein lies the problem.

We see for example that the ten ounces of silver do not go to the next Joe and him put aside some for saving and then 9 ounces go forward. Thats not realistic at all when most of the spending that goes on goes on within business. What happens is that this money immediately gets split up and goes outwards in different directions. So to do the next freeze-frame we have to go to another bloke with a reconstituted ten ounces of silver. 

In the case of the typical Keynesian narrative, as George Reisman points out, if that was how spending worked and each fellow consumed all the money he received, then the entirety of national income almost would be profit. Of course the economy would crash, and there would be famine and galloping consumer-goods price rises, and all that. But when you looked at the national accounts it would be the case that most of national income would be profit. Since people would be spending on what little consumer goods were still available, and almost nothing would be being spent on items that would one day wind up as cost of goods sold. The Keynesian multiplier examples are inherently idiotic. But since you can follow them easily in your minds eye they become like an infection. And the cure of reading Hayek and Reisman on the train everyday for a couple of years, isn’t a cure that all that many people put themselves through.

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Responses

  1. http://www.theaustralian.news.com.au/story/0,25197,24776952-5015664,00.html

  2. thank yoy very good blog

  3. Right. Henry has a lot of good sense hasn’t he. So yes he’s been alright too on this matter. But it looks like his mind is repelled by the silliness of the Keynesian multiplier. But it does not look like he’s completely sussed out that its totally and always wrongheaded to follow Keynesian prescriptions. It looks like his common sense is talking rather than that he’s mastered the technical side of it.

  4. Henry is probably overall the best mainstream commentator in the newspapers at the moment. But he reminds me of something that Sugar Ray said about Michael Sphinx. He reckoned he’d be sparring with him at the olympics and Michael would set someone up for the punch and then not throw it.

    Like Henry is always on the side of the white hats. But he will jab around the bad guys. He won’t lay out the knockout punch. He won’t say that this sort of thinking or that sort of thinking is wrong and idiotic.

  5. Larry Kudlow at the NRO has an interesting post up on the efficacy of infrastructure spending as recessionary stimulus.

  6. Right. He talks about cutting the corporate taxation. If you could cut taxes on retained earnings and make up for the loss with massive government spending cuts the private economy would recover almost immediately. We would see that since the resources would be directed to business-to-business spending. But funnily enough the recovery would not necessarily show up in the figures. In fact if you did things right the figures would be saying that things were going wrong.

    You see with GDP they have it like this:

    GDP = C+ net I + G + X – M

    What is left out of these figures? What is left out is the one thing that you need to know. That is to say business to business spending. And supposing you cut government spending, business to business spending recovers and the recession is ended. But when you went to look at the figures you might add them up and see that GDP had reduced!!!!!!!!!!!!!

    This is the crap state that mainstream economics is in at the moment.

  7. Goddamit.

    The fucking way out of a recession is to start a war and let God choose the fallen to make the fields fertile again. I want a war. I need a war. Let’s nuke Canada and then invade Japan.

    • Well unfortunately from an economic perspective thats not really right. Still it makes the figures LOOK like they have come out of recession.

  8. More Reisman and less Obama! 🙂

  9. Dear GMB,

    Kudos to you for this brilliant expose, I am deeply impressed.

    If I were you I would email this plan to President-Elect Barack Obama, because he would surely hire you in his cabinet.

    Yours devoted.

    Murray

  10. He wouldn’t listen, he is not the President-Elect, and for that matter he has no interest in genuinely helping his constituents. Or rather his primary constituency is not the American people.

    The American people are not number 1 in his thinking. Are you an Arab? Are you in fact an Arab Murray Abraham? And do you have a billion dollars?? If you are an Arab with a billion dollars Barry Soetoro wants to know how he may be of assistance to you. Otherwise you aint number one on his list. Nor are you likely to be number 2 or 3.

  11. Doghouse Reilly reminds me of an ethic that prevails amongst many of the couzie bros. Not necessarily technically or ethically sound. But somewhat useful perhaps, when there is not much room left to argue with these goons any more.

  12. Actually Murray. I think Barry has mistaken you for an Arab with over a billion dollars and he will contact you soon with any number of deals to your mutual benefit.

  13. “More Reisman and less Obama..”

    Right. I’m glad you liked it. Make sure you ask questions if there is anything you don’t understand.

    HAYEKIAN-CHIC.

    Look at what Henry Ergas has to say:

    “As for funding the increased infrastructure outlays through substantial increases in public debt, the scale of the proposed increases is disturbing. The letter recommends “NEW BORROWINGS OF UP TO 10 PER CENT OF GDP” which “should be deployed as rapidly as possible”.”

    These people are lunatics. They would destroy all our prospects. Maniacs. None of them ought to be employed as economists. They are probably eschatological-utopian Keynesians, who believe that with this sudden splurge they can ignite runaway investment that will lead to a third age that will last for a millenium. These people ought better be locked up than anywhere near the treasury. Think of the damage they will do if they influence, even in a small way, Ken Henry, Swan or Rudd?

    But then check out Henry’s form???

    “All of this is not to slight in any way the letter’s authors, whose initiative in engaging a debate on these issues should be commended.”

    COMMENDED? Is that what they call a public horse-whipping these days? COMMENDED? Is that some sort of code Henry uses? Jason? When the boss comes in and says “Times are tight. We have to make cutbacks. Some of you will be COMMENDED.” Does that mean there are mass-sackings afoot? Does Henry give his staff lectures in medieval history and does he show them people in the stocks, having rotten food thrown at them, and does Henry describe these people as being COMMENDED?

    If he’s using the word in the normal usage, isn’t that taking HAYEKIAN-CHIC to ridiculous lengths? I mean everyone might have a different self-image and different ASPIRATIONAL SELF-IMAGE to aim for. So that different people might have different ideas of what constitutes COOL.

    Does Henry retreat to the shed and leave his girls behind. And when he gets there, does he wear his leather jacket and cowboy boots, grease his hair back and look up at the big poster of Freidrich Hayek?

    I can imagine it now. A desk. A Hammock. Sound system. Tools. Couple of old motors he’s working on. And two big posters. One of Friedrich. One of Salma. Perhaps he snaps his fingers and looks at Freidrich and says…

    … “You are so cool. And I am going to be just like you. I am going to go out there amongst those lunatics and leftist nutballs and I am going to be relentlessly polite to every damn one of them.”

    This is part of the problem I think. Economists are way too nice to eachother. They ought to be trying to get each-other arrested, sacked and sent to the loony-bin.

    The stakes are too high for Hayekian-Chic on the part of the good guys.

  14. Dear GMB,

    Their is a weel known and respected conservative columnist who says Barack Obama is born in the US.

    In fact it is the title of the article “Obama Was Born in the United States”

    http://www.newsmax.com/kessler/obama_birth/2008/12/08/159417.html

    You should get in touch with him to show how he’s wrong. Here is the contact information

    NewsMax.com
    NewsMax.com
    NewsMax.com
    P.O. Box 20989
    West Palm Beach, FL 33416
    Main Office: 561-686-1165

    He also works for the Wall Street Journal

    Wall Street Journal
    Wall Street Journal
    WSJ Editorial Staff: wsj.ltrs@wsj.com
    WSJ Feedback: wsjcontact@dowjones.com

    Stay strong my friend

    Regards

    Murray

  15. Right. He doesn’t know shit either. The odd thing is he’s got a background in looking into spooks and things. And its the same as David Horowitz whose magazine deals with stealth-jihad and semi-secretive leftist networks.

    So its a bit of a mystery why these two are toe-ing this particular line. Perhaps they have been leaned on. Or perhaps they are in co-operation with some FBI moves to clean up this breakout of massive corruption and they are providing cover to allow the enemy to become complacent.

    Of course all such speculations lend themselves to likelihoods too small for integer percentages. But Kessler doesn’t have any evidence for this JIVE!!!!! and neither do you.

    So why did you bring Kessler up?

  16. Why would I get in touch with him? He knows he’s wrong. And if he doesn’t he’s beyond persuasion.

  17. Mr Bird,

    I suspect they have been briefed on the possibility of the suitcase nukes. As I pointed out to you some time ago it seems likely that these were distributed into a number of American cities by Russian agents and used to keep McCain and Bush quiet on the topic during the election.

    • Right. Well you would suspect that there would be suitcase nukes planted there by someone just on the basis that it would be so easy to do.

  18. Look here is the most odd thing and I didn’t think I’d wind up saying it. But there could be the offside chance that the FBI IS ACTUALLY GOING TO DO ITS JOB for a change.

    They might be stitching these clowns up right now as we speak. I cannot get over the idea that three conservatives who have come out most strongly against the idea of checking his eligibility are three people you just would not have expected it from in a decade of Sundays.

    They might be closing this fellow down. You know. His eligibility. Campaign finance fraud. Activities in Kenya. Getting his sheila a cushy job through. corruption. The death of Donald Young. Arab financiers. Vote-rigging. Bribes to various people. They could be getting ready to throw the whole damn lot at him.

  19. How about that Illinois Governor!!! More stink to add to the increase pile of defication Obama rose out of.

    If you and Dave Ramsey could run the financial show in Congress and Corporate America, we wouldn’t have some of these problems. Paulson has been the biggest moron to ever try to run the Fed. It’s common sense, something there is not an abundance of these days, especially in gooberment.

  20. “increased pile” and “defecation” I believe… my spelling stinks right now, please pardon it.

  21. Right. And Paulsons malign influence spread over here too. There are bailouts and bailouts. And if there were a run on the banks it would be quite normal to send truckloads of notes around there, at loan shark rates of interest, to deal with the problem and then these guys would have to hand over their books to see if any laws were broken so that there may be redress through fining management.

    But this is not what the original Paulson bailout plan was. That was a transfer of wealth to banking bigshots and money that would amount to a bribe NOT TO REFORM. He’s settled on a slightly better deal (in theory) of equity investment. But in practice its been arbitrary wealth transfers. Its not knowable how much of this largesse will be recouped out of that portion of the bailouts that are authentic short-term, equity investments. But that percentage aside, whatever it turns out to be, the size of the bailout commitments has TOPPED THE EXPENSE OF WORLD WAR II IN REAL TERMS.

    Now this is ridiculous. This is lunacy. And this is the main thing that has gotten me freaked out about Obama bin Laden Saddam Hussein Dunham. Because its this leadup where it almost appears like the Republic is unravelling which gives this fellow a wave to ride in on.

    And what it means is that we are heading for a shift in the international monetary system. So you have Bretton Woods I which lasted from Word War II until 1971. And then you had Bretton Woods II once the last tether to gold was cut. And thats lasted up until now plus 1 or 2 or 3 years. But what is clear is that this phase is doomed. One might put another division in. After 1971 you had that time up until the early 80’s still on fixed and moving pegged currencies. Then after that you had the currencies floating for the most part.

    Its really that prior to the early 80’s fixed was the rule and exchange rate alterations were the exception. Whereas after the early 80’s it was the other way around.

    We can make it then three distinct phases. 1945-1971 (ie about 26 years.) 1971 to circa early 80’s (ie about a dozen years or so but a shorter time for the Americans.) And mid-80’s perhaps to about 2010-2012 or someways around there. Unless someone serious comes in after Barry is lead away in cuffs, and that serious person practices full-on fiscal triage this current system cannot last.

    Thats the thing. These paper-money systems always seem like a great idea but the fact is they cannot last and they never do.

  22. Hoosiermom. If you let this fellow take the oath just think of what the USA will become. Thats right. It will be COOK COUNTY AND SURROUNDING LOCALITIES. Had Palin been elected with the right crew she would have brought a bit of the golden years back. Or influenced things in that direction somewhat. But with this fellow and with the evil that Paulson has perpetrated its just going to be BARRYLAND!!!!! (AKA COOK COUNTY AND SURROUNDING DISTRICTS.)

  23. mr Bird

    have you noticed this detestable piece of cowardice from your ideological associate Mr Hill?

    http://alsblog.wordpress.com/2008/12/11/libertarian-new-views/#comment-57447

  24. Isn’t he just so fucking frustrating?

    “The pro warming crowd should just conccede defeat on the hockey sticks and never refer to them again……………….. ”

    rrrrriiiiiiiiiiiggggggghhhhhhhhttttt

    “…….. The methodology was really, really bad…….”

    RRRRRRIIIIIIIIGGGGGGHHHHHHHHHHTTTT

    “……………It detracts from the valid evidence that AGW is a concern and may need to be tackled by Government policy………. ”

    AAAAAAAAAAAAAAARRRRRRRRRRRRRRRRRRRGGGGGGGGGGGGGGGGGGGHHHHHHHHHHHHHHHHHHHHH!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!1

    WHY DO YOU KEEP LYING YOU FUCKING LYING CUNT MARK?????????

    Well spotted Winchester. Good stuff. Keep an eye out for these compulsive liars and traitors. That simpleton knows damn well he’s never made good with even a smidgen of evidence yet.

    Onward.

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  26. Well it would be if I spent more time on it.

  27. Wow that was odd. I just wrote an really long comment but after I clicked submit my comment didn’t show up. Grrrr… well I’m not writing
    all that over again. Anyway, just wanted to say superb
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  28. I’ll try and find it.

  29. Wow, superb blog layout! How long have you been blogging for?
    you make blogging look easy. The overall look of your website is great, as well as the content!


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