Thursday, October 7, 2010

Open Thread

Smoke 'em if you got 'em! Looking for post ideas, visits, whatever you have on your mind. So go ahead, rub one out.

I'll also be inviting folks at Donklephant to swing by here and continue a conversation that has been stifled by a moderation queue glitch.

47 comments:

  1. kk, WHQ here, using a Google account with a different profile name:

    If you can give me the reader’s digest version of why Billy believes this is not inevitable, then I’d consider reading the rest of that extremely lengthy post in good faith.

    I don’t know that a debt crisis, given the way we choose to do things, wouldn’t be inevitable. Modern Monetary Theory (MMT) would suggest that there is no need to issue debt in the first place. What purpose does it serve?

    The example of the German Mark doesn’t apply because it wasn’t a fiat currency and there were debts not denominated in Marks. From Wikipedia:

    It is sometimes argued that Germany had to inflate its currency to pay the war reparations required under the Treaty of Versailles, but this is misleading, because the treaty did not allow payment in German currency.

    and

    The total reparations demanded was 132,000,000,000 (132 billion) goldmarks which was far more than the total German gold or foreign exchange.

    It was a currency backed by gold, of which they didn’t have enough, and they had debts that could not be paid with their currency. These things don’t apply to the United States today. The real constraints are different, and have more to do with the amount of productive slack in our economy as regards inflation. That’s not to say that the government couldn’t induce hyperinflation by net spending. It is to say that we don’t need to borrow money to spend it and we don’t need to tax to spend it.

    Taxation and borrowing perform functions not related to funding anything, really (or they shouldn’t). What they should do is allow the government to manage the economy in aggregate through net spending/taxation, provide the public service of a safe savings vehicle for its citizens, and make distributional adjustments (sub-aggregate) as necessary.

    To be honest, I’m not sure how much I buy into MMT. I do to some extent, but I’m not expert enough to do so with a great deal of confidence. It appeals to me because it gives me an entirely different way of looking at macroeconomics, particularly with regard to the role of the government.

    I know it sounds nutty when you read some of what Bill writes, particularly if it’s not entirely in context, which it often isn’t in the mind of someone reading it for the first time. Part of it, I think, is because he writes from a particular perspective in reaction to established, mainstream, economic “conventional wisdom,” for lack of a better term. This makes him emphasize his points of disagreement, which pushes his writing in one direction more than the other, if that makes sense. But it’s interesting stuff, and he’s no amateur.

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  2. Well, for me the biggest problem is a personal lack of overarching understanding of the idea. So for example, I'm seeing you repeat a one or two of the claims that I've yet to see support for. Like

    _____
    Modern Monetary Theory (MMT) would suggest that there is no need to issue debt in the first place. What purpose does it serve?----

    See, without an explanation of the lengthier rationale behind that, I don't know what it means, that there is no need to issue debt. I don't know what being driven at, I can only guess.

    My guess is that it means that a nation can simply print more money, instead of selling bonds as debt. Technically that's true, but how useful is it? Presumedly, a nation issues bonds as way to borrow money because simply printing it is more likely to make the rest of the world worry about the value of the currency.

    I don't see that it really matters which path is undertaken, as the result is the same: a dilution in the value of the currency because there are more existing units (dollars in this case) that represent shares of national wealth. So, even if we didn't "issue debt" but grossly diluted our currency, there'd still be the same problem. Which is that we consume way more than we produce, and as we do, other nations doubt the worth of America and its money.

    As to the mark, I'm thinking along those same lines. Whether it's a fiat currency or not, there are still the issues of the role of faith and inflation. Supposing we eschewed issuing debt but still spent more than we had. So we avert a "debt" crisis per se, but we have a currency/inflation crisis. What's the diff? Either way, we're stuck with the problem of a diminishing ability to acquire goods and services because we've continued to consume way more than we produce from other nations.

    FWIW, I think that the purpose of issuing debt (instead of just printing more money)is to provide transparency which engenders trust.

    I get what you say about the various comprehension problems and emphasizing points of disagreement. One other problem I recall is where he mentions an affiliated idea of his, something about a job bank and guaranteed employment. That sounded so far away from "the adjacent possible" for America that I just skipped over it.


    ___
    Taxation and borrowing perform functions not related to funding anything, really (or they shouldn’t). What they should do is allow the government to manage the economy in aggregate through net spending/taxation, provide the public service of a safe savings vehicle for its citizens, and make distributional adjustments (sub-aggregate) as necessary.
    ___

    I don't understand a word of that. Care to try again, at somewhat greater length?

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  3. You've made a point that is made over and over again at billy blog - that issuing bonds dollar-for-dollar against deficit spending is a wash.

    http://bilbo.economicoutlook.net/blog/?p=11587

    From a macroeconomic flow of funds perspective, the funds (net financial assets in the form of reserves) that are the source of the capacity to purchase the public debt in the first place come from net government spending. Its what astute financial market players call “a wash”. So at the federal level, the funds used to buy the government bonds come from the government!

    The funds to buy government bonds come from government spending! There is just an exchange of bank reserves for bonds – no net change in financial assets involved.


    With that, what I was saying in the last quote in your comment is that all the government is really doing with it taxes and borrows is take back some of the money it put into the economy in the first place. It's funding itself, regardless of whether it simply "prints money" or "prints money" and then takes it back, be it by soaking up bank reserves or taxation. So what's really going on is management of aggregate demand in response to the private sector, management of interest rates, redistribution below the aggregate level (where do you take money out and put money in, given aggregate net spending?), and providing a secure place for people to put their savings.

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  4. Sorry, I still don't get it. We're not talking about one government, we are talking about many different governments. People and organizations from all over the world buy US bonds.

    Dollars represent an imaginary share of American wealth. Other currencies represent imaginary shares of the wealth of other countries.

    Aa long as there are many governments and currencies, that means that there are real transfers and real debts and real changes, Which means that the deficit spending isn't a wash at all. Maybe it is in some sort of loose theoretical sense, but in practice I don't think it is. It sounds kind of preposterous to me.

    So at the federal level, the funds used to buy the government bonds come from the government!

    The funds to buy government bonds come from government spending!


    A substantial portion comes from other governments and their economies, which are competing with ours. More than once while reading this billyblog stuff I've gotten the impression he was imagining some sort of very powerful single government or considering all of the governments as a de facto single system. That seems quite suspect to me. Not the kind of thing anyone would find consoling if one needed a wheelbarrow full of dollars or marks to buy a loaf of bread.

    Mind you, I'm just talking out my ass here. If I'm missing something, feel free to keep trying to enlighten me.

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  5. How do other governments or any foreign entities buy our bonds? What do they use? What do they get back when they sell those bonds?

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  6. kk, here's something to chew on from today's post at billy blog. It's not exactly what you're asking about, but it provides some of the basics underlying Modern Monetary Theory. I know it all sounds nuts, and I hope you don't mind continuing this discussion. I've been hoping to have a sort of one-on-one with someone willing to think about it and capable of challenging it, just to get my head around it a little better, and you seem like a perfect candidate. And you have new blog!

    Dean has grasped that the sectoral balances are indeed a powerful framework for organising one’s understanding of the way the economy works. He says:

    "There are few areas of economics more boring than accounting identities. This is really unfortunate, since it is virtually impossible to have a clear understanding of economic policy without a solid knowledge of the underlying identities.

    "Most of the people in Washington policy debates were apparently overcome by boredom before they could get this knowledge. As a result, we see some really silly policy debates.

    "The debate over the value of the dollar against the Chinese yuan is the latest episode in this silliness. The Washington tribal elite has been on the warpath against budget deficits in recent months. They have worked themselves into such a frenzy that nothing will stand in their way: neither concerns about unemployment, nor concerns about the well being of our elderly, nor even concerns about basic economic logic."

    I completely agree that the debate about the Chinese currency is out of control. Most commentators have not thought through the implications of their demands, understood the underlying relationships that are involved and considered history. Most of the commentary is at the level of the first-year text book which is bound to lead to erroneous conclusions.

    Baker then says by way of 101 instruction that:

    "The central problem stems from the simple accounting identity that national savings is equal to the broadly measured trade surplus. A country with a large trade surplus will also have large national savings. Conversely, a country with a large trade deficit will have negative national savings. These relationships are accounting identities – there is no way around them."

    Well this is not what I would want a deficit terrorist to learn. Please read my blog – Twin deficits – another mainstream myth – for a derivation of the sectoral balances and more background material.

    The sectoral balances are:

    (T – G) = budget balance, where T is tax revenue and G is government spending.

    (S – I) = private domestic balance, where S is total private saving and I is total private investment.

    (X – M) = external (trade) balance, where X is total exports and M is total imports.

    If (T – G) > 0 then there is a drain on aggregate demand via the public sector. If (S – I) > 0, then the private domestic sector is saving overall and this creates a drain on aggregate demand. If (X – M) > 0, then net exports are positive and this would add to aggregate demand via the foreign sector.

    Further, by implication, external deficits drain aggregate demand from the economy and budget deficits add aggregate demand.

    These balances are linked via a strict accounting relationship which is derived from the National Accounting framework such that:

    (S – I) + (T – G) – (X – M) = 0

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  7. The New York Yankees are the source of all evil on this planet.

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  8. in re: shorter question
    Other entities buy our bonds using their money. What's your point?

    At some point are you going to explain why we don't have to worry about other countries losing faith in America because it keeps consuming way more than it produces?

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  9. in re: longer excerpt

    OK, I think I understand most of the sectoral balance claim asserted.

    Suppose we call T-G the budget deficit, because that's what it is now.

    Then suppose we call X-M the trade deficit, because that's what it is now.

    I am not sure what S - I refers to. It sounds like maybe it ought to refer to total private assets minus total private debt. But it refers to savings minus investments, which I guess means "available uninvested private capital."

    So acc to BB

    trade deficit = budget deficit + uninvested private capital

    I don't see why this is true. Feel free to enlighten me.

    It still sounds to me like this guy is positing a closed economic system, not a system composed of a series of only partially related systems that rely on imaginary (or subjective) valuations of things.

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  10. Todd, you've got my sympathy. The Yankees' only real weakness is suspect depth in its starting pitching. And that's almost impossible to exploit in the first round of the playoffs.

    With the Yankees back end of Woods and Rivera and some other capable guys, you really need to carry a lead off of Sabathia and Pettitte into the last few innings. And then you need to have a bullpen that can hold off the best batting line-up money can buy for the last 3 innings.

    You don't need to explain any of this to a Red Sox fan. Go Giants!

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  11. Other entities buy our bonds using their money. What's your point?

    Dollars. You must obtain dollars before buying US bonds. You get only dollars when you cash in the bonds. The only source of dollars is the US federal government. They are the sovereign and sole issuer of dollars. To the extent that the system is "closed," that is the reason. (Dollars are also the only acceptable form of payment for federal taxes, so, at least partially, taxation serves to keep the currency relevant to US citizens and other entities who must pay federal taxes.)

    At some point are you going to explain why we don't have to worry about other countries losing faith in America because it keeps consuming way more than it produces?

    Why? No one has claimed such a thing in general. It's just that right now we have so much slack in our economy that the risk of damaging inflation due to budget deficits is very low, much lower than the danger of continuing idle resources. Leaving our economic resources idle doesn't seem like a good way to increase production relative to consumption.

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  12. I should add, kk, that I don't know these things, and I'm not asserting them as fact, even if I don't preface everything I write with an acknowledgement of uncertainty. It just gets cumbersome, so please accept this as a blanket statement that covers everything I write about MMT.

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  13. It still sounds to me like this guy is positing a closed economic system, not a system composed of a series of only partially related systems that rely on imaginary (or subjective) valuations of things.

    Close enough. Hairshirt is talking about neo-chartalism, which modern proponents have re-dubbed "Modern Monetary Theory." As compared to the Monetarist school best known from Milton Friedman's work. It's an extension of a post-Keynesian school of economic thought that is wildly beloved by some dedicated neo-liberal statists, because it implies a Free Lunch for the state, especially as relates to deficit spending and state job guarantee programs.

    Chartalism itself is not devoid of theoretical sense, proponents just habitually extend it past its own inherently limited definitonal boundaries of the basic limited-context theory. (As does every economic school that thinks it's found a GUT.) While neo-chartalists have Big Conflicts with monetarists, their Really Big opposites are the "gold bugs" who view with disgust any money that is not itself an actual physical commodity.

    Mainstream economists consider neo-chartalism to be considerably less than empirically robust. Of course, neo-chartalists can make the same (somewhat justified) claim about mainstream economic theory. Which is why I remain an empiricist. Theorists tend to make entirely too much cultish stew out of the few oysters they find.

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  14. Oh, and: So acc to BB

    trade deficit = budget deficit + uninvested private capital

    I don't see why this is true.


    Mainstream economists would simply refer you to the standard GDP equation of GDP = C + I + G + [X - M] that says that when government spends more than it can tax away from the national economy, the excess has to come from external sources because it can't miraculously appear out of thin air. Which means that net exports, [X - M], must be negative -- a trade deficit.

    If you run government deficits, the resources have to come from somewhere. If domestic sources can't/won't lend (or be taxed) enough to cover, you have to get them from foreign sources. The terminology used in the alternate agg-demand model above is indeed confusing, and obscures that a bit.

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  15. I knew that technically the bonds always got purchased with dollars, but so what? Anyone can get dollars via exchange. It's not like this rule prevents an actual, you know, barrier.

    ____
    Why? No one has claimed such a thing in general. It's just that right now we have so much slack in our economy that the risk of damaging inflation due to budget deficits is very low, much lower than the danger of continuing idle resources. Leaving our economic resources idle doesn't seem like a good way to increase production relative to consumption.
    _____

    Not claimed per se. But I've sensed the repeated implication that circumstances are not dire because acc this theory the government has vast powers approaching that of a free ride. A ride that isn't constrained by things like foreign perception of our spending practices. That rings false to me.

    I agree that it's possible in this low demand environment that inflation does not present an immediate. It's even possible that we'll "get away" with this gross overspending because our bonds keep seeming like a better risk that outer alternatives. But I don't think it's likely, not when there are other economically healthy countries that are outproducing their own consumption. If there's a shift away from dollar worship, it's going to come fast and then we won't have any good moves. So I think we're MUCH better off voluntarily curbing our appetites to reinforce dollar trust than we are trying to curb our appetites under the gun in order to attempt to restore trust. Because once those other countries who've supported the dollar discover they don't really need it, we're in a real fix.

    I don't really see in what sense we are "leaving our economic resources idle." When you borrow, you aren't using your own resources. Borrowing is an action you undertake when you lack resources. Lending is done under terms when the lender appreciates your growth potential/ability to repay.
    .
    ____
    I should add, kk, that I don't know these things, and I'm not asserting them as fact, even if I don't preface everything I write with an acknowledgement of uncertainty. It just gets cumbersome, so please accept this as a blanket statement that covers everything I write about MMT.
    ____

    I appreciate that and am doing my best to discuss what you're saying here in that good faith sense that we're BOTH trying to wrap our heads round it.

    Tully, thanks a ton for stopping by, I was hoping you would. I am way over my head with this stuff, so the views of someone with a broad and historical understanding is really appreciated.

    I've run into those folks with disdain for all fiat currencies. They seem to want to be utterly free from the power of other people in determining what wealth means and what it is. But it derives from trade and cultural belief and communication and imagination and opinion much more than we want. Any possession you or I have has no fixable extrinsic value without another person to make the trade.

    We're all stuck with each other, and with the fact that currency values and exchange rates and so on are fungible and potentially unstable. There is neither a free lunch as MMT folks seem to think, nor a pure escape from subjectivity as gold bugs think.

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  16. Your last para, kk: bingo.

    Yes, deficits do matter, and no, there's no free lunch. We are paying for our recent massive deficit spending right now in the domestic markets, the currency markets, and when domestic demand picks back up we will pay in inflation as well. We're gonna be paying in the future as well.

    Modern Monetary Theory (MMT) would suggest that there is no need to issue debt in the first place. What purpose does it serve?

    In a completely domestic context, simply creating more money (expanding money supply faster than GDP growth) results near-directly in inflation. Inflation increases both uncertainty and interest rates. This has real effects on investment. Also on real resource usage and the efficiency thereof. Government simply does not use resources as efficiently as the private sector, so, ceteris parabus, overall national productivity declines as government share of resource usages increases.

    Of course, we're not a closed economy, so we have other effects. Some of that deficit spending (a large portion) is funded by external borrowing which represents real resources, and in the long run the lenders want their resources back with interest. Expectations of future economic/currency performance are determinants of interest rates as well, so the deeper in debt you are, the higher the interest rates demanded and the more your currency is discounted in exchange markets. Ask Greece or Ireland if that matters. Or look at the five-year performance trend of the dollar versus yen and euros. Debt creates DRAG. The greater the debt, the greater the drag.

    Theorists tend to get locked into their mathematical models, and forget that economies are not mechanistic systems. They're living organic systems. IOW, theorists completely lose sight of the human side of the equation. Some parts of econ are indeed deterministic, involved with the physical constraints of available resources. And others are pure mob psychology. Attempting to apply mechanistic principles to complex organic systems that have complex (and oft irrational) behavioral patterns that are NOT mechanistic is a sure loser.

    So, yeah, beware of people with shiny theories. Models are best used for gaining insight into processes, and not nearly so much for trying to mechanically control them.

    Of the nations that have actively employed chartalist-derived policies (such as job guarantee programs and non-debt monetary expansion for financing) it is notable that the only ones to have avoided excess inflation are those with major trade surpluses. And not even all of those. Essentially trying to employ the "free money" principle for excess spending removes the constraints imposed by the debt market, and operating without those constraints tends toward a lack of restraint on deficit spending, with predictable (and empirically and historically verifiable) results.

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  17. I've come to believe that the best course of action wrt macroeconomic policy is a dedicated mix strategy of sorts.

    The best way to commit to a mixed strategy is to handicap the rivalry between both the major parties in the US, since each has their preferred sort of macro/fiscal policy. And the easiest way to handicap them would be to use 3-seated Hare-LR in State representative elections, as soon as possible.

    http://rationalargumentator.com/issue261/winnerdoesnttakeall.html
    dlw

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  18. I don't really see in what sense we are "leaving our economic resources idle."

    What I meant was that we have lots of people not working and lots of productive capacity that is unrealized.

    I wouldn't suggest that we simply deficit spend for the sake of it. I would suggest that whatever spending occurs, be it in deficit or otherwise, should serve to foster the future growth of the private economy. That's an admittedly high-level postition, and every individual policy needs to be evaluated. But I think we're falling short in education, public health and infrastructure. I also think we'll be paying for that for a long time, perhaps longer than for our existing debt, and probably through greater future debt.

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  19. This is the most succinct and complete explanation of the sectoral-balance equation I was able to find at billy blog:

    The basic income-expenditure model in macroeconomics can be viewed in (at least) two ways: (a) from the perspective of the sources of spending; and (b) from the perspective of the uses of the income produced. Bringing these two perspectives (of the same thing) together generates the sectoral balances.

    From the sources perspective we write:

    GDP = C + I + G + (X – M)

    which says that total national income (GDP) is the sum of total final consumption spending (C), total private investment (I), total government spending (G) and net exports (X – M).

    From the uses perspective, national income (GDP) can be used for:

    GDP = C + S + T

    which says that GDP (income) ultimately comes back to households who consume (C), save (S) or pay taxes (T) with it once all the distributions are made.

    Equating these two perspectives we get:

    C + S + T = GDP = C + I + G + (X – M)

    So after simplification (but obeying the equation) we get the sectoral balances view of the national accounts.

    (I – S) + (G – T) + (X – M) = 0

    That is the three balances have to sum to zero. The sectoral balances derived are:

    The private domestic balance (I – S) – positive if in deficit, negative if in surplus.
    The Budget Deficit (G – T) – negative if in surplus, positive if in deficit.
    The Current Account balance (X – M) – positive if in surplus, negative if in deficit.

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  20. I wouldn't suggest that we simply deficit spend for the sake of it. I would suggest that whatever spending occurs, be it in deficit or otherwise, should serve to foster the future growth of the private economy. That's an admittedly high-level postition, and every individual policy needs to be evaluated. But I think we're falling short in education, public health and infrastructure.

    I agree about targeting future growth.

    I also agree that targeting infrastructure makes intrinsic sense, with the caveat that we need to do better than to hand out federal funds to any town that wants a traffic light or has some sort of next generation energy scheme. Fixing crumbling roads and bridges and modernizing our electric grid are tops for me.

    Public health is not something I favor pouring lots more resources into as a way o spurring growth.

    Education? I think there's far too much demagoging going on: politicians wrapping themselves in "children are our future" as a preamble to trotting out out old ideas that haven't borne fruit in the past.

    We've increased spending on schools over and over, and reduced class sizes, and test scores haven't budged. We spend ever-increasing shares of resources on mandated remediation for less able students and they don't improve. We keep falling farther behind nations with old-fashioned approaches and a much higher cultural appreciation of the value of education. These nations reward excellence and they reward solid noticeable achievement too. And they worry somewhat less about less able kids who might be "left behind."

    I am all for trying to help American kids thrive in the classroom. And I don't pretend to have all the anwers. But I do know that encouraging self-esteem without regard for linking it to merit can be counterproductive. And I doubt we can afford to keep pretending that no child can be "left behind."

    We should be building kickass tech schools, not struggling to train more teachers to fill special ed vacancies. There's something troublesome about the fact that its the least capable American students who get Individualized Education Plans.

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  21. "Gifted" children get IEP's too, KK.

    But yeah, I was just going to comment on that same para. That we are falling short in performance does NOT mean that we are falling short in funding. That assumption's one of the theory/reality traps I was referring to, and nowhere does it show more clearly than in education. Throwing more money at things does not neccessarily improve results, and even where it can, the larger and more entrenched the bureaucratic structure, the less effective that extra money is at fostering improvements. Our very worst schools are actually in some of the places that spend the most on education per pupil. Washington DC schools, the worst in the nation, are under the control of the DC muni gov't and Congress. You can tell at a glance how good they are at running schools ...

    Not to mention the regulatory burden problems associated with larger government. Hoover Dam was built during the Depression. It took five years and cost $49M. The inflation-adjusted equivalent today would be about $800M. If we tried to build it today it would cost many mutiples of that and take over a decade to construct. It's not just what you spend, but how you spend it and in what cost environment.

    WHQ offers the standard derivation of the Twin Deficit Hypothesis using the theoretical income/expenditure equivalency (sources/uses = income/expenditure). And, no surprise, all three predicted effects of deficit spending are present today: an increase in private savings rate, an increase in trade deficit, and a decline in private investment.

    Expanding the money supply doesn't change that, because money is not the same thing as resources. You're still borrowing resources from the future. When you borrow them domestically (closed economy) they come from current consumption (private savings rise as current consumption is deferred) and private investment falls (crowding out) while the value of money is diluted (inflation results). In an open economy you can also borrow externally, but you're still borrowing from future resources (inflation/currency devaluation results).

    As long as growth exceeds borrowing, that's not so bad. Debt shrinks proportionally as a percentage of GDP, and the value of money can stay constant or rise despite deficit spending. You're still paying a "hidden tax" in growth & monetary appreciation foregone but you're in profit territory. But when borrowing exceeds growth ... well, the bill always comes due, sooner or later.

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  22. Ack. I said "value of money" when I should have said "national wealth." Big diff.

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  23. Anyway, I'm being kind of roundabout in explaining why we issue debt for deficit spending rather than just expand the money supply to cove. The basic reason is that people instinctively know there is no free lunch, and that fiat spending must still be paid for in real resources. They do not want to provide those resources without some assurance of repayment PLUS at minimum enough interest to cover the depreciation of money, and preferably enough interest profit to motivate them to lend rather than retain those resources. AND the value of money is strongly affected by the expectations of its future value. So borrowing capacity is much higher when there is payback/profit involved, and the negative effects are reduced. Lenders' willingness to provide debt funding is based upon a somewhat rational assessment of expected return. That expectation is missing in straight deficit spending/monetary easing, where the rational expectation is that such will result in both inflation and curency devaluation. This in turn begatively impacts both savings and investment as funding sources, both internal and external.

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  24. Just to be clear, I don't think we necessarily need to spend more on education. We definitely need to spend better. Given whatever set of goals one might have, it may require more spending or it may require less. I don't know enough to say either way, but I do think we need a better outcome and I do think we're wasting too much of what we're now spending. (I mean, any waste is too much, but there's always going to be some. Nothing's perfect, but I don't think we're remotely close enough to perfect right now.)

    Tully, I'm not enough of an expert to know (or have a strong opinion on) whether you or Bill Mitchell is right about the various points under discussion. What I can say is that he addresses every point you've made. I'll grab some excerpts when I have time, because I'm very interested in your analysis. If nothing else, MMT will increase my knowledge of economics, be it through my finding out what's wrong and what's right (doubtful), or simply by better understanding what the different points of view are, even if I still can't figure out who's right or who's wrong (more likely).

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  25. Hey, I may not be disagreeing with Mitchell all that much but simply approaching from a different (and much more conventional) angle. But there is a reason that chartalism and other post-Keynesian schools are considered heterodox and are not widely accepted -- they deviate from the conventional wisdom. It's a good thing to consider such analysis, if only to remind oneself that mainstream economics is not exactly a science either.

    As I said, I remain an empiricist because there are simply too many holes in theory and because organic systems are not mechanistic ones, and macroeconomics is at root the study of human behavior, which is oft irrational. I would say that when studying heterdox theory it's enormously helpful to have a solid background in mainstream theory to know where and how you're jumping off into contested interpretations.

    As I understand it (which may not be all that deeply) the chartalists believe that the government can create and utilize money with minimal adverse consequences under certain circumstances, which is a step beyond Keynes and even the subsequent neo-Keynesianism, which recognize the adverse consequences of deficit spending. I've never dug too in-depth on chartalism, but my knee-jerk reaction is that the hypothesis runs into that theory/reality problem, particularly the point that money itself represents real resources, of which there is a finite amount at any given time, and the effects of taking real resources out of the economy exist regardless of the theoretical origins and nature of money. Resources used today are not available for tomorrow, regardless of the creation and destruction of money.

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  26. Very briefly, what I get from Mitchell is that he views government spending as a sort of opportunity cost that is determined by the other possible private-sector uses of the resources government would claim the use of. He generally discusses the government using resources that are available but currently going unused. I don't know how to square that with the today-versus-tomorrow paradigm, because I think he's mostly talking about people and equipment that are otherwise doing nothing at present. Using them now shouldn't prevent someone else from using them later. As far as raw materials go, I can see what you mean.

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  27. OK, I can understand that line of reasoning. Certainly not without merit, though I can't resist the "Yes, but..." thing.

    I don't know how to square that with the today-versus-tomorrow paradigm, because I think he's mostly talking about people and equipment that are otherwise doing nothing at present. Using them now shouldn't prevent someone else from using them later.

    The problem I would see there is that in utilizing those resources you still inject claims ("new money") on current physical resources into the system. Wages paid out will still be eventually collected by the workers in real goods and services, for example. Machinery owners would still expect to be paid (for depreciation, if nothing else) and will use that money for real resources elsewhere. And so on.

    So to the extent that you are not creating new net positive value (a societal "profit" in new capital created over and above the value of the resources consumed) you're still reducing total available resources, i.e., borrowing from the future. The resources you're using are usually idle in the first place because the markets do not see profit in currently utilizing them, and government does not tend to be more efficient than private markets in resource utilization. (It might be to government's profit to do so, but unless it produces a public-good "profit" that increases overall societal capital that would still come at a cost/loss to society overall. )

    That's most explicitly NOT to dismiss the social utility of the idea. Much of what government does it does at a loss in overall public economic utility anyway. Where and how we want to incur those costs is a political policy issue -- many of the perceived benefits are intangible in economic "profit" terms and are total value judgements in other ways. Regardless of what anarcho-capitalists may think, we do indeed do some things for non-economic reasons that make great sense to us as human beings.

    For instance, using my previous example, Hoover Dam cost over 100 lives in the construction, and the economic cost of those lost lives is subjective. Even if you stick dollar numbers on them, those numbers will inherently be somewhat arbitrary at best. If we built Hoover Dam today a substantial part of the increased cost/time would be avoiding some or most of those deaths through safety spending and regulation, which impose a stiff cost burden. We supply the poor with food stamps, because we consider it better than widespread starvation. Etc.

    Is that helpful to your understanding? There is still no free lunch, but it's useful to know when you're leaving the empirical realm and diving into the area of politics and value judgement calls.

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  28. Is that helpful to your understanding?

    Absolutely. For the most part, I don't disagree with anything you wrote, but I have a "Yes, but..."

    Wages paid out will still be eventually collected by the workers in real goods and services, for example. Machinery owners would still expect to be paid (for depreciation, if nothing else) and will use that money for real resources elsewhere. And so on.

    But, at that point, aren't you talking about the private sector and the market? The government won't decide for those individuals how their (after-tax) money gets spent. By then, the invisible hand has regained control.

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  29. Doesn't matter. The money has still been created by fiat and used on real resources, so it's still an expansion of the monetary base in excess of actual growth, and can thus have deleterious effects. No free lunch.

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  30. In other news, the dollar continues to slide and the commodity indexes are up sharply over the last couple of months, as investors increasingly opt for "hard goods" in the face of expected inflation.

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  31. Yeah, and meanwhile a short blurb about countries all trying to devalue their own currency and a meeting to curtail this? That appears on page A15,

    It's an extremely important story, but most journalists don't particularly get it. And most regular folks have no no clue and less interest.

    Which seems like a bad thing, I think at first. But then, if more folks got it, they'd probably all be busy panicking. No gold ATMs in my neighborhood yet, but we'll see.

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  32. Yep, competitive devaluation is going on, though the Fed officially denies it.

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  33. RE: IEPs My understanding is that gifted kids "might" have an IEP. But if you're a special ed kid, you MUST have an IEP by law, one that's reviewed, revised, annually agreed to, and so on.

    Is that incorrect?

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  34. It is certainly incorrect in my state.

    What IS true is that parents can always reject IEP's, can always choose other programs if they wish (though only in private placement at state expense after hearings and such), and that "pull-out" standardized public-school programs that satisfy IEP requirements out of hand for gifted kids are far more common than equivalents for kids at the other end of the spectrum.

    IOW, even though the law requires the same for all "special needs" kids and gifted kids are by definition "special needs," parents of gifted kids are enormously more likely to accept a standardized AP or IB or gifted program than parents of lower-spectrum kids are to accept standardized warehousing and baby-sitting.

    Parents of low-end kids will demand every jot and tittle of what the law requires. And rightly so -- a low-spectrum kid needs everything they can get to have a chance at a life, while a high-end kid is still gonna be in good shape even without an honors program. And public schools get handsomely rewarded for producing exceptional students, in National Merit honrs and state funding and such, wheereas they get a fixed amount to handle ALL their low-end kids, and have to be sued to allocate anything extra to them.

    My take, anyway.

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  35. The money has still been created by fiat and used on real resources, so it's still an expansion of the monetary base in excess of actual growth, and can thus have deleterious effects.

    I'm not debating that. I was addressing your scenario of after-the-fact spending by workers and owners in relation to the efficiency of government spending versus private spending. It's a minor "Yes, but...."

    Just by chance, as I'm here typing, Bernanke comes on the radio saying inflation is below the 2% target. ???

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  36. WHQ, the first layer of spending runs through an inefficient machine (gov't) that extinguishes a good chunk of the value of the money spent before it ever gets to direct consumption spending.

    IOW, despite the standard CBO/admin model assumptions that government spending has the same or near >1 multiplier effect of private spending, the empirical research indicates that it actually has a mulitplier of <1, more like 0.8. So you start out in the hole because of the bureaucratic/regulatory overhead load even before we consider the problem that government allocates by politic prioritization, not by any market cost/benefit efficiency considerations. And you have to climb out of that hole before you can even start to play catch up. That's before we even consider the other adverse effects of deficit spending or currency dilution on future GDP.

    Increased demand is the goal. Without that, there's no growth. Without growth, stagnation. Spending at multipliers less than 1 does NOT boost demand, simply steals it from somewhere else.

    Re your Q: Yep. With real interest rates near zero, monetary policy becomes the remaining tool in the Fed toolbox to spur growth. But it only works if it boosts demand, which means inflation as all that excess liquidity from deficit spending in excess of GDP growth is absorbed and price levels adjust. If you're familiar with the concept of a liquidity trap, the rest of the Fed's reasoning should follow. If they can get demand growing again (and thus sustainable GDP growth, versus "propping up" GDP with sub-optimal spending) then interest rates will sooner or later rise, giving them their favorite tool back again.

    Inflation sucks, it's a very real hidden and non-progressive tax, but as long as we avoid hyperinflation it's better than deflation and/or stagnation. We're not going to get demand (employment, GDP growth) back up without some inflation.

    If I weren't so personally debt-adverse and could be assured of my ongoing income, NOW would be the time to borrow at locked-in low fixed rates. But few are lending -- they can read those tea leaves too. Most people's major loan asset is their home, and the RE sector has not finished bouncing around, and won't anytime soon. So lenders do not want to get locked into low-return investments. They remember the S&L debacle, where long-term fixed-rate loans became millstones when inflation kicked in. And they see both the spectre of inflation and the uncertainty of RE values in the current market.

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  37. If I weren't so personally debt-adverse and could be assured of my ongoing income, NOW would be the time to borrow at locked-in low fixed rates.

    I'm pretty debt-averse myself. The only debt I have is my mortgage, which I very recently refinanced to get the low fixed rate available. But I wouldn't go looking for new debt, either, regardless of the low rates. I'm just not built for that.

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  38. I don't even have a mortgage anymore. We bought well within our means (50% down, even!) and paid that 30-yr note on the remainder off in 6 years. I have no secured debt at all, and pay off my AMEX every month to stay out of unsecured debt. Our newest car is ten years old, and I bought it used from a fleet auction at half of Blue Book with 100K already on it. Still running great 50K miles later. I would rather eat beans and rice when things are tight than reduce my regular savings contributions to have steak instead.

    Having been really poor at times as an adult, I know cheap. :-) I want to retire while I'm young enough to enjoy it. If the government doesn't make that impossible.

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  39. Testing to see if I can still comment(settings at work).

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  40. Okay. Looks like I'm good. Anyway, here's a recent entry at Billy Blog on debt issuance, split in two to avoid character limits. Have at it, fellas.

    Question 3:

    The expansionary impact of deficit spending on aggregate demand is lower when the government matches the deficit with debt-issuance because then excess reserves are drained and the purchasing power is taken out of the monetary system.

    The answer is False.

    The mainstream macroeconomic textbooks all have a chapter on fiscal policy (and it is often written in the context of the so-called IS-LM model but not always).

    The chapters always introduces the so-called Government Budget Constraint that alleges that governments have to “finance” all spending either through taxation; debt-issuance; or money creation. The writer fails to understand that government spending is performed in the same way irrespective of the accompanying monetary operations.

    They claim that money creation (borrowing from central bank) is inflationary while the latter (private bond sales) is less so. These conclusions are based on their erroneous claim that “money creation” adds more to aggregate demand than bond sales, because the latter forces up interest rates which crowd out some private spending.

    All these claims are without foundation in a fiat monetary system and an understanding of the banking operations that occur when governments spend and issue debt helps to show why.

    So what would happen if a sovereign, currency-issuing government (with a flexible exchange rate) ran a budget deficit without issuing debt?

    Like all government spending, the Treasury would credit the reserve accounts held by the commercial bank at the central bank. The commercial bank in question would be where the target of the spending had an account. So the commercial bank’s assets rise and its liabilities also increase because a deposit would be made.

    The transactions are clear: The commercial bank’s assets rise and its liabilities also increase because a new deposit has been made. Further, the target of the fiscal initiative enjoys increased assets (bank deposit) and net worth (a liability/equity entry on their balance sheet). Taxation does the opposite and so a deficit (spending greater than taxation) means that reserves increase and private net worth increases.

    This means that there are likely to be excess reserves in the “cash system” which then raises issues for the central bank about its liquidity management. The aim of the central bank is to “hit” a target interest rate and so it has to ensure that competitive forces in the interbank market do not compromise that target.

    When there are excess reserves there is downward pressure on the overnight interest rate (as banks scurry to seek interest-earning opportunities), the central bank then has to sell government bonds to the banks to soak the excess up and maintain liquidity at a level consistent with the target. Some central banks offer a return on overnight reserves which reduces the need to sell debt as a liquidity management operation.

    There is no sense that these debt sales have anything to do with “financing” government net spending. The sales are a monetary operation aimed at interest-rate maintenance. So M1 (deposits in the non-government sector) rise as a result of the deficit without a corresponding increase in liabilities. It is this result that leads to the conclusion that that deficits increase net financial assets in the non-government sector.

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  41. Part 2:

    What would happen if there were bond sales? All that happens is that the banks reserves are reduced by the bond sales but this does not reduce the deposits created by the net spending. So net worth is not altered. What is changed is the composition of the asset portfolio held in the non-government sector.

    The only difference between the Treasury “borrowing from the central bank” and issuing debt to the private sector is that the central bank has to use different operations to pursue its policy interest rate target. If it debt is not issued to match the deficit then it has to either pay interest on excess reserves (which most central banks are doing now anyway) or let the target rate fall to zero (the Japan solution).

    There is no difference to the impact of the deficits on net worth in the non-government sector.

    Mainstream economists would say that by draining the reserves, the central bank has reduced the ability of banks to lend which then, via the money multiplier, expands the money supply.

    However, the reality is that:

    Building bank reserves does not increase the ability of the banks to lend.
    The money multiplier process so loved by the mainstream does not describe the way in which banks make loans.
    Inflation is caused by aggregate demand growing faster than real output capacity. The reserve position of the banks is not functionally related with that process.
    So the banks are able to create as much credit as they can find credit-worthy customers to hold irrespective of the operations that accompany government net spending.

    This doesn’t lead to the conclusion that deficits do not carry an inflation risk. All components of aggregate demand carry an inflation risk if they become excessive, which can only be defined in terms of the relation between spending and productive capacity.

    It is totally fallacious to think that private placement of debt reduces the inflation risk. It does not.

    You may wish to read the following blogs for more information:

    Why history matters
    Building bank reserves will not expand credit
    Building bank reserves is not inflationary
    The complacent students sit and listen to some of that
    Saturday Quiz – February 27, 2010 – answers and discussion

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  42. WHQ, as I said, I'm an empiricist. I'm not terribly interested in arguing or dissecting theory (especially by proxy) when there's no notable empirical support for it. Especially when there's not exactly a lot of ways to test it, or at least ones that aren't rather destructive. In the case of neo-chartalism versus monetarism, the available historical evidence is overwhelmingly on the side of the monetarists, yet IMHO their theory has holes in it too, particularly as involves the short-run effects of fluctuating money supply.

    As I've said above, the big problem with theory in this game is that it is mechanistic, and human economies are only partially mechanistic, namely within the bounds of available physical resources and applied technologies. The rest of econ is essentially mob pyschology, the applied study of what people actually do with physical resources and technology in varying situations. And people aren't at all neccessarily rational, they're rationalizing.

    So reading through the MMT theorizing above I am struck by the same thing that strikes me with much of econ theory, namely, that we are speaking of people trying to assign neat mechanistic modeling and even proclaim immutable physical laws applying to the imputed behavior of human-invented conceptual tools (money) on the basis of the theorist's preferred philosophical conceptions as to the meaning and conceptual foundations of same as if they were discussing the laws of physics, and IMHO that's a fool's game.

    Econ, particularly as it varies from the physical constraints imposed by/on physical resources, is not remotely physics. Theory is interesting, but at heart we are primarily concerned with how people actually perceive and treat money and the resources it represents, whether fiat or commodity money. And the way that money is perceived and treated is as if a monetary unit represents a proportional share of the national economy.

    Shorter version: Theory is much like theology, and as an agnostic and professional skeptic I'm not terribly interested in arguing or defending anyone's theology past the empirical evidence. MMT is interesting, but until the Shiny Idea produces measurable improvements in useful applications, that's all it is.

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  43. Apologies if I sound like I am piling on in a me-too way on top of what Tully said. He expresses impressions similar to mine. Though he understands way more than I do about economics.

    Across a much broader scope of thought. I am pretty familiar with various theories which suggest human systems could be optimized if only people would do this, believe that, have faith in the other. And my gut generally says that the "if only" might as well be fantasy.

    We might well be able to run the economy as billyblog suggests, complete with job guarantees and huge piles of government spending. If only we could get people to buy into the whole kit and kaboodle of his theory, of course. But these ideas are, in my opinion, so far away from being adjacent to current reality as to be impossible in an empirical sense.

    So I don't find MMT interesting enough to really dig into, because I don't see the theoretical component as especially useful without speaking to human nature and behavior, as Tully suggests. That happened to me alot when I reached graduate school, where, this or that theorist would in the very beginnings skip over big problems with human nature and the world as it is. I'd be on page 3 and think, "this guy is an idiot." And I admit this reflects poorly on me is some respects. But most sensible folks do reach a point where they become impatient with pie-in-the-sky optimization.

    My impression is that empiricists and skeptics and other folks with real-world experience prefer to narrowly channel their small reserves of optimism into ideas and approach which I recently heard someone refer to as "the adjacent possible." Something a little different yet similar enough to be believable, and hopefully a little bit of an improvement.

    Since this seems to be winding down, I'd like to thank both you guys for having a lengthy, civil, and insightful discussion ON A BLOG. Practically a miracle, eh? And I'd like to use one exchange from this thread as a jumping off point for another discussion, in the hope of duplicating this.

    What I'd like to talk about is something involving human nature in relation to risk. As a jumping point, I'll use the following bit from this thread, and open a new thread on it:

    ___
    If I weren't so personally debt-adverse and could be assured of my ongoing income, NOW would be the time to borrow at locked-in low fixed rates.

    I'm pretty debt-averse myself. The only debt I have is my mortgage, which I very recently refinanced to get the low fixed rate available. But I wouldn't go looking for new debt, either, regardless of the low rates. I'm just not built for that.
    _____

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  44. To extend: Why MMT is a heterodox minority position held by few.

    Take as a given that how money is perceived is crucial to how changes in money supply effect the economy, including inflation, etc. What is the key underlying assumption of neo-chartalism? That all fiat money comes from government, and has value only in relation to government.

    Now, money is perceived by people at large as representing shares of real resources in the economy, and that perception is based on the ability to readily exchange money for same. This is axiomatic to markets involving money,and is why I keep harping on the relation between money and real resources. (Money = Resources) So what is the implicit assumption underlying the prime assumption of neo-chartalism? That ALL resources that can be obtained with money belong to and/or are rightfully controlled by the government.

    Now, I said earlier that NC is wildly beloved by statists, and that's why. NC is about as inherently statist a view of property and money as one can hold. And it's inherently at conflict with the very concept of free markets and private property.

    This is also why there is a very real difference between simply issuing currency to garner resources for government and issuing debt. When the government simply issues currency for deficit spending, it is blatantly expropriating resources from everyone in the economy. (If it does this, then theoretically taxes aren't even really needed either ... I think you can see where that leads in terms of political philosophy.)

    But when the government issues debt, it acknowledges that it is using resources that it has not yet "earned" or gained possession of through taxation or conquest, resources that it promises to repay/replace in the future, hopefully through growth expanding tax base and revenues.

    In a closed economy, of course, the government just seizing whatever it wants means the people don't get it for their private use, and can only hope to retrieve some of that value through public goods provided by government. Call that theft or whatever, but it's once again incompatible with our conception of a free society. In an open economy, where external resources come into play, how likely are other nations (and non-citizens living outside the borders) to GIVE those resources to a government not their own with no assurance of future repayment? Other than, of course, at gunpoint?

    I think you this should be enough exposition to give you a hint at the problems underlying the implementation of NC/MMT in the real world, especially as regards foreign capital and a functioning market economy. Regardless of how nifty a theory, in application it runs into the universal perception of money being exchangable for real resources. Particularly in a society based on the ideas of individual liberty and private property.

    Even the old USSR used bonds for internal debt/spending. Of course, they stacked the deck so that people repaid that government debt through naked theft-by-inflation-and-scarcity, so that bonds tended to be used simply as perks for the apparatchiks as no one really wanted to buy them, but they still used them. (Communist China is just now coming around to the idea that internal bond financing might be useful -- I'm interested to see how that plays out.).

    For an idea of how well the NC/MMT theory plays out in international financing, one can check out the prices of bonds issued by staist countries, particularly those with a habit of nakedly inflating their currencies. It's not a pretty picture.

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  45. It has been interesting. I've never paid much attention to NC/MMT before, and it was interesting to dig around in it a bit. As a professional skeptic, I freely acknowledge that just because I can see flaws with the basic assumptions doesn't mean there aren't potential applications, and the theory itself seems internally consistent, rather than simply theological pronouncement. Back when I was still doing mostly corporate work, I shot down many investment opportunities because of what I saw as deadly structural flaws, only to see them actually work in practice because the investors/entrepeneus managed to find ways to avoid those pitfalls. But they did it despite the odds, not with them.

    For additional tap-dancing, watching both monetarists and neo-Keynesians build epicyclical models to explain why their theories seem to be really sloppy in short-term real-world response effects is also entertaining. Once again, those efforts are IMHO mainly atttempts to mathematically codify non-mechanistic human behavior into theoretically-based mechanistic modeling, which is always good for a chuckle. And it is just MHO after all. :-)

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  46. Thanks for entertaining my latest economic diversion, guys. I was thinking about gathering some more quotes, but I think this discussion has run its course, at least for now, and I don't want to push it too far. Maybe something will come up later on that will allow me to go back to it for a reason more compelling than "just 'cause I want to."

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