Facilitating dialogue to promote open and multi-faceted discussion and awareness

Some invoke it’s the best medicine. Cut it all off immediately. Cut the spending, cut the taxes, and stop fueling the flame of a severely over-leveraged economy. Others supplicate the world leaders not to cut spending just yet. The world economy is still incredibly fragile and to begin quantitative tightening would just send us back into an economic downward-spiral.  There are some valid points in both arguments. Indeed Chairman of the Fed, Ben Bernanke, conceded as much earlier this month; “the federal budget appears to be on an unsustainable path.” But how to approach the budget deficit, the recent reports of consumer confidence diminishing, yields on 10-yr Treasury notes falling below 3%, the Dow falling several percentage points over the past several days, and employment growth receding significantly last month seems to elude and divide even the world’s leading economists. To place this situation in a bad metaphor: Daddy’s out of work and we’ve been living on the credit card and blessed with pretty good credit….do we starve the children to get out of this debt, or do we plan for long-term weening off of the deficit bottle? Let’s look into the possibilities.

The Case for Immediate Fiscal Austerity

The world leaders have united, calling for tightening fiscal policy and getting debt under control. Of course there have been many alarmed politicians and economists with the U.S. debt  expected to rise to 67% of GDP (it has averaged about 36% of GDP over the past 40 years…) and, if conditions stay the same, up to 90% of GDP by 2020.  Carl Richards argues that the recession was a “credit-fueled” downturn, so to even try to stimulate to get the economy back to its pre-2008 levels would mean to simply over-leverage again. The Economist explains it this way: “The peak [debt], so far, was almost $2.6 trillion in July 2008. Household debt approached 100% of GDP in 2007, a level seen only once before, rather ominously in 1929.” Obviously, households have taken notice, cutting back debt by 1.7% in 2009, the greatest cut-back on record (since 1946). Consumer credit declined 4.3%, and even business debt has declined by 1.8%. Personal savings grew in incredible amounts during 2009 as well. But….total debt still grew overall by 3.3% as government helped fill in the gap. So, why is government trying to reaffirm debt levels that were significant causes of the economic crisis? Another point, elaborated upon by Alan Greenspan here, is that we are reaching our borrowing limits. 10 year swaps spreads- a hedge against fluctuating interest rates and a “sensitive proxy of Treasury borrowing capacity: a so-called canary in the coal mine” have fallen to an unprecedented negative 13 basis points. “An urgency to rein in budget deficits seems to be gaining some traction among American lawmakers. If so, it is none too soon,” Greenspan forewarns. And if the U.S. is serious about fiscal austerity, policy should be built around reigning in health care costs, an incredibly politically delicate subject to confront.

“Growth in spending on health-care programs remains the central fiscal challenge,” CBO Director Douglas W. Elmendorf said in a presentation to Obama’s bipartisan deficit commission. “In CBO’s judgment, the health-care legislation enacted earlier this year made a dent in the problem, but did not substantially diminish that challenge.”

According to deficit hawks, prepare for pain sooner than later, and then we’ll be on a sustainable path to economic health and recovery.

The Case for More Stimulus, and Plan for Fiscal Austerity in the Near Future

Right now some argue our debt is manageable….for the time being. As European markets suffer, investors are fleeing to safer U.S. Treasury securities, placing downward pressure on our long term interest rates and fueling our capability to spend in the interim. Also, inflation expectations seem suppressed. As a matter of fact, “Atlanta Federal Reserve President Dennis Lockhart Wednesday warned the recovery remains so weak that deflation–or a dangerous generalized drop in price levels–is a risk that warrants watching.” The Fed has continued to keep interest rates pressed on the zero-bound (theoretically, the Fed should be targeting a negative rate), leaving little space for much more monetary action, contrary to what Tyler Cowen would suggest. Congress just barely passed legislation offering more help to the unemployed while payrolls continue to increase (meaning the employed are working more hours for higher wages, but businesses are not yet willing to commit to new hires or looking for more skilled workers…) and the unemployment rate is still brushing up against the 10% mark. Also, fears of towering debt seem to be exaggerated, in the short-term it looks rough, but over the long-term, to decline significantly to manageable levels.

Obviously, worldwide demand just seems too weak to push for simultaneous global austerity programs without sending us all back into another recession. Long term fiscal austerity plans are incredibly important, but right now some see grounds for greater stimulus spending, even though some argue against the evidence that the previous $787 billion stimulus plan didn’t work.

At the moment it seems like the world is leaning towards fiscal austerity, and maybe rightfully so. This may reset the market and place it on a path not fueled by debt but rather by healthy consumption. But then again, maybe not. John Maynard Keynes boldly stated, “in the long run, we are all dead;” maybe this is justification for short-term stimulus. Either way, something must be done. To fall back into another vicious and endless cycle of recession, or to reaffirm a market dependent on deficit spending are not sustainable or valid outcomes.

I got a real-life example of a fundamental idea in the study of economics a few months ago I’d like to share with you today:

It was finals week and I was sick. Now, I’m a pretty healthy guy (although since getting married this past summer I’ve probably accrued a little more mass then normal…), but this was deathly ill. My esophagus was on fire, my lungs felt like there were hands squeezing them inside of my chest, and it’s about the point of near death or coma that I tend to decide, “Yep, maybe I should go to the doctor…..” There’s a Walk-In Clinic on the south-side of town that everyone from my school goes to, so I assume this guy must really like college students, or at least he’s been pretty successful in my demographic. So I walk in about 9:27 AM adorned with the typical sick garb (blazoning sweat pants and puppy-dog sad face). I wield my insurance card, implementing the dual “I need a doctor”/bellowing cough trick to express the gravity of the situation. “Fill this out with your information and we’ll be right with you.” Blast. So I sit and scan through a Healthy Living mag till I’m finally called in. The nurse takes my weight, blood pressure, height, barometric pressure, and gravitational pull on the earth… and then tells me to wait in the room two doors down the hall on the left.

There isn’t much going on in this room. There’s the cotton balls, the ear-temperature thingy hanging on the wall, the bed with crinkly paper, it’s all there. A poster displaying the skeletal structure of the human left foot hangs on the wall to my right, and in front of me is a blue poster of XYZ Nasal Spray explaining it’s miracle effects on the sinus system. After my first impressions ease my sub-conscious fear of evil, scalpel-happy doctors, I notice the sound of the doctor walking down the hall towards my room. And it’s here where it gets interesting.

He walks in and with an Indian accent he hurriedly offers a greeting and proceeds with the poking, prodding, and analyzing. It literally took about 3 minutes and he came to his diagnosis. “Respiratory infection. Take 3 Ibuprofen every 4 hours, pick up these antibiotics, here’s a $20 off coupon for this XYZ Nasal Spray you’ll need, and hydrate yourself….”. And with that he walked out. I payed the $60 bill for a meeting that took less then 5 minutes (do the math, that’s $720 an hour, and that was with a health insurance discount!). Regardless, I just wanted to get out, get drugs, and get better. I rushed to the pharmacy to get my drugs.

More waiting in line….

Finally, I’m at the register in the pharmacy, and I pull out my prescription and my credit card, and my student i.d. accidentally falls out. The amicable pharmacist noticed the card, and went on to tell me a story about her experiences when she got sick and she was at college; all the while her fingers flying at 80 mph on the computer without hesitation. “Impressive,” I thought, “but lady, please, I’m losing this fight and I need your wonderful medicine!”

It was at this point she did a double take between the prescription, the computer, me, and back again. “I know your in school, and money’s probably tight, so I’m going to let you in on a little secret. This XYZ Nasal Spray you’ve been prescribed is pretty much useless. It doesn’t really kick in till almost two weeks after it’s administered, and you will surely be feeling better by then. Also, WITHOUT this XYZ Nasal Spray your bill comes out to about $23, WITH this XYZ Nasal Spray your bill comes out to about $150, even with this joke $20 coupon.”

WOW. I left with a $23 bill and a sick feeling like I’d almost been jipped. All the talks I’d heard about the sanctity of the doctor/patient relationship kind of gave way to a simple doctor/profit-from-sponsor-drugs kind of a relationship.

What did the doctor have that I didn’t in this situation? What did the pharmacist give me that really helped me out in this situation? Information. The economics of information is a fundamental facet in the study of economics. In Economics 101 we learn that in a nominal world, information is “perfect”. Information creates an optimal condition for decision-making, therefore increasing the utility (benefit) gained from a mutual transaction for both parties. When one party in a transaction holds more information then the opposite side of the transaction, it’s known as information asymmetry, which creates an uneven balance of power in the transaction process. In the situation above, both the doctor and the pharmacist had more information on the usefulness of XYZ Nasal Spray then I did. The doctor did not share this information, leading me to believe that in order to attain the utility I was seeking (feeling better) I needed this medicine. The pharmacist was willing to share the information with me, letting me know that this medicine was of no good for my situation.

Granted, information is exponentially more accessible now then even a few decades ago. A brilliant invention, the internet, has created a mind-blowing cyber-library with information on nearly every single topic one can imagine. But even then, in the midst of a transaction, one may be limited to the information at hand while the other may have all the information to maximize his/her utility (this would be a great business venture, maybe a mobile phone application that details the benefits of medicines prescribed or the ratings of a certain doctors office, both options granting access to information). We recognize that in the Real Economy, information is not always perfect nor absolutely revealed in a transaction, hence often creating micro-distortions in the hundreds of millions of organic transactions taking place everyday. And theoretically, these micro-distortions can cause incredible distortions on prices of medical care (pretty hot topic nowadays…).

Also, when one finds out that the other side of a transaction is working and benefiting from information asymmetry, it breaches the trust of a transaction. Trust is another fundamental moral principle foundational to the workings of a free market society. Honesty and the punishment of both coercion and fraud. This experience has birthed in me an unhealthy (or maybe healthy) suspicion of the industry of medical care and doctors visits. It’s those kinds of feelings and experiences that drive societies to place regulations on industries in order to maintain “open-air” in transaction environments, a reactionary effect that may further manipulate the market, price levels, and perpetuate the distrust of business and industry.

We see from above that information is vital and beneficial to economies. Information asymmetry only builds distrust and more power for one side of a transaction, where as free and open information precedes a mutually beneficial transaction. Hopefully that doctor will learn one day, and if not maybe the amicable pharmacist will continue to help poor college students like me that may find themselves sick in the middle of finals week. Regardless, information in transactions is vital for success in the Real Economy.