Tag: debt

What I believe

I am a classical liberal fusionist. The following brief outline will hopefully explain what that means followed by a brief summary of where Trump stands relative to my beliefs of what is good for America.

I want to be free to make my own decisions about my life and for you to be similarly free as well. As we live together with 8.3 billion others, we must have understandings/rules/laws guiding our interactions if we are to live peacefully with each other. An efficient government limited to those purposes is essential. As a classical liberal I strongly support the limited, enumerated powers and structure (checks and balances) of government provided by the American constitution. Our constitution provides that our government will have limited powers sufficient to protect us from foreign and domestic threats of corruption, fraud and attack, secure our property rights, adjudicate disputes, provide public goods (e.g. roads, pollution regulations) and establish the rules (guardrails) for private enterprise. Our constitution specifically prohibits our government from infringing upon our freedom of speech, assembly, or religion.

Such limited government powers would leave use with substantial freedom to choose our own way of life. The quality of our lives will depend importantly on how wisely we use that freedom. While it would be ideal for those in need of help to receive it from family and friends and from private charities established for that purpose, I believe that the private provision of charity on any large scale has been so displaced by government welfare that I accept the government’s role in providing a social safety. But the current mix of programs restrict our freedoms and are inefficient. I propose a Universal Basic Income as the most efficient approach and the most consistent with individual freedom. https://wcoats.blog/2020/08/20/replacing-social-security-with-a-universal-basic-income/

America has flourished because the substantial freedom our government leaves us is generally used well. The vast majority of us use our freedom in ways that respect the freedoms of others. The three monotheistic religions—Christianity, Judaism and Islam (and no doubt others as well)—provide important guidance for virtuous behavior. These include honesty, charity, love, prudence, justice, fortitude, temperance, humility, forgiveness, etc. Virtue is the other leg of Fusionism, which is explored in the wonderful new book by Stephanie Slade: Fusionism: Liberty, Virtue, and the Future of the American Right.

While respecting the freedoms of others, I may choose (within my abilities) how I make my living, whom to buy from and sell to (free trade), and how to spend my free time and with whom. Much of our relationships with others will reflect the locally accepted norms of good behavior. This extends far beyond driving on the same side of the road. Some of these norms have been codified into laws, which we expect to be applied equally to all of us. Some are the norms of courteous behavior (good manners). Thus, freedom and rights have fostered the entrepreneurship that has made the U.S. the economic envy of the world.

But today, with the internet and jet planes, our world extends far beyond our own communities. Engaging with as much of the world as possible peacefully has benefits. It can enhance our safety by making agreements with other governments that reduce the occurrences of war. It can add joy to our lives by exposing us to the many wonder of other cultures and geographies. It has enormously lifted the average standard of living because of the extension of the benefits of specialization made possible by trade. Global average per capital real income has risen 13 to 15 times (1,200 to 1,400%) over the last two centuries. This after many, many centuries of virtually no change.      

But what is required to travel to or trade with other countries? How can our planes fly over and safely land in other countries? How do we prevent the signals from other countries’ satellites from interfering with the internet and other signals from our own as they fly over? Just as our Federal government can establish laws to protect our safety, liberties and property across state lines that benefit us all, they need to do so across country borders.  https://wcoats.blog/2020/12/01/the-rule-of-law-china-and-the-u-s/ Without such agreements we would not be free to trade and travel nearly as widely as now. https://wcoats.blog/2017/01/06/the-liberal-international-order/

We have failed to live up to these standards on many occasions, but they are the north star to which we strive. Or at least until now. On July 23, 2019, speaking to a Turning Point USA audience (and on other occasions as well) President Trump said: “I have an Article II, where I have the right to do whatever I want as president.” With that he threatened to throw away the limits on the power of our government and the checks and balances on its exercise. Some of his policies have been consistent with the principals I believe in, but many have not.

The Economy: The government’s limited role of protecting property rights and promoting business transparency has unleashed the entrepreneurial energies that have led to our country’s flourishing. Like President Biden before him, Trump thinks his ideas of where to put our resources are often better than the market’s—thus projecting government activities beyond its proper functions. He was right, however, to think that many government agencies and their regulations were more burdensome than helpful to the private sector. A review and streamlining of the government’s oversight of the economy would be a good idea. Unfortunately the Department of Government Efficiency (DOGE) led by Elon Musk was a crude hatchet job that did more harm than good.  https://wcoats.blog/2020/11/04/saving-the-american-dream/

Immigrants: America would not exist without immigrants. https://wcoats.blog/2026/07/06/immigrants-2/ Currently they are important to provide the younger workers needed to pay the expenses (e.g. Social Security benefits) of our growing number of longer-living retirees. Rather than allowing more legal immigrants, Trump has reduced the number and promised to deport those here illegally. https://wcoats.blog/2026/02/08/immigrants/ . While I support efforts to prevent illegal immigration, Trump’s quickly recruited and improperly trained ICE agents have murdered innocent Americans and deported American citizens, along with illegal immigrants, without due process and in violation of court orders. The rule of law be damned. https://wcoats.blog/2025/08/29/immigration/

Free Speech: Our constitution specifically protects free speech for a good reason: https://wcoats.blog/2012/09/15/further-thoughts-on-free-speech/ It helps build public consensus and support for good public policies.

Trump goes ballistic when criticized and misuses executive power to punish critics. These have included suing critics, threating the licenses of their employers, etc. https://wcoats.blog/2026/08/21/our-first-amendment-freedom-of-speech/

“ABC late-night comedian Jimmy Kimmel said an interview he conducted with Texas Democratic Senate nominee James Talarico will not air on broadcast because of what he called threats issued to his network by President Trump’s Federal Communications Commission.” The Hill 9/10/2026

Our constitution provides checks and balances on the powers of government in an effort to prevent (or minimize) the overreaching of government. Donald Trump took major actions against agency inspectors general across both of his presidential terms: Between April and May 2020, he removed or replaced five agencies’ inspectors general in a series of late-Friday decisions: just days into his second term, he dismissed seventeen independent inspectors general at once across cabinet departments—including Defense, State, Transportation, Labor, and Energy. Subsequent individual firings followed throughout early 2025 (such as the USAID IG in February 2025).

The nonpartisan inspectors general review agency programs, financial statements, and operations, recommend changes to make government operations more economical and effective, manage hotlines and intake processes for employees to report wrongdoing safely, and report their findings to the heads of the agencies they monitor and to Congress. In September 2025, a federal judge ruled that the mass January 2025 firings violated federal law because the administration failed to provide the mandatory 30-day notice and substantive rationale to Congress, though the court did not order their reinstatement.

At least 20 high-ranking generals, admirals, and civilian defense leaders have been directly fired or pushed out of their roles by Defense Secretary Pete Hegseth and President Trump. When including behind-the-scenes actions—such as blocking promotion rosters, cancelling appointments, and forcing early retirements—over 80 generals and admirals have had their careers altered, blocked, or cut short as part of a sweeping restructuring aimed at downsizing senior military leadership and reshaping the Pentagon. According to my military friends, those removed were generally the best of the lot. Not bowing to Hegseth’s silly games proved fatal. Where might this be going?

Trade: The Trump administration has stifled the free market allocation of resources to the detriment of our growth in several ways. He has complained about offshoring manufacturing resulting in our trade deficits (which by the way help finance the government’s fiscal deficits thus keeping interest rates on government bonds lower than otherwise). In fact, however, manufacturing output in the US is greater than it has ever been. Domestic employment in manufacturing, however, has fallen because of increased labor productivity.

Trump claims that high tariffs are needed to reduce our trade deficit. But he has not imposed them in ways sanctioned by the World Trade Organization, i.e., to improve competitiveness with a level playing field. His tariffs often seem weapons to get countries to agree to other totally unrelated goals. Trump’s bullying has cost the U.S. more than trade. Often his threats require that foreign companies building plants in the US give shares to the Federal government. The US government now owns shares in some 40 or so such companies (https://wcoats.blog/2026/08/10/econ-101-capitalism-and-socialism/ ). And the courts have struck down some of his tariffs. https://wcoats.blog/2024/11/26/tariffs/

Wars and foreign policy:  During his Presidential campaign, Trump promised to end our forever wars. Then, with Israel, he ordered an invasion of Iran. One reason seemed to be to stop Iran from developing atomic bombs (correcting Trump’s first term error of withdrawing from the Joint Comprehensive Plan of Action with Iran which prevented such a development). https://wcoats.blog/2026/04/02/iran-and-the-bomb/. “Trump’s threats against countries trading with Iran expose the limits of US economic power, as allies resist Washington’s demands and the global economy moves towards a less American-dominated order.” “Trump is hastening the decline of American power,” by Joseph E. Stiglitz 9/12/2026. https://johnmenadue.com/post/2026/09/trump-is-hastening-the-decline-of-american-power/

Trump’s continue support of Israel’s ethnic cleansing of Gaza and increasingly the West Bank has further isolated the US, which stands alone with Israel in the UN in defense of these humanitarian atrocities. https://wcoats.blog/2026/03/31/fixing-palestine/

I agree with Trump’s insistence that others (in particular NATO members) pay their share of the cost of the defense they get with American help. But insulting our allis, often with tariff increases or threats, is not in America’s interest, nor in compliance with WTO rules.

In The New York Times (9/10/2026), Tom Friedman proclaimed that: “Trump is the most un-American president in my lifetime. No president has done more, and continues to do more, to unravel the post-World War II institutions and alliances that were built and sustained by his predecessors. We are talking about… our intimate relationships with Canada and Mexico and our military alliances with South Korea and Japan — to name but a few. These relationships and institutions together produced global and American prosperity and great power peace for generations….”

During his presidential terms, Donald Trump initiated U.S. withdrawals from or ceased participation in a wide range of prominent international treaties, agreements, and bodies:

  • Paris Climate Agreement: Withdrawn during his first term and formally pulled out of a second time in January 2025.
  • Iran Nuclear Deal (JCPOA): The U.S. withdrew in May 2018.
  • Trans-Pacific Partnership (TPP): Withdrawn via executive order in January 2017.
  • UN Framework Convention on Climate Change (UNFCCC): Trump ordered the U.S. withdrawal from the founding 1992 climate treaty.
  • Intermediate-Range Nuclear Forces (INF) Treaty: The U.S. exited this Cold War-era arms control treaty with Russia in August 2019.
  • Open Skies Treaty: Withdrawn in November 2020.
  • World Health Organization (WHO): Initiated withdrawal in 2020 and executed withdrawal actions again during his second term.
  • UN Human Rights Council (UNHRC) & UNESCO: Withdrawn during his first presidency.
  • Global Compact for Migration: Withdrawn in December 2017.

Standing alone we are much weaker than when standing together with friends.

Interest rates: While Trump’s threats to the Federal Reserve to lower interest rates reflects a complete misunderstanding of the forces in play and the Trump administration’s perverse impact on them, I have confidence in the integrity of Kevin Warsh and expect the Fed to raise its policy rate next week in keeping with its commitment to lower inflation to 2%. https://wcoats.blog/2026/08/29/inflation/

Corruption: Trump’s wealth increased $3 to $4 billion dollars during his second term so far. Corruption? No comment. “Trump has pledged a $5,000 dividend to every American adult if Republicans retain control of Congress in November’s midterm elections, prompting questions about how the benefit would work, whether it is legal and where the funds would come from.” Washington Post 9/10/2026. Amazingly Trump publicly proclaims this bribery.

The Washington Post reported on 9/12/2026:

“Democrats hope to retake control of the House, and to use that power to probe Trump’s business ventures, legal maneuvers and policies…. ‘There’s so much corruption and grift that it’s going to take the entire House on the Democratic side to do investigations appropriately,’ Rep. Robert Garcia (D-California), who would probably lead investigations as chair the Oversight Committee in a Democratic-held House….

“Trump family enrichment…

“Handouts to supporters…

“Construction projects…

“Immigration enforcement…

“Prosecutions of Trump’s political enemies…

“Institutional pressure campaigns.”

https://www.washingtonpost.com/politics/2026/09/12/house-democrats-plan-sweeping-trump-investigations-if-they-win-november

It goes without saying that Trump does not support many of the US Constitution based principles I support. If I am right, as I am sure I am, that adhering to the principles of our Constitution is an important part of the foundation of our flourishing, Trump’s abuses of those principles will have the opposite effect. His disregard for the rule of law, his expansion of the powers of government to coerce us, and his disregard and flaunting international agreements and relationships will turn the US into a society of uncertain rights heading in uncertain directions depending on who is leading it at the time.

To give Tom Friedman the last word from his NYT article sited above:

“A year ago, I heard one of our former presidents privately observe that we can survive Trump’s second term as long as our institutions remain intact. Well, unfortunately, they have not. Who would argue today that the Justice Department, which has been turned into a personal legal weapon of the president, is intact, that the Department of Health and Human Services is intact, that the Pentagon is intact, that the Centers for Disease Control and Prevention is intact or that the Federal Communications Commission, which is now run by a Trump-appointed hack who acts as combined government censor and minister of propaganda, is intact?”

Foreign Students

The Trump administration finalized a major rule to tighten student visas by ending the “duration of status” policy and imposing a fixed four-year maximum admission cap. https://www.dhs.gov/news/2026/07/16/trump-administration-issues-final-rule-end-foreign-student-visa-abuse   Why? Foreign students benefit the U.S. in a number of ways and we should seek to increase their number.

First: hosting foreign students is an export, it pays foreign money into the U.S. via tuition, room and board and other purchases these students make in the U.S.. The inflow of foreign exchange helps provide us with the means for paying for what we import from abroad. https://wcoats.blog/2025/11/04/trade/

Second: Foreign students gain firsthand experience of life in the U.S., often making lifelong friends. They take this knowledge home improving American relations with other countries. American student benefit from meeting and befriending the foreign students, thus broadening their knowledge of other cultures.

Third: When foreign students decide to remain in the U.S. we benefit from their knowledge and expertise increasing American income and wealth.

According to annual economic impact data calculated by NAFSA: Association of International Educators, foreign students spent and contributed $43.8 billion and supported approximately 378,000 jobs in the U.S. in the 2023–2024 Academic Year. This fell 2% during the next year, which was the first year of the current Trump administration.

We would do much better to deport Stephen Miller.

Econ 101: Interest Rates –Another Go

A month ago I reviewed the role of the Federal Reserve’s policy interest rate: https://wcoats.blog/2025/07/17/the-feds-policy-interest-rate/   The subject is so important and seemingly misunderstand by many that I am reviewing it again here.

Interest rates balance the supply and demand for financial assets. Households and firms that save some of their incomes demand financial assets. Households and firms that borrow to invest in productive capital or for whatever reason supply those assets (mortgages, bonds, etc.). Rates on longer term assets reflect the expected value of the short-term rates over that period. Thus the interest rate on a ten year bond reflects the expected value of one year bills over the ten year period plus a small risk premium because the string of short term loans are an alternative to the single fixed rate ten year loan.

The policy interest rate of the Federal Reserve is set by the Fed to pursue its objective of stable money (defined by the Fed as 2% inflation) and high employment (the Fed’s dual mandate imposed by Congress).

This note reviews the Fed’s policy rate. Since 2008 the Fed’s policy rate has been the rate it pays banks for the money they keep on deposit with a Federal Reserve Bank (of which there are twelve but that is unimportant for understanding the role of the policy rate), which on Aug 6 amounted to $3,332 billion. This rate is known as the Interest on Reserve Balances (IORB).

If the IORB matches comparable market rates for equally liquid funds (the so-called neutral rate), banks will maintain their existing Fed deposits. If it is set above that level, banks will have a financial incentive to place more money with the Fed, i.e. lend less in the market, thus creating fewer deposits and reducing the money supply. If the IORB is set lower than the neutral rate, banks will draw down their Fed deposits to lend more in the market thus increasing deposits and the money supply.

The IORB is currently (Aug 6) 4.5%, where it has remained since Dec 2024. At this rate broad money (M2=bank demand, time and savings deposits) has grown between 4% and 5% (from a year earlier) over the last three months. Given that inflation remains above the Fed’s target of 2% it would not seem wise to lower the policy rate and increase the rate of monetary growth especially as higher tariffs go into effect.

To repeat from earlier blogs (because it is so important), if markets anticipate higher inflation in the future (next few years), market interest rates on longer term debt will increase to preserve their real (inflation adjusted) value. Lowering the Fed’s policy rate prematurely would increase the market’s anticipation of higher inflation rates in the future. In other word, lowering the IORB now is likely to increase interest rates on longer term debt. Leave the Fed alone to do its job as best it can.

Econ 101: Trade deficits

A trade deficit is the difference between what we buy from the rest of the world and what it buys from us. To that extent rather than buying our goods and services, the rest of the world holds our dollars. These dollars are most often held in the form of US securities (Treasury bonds, etc.). Though trade deficits help finance Uncle Sam’s spending that is not financed with tax revenue, and thus reduce the crowding out of domestic investment by government deficit spending, President Trump doesn’t like them. Our trade deficit in 2024 was $918 billion.

Trade deficits can be reduced by reducing our imports (this is what tariffs tend to do) and/or by increasing our exports. We export many things including food and oil. Tourism and foreign students studying in the US generate about 9% of our export revenue. This has dropped sharply this year as the Trump administration has blocked or discouraged foreign students and badly treated other visitors, denying entry to some. It has suspended entry of new foreign students to Harvard and is threatening to revoke existing student visas at Harvard.

Trump has not only reached into the affairs of Harvard (and those of many other “enemies”), he is also demanding that the US dollar surpluses held by our trading partners be invested as dictated by the Trump administration. This was stated explicitly by US Treasury Secretary Bessent in an interview by Larry Kudlow on Fox Business. https://www.youtube.com/watch?v=IgcmRJpE1pc  

It is hard to see much free market here. Gregg Ip nails it in his recent WSJ article “The U.S. Marches Toward State Capitalism With American Characteristics”  https://x.com/greg_ip?lang=en

Econ 101: Government Budgets

Newspapers are full of articles about the deaths or other losses that will result from proposed budget cuts. Today’s Washington Post, for example, headlined a story on USAID cuts “USAID cuts may cause 14 million more deaths in next five years, study says”  “Washington post /2025/07/01/”

If the government’s spending on X is reduced (aside from any improvement in efficiency) the benefits of that spending will be lost. But our resources are limited. If we spend more on X we have less to spend on Y.  So when we lament the losses from reduced spending on X we should take account of the gain from the increased spending on other things.

To put a bit of flesh on this issue, consider the following: “The administration has cut more than a hundred contracts and grants from the President’s Emergency Plan for AIDS Relief, the HIV and AIDS program credited with saving millions of lives in poor countries. President Donald Trump has shut down the agency that signed off on most PEPFAR spending and fired other staffers who supported it.”  “Rubio-pepfar-aids”

Evaluating whether this cut is “good or bad” is not easy because determining the likely alternative use of the money saved is not easy. If we stick to a fixed government budget total, the alternative use by the government of the money saved might save even more lives (or maybe not). But the saving could also be given to tax payers whose use of that money would reflect their own personal needs and priorities.  

The process used by Elon Musk’s DOGE to arrive at the spending and/or personnel cuts they proposed was not transparent thus is largely unknown to us. But I have serious doubts that it was appropriate. Semafor offers the following advice:

“A lot of US government work is highly inefficient, says the science reformer Stuart Buck. Federally funded scientists say they spend 44% of their research time on bureaucracy, federal procurement is “broken” and often results in the government buying products that don’t work, and “the Paperwork Reduction Act paradoxically results in endless paperwork.” “Many such cases,” says Buck. “We should have an official effort to address these issues… We could even call it a ‘Department of Government Efficiency.’” As you might be aware, there is one: It is “widely viewed as a failure,” but the basic idea is sound. How could we make it good?

“The first step, says Buck, would be taking a long time to deeply understand how each government agency works, so you don’t mistake routine human error or some statistical artifact for fraud. Second, it should focus on high-value reforms, like outdated data systems or software. Third, it should learn from previous attempts to cut red tape — because there have been many, not all of which worked. And importantly, a good DOGE would not mistake things we don’t use for “waste” — like an insurance policy, we hope pandemic preparedness infrastructure and fire departments are never used, but they’re in place in case we need them. The real-world DOGE is a failure, says Buck, because it ignored all of these strictures.”  “Semafor.com/newsletter/06/30/2025/”

I think some, if not many, government programs or activities should be reformed or eliminated. But those the public really want must be paid for by the public paying additional taxes or lending to the government (buying US bonds). U.S. debt is dangerously high (123% of US GDP) and continuing to grow.  So to the extend spending is not reduced, taxes should be raised.   

The latest on Social Security Benefits

If no changes are made to the Social Security law: “Starting in 2034… Social Security will only have enough money to pay 79% of its promised benefits.” “Day of reckoning for Social Security draws closer”  The system promises a given pension upon retirement (a defined benefit) that is financed by a given payroll tax. It is not a pool of saving that is drown down at retirement. It is pay as you go. “Saving Social Security”.

This financial problem results from the fact that Americans are living longer and thus receive their SS pension for more years if there is no change in the retirement age. Moreover, the growth in the population has slowed so that the ratio of workers (i.e. those paying the tax financing the pensions of the retired) to retirees has fallen from approximately 3.3 in 1970 to 2.9 in 2020. It is projected to fall further to 2.0 by 2030.

The system must and will change, the only question is how. Legal immigration could be increased to increase the number of workers. The wage tax could be increased. Retirement age could be increased (20% voluntarily work after retirement already). As people live longer many choose to work longer for more than just the extra income. Pension benefits could be indexed to inflation rather than to wage growth (which has been greater than inflation). But more recently I have proposed replacing Social Security and other safety net programs with a Universal Basic Income for every man, woman and child without exception. Such a remake of our social safety net would have several very good features. “Replacing Social Security with a Universal Basic Income”

Immigration and smuggling

America has a labor shortage. We need to widen the door to legal immigration and patrol our borders against illegal immigration and drug smuggling more effectively. The Biden administration has requested several billion dollars for that purpose and Congress should approve it. But how should it be paid for. “Congress funding of border control”

Every person and every country’s resources are limited. Their use for one thing means that they are not available to be used for something else. Budgets reflect our choices—our priorities. Increasing our border security would save tens of thousands of lives a year from reduced drug smuggling alone.

I suggest that we close our military bases in Europe and apply the money saved to increased border security and deficit reduction (sadly it would not be enough to reduce our debt only the deficit –i.e., the annual increase in debt). Our European bases cost $24.4 billion in 2018 (the latest figure I could find and with our support for the war in Ukraine it could only have increased). Our EU basses save no lives and add nothing to our security. They largely reduce the incentive for EU countries to provide for their own defense. But our immigration policy and border controls are a mess and should be improved.

The Debt Deal

CNN reported today on the compromise bill to raise the Federal debt ceiling agreed between Biden and McCarty, saying that:” The Congressional Budget Office estimates the bill would reduce budget deficits by $1.5 trillion over the next 10 years, and reduce discretionary spending by a projected $1.3 trillion from 2024 to 2033.”

Language can be tricky. Debt and deficit are not the same.  Reducing projected spending need not mean a reduction in actual spending. In fact, the package agree to by Biden and McCarthy will continue to increase the Federal debt (though at a slower rate than was proposed initially by Biden) and all categories of spending will continue to grow.  Not only will they continue to grow, they will be growing from the abnormally high levels reached during the COVID pandemic.

If we really want all of these expenditures, we should, and will ultimately need to, raise taxes to pay for them.  But do all of them pass the cost benefit test? Do all of them contribute to American wellbeing?

One Republican blind spot is defense spending (which, by the way does not include foreign aid to, for example, Ukraine). The defense budget for 2023 is 9.8% higher than in 2022 and is projected in the Biden/McCarthy package to continue to grow over the next two years covered by that deal. Our huge defense budget has resulted from (or encouraged?) American military adventurism that does not contribute to our security.

Econ 101: SVB and bank runs

What is a bank run and how can we prevent them? A bank run, as I am sure you all know, is a rush by depositors to withdraw their deposits for fear that the bank will not have the money to give them. But there is a lot to unpack there in order to understand what is going on and how runs might be prevented.

It is important to understand the difference between debt and equity—between lending a specific amount of money with specific terms and investing an amount of money in exchange for a share of the earnings (or losses) of the recipient. When you buy shares in a company, it has no obligation to return your money. If you no longer want to invest in that company, you can sell your shares to someone else or the company might, at its discretion, buy them back. Its failure to “return” your money cannot be the cause of a company’s bankruptcy (take over by creditors to collect what the company is no longer able to return).

The deposits that we make in our banks are a special case of debt finance of whatever the banks do with our money. As we know, they lend much of it to people and companies for one thing or another and invest some in hopefully safe assets like Treasury bills and keep a tiny bit on hand for when you need cash. But the deposit contract says that you have the right to withdraw (or pay to someone else) any or all of it whenever you want to. Thus, banks must keep sufficient liquid assets in order to satisfy such withdrawals by selling them in the market when you demand your money back. The Federal Reserve, our lender of last resort, also has facilities for lending to banks needing cash against the collateral of bank assets.

The difference between illiquidity and insolvency is critical as well. A bank is solvent when the value of its assets match or exceed the value of its liabilities (such as your deposits). But having sufficient good assets doesn’t mean that that bank can always honor your deposit withdrawal demand. That is a question of liquidity. Does the bank have enough of its assets backing your deposit in forms that it can pay out immediately (cash in its vault, deposits at the Federal Reserve that it can transfer to another bank or use to buy cash, or assets it can quickly sell such as t-bills, or credit lines with other banks or the Fed, etc.)?  “The difference between bank liquidity and capital” Thus, even a solvent bank (positive capital) might fail to honor your withdrawal demand if it doesn’t have sufficient liquid assets. “The big bailout-what next?”

Usually, a bank becomes insolvent when more of its loan assets default than the bank has capital to cover such losses. But as we will see in the case of Silicon Valley Bank, insolvency can also result from a decline in the current market value of a “good” asset.  When depositors suspect that their bank might be insolvent, they will withdraw their money while they still can. This tends to use up the bank’s liquid assets compounding the risk of default. As the word spreads the classical bank run takes off (electronically these days rather than long lines outside the bank as in the old days).

The SVB, which specialized in financial services to start-ups and technology companies, enjoyed a huge increase in its deposits over the last four years, increasing from $49 billion in 2018 to $189.2 billion in 2021 dropping back to $175.4 billion at the end of 2022. It invested most of those deposits in “safe” long term government and similar debt. While the default risk for these assets was negligible, the risk of a loss in current market value if market interest rates increased was high. No one will pay the face value of a 3% ten-year bond while current market rates for the same maturity are 4%. The rapid increase in interest rates as the Federal Reserve reversed money growth to fight inflation tanked the current market value of a large share of SVB’s assets making it impossible for it to come up with the cash depositors might demand if they “ran”. That is how runs work. On March 10 SVB was put into receivership.

The original sin of modern banking is financing long term loans/investments with money (demand and savings deposits). Islamic banking, what uses equity investing, is wiser in this regard. During the Savings and Loan crisis in the U.S. in the 1980s and early 90s (financing mortgages with deposits) more than 1000 S&Ls failed when interest rates increased. But in fact, the U.S. bank regulation regime has some good features. While bank risk taking is subject to many, often costly, regulations, the ultimate check on risk taking comes from the knowledge of bank owners that they will lose their entire stake if their bank becomes insolvent. The Federal Deposit Insurance Corporation (FDIC), which oversees America’s deposit insurance scheme, has developed effective bank bankruptcy and resolution procedures that allow it to take over and resolve insolvent banks with barely a ripple. A favorite tool is the so-called purchase and assumption transaction by which a healthy bank buys the assess of the insolvent one and assumes its liabilities (deposits), usually over a weekend. Thousands of insolvent banks have been resolved by the FDIC in the last fifty years.  See “Institutional and Legal Impediments to Efficient Insolvent Bank Resolution and Ways to Overcome Them” by Warren Coats and Arno Liuksilo “Warren Coats-17”

Most bank depositors pay no attention to the financial condition of their bank because their deposits are insured against losses, which until last week had been raised to $250,000. But the government has now implicitly extended such insurance to all deposits via accounting and other tricks, thus removing any remaining check on bank risk taking from all depositors. On Monday, President Biden announced that no depositors in SVB (and Signature Bank of New York) would lose any of their deposits.  Following the banking crisis of 2008, the Dodd-Frank law further strengthened financial sector regulations. The most important and helpful provisions of this 2,300 page law provided for significant increases and strengthening of bank capital requirements.  

The overuse of debt rather than equity financing is a more general weakness in our economy. The IRS should stop subsidizing it. Interest on borrowing is deductible from taxable income while dividends on equity financing are not. While increasing bank capital makes them less run prone, a simpler and easer to regulate approach is to remove the cause of runs all together by eliminating any risk that your bank can’t honor its obligation to return your money on demand. Another few thousand pages of laws and regulations might catch the last mistakes (though it is hard to see why regulators didn’t address the obvious duration risks taken by SVB), but there is an easier, less costly solution. Bank failures result from the mistakes of banks (their owners and managers) and the failure of depositors to more carefully evaluate the soundness of the bank in which they deposit their money. But depositors have little competence to evaluate bank soundness, and why should they be expected to?

Money (bank deposits) should be fully separated from credit. Deposits should not finance loans. Those financing investments should share in its risks (and rewards) via equity financing. “More than decade ago Professor Kotlikoff and [John Goodman] proposed “limited purpose banking” in The New Republic and in Investment News. The idea is that credit market institutions should be intermediaries between savers and investors and should not themselves use depositors’ money to make risky investments.”

When we deposit money in banks for safekeeping and making payments there should never be any doubt about the bank’s ability to return it on demand and thus no reason to “run” on the bank to protect our deposits. This is the essence of the Chicago Plan which would replace so call fractional reserve banking with 100% reserves (deposits at the central bank). When my bank deposit is backed totally by my bank’s deposits at the Fed, I would know with certainty that they were 100% safe and instantly available.  The “Chicago Plan” and New Deal Banking Reform | Levy Economics Institute (levyinstitute.org) Narrow banking schemes have a similar motivation. “A proposal for the feds balance sheet”

Econ 101: Inflation –Temporary or Longer Lasting?

Prices of many goods and services have increased in recent months. Are these increases permanent or temporary or will they continue rising in the future? Before exploring those questions, it is important to understand the measures of inflation we are considering. What is the current rate of inflation in the United States? U.S. inflation in September was 3.0% (Compound annual rate of change for Consumer Price Index without food and energy prices over the month of September), or 4.0% (percent change from a year ago) or 5.4% (percent change from a year ago including food and energy prices). What does it mean if this is temporary or long lasting?

If prices remain where they are today after the 5.4% increase from a year ago, inflation going forward would be zero even though the cost of living would be permanently higher. If inflation is long lasting it means that prices will continue to rise for some time (years). What are the factors that influence the future behavior of prices? What should we expect in the U.S.?

The price of a good or service increases when its demand exceeds its supply and similarly for prices in general (when aggregate demand exceeds aggregate supply). As prices are measured in a country’s currency, supplying too much of the currency (generally when the money supply grows more rapidly than the supply of goods and services) causes its value to fall (i.e., prices in the country’s currency to rise).

On the cost side, firms will hire workers and pay them a particular wage (and related benefits) when it adds more to the company’s income than it costs, which includes the cost of the tools they use (capital). Workers will accept a job when its benefits (pecuniary and nonpecuniary) are the best they can find. The inflation expected by the employer and the employee over the period of the wage contract is an important factor in determining what will be offered and what will be accepted.

Because of changes in consumer demands, worker preferences, halving of work visas for immigrants, and supply chain disruptions, labor markets are temporarily in turmoil. September unemployment in the U.S. was 7.674 million while there were 10.4 million job vacancies. Employers are raising wages in an effort to fill those vacancies. As reported by Scott Lincicome: “Goldman Sachs analysts saw a ‘perfect storm of factors that have significantly reduced the supply of workers who are currently looking for jobs at the same time that labor demand—as measured by job openings—has risen to an all-time high.’ This includes… state and federal benefits, early retirements, severely restricted immigration, a switch to self-employment, fear of COVID, and a geographic mismatch between unemployed workers and available jobs. Combined, these factors account for most of the missing workers out there.”  “What if the labor shortage isn’t transitory?”

In short, the labor force has shrunk just as the demand for output is increasing. This excess demand for workers is driving up labor costs and thus pushing up output prices. If the 5 or 6 percent price increase experienced over the present year is expected to be temporary, i.e., if prices are expected to return to their level a year ago, because the supply of labor returns to its pre-pandemic level, wage increases should be temporary as well, falling back to their pre pandemic level and growing thereafter on average with labor productivity plus the 2% inflation target of the central bank once there is full employment and better labor market balance.

More likely, if the inflation is expected to be temporary, i.e., the current 5 to 6 percent inflation stops but prices remain at their increased level, wages will remain at the increased level, but their real (inflation adjusted) value will fall back to their original level. In other words, if these higher prices are expected to be “permanent,” the nominal wage increases now being experienced will not result in any increase in real wages and the worker short fall might remain.

While some of those who withdrew from the labor force will probably return, it is not likely to fully satisfy the demand for various reasons (early retirement, fall in immigration, etc.). Filling (or attempting to fill) the remaining labor shortage will require additional wage increases (unless the public’s demand for goods and services falls–see below). In that case, firms will plan to pass on their higher cost of labor to their customers. If we, the customers, can continue to pay the higher prices, the inflation will continue. Expectations of higher prices and or inflation will be realized.

The Covid-19 pandemic caused a sharp fall in output and thus to most people’s incomes. The government provided extraordinary financial support to temporarily fill the resulting income gap. Such support did not increase the output of goods and services or even prevent their decline but rather temporarily redistributed income from those saving it to avoid hunger and defaults on rents, mortgages, and other financial obligations by those who lost it.  “The new covid-19 support bill”  Because personal incomes were substantially maintained while actual output fell, personal savings rates increased dramatically and continue to be well above pre pandemic levels.

The Federal Reserve pitched in by buying up huge amounts of the resulting government debt increasing its balance sheet from $3.5 trillion in February 2020 to $6.3 trillion in August 2021 (measured by the monetary base, M0). This fueled an increase in board money (M3–M0 plus bank deposits and similar liquid assets of the public) from $15.5.0 trillion in February 2020 to $20.8 trillion in August 2021. This increase, though substantial, was significantly less than the increase in M0 (which almost doubled) because the Fed paid interest to banks for keeping the new base money with the Fed (excess reserves) rather than lending it to the public, by paying banks interest on all bank reserves kept with the central bank.

Historical experience is that the public will not be willing to hold these larger amounts of money for ever. They will eventually attempt to spend them down to their traditional (normal) levels, thus adding to aggregate demand for goods and services (and inflationary pressure).

Eventually, the demand for goods and services (aggregate demand) must fall to match real output, or output must rise to match demand. But if the Federal Reserve continues to print money faster than its real value is being inflated away, the inflationary process will continue or accelerate. Similarly, if the government continues to redistribute income from those with a lower propensity to consume (generally higher income families with a higher savings rate) to those with a higher propensity to consume (generally lower income families that save little), aggregate demand will remain excessive perpetuating inflation.

Historically, hyperinflation episodes invariably exploded in the collapse of the currency.  “Hyperinflation in Zimbabwe”  Turkey has come closest to a high inflation “equilibrium.” From the mid 1980s to the end of the 1990s Turkey’s inflation rate varied between 80 and a 120 percent. A high inflation “equilibrium” would be characterized by nominal interest rates and wage rates that fully incorporate the ongoing expected rate of inflation in order to preserve the appropriate real (inflation adjusted) rates. Interest rates in Turkey in this period generally exceeded 100%, as did wage growth.

In its most recent World Economic Outlook, the International Monetary Fund stated that: “In settings where inflation is rising amid still-subdued employment rates and risks of expectations de-anchoring are becoming concrete, monetary policy may need to be tightened to get ahead of price pressures, even if that delays the employment recovery.” “World Economic Outlook-October 2021”

As stands out clearly from the increasingly but unevenly rising inflation in the 1970, the process of increasing inflation is not linear (see the chart above).  As inflation increased, the Federal Reserve tightened monetary policy (raised interest rates to slow monetary growth) to slow inflation, causing real output to slow or decline. Policy then eased prematurely, and inflation and the expectation of higher inflation took off again, each time reaching a higher peak (until Paul Volcker stepped on the breaks and ended the game in 1979-80–the exciting year I worked at the Federal Reserve Board).

The Federal Reserve is smarter today than it was in the 1970s and has the tools to prevent the acceleration of inflation and the unhinging of inflation expectation. But the excess money balances and personal saving are very large and the government’s seeming willingness to run up unprecedented deficits create a powerful inflationary head wind. The tightening of monetary policy that will be needed (sooner rather than later in my view) will reduce the Fed’s purchases of Treasury debt and increase interest rates. Higher interest rates will increase government spending for debt service on its very large stock of debt, which will further increase government borrowing and debt or require cuts in spending for other programs. This must be added to the economic challenges of confronting climate change, the continuing recovery and adjustments from the Covid-19 pandemic, the deepening and destructive partisan divide that is stifling Congress, and the growing lack of public trust that drives it.

Whether our current inflation is temporary or longer lasting depends on how quickly and decisively the Federal Reserve tightens monetary policy and how quickly people go back to work. Whether the U.S. economy and the government’s large stock of debt continue to enjoy safe haven status around the world depends heavily on whether our government brings its spending and tax policies under better control.