DRI-224 for week of 11-24-13: The ‘Cost’ of the Government Shutdown: Another Myth Bites the Dust

An Access Advertising EconBrief:

The ‘Cost’ of the Government Shutdown: Another Myth Bites the Dust

The sixteen-day federal-government shutdown that occurred in early October is gradually shaping up as a watershed event. That is what the mainstream news media and the political left, not to mention the Obama Administration, expected to happen. They believed a government shutdown would bring life as we know it to a grinding halt. But the actual experience of shutdown was dramatically different; no such thing happened. To free-market devotees, the myth of all-purpose government is undergoing exposure.

Is there any way to reconcile two such divergent views?  Seemingly, they should be readily distinguishable in reality. People approach these matters in two ways. Sometimes they consult fact. Other times they try logic. To be thorough, we’ll try both.

Uncertainty Over the Shutdown? None Visible in the 3rd Quarter Economic Data

Prior to the shutdown, the news media agonized over the prospect of government shutdown. The attendant uncertainty was not merely an annoyance for government employees whose income and work schedules were at risk of disruption. No, this was a threat to the economic lifeblood of the nation, whose circulation depended on the full-bore operation of the federal government. Even a temporary interruption in day-to-day activities would deal a severe blow to real incomes of Americans – or so went the party line.

Were this really true, we would certainly expect to see advance indication. One of many purposes of markets is to discount the future. The prospect of a measurable economic setback would be reflected in various indices prior to the actual occurrence of the shutdown. Among these would be the stock market, interest rates, short-term investment and futures markets. And adverse changes in these indicators would have immediate adverse effects on markets and real incomes prior to the shutdown.

None of this actually happened. In the third quarter (July-September) 2013, GDP grew at an annual rate of 2.8%, exceeding the 2.5% growth recorded in the second quarter. This result caused considerable surprise, not to say consternation, in media quarters.

This is not to say that uncertainty does not affect the pace of economic activity. All evidence and logic says that it does. And uncertainty has never bulked larger in the minds of Americans than in the last few years. We are uncertain about the general status of the economy; GDP reports suggest that we are in recovery while labor-market data suggests the serious recession. We are uncertain about the course of interest rates in the short-, medium- and long-term. The level of government debt is the subject of pervasive uncertainty.

All these factors were present in the third quarter. But they were no more or less troubling than previously. If the government shutdown were truly a fundamental threat to our well-being, we would have expected markets to register it in advance of the event. And they didn’t.

Did the Government Shutdown Devastate the Economy? October Economic Data Say Otherwise

When the federal government did actually shut down – albeit only partially – we would certainly expect this event to make its mark on contemporary economic statistics. Economists and business forecasters awaited the October jobs report from the Labor Department with trepidation.

The result dealt a knockout blow to devotees of big government. Economists had forecast an anemic employment gain of 120,000 jobs. The actual gain was 204,000, one of the largest totals of the year. Not only that, both August and September jobs totals were revised upward, by 46,000 and 15,000, respectively. While October saw continuing decline in government employment (by 12,000), net employment increased in the retail, hospitality, health-care, manufacturing and technical services sectors.

The Cost of the Government Shutdown, As Viewed By Various Sources

The federal government’s Office of Management and Budget (OMB) compiled a document purporting to list various costs of the federal-government shutdown. The document consisted of various monetary amounts estimated on a daily basis. Various other entities, notably Standard & Poor’s and Moody’s, compiled what they called an aggregate or sum of these costs, using the OMB components and multiplying them by sixteen (the length of the shutdown in days). Curiously, OMB itself disclaimed any pretensions to completeness for its document, despite the fact that it served as the basis for other aggregate estimates. (Possibly this is because the figures come mostly from independent sources rather than from OMB’s own internal research.) Both S&P and Moody’s ended with a total roughly equaling $24 billion. This figure was very widely distributed and quoted throughout the mainstream news media, as were several of OMB’s component estimates.

Since the OMB document was the apparent source of the components used by S&P and Moody’s, we will treat it as the source of the relevant information even though the government agency disowns the aggregate results obtained by the rating agencies.

Economics is the study of human choice. The essence of choice is the estimation and evaluation of cost, which is the highest-valued alternative foregone in any situation of choice. Although the OMB’s document purports to list the costs of shutdown, we cannot take this claim for granted. Instead, we must evaluate the line items on the OMB document by relevant economic criteria.

The OMB estimates that some $217 million per day in federal and contractor wages were lost as a result of the shutdown. Since the shutdown lasted 16 days, the aggregate value of these lost wages adds up to $3,472,000,000. The U.S. Travel Association estimates that some $152 million per day was lost in travel expenditures thanks to the shutdown; OMB accepts this figure and multiplies it by 16 to add $2,432,000,000 to the cost total. Closure of national parks adds $76 million per day to the kitty, according to the Parks Service, which translates into an aggregate addition of $1,216,000,000. The noted consulting firm IHS Global Insight estimates a loss of approximately $3.1 billion in government services that weren’t provided because of the shutdown, which OMB throws into the pot as well.

So far, the total adds up to $10 billion and change. OMB continues in this vein to accumulate its $24 billion total. But we need to pause long enough to ask ourselves if what we are adding up constitutes valid economic costs – or something else. Accuracy of computation is not the issue. Rather, the point is that OMB has engaged in the sort of “kitchen sink” type of pseudo-economic exercise common to state and local “economic development” programs. The idea behind the exercise is to build up an impressive-looking monetary total. To that end, the compilers throw everything but the kitchen sink into their list of numbers. In this connection, we need to remember that, while the figures were not dug up by OMB, that agency compiled them within a single document and thus bears liability for its lack of discrimination.

How to Rig a Cost-Benefit Analysis: Count the Costs as Benefits

In principle, the costs of the government shutdown are the benefits that citizens have to forego because our elected representatives chose to shut the government down instead of keeping it open. That is, the costs are the “benefits foregone” or the “road(s) not taken.” If the OMB’s portrayal of costs is correct we should know how large the benefits of shutdown would need to be in order to justify it.

When businesses produce output in the private economy, they incur costs in order to provide benefits to consumers. The benefits to consumers come from the output produced by the business, which provides utility or satisfaction to consumers. The costs are incurred by the business in order to get the output produced. Although accountants tote up costs in monetary form, economists know that the costs are really foregone alternatives; they are incurred because inputs are used in producing output rather than in their next-best alternative use, whatever that might be. In principle, that next-best alternative use is reflected in the market price paid by the firm for each input.

So, the delineation between costs and benefits is pretty clear: Benefits are what consumers get from consuming the goods they buy; costs are what firms pay for the inputs used to produce the goods.

When government produces goods and services and provides them to citizens, the process should work the same way. Citizens derive benefits from the goods and services the government provides, such as (say) weather forecasts provided by the National Weather Service. The costs are what citizens pay the meteorologists and other government employees, as well as the costs of using the various capital goods necessary to produce the forecasts. Then there is the bureaucratic overhead to consider as well.

It can sometimes be tough to estimate costs in practice because not all inputs are traded in markets. But the problem is vastly magnified when studying government since so many government goods and services do not command a unit price and are not sold to citizens. Alas, this does not mean that they are “free;” it simply means consumers don’t know what they are paying and can’t compare that to the value they place on the output they receive. And it also means that economists at OMB have no way to place a dollar value on government output either.

Now we have the basic knowledge necessary to evaluate the cost computation done by OMB. Here is our verdict: OMB’s so-called compilation of government shutdown costs is utter gibberish, a meaningless aggregation of numbers. If its authors were put on a witness stand and asked under oath whether they could honestly claim that it constituted the true costs of the government shutdown, an affirmative response would make them guilty of perjury.

Consider the line item of $3,472,000,000 for “lost wages.” Wages are paid for labor costs. Labor is used to produce output. It is a cost of production, not a benefit of consuming output.Since it is not a benefit of consuming the output produced by government, it cannot be an alternative foregone by citizens because of the shutdown. The OMB has counted a cost as a benefit.

If we call the OMB to account for this obvious mistake, this is what they will say. “We often have to value government output ‘at cost’ because government output is usually not sold in a marketplace the way private goods and services are. For example, economists study the research and development services provided by government. They have no choice but to substitute the costs of providing the service for the value of the service because R&D is not sold in the market. What we’re doing here is the same thing.”

But it isn’t the same thing. When economists study R&D, they include all the costs (or try to), not just wages. Their justification for this is that long-run equilibrium in a perfectly competitive industry occurs at a zero-profit level of output, in which the price is just sufficient to cover all costs (including the opportunity cost of the firm’s capital). So by adding up all costs and counting them as benefits, they are “assuming” a condition equivalent to long-run competitive equilibrium. In this case, however, OMB is counting only wages – just one of the costs of producing output.

That’s not the worst of it. Consider further that OMB is also adding in benefits of government output of travel services ($2,432,000,000) and National Park tourism services ($1,216,000,000). Some of the lost wages just referred to undoubtedly were incurred in producing these services. So what OMB is doing, at least to some extent, is adding together the costs and benefits of producing the same services – and calling the resulting total “benefits.” (Remember: The costs of shutdown are the benefits derived from output of government goods and services. And also keep in mind that, while three separate sources compiled the figures for lost wages, foregone travel services and foregone Park services, OMB is the agency that put them together for cost-calculation purposes.)

For several decades, state-level “economic development” programs throughout the U.S. have operated in exactly this manner. They have bankrolled investment by politically favored individuals but, in order to present this crass activity in a favorable light to voters, they have pretended to validate the investments through the use of “economic impact” statements using “cost/benefit analysis.” Early on, practitioners of pseudo-economic development learned that the best way to inflate the benefits in a cost/benefit analysis was to call the costs “benefits” and include them together to generate one, huge staggering total. In effect, that is what OMB has done here; the structure of economic theory makes it confusing to penetrate this fallacy because economic costs are really foregone benefits.

What about the $3,100,000,000 in lost government services? Since this represents foregone benefits in the form of lost services, this is a valid line item, right? As a practical matter, the answer is “no.” We’ve already alluded to the problem; because government doesn’t usually charge a price for its services, we cannot assume that people really value those services “at cost.” (In a competitive market, we could, since the price of the produce would reflect the unit cost of its inputs.) The real value that citizens place on that foregone $3,100,000,000 might well be much lower. When we consider the periodic revelations about the inflated wages paid to government workers relative to private-sector workers, this becomes downright likely.

There is no getting around it. The OMB estimate of government shut-down costs is a mess. It is bureaucratic toadyism at its most craven. The professionals at OMB are forced to inflate the importance of government in order to preserve their own bureaucratic standing.

Having roasted OMB, we should at least sear the rating agencies on a hot grill for intellectual opportunism. By taking OMB’s mélange of figures to their extreme of absurdity and calculating aggregate totals of shutdown costs, S&P and Moody’s remind us why some people wanted to generously award them the lion’s share of blame for the Great Financial Crisis of 2008.

A Necessary Caveat

It is only fair to note that OMB’s list of cost components contained at least two reasonable entries. One of those assigned roughly $2 billion for “lost productivity” to the fact that furloughed employees received payment for work they never performed. In this case, the foregone benefit was the $2 billion worth of benefits that could have been provided had work actually been performed. Another $4 billion entry was made for tax refunds the IRS couldn’t make because of the shutdown. Since these refunds were presumably only delayed rather than cancelled, this entry seems mysterious. Moreover, it illustrates still another distasteful facet of the shutdown-cost calculation business. The income tax is bad government and tax refunds are sub-optimal behavior by citizens; blaming the shutdown for disturbing this system is like blaming America’s Founding Fathers for spoiling the beverage consumption of dedicated tea drinkers among the colonists.

The poor excuse for analysis offered by OMB and the parasitic commentators who tried to inflate its half-baked conclusions into an apologetic soufflé doesn’t really address the underlying issues of cost created by big government. On a purely short-term basis, it is possible to identify legitimate benefits foregone by shutting down government simply because government has a hand in practically every human activity. The real economic issue, though, is to outline the optimal parameters of government involvement in daily life. On that long-term basis, it is clear that most of what government does today should be shut down. The things that are worth doing can be done much better by the private sector, either for profit or by what the late Richard Cornuelle called the independent sector.

Government has morphed into an unhealthy wish-fulfillment mechanism for a sizable political majority encompassing the political left and most of the political right. Everybody sees it as a deus ex machina for realizing their cherished dreams and everybody suspends their disbelief of its motives and capabilities when their own interests are at stake. Meanwhile, the reality of government is that it operates for the advantage of politicians, bureaucrats and government employees, not for the citizenry at large. There is no private-sector analogue to this, but if there were it would entail private business being run entirely for the benefit of CEOs, middle managers and their employees, while the interests of shareholders and consumers were completely ignored.

Viewed in this light, the failure of the Keynesian economic paradigm – government spending as a supercharged elixir injecting vitality into the economy with its multiplier benefits – no longer seems inexplicable. It seems inevitable.

The Index of Leading Economic Indicators Makes It Unanimous

Just to confirm the unanimous verdict of the objective indices, the Index of Leading Economic Indicators rose in November for the sixth time in the last seven months. Leading up to this announcement, economic forecasters had been vying to predict the precise magnitude of decline in the fourth quarter. Whoops! Between gritted teeth, news commentators reported this development as a sign that business and consumers apparently “shrugged off the recent 16-day government shutdown.” For years, the political right has been accused of “wanting America to fail” because of its opposition to the Obama Administration’s policies. Now it is the political left’s turn. Never has good economic news been greeted with more chagrin and forced cheer by the Establishment.

Valediction for a Myth

The White House jumped on the bandwagon for bad economics with a resounding endorsement of the shutdown-cost estimates promulgated by OMB, et al. The Obama Administration has cemented its status as the realm where economic myths go to die. The best valediction for this myth of irreplaceable government was delivered, appropriately enough, by the venerable Keynesian economist John Kenneth Galbraith. “The ultimate enemy of myth,” Galbraith declared gravely, “is circumstance.”

It was “Mr. Keynesian Economist” himself, James Tobin, who sounded the keynote for Keynesian theory when he once asserted that “it doesn’t matter what you [in government] spend the money on; spending is spending.” Tobin intended to assert that even wasteful government spending will raise incomes and employment in a time of recession. If true, that would imply that cessation of government spending would curtail economic activity.

Wrong. We are now in the gruesome position of having to disprove each and every Keynesian nostrum, one by one, before we can regain some semblance of normality. The federal-government shutdown has not only failed to produce political disaster for Republicans, it has crossed off one more Keynesian fallacy on the road back from serfdom. Thanks to the Tea Party, another myth bites the dust.

DRI-266 for week of 10-13-13: Don’t Raise the Debt Limit

An Access Advertising EconBrief:

[The following was completed one day before the debt-limit deal between Congressional leaders was announced on Wednesday, October 16, 2013.]

Don’t Raise the Debt Limit

The political melodrama now unspooling in Washington, D.C. is unique because it is playing on split screen. Our point of focus is the government shutdown – or rather, the partial shutdown, since somehow we just can’t seem to get the federal government shut down no matter how hard we try. Somebody can always find an excuse to fire up the machinery of government, cut checks, get them signed and sent out for some ostensibly vital purpose.

Meanwhile, up in the corner of our field of vision, always distracting our attention even though not occupying it fully, there is the debt-limit crisis. October 17 is the deadline for Congressional approval on raising the limit on the total volume of federal-government debt, thereby clearing the way for Treasury borrowing to finance expenditures in excess of revenue collections. The party line has it that failure to increase the debt limit by that date will put the U.S. government in “default” of its financial obligations to holders of its debt. The implication is that we have to borrow more money to pay the interest on the money we have already borrowed.

And what happens if we default on our debt? Well, opinions vary. They vary from “financial disaster” to “the end of life on earth.” According to Warren Buffet, the threat of default “should be like nuclear bombs… it should never be used.” Lloyd Blankfein of Goldman Sachs declares gravely that default would be “magnitudes worse” than the current shutdown in its effects. Perhaps sensing a need for escalation, former Treasury official and current BUP Paribas SA executive Tim Bitsberger ups the ante by stating that default “…blows Lehman out of the water” in its potential effects, implying that the 2008 financial crisis would be dwarfed in comparison.

Alternative to Default: Sales of Federal-Government Assets

If we’re not to default, what are we to do? En masse, the Democrat Party wants to simply raise the debt limit enough to get by the current fiscal year. That is what Congress has been doing for decades. That is what has enabled the culture of tax-and-borrow-and-spend – a culture that has made Washington, D.C. and environs the most prosperous, recession-proof habitation in the nation. Gradually, the Republican Party has evolved into a go-along-to-get-along enabler to this culture. They have tolerated vocal dissenters among their ranks because that provides convenient cover for the tacit collusion of the majority with the Democrats.

The recent emergence of the Tea Party and current mutiny led by Sen. Rand Paul and Congressman Ted Cruz has discomfited veteran Republicans almost as much as it has their opposition. But the mood of the general public – on both the political right and the left – is so dissatisfied with the status quo that the pols are bent on preserving that they are reluctantly contemplating the need for some sort of change. At the moment, though, the problem is getting past the immediate crisis.

That is now the motif of the governing process: a calendar dotted by scheduled crises and spotted by unscheduled ones. Its momentum is best characterized as a stagger from one crisis point to the next.

On the one hand, the Establishment – consisting of most of Congress and the entire Executive branch, plus all the bureaucrats, rank and file employees, lobbyists, contractors and news media – maintains that the only option is to raise the debt limit. They say this because the increase is the only option that would keep their world intact – at least for awhile. The alternatives would shake its foundations or topple them.

The general public is largely unaware of any third option beyond increasing the debt-limit and default. That is by design. The Establishment views any option averse to the current spending culture the way a vampire views the dawn.

Yet there is such a third option. It sticks out a mile. It is the option customarily exercised by private businesses overburdened with debt.

The federal government owns a huge portfolio of assets, both liquid and non-liquid. Its total value can only be estimated, but it is only modestly less than the estimated value of privately owned U.S. assets. The most cogent approach to the immediate – debt-limit – crisis is to begin selling off those assets to fund government operations. Government assets are more than ample to support annual operations, particularly due to the sequester’s success in temporarily reducing the deficit for this fiscal year.

Every year, some private companies work their way out of trouble this way. The key is acknowledging the company is in trouble, then taking steps to dig it out of its hole, rather than doing business as usual and hoping for miracles. Today, the federal government (along with many state governments) is in trouble. Like many corporate conglomerates, it is bloated and over-extended. It needs to stick to its core businesses and sell off its conglomerate holdings to those who can preserve them and make them pay off.

Over the course of this fiscal year, branches and agencies of the federal government can concentrate on raising revenue by selling liquid and non-liquid holdings. Meanwhile, Congress can tackle the job of cutting spending – a task too time-consuming to consummate prior to October 17.

And speaking of October 17 – the date itself has very little meaning once it becomes known that the government is selling assets and revenue is assured. Creditors – even bondholders – are more than willing to wait for a payment they know is coming, as opposed to a situation when everybody knows that incoming revenue is insufficient and somebody will inevitably get stiffed. That is why the option of asset sales is a viable way of rejecting a debt-limit increase.

The last thing Republicans should do is to raise the debt limit. This is an act of surrender to the spending culture, a can-kicking capitulation to the Establishment. It is not the failure to raise the debt limit that is irresponsible; it is the act of raising it that throws responsibility to the winds.

Estimates of the Federal Government’s Assets

At various times, estimates have been made of the federal government’s financial and tangible assets, both liquid and non-liquid. Despite the fact that they were often made when annual deficits were higher than the one projected for the coming fiscal year, the estimates invariably found that assets sales could easily support annual government operations.

Using mostly Treasury and Federal Reserve data from 2011, economist Robert Murphy identified federal government liquid assets of about $1.6 trillion. In June, 2011, the Treasury reported “international reserve assets” of $144.2 billion. They consisted of gold, securities, foreign-currency deposits of euros and yen, Special Drawing Rights [an international asset provided to governments by the International Monetary Fund] and IMF reserves. (The IMF assets were developed specifically to provide liquidity in emergencies like this one.) The official valuation is distorted, since the government’s 261.5 million troy ounces of gold was valued at a par value of $42.2 per ounce rather than its then-current market value of $1500 per ounce.

We can update Murphy’s numbers with some back-of-the-envelope calculations. Adjusting the numbers using a current gold price leaves non-gold assets of approximately $133 billion and a true valuation of roughly $337 billion in gold, yielding liquid assets of $470 billion+. Subsequently, gold has declined while the yen and euro have fluctuated in value. A current estimate of $450 billion would be conservative.

The Strategic Petroleum Reserve held about 726 billion barrels of recoverable oil. At today’s price nearing $100 per barrel, that would be worth about $72 billion. But since the oil is actually buried in salt caverns, Murphy suggested a discount of 25% to reflect recovery costs and time. Tack on another $58 billion to our current liquid-asset total, then.

The federal government owns offshore oil deposits whose estimated recoverable reserves total some 59 billion barrels. Murphy estimated the royalty income in years 8-38 of recovery at about $14 billion per year. He discounted that income at 5% and came up with $164 billion, which is an estimate of what the government might receive from selling the rights to that revenue for a lump sum.

So far, we have come up with nearly $675 billion. Murphy also found some $786 billion in “credit-market instruments” in Federal Reserve documents. These include $138 billion in agency-backed and GSE-backed securities and $355 billion in student loans. This total is much larger now, since the Fed has been buying mortgage-backed securities in order to support their market prices. He also included $55 billion in corporate (TARP) equities, which have mostly since been sold back into private hands. If we assume the changes cancelled out, we can stick with Murphy’s original $786 billion.

That produces somewhat less than a trillion and a half, far above the anticipated $650 billion deficit. It is reasonable to assume that the mortgage-related securities would be sold slowly over the course of the year and the full holdings might not be depleted, so as not to depress mortgage prices unduly.

We have not yet even touched the federal government’s huge land holdings. The government owns most of the state of Nevada, for example, among its 650 million acres of land. A couple years ago, then-OMB head Peter Orszag estimated that there are some 14,000 “excess” structures and 55,000 un-utilized or under-utilized structures and buildings in the federal government’s portfolio. These could and should be sold. The government’s power-generation facilities and the electro-magnetic spectrum are other lucrative holdings that are ripe for sale and privatization.

If we were to construct a net worth statement for the federal government, the bottom line would probably astound most Americans. Financial analyst John Rutledge has occasionally attempted it and come up with government asset valuations of between $150 and $200 trillion. (He estimates the value of private U.S. assets at $230-$250 trillion.) Thus, the potential for solving our debt problem completely by selling assets is clear. Of course, this would involve various technical and logistical complications. It would unquestionably alter the fundamental character of the federal government as it exists today. But isn’t it about time to do just that?

Arguments Against Selling Federal-Government Assets

The foregoing is persuasive. But it is only natural to wonder what drawbacks might lurk under its surface. In 2010, Treasury Secretary Timothy Geithner responded to calls for asset sales by pooh-poohing the idea. Holding a “fire sale” of government assets would damage “financial markets and the economy and undermine confidence in the United States,” Geithner maintained.

Each of these contentions deserves some scrutiny. It is perfectly correct that when a company starts selling assets, it tells the world that it is in trouble and it runs the risks that this knowledge will have adverse effects. Among other things, the company may now have more trouble borrowing money and its stock price may well decline (assuming the stock trades publicly). But these are not fatal flaws, merely tradeoffs; they have to be weighed against the risks of inaction.

The drawbacks of straightforwardness do not tell nearly as heavily against a country as against a single company. A company can sometimes hide its financial condition from the public and the markets, but a country can’t. We aren’t fooling anybody by sitting on our gigantic stockpile of assets; our credit rating has already been downgraded and our debt and deficit problems are open secrets. Sooner or later, our interest rates are going to rise – the only question is how much debt is weighing us down when they do. The world will have a lot more confidence in a United States that has finally started whittling down its debt than one that has buried its head in the sand while continuing to spend itself silly. This assessment is not merely speculative; two days before the financial equivalent of “Mayan calendar” oblivion, a Wall Street Journal headline reads “Uneasy Investors Sell Billions in Treasurys.” Apparently confidence in the debt-limit-raising approach is not exactly unshakeable.

Geithner’s warning about “damage to the economy” presumably derives from the Keynesian concept that government sales of assets to the public drain money from the circular flow of income and expenditure, thereby reducing income and employment. As Murphy points out, this requires us to believe that people would rather end the year with $650 billion or so of IOUs than $650 billion worth of valuable assets formerly managed (often mismanaged) by the government. How could asset sales “damage the economy” as much as the status quo of wasteful spending and debt accumulation?

There is at least some superficial cogency to Geithner’s concern about financial markets, since some of the liquid assets in the federal portfolio were purchased in the first place to prop up the asset’s price. Clearly, selling will have the opposite effect, especially in quantity. This is why sales of mortgage-backed securities would presumably be strung out over long time periods, although the anticipation of continued sales would have the effect of driving down prices in advance of sales anyway. But the real issue is the legitimacy of the price itself. In effect, Geithner is admitting that the so-called housing “recovery” is really an artifact of government contrivance and will evaporate without it. How long is this supposed to go on, anyway? Is the tail of the housing sector supposed to wag the general economic dog forever? Orderly asset sales would seem the indicated exit strategy for this misguided policy.

Democrat arguments against government-asset sales are a pretext. The sales would represent a turning point in over a century of big-government, “progressive” policy. According to progressive doctrine, government is supposed to accumulate power, control and authority – not cede it.

The ironic thing is that asset sales would leave the skeletal structure of big government intact. The entitlement programs – Social Security and Medicare – would be untouched. Most of the regulatory agencies would be unaffected; only those entrusted with caring for assets that were sold off would be downsized or eliminated. (A major benefit of selling assets would be that the overhead expense of minding them could be offloaded.) Yet this minor impact on the welfare state has little effect on the Democrats’ intractable opposition to the idea. The fact that government does a perfectly terrible job of managing assets is also completely beside the point. Democrat policies are inherently designed to exploit the many for the benefit of the few and this demands not only big government but continually expanding government. Anything that threatens that, threatens their livelihood.

Hole Card?

A recurring theme among reactions to the prospect of default is incredulity that Congressional negotiators (read: Republicans) would be so reckless as to tempt fate by flirting with the debt-limit date. How dare they run even the tiniest risk of default?

For several years, the Federal Reserve has already been doing the unthinkable, more or less in plain sight but without provoking the same sort of outrage from the business and financial community. It has been “monetizing the debt” by buying new issues of federal-government debt directly from the Treasury using newly created money for the purpose. That activity has been technically illegal throughout the Fed’s existence, but the Fed circumvents the intent of the Federal Reserve Act by acquiring new issues directly from the primary dealers who transact directly with the Treasury. This was an important part of the QE (quantitative expansion) policy, which was designed to keep the federal-funds rate (thus, short-term interest rates in general) as low as possible. If the rest of the world was becoming reluctant to take on more and more U.S. debt – why, then, the Fed would just have to step into the breach. After all, it’s not as if the federal government should actually have to cut spending, is it?

Of course, there was the little matter of all that money that the Fed created. Ordinarily, the money would have had a multiple effect on the total money stock. The Fed formerly did its bond buying in the secondary bond market for the express purpose of creating reserves for banks to use as a reserve base for pyramiding loans to businesses and households. (Students will recognize the term “money multiplier,” used to estimate the amount by which the money stock increases based on an initial injection of money.) When the money was spent, this effect produced economic effects extending beyond the initial recipients of the spending. The trillions of dollars the Fed has recently created (some of which has financed U.S. government debt) would be sufficient to kindle hyperinflation when fed through an ordinary market process. Throughout history, this kind of money-creation has been considered strictly “the policy of the desperado,” as F.A. Hayek called it. Allan Meltzer, whose multi-volume history of the Federal Reserve has cemented his reputation as perhaps the world’s leading monetary economist, admits that despite his personal liking for Ben Bernanke, “It’s pretty hard for me to argue that if you have a few trillion dollars of excess reserves in the banking system, you think you’re doing it for the good of the economy.” Once again, though, the Fed has escaped censure for its actions thus far.

Doubtless this general insouciance is explained by the results. The created money and/or its loan potential has mostly sat idle in bank excess reserves, because a law change allowed the Fed to pay interest on money held in excess reserves by its member banks. Meanwhile, the bonds themselves have been quietly added to the Fed’s portfolio, where they have been quietly drawing interest. The Federal Reserve has now become one of the world’s leading holders of U.S. debt.

This raises an interesting possibility. Even though the Federal Reserve is a bank and operates as such, earning profits and suffering losses on individual transactions, it is not an ordinary bank. One quaint feature of its operations as a “quasi-public” institution is that it remits interest earned on its holdings of federal-government bonds to the Treasury. (It does this in spite of the fact that the Federal Reserve System is composed of its member banks and the Fed presumably has a fiduciary responsibility to them.) Thus, when the Fed buys bonds from the Treasury and holds them, that means the Treasury is getting interest-free financing for its deficit expenditures with money the Fed creates.

This raises the possibility that the Obama Administration’s debt-limit hole card may be an arrangement with the Fed that it will buy up all new debt in the coming fiscal year – and maybe more besides. Remember, the Fed was widely expected to end its program of quantitative easing in September, but continued it unabated, confounding markets and the public. Its explanation for this was confused – even normally tame Fed-watchers criticized Bernanke for leaving markets in the lurch. Remember, also, what everybody is most worried about – that default on our debt will take away the U.S. government’s ability to borrow.

Preempting the bond market is not something the Fed would normally be happy to do. U.S. Treasury bonds are traditionally one of the world’s leading fixed-income assets. People line up to buy them. Frustrating this demand would be unprecedented. But recently the Fed has been buying most of the new Treasury debt anyway; Bloomberg estimated that in 2012, the Fed was starving the market for Treasurys by soaking up 90% of new issues. In any case, the prospect of a debt default might be considered a big enough emergency to justify such high-handed action. And the Administration would be willing to consider any alternative to spending cuts or asset sales, as explained above.

The Fed’s actions are so outré and its politicization so apparent that this kind of hidden agenda makes about as much sense as any other explanation for its actions. It isn’t as if Bernanke’s tenure thus far has been squeaky clean and free of any taint of political collusion. Quite the contrary.

And this theory doesn’t argue in favor of raising the debt-limit, either. Thus, the verdict on the debt limit is clear-cut: Don’t raise it.

DRI-312 for week of 9-29-13: Suppose They Gave a Government Shutdown and Nobody Cared?

An Access Advertising EconBrief:

Suppose They Gave a Government Shutdown and Nobody Cared?

Midnight on Tuesday, Oct. 1, 2013 is the deadline for the shutdown of the federal government. That is the start of the new federal fiscal year. The U.S. Constitution specifies that Congress must authorize spending by the executive branch. Strange as it seems to a country by now inured to executive and regulatory high-handedness, the government cannot legally initiate operations by writing checks on its own hook. Fiscal delinquency, delay and deceit have long been the hallmarks of Congressional action, so it seems only fitting that Congress has failed to agree on the spending authorizations for departments that would get the federal government up and running in the New Year. And this year’s calendar offers a special treat, since the Oct. 17 deadline for default looms on the horizon as the next bureaucratic drop-dead date for civilization as we know it.

Amid the breathless media countdown to Armageddon, a sober pause for introspection is in order. How big an emergency is the federal-government shutdown, really? What underlying significance does a government shutdown have? How did we reach this position? Has the underlying economic significance of our situation been correctly conveyed by commentators and news media?

OMG! The Federal Government is About to Shut Down! Oh, Wait, Time for Vacation…

The attitude of Congressional representatives toward the prospect of government shutdown might best be compared to that of college students facing final exams. The exam schedule is announced at the beginning of the semester; indeed, it is printed in the course catalog distributed at registration. The course syllabus carefully explains the importance of the final to the student’s grade. The student knows the format of the exam, its location and exact time of day.

So, having had nearly four months to prepare and all the advance warning anybody could ask for, students are well versed, confident and unruffled in the waning days of the semester, right? On the night before the exam, they spend a short time reviewing basic ideas before retiring to get a good night’s sleep, to arise refreshed and eager to meet their task on final-exam day, don’t they? And they pass the exam with flying colors?

No, students generally seek out any excuse to avoid studying the material – and excuses emerge in profusion. As time passes and the semester ages, the knowledge of their approaching fate weighs on students’ minds, producing a buildup of anxiety and kinetic energy in their bodies. This demands an outlet, and late semester is a popular time for beer busts and other recreational modes of escape. The waning days before the final exam are spent in frantic efforts to complete course work and accomplish several months’ worth of study in a few days. The culmination of this crash program arrives on execution eve, when the students cram as many isolated facts as possible into their brain cells, relying on short-term memory to pinch-hit for solid comprehension. The surprising success rate of this modus operandi is owed less to its inherent effectiveness than to the grade inflation that has overwhelmed higher education in recent decades.

Anybody who expected their Congressional representative to behave in a more mature, sensible fashion than a college underclassman has been bitterly disillusioned by experience. Consider this latest example of budget brinkmanship.

The end of the fiscal year is not a national secret. Congress has known all year it was coming. The issues dividing the two major parties were well-known from the first day; ObamaCare has been a dinosaur-sized-bone of contention since its proposal and passage in 2010 and shocking reaffirmation by the Supreme Court in 2011. There was ample time to resolve differences or remove the legislation as a political roadblock to process.

As the year wound down, it became increasingly clear that opponents were eyeball to eyeball, each waiting for the others to blink. Now it was August, with only two months left in which to stave out a shutdown. When the going get tough, the tough… go on vacation – which was exactly what Congress did, for five weeks.

For the last week, leaders like Senate Majority Leader Harry Reid (D-Nevada) and Republican Ted Cruz have suddenly come alive with frantic last-ditch efforts. Each side has crafted and passed proposals (in the Democrat-controlled Senate and the Republican House) that the other side has torpedoed. At this writing, we are down to the last-minute cramming… but it should not escape notice that Sen. Reid was not too appalled by the prospect of shutdown to leave town the weekend after superintending the defeat of Rep. Cruz’s proposal in the Senate.

A few of the more cynical commentators have observed that we have been down this road before without careening off the highway and down a mountainside into oblivion. One set of talking points refers to this as our third experience with actual shutdown, but this is far from true. In fact, the federal government has survived 19 previous shutdowns – 17 since 1977 alone, according to the Congressional Research Service. Most have lasted a few days; the most recent (and famous) one in 1996 lasted for 21 days. So much for the artificially contrived atmosphere of urgency surrounding this one, which has been another production of political theater brought to you by your national news media.

Is There a Point to the Shutdown? If So, What is It?

It should be obvious that the hype surrounding the shutdown is phony. Even if we make allowances for the timing coincidence of the fiscal-year dividing line and debt-ceiling deadline, the attention paid to the shutdown is out of all proportion to its real effects on American well-being. But even though the shutdown may be relatively innocuous in its effects, that does not make it a good idea. What does it accomplish – ostensibly or actually?

It goes without saying that detractors of the Tea Party and the Republican Congressional leadership foresee nothing good coming of the shutdown. Since these are the people who got America into the mess that now plagues it – or stood by while that happened – we can disregard their opinions.

If there is an overriding goal of those who drove the events leading to the shutdown, it is opposition to ObamaCare. This opposition has taken the form of attempts to “defund” it; that is, to deny the Obama Administration the money necessary to implement the program. Were this successful, the program would remain on the books de jure as law, but would be repealed de facto by the lack of funds to run it. The most direct means taken to achieve this end is by passing a spending authorization bill containing a rider that defunds the Affordable Care Act. The problem with this measure is that the President will never sign this bill; ObamaCare is the signature legislation of his presidency.

Plan B of the defunders has been to replace that defunding rider with one that delays implementation of ObamaCare provisions for individual citizens by one year. This is directly analogous to the delay instituted by the Obama administration itself for businesses; in effect, it simply gives private individuals the same one-year reprieve given to employers by the President himself. This measure not only has the virtue of symmetry but also of fairness and logistical convenience. It is not clear why the bill should be delayed for businesses and not for everybody else. The state exchanges that would enable individuals to acquire health insurance are not up and running anyway in several states, so this would give the system more time to iron out the kinks. And this delay is entirely legal, being instituted by the Congress and submitted for Presidential signature; the business delay was a flagrantly illegal action imposed by Presidential fiat.

But President Obama is not about to agree to this compromise measure, either. He knows that the longer ObamaCare is postponed, the longer opposition will have to build and the longer its defects will have to become manifest. Once in place, a national system this massive and bureaucratic will be almost impossible to dislodge if only due to the inertia that will set in. The President only delayed applying its business provisions out of direst necessity; everybody was so unprepared that imposition would have led to complete fiasco. So Obama wants to get half of ObamaCare going while the going is good – or at least feasible.

Republic Speaker of the House John Boehner is already confronted by panic in the ranks. Republican representatives have hardly faced the first unfriendly fire from the news media – accusing them of irresponsibly jeopardizing the welfare of the nation for their own petty political purposes – before bolting for cover. Boehner’s queries as he gives them the flat of his sword are: What is this all about if not standing on principle against the President’s program? If we can’t work for the repeal of a terrible law as soundly unpopular as ObamaCare, when will we ever oppose the President? If now isn’t the time to stand firm against policies that are spending the country into the ground and destroying the heritage of our children, when will a better time come around? Over 30 years ago, President Ronald Reagan asked: If not now, when? Well, we didn’t do it then. If we don’t reform the budget now, when?

And those are indeed the relevant questions. Most Republicans oppose ObamaCare, all right; they have enough political courage to stand up against a law when the polls proclaim it heavily unpopular. But ObamaCare is merely the tip of the spending iceberg; the entitlement programs lie jutting beneath the surface waiting to scuttle the most unsinkable of reformers. There is no sign of Republicans boarding icebreakers, kissing wives and children goodbye and signing on for the duration of the voyage to clear the sea lanes of entitlements.

And Now for Some Opinion Completely Different

Holman Jenkins of The Wall Street Journal is a commentator not noted for his sunny optimism. Nevertheless, his take on the federal-budget stalemate is decidedly more upbeat than others commonly bruited. “What if, 10 years ago, Greece had made itself a laughingstock, sacrificed its credibility, brought shame on itself – all phrases used against Washington this week – by shutting down its government because certain legislators saw ideological and electoral rewards to be gained from making a fuss over unsustainable spending? Greek TV hosts would have shouted ‘Athens is broken!'”

Instead, as Jenkins knows only too well, Greece went sleepily on its corrupt, lazy, insouciant way, only to collapse in a heap nearly a decade later. Meanwhile, Americans today “all shake a fist at Washington, denouncing its irresponsibility because politicians are ‘playing politics’ with the debt ceiling and government shutdown.” But “then again, politics is how we govern ourselves. It’s better than despotism not because each moment is a model of stately order and reason, because America is a diverse, fractious society. The only way it works is by the endless grinding out of political compromises amid shrieking and making threats and turning blue.”

Jenkins anticipates the typical facile rejoinder. “The usual suspects at this point will be stamping their feet and insisting the U.S. isn’t Greece, as if this is an insight. No country can borrow and spend infinite amounts of money, and no political system is immune to the incentive to keep trying anyway. Herein lies the real point that applies as much to Washington as to Athens.”

“It would be nice if today’s fight were genuinely about the future. Oh, wait, that’s exactly what the ObamaCare fight is about. By trying to stop a brand new entitlement before it gets started, in a country already palpably and indisputably committed to more entitlement spending than it wants to pay for, those radical House Republicans aren’t trying to chop current spending amid a sluggish recovery (however much one begins to doubt that pump-priming from Washington is the solution the economy needs). Those terrible House Republicans aren’t trying to force colleagues to commit painful votes to take away established goodies from established voting blocs – votes that neither Republicans nor Democrats have the slightest yearning to cast.”

“Those disgraceful House Republicans have made the fight exactly about the long term. Where’s the grudging approval from our Keynesian friends who constantly say immediate spending must be protected and reform saved for the long term?” Again, Jenkins knows full well that Keynesian economics is no longer a putatively consistent set of theoretical propositions; it is now a policy admonition in search of a theory and for sale to any political sponsor willing to fork over lucrative, visible jobs to Keynesian economists.

“Not only will there by more such shutdowns,” Jenkins predicts. “What passes for progress each time will be tiny – until it’s not. The 2011 sequester, which caused critics to engage in choruses of disapproval and the S&P to downgrade U.S. debt, set us on a path to today’s modestly smaller current deficits. This week’s peculiar fight may be resolved by a near-meaningless repeal of ObamaCare’s self-defeating medical-device tax – a teensy if desirable adjustment, having no bearing on the deficit tsunami that begins when the baby boomers start demanding their benefits.”

Jenkins’s peroration combines elements of Churchill and Pericles. “We are at the beginning of the beginning. Yet the birth pangs of entitlement reform that will one day inspire the world (as we did with tax reform in ’80s) may be what we’re witnessing.” Hence the title of the column: “Behind the Noise, Entitlement Reform.”

Too Little, Too Late

Holman Jenkins’s vision is seductive, but unconvincing. Its visceral appeal lies in its pragmatism and its familiarity. Pragmatism is the great American virtue. We have grown up learning to accept and adapt to incremental change. Surely the changes necessary to cope with the downsizing of the welfare state will be just one more set of adjustments – painful but bearable. How many times have we heard Cassandras prophesy doom? How many times has it appeared? This is apparently the comforting set of rationalizations that insulates us from the truth of our situation.

Unfortunately, there is no reason to believe that a long series of small changes will be both timely and sufficient to our purpose. Not only has the Obama Administration’s fiscal policies shifted the velocity of fiscal decline to warp speed, but its monetary policies have changed our major problem from financial crisis to monetary collapse. Financial crisis is something that both individual countries and world systems recover from. Monetary collapse can lead to the destruction of a nation’s economy and the end of the civil order. We not only have to change our ways, we must reverse course by 180 degrees. And do it quickly.

It seems that Jenkins envisions entitlement reform from the austere perspective of an actuary contemplating the future of a program like Social Security. Tut-tut, the actuary admonishes, this program will be bankrupt in another 20 years or so. Well, in 20 years, a solid plurality of Wall Street Journal readers will be dead or near death. Quite a few will be financially independent of the program. Most of the rest view 20 years hence as imperceptibly distant – ample time to recover from the financial improvidence of youth.

But the real crisis on our trip planner is not actuarial. Social Security affects it long before it actually becomes insolvent because its unfunded status will be factored into the calculations of bond traders, credit-rating agencies and interest-rate setters. We may or may not be at Jenkins’s “beginning of the beginning,” but we are certainly not standing in the starting blocks in terms of debt. Government at every level is in hock up to its hairline. The private sector has been making a valiant effort to deleverage – and for its pains has caught hell from Keynesian economists who lecture us about the evils of saving in the middle of a recession. (Just prior to the Great Recession, the same people were decrying our “consumption binge” and running public-service ads begging us to save more.) American banks have trillions loitering in excess reserves, just spoiling for the chance to torch the value of the dollar at home and abroad. Foreign holders of dollars and dollar-denominated assets are dying for a convenient chance to unload them. Business forecasters need binoculars to view the upside potential of U.S. interest rates. And when interest rates skyrocket, interest payments on the federal debt will crowd out practically everything else on the docket, making the budget wars of today look like Sunday-school theology debates. The endpoint of this process is monetary collapse, when the U.S. dollar is abandoned as a medium of exchange, unit of account and store of value.

Oh, and just in case the foregoing doesn’t fill you with a sense of dread, there’s the little matter of international “currency war” to ponder. During the Great Depression, many nations used monetary expansion to deliberately trash the value of their own currencies. Their aim was to make their goods look cheap to foreigners, thereby hiking their number and value of their exports and increasing employment in their export industries. Since their depreciated domestic currency would also buy fewer imports, this would supposedly encourage the citizenry to buy fewer goods from abroad, thereby increasing domestic employment in import-competing industries. This game plan is well-known to economic historians as the “beggar thy neighbor” strategy. Its inherent flaw is that it can work if, and only if, only one nation employs it. When all or most nations do it simultaneously, the effects cancel each other out in the currency market and the only result is that international trade evaporates – which is roughly what did happen during the Depression. Since international trade is a good thing which makes practically everybody better off, its virtual elimination was a disaster for everybody. And guess what? The rest of the world, watching Ben Bernanke and the Fed at work creating money like there’s no tomorrow, may well suspect the U.S. of trying just this tactic. Whether they’re right or wrong is beside the point, since it is their belief that will determine whether they retaliate by starting a trade war that mimics the devastation of the 1930s.

It is barely possible that Congress might embark on a program of haphazard, gradual deficit reduction a la Jenkins. But a thoroughgoing reform of the process is not in the cards. Thus, the danger is not a collapse caused by a government shutdown. The danger is a collapse caused by the failure to shut the government down. It is government at all levels that has turned itself into a machine for spending citizens’ money to benefit employees without providing substantial benefits to the citizens. Since there is virtually no competition for government services, there is little or no way to gauge whether any government good or service is worth what we have to pay to get it. So government just keeps rolling along, like Old Man River, carrying us all along with the flow.

The mass delusion afflicting America is cognitive dissonance. Most of us agree with Jenkins that no government can increase spending indefinitely. Yet we do not admit that this requires our government to actually cut spending for the purposes that (we believe) benefit us – or, at least, we do not admit this necessity in our lifetime. The same people who normally consider government to be intrusive, inept and unproductive magically reverse their position 180 degrees and assume that government is efficient and productive when pursuing their pet project, benefitting them and saving the world from their latest hobgoblin. This is the politico-economic equivalent of William Saroyan’s lament that everybody had to die but he had always assumed that an exception would be made in his case.

The dissonance is actually three-sided. We fail to recognize not only its quantitative dimension but also its qualitative side – government’s utter failure to solve problems and produce things of value. Thus, the real entrenched constituency for big government is not its ostensible beneficiaries – the poor, downtrodden, minorities and such. It is the bureaucrats and their minions, who collect paychecks but whose real net contribution to the social product is negative.

Until this dissonance is dispelled, it is idle to blame politicians for acting true to form.