Wednesday, June 15, 2011

The Choice is Welfare or Wealth

Economist Allan H. Meltzer has an excellent article in today's (June 16, 2011) Wall Street Journal opinion pages entitled A Welfare State or a Start-Up Nation? (article also available on the Web) in which he clearly lays out the economic and policy choice the United States is faced with.

We can either continue on with the tax, borrow and spend polices favored by the Obama Administration and its supporters or return to policies that encourage economic growth.

Meltzer makes the point that, while the redistributionist policies favored by the Obama Administration and the left are backed by good intentions to help the poor and less fortunate in society, these policies have never worked.  It has been the free market growth policies which have lifted millions of people out of poverty in recent decades and in times before that in the places, like the United States where free markets were allowed to flourish.

The United States, Great Britain and Japan all grew and their people prospered when their governments followed free market policies.

Following World Wars I and II Great Britain opted for statist, sosocialist style policies and by the 1970s had an that was approaching that of a poor, underdeveloped Third World nation.  However, the economy of Great Britain quickly turned around when Lady Margaret Thatcher became Prime Minister and immediately began instituting free market policies.

In the United States, President Franklin Roosevelt managed to turn the 1929 economic downturn into a quarter century long depression, with near zero economic growth and 25% of the workforce unemployed, by replacing the free market with his socialist style central planning.

In the immediate post World War II era Sir John Cowperthwaite spent his career as the British Royal Governor of Britain's former island colony of Hong Kong fighting off attempts by his superiors in London to impose their failed socialist policies on the colony.  Cowperthwaite succeeded in protecting Hong Kong's free market economy from Britain's left leaning government with the result that, in the years between the end of the war and the election of Margaret Thatcher, the Gross Domestic Product (GDP) of tiny Hong Kong was greater than that of the mother country Great Britain.

Then there is the rapid transformation of formerly dirt poor nations in Asia, Latin America and even parts of Africa which in the course of a couple of decades in the last part of the 20th Century whose economies were transformed from poverty to plenty thanks to government reforms that allowed the free market to operate within their borders.

Finally, there are the nations of the former Soviet Union which threw off the shackles of communism in the 1990s and today are prospering.

As a nation, America faces a choice of following the current Administration and its dream of a socialist utopia which has always resulted in an economic nightmare or a free market policy which has always resulted in a better life for everyone.

Socialist policies promise economic equality and sharing of the wealth.  But what people end up sharing is not prosperity and wealth but hardship and poverty.

The free market, on the other hand, doesn't promise economic equality and, in practice doesn't end up distributing the wealth equally.   What it does do is create wealth in quantities which make everyone better off economically.

Monday, June 13, 2011

Supply & Demand

A question on a recent exam in my online Introduction to Micro Economics course asked:

If the price of a product increases, we would expect

A. the level of demand to decrease.

B. quantity supplied to increase.

C. the level of supply to increase.

D. an increase in quantity demanded.

The correct answer here was B. quantity supplied to increase. However, one of my students chose option A. the level of demand to decrease and then sent me an email asking why here answer was incorrect.

Here is what I replied:

An increase in price, other things being equal, will cause suppliers to increase the amount they are producing and selling. The idea here is that existing producers can make more profit by producing and selling more while other, less efficient, producers who could not make the product profitably at the current price will be able to make a profit at the new, higher price.

You confused "level of demand" or "demand" with "quantity demanded". "Demand" refers to the entire demand curve and this only changes when the entire curve shifts.

"Quantity demanded" refers to a movement along an existing demand curve.

The same is true of supply. "Supply" or "level of supply" which refers to the entire curve while "Quantity supplied" refers to movements along the curve.

In this question all we know for sure is that the price has changed and there is no indication that the curves have shifted so the answers referring to "Level" of demand or supply don't apply. Of course, since the price has risen the answer "an increase in quantity demanded" is wrong which leaves "quantity supplied to increase" as the only possible answer.

What has happened here could be a government imposed price floor in which a law is passed making it illegal to sell below a certain price and that price has been set above equilibrium. Or it could be a cartel (a group of suppliers coming together to agree not to sell below a certain price - this is illegal in the U.S.) like OPEC and the new agreed upon price is above equilibrium.

Finally, it could be a shift in the supply and/or demand curve which results in a new, higher equilibrium price. Any one of these will result in an increase in the quantity supplied as explained in the first paragraph. However, there is nothing in the question that indicates this, so all we have to go on in selecting an answer is the fact that the price has risen.

Wednesday, June 08, 2011

Deleveraging Defined

Deleveraging or de-leveraging is a financial term that has become increasingly common since the start of the current recession.

In finance we use the term leverage or financial leverage to describe the process of borrowing and using debt to help finance the purchase or acquisition of assets. It is no secret that borrowing is a way for a business or a person to acquire more money for a purchase and the more money one has the more they can buy.

Deleveraging refers to paying down and reducing debt. In business this usually involves the selling of assets and using the proceeds to repay debt. In many cases the assets being sold are ones that the business took on debt by borrowing money to purchase the assets they are now selling.

Deleveraging is a term that is also applied to individuals. Since the start of the current recession the term has frequently been used to describe reduction of debt by individuals.

While many individuals have done this by selling assets - homes, cars, etc. - the more common way is to accelerate the repayment of outstanding debts by devoting more of their disposable income to debt reduction rather than to other things. This has frustrated some economists and policy makers, especially those of the Keynesian persuasion, who have been counting on households to maintain their spending levels on consumer goods rather than on paying down debts.

Debt can be a useful tool for business, households and even governments when used wisely. However, after splurging on debt for the past couple of decades or so, the current spate of deleveraging is a healthy trend.

Monday, June 06, 2011

Why Congress Shouldn't Raise the Deficit Ceiling

Listening to the Democrats in Washington and their allies in the liberal media one would think that the United States is similar to Greece and on the brink of financial collapse.

However, looking at the financial markets, especially the bond market, one sees business as usual with no concern.

The markets are only concerned with default if the default, which is failing to pay or being unable to pay a debt on time, affects the government's ability to pay the interest due bond holders when due. What the markets are concerned with is not whether the U.S. Government will be pay all its bills on time, but whether or not the U.S. Government will be able to make the full interest payment that is due holders of U.S. Government bonds later this summer.

In the case of the U.S. Government, even skipping the interest payment would not put the U.S. on par with Greece. Instead, it would be more like and individual being late with a mortgage payment. The bank would become concerned, slap a late charge on the account and lower the individual's credit score. However, so long as the borrower has the potential to continue to make payments, the bank is not going to foreclose just because a payment is a few days late.

The United States remains a very wealthy nation and has the capacity to honor all of the government's debts.

The U.S. Government is basically having a cash flow problem in which its revenues (tax receipts and other sources of revenue) are not quite sufficient to meet its expenses as they come due. This revenue shortage is due partly to the recession which has resulted in an economic slowdown and mostly due to the out of control spending by the mostly Democratic Congress and Obama Administration.

This irresponsible spending binge has now caught up with them and their solution is to ask Congress to be allowed to borrow more and to also raise taxes so that the Administration's spending binge can continue. This is like an individual maxing out his credit cards in Vegas and, rather than coming home, calls his credit card issuers and asks to have his credit limit raised on the cards and then calling his employer requesting a raise supposedly to pay down the debt.

However, if he gets the credit card limits increased and pay raise he will simply continue his Las Vegas vacation and run his debts up to the new credit card limits.

If the employer and credit card issuers refuse to grant the vacationer's requests, he will be forced to cut his vacation short, return home and start making some serious changes in his spending habits.

The same is true of the Administration and Democratic controlled Senate. This is why the Republican controlled House of Representatives should hold the line and demand major spending cuts, and no tax increases, before agreeing to raise the debt limit which will allow the Government to continue to pay all of its bills - bond interest and other bills - on time as they come due.

Since the U.S. Constitution stipulates that all revenue bills (i.e., bills dealing with taxes, spending and borrowing authority) must originate in the House of Representatives, responsibility for halting the insane spending and borrowing by the government lies with the House of Representatives. With their control of the House of Representatives, the Republicans are in a position to force the rest of the government to get its fiscal house in order so that U.S. does not end up facing bankruptcy like Greece.

Friday, June 03, 2011

Fear of Future Oil Shortages are Causing Gas Prices to Rise

In addition to the stagnant economy and continued high unemployment, the American economy is also being hit by rising gas prices.

People are paying as much as $100 or more every time they fill their tank.

According to the Administration, Congressional Democrats and their supporters in the mainstream media the problem is a combination of a shortage of oil and and the OPEC cartel conspiring to raise oil prices.

The fact is that the so called oil shortage or energy crisis is a myth. The problem is the misguided policies of the Federal Government and not a lack of oil or conspiring by Middle Eastern oil producing nations.

The oil shale lands in the Rocky Mountain area of the United States and the oil sands area in western Canada EACH have potential oil reserves greater than the proven reserves in the Middle East.

These shale oil deposits are in ADDITION to other oil producing areas in Texas, California, Pennsylvania, Alaska and other parts of the U.S. which are currently producing oil.

Then there are the proven reserves, most of which are currently off limits to drilling, off our Pacific, Gulf and Atlantic coasts as well as the, also off limits, Alaskan National Wildlife Refuge (ANWR).

Oil and gasoline prices are being driven up not so much by rising current demand and limited Middle Eastern supplies of oil but by fears of future shortages when the Middle Eastern supplies run out.

It is true that oil produced from the shale fields and offshore fields will be more expensive than current Middle Eastern oil and. It is also true that it will take a number of years to get production in these areas in the United States up to speed (actually Canada is already producing from its oil sands fields, but environmentalists in the U.S. are blocking a proposed pipeline that would bring it to the U.S.).

However, simply removing U.S. Government restrictions preventing the drilling of the shale oil and in off shore areas would be a signal to users that future supplies will be available. This act alone will cause prices in oil futures markets to fall and when they fall current prices will also fall.

Proof of this can be found in 2008 rapid rise in oil prices which promptly fell when then President George Bush removed restrictions on offshore drilling causing current prices to drop almost immediately. Click on the link below for my article on this.

Politics and Falling Oil Prices


Wednesday, June 01, 2011

A Plan to Keep Medicare From Going Broke

It is no secret that Medicare is going broke.  Costs are rising faster than revenue from Medicare taxes paid by existing workers.  Each time a member of the Boomer generation retires and becomes covered by Medicare, the system's costs increase due to increase in the number of people covered while its revenues decrease as fewer people are working and paying Medicare taxes.

Left unchecked, the system will soon go broke.  To prevent this Wisconsin Congressman Paul Ryan and his fellow House Republicans in their budget proposal, known as A Road Map for America's Future, have included a section with a very good proposal to solve the Medicare problem and keep it from financial collapse.  

Congressman Ryan explains the plan for Medicare in the video above.

Business Management Daily Quote