H/T to Tao
For those of you who get bored very quickly with graphs and econ-speak, please stop reading now. I rarely write and indulge in the following types of discussions on my blog, because no one understands it, it can’t be explained without boring people to sleep, and most people don’t care. If you aren’t interested, just skip to the next post.
However, my good friend Tao had an interesting post a week or two ago and I’d be crazy not to mention it since it made the economist section of my brain cringe in pain. Anything that awakens my desire to engage in an economic discussion is worth mentioning. To date, Tao is the only one aside from President Obama who has been successful in doing so. Congratulations Tao (I apologize for the delay in this post)!
Below is a graph posted by Tao last week in his post “Back to the Farm” It shows Year-to-Year changes in Real Private Investment in Software and Equipment.
From it, two things can be learned. First, if you want to get my attention, post a graph. After living in the economics world for so long, I love graphs. Second, according to Tao:
“The 1990s saw a remarkable period of sustained, high levels of investment in equipment and software. In contrast, a sustained period of very low interest rates during the current decade was barely able to coerce firms to invest in the high single digits. This, is a critical problem, reflecting low expected returns to capital investment.”
I’m on board. This makes sense! But, in classic Tao-Conservative Generation paradox, we agree on premise and come to two totally different conclusions.
“If you are not making investments in equipment and software you are basically saying that current productive capacity is good enough for the future. This should have been a sure sign that there was trouble ahead.”
Tao goes on:
“You see, during the Bush Administration you had very low interest rates and very low taxes and still you could not entice people or companies to investment in equipment and software to grow their own capabilities. Thus, as long as investment growth remains constrained, as we have saw throughout this decade then withdrawing monetary stimulus would be a significant policy error. In fact, it would lend additional credence to reports that the Fed needs to do much, much more - a massive, unsterilized expansion of the balance sheet - should they even hope to stimulate sufficient investment demand to absorb underutilized labor.”
My guess at Tao’s conclusion, which is murky, would be; Since investment has not been sustained over the last decade, companies are either obtuse in failing to invest or unable, in which case big government/big bank Fed should come in and save the companies from their stupidity or immobility or maybe even replace private investment with government investment. This is pretty much the standard song and dance from the planned economy crowd. However, our recent economic situation is telling us something completely different.
One of the biggest problems with Tao’s argument is that it fails to take into consideration a recent nuance with regard to interest rates and big government spending, which is most likely the result of a common misunderstanding between how the Fed controls long term and short term interest rates.
When companies invest in capital it is through long term interest rates and not short term. When we hear that the Fed has cut interest rates, they are cutting short term interest rates, the result of which generally has no effect on the long term rate. The Fed often tries to influence the long term interest rates through open market transactions by buying and selling stores of US treasuries. Treasuries are a major factor in long-term rates since they represent the risk-free portion of the rate of interest. Generally speaking, when the Fed buys securities, the long term rate drops and when they sell, the long term rate increases. This is the general rule when you don’t take into account the current fiscal/monetary policy. The problem with our current situation is the massive and unhealthy fiscal spending coming out of Washington, which, if left unchecked, can and will crowd out the market, negate the Fed’s ability to influence the long term rates and send interest rates soaring.
Oh, before I forget…Tao, there was something missing from your CBO graph the day before this farm post. It was President Obama’s fiscal policy, so I decided to give the full picture below.
Don’t worry folks, Obama’s definitely not as bad as Reagan or Bush or 40 years of past President’s. He’s way beyond worse. I suppose my concerns are irrational and motivated by my conservative bias. It has nothing to do with the graph above, so don’t even look at it.
President Obama’s fiscal policies leave us with a “do one of two things” dilemma. Either we don’t pass a ton of massive spending increases finally giving the little guy what he deserves and repeal the joke of stimulus Obama signed into law so that we can open up private investment in capital, or we can have government investment in capital. Please, note that this is not a short term decision. If the US government crowds out the market with high interest rates, we are not likely to see a rebound in private capital investment for years. For those of you who have faith in government capital investment…I agree, a more mobile turtle force is going to bring us into the 21st century!
Another issue that Tao, Keynes and many other economists often neglect is the company’s second source of capital funding, equity financing, which is also known as “selling stock.” Below, is a side by side comparison of the change in the S&P 500 and the change in Real Private Investment. Looks similar, doesn’t it? This is why many, including Larry Summers, have argued (and yes many have also disputed) that lowering the capital gains tax can boost Real Investment, but that would require a “lower taxes” kind of solution that just makes the rich, richer.
In short, Tao is right! There is no way us smaller-government, lower-taxes types have any solutions to grow Real Investment. Central planning is doing a great job. Especially, with turtle mobility! How silly can we be? I’ll just sit here and wait for President Obama to assign me to my farm. Like the many philosopher-king types, I look forward to the return of serfdom.
Quick note to Tao: I’m not sure where your investment graph came from, but when I pulled the data from govstats.org, I could not reproduce the same large double digit changes in the 90's. Not sure if the problem is my data or yours.