Higher Taxes, Inflation, Default (Choose One)

I am a mix of analysis and intuition. Few argue with my analysis, a decent number argue with my intuition.  But I am not the only one concerned about monetary policy.  Listen to Warren Buffett (pages 12-16, but he comments elsewhere on the cost of capital and the inability to compete on an unlevered basis because of low rates.  Buffett is uncomfortable with the idea that the Fed can expand its balance sheet indefinitely.  He doesn’t know why it won’t work, but he knows that there are no free lunches, and wonders what might happen as a result.

Or, read this piece that disses quantitative easing.  Truth, there is no easy transmission mechanism between quantitative easing and employment.  It is a fools game, and when I say that, I say that neoclassical economists are sophomores, that is, “wise fools.”

Are they bright? Yes.  Have they imbibed dumb ideas that have a patina of intelligence? Yes.  Too much private debt leads to banking crises.  Too much public debt leads to worries over higher taxes, inflation and default, which inhibits private action, leading to a slower economy.

The Federal Reserve has discovered that they have a real balance sheet.  They not only have a liability policy, as in the old days, but they have an asset policy, allowing them to take on pseudo-fiscal stimulus.  Sadly, the idea that a central bank should not take asset risks is out the window.

Just as the referendum process makes legislators lazy, in the same way delegating economic policy to a central bank makes legislatures lazy — they can do nothing, and let the central bank react.

Part of the problem here is that we are relying on the models of the economists who argued that debt is neutral, and could not see the crisis coming.  Debt is the problem.  Debt-based systems are inherently inflexible and lead to crises when they are too big.  All significant economic crises are debt crises.

We need to get the neoclassical economists out of the Fed.  They can’t think broadly enough to see the problems we are in.  We need people who can think long-term, like actuaries and value investors.  (Please tell the SOA, CAS, and CFA Institute to rid their curricula of neoclassical economics.)  There is enough intelligence in those two groups that a new theory of what to do could emerge, perhaps realizing that optimizing the short-term ruins the long-term, and vice-versa — sometimes you have to take a depression to realign your economy.

In general, the US Government has not displayed any real talent in managing the economy.  If I could rewrite the Constitution, I would limit the Federal role in matters economic, and eliminate the possibility of a central bank.  Even when it did work well under Martin and Volcker, it does not make up for Greenspan, Bernanke, Burns, Miller, Harding, Crissinger, and Young.

I would also require balanced budgets on an accrual basis, ending the problems of non-funding Social Security and Medicare.  The problem of promises now, performance later will bite us hard, and most of the rest of the world also, because changing old age security from a personal issue to a collective issue has this problem: there is no reason for any husband and wife to have more children.  This is hitting the rest of the world harder than the US, because the (mostly dead) Protestant optimism of the US leads people to have more have more children. (Please remember that the group in history that had the largest completed family size was not the Catholics or the Mormons, but the New England Puritans, who averaged 9.5 children in families where the wife survived.)  Also note that Puritan husbands cared for their wives deeply.

As for me, my wife and I bore 3 children, but not for lack of trying for more.  We never used birth control.  We also adopted 5, sending us through the social work system 5 times.  It is challenging to raise a large family, but it was worth it.  We are on the receding side of it, with our youngest now aged 10.  The challenge of raising older children is significant.

Um, I got off-track.  The grand scheme is that many think that they can borrow big in the present, and it won’t have any significant consequences in the future.  That idea will fail in some way in the future, but how it fails is an open issue.


  • taw says:


    Thank you for sharing. God Bless you and your family.

    I enjoy your blog especially your actuarial approach to more than just insurance company pricing and reserving. I am a FCAS and we need to encourage more actuaries to head off in non-traditional careers as you have done.

  • vin says:

    I’m still in the formative stages of wrapping my head around the subject of economics and all its various tangents and theories, so you’ll have to pardon me for my ignorance, but I just have a few questions:

    1. “Too much private debt leads to banking crises. Too much public debt leads to worries over higher taxes, inflation and default, which inhibits private action, leading to a slower economy”

    I agree with private debt being a huge concern but aren’t the worries over public debt mostly hyperbole? On a purely operational basis, why would a country like the US, or Australia, which is where I’m from, choose to default on debt denominated in its own currency? I don’t see why default risk should be a concern. Inflation is a concern in theory but it currently low in the US.

    I’d say the worries should be inflation and inefficient government spending not insolvency, though I can see how incorrect perceptions about the economy and its various institutions can lead to misplaced worries about the market.

    2. Balanced Budgets:

    Under current economics conditions, where firms are deleveraging and consumers aren’t spending, wouldn’t a balanced budget completely destroy the economy? I was of the belief that deficit spending saved the economy from spiralling into a deep recession; if one sector of the economy isn’t spending the other needs to spend to drive aggregate demand.

    Further, don’t deficits automatically increase as an economy enters a recessionary period due to the automatic stabilisers? Household income and private spending/profits fall, tax revenues decrease, transfer payments increase therefore gov spending as % of GDP increases.

    or is my eco101 useless :(


  • cig says:

    Isn’t there an internal consistency problem between the argument that QE doesn’t work and that QE is dangerous? What about picking one? (Personally I believe QE is as pointless as it is harmless.)

    On the issue that “all significant economic crisis are debt crisis”: technically it should not be hard to move most/all forms of financing currenty done with debt to equity (fixed income need not exist), do you believe that would remove “significant economic crisis”? I don’t think so, it would make resolution smoother but not eliminate them: basically the forces involved would still be at play in the absence of debt as the most popular transmission mechanism.

    As for long term vs. short term, in the long term we’re all dead — optimal individual financial planning should end with a balance of $0 after funeral expenses are paid — and so the sweet spot is somewhere in the middle, being full on either side of the dial is no good, as in many things.

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