Coyote Blog

If I was an economics grad student, here is a study I would love to do.  Identify products or industries for which third-party payers, and particularly the government, contribute a substantial amount of the purchase volume, either from outright payments or loan guarantees.  Here are three biggies I can think of:

• Health care
• Houses
• College

Then look at the differing inflation rates over the last 20 years for these vs. a basket of other goods purchased the traditional way (ie with your own damn money).  I think you can see just from visual inspection where the answer is going to go.

My new column is up at Forbes, and is on the Democratic push to raise the prices of Chinese goods (either through currency policy or tariffs).  This has to be one of the craziest campaign themes of all time -- please, let us raise your prices.

We should be thrilled that the Chinese government and its people see fit to spend their own money to subsidize lower prices for American businesses and consumers.  Last week, President Obama put substantial pressure on the Chinese prime minister to revalue Chinese currency, a revaluation that would have the effect of raising prices of all Chinese goods in the United States.  What possible sense does such a move make, particularly in a recession?

Christian Broda and John Romalis, a pair of University of Chicago economists, have been doing work on income distribution.  A couple of years ago they published a paper that showed how our measures of income inequality may be exaggerated because the metrics assume that both rich and poor experience the same rate of inflation.  In fact, the researches found, over the last decade or so the poor have seen much lower rates of inflation than the rich, in large part due to goods of the type imported by China and sold at Wal-Mart (another institution Democrats like to demagogue against).

Sadly, prices for low-income Americans could be even lower were it not for past protectionist measures.  When one looks at the goods that have the highest import tariffs, one sees the very same goods that typically make up a disproportionate share of the poor's purchases:  Tobacco, clothing, tires, auto parts, fruits and vegetables.  All of these have their prices raised 20-350 percent by import tariffs.

This means that at the same time Democrats have again raised issues of rising income inequality, they are trying to stop some of the most powerful forces at work mitigating these income differences.  There is no question that if Democrats are successful in changing China's currency policy and/or imposing new tariffs (taxes) on Chinese goods, prices will rise for all Americans, but particularly so for the lower income brackets that are supposedly the Democrats' constituency.

The most frustrating part of this whole effort is that it is aimed at a myth: the declining American manufacturing base.  In fact, American manufacturing output continues to hit new all-time highs "” despite the current recession, American manufacturing output today is still 40% higher than it was in 1990.

Consider this story in the context of my previous post on the poor having a lower inflation rate due  in part of the effects of Wal-Mart and Chinese -made goods:

President Obama increased pressure on China to immediately revalue its currency on Thursday, devoting most of a two-hour meeting with China's prime minister to the issue and sending the message, according to one of his top aides, that if "the Chinese don't take actions, we have other means of protecting U.S. interests."...

The unusual focus on this single issue at such a high level was clearly an effort by the White House to make the case that Mr. Obama was putting American jobs and competitiveness at the top of the agenda in a relationship that has endured strains in recent weeks on everything from territorial disputes to sanctions against Iran and North Korea.

Democrats in Congress are threatening to pass legislation before the midterm elections that would slap huge tariffs on Chinese goods to undermine the advantages Beijing has enjoyed from a currency, the renminbi, that experts say is artificially weakened by 20 to 25 percent.

Somehow this was written with words like "competitiveness" and "artificially weakened" to hide the fact that what we are talking about is raising prices to American consumers (by as much as 20-25%, one infers from the last paragraph).  Not only would this make Chinese goods more expensive, but it would reduce the downward price pressure on goods made elsewhere.

Which of course is the whole point, because this is a narrow special interest issue putting a few vocal industries interests over those of the broader group of American consumers.  How many of us are consumers?  How many of us work for service and manufacturing and retail businesses that buy Chinese goods?   Now, how many of us work for a product business that competes directly with Chinese manufacturers?  The first two groups dwarf the second, but Obama is just as beholden to these interests as was Bush.

First, I have not doubt that income inequality--  in whatever way the folks who care about such things measure it -- has increased.  The analysis that has been making the rounds of liberal blogs show the rich "capturing a higher share" of total output.  The very terminology here reveals their faulty core assumption, treating wealth as a zero-sum that must be grabbed and fought for and can only be gained to someone else's disadvantage.  They always write about incomes as if GDP is a sort of natural fountain in the desert, and the piggy rich crowd in too close to get more than their fair share of water from the fountain.

This is silly.  Wealth is created from the minds of human beings, and there are human minds that create far more wealth than others, and are able to keep some of that wealth for themselves as a reward.  I say "some" because even the richest people tend to keep only a small percentage of the wealth they create.  Sum up the benefits we all get from our iPods and iPhones and iPads, and the total number dwarfs what Apple shareholders have made from these devices.

Anyway, the actual point of this post was to revisit the notion that there are different inflation rates for the rich and poor (via Carpe Diem) that may be skewing income inequality numbers

Using scanner data on household consumption of non-durable goods between 1994 and 2005, we document that the relative prices of low-quality products that are consumed disproportionately by low-income households were falling over this period. This implies that non-durable inflation for the 10th percentile of the income distribution has only been 4.3 percent between 1994 and 2005 (0.4 percent per annum), while the non-durable inflation for the 90th percentile has been 11.9 percent (1.0 percent annually), and 13.4 percent (1.2 percent annually) for the richest 5 percent of households in the sample (see chart above)."...

"A large literature has focused on the rising inequality observed in official statistics, but have mostly abstracted from the fact that these official measures are based on a single price index for a representative consumer. This assumption is not crucial in a world with a stationary relative price distribution or where an identical basket of goods is consumed by different income groups. However, using household data on non-durable consumption, we document that the relative prices of low-quality products that are consumed disproportionately by low-income consumers have been falling over this period.

This fact implies that measured against the prices of products that poorer consumers actually buy, their "real" incomes have been rising steadily. As a consequence, we find that around half of the increase in conventional inequality measures during 1994"“2005 is the result of using the same price index for non-durable goods across different income groups. Moreover, given that the increase in price dispersion does not seem to be specific to our sample or time period, the overstatement in the increases in inequality from official measures can be even more significant, changing our view of how progress has been distributed in recent decades substantially."

The price of a night at the Four Seasons has gone up more than the price of a shirt at Wal-Mart.

Kevin Drum observes that the Post Office is more efficient and effective than we give it credit because ... it fully accrues for future pension and medical costs.

Over at Jon Cohn's place, Alexander Hart explains why the post office is better run than you think. Go read it. I don't have any big axe to grind in favor of the USPS "” in fact, I'm pretty annoyed at how complicated it is to calculate postage these days on supposedly "odd" size envelopes "” but the fact is that they're actually pretty efficient and pretty cost effective. I'd welcome private competition for first class mail, but just go ahead breathe the words "universal service" and see how many private sector companies are still eager to compete with the post office for 46 cents an ounce.

Wow, I have been so unfair to the post office.  I commented:

Great - the post office is really efficient because ... it fully accrues for benefits plans that are way beyond anything paid in the private sector, and reliably pays these benefits to huge, bloated work forces.  I am confused Kevin.  I read the article you linked.  What the heck did you find in the linked article that had anything to do with "efficient" or "cost effective."  Postal rates have grown at something like twice the rate of inflation.  Even industries you demagogue against, like oil, have raised prices less than the post office.

I don't know much about Alexander Hart, but my suspicion is that this is somehow a broadside in the public-private battle.  If so, then his focus is awfully narrow.  The feds may have accrued for their pension and health benefits, but they sure have not socked away any assets besides government IOU's to pay for them.  At the end of the day, most private company health and retirement plans are actually backed with real, 3rd party assets.  If you want to talk about pension law, private companies are not allowed to invest but a small percent of pension funds in their own stocks and bonds.  Not so the Feds -- the Post Office is running the equivalent of the Enron 401K invested 100% in Enron bonds.

And oh by the way, if we turn our attention to the states or local governments, the situation is entirely reversed.  In fact, many US public entities have ZERO percent funding of health plans and ZERO accrual of future costs, taking retiree benefits entirely out of current cash flow.

Opponents of free trade will often say publicly that they are all for free trade but it must be "fair," which they generally would define as balanced between imports and exports.  This is a dodge, because they know many of our trading partners are not going to open up trade to be entirely free so they can use that inevitability as an excuse not to remove American protectionist barriers.

But trade does not need to be balanced to create wealth, and in fact it is not just exports that provide a boost to real incomes.  Daniel Ikenson at Cato has these two charts comparing the CPI for items that face competition from imports and those that don't:

See his article for more discussion.

This is also related to something I read about a while back, that we may be underestimating income gains among the lower income quartiles in this country because we adjust to real wages based on an average inflation rate.  The argument was that the inflation rate for the poor has been lower  (the Wal-Mart effect) than the inflation rate for the rich (prices at the Four Seasons keep going up).  One estimate put the difference in inflation rates as high as 6 percentage points, in part because the poor proportionally consume a lot of goods that are imported while the rich consume proportionally a lot of services that are produced domestically with high cost labor.

At least, that is, when the government is managing the ice supply:

Venezuela's economy is in trouble despite the country's huge oil reserves. Blackouts plague major cities. Its inflation rate is among the world's highest. Private enterprise has been so hammered, the World Bank says, that Venezuela is forced to import almost everything it needs.....

This is not the way it was supposed to be. Venezuela is one of the world's great energy powers. Its oil reserves are among the world's largest and its hydroelectric plants are among the most potent.

I missed this in the original discussion of the stimulus.  I was one of the first to point out that most of the stimulus was earmarked for maintenance of state government budgets rather than the infrastructure projects people thought they were getting  (here and here).  But I missed this part of the law, which basically made acceptance of these funds a suicide pact for many states:

Worst of all, at the behest of the public employee unions, Congress imposed "maintenance of effort" spending requirements on states. These federal laws prohibit state legislatures from cutting spending on 15 programs, from road building to welfare, if the state took even a dollar of stimulus cash for these purposes.

One provision prohibits states from cutting Medicaid benefits or eligibility below levels in effect on July 1, 2008. That date, not coincidentally, was the peak of the last economic cycle when states were awash in revenue. State spending soared at a nearly 8% annual rate from 2004-2008, far faster than inflation and population growth, and liberals want to keep funding at that level.

A study by the Evergreen Freedom Foundation in Seattle found that "because Washington state lawmakers accepted $820 million in education stimulus dollars, only 9 percent of the state's $6.8 billion K-12 budget is eligible for reductions in fiscal year 2010 or 2011." More than 85% of Washington state's Medicaid budget is exempt from cuts and nearly 75% of college funding is off the table. It's bad enough that Congress can't balance its own budget, but now it is making it nearly impossible for states to balance theirs.

These spending requirements come when state revenues are on a downward spiral. State revenues declined by more than 10% in 2009, and tax collections are expected to be flat at best in 2010. In Indiana, nominal revenues in 2011 may be lower than in 2006. Arizona's revenues are expected to be lower this year than they were in 2004. Some states don't expect to regain their 2007 revenue peak until 2012.

So when states should be reducing outlays to match a new normal of lower revenue collections, federal stimulus rules mean many states will have little choice but to raise taxes to meet their constitutional balanced budget requirements. Thank you, Nancy Pelosi.

Apparently a couple of states (no surprise, Texas is among them) were smart enough to turn down some of the money.

I am sure there are more landmines hidden in the Senate Bill, but the Heritage Foundation has parsed an implementation schedule from the most recent bill:

2010: Physician Medicare payments decrease 21% effective March 1, 2010

2011: "Annual Fee" tax on health insurance, allocated according to share of total premiums. Begins at $2 billion in 2011, then increases to $4 billion in 2012, $7 billion in 2013, $9 billion in the years 2014, 2015, and 2016, and eventually $10 billion for 2017 and every year thereafter. Two insurers in Nebraska and one in Michigan are exempt from this tax.

2012: Medicare payment penalties for hospitals with the highest readmission rates for selected conditions.

2013: Medicare tax increased from 2.9% to 3.8% for incomes over $250,000 (joint filers) or $200,000 (all others). (This is stated as an increase of 0.9 percentage points, to only the employee's share of the FICA tax.)

2014: Individual mandate begins: Tax penalties for not having insurance begin at $95 or 0.5% of income, whichever is higher, rising to $495 or 1% of income in 2015 and $750 or 2% of income thereafter (indexed for inflation after 2016). These penalties are per adult, half that amount per child, to a maximum of three times the per-adult amount per family. The penalty is capped at the national average premium for the "bronze" plan.

2015: Establishment of Independent Medicare Advisory Board (IMAB) to recommend cuts in Medicare benefits; these cuts will go into effect automatically unless Congress passes, and the President signs, an override bill.

2016: Individual mandate penalty rises to $750 per adult ($375 per child), maximum $2,250 per family, or 2% of family income, whichever is higher (capped at the national average premium for the "bronze" plan). After 2016, the penalty will be increased each year to adjust for inflation.

There is a link in the original to a more detailed timeline.  There is a lot more that is left out of this brief timeline, see it here.

I think this kind of argument might work for a libertarian, but I am not sure it is a very strong argument for a liberal Democrat that wants to do more rather than less of what Congress and the GWB administration did over the last 8 years to worsen the recession.

Personally, though, I'd say Obama has been remarkably restrained about the whole thing, especially when it comes to our disastrous fiscal situation.  In a mere eight years, George Bush and the Republican Party managed to take a thriving economy and a federal surplus and turn it into a hair's breadth escape from Great Depression II and an endless fiscal sinkhole.  Rome may not have been built in a day, but it didn't take much longer than that for the modern Republican Party to bankrupt America.

Particularly hilarious is that Drum blames the cost of the useless but expensive stimulus bill on GWB.  Huh?  And blaming Republicans for Fannie and Freddie is a real joke.

As you might imagine, the deficit in his world is all from tax cuts and not above-inflation increases in spending.  The basic picture he shows is absurd - money is fungible, so any trillion dollars of the government spending could be blamed for the deficit - it just depends on what spending you consider incremental.  Stupid analysis.  Though it is interesting that at least two of the major drivers even by their slanted analysis - Bush tax cuts and Afghanistan - are policy issues Obama was presented with opportunities to reverse and chose not to.

Violet at Reclusive Leftist writes in an article entitled, "Dreaming of Diocletian":

When the Roman Empire was broken, Diocletian fixed it. He completely revamped the imperial government, discarding centuries of tradition in favor of a new organizational structure designed to meet the challenges of the day. You can do stuff like that when you're an emperor. It was sort of a one-man Constitutional Convention.

I think of Diocletian whenever I contemplate the political mess in this country.

Let's make sure we understand what Diocletian did.  What she calls "fixing the Roman Empire" was in fact the imposition of a new level of autocracy.  The best modern equivalent would be if Putin were reunify the old Soviet Union through military force and repression.  Would we celebrate this? No?  Then why do we celebrate when it happened 18 centuries ago?

Certainly since Augustus, the Empire had been ruled autocratically, but there were checks on the Emperor's power, not the least of which was the fact that the Empire simply didn't have the bureaucracy or communications for real command and control governance.  Further, the Emperors had at least maintained a facade, and sometimes a reality, of being a servant of the people - calling themselves Princeps , or something like the "first man."

Diocletian changed all of that.  He demanded people call him Dominus and Deus, meaning Lord and God.  But Lord is a poor translation of Dominus - literally dominus meant master to a slave.  The Empire became a nation of slaves with one master, Diocletian.  Any who approached Diocletian for audience had to approach on hands and knees with face averted.  If Diocletian ruled in ones favor, he was allowed to crawl on hands and knees and kiss the hem of the Emporer's tunic.

Diocletian was faced with an enormous economic problem - the debasement of a currency by generations of emperors who spent more than they had (sounds familiar).  Instead of forcing the hard changes to re-establish a sound currency, Diocletian dealt with the rampant inflation from the debased currency by setting maximum prices for every good and service in the Empire, with violations punishable by death.

When the inevitable shortages occurred (as happen whenever the government enforces a price ceiling), Diocletian dealt with the shortages by forcing key businessmen (bakers, sausage makers, etc.) to remain in business (can you say directive 10-289?)  Further, he mandated that all children of these men must remain in the same profession perpetually.  If your father was a baker, by law you were to be one as well.  He also did this for a number of underpaid government jobs that no one wanted - making them hereditary so people of the future would be forced to fill them.

Diocletian also had a tax problem.  Much of his taxes came from property taxes on farm land.  The tax was attached as a fixed amount to certain pieces of land.  When those values got too high, the occupants abandoned the land and moved to the city, and no one was there to pay the tax.  Diocletian took a census and forced peasants to return to the land of their birthplace, and forced them to remain in perpetuity on certain plots of land and then pay the taxes on that land to the government  (eventually these taxes morphed into rents to the local government noble in charge).

If you see the origins of much of the worst of the middle ages in all of this -- serfs tied to the land, paying rents to the master, with hereditary professional guilds in the towns -- you are not far off.

When I dream of Diocletian, all I get is a nightmare.

PS- Which is really what the quoted author wants, some sort of fascism by females.

For years in Arizona we have been told by the state government that we need to subsidize science.  I have never really figured out why my life would be better if scientists lived in Arizona instead of California, but apparently when governors get together and compare their states' penis lengths, this is one of the key topics that come up.  Why we need to subsidize, for example, bio-science in Arizona to keep up with California but folks in Kansas don't need to subsidize, say, awesome golf resorts to keep up with Arizona has always escaped me.  I have always felt that if we just keep taxes low and wait long enough, California is going to blow up and we will collect a lot of the best and brightest with no extra effort.

Well, I am starting to understand why we needed to subsidize bio-science with our Arizona taxes.  We apparently need to do so to ... attract large grants for Federal tax money.  So by subsidizing this sector locally, we built it up enough to attract Federal subsidies.  Great.  Actually we probably did not build up the sector per se, we just built a quality private bureaucracy that had the skills and incentives to write lots of successful grant applications.  Apparently there is still work left to do, though, as other states have invested in even larger grant-magnets:

States with strong science bases such as California, Massachusetts and New York, each landed more than 1,000 grants.

Twenty states secured fewer grants than Arizona's haul of 101 awards.

Arizona scientists will study things such as predicting asthma in babies, prostate cancer and the behavioral responses of kissing bugs, which are blood-sucking insects linked to a blood-borne disease that afflicts 11 million to 13 million people in Mexico and Latin America.

Arizona scientists say the batch of stimulus dollars through the NIH is a welcome change from years of stagnant federal funding for scientific research.

"There was no increase in federal funding for cancer research for five years - that was devastating," said Dr. David Alberts, director of the Arizona Cancer Center in Tucson. "Now, I'm encouraged."

Wow - thus we see why government spending grows so much faster than inflation.  Flat spending = devastating.

If I were in academia, the study I would like to do is to try to assess the total value destroyed by state and local governments merely in trying to move businesses and facilities from one part of the country to another.

To some extent, there are signs Obama may be willing to walk back health care "reform" to just insurance "reform," though the two are highly related.  As a minimum, insurance "reform" is likely to include rules that no one can be denied coverage, community rating, and minimum covered service requirements.

These are really, really expensive.  Megan McArdle on the NY experience:

John Cole takes me to task for not knowing that health insurance premia have tripled in New York State.  Indeed, he's right--I should have checked.

But this is not the "gotcha" the left believes.  I erred so low because I was trying to be charitable to the cause of national health care.  You see, the reason that insurance premia are so high in New York State is that New York State enjoys community rating, guaranteed issue, and a very generous bevy of mandatory services.  The result is that the cost of insurance is very, very high.  What I failed to realize was just how radically out of line New York's rules had pushed its health care costs.  The average premium across the United States has increased about 25% since 2004.  In New York, the rate of inflation has apparently been about 16 times that.  I wasn't "aware" that insurance premiums have doubled and tripled over the last seven years, because for the country as a whole, this isn't true.

McArdle is sometimes irritating in bending over backwards to be fair to folks whose views don't deserve such charity and who would not ever extend the same favor back at her.  So it is kind of fun to see her going a bit postal over the last few days.

From Randal O'Toole (of course). I usually try not to over-excerpt other folks work but I just can't resist in this case.  I like Mr. O'Toole's work on transit because he does not just focus on the cost-benefit issues, but the personal liberty aspects as well:

My testimony focused on two points. First, despite increasing transit subsidies by 1250 percent (adjusted for inflation) since 1970, transit travel has declined from 49 to 45 trips per urban resident and transit's share of urban travel has declined from 4.0% to 1.6%. Second, even if we could get more people to ride transit, transit uses as much energy, and emits nearly as much greenhouse gases, as cars; and the trends suggest that cars will be more environmentally friendly than any transit system in the country by 2025.

There were two interesting responses to my testimony. First, another witness said (and I'm quoting from memory), "All he did was divide total greenhouse gas emissions by passenger miles." A reporter told me later that it sounded like he was questioning my methods, but his real argument was that more money spent on transit in combination with smart-growth land-use planning would lead to reduced auto driving.

I don't believe that is true (and said so), but even if it were true: can you imaging AT&T (back when all phones were land lines) telling Congress, "We want you to restrict property rights, drive up housing prices, and prevent people from living in their preferred lifestyles so that we don't have to extend our lines so far?" Or FedEx or UPS saying the same thing today? Why is transit so special that everyone else in the country has to completely rearrange their lives just for it?

You can say the answer is "climate change," but transit agencies and smart-growth planners wanted to do all these things before climate was an issue. The truth is that transit is a declining but politically powerful industry, and part of its power comes from the fact that it is publicly owned and so elected officials have a vested interest in keeping it going.

In a very real sense, transit is just like the British coal, rail, and other nationalized industries in the 1960s: its main purpose is no longer transportation but to meet other political goals such as keeping transit workers employed and construction contracts going to transit builders. If transit were private, no one would argue that we have to make the world less convenient and more expensive for the 95 percent of people who travel by car so that it will be more convenient for the 1 or 2 percent who travel by transit.

A while back I worried that frequent, random, and unprecedentedly extensive Obama interventions in the economy and private commerce could well cause any economic recovery to stagnate as businesses sat on their wallets waiting for more clarity.   Though the ins and outs of the Great Depression are endlessly debated, there is good evidence that the Depression was extended by just this effect, in particular by the effects of the National Industrial Recovery Act, America's flirtation with Mussolini-style fascism.

Economist MaxedOutMama (who, to her credit, was sounding alarms last year long before most everyone else including me were) says that there is still a lot to be worried about and that businesses are indeed sitting on their wallets:

The rolling four-quarter change for GDP is now -2.5%. Far more frightening is the same figure for gross private domestic investment, which in Q1 was -23.6%, and has now been falling since fourth quarter 2006! Gross private domestic investment is the fundamental driver of this economy and just about every other economy, and at no time can one ever rack up a such a string of GPDI decreases in an economy without generating a pretty intense recession.

That is the first thing on which every realistic economist must stay concentrated. Talk about a credit crisis does not address the fundamental economic operator, and dumping a lot of stimulus money into the economy will not overcome a recession produced by collapsing GPDI unless it boosts domestic investment - which our stimulus package does not.

In fact, I would argue that government actions over the last 6 months, from executive compensation controls to Waxman-Markey to health care "reform" all do just the opposite -- suppress investment by increasing uncertainty.

By the way, the inflation I have been promising for a while has obviously not occured yet.    The Fed says they have it under control.

The Federal Reserve signaled Wednesday that the weak economy likely will keep prices in check despite growing concerns that the trillions it's pumping into the financial system will ignite inflation.

Fed Chairman Ben Bernanke and his colleagues held a key bank lending rate at a record low of between zero and 0.25 percent. And they pledged again to keep it there for "an extended period" to help brace the economy.

Inflation is this massive rock that takes a while to start moving.  The Fed has pushed the rock right to the top of the mountain but says not to worry, if it starts accelerating down the hill they will be able to stop it.   Don't believe it.

If I have not been convincing enough, Q&O has more on why you really, really should be planning for inflation.

I don't generally give investment advice, because I am not really qualified to do so and I make enough mistakes with my own investments that it seems silly to give other people advice.

But these are extraordinary times, and I do want to pass on one general piece of advice: Be ready for inflation.  If you are under forty, you probably don't even remember any real inflation, so you may need to seek advice as to how to handle it.

I just do not see how there is going to be any way to avoid a substantial uptick in inflation over the next couple of years. Crazy-large deficit spending, huge inflation of the money supply, absurdly low interest rates, massive government money-printing efforts, and government-mandated tilts in the balance of power between labor and management towards the unions can only add up to inflation,

Now, if we were really in the next Great Depression, as the Obama administration tried to tell us in its early weeks (mainly in order to pass pet legislation in a mood of total panic), then we might not see much immediate inflationary pressure. But I think most of us are realizing that the whole depression thing was over-sold. We are likely already on the first steps towards a recovery (if the Administration does not keep doing stupid stuff to kill it) and this recovery will become obvious by the third quarter (for their budget, the Obama administration is forecasting this now to be a milder-than-average recession). When the recovery starts, inflation is going to slam home hard and fast.

The smart money already knows this. That is why the government (as is the UK government) is having a hard time finding takers for long-term government bonds fixed at 4 or 5 percent. Such low rates could easily be under water after inflation.

So, find ways to hedge inflation.  Here are some general ideas:

• If you need to borrow money, now is a great time if you can borrow long and fixed (as with 30-year mortgages).  With high inflation, the amount you owe effectively goes down every year.  Borrowers love inflation!
• Avoid buying long-term bonds at fixed rates like the plague.  Again, you want to be issuing such bonds, not buying them.
• Consider various US government inflation-adjusted bonds, or shorter maturities on traditional bonds
• Equities tend to be a good inflation hedge.  Revenues and earnings go up with inflation, so equity prices and dividends tend to as well.  There will be, though, certain industries and companies that will not manage well in this environment.
• Gold is OK, but I have always thought of gold as dead value.  Sure, it can hedge inflation, but it gives no real return.  Commodity producer stocks (e.g. oil companies) may be a better bet.
• International stocks are really dicey in this kind of environment.  Added to the underlying risk of investing in less developed markets is the currency question, which basically boils down to -- we know the US is screwing up its currency, but will other countries screw theirs up worse?  If you think there is a country out there who is less likely to inflate their currency, by all means consider equities and bonds denominated in that currency.  You get the underlying return plus an exchange rate boost   (all things being equal, if the US has a lot of inflation and others don't, the value of the dollar will fall.  Thus investment returns in, say, Euros will return more dollars in the future.)

These are just some ideas, and I am not positive they are all good ones.  Talk to someone more knowledgeable than me, but whatever you do, I think you need to be planning for inflation.

The Liberty Papers thinks we have become a lawless Banana Republic.  George Will is thinking along the same lines, snarkily observing that Sweden, China, and Mexico have all observed in one way or another that the Feds seem to be acting outside the rule of law.

I have opined in the past that what really extended the Great Depression was not any real underlying economic issue, or even vast increases in government spending per se.  It was that arbitrariness with which the Roosevelt administration dealt with economic matters.  With nutty programs like the Mussolini-inspired National Industrial Recovery Act coming and going, investors and businesses never knew from day to day what the rules of the game would be next year, or even next week.

I fear that this is exactly the climate Obama and Congress are creating today.

• When Congress reacts to CNN headlines by retroactively confiscating legal compensation that it had protected just weeks before, what will happen to my compensation?
• When government deficits soar by trillions of dollars, what will taxes look like next year?
• When the Administration says that Co2 will have to be reduced by 80%, what numbers do I plug into my forecasts for fuel and electricity?
• When the government decides on a whim to print a trillion dollars more money to pay off government debt, what will inflation look like in the coming months and years?

As of two months ago, my company was still investing.  We were still getting bank credit, particularly for equipment financing, though it took more work than in the past to secure it.  We still saw opportunity in our business, and in fact saw increased opportunity in the recession for low-cost recreation options and outsourcing of public recreation facilities.

But today, I am reluctant to make any new investments.  Investing $5000 now for $8,000 a year from now normally sounds good, but what happens now that the Feds have more than doubled the money supply?  How much will $8,000 really be worth a year from now?  What will my taxes be on the increase?**  What new costs or liabilities  might be retroactively placed on me for making the investment?  What happens if beltway pundits start thinking I am making too much money?

All this commotion of government intervention started when Paulson and other Bush appointees started screaming that the banking system was going to shut down and therefore crash the whole economy.  As my readers know, I believe to this day that this was all sky-is-falling over-reaction and panic-mongering, and most of the credit crunch resulted from uncertainty about the Treasury and its statements, not due to realities on the ground.   However, whatever tightening of credit we might or might not have avoided by government action, it pales in its effect on investment in comparison to the arbitrariness and trillion-dollar-plan-of-the-day that has been the first 60 days of the Obama administration.

** footnote: For those of you who have not lived through high inflation times, taxes and inflation are a deadly combination.  That is because the Federal Government, after creating inflation, then taxes each of us on its effects.  Here is an example:  Invest $5000 now at a fixed 10% a year.  Suddenly, inflation goes up to 8% a year.  In five years, I now have a bit over $8000.  In economic terms I have made a small profit of, since $8000 in five years at 8% inflation is worth $5,445 today.

But the IRS thinks I have made $3000, not just $445, and will tax me on the full $3000.  If they take a third, I only have $7000 at the end, or $4,764 in current dollars, meaning that after taxes, I actually lost money.

This graph of the US monetary supply is un-freaking-believeable.  Someone please tell me that this is a data error or something.  I guess this is one way to bail out borrowers -- if you create enough inflation, then the real value of principle owed drops.  Sure looks like it is time to borrow long at fixed rates.  Are real interest rates about to go negative?

Via Phil Miller

By the way, this really gives the lie to the whole government stimulus effort.  They may be moving large amounts of money around, but they can't create value, and in the absence of real value creation all they are doing is inflating the currency.

Update:  Chart below is not correct.  It's enough in error that I have deleted it.  Author explains here.

William Biggs has a bunch of charts showing historic federal outlays, but below is his chart for year-over-year changes in federal outlays per capita, adjusted for inflation:

CHART DELETED

Apparently Zimbabwe had an inflation rate of 14,000% last month, for a total of 531 billion percent inflation this year.  If we assume for simplicity that inflation occurs only during working hours, if we spread if over 22 days a week, this means that ones pay at the end of the day is worth only 1/3 its value by lunch the next day, and 1/6 its value by the end of the next day.  My understanding is that Zimbabwe companies pay their employees several times a day and let them go out at lunch and buy something, anything, tangible with the cash before it is worthless a few hours later. 

By the way, I have my Zimbabwe 50 and 100 billion dollar notes on the wall of my office.  I am hoping for a trillion dollar note to go with it.  Meeses and Gippers coming soon.

I am seeing an increasing number of articles of late about differential inflation rates, and how changes in income inequality may be overstated by using a single inflation rate for rich and poor.  The argument goes that lower income folks who spend a relatively high share of income on goods that Wal-Mart and China have made cheap are experiencing a lower inflation rate than wealthier folks who have seen huge price increases at their favorite Four Seasons resort.  Mark Perry has two interesting articles along these lines.

Kevin Drum posts this chart as a one-picture refutation of McCain's statement that we are living in the best of times.

Um, OK.  We all got wealthier.  And the problem is, what?  That someone else got even wealthier than I did?  So what.  Do we really have to keep refuting this zero-sum economics-of-envy argument?

I won't get into the whole zero-sum thing, because the chart itself proves that the world can't be zero-sum, since everyone got richer on average.  But here is a full refutation of zero-sum wealth arguments.  Also, a zero-sum wealth quiz here.

Looking at changes in income brackets is
always misleading. In the US, most folks are migrating up the brackets
as they age and gain experience. So most folks benefit not just from
the increase in their bracket but a migration to the next bracket.

To this last point, the bottom end of the bracket is being flooded
with new immigrants (legal or not) with poor skills and often no
English. They drag down the averages, again understating how well the
typical person is doing.  Lifetime surveys of individuals rather than percentile brackets always demonstrate that individuals gain wealth over time much fast than this type of analysis demonstrates.  And even the new immigrants at the bottom are presumably gaining vs. their previous circumstances, or else why else would they have immigrated in the first place.

Here is an alternate response to whether we are in the best of times.

By the way, here is an interesting article on why using a single inflation rate for the poor and the rich to get real income growth may be incorrect.  There is an argument to be made that the poor have a lower inflation rate than the rich, thanks to Wal-Mart.

Christian Boda, via Q&O, discusses inflation rates in the context of income (in)equality issues.  He offers this bit of information:

Inflation differentials between the rich and poor dramatically change
our view of the evolution of inequality in America. Inflation of the
richest 10 percent of American households has been 6 percentage points
higher than that of the poorest 10 percent over the period 1994 "“ 2005.
This means that real inequality in America, if you measure it
correctly, has been roughly unchanged.

This actually makes a ton of sense - Walmart helps hold down food and clothing costs for average folks while the rich pay ever increasing rates to stay at the Ritz at Laguna Niguel.  He argues that as a result, globalization and the growth of low-cost manufacturing in China tends to help rather than hurt the poor.

It also helps to answer a question I had yesterday -- why do metrics of median wage growth adjusted for inflation tend to look unexciting, while at the same time other metrics show the poor doing so much better materially.  This notion of a graduated inflation rate by income class would go a long way to explaining these paradoxes.  In short, we may be applying the wrong inflation rate to metrics of wage growth of various income groups in assessing their well-being (not to mention the usual failing of missing individual migration between income groups).

For a while, I have been worried that the next decade may well be a return to 1970's economics, with bipartisan commitment to large government, ever-expanding government micro-management of... everything, growth-destroying taxes, and consumer-unfriendly protection of dead US industries.

Now, Megan McArdle points to an article that hints that the stagflation of the 1970's may be back as well.

Inflation and sluggish growth haven't joined in that ugly brew called
stagflation since the 1970s. They may not be ready for a reunion, but
they are making simultaneous threats to the economy and battling one
might only encourage the other.

Among a batch of economic readings today, the Labor Department
reported that import prices jumped 1.7% last month. The data included
troubling signs that consumer products, many imported from China, have
caught the inflation bug. The signs pointing to slowing growth included
a sharp deterioration in consumers' mood, as measured by the
Reuters/University of Michigan Surveys of Consumers, and a worsening
outlook for manufacturers, revealed in the Federal Reserve Bank of New
York's Empire State Manufacturing survey for February. The government
also reported that U.S. industrial production only increased slightly
during January, as colder weather elevated utilities output and offset
sharp declines in the auto and housing sectors. If indeed inflation is
teaming up with slower growth, it means big headaches for policy
makers, in particular Ben Bernanke. The Federal Reserve chief in
congressional testimony yesterday suggested that he is willing to keep
lowering interest-rates if the economy stalls. But, naturally, he will
have less room to do so if those lower rates would accelerate inflation
to unacceptable levels.