Enlightened Economics

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Archive for the ‘Monetary Policy’ Category

• Eliminate Corporate Taxes and Spur Economic Growth

Posted by Ron Robins on April 12, 2011

By Ron Robins. First published April 7, 2011, in his weekly economics and finance column at alrroya.com

What should overly indebted developed country governments do to spur economic activity and reduce deficits and debt? Should they spend more, or less? Should taxes be increased, or lowered? A number of recent studies collectively suggest that government stimulus spending provides no stimulus at all beyond the amount spent. But where there are large deficits, spending should be cut. However, the best way to stimulate the economy is through lower taxes—and especially to cut corporate taxes! But what a political bombshell these policies would be in many countries.

Increased government spending, say numerous economists trained in traditional Keynesian economic theory, should have a ‘multiplier’ effect that increases overall economic activity by an amount larger than the sum spent. However, some recent empirical research disputes that assumption.

In a prestigious US National Bureau of Economic Research (NBER) study, Identifying Government Spending Shocks: It’s All in the Timing, by Valerie A. Ramey, published in October 2009, she found that, “… none of my results indicate that government spending has multiplier effects beyond its direct effect.” That is a dollar of government spending contributes only about a dollar to economic activity.

Furthermore, the same conclusion was noted by Harvard University’s Economics Professor Greg Mankiw while reviewing new research in his blog post, “Spending and Tax Multipliers” on December 11, 2008. He stated “…Bob Hall and Susan Woodward look at spending increases from World War II and the Korean War and conclude that the government spending multiplier is about one: A dollar of government spending raises GDP by about a dollar.”

So, these studies indicate that increasing government spending does not increase economic activity by anything more than the original sum spent.

By contrast, cutting taxes may have a much larger economic multiplier effect. Quoting Professor Mankiw again, he says, “…research by Christina Romer and David Romer looks at tax changes and concludes that the tax multiplier is about three: A dollar of tax cuts raises GDP by about three dollars…” (Incidentally, Christina Romer was chairman of President Obama’s Council of Economic Advisers in 2009-2010.)

Furthermore, Professor Mankiw adds that, “…these findings are inconsistent with the conventional Keynesian model. According to that model, taught even in my favourite textbook, spending multipliers necessarily exceed tax multipliers… How can these empirical results be reconciled? One hypothesis is that compared with spending increases, tax cuts produce a bigger boost in investment demand. This might work through changing relative prices in a direction favourable to capital investment–a mechanism absent in the textbook Keynesian model.”

Reviewing the spend and tax empirical data for most developed countries suffering from large deficits and debt is this study, Large Changes in Fiscal Policy: Taxes Versus Spending, by Alberto F. Alesina and Silvia Ardagna—another NBER paper, dated October 2009. They state, “we examine the evidence… of fiscal stimuli [stimulus] and in… fiscal adjustments [reducing deficits] in OECD countries from 1970 to 2007. Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments, those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions.”

So if cutting taxes gives the best boost to economic activity, are there particular taxes to cut that provide the most economic stimulus? The answer is yes, according to the OECD study, Tax Policy Reform and Economic Growth, November 3, 2010. The reviewers say that, “…corporate taxes are the most harmful type of tax for economic growth, followed by personal income taxes and then consumption taxes, with recurrent taxes on immovable property being the least harmful tax.”

Corroborating these findings is another recent peer reviewed study supporting lower corporate taxes: The Effect of Corporate Taxes on Investment and Entrepreneurship, published in the American Economic Journal in July 2010. It stated, “in a cross-section of countries, our estimates of the effective corporate tax rate have a large adverse impact on aggregate investment, FDI [foreign direct investment], and entrepreneurial activity… The results are robust to the inclusion of many controls.” (The authors were from the World Bank: Simeon Djankov, Caralee McLiesh and Rita Ramalho. And from Harvard University: Tim Ganser and Andrei Shleifer.)

Based on this evidence, some observers argue to significantly reduce or even eliminate corporate taxes entirely! In fact, many countries and jurisdictions are reducing corporate taxes significantly, exactly because of such studies. Though no country has yet eliminated them altogether.

Most of these respected studies variously infer that one optimal solution to spur economic growth in developed countries is to cut taxes, while to reduce onerous government deficits and debt, Alberto F. Alesina and Silvia Ardagna suggest cutting spending. Moreover, some of these studies clearly demonstrate that to promote economic growth, governments should most especially cut corporate taxes. Of course this is advocated by some US ‘Tea Party’ leaders, though it is a problematic issue for electorates in many developed countries.

However, shouldn’t at least one country try eliminating corporate taxes entirely? Now that would be one country to study!

Copyright alrroya.com

Posted in Economics, Finance & Investing, Monetary Policy | Tagged: , , , , , , , , , , , , , , , , , , , | 2 Comments »

• Banks’ Cheap Money is Economic ‘Poison’

Posted by Ron Robins on March 13, 2011

By Ron Robins. First published March 10, 2011, in his weekly economics and finance column at alrroya.com

Developed world bankers continue to proclaim that enforced low interest rates—cheap money—will lead their countries back to economic prosperity. But didn’t the same policies a few years ago help bring us to the precipice of financial and economic collapse? Do they still not understand that cheap easy money led to many large US and European banks becoming gambling institutions, eventually failing and bailed out at taxpayers’ expense?

And above all, that cheap easy money enticed people, companies and governments, to become horribly indebted, with many individuals and companies failing. Soon, even developed country governments may go bankrupt. As proof that cheap easy money is again causing extraordinary economic problems, just look at where some of it is now going—to the commodities’ markets. There, it helps inflate food prices, thus causing starvation and food riots around the world.

Do the bankers not read history and know that artificially induced cheap easy money can be economic poison?

Of course one simple reason that many bankers advocate cheap easy money is that it makes them a lot of money. When they can—as they did for many years and still seem able to do—‘leverage-up’ their assets in relation to their equity, they can make multiples of profits compared to before. And since, often courtesy of their benevolent central bank, they can frequently borrow at nearly free rates and ‘invest’ those proceeds in bonds/securities/commodities that often offer high potential returns, it is possible for them to make ever bigger profits.

For most large US and European banks, their assets frequently exceeded their equity by 20 to 60 times before the financial crises. That is, keeping it simple, they were somehow able to leverage every $1 of equity, usually by borrowing funds, to create $20 to $60 of assets! The risk in such high leverage is that a small loss in asset values of say, just five per cent, could wipe out their equity and cause insolvency and bankruptcy.

Unfortunately, very high leverage ratios continue in many developed countries’ banking and financial institutions. (Perhaps this is the real unspoken reason for cheap money: to inflate asset markets to keep the banks semi-solvent! Though, that topic is for another post.)

Therefore, the real story is the culture of leverage and risk that numerous developed world banks now embody as a result of easily available cheap money. This is in contrast to that during much of banking history when money was regularly relatively expensive (with higher rates of interest) than today and often difficult to obtain.

The easily available cheap money encourages enormous ‘moral hazard’ among bankers and all players in the financial system. Moral hazard denotes a lack of morality and a carefree greed mentality that produces excessive speculation. It is this attitude that promotes the creation of maximum leverage and the taking of big risks—and not caring too much about any potential losses as they are covered by others. Bankers under the influence of moral hazard are like addicted gamblers who cannot stop gambling. But the gambling is not at the card table. It takes place in their boardrooms and trading desks.

And fortunately for the bankers they can enjoy their moral hazard largely at the expense of taxpayers. As we know, much of the potential and accumulated massive losses in the US and European financial and banking systems have been transferred to governments and central banks. The US and European governments and central banks make light of these burdens saying that as their economies recover these losses will be greatly reduced. However, the ‘central bank of central banks,’ the Bank for International Settlements (BIS), has issued new global bank regulations (Basel III) that—if implemented—might reign in some of the excesses associated with moral hazard.

Of course not all banks speculate or gamble to the same extent. In Islamic banking, spiritual and ethical considerations greatly restrain speculation. Also, for instance, Canadian banks adhere to more conservative principles and are better regulated and so have not suffered the same fate as that of many of their US and European rivals.

For now though, cheap easy money is seen by bankers as our economic salvation. And it inflates global markets, including those related to food and energy. As their prices rise, the unforeseen repercussions of the bankers cheap easy money ‘poison’ assists in creating starvation, food riots, and political upheaval around the globe.

Furthermore, the continuing high leverage, moral hazard, and gambling tendencies within the banking and financial system assures that some of today’s ‘good’ investments will sour and suffer large losses. Will the taxpayers again assume those losses? If not, then what? Until the cheap easy money poison is banished it continues creating conditions for even bigger economic and social catastrophes in the years ahead.

Copyright alrroya.com

Posted in Banking, Economics, Monetary Policy | Tagged: , , , , , , , , , , , , , , , , , , | Leave a Comment »

• Gold and Silver Rise Again as History’s Chosen Currencies

Posted by Ron Robins on March 13, 2011

By Ron Robins. First published February 25, 2011, in his weekly economics and finance column at alrroya.com

Gold, “the ancient metal of kings,” is reasserting itself as the currency of choice as it has done again and again since the earliest of human times. In our modern era, as central banks and governments fight to devalue their currencies to gain purported trade advantages, gold rises in value against them all. And central banks are buying gold again amidst serious doubts as to the size of some of their real physical gold holdings. Silver too is experiencing a similar re-emergence. The reasons for gold and, to a lesser extent, silver acting as currencies, are easy to understand.

Gold’s history as a currency extends back thousands of years. The western world’s first known standardised minting of gold currency took place in 564 BCE by King Croesus of western Asia Minor. However, it is also believed that China in the fifth and sixth century BCE, minted the Ying yuan gold coin as well. In the great Gupta Empire of India, from 320 to 550 CE, gold coins were used throughout its domain. And in the early Islamic world around the time of the Prophet Muhammad, the gold dinar coin led as its currency. In Europe, gold coins became an important or central monetary unit for the Greeks, Romans, Venetians, Dutch, Spanish and British.

During approximately 1870 to 1910 all major countries linked their currencies to gold, thereby adopting the gold standard. However, China was the exception preferring a silver-based standard. The first silver coins are reported as being minted by King Pheidon of Argos around 700 BCE.

Gold and silver have historically asserted themselves as monetary mediums due to their intrinsic value. They are consistent, divisible, durable and convenient, and they are nobody’s liability.

Unlike paper money, gold, particularly, has proven itself in maintaining its value over many centuries. The World Gold Council (WGC) says that, “since the 14th Century, gold’s purchasing power has maintained a broadly constant level… an ounce of gold has repeatedly bought a mid-range outfit of clothing… in the fourteenth century… in the late 18th century and… at the beginning of this century (2000 to 2008)… On the other hand, the US dollar that bought 14.5 loaves of bread in 1900 buys only 3/4 of a loaf today. While inflation and other forces have ravaged the value of the world’s currencies, gold has emerged with its capacity for wealth preservation firmly intact… [whether] in the face of financial turmoil… [as] a crisis hedge… [or] as an inflation hedge.”

Since their origins, central banks have realised the importance of gold, and sometimes silver, as a strategic part of their reserves. Commenting on the rapidly rising price of gold, Alan Greenspan, former chairman of the US Federal Reserve, said in a Bloomberg report on September 9, 2009, that, “[the rising gold price is] an indication of a very early stage of an endeavor to move away from paper currencies… What is fascinating is the extent to which gold still holds reign over the financial system as the ultimate source of payment.”

And this is also because, “[the central banks] no longer trust each other… [and] there’s this perception that different countries are trying to weaken their currency in order to get a competitive advantage,” said Francisco Blanch, head of global commodity research at Bank of America Merrill Lynch at a New York City November 2010 conference, reports Fastmarkets. Among the countries whose central banks are increasing their gold reserves are China, India, and Russia—all countries with mammoth trade surpluses and foreign exchange reserves.

However, as throughout history, he who owns gold and how much he owns is often shrouded in secrecy. For a central bank, covertly selling and buying of gold and its currency can be used to secretly manipulate the value of its currency. Some indirect proof of this comes again from Mr Greenspan during testimony to a US Congressional committee in 1998. He remarked that, “central banks stand ready to lease gold in increasing quantities should the price rise.” Therefore, declaring the precise gold holdings of a central bank might be akin to giving away ‘trade secrets.’

Central banks worldwide supposedly hold around 30,000 tonnes of gold, perhaps 20 to 25 per cent of all the gold ever mined. But true independent verification of their holdings is not available. The US based Gold Anti Trust Committee (Gata) has compiled extensive and critical information concerning western central bank gold holdings. Their information and that from other sources suggests the actual physical gold holdings of some western central banks could be 30 to 50 per cent lower than publicly reported.

As an example, the US boasts official gold holdings of 8,133.5 tonnes. However, it is known that some, perhaps a significant portion of these holdings, have been leased out to various financial entities and might not be returned without huge financial losses. Ron Paul, the chairman of the influential US Congress’s Domestic Monetary Policy Subcommittee of the House Financial Services Committee, is so concerned about such activities that he is calling for a full public audit of US gold holdings.

Additionally, gold is possibly set to play a reinvigorated role in the international monetary system. The International Monetary Fund (IMF) as well as most members of the G20 are seeking alternatives to the US dollar as the world’s principal reserve asset. And in this regard, gold—perhaps silver too—could be included in a basket of currencies and commodities that create the basis for a new international unit of exchange (currency).

Moreover, an RBC survey of global financial executives and business leaders reported on Yahoo! Finance on February 3 that “just 52 per cent of respondents expect the dollar to be the world’s currency in five years,” and that “gold is coming back as a reserve currency ‘of sorts,’” says Marc Harris, head of global research at RBC Capital Markets.

Probably since the beginning of civilisation, gold especially, but silver as well, have served as monetary vehicles. Gold has demonstrated itself to hold its value over centuries and in many diverse cultures. And despite today’s sophistication with paper money, gold is still seen by central banks as the ultimate source of payment. Concerns are growing that the real physical gold holdings of some major central banks might be substantially lower than they have reported, and as they unabashedly devalue their paper money, gold and silver rise once again as history’s chosen currencies.

Copyright alrroya.com

Posted in Banking, Economics, Finance & Investing, Gold & Precious Metals, Monetary Policy | Tagged: , , , , , , , , , , , , , , , , | Leave a Comment »

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