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Friday, February 13, 2004

More Unreality

As I've mentioned several times on this blog, many statements appearing in the financial press and in public discourse simply do not hold up to a reality check. The many excerpts from a fine Alan Reynolds column demonstrate the point.

Whenever Fed Chairman Alan Greenspan testifies before Congress, as he did on Wednesday, legislators are fascinated with what they can get him to say about fiscal policy -- budget deficits.

Why do investors pay no attention to Greenspan's warnings about budget deficits? Because they know these warnings are based on archaic theoretical conventions that have recently been well tested and found false.

Greenspan described deficits, for example, as making "demands on national savings." The idea is that government borrowing must be subtracted from an otherwise fixed amount of saving. Proponents of this idea imagine that if tax collectors would simply take more money from the private sector and give it to the government, the sum of both public and private budgets would be magically improved. It is on the basis of this sort of imaginative bookkeeping that Greenspan and others once predicted that moving from deficits to surpluses would greatly increase the "national savings rate" (public and private saving as a percent of GDP).

Comparing net savings to gross product is a common but disreputable statistical gimmick. It would be more honest to express net savings as a percentage of net national product. But doing that would add nearly a percentage point to the net savings rate during the Reagan years. The only purpose of comparing net savings to gross product is to minimize measured savings and exaggerate its decline. What looks like a secular slide in net savings is largely a secular acceleration in estimated depreciation. Besides, even an honest estimate of net savings would be inappropriate for the most infamous prediction of conventional theory -- twin deficits.

The only theory that proved even more bogus than twin deficits was the theory that predicted long-term interest rates must have gone up in 2001-2003 when surpluses turned into deficits.

Projected federal spending is indeed a huge threat to future prosperity, particularly the unpayable future promises of Social Security and Medicare. But the essence of that threat -- which Greenspan described very well -- is "debilitating increases in tax rates."

Politicians and their advisors who promise to "fix" some future budget forecast by imposing debilitating tax rates as soon as they can are just threatening to turn a possible future risk into an immediate and debilitating economic infirmity.

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