Pennsylvannia Tea

So I've been tracking the development of the natural gas industry, and while Syria and Egypt have been hogging all the good press lately (bloody ingrates), these developments warrant interest. Since 2008, when large deposits of natural gas were discovered in the Marcellus and Utica shale deposits in the Midwest, unprecedented investment dollars have been plowed into their extraction. In recent months gas has finally begin flowing, and how. It turns out we have more gas then anticipated, and in fact it looks like investment overreached. And now prices have collapsed in the States. Cheap natural gas seems to be the new norm, and this is big news for the future of the economy, the environment, and the balance of trade.

Cheap natural gas is already spurring investment in steel, petrochemicals, and other industries that supply the sector and use it as an input. In addition, natural gas burns cleaner than coal and oil, and as such while result in reduced CO2 emissions and cleaner air at a lower, not higher, cost.

Our natural gas resources also herald in an export opportunity, albeit one that needs to be approached carefully. Natural gas is about twice as expensive in Europe as it is here and eight times as expensive in Japan. The Department of Energy is in the process of approving up to 20 applications by various firms to export their gas. Unfettered exports of gas would increase output and stimulate employment in the sector by allowing the domestic price to drift upward to the world equilibrium. But the increase in price would also reduce the quantity of natural gas demanded in the States and slow the transition from other fossil fuels and increase input costs to industry.

In light of this tradeoff, I'd recommend the resurrection of a policy tool we haven't seen in a long time: the export tariff. In the ante-bellum period, the Federal government was almost entirely funded bu export tariffs from Southern cotton (brings the importance of preserving the integrity of the Union into context, doesn't it?). In recent years, of course, we've been more interested in increasing exports than taxing them. But levying a modest export tax on America's recent find would allow the industry to make a profit from exports while limiting the extent of domestic price increase, all while adding a new revenue stream to the public coffers. Hell, we could even use some of the money to research alternative energy.

Tax Reform Proposal, or: The Closest Shave in Fiscal History

A break from the endless droning of monetary economics. Lately I've been enraptured by the subject of tax reform. For years we've been told by Democrats that we need to raise tax rates on the wealthy (over $250,000 by their estimates) and by Republicans that we need to lower rates on everyone (especially people who earn their living from investment income; less so for that vulgar income stream known as wages). I've never been entirely sure about how I feel about this, until now: I hate taxes, and think even a top marginal rate of 39% is a little absurd. And don't get me started on how high corporate rates are. On the other hand I hardly like the imagery of slashing tax rates on the opulent and benefits for the indigent. But lately I've concocted a reconciliation for the two.

It starts with an idea that no one likes and only a few brave politicians ever suggest, but I'll take it a step further: eliminate all Federal tax expenditures. To a man. Dead in the water. Take away all the goodies, and piss off everyone in America. I'd eliminate the tax deduction for employer-funded health insurance, charitable contributions, accelerated depreciation, tax deductions for dependents, mortgage interest deduction, and deductions on corporate bond interest and Treasury interest, to name a few. I'd also remove the lower rate paid on realized capital gains. Income is income, and it's all game, no exemptions.

And then I'd slash all the rates. By how much I'm not sure, because it depends on how much can be raised by eliminating these tax expenditures. I've heard that we "spend" about $1.2 trillion on these types of deductions, so that implies we could collect about 37.5% less in direct taxes. That's intense. Even if we reduced everyone's taxes by 37.5%, that's dramatic. Now imagine if we lower rates on everyone, but by 50% on the lowest income earners and only 24% on the highest earners. That's a budget neutral tax cut both parties could get behind.

The Return of American Savings...

This is something that I almost never see addressed in the media or practically anywhere else. And its a phenomena that bears mentioning, because it has tremendous implications for nearly every aspect of economic policy. I'm talking about the return of private savings in the United States. Take a look at the graph below; private saving as a share of gross domestic income is at a historic high since the late 1970s.

If this rate stays high, it will have tremendous benefits for the economy in the coming years.
1. Interest rates will remain low, regardless of international capital flows. This will keep interest costs on the Federal debt low as Medicare and SS costs continue to rise and alleviate pressure to raise taxes and run higher deficits.
2. Global imbalances will subside as domestic investment is funded out of domestic savings. This means a re-balancing of East Asian economies and even more net-factor payments to bolster American GNP.
3. Improved household net worth will take pressure off government social programs that make up 2/3 of Federal outlays. If individuals start accumulating savings at a faster clip, programs such as SS, Medicare, Pell Grants, ect. all become less critical for the median American, as retirement income, health spending, and college can be funded on an individual basis drawn on a private stock of savings.

My Wager with the OECD...

The OECD is now warning that US interest rates will rise if and when the Fed stops its latest round of bond-buying. Color me skeptical. First of all, there is no indication that the Fed intends to do any such thing- the warning itself pointed out that growth would slow and made no mention of inflation. But anyways, we have here another opportunity to evaluate the Fisher Rule in real time; I'd go so far as to say that if the Fed stopped its bond buying program, interest rates would be as likely to fall as to rise. I truly wish people would stop belly-aching about Fed policies as they related to interest rates. The Fed influences the price level and its attendant derivatives, nothing more and nothing less. If you want to know where interest rates are going, focus like a laser on capital inflows and inflation expectations. 

Another Ugly Regression, Plus Inflation and Interest Rates or Something

Another nail the coffin of of the myth that loose monetary policy means low interest rates. Either monetary expansion means higher nominal interest rates or lower inflation, because these two variables are definitely correlated. And I'm pretty sure printing money does not cause deflation. This is the 10 year rate on Treasuries run against annual inflation.

It's (Probably) Not Inflation Expectations...

That are driving up interest rates in Spain and Italy. As a card-carrying monetarist, one of my maxims is that nominal interest rates are driven by inflation expectations. This presents a quandry as far as the eurozone goes, because nominal interest rates are high and inflation low. Presumably, bond investors in Spain and Italy should not be expected substantial inflation anytime soon, unless they are anticipating a departure from the euro and a subsequent devaluation.
Either that is the case, or the equilibrium real cost of borrowing the these two major European economies has gone up. And whereas in the past I have demonstrated that interest rates on U.S. debt mostly rise and fall with inflation, it may not be the case with Spain and Italy.

Austerity Might be Expansionary in the Eurozone

Or at least not contractionary. I've been thinking about the fiscal situation in Europe, and how Keynesian critics of Eurozone policies advocate that government swear off austerity in favor of spending to boost the economy. According to standard Keynesian theory, when interest rates are up against the zero lower bound, monetary policy has no traction and fiscal policy has no opportunity cost because interest rates don't rise to crowd out private investment spending. As a result, countries like Spain and Italy should keep running budget deficits despite fiscal concerns, to support the fledgeling economy. Here's the problem:

That's the real interest rare on government bonds for Italy and Spain. Real interest rates are very much not zero, at least not in Spain and Italy, the two biggest economies presently in crisis. Nor are interest rates very high. But at an interest rate at anything above zero, public borrowing DOES crowd out private borrowing euro-for-euro. Krugman makes this point all the time, saying that deficit spending for the US economy is only appropriate in a liquidity trap with zero interest rates. But I guess the rules are different in Europe.