Friedman’s Law of the First Thing: Macroeconomics and The Sequester

Monday, February 18, 2013 at 12pm
By John Friedman

Imagine that you live in a world with three people: a farmer, a tool builder, and a tailor. Got it? So the farmer grows the food all of ’em eat, the tool builder builds the tools all of ’em use, and the tailor makes the clothes all of ’em put on their backs.

Imagine also that, many years ago, this trio survived by gathering food and sheltering in a cave, but that, growing tired of that way of life, and figuring out that tools really were where it was at, they started working together to cultivate some food, build some tools and sew some clothes, and then imagine that, once all that was done, they figured they’d had it with that cold, dank cave, so they set about to build three houses, one for each of them, and then finally imagine that, once they moved into their respective houses, they also decided to divvy up all the work, with the farmer farming, the tool maker tool-making and the tailor tailoring.

And with that they had the basics covered. Between what the Earth gave unto them in terms of water and air and sunshine and stuff under their feet with which to make things, and their own endeavoring, they had what they needed.

Next imagine that, over time, they all became specialists, so they all grew better and better at their respective crafts and more and more daft at doing any of the other two crafts, and imagine also that, in tandem with becoming specialists, all of their dealings with one another — all of their food-for-tools exchanges, and all of their clothes-for-food exchanges, and all of their tools-for-clothes exchanges (yup, there are only three possible exchanges among ’em) became arm’s-length transactions in all ways, i.e., they were doing business with each other.

And let’s say that things went along like this for a good long while, with everything perfectly in sync. The farmer worked just enough to grow just enough food to feed all three of ’em. The tool builder worked just enough to en-tool all three of ’em. And the tailor worked just enough to en-clothe all three of ’em.

But now let’s say that all of a sudden the tool-maker has an accident and gets hurt, and that this sad state of affairs reduces the toolmaker’s output to only two-thirds of that just-right amount of tools the three of ’em need to do their work.

What happens?

*  *  *

I am not a macro-economist. I am not all that astute when it comes to the workings of the huge economies in which we all play a role. So those who are, please forgive my trespass.

But I do know enough macro to have been able to apply Friedman’s Law of the First Thing to macroeconomics. Friedman’s Law of the First Thing says that everyone should know at least the first thing about each aspect of their financial life. And since we are all little fishies swimming in the vast macroeconomic sea, Friedman’s Law of the First Thing applies here: the overall economy is an aspect of all of our financial lives (and if you think it’s not, ask yourself whether your life or the lives of those around you changed during The Great Recession), so we should all know — at least — the first thing about it.

So what’s The First Thing to know about the overall economy?

The first thing to know about the overall economy — about macroeconomics — is that every person’s money-out is another person’s money-in. So just as every sale of a share of stock is also a purchase of that share of stock by someone else, so too is every dollar departing from your financial world a dollar coming into someone else’s (Yes? Yes, you over there waving a flaming something-or-other at me? What’s that you say? What’s your question? . . . Uh huh. . . . Uh huh. . . . Yea. . . . Got it. Did everyone hear the question? Good. So the answer to the question is this: yes, we can have an exception to that general rule for that twenty-dollar bill you just set a’fire, and yes, we can also except other similarly ignited and/or otherwise vamoosed-from-usage pieces of money).

*  *  *

We are currently facing down another Obama vs. GOP showdown over a thing called the Sequester — the precommitment that has thus far failed to thwart Congress’s subsequent bad decisions and which calls for, starting the beginning of next month and continuing for ten years, $1.2 trillion in spending cuts in certain parts of the federal budget.

There is near-universal agreement that, if The Sequester goes into effect as scheduled, then the economy will take a hit — near universal agreement that the Sequester cuts will reduce GDP and possibly tip us over into recession.

The math is this: if we assume that the $1.2 trillion in cuts happens evenly throughout the ten years (that is not the case, but we’re keeping it simple here), then that would mean $120 billion per year in spending cuts, which works out to about $2.307 billion in spending cuts per week, or about $330 million a day in spending cuts for ten years — about a dollar a day for every man, woman and child among us, for ten years.

So why would taking a dollar a day per person out of federal spending every day from now until 2023 decrease GDP?

*  *  *

Well, for starters, there’s that GDP = C + I + G + (X – M) equation thingie, in which “G” is government spending. So, if everything remains the same while G goes down, so too does GDP.

But not everything would stay the same, would it?

And why go all math’y on this, when we can instead look to the three-actor economy hypothetical I set out above. This approach might be a bit more intuitive and less off-putting (math is so . . . so . . . . math’y for so many folks . . . ).

We can look to that three-actor hypothetical economy because the mechanism through which a government pullback in spending can hurt the overall economy is pretty much the same mechanism as the one that messes things up in that hypothetical when the tool-maker’s injury leads to less tool-making which in turn leads to less food-growing and clothes-making, which in turn leads to less of everything, which in turn leads to . . . yada yada yada . . . .

That is, the government’s spending is someone else’s income, and, especially when that someone else receiving the government’s spending is living close to the bone cash-wise, that someone else is going to spend that money right away, which will then in turn go into someone else’s income, yada yada yada. So regardless of whether the government spending goes to people (e.g., the less well-off) or to organizations (e.g., schools, which then spend the money locally to hire teachers or to fix up school buildings), the government’s money-out is someone else’s money-in, which in turn becomes someone else’s money-in and on and on and on and on and on and on.

In fact, the Congressional Budget Office — which is about as neutral and non-partisan as you can get because it’s designed to be that way — predicts that the Sequester will reduce GDP by more than 1.5% — potentially enough to tip us back into a shrinking GDP and mild recession.

*  *  *

So why might the Sequester go into effect?

Some on The Right view it as good policy — as good for the economy. Larry Kudlow, for instance, thinks that the Sequester will not hurt the economy because government spending is not the same as — not as good as — private sector spending. See, e.g., his piece on CNBC.com, in which he states, “By keeping resources in private hands, rather than transferring them to the inefficient government sector, the spending sequester is actually pro-growth.” Best I know, Larry has always hated hated hated government spending and is an absolutist crowding-out sort of guy.

Others think that, although the Sequester will harm the economy, it’s the only leverage the GOP has against that budget-nightmare that is four more years of Obama. See, e.g, Scott Galupo of The American Conservative:

The deal, as I see it, sounds like this: Republicans can demand of Obama, “Give us entitlement reforms and we’ll turn off the sequester. If you don’t, we may slide into recession. No government shutdown. No default. Just a good old-fashioned recession. Is that how you want to begin your second term? You may blame us, call us reckless. We’ll make the case to the public that the blood-sugar of your fake recovery has finally crashed.”

Is the House GOP leadership prepared to make this threat?

I think it is.

In effect, it already has.

 

Time was when we would call this, the GOP putting a gun to the economy’s head. These days, though, all gun analogies and gun imageries rank as suspect.

And in the past and today and on in the future, you gotta love that blood-sugar/fake-recovery turn of phrase — the one where Scott says that, once the recession of 2013/2014 is underway, the GOP will let everyone know that what really caused the recession was that the GOP had finally forced Obama’s hand and taken the sweets away.

I don’t know about you, but at some point in a blood-sugar-induced recovery that’s lasted for more than three years, mightn’t it be time to say gimme s’more d’that sugar, won’t’ch’ya pleeze?

 

*  *  *

Currently the House is on vacation, so we won’t know how this plays out until at least next week.

If 12-31-12 and the Fiscal Cliff is any indication, though, the Sequester is going to happen.

The questions after-the-fact will then be, how long did it last and the less lofty, who was blamed? as well as the real questions of import, how bad a hit did the economy take? and, closer to home, how many people suffered?

Because you better believe that all us fishies are bobbin’ in this deep blue sea that is our economy, and that if it takes a pause or a plunge, we, too, in aggregate, will be taking a pause or a plunge right along with it.

Why?

Because someone else’s spending is your income — and vice versa.

 

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