Real Currency/Bond Yields and Fiscal Space

Do Real Yields in currency Accounts Increase Fiscal Space?

Real yields certainly make assets more attractive to markets, having a consistent history of growth and strong performance, is very encouraging to traders trying to bet on future trends, who influence relative asset value today, and therefore the sensitivity to asset issuance.

Importantly, this issue is true across the board for financial assets, and not specific to currencies and bonds.

A real yield is a real cost, and in that sense would reduce the fiscal space when higher real yields are offered. But if the real yield is too low,(the asset depreciates consistently at an excess rate compared to other assets), that will make people unwilling to either accept the asset as payment or hold it for savings.

So how do we think about asset yields and discounting, in a way that is both objective and aware of the inherent pricing tradeoffs? Like any product, a lower price attracts more buyers, but is more costly for the product seller, diminishing the benefits they get on a unit basis, and thus ultimately there is an optimal balance between a price that is too low, cutting into the seller's benefits or profits, and a price that is too high, which does not attract buyers sufficiently.

The same could be said of real yields for fiscal assets, although I would argue it would be a mistake to compare these yields directly across asset classes. The optimal real yield on fiscal currency assets is much lower than other asset classes, potentially even negative in the right economic conditions.

Importantly, I think the biggest notion to consider for this question is asset complementarity. Without sufficient public investment, the yields of privately issued assets are greatly diminished, at least that is the public value hypothesis.

So who can or should be willing to take a loss by holding these subpar performing currency asset accounts, whether that is bonds, bills, cash, etc?

I think the answer to this is pretty straightforward, those who will hold the lowest performing assets, are those who are also holding the highest performing assets anyway. So in other words, if they were to buy more higher performing assets, they would simply reduce the performance of those high yield assets and increase their volatility, by pumping up their valuation to a less stable level. And certainly this does happen to some extent. But I would argue we should expect this "overbidding" to peter out well before those asset classes reach a relative value share sufficient to equilibriate the rate of return across asset classes.

Public assets pay for common maintenance tasks

One practice that would certainly distort the measurement of real yields, is if we somehow separated out certain costs from the profit equation, and accounted for them separately.

For example, consider the scenario where you buy a house or a warehouse up front with cash, in order to run your business, and then after that, you fail to impute the rent or mortgage as an operating cost. The house appears to be an asset, not a liability. If the cost is not accounted for as a part of operating, this distorts the measurement of your level of profit, although importantly, it does not change relative profit assessments. You still know whether one activity is more profitable than another, but not exactly how profitable it is. This breaks down when you try to compare your operations to another enterprise, which does not make a similar accounting mistake.

Anyway, it is similarly important to consider the impact that both taxation and public spending programs might have of profitability, both in relative terms with one business competing against another, and in absolute terms, when a business is forced to close due to operating at a loss. Taxes have the potential to affect both, but upward and downward. Taxation is essentially a nominal account adjustment, which helps maintain a certain relative after tax distribution of purchasing power. It is important to remember that at the most general level, taxes do not "pay for" the public spending effort. They are a condition or terms of service placed on a privilege or benefit, such as owning a piece of property, or working or receiving benefits within a system.

The spent tax credits do not have to "come from" anywhere, after all, a tax authority, ie any authority, faces a political constraint, not a financial one. If you can convince people to do things without any reciprocation, just because it is a good, idea, then that is not a financial activity. Finance is for those activities which people are willing to do conditionally: they will do it, but only if they get some benefit in return.

When it comes to government and public service, it requires essentially a public "free choice" to support that. It is not that participating in public service does not create value, enabling an individual disbursement of relative benefit share. No, instead when we consider a political jurisdiction as a whole or singular entity, that entity does not receive external benefits from embracing a particular political union or hierarchy. So as self contained entity, political unions embrace or reject a political framework from a non-financial viewpoint: are we better off doing this for its own sake?

So finance is a behavioral choice made contingent on the receipt of external benefits for a particular decision, and considered as a whole entity, a country or state or city receives no external benefit from embracing a particular political arrangement. So the value proposition of these entities is non-financial. They do not have a financial constraint, meaning their existence does not depend on external benefits, but rather internal ones.

So to account correctly for taxes, how do we in fact do that?

They are merely relative account adjustments among a constituency. And accounting for public spending is a very different proposition, it cannot be measured financially, because it is not based on external financial benefits, it is based on political support for internal real benefits.

Cities and states, and countries, and counties-- these are real entities not just a composition of individual human atoms. It is a mistake to try to consider all aggregated entities as only a collection of individuals, and that is precisely because these entities maintain their own accounting information, independent of the individuals that compute them. In this sense, the individuals are only calculators or computers in service of the aggregated entity, much like your liver is an organ which serves you, or your kidneys, heart or brain. The difference being that the relative structure of roles can be re-shuffled, but that does not fundamentally change the reality of the aggregate as entity of self.

That gets to be a little philosophical, and people start talking about how this is simply abstractions, but at a certain level abstractions are what let us know what reality actually is.

How do we correctly account for taxes and public enterprise?

If we make the same mistake with a political organization, that we made with the house, if we assume that all the work to establish and maintain this union, is just background, then that will lead to a similar accounting error: the absolute level of profits will appear higher than they really are.

So if we ignore the costs of public enterprises(for example by failing to impute them correctly), then our absolute profit level is artificially increased. But what does it mean to actually impute the costs of public enterprise correctly? It may be counterintuitive, but this mistake tends to come from taxes that are too high, rather than too low.

If you have a very high nominal level of taxes, which greatly exceeds the actual costs of public enterprises, then the parties which, on paper, are paying that tax, cannot in fact be bearing the real burden of it. Instead, they are merely receiving a nominal account adjustment downward. And in fact, in terms of trade, parties will adjust their bids and asks to reflect real costs, not nominal costs.

So by taxing someone a lot, their level of contribution becomes nominally distorted. They ask for a lot of income, simply to offset the tax, not because it correctly accounts for actual contributions.

While this may sound like an argument against a progressive tax scale, I don't think that is the correct conclusion, and that is because the accounting of work property rights and more, is equally important. If you merely tried to eliminate a progressive tax scale, that alone would not correct such accounting distortions, it could easily make them worse for quite a while. It is important to simply be aware, that the level of nominal taxation does not correspond automatically with real contributions. It is merely an nominal adjustment to accounts.

But what about the opposite scenario? What if nominal taxes are too low? How does this affect the accounting measurements of the profits of business enterprises?

If the nominal taxes are too low, then profits will likely appear lower than they are. You see, what it means for nominal taxes to be too low, is that you impose a real burden of public service on an entity, without any nominal offsets. So for example, suppose a certain property owner is required to build and maintain roads through their space.

Rather than simply financing this public enterprise through public accounting, and then making account adjustments to try to discourage excess capture of public benefits, you impose the real costs of public maintenance directly. By omitting the nominal tax, the entity cannot effectively absorb a greater share of public benefits, with a correct nominal profit offset through taxes. Instead, they will likely be imposed public costs directly, and then their enterprise appears less profitable, since more real resources must go to those costs.

What an effective accounting tax framework looks like, is it allows entities to absorb a greater share of public benefits, when doing so will genuinely lead to greater public welfare. If you control more land, you have to pay a greater property tax, but if you remain profitable despite that, then you have justified that resource claim. By taxing correctly, entities can scale and adjust their real share of absorbing public benefits, such that public welfare in the final outcome can be targeted.

Does (passive) r>0 make any sense at all?

So a profit, with an effective accounting system, comes from the operation of enterprises, whether public or private. What we should definitely do, is call wages the profit of workers.

So for a worker, their capital is unmeasured, and for a capitalist, their time is unmeasured. But both use both. The capitalist uses their time to improve the yield on their capital assets, even if their time is untracked. And the worker uses their capital: such as clothing, transportation, housing, etc, to help them better perform their job, and ultimately secure higher and better compensation. But for the worker, their capital assets are untracked directly in the business operations they participate in.

What an interest rate does, is track the return on capital value, without considering the composition of labor/time input. Assets which require little time, such as store inventory, tend to have small or no returns over time. The value added is already determined. They will not passively generate returns and increase in price.

Meanwhile, assets which require more time, like a computer you need to use, tools, vehicles and transportation, they generate value over time. So the input of time is one of the biggest determinants of asset returns. Once we mix together the labor involved in a business, subtracting out the market wage costs, it becomes much more difficult to assess these proportions and the marginal costs/benefits of the labor/capital mix.

Once we account for public enterprise, the question is whether assets are passively generating returns at all? I think they do not. That is the principal reason why raising rates to fight inflation is questionable. If assets only generate passive returns by failing to impute the costs of public enterprise, then r is in fact not greater than zero. And so the game of interest rates is a giant misdirect, whereby what is in truth a tax on the working public, becomes relabeled a "rent", and that passive holders of capital are able to enjoy unquestioned.