Moving the Policy Discussion Forward

Some interesting articles on the state and direction of economic policy:

David Frum challenges fellow conservatives to come up with compelling policy alternatives to Paul Krugman’s recommendations:

 …if Krugman’s direct government expenditure is not a very good policy answer, his dire economic warning remains a haunting policy question. What can we do to accelerate economic growth and job creation? For those of us on the free-market side of the debate, the question is even more haunting: What’s our countervailing idea? And if our countervailing idea is tax cuts, what is our reply to the obvious rebuttal that the Bush tax cuts have been in effect through the whole of this crisis, seemingly without effect?

Marshall Auerback outlines a bevy of progressive policies in response:

…Professor James K. Galbraith sets out some useful criteria for good stimulus:

1. Open-ended support for the current operations of state and local governments…

2. Comprehensive foreclosure relief…

3. Increased Social Security benefits…and a cut in the eligibility age of Medicare…

4. A payroll tax holiday to restore effectively the purchasing power of working families. By setting the payroll tax rate at zero (and letting the government write a check to the Social Security Trust Fund for the uncollected sums), tax relief can be delivered at large scale and with immediate effect…

…And finally deploy government spending in a way which REDUCES unemployment, rather than arises as a consequence of it. We therefore suggest a new approach: a Job Guarantee Program. The U.S. Government can proceed directly to zero unemployment by hiring all of the labor that cannot find private sector employment. Furthermore, by fixing the wage paid under this ELR program at a level that does not disrupt existing labor markets, i.e., a wage level close to the existing minimum wage, substantive price stability can be expected…As we have argued before, the Job Guarantee program should remain a permanent feature of our economy, in effect acting as a buffer stock to put a floor under unemployment, whilst maintaining price stability whereby government offers a fixed wage which does not “outbid” the private sector, but simply creates a stabilizing floor and thereby prevents deflation. [Many on the right might reflexively think of such a program as socialism run amok, but as we've pointed out more than once, an employer-of-last-resort program has been proposed on the right by Nobel economist Ned Phelps. The idea is definitely worth a closer bipartisan look.]

There are good ideas out there, but there is a distinct failure of political imagination and courage to implement them. With any hope Frum’s provocative article will spur a healthy discussion on the possible solutions, rather than a retreat to tired, discredited economic shibboleths.

But Brad DeLong gives little hope that Auerback’s retreat can be avoided:

…Congress is balking. Republican legislators from states with double-digit unemployment have put party above country. Blue Dog Democrats, who think that they can marginally improve their chance of gaining more terms in office if they publicly worry about the deficit to the exclusion of all else, have put self above country and party. And, significantly, the Obama Administration has never offered a grand bargain for tax increases and entitlement caps in the future in return for more spending now to restore full employment.

We’ll toss a few cents into the discussion in an attempt to show that we can and should overcome irrational deficit phobia (yes, there are sometimes rational reasons to fear government deficits), we’re likely to make little progress towards ensuring a strong and durable economic recovery, and ironically, we’re likely to end up in a worse public debt position. 

On Frum’s question, Randy Wray has pointed out (pdf) that an accelerating pace of federal government tax receipts followed the Bush tax cuts and recovery, and may have contributed to the intersectoral strains that eventually resulted in financial collapse (emphasis added):

Every recession since World War II was preceded by a government surplus or a declining deficit-to-GDP ratio, including the recession following the Clinton surpluses. Recovery from that recession resulted from renewed domestic private sector deficits, although growth was also fueled by government budget deficits that grew to 4 percent of GDP. However…the Bush recovery caused tax revenues to grow so fast that the budget deficit fell through 2007, setting up the conditions for yet another economic collapse…

In 2005, tax revenues were growing at an accelerated rate of 15 percent per year—far above the GDP growth rate (hence, reducing nongovernment sector income) and above the government spending growth rate (5 percent)…this fiscal tightening was followed by a downturn—which automatically slowed growth of tax revenue.

Thus, conservatives might not be painted into as severe a policy corner as Frum fears. But that’s true only if they can let go of their (newfound, circa 2006?) deficit phobia and escape the intellectual tyranny of Ricardian equivalence. We think that’s easily done, but there are two basic concepts that need to be framed out before the policy conversation can make any significant progress.

First, we need to frame our modern financial economy as Knut Wicksell did over 100 years ago. There are two ‘interest rates’ at work, one on the credit (financial) side, and one on the real (economy) side. The financial rate (in reality, there are many of them) is determined in large part by the cost of a marginal unit of money. The economic rate (in reality there are many of these too) is determined by the expected return on a marginal unit of investment.

When the financial rate is below the economic rate, the result is inflation (greater expected returns on investment lead to increased demand for credit, and money eventually becomes less valuable relative to real goods and services). When it’s above the economic rate, the result is deflation (negative expected net returns on investment lead to decreased demand for credit and increased demand for saving; money thus becomes more valuable relative to real goods and services).

Wicksell’s original thesis has been tweaked to acknowledge that inflation and deflation are unlikely to persist indefinitely. We also need to incorporate the idea of leverage. Low systemic leverage (the amount of credit relative to money) implies a higher cost of credit and lower inflationary pressures. When there’s a high degree of leverage, inflationary swings can be exaggerated, and can turn sharply and suddenly into deflation (Minsky’s “Ponzi finance” or Austrian’s “crack up boom”, of which 2008-2009 was a prime example).

Second, we need to get a better grasp of money — what it is, where it comes from, and how it works. 

Under any type of gold standard, gold is essentially money, and over the long run, gold’s real value is a function of its supply relative to all other goods, services, and assets (gold’s flexibility, durability, and steady long term accumulation rate give it its monetary properties). As long as money is defined as a fixed weight of gold, the value of money will closely track the value of gold. Thus, under a gold standard, the financial rate of interest is determined in large part by developments in the gold industry relative to the rest of the economy (as an aside, Ricardian equivalence might have some merit in that type of system).

However, in a fiat currency system like the U.S. has had (officially) since 1973, money is just money, which the government sector creates at minimal cost (currently the money creation process is controlled by the Federal Reserve through its interactions with member banks and primary dealers). Thus, the financial rate on fiat money is more easily attuned to the economic rate, thereby helping to mitigate the cycles of inflation and deflation that occurred regularly under classical gold (that was Wicksell’s stated intent when he first outlined his monetary theory). Granted, it’s taken policymakers and markets several decades to learn how to run such a system effectively, and there’s still plenty of room for improvement, but that’s to be expected with any large scale innovation.

A key takeaway is that the federal government creates the money used in private sector transactions, satisfaction of tax and other liabilities to the public sector, and demand for goods and services by the public sector. Thus, saving or spending desires of the private sector can only be accomodated by the federal government (leaving aside export income), while under a gold standard, they could only be accomodated (with some qualifications) by the available supply of gold. In other words, despite the widespread belief that they are subject to the same constraints, the federal government’s budget is nothing like households’ or businesses’ budgets, and in fact, in some key respects it is the inverse (just as under a gold standard, the gold industry would need to “dis-save” gold in order to satisfy the desire for saving in other sectors of the economy).

Today, if households, businesses, and state and local governments want to run a surplus, then the federal government must by definition (again ignoring exports) run a deficit. That’s not an ideological statement, it’s a simple operational fact, which is why (we think) it opens up a lot of common ground for policy.

So what role do federal government deficits play in our economy?

Depending on how they come about, they can raise the expected rate of economic return (by increasing aggregate demand), lower the financial rate (by increasing the supply of money), or both (by financing its demand for real goods and services with new money).

Conversely, a budget surplus (or a smaller deficit) can lower expected economic returns, and can also impact the financial rate (under our Wicksellian framework, if money becomes more scarce, then the prevailing nominal interest rate becomes tighter, all else equal).

In certain environments (e.g., Japan 1990′s thru 2000′s, U.S. 2000′s thru 2020), expanded deficits make sense, while in others (e.g., Japan 1970′s thru 1980′s, U.S. 1980′s thru 1990′s), smaller deficits or even surpluses might make sense – albeit with this caveat from Wray:

…the United States has also experienced six periods of depression that began in 1819, 1837, 1857, 1873, 1893, and 1929. Comparing these dates with the periods of budget surpluses, one finds that every significant reduction of the outstanding debt, with the exception of the Clinton surpluses, has been followed by a depression, and that every depression has been preceded by significant debt reduction. The Clinton surpluses were followed by the Bush recession that was ended by a speculative, private debt–fueled euphoria, and was followed in turn by our current economic collapse. The jury is still out on whether we might yet suffer another Great Depression. While we cannot rule out coincidences, seven periods of surplus followed by six and a half depressions (with some possibility for making it a perfect seven) should raise eyebrows…our less serious downturns in the postwar period have almost always been preceded by reductions of federal budget deficits. [Note that all six depressions occurred under a gold standard of some kind, so the direction of causation is open to question.]

Where are we today? U.S. demographic composition (pdf) implies a relatively pessimistic outlook for productivity, saving, and investment, possibly until the end of this decade. Large swaths of the private sector — notably households, but also some state and local governments – are in desperate need of repairing their balance sheets. Many corporations are flush with cash but apparently reluctant to invest it in human or physical capital. In other words, the demand for saving in the private sector remains high, and probably will for some time. 

What’s the proper response?

For households, some combination of fiscal support (e.g., extended payroll tax holiday, financed by money creation if need be) and financial relief (e.g., cleaning up the mortgage mess in as fair and transparent a way as possible, possibly with greater commitment from the federal government, as opposed to the private sector incentives and public-private partnerships experimented with to date) should help.

For state and local governments, direct budget assistance, again financed with new dollars if necessary (which is essentially how it’s now done, except that primary dealer and other banks get to hold Treasury paper for “financing” the federal deficit and earn the spread over the fed funds rate).

For the corporate sector, expanded public sector demand (e.g., maintenance and productivity enhancing infrastructure improvements, R&D into promising areas like energy and health care, etc) and perhaps most importantly, tax and regulatory assurances that will decrease the level of political uncertainty that businesses now face.

All of these would mean higher deficits in the short run, but if we’re right about the underlying state of the economy for the next decade, they will mean lower future debt and deficits than would otherwise occur (unless liquidationists and entitlement cutters were to win in drastic fashion, but in that improbable case the net costs would be much greater than any savings implied by a smaller federal debt).

It’s also important to point out to the Tea Party types that, as Jamie Galbraith and many other economists have noted, only a small percentage of the rise in federal deficit and debt to GDP ratios was driven by increased discretionary outlays by the Democrats. Almost all of the rise is simply a function of counter cyclical measures like unemployment insurance in the numerator and lower GDP in the denominator.

However it turns out, the federal government is not “broke” and never can be. The only true constraint on federal deficits is inflation, and there simply aren’t any signs of elevated inflation risk  today — although USD exchange rate depreciation is a meaningful risk, depending upon the relative movements of fiscal, trade, and monetary policies in different countries and regions. As Wray observes (emphasis added):

…there is no financial constraint on the ability of a sovereign nation to deficit spend. This doesn’t mean that there are no real resource constraints on government spending, but these constraints, not financial constraints, should be the real concern. If government spending pushes the economy beyond full capacity, then there is inflation. Inflation can also result before full employment if there are bottlenecks or if firms have monopoly pricing power. Government spending can also increase current account deficits, especially if the marginal propensity to import is high. This could affect exchange rates, which could generate pass-through inflation. [Viewed in this light, the Obama administration's export initiative might be a wise idea.]

The alternative would be to use fiscal austerity and try to keep the economy sufficiently depressed in order to eliminate the pressure on prices or exchange rates. While we believe that this would be a mistake—the economic losses due to operating below full employment are almost certainly much higher than the losses due to inflation or currency depreciation—it is an entirely separate matter from financial constraints or insolvency, which are problems sovereign governments do not face.

We openly admit that:

• While some of the measures we’ve outlined could be easily implemented, others are much easier said than done.
• All of them are subject to severe agency and other risks. But that’s true for most things in life, not just politics!
• Many of the distortions and perverse incentives that got us here still need to be corrected.
• Many voters may fear — perhaps justifiably, judging by some of the rhetoric on the left — that deficits do indeed imply higher future taxes and should thus be avoided.

We also admit that under certain conditions, fiscal austerity (via higher taxes and/or lower spending) may indeed be supportive of growth. But we do not think those conditions are in play today in most developed nations.

The bottom line is that no meaningful, bipartisan measures capable of supporting of economic growth at a reasonably healthy level can be crafted until we’ve moved beyond irrational deficit hysteria. And that requires a broader and deeper understanding of how modern money and financial economies work.

URLs:

http://theweek.com/bullpen/column/204603/the-krugman-question

http://www.newdeal20.org/2010/07/02/free-market-showdown-david-frum-poses-the-question-heres-the-answer-14105/

http://theweek.com/bullpen/column/204665/keynes-amp-co-have-lost-the-stimulus-argument

http://www.levyinstitute.org/pubs/ppb_111.pdf

http://en.wikipedia.org/wiki/Ricardian_equivalence

http://654advisors.com/index.php/blog/2006/12/committees-vs-markets/

http://654advisors.com/index.php/blog/2010/07/galbraith-blasts-the-deficit-commission/

“Money we don’t have”

Good NYT article on deficit hysteria, with an especially illustrative quote from Rep. Cooper (D, TN):

“We have to stop spending money we don’t have,” said Representative Jim Cooper, a Tennessee Democrat who voted against the bill. “I hope deficit reduction fever is catching.”

The U.S. is in the midst of a balance sheet recession, with demographic ratios shifting an an unfavorable economic direction for several more years.  Under those conditions, deficit reduction fever will lead directly to the dreaded Japanese Disease —  another decade of stagnation, underemployment, and opportunity costs, all of which will impose greater burdens on future generations than expanded federal deficits would.

And policymakers — not to mention most members of the electorate, including analysts and the media — continue to commit two fundamental errors regarding fiscal policy:

1. They believe that all deficit spending must be financed with interest bearing debt, thus competing with the private sector for scarce financial resources.  However, judging by current Treasury rates, there’s still plenty of room for expanded federal borrowing.  And there’s a symbiosis between federal deficits and repair of balance sheets in the financial sector, as evidenced by the perfect quarters turned in by several major investment banks recently.  Politically, that relationship is almost nauseating, as it’s doing very little to relieve distressed households — but it nevertheless makes apparent the  dynamic between public sector fiscal deficits and private sector balance sheet relief.
2. They also believe implicitly that the U.S. is on a gold or similar standard, where fiscal and monetary policies are constrained by the supply of some exogenous factor, and governments can thus literally “run out of money.”  Governments can’t run out of money, as it is ’created’ by nothing more than digital ledger entries.  In other words, government (today, via operations of the quasi-private Fed) is the sole creator and supplier of high powered money.  Thus, the only constraint on money creation is inflation and a loss of confidence in the currency, and at the moment, those forces are emphatically not in play.  This too is symptomatic of Japanese Disease.

The fears of incumbent politicians like Cooper are certainly understandable.  But they’re borne of either ignorance about how these things work, or self-preservation.  Either way, it smacks of lousy political leadership. 

And given that Republicans are likely to benefit in November, we’d expect the trend towards fiscal conservatism to intensify.  Even President Obama, in a speech yesterday, promised the following:

• A three year freeze on all non-discretionary federal spending beginning in 2011
• Expiration of tax cuts via sunset provisions
• Elimination of 120 federal programs
• Reinstatement of PAYGO
• Higher fees on banks that are expected to lower federal deficits by $90B over ten years

He promised all of this as a way to force the public sector to budget in the same way that families and businesses do.  Again, this is wrong, and is borne of either ignorance or pandering.  And as with Congress, it smacks of crummy political leadership either way. 

The administration’s jawboning is also reminiscent of budget austerity measures touted by the Carter administration in the 1970s in reaction to the “tax revolt” — austerity measures that contributed to its eventual demise, even though they may have been more appropriate to the conditions prevailing at the time (e.g., baby boomers entering adulthood, global trade and financial integration, etc).   Today, austerity is far less appropriate, but even more vigorously pursued.  That almost certainly spells trouble for Obama in 2012 – assuming the GOP can field a worthy candidate and avoid blowing all of its political capital in the intervening years. 

You also have to wonder, were he to experience a change of heart, whether there’s any credible way for him to backtrack from his neo-liberal rhetoric.  The DLC, Brookings, Peterson, and all the other usual suspects have painted the guy into one hell of a corner.

In the meantime, assuming that reality will align with rhetoric, the political climate continues to be favorable to the USD and Treasuries, and rather risky to gold.  A contrarian call? You bet.  But it’s based on what we think is a well-grounded and – just as importantly – non-ideological assessment of the facts. 

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC (“SCM”) is a state registered investment adviser in the Commonwealth of Pennsylvania. The views expressed by the author are as of the publication date, and are subject to change based on market and other conditions. The foregoing information is for informational, educational, or entertainment purposes only. It does not constitute an offer to buy or a solicitation to sell any security, or to engage in any investment strategy. Investors should not use this information as a basis for any investment decisions without first consulting their own financial adviser. SCM is an Amazon.com associate, and earns a commission on sales generated through links from our website. Some clients of the firm are long GLL and/or long TLT.  At the time of writing, neither the firm nor its principals owned any securities mentioned. PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.

URLs:

http://www.nytimes.com/2010/05/29/us/politics/29deficit.html

http://www.japanreview.net/review_bsr.htm

http://www.miraeasset.com/ourmarket/outlookView.do?board_id=1125&group_id=1&pageNo=2

http://www.investmentnews.com/article/20100602/FREE/100609973

http://seekingalpha.com/article/208174-how-deficit-hawks-will-keep-cutting-spending-until-we-re-all-on-food-stamps

Stiglitz: The Dangers of Deficit Reduction

A timely column from Nobel economist Joe Stiglitz (emphasis added):

A wave of fiscal austerity is rushing over Europe and America…But despite protests by the yesterday’s proponents of deregulation, who would like the government to remain passive, most economists believe that government spending has made a difference, helping to avert another Great Depression.

…even deficit hawks acknowledge that we should be focusing not on today’s deficit, but on the long-term national debt. Spending, especially on investments in education, technology, and infrastructure, can actually lead to lower long-term deficits. Banks’ short-sightedness helped create the crisis; we cannot let government short-sightedness – prodded by the financial sector – prolong it.

Faster growth and returns on public investment yield higher tax revenues, and a 5 to 6% return is more than enough to offset temporary increases in the national debt. A social cost-benefit analysis (taking into account impacts other than on the budget) makes such expenditures, even when debt-financed, even more attractive.

In those last two paragraphs, Stiglitz is pointing out that if the returns on public spending are greater than the cost of financing them, then the future debt level will actually be lower. The government’s current cost of financing is simply the yield on Treasury debt. As of Friday, the ten year Treasury note yields 3.7%, while thirty year Treasury bonds yield about 4.6%. If publicly financed investments can be expected to return more than those figures, then undertaking them — and adding to current deficits and debt levels — is a no-brainer.

And as long as the yields on the securities of private sector issuers aren’t abnormally higher than those on Treasuries, the argument that the federal government is going to ‘crowd out’ the private sector is without merit.

Of course, it’s debatable (1) whether public expenditures are likely to produce returns of that magnitude and (2) whether future Congresses, Administrations, and Treasury Departments will manage the federal balance sheet appropriately. Unfortunately, no one’s openly debating these points. Instead, we’re treated to pithy but nonstop dogma from both sides, and a peculiar obfuscation by those in the middle, which in all cases overlook the basic financial calculus that Stiglitz reminds us of in his column.

Most importantly for debt and deficit hawks and those who fear higher taxes (those whom econo-nerds would refer to as ‘Ricardian equivalence’ subscribers), when the financial calculus is positive, then the debt service associated with marginal federal spending can be financed organically, via higher growth, rather than through higher taxes.

In short, people on all sides of the deficit issue should be able to agree, at least on financial and economic grounds, that investments yielding more than their cost of financing, when they do not crowd out private sector borrowing or resource demand, should absolutely be carried out.

—

Unfortunately, Stiglitz overlooks his own argument when he writes the following, which make us wonder if he doubts his 5 to 6% return figures, or if he’s just offering a gratuitous slap at the financial sector (emphasis added):

As the global economy returns to growth, governments should, of course, have plans on the drawing board to raise taxes and cut expenditures…

Continuing with his love of taxes:

The financial sector has imposed huge externalities on the rest of society. America’s financial industry polluted the world with toxic mortgages, and, in line with the well established “polluter pays” principle, taxes should be imposed on it. Besides, well-designed taxes on the financial sector might help alleviate problems caused by excessive leverage and banks that are too big to fail. Taxes on speculative activity might encourage banks to focus greater attention on performing their key societal role of providing credit.

As we’ve pointed out elsewhere, the domestic financial sector is going to shrink even without  punitive measures, as demographic composition shifts away from the saving and investing age groups. Well-designed regulation might be a better approach than taxes to constraining financial sector activities to socially beneficial ones (we admit that a ‘Tobin tax’ can be the most efficient approach to regulation under certain conditions, but aren’t convinced that it’s optimal for the financial sector).

And it would be profoundly unjust for the federal government, which so strongly encouraged and underwrote the expansion of mortgage financing (Stiglitz’ “pollution”), to retroactively punish the financial sector, its employees, and its current and future clients for simply following the government’s orders.

Stiglitz also takes a step back from his underlying thesis with this sentence:

Over the longer term, most economists agree that governments, especially in advanced industrial countries with aging populations, should be concerned about the sustainability of their policies.

From a technical standpoint, this isn’t as iron clad as so many of us reflexively believe. First, we have no idea whether an aging population is bound to be a drag on an economy, whether it depends on particular conditions, or anything else. There simply isn’t much historical data available to test such a proposition. Second, if we assume that it is a significant drag, then policies that are seen as unsustainable under “normal” conditions might very well be the most sustainable under those novel conditions. This could include expanded deficit spending and public debt, and/or expansion of money supply.

[To be fair, Stiglitz is almost certainly referring to entitlement spending obligations in that passage, which might be a bird of a different feather. We're just using it as an opportunity to critique some of the conventional wisdom around demographics.]

—

Despite Sitglitz’ inability to break out of his New Keynesian box, or part ways with his passion for higher taxes, we agree wholeheartedly with his essential argument:

…even with large deficits, economic growth in the US and Europe is anemic, and forecasts of private-sector growth suggest that in the absence of continued government support, there is risk of continued stagnation – of growth too weak to return unemployment to normal levels anytime soon.

The risks are asymmetric: if these forecasts are wrong, and there is a more robust recovery, then, of course, expenditures can be cut back and/or taxes increased. But if these forecasts are right, then a premature “exit” from deficit spending risks pushing the economy back into recession. This is one of the lessons we should have learned from America’s experience in the Great Depression; it is also one of the lessons to emerge from Japan’s experience in the late 1990’s.

…we must be wary of deficit fetishism…high-return public investments that more than pay for themselves can actually improve the well-being of future generations, and it would be doubly foolish to burden them with debts from unproductive spending and then cut back on productive investments.

These are questions for a later day – at least in many countries, prospects of a robust recovery are, at best, a year or two away. For now, the economics is clear: reducing government spending is a risk not worth taking. 

URLs:

http://www.project-syndicate.org/commentary/stiglitz123/English

http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml

How do you spell W-I-M-P-Y?

First Congressional jobs bill of 2010 has cleared the Senate:

Senate Democrats Wednesday delivered the first of several promised election-year jobs bills, passing a measure blending tax breaks for companies that hire unemployed workers with highway funding eagerly sought by the states.

The bipartisan 70-28 vote to pass the bill sends it to the House, where many Democrats say it is too puny…

We tend to agree with the House Dems. Among the bill’s measures:

Democrats promise additional measures to create jobs, promising help for small businesses having trouble getting loans, aid for cash-strapped state governments, and subsidies for people who make their homes more energy efficient…

The bill contains two major provisions. First, it would exempt businesses hiring the unemployed from the 6.2 percent Social Security payroll tax through December and give them an additional $1,000 credit if new workers stay on the job a full year. The Social Security trust funds would be reimbursed for the lost revenue.

Second, it would extend highway and mass transit programs through the end of the year and pump $20 billion into them in time for the spring construction season. The money would make up for lower-than-expected gasoline tax revenues…

And the reason it is so wimpy:

But budget deficits are a worry, and future measures are going to be more difficult to pass — especially since a top Senate Democrat has blocked unused authority from the Wall Street bailout program from being used to “pay for” jobs initiatives…

Sen. Judd Gregg of New Hampshire, top Republican on the Senate Budget Committee, blasted the measure for increasing the budget deficit to fund highway and transit programs. He said the measure made a joke of Democratic promises to adhere to “pay-as-you-go” budget rules requiring new spending programs to not increase the deficit.

“I don’t think you get people back to work in this nation by loading more and more debt onto the next generation,” Gregg said.

Sen. Gregg seems like a good man, but he just doesn’t get the underlying economics (unless he believes that the private sector is in robust shape and capable of standing on its own, which means he’s looking at different data than we are). And as we continue to point out, if he and other budget hawks are wrong about the underlying economics, then they are actually going to leave “the next generation” in even worse shape than they would be with more concerted stimulus.

Mark Zandi is cited as estimating that the Senate bill will create roughly 250,000 jobs. That number is unlikely to even make a perceptible dent in structural unemployment. By our back of the envelope calculations, the Senate bill will add about half a percentage point to GDP under the most optimistic assumptions.

We’ll close by calling again on correspondent J. Wellington Wimpy:

“You will gladly pay me today for a job that might be created tomorrow.”

URLs:

http://news.yahoo.com/s/ap/20100224/ap_on_bi_ge/us_congress_jobs

http://654advisors.com/index.php/blog/2010/02/the-hawks-are-circulating/

The hawks are circ(u)l(at)ing

Two interesting and somewhat discouraging trial balloons have been floated by the Senate recently:

Schumer-Hatch payroll tax break

First, in a NYT op-ed, Sens. Schumer and Hatch propose a payroll tax credit for employers who hire someone who’s been out of work for 60 days or more. This is intended to be a much simpler approach than the disastrous jobs tax credit of the 1970s:

…any private-sector employer that hires a worker who had been unemployed for at least 60 days will not have to pay its 6.2 percent Social Security payroll tax on that employee for the duration of 2010. The Social Security trust fund will then be made whole with spending cuts elsewhere in the budget between now and 2015. That’s it. Simple to understand, and easy to explain.

Simplicity is a reasonable objective, but as described, the proposal is NOT going to stimulate a return to full employment, because it’s fiscally hawkish, i.e., it aims for budget neutrality. Thus, the net economic effect is likely to be somewhere around nil, give or take.

It also gives no payroll tax break to the newly hired employees! That is NOT likely to play well to a frustrated electorate. Warren Mosler’s version of a payroll tax holiday would be fairer and much bolder. As he framed it at a recent Tea Party get together:

I believe that the surest engine for full economic recovery is a full payroll tax holiday. Payroll taxes take away over 15% of everyone’s paycheck, from the very first dollar earned. This is big money- about $1 trillion per year. Half comes from the employee and half from the employer. A payroll tax holiday does not give anyone anything. What it does is stop taking away $1 trillion a year from working people struggling to make their payments and stay in their homes, and businesses struggling to survive. A full payroll tax holiday means a husband and wife earning $50,000 a year each will see their combined take home pay go up by over $650 a month, so they can make their mortgage payments and their car payments and maybe even do a little shopping.

In their op-ed, the Senators also claimed:

Our two-pronged approach would be a far more efficient use of taxpayer dollars than other proposals under discussion, all of which could cost many times more with very little guaranteed improvement in unemployment. [emphasis added]

Taking care to use taxpayer dollars efficiently is a wonderful thing when resources are fully employed and there are sufficient dollars in circulation. But in the prevailing environment, it’s far too hawkish. As some have noted, the key factor that will incentivize hiring is for businesses to see signs of improving demand; tax breaks like this one are unlikely to have more than a marginal effect. And as long as Congress is stingy about deficits and about where taxpayer dollars come from, it could merely reallocate existing resources, rather than raise overall employment.

The entire idea brings to mind the old Hefty Bag jingo: WIMPY WIMPY WIMPY!!!

Senate jobs bill

Second, Senate Democrats have been circulating a comprehensive jobs bill that includes the Schumer-Hatch proposal. Positive features include extension of unemployment benefits and subsidies. More questionable are the extensions of various expired tax provisions through the end of 2010. Like financing federal expenditures with existing “taxpayer dollars”, sunset provisions will tend to offset any stimulative effects of ‘stimulus’.

From the proposed measures in the bill, it looks like members of Congress, especially Senators, believe that their reelection prospects hinge on budget and debt hawkishness. That might well be true, given that our educational system has done a lousy job teaching economics for generations. If that’s their angle, then they’re as bad as their policy ideas: WIMPY WIMPY WIMPY!!!

It’s estimated that the bill would create 80,000 to 180,000 new jobs in the coming year. We would need 180,000 or so per month to meaningfully reduce unemployment. Taking secondary effects into account, the typical employment multiplier falls in a range of roughly 2 to 4. That means that the overall impact on employment would range from 160,000 to 1.44 million new jobs in 2010. This would make less than an 18% dent in the number of jobs lost in this recession! [We've assumed that multiplier effects are not accounted for in that number; if they are, the package is even more pathetic.]

Admittedly, we’re leaving out private sector employment and the related multipliers, and 1.44 million new jobs would still be a good thing. But the glaring problem is that policymakers seem to believe that the real economy is in the kind of shape it’s been in since the mid-1980s, and that it will do just fine with the federal government contributing a net 20% or so to economic activity. We strongly disagree, and would point out that policymakers in Japan made the same error over their two lost decades. Policymakers need to dramatically raise expectations in the private economy, whether it’s through spending, tax cuts, or a combination of both. Wimpy proposals are not going to get it done.  

If the Senate bill is as good as we get, then our strong dollar call remains in place, and incumbents could face some rough sledding in November. The Obama administration is reportedly trying to work some better features into the bill, but most of them have an undeniable fiscal wimpiness to them, and thus won’t do much to alleviate the stubborn shortage of dollars, income, and employment in the real economy.

As J. Wellington Wimpy might say, “You will gladly pay me today for a job created tomorrow.”

Update 2/14/2010 – Perhaps this description of neo-Keynesian economics explains the cruelty of Hatch-Schumer:  “Tax cuts can deepen a recession if the short-term nominal interest rate is zero, according to a standard New Keynesian business cycle model. An example of a contractionary tax cut is a reduction in taxes on wages. This tax cut deepens a recession because it increases deflationary pressures.”  Good grief. The honorable gentlemen should note that this is just economic theory, which is far from settled (and that economists are probably not a good source of reelection advice). 

URLs:

http://www.nytimes.com/2010/01/26/opinion/26hatch.html?scp=2&sq=orrin%20hatch&st=cse

http://moslereconomics.com/2010/02/04/dallas-address/

http://www.webcpa.com/news/Senate-Democrats-Jobs-Bill-Includes-Tax-Breaks-53257-1.html

http://news.yahoo.com/s/ap/20100210/ap_on_bi_ge/us_what_jobs_11

http://www.newyorkfed.org/research/staff_reports/sr402.pdf

Obama Budget & 4Q09 GDP

We were feeling a little smug about Friday morning’s GDP print, given our argument in 2H09 that growth prospects were probably being under estimated. At 5.7%, it wasn’t quite the six handle that we thought we might see, but barring any significant downward revisions, it was closer than most expected, and nominal GDP did indeed have a six handle.

Interestingly, headline government spending added little to the quarter’s numbers, so there will be an interesting debate over how much of a role ‘fiscal demand’ is playing, but we’re cautious about that for a few reasons. First, the slower pace at which private inventories were liquidated was a large contributor to GDP, but sustainable private sector growth and employment are unlikely as long as inventory building remains anemic.  Second, federal spending was down due to a lower defense spend, while non-defense spending was up 8% versus 7% in 3Q09, so it’s hard to argue there was no fiscal component. Third, it ignores the possibility of lag effects between public sector spending or deficits and subsequent private sector activity. And if we’re right that fiscal expenditures are still playing a role, the GDP data could imply a very healthy multiplier, a possibility sketched out in this recent academic paper.

This leads us to the Obama budget released today, which will be a real tooth gnashing, garment rending piece of work to many. But it looks pretty good to us at first glance (see the criteria on page six of this Idle Speculator), far better than recent rhetoric led us to expect. The deficit is forecast to be a record $1.56T in 2010 and to remain above $1T in 2011, and it’s beginning to appear that Obama is “triangulating” on fiscal austerity measures, or at least on the time frame over which deficit reduction will occur (though it’s not clear how PAYGO fits into this).

The President’s budget will be tough for some to swallow, but as we’ve pointed out elsewhere, the belief that government is always and everywhere the problem, or that it cannot contribute to real economic growth, is based on a massive underlying assumption: that the private sector is always and everywhere able to grow. It’s not hard to reduce that position to an absurd one, e.g., if a natural or biological calamity were to severely impact private sector potential, a government with a monopoly over money creation could pick up some or perhaps all of the slack.

Reality is far more complicated of course, but since demographic ratios came to our attention, it seems patently clear that private sector potential can vary wildly over multi decade periods, especially in economies where a steep fall in childhood mortality occurred at some point in history. Japan is the most recent example of a two decade downswing in potential output, and its policymakers mistakenly approached the problem as a cyclical rather than a secular one. The U.S. and other western nations are roughly ten years behind Japan in demographic terms, so there’s still roughly a decade of slow, no, or even negative growth ahead of us, barring an active public sector (note: “active” can include tax cuts). As we wrote last November:

We’re familiar with the major [economic] catechisms; we’re just not sure that the evidence supports any one of them over another. Structural economic conditions can and do change — age structure is just one example of how this can come about — and different conditions may call for different approaches.

There are several economic measures that, when viewed over the last two decades, support our assessment that demographics are playing a powerful role in the performance of the U.S. economy (and by extension, these measures tend to undermine arguments against Republican budget profligacy in the 2000s). For example:

The year over year decline in state and local income tax revenue has never been so precipitous, and it has become far more volatile since demographic ratios first turned negative in the late 1990s;

The trend in real private inventories has also been declining since the late 1990s; and 

Equipment and software investment has been in a similar downtrend since the late 1990s.

Admittedly, we’re just eyeballing graphs here and speculating on whether they correspond well to more robust empirical analyses. But we’re fairly confident in our speculation, and this has led us to accept that we are in a Keynesian moment, or more accurately, two Keynesian decades with a Minskian moment in the middle. In such an environment, where private sector expectations are pessimistic, the optimal response is for the public sector to pick up the slack in consumption, investment, and intermediation, within the constraints set by inflation expectations (granted, inflation is a messier issue in a world where the USD is the global reserve currency, and based on a first cut view of today’s budget, we believe our tradable goods inflation thesis is back in play).

The Obama budget appears to pick up a healthy measure of private sector slack, and should thus be favorable overall for employment, asset prices, and economic output. The inflation issue will be far more slippery: on the one hand, a well designed federal budget gives the Fed more room to tighten, as private sector expectations improve; on the other, fiscal direction is uncertain, especially beyond 2011, and prone to shocks, so central banks will have to be rather nimble (more nimble than they were in 2003-05 and 2008) to avoid taking an overly easy or tight approach to policy.

Obama’s proposed tax increases on high income households will cause some resentment, but it’s hard to see how the income disparity pendulum could keep swinging on its current arc. The administration might also believe that higher tax rates on higher incomes will be supportive of state and municipal debt financing. We’d feel better about it if there were an accompanying reinvention of the corporate tax code, as we believe that would have some positive second and third order effects on lower and middle class incomes; first order effects could be achieved by instituting a payroll tax holiday as Warren Mosler has suggested.

Unfortunately, we place a zero probability on corporate tax reform happening any time soon (the budget calls for increasing taxes on certain sectors of the economy), and a near zero probability on a long payroll tax holiday. Despite that, the President’s budget does brighten the economic outlook a bit for 2H2010 and 2011, and the possiblity of a double dip might have been pushed back to 2012 or 2013 (which clearly calls the semantics of ”double dip” into question).

URLs:

http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm

http://faculty.wcas.northwestern.edu/~yona/research/Multiplier-version12.pdf 

http://www.whitehouse.gov/omb/blog/10/02/01/Introducing-the-2011-Budget/

http://654advisors.com/idlespeculation/20100112.pdf

http://654advisors.com/idlespeculation/20091109.pdf

http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=ASLPITAX&s[1][transformation]=pc1

http://research.stlouisfed.org/fred2/graph/?s[1][id]=CBIC1

http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=NRIPDC96&s[1][transformation]=pc1

http://en.wikipedia.org/wiki/Minsky_moment

http://moslereconomics.com/2010/01/28/tea-party-plan-for-dems-cut-to-the-front-with-tax-cuts/

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC is a state registered investment advisor. The foregoing information is for informational, educational, or entertainment purposes only. It does not constitute an offer to buy nor a solicitation to sell any security, or to engage in any investment strategy. Symmetry Capital Management, LLC is an Amazon.com associate, and earns a commission on sales generated through links from our website. At the time of writing, the firm, its principals, and its clients did not own any securities mentioned, or any securities issued by entities mentioned.

I’ll see your PAYGO and raise you a double dip

A key objective raised by President Obama in his state of the union address was to address the ‘fiscal hole’ of the federal government. His rationale was that “like any cash strapped family, we will work within a budget to invest in what we need and sacrifice what we don’t.” he asked Congress to reinstate PAYGO, which reportedly helped the federal government “record surpluses in the 1990s,” and advocated investing in people “without leaving them a mountain of debt.” He closed on this point by saying that it’s just common sense.

Culturally, these ideas resonate with Americans. And for a business or household, budget constraints are a matter of common sense (even though we don’t always adhere to them). But there is no budget constraint on a government that can create money, i.e., non-interest bearing debt, out of thin air. The only meaningful constraint to the level of non-interest bearing debt is inflation, which occurs when a government creates more money than the economy requires, causing its non-interest bearing debt to lose value against most goods and services. Thus, while it may score some political points (thanks to our primary educational system’s lack of a financial and economic curriculum?), it’s absurd for the president to embrace the common sense that households and businesses use in setting budgets. The federal government faces an entirely different kind of budget constraint.

Instead, given the government’s power to create money, common sense would hold that the amount of money supplied to the economy should be equal to the amount of money required by the economy (please note, this simplification is not an attempt to resurrect the policy prescriptions of old school monetarism). Thus, the proper approach to budgets at the federal level is to ask whether there is currently a surfeit or deficit of USDs in our economy. Given the number of private financial commitments that were entered into in the past decade, and dramatic declines in economic activity, it’s difficult to argue that there’s currently a surfeit of dollars. And if recent political rhetoric is any indication, dollars are likely to become scarcer in the years ahead (it would be ironic if, instead of inflation, deflation became the motivating force behind a move away from the USD as global reserve currency).

The president did set forth some positive ideas, such as a zero capital gains tax on small business investment, capital investment incentives for companies of all sizes, and infrastructure investment. Assuming these are financed at least in part by new money creation, they would help to prevent a renewed liquidity crunch. But to the extent that they are “offset” by cuts or freezes elsewhere in the name of closing fiscal gaps and filling in budget holes, or by higher taxes on other activities, the net short term effect on the economy will be nil or worse. And like Japan, we’ll be in for our second lost decade out of two. As we’ve pointed out, leaving future generations without a “mountain of debt” sometimes means leaving them with equivalent (or greater) opportunity costs. We should strive to avoid both of those outcomes. To do so, we have to rethink the cultural common sense that debt is always and everywhere to be avoided.

From an investing standpoint, if vigorous policy actions follow the path being laid out by the rhetoric and “common sense” emanating from so many quarters, then the USD will continue to strengthen, the real economy will stagnate or weaken further, and nominal asset values will fall for all but the highest grade government paper. In that scenario, we would be lucky to tread water and leave only 16% of the country underemployed.

Mr. President, I’ll see your PAYGO and raise you a double dip recession.

RELATED READING (file under confirmation bias): 

We’re well aware that our current view of things puts us shoulder to shoulder with some members of the “loony left”, but the macroeconomics of this stuff are fairly straightforward. Our lonely wing nut sojourn continues, placing us in lockstep with one Mr. Paul Krugman: http://krugman.blogs.nytimes.com/2010/01/26/obama-liquidates-himself/.

The Fed is seeking an exit strategy from its liquidity programs and low interest rate policy. The impact of that exit can be either muted or amplified by Congressional actions. If Congress becomes hawkish, there is no reason for the Fed to do so. If they both begin tightening, it’s hello 1937: http://www.bloomberg.com/apps/news?pid=20601015&sid=aXeUAV7_bz_o

An excellent idea from Warren Mosler — a full payroll tax holiday — that has yet to fall on the radar of federal policymakers: http://moslereconomics.com/2010/01/28/tea-party-plan-for-dems-cut-to-the-front-with-tax-cuts/. Here’s how Mosler describes the cause of poor economic policymaking: “…so-called economic experts have confused themselves and their political masters with contrived explanations for the way the economy works, and their limited vision has limited the range of policy choice. The result has been a monumental economic and social disaster caused by an obvious shortage of aggregate demand. The spending power needed to make mortgage payments, car payments, and do a bit of shopping- all of which would fix the economy and end the financial crisis- just isn’t there.”

Marshall Auerback writes that “Any kind of spending cuts in the middle of the worst recession since the Great Depression is insane.  What we are beginning to see is the return of Herbert Hoover and the ‘liquidationists.’” http://www.newdeal20.org/?p=7731

Ed Harrison posts an email exchange with Auerback, in which the latter wrote: “What the US government is now in danger of repeating is taking its economy down the fast track to a double-dip recession.  With investment still flat, consumers trying to increase their saving ratio and net exports making a negative contribution to growth – the President and his advisors evidently believe the persistently high unemployment is something the private sector has to deal with.”  http://www.creditwritedowns.com/2010/01/what-president-obama-can-do-to-improve-the-economy.html. As we’ve noted elsewhere, the demographic research of folks like John Geanakoplos, Diane Macunovich, and Ajay Kapur implies that for the next decade, the U.S. private sector is not going to behave as the baby boomer decades have conditioned us to expect. Hence the case for a more activist — and just as importantly, ‘self-financing’ – public sector. ‘Self financing’ today means the Federal Reserve creating the dollars that enable primary dealer banks to absorb Treasury offerings at auction via direct bids.  For that process to continue, the federal government must continue to issue debt, rather than shoveling dirt on the people and institutions that are still near the bottom of our deep ’fiscal hole’.

Jonathan Zasloff writes (TOH Krugman) that “At some point someone must make an argument for government.” http://www.samefacts.com/2010/01/politics-and-leadership/obamas-self-inflicted-lobotomy-proceeds-apace/  Why are Democrats today so afraid to make that argument? Like the health care debacle, could the lessons learned in the Clinton years be ill suited to today? As for the GOP, our take is that by harping on government in all its forms (besides those forms that help favored firms and industries collect their share of rents from the rest of us, of course), Republicans leave the door open to the development of increasingly socialist policies. In fact, if our take on the state of the private sector in the coming decade is accurate, they will practically mandate it.

State unemployment insurance tracker at Pro Publica (TOH Credit Writedowns) shows how critical federal government support currently is for many states: http://projects.propublica.org/unemployment/

George Soros thinks that premature budget tightening could be bearish for gold prices: http://www.telegraph.co.uk/finance/financetopics/davos/7085504/Davos-2010-George-Soros-warns-gold-is-now-the-ultimate-bubble.html. Reminiscent of Jon Nadler’s argument last fall against gold: http://654advisors.com/index.php/blog/2009/11/a-gold-bears-comments/

Finally, in what might be a mirror image of our loney wing nut position, Bill Gross seems to be exhibiting a profound case of anti-Keynesianism: http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2010/February+2010+Gross+Ring+of+Fire.htm

Bookstaber: ‘Controlled Burn’

Rick Bookstaber put forth an interesting argument about easing debt burdens on the public and private sectors through “controlled burn” inflation. If creditors aren’t willing to take large enough haircuts, that’s pretty much what you have to do to get aggregate credit burdens to a more manageable or desirable level.

There are a lot of misperceptions around this issue. FDR allegedly devalued the dollar c. 1934 by repegging it to gold at $35, instead of the $20 that prevailed before WWI. But if you look at the historical data, the USD was powerfully deflationary in the years leading up that action. And at best, the repegging only stemmed the rate of deflation. It did not create any inflation at all. In fact, the more closely we look at the data, the more closely aligned we become with folks who argue that the New Deal didn’t go far enough.  Paul Krugman’s warning in 2008 is looking fairly prescient:

…Barack Obama should learn from F.D.R.’s failures as well as from his achievements: the truth is that the New Deal wasn’t as successful in the short run as it was in the long run. And the reason for F.D.R.’s limited short-run success, which almost undid his whole program, was the fact that his economic policies were too cautious.

[I would add that other FDR actions were too bullheaded and hasty, errors that Obama also risks repeating.]

During the recent crisis and recession, plenty of pundits argued that USD devaluation would be the order of the day. We saw some risk of that, but not as much as those who pointed repeatedly to the Federal Reserve’s unprecedented balance sheet expansion of 2008-2009, or the federal government’s enlarged deficits. That’s because those factors are meaningless if the private sector is not taken into account (i.e., the effects of monetary policy and public and private sector borrowing are not independent). If there’s intensive deleveraging and a rising desire for saving in the private sector, then expansive actions by the central bank and federal government are merely going to absorb some slack. Ony if they absorb more slack than exists will there be any risk of inflation.

Unfortunately, of late, the messages coming out of almost all political quarters is that the slack in the real economy is going to increase — and that means higher deflationary risk, and conversely to Bookstaber’s argument, rising real credit burdens. That, in turn, will lead to credit after shocks and rising unemployment. Granted, to the extent that people’s nominal income stays the same, real incomes rise in a deflationary environment, so this would be good news for pensioners, savers, and highly valued employees. But we shouldn’t overlook the real opportunity costs that deflation implies.

We see a threat of increasing slack because there’s a rising chorus of fiscal hawkishness all around us. Today, Rep. Chris Van Hollen, chairman of the Democratic caucus, told a CNBC interviewer that the government ”need[s] to get every penny back” from TARP. Yesterday, Republican Rep. Jeb Hensarling said that the election of Scott Brown was a sign that voters cared about debt and deficits (to be fair, he did mention lowering capital gains and payroll taxes, but debt and deficits seemed to be on the top of his mind). Today, a CNBC commentator referred to “your [taxpayers'] money” leading into a report on pending transportation spending. Policymakers are treading the line between semi-sensibility and madness.

First, Congress and the Administration should look forward. That requires changing the regulatory framework in a way that will prevent excessive systemic fragility in the future, and that’s the direction that Obama laid out in his remarks yesterday, with Paul Volcker, who imposed a massive deflationary contraction as Fed chairman in the early 1980s,  smiling in the background. But all else equal, this will lower overall credit capacity, and demanding full repayment of TARP will will make it worse. In order to avoid a double dip, the federal government has to act as the borrower of last resort, i.e., run larger deficits. To us, that’s the real problem with the path being laid out by Obama and Democratic leaders — taking with one hand, and not giving with the other, means economic contraction, all else equal.

Second, debt and deficit hawkishness could not be more untimely. We should pay serious attention to where and how public expenditures are directed, but we need to be honest about the need for significant deficit financed expenditures. Looking at underlying demographic structure, we probably shouldn’t concern ourselves with lowering the federal debt until the end of this coming decade.

Finally, the dollar is ”our money” in the sense that we use it to pay our tax liabilities to a government that has monopoly power to create it. Better yet, it creates it out of thin air (yes, if that power is abused or misused, it can lead to inflation, even hyperinflation, but the risk of such an outcome right now is very, very low). If fiscal policy does indeed swing in a more hawkish direction, then there’s going to be a surfeit of monetary units. And the more we taxpayers or our elected representatives grab for ”our money”, the worse it’s going to get. This ‘chartalist’ view is also somewhat complicated by the fact that our money creation process is controlled by the quasi-public Federal Reserve system. That means that the federal government can only issue interest bearing debt to finance its deficits. It sells those securities to primary dealer banks at auction. And the primary dealers rely on the Federal Reserve system to create the monetary units (the non-interest bearing debt of the U.S. government) that are used to purchase its interest bearing debt.

Keeping those last three sentences in mind, consider that:

• The President intends to tighten the tax and regulatory collars on the banks
• Fed Chairman Bernanke’s confirmation by the Senate is now in serious doubt
• Government spending and investment are especially critical in this recession (see here and here)
• Policymakers are clearly signalling that they’re going to get serious about “fiscal responsibility” 

The clear implication is that USDs are more likely to increase in value. So while Rick Bookstaber is right about the ability of inflation to lower existing debt burdens, it looks to us like we’re headed in the opposite direction, at least for now. The consequences will be discouraging to just about everybody.

URLs:

http://rick.bookstaber.com/2010/01/controlled-burn-inflation.html

http://www.aei.org/article/26390

http://www.nytimes.com/2008/11/10/opinion/10krugman.html

http://research.stlouisfed.com/recession/gdpdata.html

http://research.stlouisfed.com/recession/indicators.html

Idle Speculator: Payrolls, Policies, Politics

Friday morning’s report on the employment situation had a little bit for everyone, bulls and bears alike. November revisions saw the first positive month for payroll growth since the current recession began, and the “less bad” trend remains firmly intact. However, the number of discouraged workers jumped dramatically, and payroll growth is still far too low to significantly bring the unemployment rate to a persistently lower level. While unemployment continues to pose a risk to Democrats in 2010, neither party is making a compelling offer to the electorate at the moment, and both of them are too focused on scapegoating the other. While we expect some positive economic surprises in 2010, the U.S. electorate and economy will remain stuck between an elephant and a donkey for some time.

Continue reading: http://654advisors.com/idlespeculation/20100112.pdf

Between a ‘Derm and a Donkey

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2010.01.14  MEA CULPA – The following entry was based on a news report that mislabeled bank assets (loans, credit) as liabilities (deposits, capital). That’s a common mistake — most people would tend to think of money that someone else put into their care as an “asset”. After reading the FT’s front page story on the proposed bank levy, we note that it’s designed to be applied to exactly the kinds of assets that helped to precipitate the financial crisis. We therefore apologize for calling it a joke, and for the other aspersions we cast in its direction (see below). Our initial assessment was obviously wrong. It might not be a bad idea, and perhaps the Obama administration has taken the position that it will be easier to administer than tighter capital requirements; or perhaps the threat of the tax is being used as leverage in tightening long term capital requirements.  However…

(1) A fifteen basis point haircut on typical investment bank returns, especially if nothing is done about the leverage that can be employed, is awfully skimpy;  

(2) There are still risks in who will actually bear the cost;

(3) the activities of investment banks actually do some social good, believe it or not;

(4) The President and Congress are still more like Herbert Hoover than FDR/JFK/RR; and

(5) We’re still stuck between ‘Derms and Dems for the foreseeable future.

=====

In our latest Idle Speculator, we asserted that in the years ahead, the U.S. economy was likely to remain stuck between a pachyderm and a donkey. If today’s events are any indication, it’s a good call. President Obama called for a punitive tax on large banks, and the only Republican response we’ve heard so far is from a Congresswoman who mostly railed against public spending. In our view, both sides continue to make little if any sense. 

President Obama’s bank tax would apply only to institutions with $50B or more in assets, and the rate would be 15 basis points (0.15%). However, the levy would not be on bank income, but rather on banks’ liabilities, i.e., deposits. What does this mean? We’d need to take a closer look once legislation is drafted, but based on what’s been said, here’s our initial impression:

First, the large banks aren’t going to pay a damn thing. Depositors (savers) are simply going to take a 0.15% haircut on the interest rate they receive, all else equal. Essentially, this will just act as an additional tax on people who deposit funds with large banks, and/or as a marginal incentive to deposit funds with other institutions.

Second, it won’t do anything to prevent the systemic leverage and boneheaded risk taking that got us into this mess. Systemic fragility arises when banks create too many assets (by extending credit) relative to their liabilities and capital. If the government wanted to prevent this through taxation rather than regulation (probably a bad idea to begin with), then it should be taxing bank assets. Of course, even then, it would simply mean that debtors’ interest rates would go up by the amount of the tax…which means the banks still wouldn’t pay a damn thing (refer back to point one).

In his remarks, the President said:

“My determination to achieve this goal is only heightened when I see reports of massive profits and obscene bonuses at the very firms who owe their continued existence to the American people who have not been made whole, and who continue to face real hardship in this recession…”

As in his recent comments on the jobs situation, the President shot well wide of the mark. While it’s reportedly an attempt to marshall populist support by attacking a particulary unpopular industry, the approach is a joke (as supporting evidence, we’d point out that Financials are the third best performing sector in the S&P 500 today, and that Money Center and Regional Banks are among the best performing industries within it). 

We can only infer that of late, the President has been listening to the very worst strategists in his Cabinet, folks who would recommend Herbert Hoover’s approach to economic crisis and recovery over FDR’s (or JFK’s or Reagan’s if you prefer) at a time when the latter’s is far more appropriate. Obama’s current hawkishness is evident in the AP article:

Obama said he was determined that every dollar spent from the $700 billion Troubled Asset Relief Program to rescue Wall Street firms, auto companies and mortgage holders is either repaid or paid for in some fashion.

His party’s hawkishness is also evident in the continuing failure to extend the COBRA subsidy under ARRA (a cynic might infer that this is intended to garner more support for heath care reform, but it’s a hawkish action either way). Thus, despite all the talk on the right and among tea party goers about “tax and spend liberals”, the reality looks quite different to us. The American electorate continues to be presented with only two choices — revenue hawks and budget hawks, i.e., higher taxes or lower spending – and those are essentially flip sides of the same coin.

In any case, forcing depositors to take a haircut, forcing debtors to pay marginally higher interest rates, or recovering every single dollar issued under TARP will do nothing to remedy the real hardships being faced by the American people in this recession. It also does nothing to prevent another financial crisis. If the President really wants to accomplish something on those counts, here are a few suggestions:

• Push hard for focused, meaningful financial regulatory reforms that will prevent excessive systemic fragility.
• Use the federal government’s creditworthiness and risk taking capacity to provide more direct assistance (i.e., employment) to the underemployed. 
• Stop being so terrified of budget deficits. Thinking about structural deficits is OK, but acting now to solve them could actually make the problem worse (ask Japan).
• Let private sector intermediaries (banks) use a historically steep yield curve to continue repairing their balance sheets by financing public deficits.
• If you insist on attacking TARP recipients, target the agents who control them (e.g., executive compensation or bonuses above a certain level), not owners, depositors, and borrowers.
• Enact policy measures that lower uncertainty, raise optimism, and thus increase the private demand for credit and investment.

You might also demand some accountability from whichever advisors had the most influence over today’s statement and last Friday’s…

URLs:

http://654advisors.com/idlespeculation/20100112.pdf

http://news.yahoo.com/s/ap/20100114/ap_on_bi_ge/us_obama_bank_fees

http://biz.yahoo.com/p/

http://biz.yahoo.com/p/4conameu.html

http://www.dol.gov/ebsa/faqs/faq-cobra-arra.html

http://www.ft.com/cms/s/0/a025fd26-00ad-11df-ae8d-00144feabdc0.html

http://ftalphaville.ft.com/blog/2010/01/14/126481/the-back-of-the-envelope-bank-levy/