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

More Important Than Facebook?!?

Hold your tongue, internet security expert!

A Georgia mother and her two daughters logged onto Facebook from mobile phones last weekend and wound up in a startling place: strangers’ accounts with full access to troves of private information.The glitch — the result of a routing problem at the family’s wireless carrier… — revealed a little known security flaw with far reaching implications for everyone on the Internet, not just Facebook users.

In each case, the Internet lost track of who was who, putting the women into the wrong accounts. It doesn’t appear the users could have done anything to stop it. The problem adds a dimension to researchers’ warnings that there are many ways online information — from mundane data to dark secrets — can go awry.

Several security experts said they had not heard of a case like this, in which the wrong person was shown a Web page whose user name and password had been entered by someone else. It’s not clear whether such episodes are rare or simply not reported. But experts said such flaws could occur on e-mail services, for instance, and that something similar could happen on a PC, not just a phone.

“The fact that it did happen is proof that it could potentially happen again and with something a lot more important than Facebook,” said Nathan Hamiel, founder of the Hexagon Security Group, a research organization.

URLs:

http://news.yahoo.com/s/ap/20100115/ap_on_hi_te/us_tec_facebook_at_t_glitch

2004 CSE Not to Blame for Crisis?

We’ve argued in several places that changes to the SEC’s Consolidated Supervised Entity’s program in 2004 contributed to the dramatic rise in systemic leverage that precipitated the financial crisis. The SEC’s Director of Trading and Markets offered a rebuttal to this argument back in April 2009: http://www.sec.gov/news/speech/2009/spch040909ers.htm

Today, I want to discuss a Commission action that I believe has been unfairly characterized as being a major contributor to the current crisis. I am referring to the Commission’s 2004 rule amendments to the broker-dealer net capital rule that established the consolidated supervised entity (CSE) program. Since August 2008, commenters in the press and elsewhere have suggested that the 2004 amendments removed a leverage restriction that had prevented the firms from taking on debt that exceeded more than twelve times their capital and, as a consequence, the Commission allowed these firms to increase their debt-to-capital ratios to unsafe levels well-above 12-to-1, indeed to 33-to-1 as some have suggested. These commenters point to the 2004 amendments as a significant factor leading to the demise of Bear Stearns. While this theme has been repeated often in the press and elsewhere, it lacks foundation in fact.

It’s an interesting speech, but several facts still argue against letting the SEC and other regulators off the hook. First, leverage at the largest investment banks, including Bear Stearns, Lehman Brothers, and Merrill Lynch — and in the financial system as a whole — was far beyond anything that could be considered prudent. So whether due to CSE changes or something else entirely, this is still a clear sign of regulatory failure. Second, Christopher Cox, towards the end of his tenure as SEC chief, took actions and made statements that were damning of the CSE:

Washington, D.C., Sept. 26, 2008 — Securities and Exchange Commission Chairman Christopher Cox today announced a decision by the Division of Trading and Markets to end the Consolidated Supervised Entities (CSE) program, created in 2004 as a way for global investment bank conglomerates that lack a supervisor under law to voluntarily submit to regulation. Chairman Cox also described the agency’s plans for enhancing SEC oversight of the broker-dealer subsidiaries of bank holding companies regulated by the Federal Reserve, based on the recent Memorandum of Understanding (MOU) between the SEC and the Fed.

…Because of the lack of explicit statutory authority for the Commission to require these investment bank holding companies to report their capital, maintain liquidity, or submit to leverage requirements, the Commission in 2004 created a voluntary program, the Consolidated Supervised Entities program, in an effort to fill this regulatory gap.

As I have reported to the Congress multiple times in recent months, the CSE program was fundamentally flawed from the beginning, because investment banks could opt in or out of supervision voluntarily. The fact that investment bank holding companies could withdraw from this voluntary supervision at their discretion diminished the perceived mandate of the CSE program, and weakened its effectiveness.

It sounds like Director Sirri’s argument, that the CSE did not explicitly allow higher leverage ratios, might very well hold water. But his speech does not address the issues that Chairman Cox’s statement raised — namely, that the CSE left gaping holes in financial regulation that were ruthlessly exploited by the largest investment banks.

URLs:

http://www.sec.gov/news/speech/2009/spch040909ers.htm

http://www.sec.gov/news/press/2008/2008-230.htm

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://symmetrycapital.net/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/

Rubin to the Rescue?

In Newsweek, former Goldman Sachs CEO, Clinton Treasury Secretary, and Citigroup bigwig Robert Rubin offers his analysis of the Great Recession and proposed nostrums for preventing another:

Given my views as to the causes of the crisis, I would recommend the following:

• There should be greatly increased capital and margin requirements for derivatives and other instruments of financial engineering to create a greater cushion when trouble develops and to reduce risk exposure. I developed this view during my many years of working with derivatives before entering government, as described in my 2003 book, In an Uncertain World.
• Standard derivative contracts should trade on an exchange to increase transparency. Transactions that are custom designed would not be exchange traded but would be subject to the same capital and margin requirements as listed transactions. Disclosure requirements could be considered for customized transactions, to provide private counterparties and regulators with the transparency to understand the risks.
• There should be two sets of more stringent leverage limitations for systemically significant institutions, one defined by risk-based models and the second by much simpler measures, since mathematical models can’t capture the full range of real-world possibilities.
• There should be significant constraints on off-balance-sheet financing; for example, institutions must retain ownership of a portion of off-balance-sheet assets.
• We need a change in accounting systems to avoid the artificial effects of mark-to-market accounting for illiquid assets on balance sheets and on markets. There are other accounting approaches that would better reflect long-run values for these assets.
• We should also provide effective mechanisms for dealing with systemically important nonbank financial institutions—including bank holding companies—that get into trouble, to mitigate “too big to fail” concerns, but practical ways to do this need to be developed.
• There should be greatly increased protections, both to safeguard consumers and to reduce systemic risk. The elements should include readily understandable disclosure, suitability requirements, prohibition of practices or instruments inherently susceptible to abuse, and, if some practical way can be found, personalized advice for the most vulnerable consumers.

Fair enough, mostly no brainers, but is Rubin being disingenuous? As we’ve previously written, there seem to be growing threats to to the man’s political capital, particularly within the Democratic party. And judging by this piece from Marshall Auerback, those threats still exist, and have intensified since 2006:

As one of the people whose policies threw the global economy off the rails, Rubin may be uniquely qualified to provide solutions as to how to get the economy back on track. But that would presuppose that the man actually acknowledged mistakes (as some of his other Goldman Sachs/Clinton Administration colleagues, such as Gary Gensler, have done) and displayed at least a marginal understanding of where he went wrong.

No such luck. We get the usual self-serving “nobody could have possibly predicted a crisis of this magnitude” right at the start…

Auerback cites a damning interview with the former head of the CFTC, Brooksley Born (a position now held by the aforementioned Gary Gensler):

…as analysts sort out the origins of what has become the worst financial crisis since the Great Depression, Born has emerged as a sort of modern-day Cassandra. Some people believe the debacle could have been averted or muted had Greenspan and others followed her advice.As chairperson of the CFTC, Born advocated reining in the huge and growing market for financial derivatives.

According to Auerback:

Rubin now suggests that Born’s problem was one of style, rather than substance: she, being “too confrontational”, risked aborting any politically feasible reform of OTC derivatives. That’s certainly an interesting reinterpretation of Rubin’s actual role as Treasury Secretary, during which he laid the groundwork for today’s crisis through an aggressive championing of financial deregulation. It’s hard to think of one instance where the former Goldman Sachs CEO actually came down hard on his former Wall Street colleagues. Had he at least acknowledged some remorse or recognition of error, he would be more appropriately suited for an advisory role on how to fix the global economy, much as a reformed criminal often has useful insights on penal reform.No such luck here. If being one of the worst Treasury Secretaries ever wasn’t enough, Rubin left another unfortunate legacy at Citigroup, where he was a senior advisor after he quit the Treasury. He left Citi just before its near collapse amidst criticism of his performance. A distinguishing moment of his tenure was when Rubin got hold of Peter Fisher in the US Treasury Department to try to put pressure on the bond-rating agencies to avoid downgrading Enron’ debt which was a debtor of Citigroup…

Letting him publicly expound on getting the global economy back on track is akin to providing Kim Il Jong-il a public platform on human rights. Unlike Greenspan, who at least admitted mistakes, Rubin expects to be taken seriously as a policy maker despite acknowledging zero responsibility for the debacle that threw millions of Americans into unemployment. People around the world have lost their jobs, savings, and more largely thanks to the policies championed by this misguided deficit warrior.

Ouch.

We’ll pile on by reminding people that as Treasury Secretary, Rubin presided over implementation of the “strong dollar” policy designed by his predecessor, Lloyd Bentsen, which had damaging effects on many developing nations’ economies. He’s also featured prominently in a recent list at Motley Fool of “The 10 Dumbest Banker Quotes of All Time”. And we agree with Auerback that a sincere mea culpa for past errors, whether at Treasury or Citigroup, would buy the man some badly needed goodwill. We think he should also expand his bullet points to include the following: 

• Let’s not repeat the mistake of believing that experts always know best.
• Let’s agree that optimal outcomes often require more than just unbridled private actors.
• Let’s resolve not to get caught up in any more cults of personality, whether adorer or adoree.

Update 01/07/2010 (via Mark Thoma) – Larry Summers, who is currently President Obama’s National Economic Council chief, and was Robert Rubin’s protege and eventual successor at the Clinton Treasury, also finds his political capital under attack from both the left and the right.   

IMPORTANT DISCLOSURE: Symmetry Capital Management, LLC is a member of the Amazon Associates program, and earns a revenue sharing fee of approximately 4% on qualified purchases made by clicking through from our website.

URLs:

http://www.newsweek.com/id/225623/page/2

http://www.amazon.com/gp/product/0375757309?ie=UTF8&tag=symmetrycapit-20&linkCode=as2&camp=1789&creative=390957&creativeASIN=0375757309

http://www.newdeal20.org/?p=7270

http://www.stanfordalumni.org/news/magazine/2009/marapr/features/born.html

http://www.fool.com/investing/general/2009/11/25/the-10-dumbest-banker-quotes-of-all-time.aspx

http://www.economicprincipals.com/issues/2010.01.03/880.html

http://capitalgainsandgames.com/blog/bruce-bartlett/1373/summers-out

IMF: Political Lobbying ~ Financial Risk

A new IMF analysis tests the common sense assertion that some mortgage lenders engaged in heavy political lobbying in the years prior to the financial crisis, and that the political results helped to precipitate the financial crisis (emphasis added):

On December 31, 2007, the Wall Street Journal reported that Ameriquest Mortgage and Countrywide Financial, two of the largest mortgage lenders in the nation, spent respectively $20.5 million and $8.7 million in political donations, campaign contributions, and lobbying activities from 2002 through 2006. The sought outcome, according to the article, was the defeat of anti-predatory lending legislation. In other words, timely regulatory response that could have mitigated reckless lending practices and the consequent rise in delinquencies and foreclosures was shut down by some mortgage lenders. Such anecdotal evidence suggests that the political influence of the financial industry contributed to the 2007 mortgage crisis, which, in the fall of 2008, generalized in the worst bout of financial instability since the Great Depression.

The researchers’ findings lend strong empirical support to the common sense:

Using detailed information on lobbying and mortgage lending activities, we find that lenders lobbying more on issues related to mortgage lending (i) had higher loan-to-income ratios, (ii) securitized more intensively, and (iii) had faster growing portfolios. Ex-post, delinquency rates are higher in areas where lobbyist’ lending grew faster and they experienced negative abnormal stock returns during key crisis events…These results show that lobbying lenders engage[d] in riskier lending.

URLs:

http://www.imf.org/external/pubs/ft/wp/2009/wp09287.pdf

More confusion on federal deficits

BNET’s Steve Tobak, in a series of retrospectives, penned a critique of federal spending in 2009. While he’s spot on regarding the role of leverage in creating systemic fragility, and about the importance of agency risks, potential and realized, he displays the same kind of confusion about federal deficits and debt levels that threatens to end a still short-in-the-tooth recovery:

I would hope we learned from the subprime mortgage crisis that got us into this mess that too much leverage is a bad thing. That’s sort of a no-brainer, isn’t it? I mean, giving people mortgages they can’t afford with no money down is bad, right? Banks betting the farm on mortgage-backed securities and credit-default swaps … also bad.

And yet, our national response to this crisis has essentially been to leverage the entire country by ratcheting up the national debt to record levels. What message does that send to each and every American business and family with a budget to manage?

When federal deficits and central bank balance sheet expand in response to a financial crisis and deep economic recession, this does not necessarily increase the overall debt in the domestic economy.  Rather, it means that the public sector, because it has the greatest capacity to bear risk, takes on some of the burden of existing private sector debt. To do otherwise would mean a sharper and deeper recession, i.e., a depression. While “liquidation” has its benefits, one of the tradeoffs is a greater level of defaults and even higher unemployment (i.e., even lower national income), at least over the short to intermediate term. And like it or not, our political system, which does a pretty good job of discounting the desires of the entire electorate, decided long ago that unbridled liquidation was not the optimal path for economic policy. Had the federal government and the federal reserve kept the purse strings tight, given the global nature of the recession and – as Tobak pointed out – the high systemic leverage and fragility that preceded it, the outcome would almost surely have been much, much worse.

Tobak also makes the mistake of comparing private sector budgets to the federal budget. There are some critically important distinctions between them, the primary one being that the federal government creates the money needed to pay its obligations out of thin air – which is a critical part of its risk bearing capacity.

Macro errors aside, in another article Tobak offers a great strategic approach for dealing with personal nemeses in the workplace, which we highly recommend.

URLs:

http://blogs.bnet.com/ceo/?p=3499&tag=nl.e713

http://www.j-bradford-delong.net/pdf_files/Liquidation_Cycles.pdf

http://blogs.bnet.com/ceo/?p=3493&tag=nl.e713

MSNBC: Economists against additional stimulus

MSNBC.com is reporting that a majority of economists it surveyed (9 out of 11) are opposed to additional economic stimulus. We think there are a couple of errors in the panel’s prevailing outlook. First is that 2010 GDP and hiring will be sluggish — we expect that both will surprise to the upside in 2010, especially GDP. However, this will be a function of rising volatility more than a return to robust trend growth; we also see a chance that 2011 or 2012 GDP could surprise to the downside.

The prevailing view seems to be that a mild but fragile recovery is underway, and that the public sector should allow the private sector to do the heavy lifting from here. But this view might be relying on a significant ommission of evidence, if public sector (federal government) stimulus and demand have been the primary drivers of recovery thus far. As we’ve noted in recent months, there appear to be important long term factors at work (e.g., demographic ratios, increased private sector saving, slack credit demand) that will cause orthodox economic theories and policy prescriptions to present a serious and growing risk of premature fiscal tightening – again, as in the U.S. in the late 1930s and Japan in the 1990s and 2000s. The views reported by MSNBC lend additional support to our assessment.

URLs:

http://www.msnbc.msn.com/id/34452363/ns/business-personal_finance/

http://symmetrycapital.net/index.php/blog/2009/11/19046mauldin-on-japan/ 

http://symmetrycapital.net/index.php/blog/2009/11/recent-articles-on-federal-debt-and-budget-deficits/

http://symmetrycapital.net/index.php/blog/2009/12/1937-public-debt-and-job-creation/

Budget Jawboning, Right on Cue

In our most recent Idle Speculator, we argued that there’s a risk that the federal government begins to tighten the screws on the real economy too soon, which could cut short a nascent recovery, much as it did in 1936-37, and much as the Japanese government did at different times during Japan’s two decade recession. Right on cue, the Obama administration has announced that it wants to freeze or cut most domestic spending:

The Obama administration, mindful of public anxiety over the government’s mushrooming debt, is shifting emphasis from big-spending policies to deficit reduction. Domestic agencies have been told to brace for a spending freeze or cuts of up to 5 percent as part of a midterm election-year push to rein in record budget shortfalls…

[The President] is expected to make post-recession spending restraint a key theme of his State of the Union address in January and an important element of the budget he submits to Congress a few weeks later. He is under increasing pressure, including from moderate and conservative members of his own party, to show he is serious about tackling a deficit that has become both an economic and political liability.

What direction this will take is still up in the air. As the AP article points out, the move is in response to political pressures rather than economic conditions, which do not argue for a more hawkish budget. Thus, the effort might have more symbolism than substance. However it’s pursued, the primary objective appears to be the Dems’ chances in the 2010 Congressional elections, which smacks of politics-as-usual, short run consequences to citizens — whether it’s economic harm or just being lied to — be damned. Is that somehow a better recipe for electoral success than speaking honestly with your constituents about the appropriate times, places, and levels of public expenditures?

We understand the thinking that sees common sense in a balanced federal budget, and under certain economic conditions, tightening at the federal level is absolutely appropriate. But to demand a balanced budget under current economic conditions is probably not in our best interests,  especially if it includes sacrificing public investments with significant multiplier effects and/or taking tax reforms off the table. Furthermore, it would take away any room that the Federal Reserve has to tighten monetary policy, which will only exacerbate the USD carry trade that seems likely to fuel another round of commodity and emerging market speculation; that would mean yet another bout of global financial upheaval at some point. Economist Nouriel Roubini recently argued that current financial and monetary conditions could lead to the “biggest co-ordinated asset bust ever…if factors lead the dollar to reverse and suddenly appreciate.” A vigorous tightening of the federal budget could certainly catalyze such a reaction. Putting it all together, it appears that instead of helping the Federal Reserve alight from its tightrope, Congress and the Administration are choosing to step onto a tightrope of their own.

Before expressing their will in 2010, voters should keep in mind that day-to-day common sense would have called for letting large financial institutions fail in 2008, which would have short circuited the global payments system (imagine having to barter or transact in personal IOUs from September 2008, and what effects that would have had on the economy). It is important to signal to foreign Treasury debt holders that their interests will not be ignored (we’re speculating that this could have been a concession to China and Asia). And there will come a time when federal budget tightening is appropriate. But by our reckoning, that moment is not upon us yet.

URLs:

http://symmetrycapital.net/idlespeculation/20091109.pdf

http://finance.yahoo.com/news/Obama-wants-domestic-spending-apf-691348121.html?x=0

http://www.rgemonitor.com/roubini-monitor/257912/mother_of_all_carry_trades_faces_an_inevitable_bust

Idle Speculator: Is the Federal Government Too Tight?

In our latest Idle Speculator piece, we ask whether — despite large recent and expected budget deficits — the federal government risks being too tight. We argue that:

(1) At certain times and under certain economic conditions, deficit financed improvements in the tax code and public expenditures and investments make sense.

(2) The U.S. may be in one of those periods now, while Japan may be exiting one. In both cases (as well as the Great Depression), demographic trends might be playing a larger role than conventional theories assume.

(3) Pro-growth fiscal policies would give the Federal Reserve a lot more room to raise rates and defend the USD.

(4) Given: the enormous nominal dollar figures attached to discussions of U.S. budget deficits and national debt; widespread misconceptions about public finance and its economic effects; and ideological rancor among voters and politicians; there will be increasing pressure to tighten up the federal budget in coming years. Such actions could be premature and threaten a nascent economic recovery.

http://symmetrycapital.net/idlespeculation/20091109.pdf