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://symmetrycapital.net/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

A Strong Dollar Call

President Obama, continuing his recent streak of verbal fiscal hawkishness (our view is admittedly contrarian) signed a memorandum today regarding tax delinquencies among government contractors. To the extent that federal contracts are awared to tax evaders and tax cheats due to poor information sharing or availability, this is a good initiative, and it’s based on analyses from the GAO like this one.

It was the President’s remarks that were most telling, especially his argument that the federal government needs to align itself with the values and norms that tax paying households live by (of course, this completely ignores the fact that only the federal government can create the money required to fulfill tax, debt, and other financial obligations, not just of the public sector, but of the private sector as well). The underlying message of recent remarks by the President is that tightening via “fiscal discipline” is very likely in the months and years ahead; Obama is clearly signalling that he has staked out a very center-right position among Democrats, similar to the Blue Dogs and Democratic Leadership Council, as summed up in this recent piece by Harold Ford, Jr:

The ability of the private sector to produce new jobs — our economic future — depends on how quickly we can get back on the path to fiscal responsibility. This means that any health-care reform plan should be paid for — a promise that President Obama has made, and one that his predecessor should have made.

Ford’s assertions are based on the rather shaky assumption that they hold under all economic conditions. But as we’ve noted recently, there are only some environments where this holds true, while there are other environments where it does not. In the former, fiscal conservatism may be appropriate due to “crowding out” and other concerns. In the latter, the private sector’s capacity to produce jobs actually depends on public sector demand, investment, and intermediation, i.e., deficits. 

Most people, Ford included, accept this idea in the short run, e.g., during a financial crisis or a sharp economic downturn. But what we’re arguing, essentially, is that pessimistic expectations are sometimes rational, and that the factors driving them can theoretically remain in force over fairly long cycles of ten, twenty, or thirty years, even longer.  In the situation at hand, when we look at demographic shifts in the U.S. and residual damage from the financial crisis, we think the decade ahead will be of the latter variety in both the U.S. and mature European economies.  So the message of Ford, his fellow Blue Dogs, the DLC, and President Obama (especially of late) might be a suboptimal direction for policy, however well it might have worked in the 1980s and 1990s. [1/20/2010 UPDATE - well written piece here on how public thinking about policy is heavily informed by experiences since the 1980s, which might be akin to driving by the rear view mirror]

As a result, we now see several forces at work that lead us to expect a strengthening USD, all else equal. First, the prevailing view among Democrats appears to be that voters will favor fiscal hawks in midterm elections, and they will respond accordingly. Second, we expect upside volatility in the real economy in 2010 (due in no small part to public sector demand), which will relax pressures for additional fiscal stimulus. Third, invoking the ideas of the neo-Chartalists, we’d argue that when the federal government places a high value on “fiscal responsibility” or “fiscal conservatism”, it implies that monetary units are going to become more scarce, and thus more valuable. In other words, if the President’s recent signalling is sincere, the USD is likely to appreciate (as will Treasuries, despite their compressed yields), and commodities and other carry trade and risky assets are likely to suffer (today’s market movements seem to support this argument).

While most pundits are attributing today’s market developments to the Republican capture of Kennedy’s senate seat yesterday, and/or to policy tightening in China, which are almost certainly factors, we would argue that far too many are overlooking the impact that President Obama’s current policy tenor is having on the USD. He’s essentially promising that the “tokens” required to settle economic transactions and engage in productive activity are going to become scarcer.

This implies some important changes in who the marginal actors are in the political economy. After the 2008 election, we asserted that the Blue Dogs would be the marginal player in setting the course of economic policy. The President’s upcoming budget will give us a clearer idea of whether their fiscal conservatism, as Obama’s current rhetoric implies, has indeed become dominant. If it has, then we think the Fed becomes the marginal factor in policy direction and economic outcomes. How soon and how sharply they tighten will determine the risk of a 1937 or Japan style recession, and it will also have critical implications for the performance of emerging market equities and other risky assets in the short to intermediate term.

URLs:

http://www.whitehouse.gov/the-press-office/memorandum-heads-executive-departments-and-agencies-1

http://www.gao.gov/new.items/d07742t.pdf

http://www.dlc.org/ndol_ci.cfm?contentid=255070&kaid=85&subid=65

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

http://www.cfeps.org/pubs/wp-pdf/WP10-Wray.pdf

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://symmetrycapital.net/idlespeculation/20100112.pdf

Between a ‘Derm and a Donkey

=====

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/

Farmer: Farewell to the Natural Rate

An interesting theory and a cool video graphic can be found here, where UCLA economist Roger Farmer examines the relationship between inflation, unemployment, and job vacancies, adding yet another contribution to the Keynesian renaissance:

In two forthcoming books, Expectations Employment and Prices (2010a) and How the Economy Works (2010b), I provide a theory that explains these data. I argue that there is no natural rate of unemployment and that the economy can come to rest in a stationary equilibrium at any point on the Beveridge curve. Which equilibrium persists, is decided by the confidence of households and firms that pins down asset values as reflected in housing wealth and the value of the stock market.

When households feel wealthy, that belief is self-fulfilling. Consumers spend a lot, firms hire workers, and the economy comes to rest at a point on the Beveridge curve with low unemployment and high vacancies. When the values of houses, factories, and machines fall, households spend less, firms lay off workers, and the economy comes to rest at a point on the Beveridge curve with high unemployment and low vacancies. Both situations – and anything in between – are zero-profit equilibria. High inflation makes the trade-off between unemployment and vacancies less favourable, and in the steady state, any inflation rate is consistent with any unemployment rate.

Most policymakers subscribe to the theory of the existence of a natural rate of unemployment. The data suggest that this theory is unconfirmed at best. To make the theory consistent with data, one must posit that the natural rate changes between recessions in unpredictable ways. This version of natural rate theory is difficult or impossible to refute. It is religion, not science.

For more than fifty years policy makers have been trying to hit two targets, unemployment and inflation, with one instrument, the interest rate. Recently, central bankers have discovered a second instrument – quantitative easing. I believe that quantitative easing works by influencing the value of real assets as reflected in housing wealth and the stock market and that it was successfully deployed by central banks in 2009 to maintain aggregate demand. In my two forthcoming books, I argue that quantitative easing should permanently enter the lexicon of central banking as a second instrument of monetary policy and that it will prove to be a more effective and flexible tool than fiscal policy for restoring and maintaining full employment.

A competing idea is to attack this from the fiscal side rather than the monetary side, by making the federal government the ‘employer of last resort’. This is an interesting idea for a few reasons. First, it’s been proposed by economists on both the ‘left’ (e.g., L. Randall Wray) and the ‘right’ (e.g., Edmund Phelps). Second, it would put at least some intermediary stages between USD creation and the USD carry trade. And third, while either lever should work from a Wicksellian point of view, as long as the USD is the primary global reserve currency, quantitative easing may be riskier to the global financial system (not to mention the USD’s reserve currency status) than a purely domestic employment program would be.

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.voxeu.org/index.php?q=node/4452

http://www.amazon.com/gp/product/0195397908?ie=UTF8&tag=symmetrycapit-20&linkCode=as2&camp=1789&creative=390957&creativeASIN=0195397908

http://www.amazon.com/gp/product/0195397916?ie=UTF8&tag=symmetrycapit-20&linkCode=as2&camp=1789&creative=390957&creativeASIN=0195397916

http://ideas.repec.org/p/wpa/wuwpma/9802006.html

http://www.amazon.com/gp/product/0674094964?ie=UTF8&tag=symmetrycapit-20&linkCode=as2&camp=1789&creative=390957&creativeASIN=0674094964

Auerback: Deficit Hawking

Good piece from Marshall Auerback on the risk of premature public sector tightening, as manifest in a proposed ‘deficit commission’.

…President Obama has voiced support for such a plan, as have 35 Democratic and Republican senators, who have signed on to legislation that would create a bipartisan commission with broad power to force painful spending cuts and tax increases through Congress….Even before its official inception, the proposed commission is starting with remarkably partisan assumptions about debt and entitlement programs. What is so inherently “unsustainable” about our current levels of government debt? In the early Victorian period, for example, the British government debt to GDP ratio was nearly 200 per cent and almost reached that level again in the early 1920s.  The historian Lord Macaulay noted that at every stage of debt increase, “it was seriously asserted by wise men that bankruptcy and ruin were at hand; yet still the debt kept on growing, and still bankruptcy and ruin were as remote as ever.”

The ideas which underlie this new commission also display fundamental ignorance about double-entry bookkeeping principles which have been in existence for over 7 centuries.

In truth, today’s deficit hawks are nothing more than zealots — poised again to preach their nonsensical theology that government deficits are dangerous and need to be cut, without honestly explaining the full consequences of their recommendations. If households attempt to net save by spending less than they are earning, and businesses attempt to net save (reinvesting less than their retained earnings), then private sector incomes and real output will decline absent an increase in government spending. The danger of premature fiscal tightening was illustrated in the US in 1936-37, when the ending of a war veterans’ bonus and the introduction of Social Security taxes helped push the US back into recession when recovery from the Great Depression was far from complete.

I’m becoming a rather lonely wingnut, but we strongly suspect that Auerback and his ilk are right, and that the spending phobes and deficit hawks are wrong. If so, and if the Administration and Congress tighten prematurely, with or without the Fed, then the 1937 and 1990s Japan scenarios remain firmly in play. Time will tell.

URLs:

http://www.newdeal20.org/?p=7241

http://symmetrycapital.net/idlespeculation/2007110701.pdf

Krugman’s 1937 Feeling

Paul Krugman echoes our warnings of a 1937 (and Japan 1990s) redux:

The next G.D.P. report is likely to show solid growth in late 2009. There will be lots of bullish commentary — and the calls we’re already hearing for an end to stimulus, for reversing the steps the government and the Federal Reserve took to prop up the economy, will grow even louder.

But if those calls are heeded, we’ll be repeating the great mistake of 1937, when the Fed and the Roosevelt administration decided that the Great Depression was over, that it was time for the economy to throw away its crutches. Spending was cut back, monetary policy was tightened — and the economy promptly plunged back into the depths.

…will policy makers misinterpret the news and repeat the mistakes of 1937? Actually, they already are.

The Obama fiscal stimulus plan is expected to have its peak effect on G.D.P. and jobs around the middle of this year, then start fading out…Congress should have enacted a second round of stimulus months ago, when it became clear that the slump was going to be deeper and longer than originally expected. But nothing was done — and the illusory good numbers we’re about to see will probably head off any further possibility of action.

Meanwhile, all the talk at the Fed is about the need for an “exit strategy” from its efforts to support the economy. One of those efforts, purchases of long-term U.S. government debt, has already come to an end. It’s widely expected that another, purchases of mortgage-backed securities, will end in a few months. This amounts to a monetary tightening, even if the Fed doesn’t raise interest rates directly — and there’s a lot of pressure on Mr. Bernanke to do that too.

Update 1/07/2009 – An interview with Krugman on prospects for economic recovery is available on Advisor Perspectives. He still gets some political digs in, but it’s refreshing to hear his thoughts on economic issues outside the context of his NYT column.

URLs:

http://www.nytimes.com/2010/01/04/opinion/04krugman.html

http://www.advisorperspectives.com/newsletters09/Paul_Krugman_on_the_Prospects_for_Recovery.php

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

The “Obamacare” Debate

Some key pieces in the debate over the healthcare reform bills passed by the House and Senate are linked below (TOH to Brad DeLong for the first three). We put “Obamacare” in quotes in the title of this piece because, while Obama’s election certainly paved the way for health care legislation to proceed, ownership of health care reform extends far beyond - and before - the current administration.

A WSJ editorial from mid-December argued against cost containment arguments made in support of the legislation:

The White House hawked a permanent entitlement expansion on flimsy and speculative theories that its own partisans now admit—albeit when it is nearly too late—aren’t more substantive than the triumph of hope over experience, while simultaneously writing off the one policy that has been effective in the real world. The cost control mantra of ObamaCare was always a political bill of goods, and its result will be the opposite of its claims: poorer quality care at higher costs.

The editorial incited a spirited defense from Peter Orszag, head of the Administration’s Office of Management and Budget (OMB):

We are not setting out a plan with every detail laid out for what the health care system of the future should look like.  Thinking that we could lay out in full detail a perfect system today would show a foolish disregard for the dynamism of the health care sector – and of the American economy in general.  Instead, we are putting in place processes by which what works and what doesn’t can be rigorously tested, and then scaled up over time as they are reflected in the decisions of thousands upon thousands of hospitals, physicians, and other providers.  Does the Journal have a better suggestion about how to approach policymaking in a dynamic world?

…Can more work be done on health reform? Sure. And that is what is occurring through the legislative process as I write. Moreover, even after passage, we will need a continuous assessment of what works and what doesn’t and rapid adjustments to a changing market – all of which can be done with the mechanisms laid out in this bill.

The bottom line is that continuing on the road we are on will overwhelm our economy and our federal budget. The health care plan being considered in the Senate now is built on the best available knowledge and most promising ideas from across the political spectrum. Critics may fear this change, but what we should fear more is doing nothing.

Along those lines, David Frum, a bit of a black sheep in the GOP of late, offered a pithy but interesting critique of his party’s strategic response to health care reform and other legislation: “Republicans could have been architects of improvement, instead we made ourselves impotent spectators as things get radically worse. Plus – the bad new Democratic proposal will likely be less unpopular with voters than their more promising earlier proposal. Nice work everybody.”

Frum’s position on healthcare is fairly orthodox among conservatives, but for those who subscribe to Barron’s, we highly recommend the columns that Thomas Donlan has posted on the issue over the past year. In his most recent column on the subject, he reviewed T.R. Reid’s The Healing of America: A Global Quest for Better, Cheaper, and Fairer Health Care, and pointed to at least three critically important factors that will be stubborn barriers to cost control:

American docs can make four times as much as those in Japan, France, Britain and other countries. The foreign docs, however, mostly go through med school on government-paid tuition, and graduate free of debt. They pay what Americans would consider extremely low malpractice-insurance premiums. And those in private practice do not need to hire their own administrative staffers to deal with a myriad of insurance administrators and claims adjusters.

Donlan recaps Reid’s overview of the French health care system, illuminating some of the contrasts (and critical differences) between our system and one designed to provide universal access at a relatively low cost. Anticipating concerns about the potential for waste, fraud, and abuse in a system like France’s, he asks “what accounts for the fact that the country spends $3,165 per citizen for a system that covers everybody, while the U.S. spends almost twice as much per citizen and covers only 85% of them?” Donlan concludes:

Americans…should come to grips with [T.J.] Reid’s frank advocacy of some kind of universal health care for the U.S. on the grounds that everyone has a human right to “adequate” health care — although not without limits, whatever they may be.

Every other country that can afford it has decided to provide a minimum level of health care to everyone, regardless of income and wealth, at a minimum cost out-of-pocket. The U.S. Medicaid program also provides a minimum level of nearly free health care, but not to everyone. It aids 59 million people, the poorest 20% of Americans, by Medicaid but the coverage and eligibility vary widely.

Too many Americans say health care is a right and don’t want to have any responsibility in paying for it. Too many want market-driven health care without winners and losers. A close reading of Reid’s book may help them think more clearly.

Donlan’s conclusion lends support to our prior assessments of health care reform — that it is complicated stuff, both philosophically and operationally.

URLs:

http://delong.typepad.com/sdj/2009/12/ten-economic-paragraphs-worth-reading-december-21-2009.html

http://online.wsj.com/article/SB10001424052748703558004574583962940536556.html

http://www.whitehouse.gov/omb/blog/09/12/14/No-Illusions/

http://www.frumforum.com/the-cost-of-no-deal

http://online.barrons.com/article/SB125935468698266957.html

http://www.amazon.com/gp/product/1594202346?ie=UTF8&tag=symmetrycapit-20&linkCode=as2&camp=1789&creative=390957&creativeASIN=1594202346

http://symmetrycapital.net/index.php/blog/2009/07/ryan-what-does-it-look-like-in-september/

http://symmetrycapital.net/index.php/blog/2009/07/should-health-care-be-a-right/

DISCLOSURES: Symmetry Capital Management, LLC is an Amazon associate and earns a referral fee for any sales resulting from a “click through” purchase on Amazon.com.

1937, Public Debt, and Job Creation

CEA chair Christina Romer penned an interesting guest article for The Economist (subscription required) on parallels between the 1937 recession and today (emphasis added):

The recovery from the Depression is often described as slow because America did not return to full employment until after the outbreak of the second world war. But the truth is the recovery in the four years after Franklin Roosevelt took office in 1933 was incredibly rapid. Annual real GDP growth averaged over 9%. Unemployment fell from 25% to 14%. The second world war aside, the United States has never experienced such sustained, rapid growth.

However, that growth was halted by a second severe downturn in 1937-38, when unemployment surged again to 19%… The fundamental cause of this second recession was an unfortunate, and largely inadvertent, switch to contractionary fiscal and monetary policy.

Romer’s assertion generally comports with a recent paper from the Chicago Federal Reserve, in which Francois Velde found that “monetary and fiscal factors account fairly well for the pattern of [decline in] in industrial production and, in particular, for the depth of the recession.”

These are timely analyses, as debt and deficit phobia appear to be gaining ground inside the Beltway. A notable development is recent bipartisan legislation introduced by Sens. Conrad (D-ND) and Gregg (R-NH) that would establish a ‘fiscal task force’. While this isn’t necessarily a bad idea, it appears to be based on an incomplete understanding of financial principles, and it risks putting fiscal priorities in an order that could cause economic harm in 2011 or 2012.

First, Sen. Gregg’s frequent argument that we should not “saddle” our children or grandchildren with additional debt takes an overly simplistic view of financial principles. Debt levels by themselves don’t typically mean a whole heck of a lot. There are clearly upper limits to how much debt any entity can carry, and the 400% debt-to-GDP figure that Gregg and Conrad are fond of citing might well be it.

But before reaching that point, what matters is the activities that debts are used to finance. For example, at the level of an individual, it makes a big difference whether a person goes into debt to finance things like (1) an expensive new car, flat screen TV and A/V system, and nights out on the town or (2) an education that will enhance their future income. In the first case, the ability of one’s “future self” to service the debt incurred does not improve as a result of the things purchased (though as acquisitive beings we’re very good at justifying them). However, in the second case, the debtor’s ability to service their debt is expected to improve enough to make it not just tolerable but worthwhile. 

This difference reveals a fundamental tenet of finance; when financing anything, be it an education or a new piece of equipment, the borrower must ask themselves if the expected return on the purchase exceeds the expected cost of the financing. Thus, in financing decisions, whether undertaken in the public or the private sector, the question should not just be “how much debt”, but rather, “how will the debt be used, and is the expected return positive?” Any idea that would leave our children, grandchildren, and great grandchildren better off — the analogues of our “future selves” — should be on the table. And that means that we cannot reflexively dismiss all public measures that would increase federal deficits in the short to intermediate term. Otherwise, we could do as great an injustice to future generations as incurring a massive and wasteful public debt would do.

It seems clear to us, based on current and historical evidence, that we are in a period where the public sector (specifically, the federal government, given its relative scale and, most importantly, its monopoly over money issuance) is the debtor and economic actor at the margin (an assertion that issues like infrastructure disrepair might lend additional support to). But currently, as in 1936, the banking sector and market prices are signaling that there is a relative shortage of public sector credit! Granted, the desire for government paper could be due in part to the pro-cyclical nature of credit markets, and/or international currency interventions. But it might also be an indication that, at the margin, public initiatives present the most attractive financing opportunities right now (an idea that demographic trends seem to lend support to). Of course, that statement will cause our more conservative and libertarian friends to shudder, but we would simply point out that Christina Romer’s claim about the strength of the economic recovery in the 1930s is strongly supported by the data, rather than being informed by a purely ideological slant. Thus, beyond ensuring that sufficient counter cyclical stabilizers remain funded, the primary question that policymakers should be asking is, “How can we best put the proceeds from additional debt issuance to work in improving the country’s future productivity?” If the federal debt begins pushing the limits, it will be reflected in market prices. And to this point, nothing like that has happened.

If our assessment is on target, it raises some important considerations for President Obama’s current ‘job push’, and especially the use of excess TARP funds and the possibility of tax cuts and credits. The President, embodying the tension between fiscal and economic priorities, recently opined that surplus TARP funds (sometimes it’s good to be the ‘investor of last resort’) could be used to provide loans to allow small businesses to hire employees, or to reduce the deficit. More recently, the Administration floated the idea of various tax breaks for small businesses:

To encourage investment by small businesses and improve their access to capital, the administration is…calling for a one-year elimination of the tax on capital gains from new investments in small business stock…for the extension through 2010 of the Recovery Act provision that allows small businesses to immediately expense up to $250,000 of qualified investment…[and] for extending the Recovery Act provision that accelerates the rate at which business can deduct the cost of capital expenditures.

This is good stuff, though it’s fairly low hanging fruit. More important to long run investment and productivity is to make our national tax code less distorting and more competitive.

Obama also wants to make additional investments in roads, bridges, highways, transit, rail, aviation and other infrastructure to encourage job growth. More infrastructure investment projects would be selected on the basis of merit, through a combination of grants and loans.

The president called on Congress to consider a new program to provide rebates for consumers who retrofit their homes for greater energy efficiency. He also wants to expand several oversubscribed Recovery Act programs that have leveraged private investment in energy efficiency to create clean energy manufacturing jobs. Those include industrial energy efficiency investments and tax incentives for investing in renewable manufacturing facilities in the U.S.

Beyond any positive environmental impacts, these measures will improve long run productivity and efficiency. However, Obama has exhibited some conservative tendencies, at least in his words, regarding federal spending. Note the heavy reliance on loans as opposed to grants in the measures above, as well as this statement:

“There is only so much government can do,” said Obama. “Job creation will ultimately depend on the real job creators: businesses across America. But government can help lay the groundwork on which the private sector can better generate jobs, growth and innovation.”

We certainly agree that this is a valid statement most of the time, but we’re not convinced that it’s the case now. Even if GDP and employment do surprise to the upside as we expect in 2010, there will still be plenty of slack in domestic resource utilization. We should be careful not to underestimate the positive impact that the public sector is having on current and planned hiring and investment (of course, we’re also mindful of the uncertainty that policymaking has created in the past days, months, and couple of years). And as we noted recently, if the federal government’s support is given generously enough, it would allow the Federal Reserve a lot more wiggle room to raise rates and stem the increasingly speculative USD carry trade.

URLs:

http://www.economist.com/businessfinance/PrinterFriendly.cfm?story_id=13856176

http://www.chicagofed.org/publications/economicperspectives/ep_4qtr2009_part2_velde.pdf

http://www.ft.com/cms/s/0/893f01ec-e524-11de-9a25-00144feab49a.html

http://www.webcpa.com/news/Obama-Proposes-Tax-Cuts-Spur-Hiring-52689-1.html

http://www.newsweek.com/id/214096

http://symmetrycapital.net/index.php/blog/2009/11/right-on-cue/