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

President Still on Message…and It’s a Costly One

President Obama stumped over the weekend for Martha Coakley, who is running for Ted Kennedy’s vacant Senate seat against GOP upstart Scott Brown. He echoed his recent hawkishness, pitting green jobs against the oil industry, and taxpayers against “fat cat” Wall Street bankers, repeating his “I’ll get your TARP money back” meme. 

[1/20/2010 UPDATE - In an interview currently running on CNBC, Warren Buffet pointed out that most of the TARP recipient banks have repaid the federal government with interest, and that the industry, via FDIC, has absorbed the losses resulting from bank failures. TARP losses are the result of GSE's like Fannie and Freddie, and AIG, where many stakeholders - not just CDS counter parties, but also insurance settlement and annuity receipients - were paid with TARP funds. Important points, and they make the President's recent TARP rhetoric all the more puzzling.]

Obama’s current approach to policy is a net economic negative that will not reduce unemployment, at least in the short run. It will merely shuffle employment around between industries, creating inefficiencies and piling additional dislocation on top of the residual pain of a deep recession. And preaching to the choir could not have helped Coakley, given that she had lost a double digit poll lead due to migration of moderate and independent voters in recent weeks. Arch lefties are simply not going to swing the special election in Massachusetts, and they are probably not going to swing the 2010 midterm elections. For the second time in the last couple of weeks, we are left to wonder which cabinet member(s) the president is currently getting his strategic and tactical guidance from, and how much it’s going to cost his party before he starts looking for better advice.

We would assert that the Dems have lost a great deal of ground since they and the president began taking a more hawkish fiscal stance, and since PAYGO came back into vogue (though we could be wrong – perceptions of overreaching on health care reform may have been more important, for example). The parties’ current approaches to policy are basically:

Dems:    increased public spending  + higher taxes

GOP:      decreased public spending + lower taxes

It’s interesting to note that in many environments – this one included, we think – those options won’t differ a whole lot in terms of economic output. Thus, the choice may not be about economic performance as much as private versus public control of resources, which seems to be fairly characteristic of the American voter. That’s too bad, as there are some important public sector initiatives, including infrastructure, energy efficiency, gaps in the health care system, even a public employer of last resort, that could and arguably should be undertaken. Unfortunately, every time the President or members of his party claim that the private sector (however narrowly defined and targeted) will be put on the hook for funding some initiative, he shuts down these important opportunities.

As we’ve noted elsewhere, the federal government issues the money used to service its debt. Thus, the only real constraint on public sector deficits is inflation expectations coming unhinged. This has not happened to date, and most forward looking indicators are pointing in a disinflationary if not outright deflationary direction, at least in purely domestic goods and services. This realization offers a less divisive way forward for whichever party grasps it first, i.e.:

Dems:    increased public spending  + increased deficits

GOP:      lower taxes + increased deficits

In what appears to be a  ’Keynesian’ decade ahead, these approaches offer a healthier framework for policymaking. And arguably, the Dem direction – if they had the courage to advocate it, and the sense and restraint to do it reasonably well – would lead to better economic outcomes overall.

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

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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.

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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

Carbon, Risk, & Uncertainty

Interesting guest blog at HBR by Bob Lurie on the risks and uncertainties posed by carbon taxation, and their importance to all businesses and business strategy:

While the US Government is working on the fine print of a new carbon regulatory system, one thing is clear: we are all going to face a new tax. It’s important that business leaders avoid the mistake of thinking this will be a new burden assessed on just a few, like the chemical industry and power utilities. Carbon is ubiquitous — part of every industry, and indeed, every human activity — from pharmaceuticals to farming to family field trips. This tax is inescapable, yet where and how hard it will hit is very hard to predict.

…[It is] essential that you view this new carbon economy not as a set of regulations you need to follow, but as an opportunity to separate yourself from those who don’t understand the implications of the new rules as well as you do.

This is about competitiveness, not compliance. Understanding the implications is a strategic imperative. And because the changes are going to be big, the time is now to develop your strategic intent and prepare for a new operational playbook.

…Let’s agree that the rationale for reducing carbon is critically important. But let’s also acknowledge the effects on business will produce outcomes that feel arbitrary and unfair.

There are big changes ahead. It will take a while for the new carbon rules to go into effect, and for businesses as well as regulators to figure out their full implications. But the impacts are large enough so that you should use this grace period to assess how the carbon tax will influence your strategy. If you take too long to move, you may get buried.

URLs:

http://blogs.hbr.org/leadinggreen/2009/07/carbon-taxes-unpredictable-impact.html

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/

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/

Recent Articles on Federal Debt and Budget Deficits

Some reading material on the issue of federal debt and budget deficits, which we’ve been working over pretty heavily in recent weeks (apparently we’ve staked out a decidedly contrarian position). Brief commentaries included (some articles may require subscription and/or registration):

Randall Forsyth of Barron’s, “A Foolish View of America’s Debt”, 11/18/2009 – Forsyth points to recent Treasury data showing that foreign purchases of Treasuries continue apace, and to research that questions how sustainable this buying is. We would argue that when the private sector is diligently saving, the public sector should be busy “dissaving”, i.e., fostering productive investment and engaging in sound counter cyclical expenditures. In a global financial economy, the ability of domestic savers to fund overseas investments poses some risk to Treasury’s cost of capital. But to the extent that foreign savers are willing to finance our public deficits, we should take advantage (though one worry is that some or much of the buying might have to do with exchange rate management by foreign authorities, which is likely to have inflationary consequences globally, and could be a more volatile source of funding than ‘real’ savings).

A mostly spot on critique of the fiscal stimulus debate from the FT, 11/12/2009 – The author calls both Dems and the GOP to task, and points out that progressive Dems need to admit that policy uncertainty undermines productive private sector activity. Unfortunately, the author falls prey to the questionable orthodoxy that we somehow know the upper limit of public debt, and thus will require “fiscal consolidation” in the mid term. These assertions need better theory and (especially) better data. As we pointed out in our recent Idle Speculator piece, an honest empirical economist will admit that the data set on modern, developed financial economies is rather limited.

The FT’s Samuel Brittan, “Simple truths about the economy”, 11/13/2009 – An important counter point to the prevailing orthodoxynoted above, Brittan argues that ”The hole in the world economy can only be filled by deficit spending by the stronger western governments.”

“Are the US and UK heading towards debt crises?”, FinanceAsia.com, 10/15/2009 – A short paper that lends some current and historical empirical support to Samuel Brittan’s assertion that western governments should be running sufficiently large budget deficits. The argument that debt-to-GDP should not exceed some magical threshold is based on a lot of conjecture (IMF, are you listening?). 

President Obama will be holding a “jobs forum” in December - The federal government has done well with counter cyclical stabilizers, and an OK job trying to clean up the mortgage mess; but it’s come up far too short on stimulating productive investment, both in public projects and in private sector initiatives. The President and his party are in a tough spot.

President Obama states in an interview that ”it’s important to recognize that if the nation keeps adding to deficit spending through tax cuts or more stimulus spending, at some point people could lose confidence in the U.S. economy and that could ‘lead to a double-dip recession.’” Err, Mr. President, judging by (the admittedly limited) historical data, the surest recipe for a double dip recession is premature fiscal and/or monetary tightening (see the U.S. 1936-37 and Japan over the past two decades). In other words, if the President and his party fall prey to budget hawkishness, both a double dip and a loss of political power are likely to result. Obama did say that he is weighing tax breaks that would incentivize private sector hiring, but judging by their policy actions to date on that front, and the current makeup of Congress, the resulting policies and their economic impact are likely to be piecemeal. And, of course, temporary, like a “sunset”.

“Tax Amnesty Reaps Billions for Treasury”, FT, 11/17/2009 – Sometimes risk taking in the domain of taxes can produce positive results, as we’ve remarked before. In today’s economic climate, the deficit hawks and redistributionists should reconsider their approaches. A less distorting tax code, and a lower marginal tax burden, might not blow up the Treasury’s credit rating if coupled with productive public investments and a sound and reasonably certain regulatory outlook. Such measures are likely to be subsumed to continuing legislative efforts on health care and financial reform, which is unfortunate. Putting the economic horse ahead of those carts might have meant an earlier downturn in  unemployment, and more political capital for getting them done. Instead, we won’t see unemployment turn down until mid-2010 at the earliest; and that could prove a bigger risk for Democrats in midterm elections than budget deficits.

“Geithner: Recovery not enough without reforms,” Reuters, 11/19/2009 – Geithner testified to Congress that “the regulatory regime that failed so terribly leading up to the financial crisis is precisely the regulatory regime we have today.” Congress and the Administration’s legislative onslaught isn’t helping matters. There’s a lot on policymakers’ plate. In the meantime, the prevailing dynamic in the global financial system is the same one that has made financial crises such frequent visitors since the 1970s and 80s.

URLs:

http://online.barrons.com/article/SB125846371623352037.html

http://www.ft.com/cms/s/0/0c521d8c-cfbb-11de-a36d-00144feabdc0.html

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

http://www.ft.com/cms/s/0/66e41076-cfc4-11de-a36d-00144feabdc0.html

http://www.ft.com/cms/s/0/0570e674-cf98-11de-b876-00144feabdc0,s01=1.html

http://www.financeasia.com/print.aspx?CIID=158204

http://news.yahoo.com/s/ap/20091118/ap_on_re_as/as_obama_economy

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

http://www.ft.com/cms/s/0/12465b26-d390-11de-9607-00144feabdc0.html

http://www.reuters.com/article/ousivMolt/idUSTRE5AI2Z820091119