recovery

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Poor Old Krugman

He’s getting glummer by the minute.

I can see why.

All the evidence piling up suggests that the best part of this recovery is now over, and that we are now entering a long, hard, and risk filled period of poor economic gains.

Not only this, but our policy options are in tatters. The sensible, text book approach is more stimulus. Then again the sensible, text book approach was massive stimulus back when it could stave off this malaise.

Oh well.

Moreover, the sensible approach to the banking crisis was the state takeover and cleaning up of the failed banks – Citibank I am looking at you – instead of this long drawn our and endless subsidization through the back door. It would have been painful and politically fraught. But we would have a healthy flow of credit right now instead of the dribs and drabs we now are faced with.

But since ‘nationalization’ is a nasty word, and since we lack the spine to deal with problems in a simple forthright way, we have condemned ourselves to years of weak and fraught activity.

Those among us who cry out that politics prevented strong action – the GOP seems hell bent on sinking the economy for their own electoral gain – should be quiet. We needed leadership. And got trimming. There is no excuse. As someone once said, countries get the leadership they deserve. We deserve mediocrity because we have drunk deeply the false truths at the free market well. We are collectively doomed to endure rather than prosper because we refuse to be strong together. We would prefer to fail apart.

The inadequacy of the economic policy team Obama relies upon has now been revealed by events. They tried to ‘get by’, and led us into the muck instead. We are given bureaucracy and paper clips, when we need declarative words and sharp knives.

The pile of debt we will accumulate in order to break the back of this crisis is huge. It could have been less had we acted decisively. The indenture we are handing forward is a token of our failure. The indebtedness a sign of our collective ineptitude and meager store of moral courage.

Throughout it all poor old Krugman has tried to point out the errors. He has been proven correct. But he has been far too nice. And now he’s glum about the future. Not because there are no solutions, but because he cannot see us deploying those solutions.

We are too weak.

So, please, no comments about ‘decline’ or anger about ‘Chinese competition’. No more wailing about the loss of manufacturing jobs. No more commentary on the diminished middle class.

The American economy is the world’s largest, most dynamic, and urgent. That we cannot muster the courage to use those qualities to restore ourselves to health is not due to the lack of anything other than spine.

So where is it?

Addendum:

Naturally Krugman is not alone. He is simply the most prominent. Other voices of economic sanity include Brad DeLong and Mark Thoma two of Krugman’s fellow travelers. Indeed the list of people complaining about the totally ineffectual nature of our nation’s leadership – in politics and in business – is very long.

The pity is that we are beset by a disease: bureaucracy has robbed us of an ability to be bold. Everything has to be ‘run by legal’. Everything has to be done by the book. Everything is reduced to jargon infested gobbledygook. Responsibility is diffused into ‘team’ rather than focused on individuals. We are a nation of face lifts, boob jobs, veneers of all kinds, fear, psychiatry, and denial. We are the age of analysis, when we need to be that age of ideas and action.

No wonder Krugman is so glum.

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Those Mystery Debt Issues

OK. Let me take another stab at this one.

There is no debt problem.

Now enjoy the summer.

We are beset with folks arguing that nations running big budget deficits ‘need’ to cut spending in order to assuage the credit markets. I have tried to argue this is fallacious reasoning, yet the fear continues. Indeed, every time it dies down, it pops right back up in a slightly modified form.

So let’s be logical.

First: there is absolutely no evidence in the credit markets of even mild concern, let alone panic. If there is one market where we should have confidence that current prices reflect a consensus view of the economy’s future, it is the market for government debt. History tells us that price movements in that market are a pretty good indicator of what the investors in government debt are thinking. And, by and large, these investors are amongst the most sophisticated there are anywhere. So the price of government debt is something we should pay attention to as an indicator of the sentiment – mood, outlook, or forecast – of these sophisticated investors.

What do current prices tell us?

That those investors are far more concerned about the likelihood of depression and deflation than they are about excessive debt and inflation. Interest rates in the market have dropped from the slightly higher levels they were back two years ago. Bond auctions are over, not under, subscribed. People are actively searching for government debt as a ‘safe’ investment. Let me repeat: rates are down, not up. Investors are scooping up, not divesting government bonds.

I happen to agree with the credit market’s conclusion.

The risks inherent in our current position are mostly downward. We are far more likely to fall into a repeat recession, and possibly a bout of deflation, than we are to boom ahead and run into unmanageable debt burdens and inflation. All of our most recent indicators show the economy slowing down from what was a very short and uneven burst of growth last fall and early this year. Austerity measures are simply adding to the downward pressure and ensuring that the slight chance of a boom is firmly eliminated. The credit markets are telling us that they recognize this and evaluate the future through a pessimistic lens.

That pessimism is driven, not by excessive debt, but by deficient demand.

OK. So maybe they’re wrong, and the ‘gut’ feel of the austerity advocates is right. What can we say to defuse that?

Second: take a look at worldwide cash flows.

The aggregate shortfall of demand worldwide is creating a staggering amount of cash. This is simple arithmetic. If people are earning, but not spending, they have an excess of cash. They become creditors. The global private sector is generating about $3 trillion in spare cash each year at the moment. Don’t forget that it is the private sector in retreat when we have a recession. So private sector savings have shot up. This includes businesses who are sitting on ‘war chests’ of cash, consumers who are paying down credit cards, and everyone else who is simply not spending. With consumption and investment this slack, the world is awash with cash. And cash is useless as an investment in itself.

So what happens?

People look for places to invest. One such place is government debt. In other words governments create debt to offset the step drop in private sector demand, and the private sector buys that debt rather than take the risk of making direct investment or consuming. So the sytem comes back into balance.

It is only when the private sector starts to see better investment opportunities within its own domain – i.e. within the private sector itself – that problems could occur. In this case investors would want to withdraw their cash from government debt and invest it in higher return, but also higher risk, projects and activities. This point of change in the attitudes and flows of cash is what could cause a run up in interest rates. Only then does the larger money supply implied by the bulge in government debt become a potential inflation problem.

It is at this moment that government funding strategies need to change course and the private sector be allowed to forge ahead.

We are nowhere near that inflection point. This is the constant and firm message from the credit markets.

In fact, if anything, those markets are crying out for more debt and thus more stimulus.

Ah … but what about all this debt? Is it not a burden on the future?

No.

It is an investment in creating that future.

The cost of living through a period of very low growth, and potentially through deflation, is vastly greater than the cost of the debt necessary to reflate growth and get GDP back to its historic levels. The higher rate of growth will allow the debt burden to be reduced as a percentage of the economy. The cost of the debt as a percentage of total government spending will increase, but as a percentage of the total economy it will be a minimal increase, if any.

People who wring their hands about passing on debt burdens to future generations would be better advised to focus on the economy itself. Given the choice between an anemic economy with low debt and a vibrant economy with higher debt, future generations would be stupid to choose the former over the latter. Vibrant growth begets opportunity, and ways in which to pay down debt, that are not on offer in a sluggish economy. And it is opportunity we should be handing down to the future, not our own fearful withdrawal from growth. In other words we should not enforce our own view of austerity on the future, but seek to create the opportunity for future generations to make their own choices. The best way to do that is to get the economy back to healthy growth.

Does this mean we have no fiscal issues?

No.

I have repeated timer and again: we have major budget funding issues to deal with.

But they do not relate to the recession, or the debt needed to fend off depression.

They relate to our fundamental choices: how to pay for retirement and health care, how to pay for defense, and how to offset the imbalances that our economic freedom produces within society. For the past thirty years or so we have followed a relentlessly self-regarding path with respect to those choices. We have focused on the self and not the community. Individualism trumped society at every turn. That created great wealth for some, and a massive redistribution of the economy’s earning power away from the middle class to a much smaller percentage of the population. It exposed the fragility of the middle class, which was a post war phenomenon based upon a very different social arrangement. It returned much of that middle class to the edge of poverty – month to month living – and away from the ‘American Dream’ of comfortable retirement ‘earned’ by a life of virtuous hard work.

The hard economic reality is that virtue and hard work do not guarantee anything. We are now learning that. The institutions put in place after the Great Depression to mitigate this hard truth, and to allow the middle class to enjoy a modest version of the life the wealthy have always enjoyed, were swept away once we started to view them as encumbrances or barriers to our continued advancement. We were beguiled into thinking we could all be rich, if only those institutions were abolished. Instead, we simply watched society revert to the older distribution of wealth, with more and more of us ‘doing the right thing’ but still being left behind.

A particularly hard lesson is that the focus on the individual withdraws funding from the community. Our bedraggled infrastructure speaks volumes about our choices. We assumed the roads, rails, and schools would repair themselves while we bought retirement homes, played golf, and had our faces and various other body parts uplifted.

Which brings me to one last comment about debt:

As always there are two sides to the story. Debt and deficits can be productive or they can be destructive. A debt created in order to invest in a productive asset is never a bad thing as long as that asset pays more than it cost to put in place. Government spending on infrastructure, and even on consumer protection, falls into that category. But debt that is incurred without a productive use is both frivolous and, ultimately, damaging.

This is where the debt fearing amongst us have a point.

Most of our current debt problems relate to the Bush tax cuts that produced no lasting wealth creation. They were simply a shift of wealth from one segment of the population to another. GDP did not rise in response to the massive debt we incurred to pay for those tax cuts. Nor did investment. We have no enduring infrastructure. We have no new roads, rail systems, no new schools, no great research initiatives, and no burst of private sector invention. All we have is appalling job creation and an enlarged number of marginally poor people. Oh … and two wars. There is no asset being passed on to the future, simply a problem.

The problem being that we refused to face our limitations. Or that we were limited at all. It became ‘unAmerican’ to talk about the limits to growth. It was ‘unpatriotic’ to mention that we needed to make choices explicitly. Instead we were led into a period of avoidance and implicit choice. The cynicism of which is breathtaking. How else we we justify the Reagan deficits? How else do we explain the plunging into debt that the 1980’s brought us? How else do we explain our apparent comfort with the 2011 expiry date put on those Bush tax cuts? It seemed like a long way off at the time. And we didn’t care about the dire budget consequences we would face when the expiry came up. Instead we basked in the few extra dollars we all received at the time. As an example of extreme fiscal folly, those tax cuts, and our complicity, are hard to top. It is extraordinary that the generation culpable for that series of decisions is now suddenly concerned about fiscal rectitude, just as the baby boomers ‘threaten’ the stability of the budget that they denuded of funding.

Perhaps it is this that so disturbs many folks that they are now fearful of all debt.

If so I hope I have reduced that fear and helped focus us on the real issues.

So allow me to end this by repeating, and modifying, my opening line:

There is not debt problem.

But there is a choice problem.

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Deficits and The Economy: Time To Get Worried?

The big question now has become: are we falling back into recession?

Who knows?

There is plenty of evidence mounting that the US economy is slipping back from its early recovery pace into a much lower, and therefore more risky, pace. The downward revision of first quarter GDP, from the original 3.1% to the more recent 2.7% is just one example. The stubborn refusal of private businesses to hire workers is a sure sign of that sector’s collective gloomy and fearful approach – private sector hiring is still anemic and was insufficient to offset the seasonal lay-offs of government workers brought onboard to do the census. Real estate is mired in a deep slump and shows no sign of recovery. On the contrary each report on housing seems to ring up a new historic low for activity. And even the springtime euphoria in manufacturing has now given way to a two month drop in factory business as measured by the Institute of Supply Management. US factories appear to be suffering the backwash from the Euro zone difficulties, where European austerity plans imply less imports from America.

In short nothing looks as rosy as it did back in April and May.

It is in this weakening context that we should assess policy. In particular we should take a good long hard look at the Federal deficit.

I have beaten this drum incessantly, so bear with me one more time.

Now is not a time to reduce the stimulus. Not at all.

Yes, that implies big and growing deficits. But, as I have stated many times, a big portion of that deficit is cyclical: it will go away when – and if – the economy picks up a head of steam.

And, yes, we have a definite and large deficit problem. We spend far too much on defense and on health care. We cannot afford to keep those expenditures at their current level without getting a more secure funding for them over the long haul. Our deficit problems are rooted in the insane and reckless budgets of the Bush era, not in the emergency and temporary measures of the Obama era. We need to keep that in mind as we argue over the next step in policy.

Take a different tack: if we adopt austerity measures now, or even in the next few months, the odds of a repeat recession shoot up rapidly. There is absolutely no evidence that the private sector is ready, willing, or able to carry the load. Just the opposite: businesses appear only too willing to reduce themselves in order to protect profit in the short term. This weakness and timidity sets in motion the classic downward spiral of the a ‘paradox of thrift’, which only the government can break.

In my mind the world’s leaders have gone crazy: they are all so hell bent on budget cutting in order to appease the credit markets that they have forgotten the long term consequences of their actions. They are all willing to abandon long term health for short term ‘confidence boosting’. As if the markets can’t see the devastation that could arise from this austerity mania. There is almost a collective reverse bubble psychology at work. No politician wants to be sen as ‘weak on deficits’. They conveniently forget the lessons of the 1930’s and rely instead on the economic theories of the last thirty years. But those theories are bankrupt. They were wrong when they were first floated, and they have been exposed as wrong by this crisis. Quite why otherwise intelligent people are still clinging to those policies baffles me.

Inertia?

Ineptitude?

Ideology?

All of the above.

Take the Germans: in good teutonic style they adopt austerity in order to get their house in order. They neglect to note, or admit, that their economy is built upon foreign consumption. That consumption sucks in German goods. So as long as the rest of the world is willing to remain profligate the Germans can be austere and feel good about being ‘correct’.

But: what if the rest of the world also gets a bout of austerity?

Who will buy those German goods? Not the Germans. They are facing austerity cutbacks. The austerity logic breaks down when the entire world goes in the same direction. There is no one to provide the consumption necessary to drive the world growth machinery.

This is why the Chinese have become so important.

The financial markets, and the more optimistic folks in the financial media, have been relying, in their forecasts, on Chinese – and to a lesser extent the rest of the emerging world – to maintain demand so as to allow the ‘old world’ to make the painful budget adjustments they need to without falling back into recession.

Which is why the most alarming news this week has been that the Chinese economy is showing very distinct signs of slowing down.

Get ready for a nasty shock later this year when the GDP numbers come perilously close to zero. Especially as the effects of last year’s stimulus fade away. I still expect us to eke out growth over the near term, maybe in the range of 1.5% to 2.0%. But it doesn’t take much – a Chinese slowdown and all that Euro austerity? – to eliminate it.

Which brings me to a question often asked: the pile up in US debt is presumed to have bad consequences. Especially: the credit markets are presumed to be jittery about our budget. How dow we know when the threshold is reached and the world won’t support our profligate ways any longer?

The short answer is that no one can possibly tell. The longer answer is that I don’t really care anyway.

The reason is this: with the world in a swoon, money has to go somewhere. The US is still, by far, the world’s largest economy, and it is still very stable. Yes the US has long term imbalances that must be eliminated. And, no, there is no sign that US voters will support the kind of cuts needed – can you imagine a Presidential candidate advocating defense spending cuts along with a increase in the retirement age and proper health care reform? We have just been witness to the deep rooted divisions in the US that prevent fiscal rebalancing. It is unlikely that we will succeed any time soon.

But: the rest of the world is in such bad shape that even a profligate and badly managed America looks safe. How else do we explain the drop in US bond prices? Were we reaching the threshold of pain for our creditors and early sign would be their unwillingness to buy our debt. Our bond prices would be rising. This is not happening. Bond prices are falling and demand for our debt is rising. In other words we have a huge capacity – still – to borrow.

We should use that capacity in order to guarantee our recovery. Our borrowing capacity remains one of our greatest assets. We should increase, not decrease, government spending to fill the demand gap. Those bond prices tell me that the markets are fine with the deficit. For now.

Which brings me to another question: are we spending our money wisely?

Not at all.

We are pouring it down the sink holes of two needless wars rather than into programs that have strong stimulative effects. Defense – offense? -spending has nowhere near the impact that increasing unemployment payments does. Neither come close to grand government works programs. This is the proper criticism to level at the anemic stimulus program of last year. And yes, it was anemic in the context of our problem.

Politics prevents us from solving the problem: we have to water down all our programs in order to reach ‘compromise’. We cannot get enough votes to extend unemployment relief even though the cost of so doing is but a week or two of our war expenditure. We have to include specious tax cuts even though all the evidence – and there is tons of it – tells us that tax cuts are just not stimulative.

Which brings me to the real reason to be worried:

Lack of leadership.

From the White House, to the opposition, to business, to academia, to ourselves. No one is willing to think on the scale that the crisis deserves. No one is willing to stand firm against the pull of the mushy center. No one wants to take responsibility and eliminate the fear that pervades the economy. Everyone, it seems, is afraid.

And that simply begets more fear.

And it leads us into wrongheaded policy making, like austerity at a time of slack demand.

That’s why I am worried. You should be too.

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Consumers Crash and Austerity Bites

These two topics are not directly related, but in the interests of brevity let me combine them into one comment.

First consumer confidence:

If you haven’t already seen today’s news, don’t look it’s awful. Consumer confidence, as measured by the Conference Board dropped sharply in June, all the way down to 52.9 from May’s revised [downwardly] 62.7. That’s a very nasty decline even for an index as volatile as this one. The standard explanation making the rounds is that people as still fearful over the employment outlook. That makes sense in the context of stubbornly high long term unemployment and the total unwillingness of Congress to do anything about it. The odd and ironic thing is that today’s news is seen as a very bad omen for the Democrats in the upcoming elections, even though they are the ones advocating action. I fear that the inability of voters to parse out their anger from their desire for sound government, will condemn them to hand Congress over to the GOP, a party bereft of any intent to deal with the problem.

Democracy is both a wondrous and foolish exercise sometimes.

Second, Austerity Bites:

I am in awe of the shallowness of our media. I read in today’s New York Times an article examining the plight of Ireland. It is not a pretty picture. Let me give you some background. The Irish economy went through a prolonged boom during the past two decades. This boom was based in large part on the cost advantage Ireland had when compared with its more established Euro zone partners. There was a steady inflow of capital – and hefty Euro subsidies – and employment, housing, and the general economy rushed along at a hectic pace. Ireland became the poster child for steady government, pro-business policy making. Except that it failed to control its banking sector and fell horribly foul of the worldwide inflation in real estate prices. The subsequent collapse destroyed the Irish economy, as the government was forced to bail out the Irish banks. The resulting budget deficit yawned so wide that the credit markets began to view Ireland as a basket case. In response the Irish instituted stringent austerity measures designed to re-assure markets and protect the economy from total melt down.

Today’s article picks up the story two years later with the general tone that despite these austerity measures the economy is still mired in a downturn, and that the outlook is now more, not less, grim.

Well duh.

I am amazed at the naivete of the writer.

Of course the Irish continue to plunge into the abyss. Austerity policies do that to you.

Let’s keep this simple: when you strip demand from the economy by cutting spending – government or private – you automatically reduce the number of jobs needed to supply the now reduced level of demand. You thus increase unemployment. And as I have pointed out endlessly: when you reduce the number of jobs, you automatically reduce the amount of spending potential within the economy. In other words you strip out demand. And so it goes around.

In short, any austerity policy is a deliberate attempt to make the economy smaller. This is a simple and incontrovertible fact. This means that, at least in the short term, that those policies create slack – resources that are no longer needed because the demand isn’t there for the goods or services those resources produce. Part of that slack is reflected in higher unemployment.

This is no news to anyone who has paid attention to Depression era economic theory. This entire narrative is the essential cause of the Keynesian riposte: in the face of slack the government should create demand, not reduce it. That demand will be artificial and should go away once the crisis is averted, but it is vital during the crisis itself.

So. It is no surprise at all that the Irish are struggling. It is absolutely no shock that their economy is still shrinking. That they are slipping deeper into crisis is a deliberate and foolish result of their policies. The expression of shock and dismay in the article that the strong ‘medicine’ has not resulted in a healthy and vibrant recovery can only result from a failure of basic understanding: it wasn’t ‘medicine’, it was poison.

Or perhaps it was a modern economic version of the old medical procedures where all diseases were presumed curable by administering diabolical purges to drive out their foul causes.

Now I think of it, modern austerity policies are simply latter day purgatives. They are medicines designed to heal through obliteration and devastation. They are a variant of a scorched earth defense.

And they don’t work.

Nor, apparently, do they ameliorate the credit markets.

If the objective of the Irish austerity was to make peace with the credit markets, then it has been a spectacular failure. Irish debt is just as expensive as before. The markets have not been quietened at all.

Why I wonder?

Because the austerity policies have driven the Irish economy deeper into recession. That makes it a worse, not better, investment.

Double duh.

Really: is this difficult to figure out?

And, for the record, those amongst us who are arguing that the US also has to adopt austerity policies in order to appease its creditors, should pay attention to the Irish example. Plus they should pay attention to long term interest rates. Were the markets baying for austerity policies they would be bidding up the cost of US bonds. Do we see a crisis in the US bond market? Do we see bond rates surging?

Ummm. No. In fact rates have back off somewhat, even though the economy is in questionable condition.

Austerity bites. Especially when it’s not needed. The only folks who get hurt are the poor, and the unemployed. The bond traders can look after themselves.

So why does anyone advocate austerity?

Ideology.

Which brings me back to my comment about the upcoming election.

It is intuitive, but wrong, to cut spending in a crisis. Ideologues who press for austerity are not trying to ‘cure’ the crisis, they are trying to exploit the public’s natural difficulty with the counter-intuitive nature of sound economics. Their objective, as it is always, is the dismantling of the entitlement programs that protect the poor and disadvantaged. So don’t be persuaded by their rhetoric.

Remember:

Austerity just bites.

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Meanness, Mediocrity, and Bank Reform

It takes a particularly virulent form of mean spiritedness for a nation to walk away from its most vulnerable citizens at a time of their greatest need. Yet that is what the US, and by implication you and I, has just done. The Senate was unable to muster enough votes to continue the extension of long term unemployment benefits. So they lapsed. The cost would have ben small in the context of our overall deficit. The impact would have been enormous for the thousands of families whose lives have been turned upside down by the corrosive effects of long term unemployment.

Do we care?

No.

We have become a nation so narcissistic and incapable of community action that we simply don’t care.

I fear for the children of those families.

And I fear for the future of any country so implacably opposed to generosity during difficult times.

This was a supremely mean action. It will have practically no impact on the trajectory of our debt. It panders to the puritanism of the right wing who are relentless in their Victorian era desire to impose punishment on the poor, as if being poor or unemployed was driven only by moral incapacity. That horrible and nonsensical attitude still rears its ugly head in Anglo Saxon economies, and is embedded in the roots of modern economics as well. Orthodox economists believe – or at least they teach – that being unemployed is a choice. To them anyone without a job has chosen not to work. So providing benefits to the unemployed to mitigate the effects of unemployment is a distortion of the workings of the ‘free market’. Naturally the puritans love this nonsense and have latched onto it in order to provide themselves with an intellectual legitimacy for their mean spiritedness.

This nasty attitude reminds me of St Augustine who, as ever the fatalist, told the slaves of his era that they must have sinned badly in the eyes of god for him to have made them slaves. His advice was to grin and bear it. And to try to pray a lot.

When historically significant preachers set this kind of example for the elite to trample on the poor, it comes as no surprise to read of the Senate’s nasty attitude.

Moving on:

Today’s report that GDP grew only 2.7% in the first quarter has been treated both as a surprise and a disappointment by the financial markets who imagined things were going better than that. I say ‘imagined’ because the evidence has been accumulating for weeks now that we are experiencing an entirely mediocre upturn. One that continues to be very vulnerable to weakness. Much of the disappointment seems to stem form the fact that every time the government has issued a first quarter GDP report the numbers have been worse. Today’s release is the third and final estimate. The first estimate was for 3.2% growth. That was trimmed in the second estimate to 3.0%. We finally settled at the 2.7% announced today.

That is not a very good growth rate for only the second quarter of recovery. Typically the US economy goes through two or three quarters of rapid growth – well over 4.0% – before settling back down at its historic 3.0% level. That we haven’t had such an experience this time merely reinforces my opinion that the economy was much more damaged by the banking follies of earlier this decade than many others give it credit for. Allow me to repeat: recoveries following financially rooted crises are always – always – more difficult and prone to setbacks. This is an empirically supported observation. Unfortunately it is not well known in academic economic circles because it is the outcome of research by non-traditional economists. Since my more orthodox brethren don’t read heretical works, like those of Keynes or Minsky, they are blissfully unaware of the dangers we still are facing.

Having said that, even the orthodox folks at the Fed are now beginning to become concerned that growth is not what they imagined it would be. That’s a relief since it removes the prospect of a Fed tightening from the immediate agenda. Any rise in interest rates now would send us downward quite quickly. We are lucky that the gloom in today’s report is sufficient to knock some sense into even the thickest of fiscal hawks heads. Or at least I hope so.

Just to complete the survey of mediocrity I should give you the actual numbers from the GDP report:

Consumption was positive, adding 2.1% to GDP

Private investment was also positive, adding 1.8%.

Net exports [exports less imports] was negative, deducting 0.8% from the total.

Government spending was also negative, deducting 0.4% .

These numbers hide a few important points.

First: the consumption figure is decent, but not great. Usually as the economy bounces back consumption is a major driver as consumers spend more than normal in order to make up for the spending they didn’t do during the downturn.

Second: the private investment figure is misleading. All of the growth came form inventory changes and not from actual investment in things like construction or machinery. Those two sectors were flat, and construction looks to be mired in a long term slump.

Third, and final: the government spending number is very worrying. I have warned of this before. The positive impact of the Federal level deficit is being more than offset by the draconian austerity plans that the States are implementing. While these local actions may appear to make sense to local politicians and voters, they are making the economy much weaker. They are draining spending power from the national economy. In effect the States are hoping that someone else will get the economy moving. The irony is that many of those same politicians and voters then express opposition to Federal deficit spending which remains our best hope for stimulating recovery and allowing those local budgets to recover.

Overall I have to admit that the economy is moving along a track that I see as both very predictable and susceptible to risk. We should expect more mediocrity for the rest of this year.

Let me add my voice to those calling for more support to the economy. I have railed against austerity enough. I believe it to be blindly stupid. Those who want to shift the focus to the long term issues, and in particular our budget problems, are missing the point entirely. Without fixing the short term the long term is irrelevant. This was the driver behind Keynes famous dictum that ‘in the long term we are all dead’. His main point being that dealing with long term, far away, issues is always easier than dealing with immediate and more intractable issues. In his view this ease draws the attention of policy makers and economists away from the difficult and often messy problems of today, while allowing them to present a virtuous facade to the public.

In this case the mediocrity is of leadership and intellect. We suffer from a bureaucratic mindset that frames everything in terms of checklists and rules. So all the solutions on offer are tweaks to existing rules or the addition of new rules. As someone once said: if the only tool at hand is a hammer, all problems look like nails.

Maybe we need new tools.

Finally today, and to add to the mediocrity, we must mention bank reform.

After all the fuss and hand wringing Congress has managed to cobble together a reconciled financial reform bill. Presumably it will get to Obama’s desk before long. The timing of agreement was driven more by political considerations than by the need for reform: Obama is off to attend the latest G20 meeting and wanted to have legislation in hand so the US can dictate the nature of worldwide reform.

The simplest question to ask about the reform is: does it prevent future crises?

No.

What is does is to paper over a lot of the medium sized holes in the system and close down some of the more egregious consumer oriented activities of the banks. It doesn’t have enough strength to stop future melt downs. And it doesn’t prevent the need for future bail outs.

The better parts of the reform focus on the consumer. A new consumer protection agency is created but buried at the Fed. This is a typically lame response to the exploitation of consumers that has characterized banking for years. Remember though that the Fed had oversight for mortgage pricing regulation before the bubble. It did nothing to stop the activities of the worst offenders. Since the Fed remains staffed to the rafters with mathematically inclined economists rather than socially minded attorneys, I doubt this new agency will have the bite that some think it may.

Meanwhile the reform does tighten up the derivatives market somewhat although I suspect that the banks and their armies of overpriced lawyers will gut the intent of the new law within weeks. The ‘Volcker’ rule survived in muted form to reduce bank speculation, and the ‘Lincoln’ initiative also made it through to force banks to offload their speculative book of derivatives into non-Federally insured subsidiaries. Quite what this achieves I am not sure. The simple question we need to ask is: will the regulators allow Citibank to go belly up because its non-insured book of derivatives goes bust and threatens the mother ship? No I don’t think so. Thus the Lincoln plan is window dressing. The Volcker rule has more merit because it simply bans certain activities, specifically the use of low cost Federally insured deposits as a funding source for non-client based speculation. The problem is that the ban is not tight or comprehensive enough. The boys still have plenty of matches to play with.

Other aspects of reform are also humdrum. The big banks will have to cough up some cash to create a bail out fund, so that future bail outs will not come from the taxpayers. This raises the interesting question: why do we need this provision if the reform ‘stabilizes’ the financial system, which is Geithner’s claim? The obvious answer is that no one really thinks we will avoid future bail outs. Nor is the amount anywhere near enough in the context of the behemoth banks that now populate our system.

Finally the much ballyhooed liquidation process for big banks, while it sounds great, will immediately run afoul of international complications. Unless there is a uniform world wide and coordinated approach to bank bankruptcy procedure no amount of huffing and puffing here in the US means much. It certainly does nothing to end too big to fail.

And that is, in my mind, the really big issue. This reform does not eliminate banks that are too big to fail. All it does is to provide some nice rules for future bankruptcy procedures and to mitigate some, but not all, the causes of the past crisis. Our legislators are intent on, and content with, planning to fight the last war. That makes them feel good, but does not solve our central financial problem. While the dinosaurs still roam and dominate finance we are destined to endure more crises and suffer through an oligopolistic market where competition is stifled by the lumbering bureaucracies we call the big banks.

Oh well. I suppose some other president can solve that problem. The current incumbent wants to punt.

Mediocrity indeed.

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