savings

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The Stimulus Arrives

Well at least those checks sent out to individual Americans seem to have arrived. Their impact was to jolt personal incomes in May and send the savings rate up to levels not seen for years.

The release this morning tells quite a positive story on the surface with some not so good news underneath.

Overall personal incomes rose 1.4% in May which is double the April rate and way beyond the anemic figures for the first quarter when both February and March recorded 0.3% declines. That’s the good news.

The bad news is that the ‘wages and salaries’ component of personal incomes actually fell because of a sharp drop in manufacturing wage payments: all those layoffs have shrunk the labor force receiving wages. So the only reason that May saw an increase was the government checks sent out as part of the stimulus. This is, of course, why those checks were sent out, and is a graphic example of why the stimulus was so necessary. It is also a strong rebuttal to the argument that the stimulus is not working.

Well sort of.

The problem is that people appear to have saved the cash rather than spending it. At least so far. The savings rate jumped up to 6.9%, which is a fifteen year high. Ironically while we need to develop an economy based less on debt and more on savings, we don’t want to see high savings right now. We need consumption in order to reflate the economy. We will have to see whether consumers gradually spend their cash rather than hoarding it as the data for the next few months comes in.

During the discussions about the composition of the stimulus I tried to make the point that cash payments and tax cuts are very inefficient ways of cranking up consumption: there is always a natural tendency for consumers to save rather than spend during times of rising unemployment. The best form of stimulus is direct government spending, especially on infrastructure projects like railroads where an enduring social asset and thus value is created even after the short term impact of job creation wears off. We cannot blame consumers for being sensible and saving in case of unemployment. But since we know from experience what they are likely to do we should have built the stimulus differently.

Having said that, the cash is now flowing. Let’s hope it gets spent and helps create jobs. If not then we are likely to need more stimulus later in the year, and getting that approved by a Congress already shell shocked by the rising national debt will be well nigh impossible.

So, once again, we have a report that sends a mixed message: incomes are up, but only because of the government checks.

I suppose that’s better than where we were last fall.

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Depression Politics

Are we about to plunge into depression? We could. Very easily. If the policy makers get their way. Nothing could be more ludicrous or dangerous than easing up on stimulus right now. Yet the folks who run our economic policy, and their counterparts throughout the large economies, are openly discussing the ways in which they can start to pull back or reduce their respective stimulus packages. We should all hope as fervently as we can that they do not pull back. That is the way to full throttled depression.

Nothing could be more dangerous to the health of our economy. Nothing. Even the most cursory reading of history tells us that those who have made premature moves to downscale the policy support for an economy in the kind of danger ours still is doom it.

The potential folly is stupendous.

Paul Krugman argues the case succinctly this morning. The risks to recovery are all on the downside. There are no obvious dangers stemming from stimulus. In fact the stimulus has hardly begun to work yet. Any discussion of its ‘failure’ is patently absurd. We are four months into a three year cycle. Yet already the administration is showing its timidity in the face of growing and concerted criticism from its opponents. It is beginning to ‘walk back’ some of its ideas.

All those gardening metaphors have addled the brains of our commentators and analysts. They are breathlessly intoning about ‘green shoots’ as if the recovery is both imminent and robust. They forget that one sharp frost and the whole thing shrivels instantly. And there are abundant signs that frost is likely: the outlook for world trade is bleak to put it mildly, which removes the traditional engine of growth for economies in our situation.

There is a particular misreading of the bond market. I have complained about that before. In summary the mistake that is now pervading the commentariat is that rising bond rates are bad: they demonstrate the market’s ‘fear’ of future inflation. That inflation, it is alleged, stems directly from the huge stimulus flooding the money supply. This is an incorrect reading of the situation. The diagnosis would have credibility in an economy running at or near capacity. Ours is so far from that condition that I am shocked anyone would suggest inflation is a near term threat. The danger from this misdiagnosis is massive. The increased money supply is what is preventing the economy caving in totally. It is providing demand to offset the collapse of private demand. More to the point: even with all this government borrowing the aggregate of state plus private borrowing is less, not more, than it was before. We have a dire excess of savings. People are unwilling to invest or spend. There is no risk of inflation while that circumstance continues.

So let me be unequivocal: the only thing standing between the US economy and full bore depression is active ‘interventionist’ fiscal policy in the form of continued government deficit spending; aided and abetted by ‘unconventional’ monetary policy. Cut back that and you cut away the only legs we have.

Why is this?

Because the economy has fallen into a classic liquidity trap. Conventional anti-recessionary policy – lowering interest rates etc – has no effect. Interest rates are so low they cannot go lower. The economy failed to respond as rates were dropped. We were left with no choice but to break out all the old Keynesian tricks.

The folks who are now talking about the ‘failure’ of the stimulus, or the fear of inflation, and even the corruption endemic in the stimulus, are all driven by a political rather than an economic agenda. They are mounting a last ditch effort to subvert the emergence of a revived Keynseian economic regime. They fear the success of the policies in place because such success would present a stark indictment of the policies of last three decades.

Either that, or they are hopelessly and naively infested with a short term view that prevents them from learning from history.

Then again the mentality that dominates the bond market is the same that brought us the bubble. That alone should tell us we ought to ignore it.

I hope my hyperventilating is an over reaction to the chatter in the financial press. But the hopeless performance of Joe Biden this weekend – where he defended the apparent ‘failure of the stimulus’ – has given me cause for concern.

We are a very long way from safety. Now is not the time for a return to depression politics.

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Forget Exports as Our Next Big Thing

The recently published IMF report on the state of the world economy is a very sobering [and very long!] read. It predicts that, for the first time in decades, the world’s economy will shrink. Normally a recession in one area is offset by continuing growth elsewhere, so the global economy keeps on expanding as a whole. Not this time. The recession, that started here and is now infecting everyone else will cause the world’s economy to shrink by as much as 1.3% this year. The report notes that this is, by far, the worst global downturn since the Great Depression. The outlook for 2010 has been revised sharply downward too, with a meagre growth of 1.9% predicted.

This somber outlook provides a cautionary tale for those who argue that the US can lift itself out of its own malaise by constraining domestic consumption – a worthy goal if we want to reduce our reliance on debt, which I think we do – while, at the same time relying on exports from a reinvigorated American manufacturing sector.

The problem can be expressed simply as this: who do export to?

The two industrial countries with the most severe contraction to deal with are Japan and Germany. They both have very similar economic models. They rely heavily on exports of manufactured goods to support a their economies and both have a much more modest level of domestic consumption than the US.

The news for both Japan and Germany is getting much worse.

Several economic think tanks in Germany are now predicting that GDP there will shrink by as much as 6% this year largely due to the collapse of trade. Also today, Japan is set to announce its first trade deficit in thirty years, also a result of trade market for its exports drying up.

The experience of Japan and Germany suggests that, apparently, the global nature of this downturn has taken away an export led recovery as one policy option we can consider.

The lesson is best learned by looking at the japanese experience. There has been much play made of the economic problems Japan had during the 1990’s: they were the most recent to experience the ‘zombie’ bank phenomenon we fear so much here. Their economy languished at close to zero growth for a decade because they made policy mistakes early on in the crisis, failed to inject a large enough stimulus, and were tentative in dealing with failed banks.

Sound familiar?

The Japanese economy revived largely because world demand sucked in Japanese products in sufficient volume to offset very low growth in domestic spending. So successful was this strategy that it has become the normal Japanese method for maintaining a rising standard of living. It is a model for economic management that works well as long as there is always somewhere in the rest of the world with a growing market for Japanese goods. It doesn’t work too well when the entire world goes down together as we now are.

Which brings us back home: if an export led boom is not a viable option for us, we have to rely on getting our own domestic house in order. Indeed, since America has become the world’s consumer sucking on goods from places like Japan and Germany, there must be plenty of foreign policy makers hoping we get our house in order too.

And we do that by pumping up demand and keeping savings low in the short run. Oh, and we have to fix the banking system … did I mention that?

So our recovery relies on the same tricks that got us into this mess: low savings and high consumption. Which is already presenting policy makers with a difficult, or should I say more layered, problem. The near term remedy is exactly the wrong medium term policy. Longer term we want to convert our economy by achieving a more balanced mix of savings and consumption. We want to re-establish the kind of structure it had back in the immediate post World War II decades.

Interestingly an economy built around a higher savings rate is one that can pay down government debt at a more rapid rate than one built around borrowing: those savings can be channelled into Treasuries. This is one, but not the only, reason why all the hue and cry about running up massive future debt loads is misplaced. As long as we are careful and construct a more fiscally balanced economy in the medium term, let’s say by 2015, then our ability to recover and return to relatively low and sustainable levels of national debt is assured. Those same post-war years provide a good example: US national debt at the end of World War II was very high, but within a decade it was returned to pre-war levels.

So: exports are not our answer. And we have a very delicate balancing act between the near and medium terms.

This really is quite a mess we got ourselves into.

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