fiscal policy

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Bits and Pieces From the Front Line

Historians will surely love to reflect on these days. Each seems to bring some violent twist. Each adds to the amounting confusion. Each makes the story that much more difficult to tell.

Today we learned that last week’s apparent uptick in the labor market was an illusion. At least until next week. New claims for unemployment assistance rose once more above the 400,000 level – to 408,000. Last week they had managed to slide slightly below, although only by a hair to 399,000. Somewhere along the way we have altered our view of what a “good” new claims number is. At the beginning of this crisis I was saying that we needed to get down to the very low 300,000 range. Below 325,000 at any rate. That level would be more consistent with healthy turnover and sufficient job creation that we were not adding to our longer term problem. We haven’t been that low for what seems like an age now, and so we have steadily changed and adopted 400,000 as being the watershed figure. The media and the stock market now greet a number below 400,000 as a sign of better times. It is not. It is terrible for an economy this far along from the last peak of employment.

We should not recalibrate. We should demand action

But our generals are now engaged in trench warfare. Their have fallen to a lowest common denominator of incompetence. Only now – how many months into the disaster – does Obama get on the road and start to talk up various jobs programs. Who knew we had a jobs problem? No one paying attention to Washington and the issues being addressed there.

Meanwhile the troops – those of us outside of the magic circle – are reporting ever lower levels of confidence. Both consumer confidence and now business confidence are declining at alarming rates. This plunging confidence has two origins. One is that the economy is self-evidently not improving. Jobs are hard to come by, wages are stalled and actually falling in inflation adjusted terms, home prices are stuck deep in depression, banks are refusing to lend, and prices are lurching about, although there the trend is in the right direction. The second is the utter collapse of our political system. It has failed us totally. People are not so divorced from current events that they cannot see the insanity that is Congress. Never have we been so poorly led. And now the political class seems content to punt problem solving into the election cycle. As if that will make decision making easier.

In that regard I have to point out the Republican Rick Perry’s extraordinary activity. Never has a candidate entered the ring in so blustering a fashion. His statement that were the Fed to take action to pump up money supply in order to lift the economy such action should be considered treasonous is inexplicably stupid. Apparently the Republicans now think that any action between now and the election – about 14 months hence – is an act of political interference. It is a biased act. It is therefore undemocratic, and – in Perry speak – treasonous. This is beyond bizarre. No wonder the Wall Street Journal is floundering about trying to encourage more candidates to enter the field. The current batch is dangerous.

Another point on Perry: he is making a big deal of his pro-business one market credentials. This, he says, accounts for the supposed resilience of the Texas job market during the recession. Well, not so much. According to recent research what job growth there was in Texas over the past three years comes from an expansion of government, not private sector, employment. The private sector in Texas shrank. But that shrinkage was offset by a large number of new government jobs. So the Texas story is one of Keynesian success. Nice. And, in any case, we should all note that Texas has a rapidly growing population – it needs to add jobs at a faster furiously in order to keep up with population growth. It didn’t. It’s employment record falls short of Massachusetts and New York amongst others. Perry’s record is dismal.

My real problem with this is that we need Obama to be challenged and attacked on his record. Which is grim to say the least. The last thing we need is a Republican party so far to the right that it scares the electorate into unthinking support of Obama, who, frankly, deserves to lose.

Meanwhile we have to suffer through nonsense such as Warren Buffet asking to be taxed more highly. While the gesture is worthy, I must note that his much discussed article in the New York Times failed to mention that his solutions would not actually raise his tax rate by much. Perhaps we need to remedy that. At the every least we need to abolish the specious notion that income from capital and income from labor should be taxed at different rates. As the very wise English judge once said: “income tax is a tax on income”, we need to tax all income, whatever its source, at the same rate. And that includes inheritances, since an inheritance is a form of income to the generation receiving it.

Another thought: the rise in risk within the global economy has been associated with a decline in rates on US government bonds. I am still waiting for the deficit hawks to concede that inflation is not about to surge and thus undermine bond rates. This wait, I think may take a while. Instead we have to suffer listening to Plosser, a Fed governor, and one of the dissenting three who opposed the recent announcement that the Fed would keep rates low at least through 2013, repeat his argument – wrong policy at the wrong time – at every opportunity. People like Plosser are the reason we have so incoherent a leadership. They are pulling against the rest of us.

At any rate with rates this low we should be borrowing every dollar we can. And then investing it in capital projects that improve our long term competitive position. The problem with this is that public accounting fails miserably to distinguish between long term and short term spending. There is no national accounting capital account. So debt borrowed to build a productivity enhancing asset – something that adds to national wealth in the future, and which thus generates revenues to pay off the debt, is treated the same as debt used to plug the gap in current consumption. This is something we need to fix. It makes enormous sense to borrow long term money for infrastructure and education – two things that will add to the economy’s future wealth creating ability and thus help pay for the debt.

And before you MMT people write to tell me we should just print money to pay for the things we want, let me argue that, while in current circumstances mired as we are in a liquidity trap, printing money is a viable alternative, I see it as a problem down the road when, and if, we have emerged from that trap. You cannot conjure real goods and services from mid air no matter how much money you print. So there is a limit on the efficacy of MMT. Beyond that point the deficit hawks argument that a surge in money could lead to a surge in inflation comes back into play. Plosser would be right. His error is that he is making that argument, falsely, while we are stuck in a deep hole. It’s all about inflation expectations and the way they are formed: an unfettered printing press is a very different animal than a bond market with the latter’s implication of repayment and thus constraint.

The housing market is going nowhere. People forget that it was real estate construction, fueled by the bubble, that made the employment record of the last ten years look vaguely acceptable. Take it away and we have had a lost decade for jobs. And there is absolutely no sign that real estate is coming back. Sales of existing homes dropped 3.5% in July, back down to an annual rate of 4.67 million homes. To put that in context the peak rate back in 2005 was 7.08 million. One problem that has now added to the gloom is the number of sales contracts that fall through. In July 16% of all contracted sales failed to materialize. The reason for this historically high level of failure seems to be the inability of buyers to secure financing coupled with home valuations being well below the agreed contract price. This implies that people are willing to buy homes at prices that the banks think are too high. Plus there is no sign that the downward pressure on prices coming from distressed sales is abating: foreclosed and short sales comprised about 30% of the total number of sales, unchanged from June.

Lastly: the ineptitude of the economics profession continues to sadden me. Whenever someone advocates we should adopt Texas style lower than average wages in order to boost employment nationally I cringe. It isn’t possible for everyone to be lower than everyone else. By definition. The existence of lower wage states implies the existence of higher wage states. Duh. But we still see such suggestions being made in the Op-Ed pages of well known newspapers. And these folks have tenure. Some at very respected schools. Maybe we should give up that respect.

Or is that too radical?

Just add it to the list of reasons to have no confidence in our elite to solve our problems.

We are truly on our own.

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The Fed at Bay

Just a very quick note about two aspects of the Fed’s announcement on interest rates today.

First: it is obviously worried about the economy. Very much so. Enough to announce that it will be keeping rates unchanged until at least 2013 – or as long as the economy stays this weak, which from my perspective amounts to the same thing. Duh. On the surface this is a clear signal of intent to combat malaise. To tell the market that rates will stay at the current lows for two more years is a profound signal. Or it ought to be. It lets everyone plan. It removes uncertainty. It ought to shock. I am left a little skeptical, though, mainly because nowhere in the Fed’s release was there much hint of other measures in the pipeline. That is unfortunate, because the economy could do with a big dollop of help right about now. In the absence of any sensible fiscal policy, and in view of the weakness of the economy, the Fed is being forced further into uncharted waters. Still, doubts aside, I am glad it is prepared to go there.

But.

Second: there is obviously great disagreement within the Fed about basic economic matters. Three of the governors, the usual gang of hawks, who objected publicly to the use of the specific time period for interest rates. These hawks, who have been wrong consistently about practically everything since the crisis first hit, are sticking to the tired and discredited theory that pumping the economy full of cash will inevitable lead to higher inflation. Note the word “inevitably”. The causal connection may, or may not, be there under normal circumstances, but it is absolutely not there in our current near depression circumstances. We are bang up against a zero interest rate boundary that invalidates normal theory. Instead it invokes the need for alternative ideas which, fortunately, the other seven governors have embraced, albeit cautiously . Still, the vocal opposition to the Fed’s new direction from the hawks, represents the strength of the old ideas and mimics the position taken by the extremists in Congress who advocate the equally discredited supply side notions and austerity policies that are undermining the recovery.

When you have an element of your leadership actively engaged in advocacy of policies that will disrupt and harm the economy you are partially crippled. It makes it harder to marshal the public behind the kind of bold action we need to avoid outright depression and a long term malaise.

We are well and truly limping at the moment. Hobbled and without leadership capable of putting in place the policies to solve the crisis.

But at least the Fed, or at least the seven governors who supported today’s action, are trying a wee bit. Which is much, much, more than we can say for the cowards in the White House and the extremists in Congress.

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Bankruptcy At The Top

One of the more difficult aspects of our crisis to digest is the manifest bankruptcy displayed by our various elites. Intellectual and moral bankruptcy that is, since as far as I can tell they have all done rather well financially.

Exhibit 1: The politicians who are now ranting and raving about what they call the unsustainable and dangerous trajectory of the US budget and debt. Sprinkled liberally within those ranks are many who supported the Bush tax cuts and the various Bush wars that, in larger measure, contribute to that trajectory. I give credit to James Kwak for digging this up this morning. He surfaced a Congressional Budget report from 2000 the main subject matter of which was the huge financial problem facing the US. Was it debt? No. It was the surpluses being generated. The US was paying down its debt at a decent rate, which was giving it ever increasing flexibility were there a crisis to occur that needed short term financing. Those surpluses eventually would disappear according to the CBO because of the well known and thoroughly analyzed demographic shifts taking place in the later years of its forecast. In particular was the very clear problem presented by increasing health care spending as the population aged.

In response to this vista of surpluses, fiscal conservatism, and long term demographic shift, the CBO urged that Congress engage in a debate about how to use those surpluses so as to ensure a safe, secure, and stress free transition, whilst safeguarding the nation’s need to preserve fiscal flexibility in case of crisis.

As we know Congress tossed this all aside.

Instead it engaged in reckless tax cuts that blew a vast hole in the budget, reduced to zero our flexibility, and failed totally to address the long term issues. It also voted to increase health care spending without raising any revenue to cover that spending – spending which, by the way, benefitted the pharmaceutical industry more than the patients. Oh, and as I have mentioned, it also voted to start or support a series of wars funded entirely by debt.

So the fiscal probity of Congress is written into the recent history books. It is an ugly picture full of hypocrisy, greed, and short term thinking. As an exercise in budget destruction it would be hard to top.

Yet many of those who voted to go down this radical and reckless path are now lecturing all about how that path is unsustainable, and how we must all sacrifice in order to undo the very errors they committed.

Are they being held accountable? No.

Are they culpable? Yes.

The dishonesty, deceit, and downright venality of these people defies description.

They are assuredly bankrupt.

Exhibit 2: The banks. Specifically Citibank. Poor Phil Angelides worked himself up into a righteous lather in this morning’s Financial Times over the absurdity of the pay package Citibank has awarded its CEO, Vikram Pandit. Nowhere is there any sign of contrition about, or learning from, the crisis. Pandit was at the helm when Citibank’s yahoo traders rendered the bank a ward of the state. Taxpayers had to prop up the bank whilst those who ruined it were left with the various fortunes they had made along the way to that ruin. That story is well known. So well known that I would have thought the bank’s Board of Directors would have heard it. Apparently they haven’t. Nowhere in Pandit’s pay package is there a sign of such sentiment. He stands to reap massive reward for extremely modest success. In other words he scarcely has to break a sweat in order to earn pay that, more correctly, ought to reflect some hard work. Worse: were things to go belly up as a result of his decision making he gets to keep all this softly earned money. There is no clawback of past bonus pay out. So if his short term policy turns out to be a longer term error the shareholders don’t get their money back. Given Citi’s history of failure – it is a perennial loss maker deserving of being broken apart so it cannot hurt itself, or the taxpayers, any longer – this is an astonishing oversight.

This is, of course, not an isolated problem. As far as the eye can see banking has returned to the path it was on before it blew us all up back in 2007/2008. I fear that poor Hyman Minsky must be turning in his grave. Or possibly he is simply chuckling at the perpetual inanity of our financial elite, obsessed as it is with its own importance, skill, and ability to allocate capital efficiently.

Why the regulators allow these thing to occur befuddles me. They must be complicit.

Exhibit 3: Which brings me to the rating agencies. Why do we listen to these clowns? I am sick of their repeated warnings about debt ratings for places like Greece or Portugal. These are the fools who raked in fortunes during the real estate bubble by turning a blind eye to the scams being run by the big banks. They used market magic based excuses to create illusions so that they could profit from the deal flow that would not have flourished without their abetting it. They were never innocent or dispassionate bystanders. They were knee deep in the same mire as the traders who gambled us towards oblivion. And yet here they are, a few years later, acting as if they were pristine, independent, and knowledgeable. Were this a joke is would be considered sick. That it is not, is even sicker.

So there we have three examples of how our elite leadership: political, financial, and regulatory, are bankrupt.

Moreover their bankruptcy is far more dangerous to our long term safety and prosperity than that of the countless homeowners being hounded out of their homes; or the vast number of people who lose everything because they cannot afford health care expenses; or the teachers being asked to give back pensions contractually owed them; or any number of other ordinary citizens whose hands were not in the till during the years of the great illusion, but who are being asked to pay for the errors committed by others.

Those others being our bankrupt leadership.

We have a problem at the top.

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Historic Fog

Ugh.

The numbers are just horrible. We have wandered off into the desert and will not return for years. Here’s why:

  • Household debt is still way too high. It is well down from its peak of about 130% of disposable incomes, and is now “only” 115%. But that compares with an average of around 75% for the last few decades of the last century. Something tells me that we are still retrenching furiously. That undermines aggregate demand. That is why underemployment is a feature of the economy we will not eliminate any time soon.
  • One result of the retrenchment is the lack of consumer spending. America is a consumerist nation. It has built its economy around private consumption. But we have never seen such a prolonged period of practically zero growth in consumption as we are currently living through. This is a first for post-war America. Our elites have no answer. They are fumbling. All their policies fail to match up with the historic fog we are in. We have had thirteen straight quarters of weakness in consumption, and while those debt levels are where they are households are likely to keep a tight lid on spending.
  • Savings are deplorable. Despite the retrenchment and the reduction in spending rates, households are having a hard time saving. Yes the savings rate is up somewhat from its derisory levels during the years of illusion, but it is less that half what it was back in the latter part of last century. And things are getting worse: one of the great shifts of the decades of illusion was the movement of risk from businesses and government onto households. The shift from defined benefits to defined contributions is one example: it exposed millions of households to a risk they had never shouldered before and are not well equipped to deal with. As the baby boomers approach retirement they are realizing how short they are in terms of invested cash. With the slump in home values depriving them of wealth too – albeit paper wealth – this is the first American generation since World War II, to be faced with an urgent need to save instead of spend. An unintended consequence of privatizing all that risk is to bring upon us the end of the consumer boom. By putting the onus onto their employees, businesses have reduced the spending power in the economy and thus cut their sales prospects. That means the endless short term focus on profit is going to end up as a longer term loss.
  • The shift of risk to households would have been ameliorated had wages risen to compensate for the risk. But they didn’t. Businesses have tried to have their cake and eat it too. They cut their own risk by trimming benefits, but they have kept wages flat too. Indeed real wages have fallen by 1.6% over the last year. This is also historic: this is the first recovery ever, where seven quarters in wages have not risen. There is no way that consumption can rise if wages are held flat. No way, unless, that is, consumers are not inclined to pile up debt. And, as I have already said, they are not so inclined.
  • This accumulated freeze up of the consumerist spigot is having an enormous impact on smaller businesses. Not only are bigger businesses slashing costs in order to boost profits – this cuts into small business sales since they usually occupy a lower rung on the supply chain – but small business sales direct to consumers are being radically reduced. The National Federation of Independent Business, a small business trade group, has just released its survey of its members: the majority are freezing hiring in anticipation of lower sales volumes. Yes fewer are reducing payrolls too, but, for the first time in almost a year, they are not hiring either. The number one one concern amongst small business is the lack of sales. High taxes and government red tape – a perennial gripe of small business owners ranks third.

Even if we ignore the continuing instability of our financial sector – too big to fail will come back to haunt us sooner rather than later – this list of issues is not one that is easily solved. These are intractable and long term in nature. They imply a very significant shift within the economy – away from consumerism … but towards what?

Some people argue we need to pump our manufacturing up again, but this is a long term solution also and worldwide competition is ferocious. Plus it is not at all clear what we would manufacture. Does this approach portend trade wars? The imposition of tariff walls? The phrase “industrial policy” gets bandied about, but where do we invest? And, even if we back winners, who is going to buy all these domestically produced goods if we have shifted from a consumerist economy? The implication is that we are headed more towards a German, Japanese, or Chinese style export driven economy. Who, then, will take our place as consumer of last resort?

If the American economy is in a historic fog, and if our policy makers have only a set of policies built for the old style consumerist days, it seems clear that a decade of stagnation and frustration is the more likely prognosis.

And on the policy set: neither major party, no business group, and few if any academics, have yet been able to articulate anything new. They all appear to be in denial of the shifts I have outlined. Their prescriptions have all been tried and all have failed at least once. The last ten years have been a spectacular flop: we cut taxes with an historic verve only to debilitate government and produce no visible boost in growth. Wages stagnated. Profits soared. Debt became the only way most Americans kept up with rising costs. The years of illusion ended with a thud when we hit the wall and our banks imploded. The clean up, and the return to sanity, like those days after any binge, will be longer and grayer than it might have been had we recognized the pathetic emptiness of the ideas that led us so far astray.

Historic fog indeed.

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Retail Sales Falter – Significant?

Today’s report on retail sales is one of those we all have to squint at in order to get a good understanding of its importance. On its face the news was not good: sales fell 0.2% in May. That was the first decline in eleven months and so it marks the end of a steady upward climb. To put that into perspective retail sales in May were 7.7% higher than a year ago. But a decline within a supposed recovery is never a strong sign, and coming, as it does, alongside a string of weak to poor news we would be excused for fearing the worst.

But this time I think we should err on the side of the optimists. Not that I have had a sudden conversion to starry eyed prognosticating: far from it, I remain steadfastly in my stagnationist mode. This set of numbers, though, is skewed by the results for auto sales which we all knew had taken quite a hit in the wake of supply side issues stemming from the Japanese disaster earlier this year. If we back out those weak auto sales the remainder managed to eke out a slight increase. This very weak positive for non-auto sales fits exactly with my forecast of an economy going nowhere fast. So, in a rare show of agreement with the Wall Street optimists, I agree we should look more at the non-auto performance than the total figure for sales.

I am not saying this, of course, simply because it fits my narrative. My point is that I see nothing on the horizon that is sufficient to provide a boost to the economy and thus lift it out of the meandering course it is currently running.

My basic analysis remains the same:

  1. Demand is too weak due to very poor wage increases and prolonged – debilitating – underemployment
  2. Fiscal policy is now shifting towards reducing growth in order to reduce debt and deficits at the Federal level; this is already the case at the lower levels of government
  3. We are about to shift to a more neutral monetary policy – QE2 ends this month and is not going to be replaced
  4. Inflation and deficit hawks have successfully prevented any discussion of further stimulus – even though today’s report on wholesale prices demonstrates clearly that those of us who decried the fears of an inflationary spiral have been completely vindicated; the recent burst of retail inflation is dying down already
  5. The US political malaise is now a major risk factor – anyone investing in America from abroad now has to add political risk to their worries; it is extraordinary that we have become a banana republic in terms of the quality our debate, and our ability to get things done [or, more to the point, not done]
  6. Our real estate binge is still hurting us and will continue to do so for a long while yet – astonishing facts: almost half of second homes are not worth what their owners paid for them; and about a fifth of all mortgages are under water; this alone will freeze spending for years to come, and drag home prices down even more
  7. Corporations show absolutely no sign of constructive expansion – by which I mean they are still pumping up profits by squeezing existing workers rather than hiring more; this perpetuates the doldrums and dampens future demand
  8. Worse, big businesses are pouring money into labor saving capital machinery in order to avoid hiring new workers; why? the marginal cost of workers is very high even in a low wage period because of health care costs – and yet health care reform remains controversial
  9. Our banks are still unstable and propped up by taxpayer guarantees – they are only slowly boosting credit availability, especially at the small business end, and are hopelessly behind in working out their own real estate blunders; our banks are just poorly run
  10. There are a variety of international risks that could harm US ability to boost GDP via exports, even with a decline in the dollar – ironically this overseas risk is boosting demand for US debt just as we are trying to reduce its supply; we should be taking full advantage of low rates to borrow longer and more
  11. US military spending is untenable and will need to be cut – since we have constructed a large part of our economy around aggressive militarism this will hurt employment

Of all these things I think the one that stands out is the political gridlock that bedevils us. Never, since I arrived here in the the late 1970’s, have I seen America so lacking in energy, new ideas, or positive attitude. The entire place has fallen into a grim self-inflicted funk. Three decades of unbalanced growth, during which a very few prospered and the rest clung on for dear life by piling up debt, has produced a sullen and deeply distrusting divided electorate. Our leadership is, flatly, a joke. We are riven through with bureaucracy in both the public and private sectors. Our politics is insanely extreme and distorted by the anger vented by voters. We are actively reducing our middle class by attacking its economic underpinnings and undermining its sense of safety by openly discussing getting rid of our safety net programs. In other words we are increasing the risk of being a middle class American, without increasing the reward. So, of course, demand drops and falters. Of course people feel uncertain. Of course they have little or no tolerance for politicians who are too timid to provide strong leadership. And of course they latch onto whatever looney fool offers up what appears to be a quick fix.

We are being led into stagnation. Deliberately and assuredly. Why, I have no idea. The country deserves so much better.

Then again does it?

It elected these fools.

Addendum:

As a coda to the above:

I wish I could detect some hope for better policy coming from our electoral process. But I cannot. Last night’s kick off for the Republicans produced nothing of note other than the observation that they all remain committed to the same set of ideas that produced this malaise. Indeed they all appear more likely to double down on those ideas and thus to make matters much, much, worse. Not one of them had anything new, fresh, or interesting to say. They are all market magic people. None spoke about the economy in any way that justifies optimism. Eventually one of these clowns will be the Republican candidate – assuming no one else enters the fray – and thus will have the opportunity to attack Obama for his limp, lame, and altogether timid approach to solving our woes. That confrontation is shaping up to be a demonstration of weakness. It looks as if it will be a debate between business school and law school bureaucrats – people who excelled in class, but who freeze when faced with the need for dramatic action. You cannot use business or law school ideas to run an economy. You cannot simply fire people to improve earnings. Being a CEO is easy. Running the economy is not. People tend to get a little peeved when they are unemployed – University of Chicago nutty ideas notwithstanding. As a CEO you don’t care about that. As President you do. Or at least you ought to. This election will expose America’s intellectual decline and its monocultural focus. We have no plan “B”. I fear a clash of dueling Power Point presentations and calls for more consultative studies. We don’t need better management, we need leadership. We need new ideas.

A titanic struggle this will not be.

Oh. And by the way: if you want a giggle, read Larry Summer’s article in the FT earlier this week. He seems to be advocating further stimulus. He’s the dolt who advised Obama to go with half measure back in 2009. Why, in view of his policy advisory failure, do we keep recycling this ego crazed person? Is there no one else?

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