interest rates

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Growth, But Not Enough

Solid is one of those words none of us wants to hear as a description of our abilities. Solid is not exciting. Solid is very middling. There is no va-va-voom in solid. But then again neither is it bad. No, solid is just dull. Very dull.

Our economy is solid.

Ugh.

Today’s reports on GDP for the fourth quarter 2010 has growth at an annualized 3.1% rate. That’s good. It just is not good enough. If you recall, the previous estimate was for growth at 2.8%, so evidently the later data has been on the plus side. The biggest contributors to the increase appear to have been a revised inventory number, which was less of a downward drag than previously thought; and a stronger business investment figure. Neither of these was the prime motor for growth, however, since the main boost came from a combination of higher personal consumption and a better trade balance. Since this is the third and final report of the fourth quarter this is the one that goes into the books. It also brings to a close the revising of the overall 2010 performance which is now settled at 2.9%, compared with the drop of 2.6% in 2009.

While that turn around appears terrific I must warn you that it is nowhere near good enough. A more typical recovery would have seen much faster growth in the first full year after a recession. Then again, the economy has gone through significant changes over the last three decades, one consequence of which is the the days of very fast recoveries seem to be over. The trajectory in the last three recessions has been for much less rapid recovery from a much longer decline. My view is that this change stems, at least in part, from the reduced emphasis on manufacturing in the overall economy. In the earlier post-war recessions, the cycle was dominated by sudden shifts in factory employment. The adjustments were quick and dramatic. But as finance, and other services, grew in importance those dramatic shifts have given way to much longer and more difficult adjustment periods. Those famous V shaped recessions have given way to elongated U’s. And the Great Recession was so deep, and so shocking, that we are still lingering near the bottom and are nowhere near climbing back to where we would have been had there been no downturn.

That, I think, is what most people overlook.

Had we avoided the downturn we would have had an economy chugging along between 2.5% and 3.0% a year. OK, but not great. Solid in fact. But we blew a great hole in that history so the long term trend line now shows a big downward dip. If we plot our actual performance against the trend line we would all notice that we are not back to where we would have been. That means we still have lost momentum to recover. And don’t forget: to the extent we wallow about beneath the long term trend line we are forgoing wealth that we will never recover. Not, that is, unless we accelerate to growth rates well above the trend line.

And therein lies our problem.

GDP growth in 2010 was insufficient to recoup our lost wealth. So that loss is permanent. In effect we have recovered in name only. The deeper reality is that we have an impoverished economy more limping than running along.

The slowness of growth last year is very worrying because there are many signs pointing to weakness at the moment. Real estate is stuck so deep in a hole that no one can credibly suggest it returns to be the boost it was during the 2000’s. Which is probably good in view of the damage it wrought. Exports are our best shot at getting medium term growth, but for that to come to fruition we need a further devaluation of the dollar and some cooperative adjustments in our trading partners to deal with their own imbalances. In particular, the Chinese, Japanese, and Germans all need to reduce their export reliance by boosting their domestic consumption. Their economies are built around excessive employment in exporting businesses which deprives us of jobs and their own people of consumer goods. Unless there is a willingness to deal with these imbalances, I doubt that our trade position will provide the boost to our GDP growth I would like to see.

So what else could?

Not much.

Business investment could be one area of extra growth, but there is little sign of a boom there. Companies are sitting on piles of cash and are not deploying it productively at the moment. This is with historically low interest rates which implies very low investment hurdle rates. If business can’t find profitable opportunities at these rates I doubt they will suddenly burst into activity any time soon.

Consumption would be another possibility for higher growth, but that too looks set for drift rather than acceleration. Households are still grappling with rebuilding their balance sheets to compensate for lost home values While the stock market has recovered, and thus boosted some family portfolios, housing was always a bigger wealth provider for the majority of people. So as long as home prices remain weak, and they have just begun to decline again, most households will look to save more than before to create a cushion against uncertainty. This, obviously, shifts a portion of income from spending to savings and thus slows GDP down. The possible offset to this slowdown would be if those savings found their way into an expansion of investment, but as I just said, there is no evidence of much growth in that sector.

The last possible area for growth would be government spending, but as we are all painfully aware the current emphasis is on reducing not increasing government activity. So, far from being a net boost, I expect the cost cutting mania now sweeping the nation to become a net drag on growth. Yes, this is dumb. And, no, it won’t change. We appear hell bent on slowing growth down.

All of this means that the outlook for GDP is not too terrific. The economy is out of the deepest parts of the hole it fell into, but it is not yet healthy enough for us to breath easily. The ugly truth is that we appear set for drift. There is no appetite for fiscal policy remedies, which leaves us reliant on the Fed’s loose monetary policy. With interest rates at practically zero we have no room to maneuver. Not that this worries policy makers. They have all moved on to the deficit and debt as their problems to solve. The fact that the best solution would have been a rapidly expanding economy eludes them.

Oh. And one more thing. Buried on today’s report is data on corporate profits. Guess what? Despite all the moaning about the administration’s supposedly anti-business attitude, and despite the gloom and doom we hear constantly from the Chamber of Commerce, profits soared. And I mean soared. Before tax corporate profits grew 36.8% in 2010. Read that agin and digest it fully. Profits boomed. Last year was the best year for profits since 1950 which was an odd year itself as business boomed after the post war recession. No wonder stock prices rose. Couple this with the news that GE is getting a tax rebate of over $3 billion on gross profits of over $14.2 billion – of which $5.1 billion was in the US – and it easy to understand why workers might be perplexed by the idea that they need to give back more in order to solve our supposed “debt crisis”.

These are boom times for capitalists. Just not for the rest of us.Today’s report simply confirms this.

Until we restore a more equable balance the economy will remain merely solid. That’s not good enough.

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From The Mouths of The Elite …

I am a big fan of the Financial Times. One or two of its contributors seem to get things right. But, periodically we come across a column or letter that exposes the thinking of the financial world a little too bluntly. Plus it’s always fun to follow the discussion when someone in that elite group responds to a column written by another of the group. It’s like sitting in a very expensive dinner and listening to dueling millionaires bemoan the price of expensive houses. Things are so bad they simply will have to give up the European tour this year. Oh my: that bad? They don’t get it. They have no idea how odd they sound. Especially given the recent history of their industry and its total ineptitude and reliance on the little people for its continued existence.

In that vein we have two examples.

Weighing in on the plight of Ireland we have a certain Peter Sutherland whose article appears on the comments page. He launches us, with all the required language of a very serious person, into a discussion of the need to renegotiate the EU-Ireland deal that provided bail out funds for that beleaguered economy. That sounds very reasonable to me, especially when I am told that the interest rate on the deal is 5.8% while the cost of funds underlying the loan is only 2.9%. That sounds like a very wide risk premium.

Or is it a premium for something else?

After being told that the need for austerity is self evident – Sutherland says “there is no denying the austerity required” – it emerges that he endorses a slightly lower premium in order to signal that we disavow moral hazard.

There’s that phrase again.

How often have we been hammered with the moral hazard argument? For all the talk about it, we would think that the important folks who worry would have eliminated its threat. The poor Irish are certainly now aware of their foolish reliance on moral hazard. They have to be punished both by harsh austerity with its loss of wealth, and now this premium on the bail out loan provided by other Europeans.

Naughty Ireland. Thinking it could fall back on the old moral hazard trick. How, well, despicable to take advantage of such an evil device.

This all sounds terrific. I, for one, want to root out the risks associated with moral hazard wherever I find it. Especially in finance, where as we now all know, moral hazard was the underpinning that helped turn Wall Street into a casino where the lads at those trading desks could play on regardless of losses, and make fortunes on the basis of knowing nothing, but how to game a tilted system.

With all Sutherland’s obvious distaste for the evils of moral hazard, and his earnest embrace of the hair shirt of austerity as a remedy for the crisis that it contributed to, you might be a little surprised to learn he is the Chairman of Goldman Sachs.

Yes. That Goldman Sachs. The one sitting right at the casino table benefitting from the very moral hazard he now seems to want to cry foul about. He is quick to impose extra costs on the Irish taxpayers. Remember how naughty they all were. He seems less quick to accept a premium on Goldman Sach’s cost of funds which are lower than they might be because investors expect Goldman to be bailed out were it ever in trouble. That market expectation is what we call moral hazard. Perhaps Sutherland should look into it.

Now, I realize that the events and revelations of the crisis revealed the extent of Goldman’s double, triple, and sometimes quadruple dealings, and its almost pathological willingness to profit from customer information, but for someone who is listed as its Chairman to be so baldfaced as to argue for an imposition his company is unwilling to accept, is stretching things a bit too far for me.

If moral hazard is rotten and austerity the just deserts for the Irish taxpayer, then they should be so for Goldman Sachs.

Then again the Irish taxpayers don’t have the same clout as Goldman Sachs. Nor are they as important – vital even – to the safe workings of the world’s financial system. So, come to think of it, Sutherland is right: we should double the premiums on taxpayers everywhere so we have a pile of cash to bail the banks out again when the bust the casino next time.

Yes. Right. No moral hazard there.

Meanwhile, over on the letters page we are treated to the sober insights of another very important financial person. This time it is Michael Mulhall, who is listed as being a Managing Principal, whatever that it is, at Capco here in New York.

His concern is the evils, not of moral hazard, but of collective bargaining by public workers, who as we all know are entirely responsible for the collapse of state budgets across the US. Were it not for these awful bargains the yawning deficits we are struggling with would never appeared. Great Recession notwithstanding. Mulhall is particularly irate about the possibility of a heinous extra New York state tax on incomes over $200,000, which is being relied upon to raise $10 billion to help fill the gaping state budget hole. Such a tax, he assures us, would drive rich New Yorkers to flee the state en masse. Presumably we should look for a Grapes of Wrath style exodus as they all pack up their limos and head to their country homes in a huff.

One of the more interesting habits the elite have when commenting on such matters is that they describe advocates of higher taxes as “well-meaning”. Never has there been a more derogatory word hurled in the current class war. Those of us who try to articulate ideas on behalf of the less well off are constantly being referred to as well-meaning. But, the implication is, we just don’t understand the vagaries and rigors of the wider world. At least not in the way that these important people understand them. Perhaps when we grow up we will. But, as of yet, our silly little heads seem filled with idealistic nonsense about fairness.

At the end of his little elitist homily Mulhall answers his own question.

The question: “What type of country will the US become should Wisconsin governor Scott Walker succeed in eliminating collective bargaining from municipal unions?”

His answer: “A fiscally more solvent, responsible, and affordable one.”

So there you have it. The elite speaks.

The conclusion appears to be that we need to hammer workers with austerity measures in order induce them to behave.

Behave more responsibly.

Once those workers are firmly underfoot the elite will be able to collect its rents, play at the casinos, and otherwise frolic safe in the knowledge that they can continue to afford their luxuries. Safe from having to flee New York. Safe from the risk that their investments might drop in value. And safe from having to concern themselves with the consequences of their own excesses. After all they will always have the workers to clean things up for them.

Above all, the financial system will be preserved for them to play within. And the preservation of that system of systems is the be all and the end all of sound policy. Sound policy, you see, must always focus on securing the safety and soundness of the things that worry the elite. No matter how unequal the national incomes have become. And no matter how indifferent the elite is to the plight of the rest of us.

You may not have known that. But now you do.

Addendum:

As I write this I am watching the devastation in Japan. Those poor people. Their troubles puts the rest we worry about into true perspective.

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Investment Versus Consumption

Casey Mulligan has emerged from his eerie to tell us that the emphasis on consumption, and especially the emphasis by Keynesian economists on consumption, is just missing the boat. The real issue is investment. If only we would encourage investment the economy would roar back to life; jobs would be abundant; and your lilacs would bloom earlier than ever before.

This despite the piles of unused cash sitting on corporate balance sheets.

This despite Alan Greenspan’s apoplexy over the aversion of business towards illiquid assets. That’s Greenspan speak for factories and so forth, i.e. stuff you can’t sell in a hurry.

As I see it the right wing economists who parade under the banner of orthodoxy are stuck with a really bad argument. They want to disparage the notion that consumption is a problem in its own right, rather than being a mere symptom of a deeper issue. Yet they have no explanation for why business is apparently willing to sit on piles and piles of cash instead of investing it.

Oh wait. They do know why: it’s the government stupid. Or as they would prefer: it’s the stupid government.

It’s always the government that mucks things up in the right wing economist narrative. Never their beloved private sector.

This is, in my view, rubbish.Not just that, but it illustrates why the very economists who laud capitalism so much fail to understand it very well.

The economy right now is experiencing a period of very low interest rates. No news there. That means that businesses can borrow at very low rates. Their cost of capital is low. They have piles of cash. So the rate of return a project has to return to them is also very low. That means that the profit a new investment has to make before it gets approved and returns a positive cash flow to the business is equally low. Yet businesses are not making such investments. They are preferring to sit on piles of cash earning even less. They are foregoing profit opportunity. As Greenspan points out they prefer liquid to illiquid assets.

Why?

This is the crux of the debate.

The right wingers claim that it is unpredictable government intervention and high prospective taxes that hold business back. The current high debt levels imply high future taxes, and so eat into those profits on new investment and make it difficult to identify the return required bothy to pay those higher taxes and to meet an adequate return on equity.

This is as if large corporations paid taxes.

And it is as if they are not able to plan around the problem. It is just not plausible that business cannot make money from all that cash when interest rates are as low as they are. The marginal impact of future tax increases could not possibly undermine every single potential investment. Some, perhaps. Very few I would wager.

Given those animal spirits we laud so much in our business class, these are the folks who ran straight aground in the high tech and real estate bubbles despite a mine load of evidence they were being stupid, I find it beyond belief that they are not gung-ho to make a quick buck any way they can. Isn’t that why they are paid enormous bonuses? They are profit driven even if it means taking on risk. Heck, their greatness is supposed to be their willingness to charge ahead an innovate, take risks, and bask in the subsequent glory.

I assume they lost that skill.

They must have done if they cannot borrow at today’s rates and make money somehow. Most of the big companies don’t even need to borrow: they just need to be willing to become illiquid. Horrid though though that may be. For the right winger orthodoxy to stand scrutiny our entire business class has to be frozen with fear, and incapable of taking risk to make a profit. Apparently government policy is one risk too far. All the other risks are small by comparison.

Mulligan always seems to make the same point: we need to encourage investment. It’s the supply side we need to address. So the switch from consumption to higher savings is not a bad thing for him. That reduced consumption has less of a proportionate impact than the offsetting rise in investment does. Remember that savings and investment equal one another. So when savings goes up, so does investment. At least theoretically. And since investment is a much smaller number in total than consumption, each extra dollar added to it has a bigger proportional impact. Thus, to Mulligan, it is investment that needs a boost since it will have a larger marginal impact on activity and thus jobs.

And this is where we keep going in circles: the cash available for investment is high already. It isn’t being used.

You can get a headache from this circularity.

An alternative view, one that I find more persuasive, is that business cannot see making a profit from ramping up investment, despite the low capital costs they are facing? Why? Because consumers aren’t buying as much as before. Demand is less, even prospectively, than is necessary to entice business to loosen its purse strings. With weak sales forecasts there is no incentive for business to live up to the right wing dream. On the contrary, the easy way to make profit at the moment is to keep costs under control, maintain a hiring freeze, and deploy current resources more effectively. That means keeping a lid on wages and using overtime and current facilities. Expansion is just not needed to play that game. At least near term. Plus, as we all know, the economy is still awash with spare capacity. Mulligan doesn’t seem willing to explain why a business would build a new factory if it has one sitting idle. Invoking government intervention surely cannot explain that.

The capitalist concern is to make profits, not, necessarily,to invest.

The problem is one of philosophy. When you build a utopian theory and then try to use it as a basis for policy prescriptions, it runs afoul of the muckiness of the real world. Perfectly obvious explanations in utopia are revealed to be less than convincing here on earth where motivations and expectations can be contradictory, and less than ideal. Businesses may not be rational in the intense meaning of that word within right wing orthodoxy, but they are sensible, and they are motivated by profit. Were there a buck to be made, someone would be trying. That they are not, at least in sufficient numbers, tells me that the deeper root of our economic malaise is not the lack of investable funds, but the lack of investable opportunities.

And to me that means demand needs a boost. Consumption is the laggard right now. Not investment.

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Debt Panic Watch

I am busy today, so I have no time to write at length. Please dampen the applause.

But.

How can I pass this by?

For all you debt panic types: today’s auction of US Treasury bonds went off without a hitch. Those cagey be-all and know-all types in those cut throat credit markets, you know, the ones who are about to leave us high and dry because we are “broke”, bid in droves for our soon-to-be worthless paper.

The Treasury sold $32 billion of three year debt at a yield of 1.298%. The auction attracted bidders with 3.22 times the amount actually sold – this is up in the recent average of 3.06 times. And that yield is nominal not inflation adjusted. You do the math to see where it would be in real terms.

So.

Where’s the imminent panic over our debt?

Not in the credit markets that’s for sure. And since that’s the only place that actually counts, why do we still hear rubbish about our debt levels?

Yes they are high. We just went through a mother of all recessions. Duh. But the credit markets seem to think we are just fine.

So the ghosts of our implosion haunt only the minds of those who seek to exploit the situation for short term ideological gain.

Yes we have a short term debt problem. But it will go away – sort of – once the economy is humming and tax revenues return to their previous levels. What we should concern ourselves with is the long term, or structural debt problem, which is the result of the deliberate attempt to suffocate the government by reducing tax revenues without cutting costs – this is the Reagan/Bush legacy; and our current inability to rein in health care costs which are running at unsustainable rates of growth.

So the plan should be: get the economy up and running at full speed by stoking demand. Then limit the rate of growth in health care spending by getting some form of rationing in place – either by price or control. Oh, and we should raise revenues back to a level consistent with the services we all demand. Sorry, that means higher taxes for some of us.

And along the way we should be leery of politicians who claim the end of the world is nigh and who want to apply leeches to bleed dry the very services that will undergird a healthy economy down the road. Cutting education funding and demonizing teachers is just plain stupid. If you like that idea, please never, ever, complain about our lack of competitiveness with China. They pour money into education. Some people think we cannot afford to any more. That’s more than stupid – it is self destructive.

By the way: much to the chagrin of the negative folks, Social Security is in ruddy health compared with Medicare. A tweak here and there and it will roll on forever. Why? Because the outgoing cash is a very predictable stream. All we need to do is to rebalance the input and output to keep the program ticking along nicely. Medicare is not at all the same. Its problem stems from the complete uncertainty surrounding the outgoing cash. The costs of health care are both rising and unknown: we cannot predict with any precision what services will be consumed at any point in the future. Thus we cannot calibrate income easily to cover those expenses. This is why rationing is inevitable. Get used to it. The only way to control consumption is either to make it so expensive we limit access to a smaller group of affluent users; or to make it scarce by limiting availability some other way, like banning the public funding of certain procedures, especially end of life care. That’s rationing under either scenario. Either the rich get whatever they want and the rest of us don’t. Or we all get somewhat less than what we want. Tough, but true.

Meanwhile back to panic watch: put away those “end of the world” placards. It’s not here yet.

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Fact Based Thoughts

For all you worriers out there, and I know there’s quite a few, calm down. It helps to keep the facts in front of you and push those more vivid opinions to one side.

Take, for example, our debt. If you listen only to the opinions, you’d think we lived in a version of the Weimar Republic replete with wheelbarrows needed to move around the useless hyper-inflated currency that we all now own. Or, as Speaker John Boehner in Washington, and Governor Walker of Wisconsin put it: “we are broke”. Really? I wonder why the rates on US bonds are going down? Could it be that those hard headed folks out there who buy and sell our debt, and who stand to lose their shirts if they are wrong, don’t see something that Boehner and Walker do?

No it isn’t possible.

The fact is that the cost of US debt is going down at the moment because world uncertainty is driving investors towards US bonds. The rise in demand for our paper is driving down rates. No one, except for some rabid Republicans with an axe to grind, thinks we face an imminent debt crisis. No one.

Our debt problem is strictly a medium term issue and is caused by the deliberate reduction in government revenues resulting from the infamous Bush tax cuts that are now so hard to undo, and from our awful health care system that is on a trajectory to destroy us whether it is publicly or privately financed. The current crisis is cyclical and so any addition to our debt stemming from it will be contained as we start to grow again. Which is why getting people back to work, and thus paying taxes again, is so important. There is no advantage in getting corporate profits pumped up: big business avoids taxes like the plague. We need honest tax paying citizens back at work. Then our deficit will start to drop.

Muddling the two problems, short term and medium term, will inevitably mean we screw up the former and forget the latter. Unfortunately that’s where our opinion leaders are headed.

Likewise the banks. The fact is that they are not fixed. We are headed back into bubble land. The opinion leaders mostly voted against any hard-nosed fixes for the banks. Now they are all for debt reduction and austerity. Yet the need for austerity is a result of the bank’s foolhardy attempt to destroy themselves by engaging in anti-social and juvenile activities they didn’t understand. The facts tell us that we should never again allow Jamie Dimon and his confreres to play with matches. They are likely to blow us all up. The poor dears cannot help themselves. The taxpayer bail out of the banks may not end up costing us a lot directly, and the opinion makers like Tim Geithner keep harping on that as evidence we should all be pleased. But the facts say something else: the crisis and its enormous social cost is an indirect result of banker lunacy, greed, and regulatory capture. So the fact that we did not fix the banking system is the result of wrong opinions holding sway.

Similarly inflation. The more dramatic of our opinion leaders are almost apoplectic about an imminent burst of inflation. This, they say, is the inevitable result of the Fed’s easy money policy. But look at the facts. Core inflation, which is our best guide for the trend in inflation, is moving down, not up. Short term factors have masked that. Some problems are no doubt out there as worldwide demand rises rapidly to squeeze raw material and commodity prices. But nowhere is that a result of US monetary policy. And, besides, food prices are being driven by shortages due to weather. That’s not a medium term policy issue. It is a short term meteorological issue. But our opinion leaders want us to think we need to tighten and possibly risk our recovery, based on their opinion. No thank you. The facts support continued easy money until we get the economy beyond its current jobless phase. When wages start to jump, that’s when we tighten.

Judging by recent history, another awkward fact, that may be never.

Of course this all just my opinion.

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