GDP

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Down The Fiscal Rabbit Hole

A few quick things on the current hyperventilation regarding the so-called ‘fiscal cliff’.

It isn’t a cliff.

Not at all. It is a roll out of a series of things that have cumulative effect, but which can be undone over a sensible timeframe. There is no sudden drop-dead moment when the lights go out. Yes, the Bush tax increases come into effect. And note my language: this is a tax increase imposed on us by the Republicans under George Bush. It is the offset to his disastrous tax cut. So it is an increase. Moving on: that increase hits everyone on January 1st. But since its impact will be on the amount deducted from incomes, its full impact will accumulate through the year. Households will react to the loss of purchasing power at different times throughout 2013, so there is no single moment when the impact smashes into GDP. There is no cliff, but there is a steady slide.

All that cash withdrawn from paychecks will suck demand from the economy. That means that sometime in 2013 we will most likely head into recession. This is what vexes business and is why it now has found its anti-austeirty voice. I find this amusing for the simple reason that by getting into a tizzy over the loss of demand big business has declared its allegiance to Keynes. Anyone who worries about the impact of a rise in taxes on GDP, and concludes that such an impact will be the loss of demand and hence will lead to contraction, is a Keynesian. Pure and simple. Notice also that this position implies that big business is not concerned that the deficit is too high. Postponing tax increases means the deficit will go up, not down. Since that’s what big business is now calling for, they are actually arguing that the deficit might be too small, not too large. Nice huh?

No it isn’t possible to raise revenues and lower tax rates at the same time. At least not if narrowing the deficit is your goal. Tax rates are already too low. Especially on high income earners. Rates need to go up. We have defunded government, we have not expanded it. We can afford what we spend once we get rid of that defunding effort. Our social programs have not suddenly become too much of a burden, we have deliberately stopped paying for them.

This was, of course, a long term strategy driven by the right and not opposed by a compliant left. Both parties sat at the table when the game was played. One wanted to eliminate entitlements by defunding them and then crying about our inability to pay for them; the other was too timid to fight back. Indeed, under Clinton, the so-called left actually added to the defunding momentum.

Oh and all this talk about raising revenues through closing loopholes is daft. Each loophole is well defended by an army of lobbyists – usually the people who bought Congress to put the loophole there in the first place – so it isn’t credible to imagine we will close many, if any. Besides the biggest loopholes are those that fund the middle class: the antiquated subsidy of home owners via the tax credit in mortgage interest, and the deduction they get for state, local, and property taxes. These aren’t listed as outlays in the budget because no one wants to embarrass the middle class by showing how much welfare gets pumped into it each year. So they are buried in the budget reports and called ‘tax expenditures’. Any drive to raise revenues without raising rates will have to do away with such things. Thus middle class taxes will go up significantly. The ruse of keeping tax rates down is simply so that the Republicans can save face with their rabid base. Taxes are going up one way or another.

One last thing: the fear mongering talk about ‘cliffs’ is designed to make it difficult to defend entitlements. It also means that debate will be truncated. In that fervid atmosphere mistakes will be made, which is why we all ought to slow things down and avoid hyperbole. In the midst of such an artificial crisis things like Social Security become sitting ducks. Already we are hearing talk about raising the retirement age again. This is because life expectancy has risen way beyond what it was when the program was introduced. Alan Simpson of Simpson-Bowles notoriety is a major advocate of such a move. He has been an outspoken opponent of entitlement programs since his election it Utah. Of course he doesn’t have to worry. His twenty years in Congress earned him lifetime health benefits and a full pension. He just thinks other sought to work longer and harder to get what he has. Sounds fair, right?

Let’s think twice though. This is because much of the increase in life expectancy is an illusion.

Yes we live longer on average. But much of the increase in overall life expectancy comes as a result of better care for infants, making life expectancy at birth much higher than it used to be. But it is that portion of life beyond retirement that we ought focus on, and which represents the actuarial problem, so gains made for infants are irrelevant. When we focus this way, we find that the gain is much less, indeed for low wage earners the gain is minimal. So the increase in retirement age from 65 to 67 has already solved a considerable part of the problem – such as it is – and little more is needed. The actuaries calculating the retirement age saw this coming as far back as 1946. And in the revamp of 1985 they nailed it. What they missed, though, is the inflation of incomes. The payroll tax funding the program has a cap of around $110,000. Incomes above that level are free of payroll tax. Adjusting for the underestimate of the impact of inflation on incomes by removing that upper cap or raising it significantly is all that is needed to solve the program’s minor difficulties.

Medicare is a whole different issue. There the problem is the lack of cost control and low productivity in the health care industry. Bending the trajectory of future cost increases is the primary goal, and, parenthetically, the last year or two have seen major strides in that direction – health care cost have risen more slowly, so we need not panic.

And this ought be our theme throughout: no panic. There is no cliff. The world will not end if we don’t hammer out an urgent bargain. We can afford to be sensible on this one. So don’t listen to the hyperventilating pundits. They’re the ones who called the election close. They were wrong then. They’re wrong now.

Stay calm.

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The Answer Is: No

Huh?

No appeasement.

We have already moved on from the Democrats sweeping victory in Tuesday’s election. And have no doubt the win was indeed sweeping. The margins were small in some states, tiny in Florida, but that they existed at all is the fact to focus on. Obama ought never have won this election. The economy is weak and unemployment still lingers in a zone that, in the past, spells doom for incumbent presidents. But he won. Handily. Not only this, but in a year when the Democrats were expected to lose control of the Senate they actually added to their majority.

Something went horribly wrong for the Republicans. It wasn’t that Romney, despite his vaunted business and analytical acumen, ran an ineptly organized campaign. It was, to put it bluntly, a day of reckoning for the extreme right. Their wild eyed radical agenda, from their misogynistic views on social issues, to their emphasis on ever more defense spending, on through to their open desire for the wholesale destruction of entitlement spending, was rejected. It was rejected wherever is was explicit. It was rejected in toto.

Yet a legacy of Obama’s own inept management of his early years was that in 2010 Republicans surged into power at the state level. This allowed them to rig upcoming Congressional elections via the time honored tool of re-drawing the boundaries of Congressional districts in order to make them Republican friendly. This paid off handsomely on Tuesday. Despite being handily beaten at the polls in terms of numbers of votes cast, the Republicans kept hold of the House.

So we enter the next two years with a split government.

This has brought forth a rush of calls for Obama to make a deal with the Republicans on the so-called upcoming fiscal cliff. This is the self-inflicted budget crisis that is also a legacy of the deadlock we suffered through during the last four years and in particular is a result of the breakdown in negotiations over budget policy in 2010 and 2011. Basically the ‘cliff’ is a term describing a series of spending cut and tax increase measures that automatically come into law on in January 2013 unless alternative, and presumably more sensible, measures are agreed to beforehand. With beforehand meaning the next few weeks.

The danger of rushing to cut a deal in a few weeks – a deal that would re-define our tax and spending profile for the best part of a decade – is that there is no time for a considered discussion. A grand bargain of such importance surely needs to be the outcome of a few months not a few weeks of negotiations.

Worse, the psychology of such a compressed debate gives the upper hand to the extremists who can force concessions from their more moderate counterparts by waiting to the last moment to make a deal. Brinkmanship becomes the order of the day and undermines the likelihood of the ultimate bargain not containing some very bad deals.

This, of course, is less of a problem were Congress not infested with a phalanx of Tea Party extremists.

Therein lies the reason for no appeasement.

The central problem we all face as we seek to strike a deal on the budget is that the extreme right is not concerned about the deficit. Despite what they say publicly about burgeoning debt and other right wing red flags, they have never been worried about the level of debt or the size of the annual deficit. These issues are simply a veil over the real agenda: the destruction of the welfare state. In recent decades it has been the Republican Party responsible most for the emergence of a long term rise in the deficit. First under Reagan and then under George W. Bush they forced through massive reductions in government revenues  without tackling a concomitant cut in spending. Reagan oversaw a massive defense build up that was paid for, not through taxation, but through borrowing. Then, after Clinton had stabilized the budget and even produced a rather lucky surplus, Bush used the existence of that surplus to argue that the government was taking in too much revenue and thus could cut taxes. He cut taxes way beyond the level needed to balance the books. In a deliberate effort to defund government and thus produce a budget crisis he cut taxes drastically in two rounds. Each added to the deficit. Each was supported wholeheartedly by the entire Republican delegation in Congress.Some of those Republicans, in a stunning volte face, have become the most vocal champions of deficit reduction. So we know that the Republicans do not worry about deficits. Recall it was Dick Cheney who said that deficits don’t matter.

Creating a funding crisis was the goal. It was a strategy that succeeded and then some when the economy fell to pieces and the long term deficit was compounded by the normal short term deficit associated with a recession. The extremists had set the game up perfectly for themselves. The chatter amongst our elite became the burden represented by the entitlement programs whose cost now looked unbearable in the context of all that lost revenue. Social Security was quickly branded as being on the verge of bankruptcy. Medicare was declared impossibly costly. The handwringing began. Earnest and sober people began to regret the harsh reality that America could no longer afford the New Deal and New Society programs. Yes, we were told, we would like to protect the poor, the young, the elderly, and the sick, but we just can’t afford it anymore. Something has to give. Someone has to pay the price for America’s diminished fiscal capacity. Just not the wealthy job creators and their friends in Wall Street.

Thus the sick, the poor, and the elderly, and the children were singled out for punishment. They were to be sacrificed so that we could get our fiscal house in order.

All the pronouncements, reports, and analyses that have flooded Washington these past two years as we began the debate over the budget have had the same target. All have taken as a truth that we have a diminished revenue raising capacity. Yes they have all talked about raising revenues, but they all, ultimately, throw the burden on the same target: the weakest parts of our society.

In other words the enormity of the Republican Party’s cynical strategy has been overlooked. The radical agenda is perilously close to being fulfilled. Had Romney won on Tuesday victory for the far right would have been certain. The credit markets and the plutocrats would have protected their privilege and the rest would have been made to pay.

But democracy is a funny thing. It gives the weak a chance to express what they think.

And they thought poorly of the entire radical right’s enterprise. They realized that they were being sold a bill of goods. Only one in ten voters mentioned the deficit as an issue. Seven in ten thought job creation was the priority. In my mind that’s a fairly good indicator for what public policy ought to be doing.

Stimulus. Not austerity.

So. As we are rushed headlong into this unnecessary panic called the ‘fiscal cliff’ we ought to listen to the voters.

Say no to cuts in entitlements. No.

Do not allow this artificially and carefully crafted moment be the excuse for ending the welfare state.

No appeasement of extremists. It never works. They always want more.

If that means going over the cliff, so be it. There is nothing that cannot be undone later. Let taxes go up. Put the blame on the intransigence of the right. Then cut them back where needed and bask in the victory of handing a tax cut to the middle class. Raise capital gains tax to the same level as income tax. After all income is income so tax it all the same. Stretch the tax code out progressively. After all the research shows definitively that higher taxes on the wealthy has no effect on the economy. Fix the tax code to plug loopholes for big business. Use the revenue to lower tax rates if you want. Get rid of the cap on payroll taxes to juice revenues into Social Security, but extend last year’s payroll tax cut as a stimulative measure. The list goes on.

But never, ever, appease the extremists. This is their last chance to execute the Reagan/Bush agenda. This is our chance to end the entire Reagan era. The stakes extend way beyond the mere budget. This is the time to re-define the American social contract.

So start by resisting the temptation to rush into a hasty deal.

The answer is: no.

 

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Modest Growth – Very Modest

Under normal circumstances – who can remember when they were? – GDP growth of about 2% would be looked at as something of a failure, but for a long time now anything in the 2.0% to 2.5% range has been regarded as an optimistic target. Such are the consequences of a bloated financial sector.

This morning’s preliminary report on third quarter growth has GDP chugging along at an annual 2.0% rate, which is the par I have been suggesting we ought shoot for all year. This marks a decent jump up from the second quarter’s 1.3%, but is nothing to shout about.

The most significant contributor to the increase was personal consumption which edged up from 1.5% to 2% quarter to quarter. This fits well with the other data we have been seeing lately. Rising confidence, a slightly more secure labor market, and the end of falling home prices all seem to be having a positive effect. Retail sales have risen across the board and households appear to be willing to go out and spend.

Whether they will – or can – continue this will depend on more improvement in employment and a return to some semblance of wage growth. And therein lies the rub. Wages have stagnated for so long for the average family that I seriously doubt we can accelerate personal spending much above its current tawdry rate. The division of the spoils garnered by improved productivity have mostly gone to profits in the past few decades. That has led to a massive reduction in household spending potential, and consequently has reduced the upper limits on GDP growth. The tensions that arise from the skew towards profit at the expense of wages reverberate throughout the entire economy. It sits at the heart of our rising inequality; it leaks into politics in the form of plutocratic defense of privilege; it distorts capital allocation via the financial system’s self indulgence; it lowers the arc of future standards of living; and it encourages specious discussions of the ‘end of growth’, which is a very fertile literature at the moment.

More on that at another time.

Meanwhile elsewhere in today’s GDP report we learned that investment languished. Capital spending by businesses fell 1.3%, whereas real estate investment bounced up 14.4%. Government spending rose too, by 3.7%, reversing a recent tightening of the Federal purse strings. The jump was largely due to a reversal of the second quarter’s unexpected decline in defense spending. Below the Federal level, state and local governments continued their budget reductions and so continue to exert a drag on growth. Lastly, trade took a turn for the worse as the 0.2% decline in imports was swamped by a 1.6% drop in exports. Evidently the continued worldwide economic slowdown and inability to resolve problems is having a marked impact on US trade prospects.

What to make of all this?

The economy is stuck precisely where it has been for many quarters. It meanders about aimlessly subject to periodic shocks, none of which throws it back into recession but which are all sufficient to prevent a break out. The private sector appears to be taking a break from its de-leveraging, that shedding of private debt was a defining factor of the last three years, but whether the hiatus is permanent or temporary will depend on re-establishing more solid gains in wages. This is something I am deeply skeptical of. Total wages will increase as more people return to work, but wages per household for the vast majority look set to fester. Add in the ludicrous and totally unnecessary focus on the Federal deficit and the supposed uncertainty that it creates, and we have a recipe for more of the same. Indeed I expect the fourth quarter to show a slow down. The odds of lower growth are higher than those for an acceleration.

Especially given the intellectual failure of our elite and its total disregard of the facts in its current obsession on austerity.

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Production and Construction Pick Up

The last couple of days have brought us more news to support the notion of a solid, if unspectacular, recovery being well underway. Both industrial production and, more particularly, new home construction support a slightly optimistic outlook by growing more rapidly than forecast. So they’re worth noting.

Yesterday we learned that industrial production which had taken quite a hit in August recovered decently in September, growing at a 0.4% rate compared with the the revised drop in August of 1.4%. Both these figures need to be treated with a little skepticism. The August number was deeply depressed by the temporary closure of oil production facilities as oil companies hunkered down to weather a hurricane. Likewise, September’s uptick includes partial re-opening of those same facilities. But setting that oddity aside we still see an increase in production in September, which suggests that the mid-summer faltering in the economy is past us at least for now.

Today’s housing starts news is, to say the least, startling. September’s starts were at a rate of 872,000, reaching a four year high. That’s 15% up from August’s 758,000. Single family home starts rose 11%, and multi-unit homes starts rose 24%. The latter is very volatile and so is less of a reliable indicator of the overall construction trend, so we ought focus more on the single family starts figure as a proxy for the outlook in real estate.

Even more importantly for the outlook, permits issued for new construction also shot up to a four year high rising to 894,000, which is an increase of 11.6%.

Taking this new housing data along with the recent firming in prices, and we can now detect a distinct and sustained recovery in real estate. The early year wobbles are well behind us and construction is, at last, on a solid footing, albeit well below its bubble driven peaks. If this keeps up it augurs well for both GDP and employment as a steady trickle of new construction jobs helps re-absorb people back into the workforce.

Naturally we need to exercise caution with this good news. There are still major issues out ahead, most notably the possible self-inflicted disaster of unnecessary fiscal retrenchment as Congress tries to thrash out its ideological differences and come up with a semblance of a budget plan. If, as is quite possible, the result of the negotiations later this year end up with a botched austerity package along the lines of the awful Simpson-Bowles proposal, we can expect GDP to take a hit in 2013. It may even slide into recession. The threat is real, and not without precedent. The Great Depression was prolonged for years by ill-informed policy making, and we appear intent on making those same errors.

In which case today’s burst of optimism will have been a short lived reprieve rather than being indicative of a long term cure.

Let’s hope not.

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Retail Sales Jump

One of our recent themes has been the underlying improvement in consumer confidence that has yet to manifest itself strongly in any of the headline numbers. There seems to have been a definitive change at the household level. Whether it has the strength to make a significant difference throughout the economy is yet to be discovered.

Today’s news of a strong September showing for retail sales, which grew 1.1% during the month off of upwardly revised figures for both July and August, suggests that consumers have, at last, shifted to a more upbeat mood and are willing to start spending at a higher rate. That bodes well for GDP, and may – only may – eventually help get unemployment down further.

The good news is that spending was not confined to any one category. Only department stores saw weakness seeing a drop of 0.2%, but beyond that all sectors experienced growth. One example of the breadth of the growth is the 1.3% jump in auto sales. In too many months during the crisis auto sales have performed well and have masked a more general weakness. This month, however, sales less autos still grew at a solid 1.1%, making September the best month for a while. Gasoline prices can also contribute to a skewed month, and in September spending at the pump grew 2.5%, but, again, non-gasoline sales were a strong 1.0%. So none of the usual caveats we use to caution ourselves about the sales figure seem to apply this time.

What does this mean?

Given that consumption accounts for about two-thirds of GDP, and given that retail sales are a rough, but not exact, proxy for overall consumption, we can expect the recent more robust trend in sales to imply stronger personal spending in the GDP accounts. This, in turn, implies a stronger third quarter GDP than the second’s anemic 1.3%, with growth being between 1.5% and 2.0%. That’s still not very good, but at least it’s going in the right direction.

 

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