Entries for January 2009

More optimism from the White House today. Excerpts (with particularly gloomy parts in bold):

This morning I'd like to talk about some good news and some bad news as we confront our economic crisis. The bad news is well known to Americans across our country as we continue to struggle through unprecedented economic turmoil. Yesterday we learned that our economy shrank by nearly 4 percent from October through December. That decline was the largest in over a quarter century, and it underscores the seriousness of the economic crisis that my administration found when we took office. ... Already the slowdown has cost us tens of thousands of jobs in January alone.

And the picture is likely to get worse before it gets better. Make no mistake, these are not just numbers. Behind every statistic there's a story. Many Americans have seen their lives turned upside down. Families have been forced to make painful choices. Parents are struggling to pay the bills. Patients can't afford care. Students can't keep pace with tuition. And workers don't know whether their retirement will be dignified and secure.

Americans know that our economic recovery will take years -- not months. But they will have little patience if we allow politics to get in the way of action, and our economy continues to slide.

Rarely in history has our country faced economic problems as devastating as this crisis. But the strength of the American people compels us to come together. The road ahead will be long, but I promise you that every day that I go to work in the Oval Office I carry with me your stories, and my administration is dedicated to alleviating your struggles and advancing your dreams.

Greg Mankiw helpfully points to this entry in The Concise Encyclopedia of Economics written by Lawrence Summer, the director of the National Economic Council:

Another cause of long-term unemployment is unionization. High union wages that exceed the competitive market rate are likely to cause job losses in the unionized sector of the economy. Also, those who lose high-wage union jobs are often reluctant to accept alternative low-wage employment. Between 1970 and 1985, for example, a state with a 20 percent unionization rate, approximately the average for the fifty states and the District of Columbia, experienced an unemployment rate that was 1.2 percentage points higher than that of a hypothetical state that had no unions. To put this in perspective, 1.2 percentage points is about 60 percent of the increase in normal unemployment between 1970 and 1985.

Me: Of course, reunionization of America seems to be a key plan in Obama's plan to strengthen the middle-class. Know what would help the middle class? Faster economic growth. As I have written before:

The problem is a lack of sustained or even spectacular economic growth. Consider this: During the 1980s, the economy notched 19 quarters of 3.5 percent GDP growth or better. In the 1990s, the economy also notched 19 quarters of 3.5 percent growth or better. So far this decade? Just eight. Or look at the number of quarters of "hypergrowth," say, 5 percent or better. (This was JFK's GDP goal in the 1960s, by the way.) There were 12 in the '80s, eight in the '90s. So far this decade? Just a single quarter, the third quarter of 2003.

Here is an interesting ideas from David Goldman of the Inner Workings blog:

Rather than claw back already-paid bonuses of about $18 billion, as some grandstanding Democrats suggest, Wall Street firms should issue common stock to employees in that amount and require them to invest the after-tax portion of their cash bonuses in the stock of their firms. The proceeds should be used to repay the government for funds injected into their firms. That will satisfy the public, which quite reasonably objects to the use of its tax money to compensate bankers who make an order of magnitude or two more than the average taxpayer, and it will incentivize the bankers to work hard and manage risks well.

Me: This makes more sense than about anything I have heard on Capitol Hill lately. Are we trying to solve a problem or score political points with some bogus populism?

I saw new RNC Chairman Michael Steele on Capitol Hill night. He didn't look like a guy who's inherited a big mess or guy with the weight of the world on his shoulders. He looked and sounded like he just nabbed the job of dreams and wants to start bright and early the next morning ...

Christopher Caldwell in the FT:

Stimulus, many economists have stressed of late, is about restoring what John Maynard Keynes called animal spirits. Keynes meant something like “morale”. But there is a more animal sense to “animal spirits” that appeals to the broad publi They are willing to be excited by what their government can do. But where is the Tennessee Valley Authority in all this? The Concorde-type project? The Apollo programme? Such initiatives work not just on economic fundamentals but also on the public’s entrepreneurial imagination and its optimism. But this bill is about funding babysitters, writing unemployment cheques and installing septic tanks with not enough money left over to give even one city a subway system.

Me:  After Obama was elected, I jokingly emailed one his economic advisers and asked when they were going to build a bullet train from my home into DC. Now it looks maybe I'll get some more potholes filled.

Larry Kudlow brings some needed clarity to the Obama stimulus proposal as only the Great One can:

And in what may prove to be the biggest stimulus-package hurdle of all, news reports suggest that Team Obama is contemplating as much as $2 trillion in TARP additions to rescue the banking system in one form or another. That would be $2 trillion on top of the nearly $1 trillion stimulus package. Government spending, deficits, and debt creation of this magnitude is simply unheard of. So the added TARP money will surely imperil the entire stimulus package as taxpayers around the country begin to digest the enormity of these proposed government actions. Financing of this type would not only destroy the U.S. fiscal position for years to come, it could destroy the dollar in the process. What's more, the likelihood of massive tax increases -- which at some point will become front and center in this gargantuan funding operation -- would doom the economy for decades.

Me: Here is what Fed economist Emre Ergungor said about nations that undergo a big credit crisis:

Banking crises can have devastating effects on the economies of developing and industrialized countries. In addition to the taxpayer costs of recapitalizing the banks, banking crises have negative longterm effects on the economy, such as slow growth, high interest rates, and lower living standards.

This seems to be right where we are headed unless we begin to adopt some pro-growth economic measures.

Rich Lowry makes some interesting points about the future of Big Government and the GOP:

I wonder if the excesses of the bailouts and the stimulus package will make big government politically vulnerable in a way it hasn't been in more than a decade by, 1) Again associating government spending with Washington irresponsibility through the truly dramatic new numbers for the deficit and the debt; 2) Intertwining government with Wall Street/corporate America in a way that makes it possible for a Main Street conservatism to run against both. There may be point here at which a Mike Huckabee populism and a Steve Forbes free-market economics can meet. There's usually a reaction to every action in American politics, and while the Democrats and Obama have basically a free hand to expand government in the current environment, you can already feel the backlash building.

Me:  Look, the deficit is about to baloon to truly monstorus levels. And at the the same there is a good chance the economy, as perceived by most Americans, is going to stink on Election Day 2010 and Election Day 2012. I can see a Republican candidate for congress or the presidency saying the following.

Well, folks, we just let Washington spend trillions of our kid's money and all we got for it the longest economic disaster than anyone under 70 can remember. It's kind of like we all got so scared in 2008 that we all went a little crazy and got a little absent-minded. We forgot that private enterprise isn't the Big Money Guys on Wall Street, it's entrepreneurs starting new business and workers thinking up new and better ways to do their jobs.  We forgot that Washington can a do a few things alright, big Big Government isn't so good at mutlitasking. We forgot that America's deep strength lies outside the 212 and 202 area codes. So let's get back to what really works, what turned America into the world's richest nation -- rewarding people who work hard and create and take risks to build the companies of tomorrow that will compete in the global economy.  Not the bureaucrats. Not the politicians. Not even the traders on Wall Street.

Something like that. Also, cutting payrolls taxes for familes.

Ryan Ellis of Americans for Tax Reform passes this along about the idea to allow companies to repatriate foreign earnings:

Once again, Congress has the opportunity to use repatriation to inject much-needed and non-inflationary capital into the United States. According to Decision Economics, $545 billion is sitting overseas today, ready to be repatriated. If even half of that money was returned to this country, it would represent a one-time boost equivalent to 2 percent of GDP. Hundreds of billions of dollars would be available to lend, pay down debt, restructure, and (most importantly from a taxpayer perspective) avoid any potential government bailouts. Repatriation, though, should be the rule and not the exception. The United States is the only country in the world that tries to tax the worldwide income of its companies, and has set up complex deductions and credits as a result. A simple, territorial system similar to repatriation would be a pro-taxpayer and modern tax reform step.

1) The fabulous Fausta Wertz  analyzes the possible collapse of Mexico.

2) John Tamny tell us why the upcoming trillion dollar budget deficits are worse than you realize.

3) Stan Collender says Wall Street banks should consider themselves federal agencies.

4) The Oil Drum tried to links the oil crisis and the financial crisis with a flowchart.

My guy Dan Clifton of the Strategas Group raises a warning flag:

Domestically, both the House and Senate stimulus packages contain “Buy American” provisions as a way to bolster the domestic steel industry, and other industries are lobbying for similar treatment. The House approved a provision yesterday requiring that Department of Homeland Security uniforms be made from U.S. textiles. Large multinational corporations, on the other hand, are growing increasingly concerned that these protectionist measures will be greeted by international backlash. These new trade measures are coming at a time when global trade is expected to decline for the first time since 1982.

Andy Busch of BMO Capital Markets is as concerned about the Fed monetizing federal debt as I am:

The actions by Ben Bernanke and the Fed will ensure that a recovery by the economy will not be choked off just as it begins.  However, there are dangers to this policy and the monetization that may occur.  The discussion of a Bad Bank and the $1-2 trillion funding of this bank is where we need to watch.  The current plan being discussed is going to utilize some of the new TARP money and then issue government bonds to fund the rest. 

My belief is that the Federal Reserve will be called upon to buy some of this paper and thus monetize debt.  Printing money to pay for programs was done with success during WWII. Doing it today is entirely different.  There is no war and there are no price controls.Should the Fed actively engage in US government debt monetization they run the risk of dramatically increasing the money supply, driving down the value of the dollar, and forcing interest rates higher which would choke off a recovery.

This is a classic CapCom that got lost in the post-election shuffle but is relevant for today, I think:

When Barack Obama's pick for budget chief, Peter Orszag, ran the Congressional Budget Office, here is what it had to say about a stimulus plan almost exactly like the one Obama is now proposing (bold is mine):

"Practically speaking, however, public works involve long start-up lags. Large-scale construction projects of any type require years of planning and preparation. Even those that are "on the shelf" generally cannot be undertaken quickly enough to provide timely stimulus to the economy. For major infrastructure projects supported by the federal government, such as highway construction and activities of the Army Corps of Engineers, initial outlays usually total less than 25 percent of the funding provided in a given year. For large projects, the initial rate of spending can be significantly lower than 25 percent.

Some of the candidates for public works, such as grant-funded initiatives to develop alternative energy sources, are totally impractical for countercyclical policy, regardless of whatever other merits they may have. In general, many if not most of these projects could end up making the economic situation worse because they would stimulate the economy at the time that expansion was already well under way."

Also here is an analysis of the new CBO report on the slow-motion Obama stimulus plan from the Tax Foundation:

According to CBO, the plan includes $604 billion in new spending and $212 billion in tax cuts for a total cost of $816 billion over the 2009 to 2019 period.  While supporters of the plan claim that it must be enacted soon to get government cash into the economy, only 15 percent (or $93 billion) of the spending will occur during this fiscal year which ends in October. Only 37 percent of the spending would occur in FY 2010, which means that roughly half of the plan's spending will occur in FY 2011 and beyond. The economy is going to be well back to health on its own by the time any of this takes effect.

While economists differ on whether Keynesian demand-side spending can boost economic growth in the short run as much as it hurts in the long run, even the most ardent advocates would agree that the plan spends too little in the short run to make much of a difference.  CBO estimates that GDP will total $28.8 trillion over the next two years but the plan spends $318 billion during the same period -- just 1.1 percent of GDP. This is like pouring a teaspoon into the ocean.

On the tax side, only about 36 percent of the $212 billion in tax cuts will benefit taxpayers this year and the rest will benefit them next year. To make matters worse, the tax provisions are heavily weighted toward "refundable" tax credits for families which are little different from the ineffective tax rebate checks Congress approved in 2008.

Bond market guru David Goldman of the marvelous Inner Workings blog thinks so:

What convinced the Obama administration not to play Dr. Frankenstein with the banking system? The collapse of the British pound and the soaring cost of insuring against a British default must have gotten someone’s attention. The sharp backup in US Treasury term yields despite an equally sharp fall in US equity market, moreover, must have alerted some in Washington that the credit of the US Treasury was not impregnable. The worst thing about bank nationalization is NOT that the government will do a bad job of banking. Everyone does a bad job at banking. The worst thing is that it places untold trillions of dollars of new liabilities on the shoulders of a federal government that already is borrowing well over $1 trillion a year.

Me: You can also toss the rising cost of sovereign debt insurance into the mix as well.  But I am not sure that the First Bad Bank of the United States option is any better.

Goldman Sachs says the Fed is ready to to bring out the Daisy Cutter of monetary tools:

In our view, it is highly likely that the Federal Reserve will eventually decide to purchase longer-term Treasuries.  First, even a 0% nominal federal funds rate is likely to look much too high by 2010 if our forecasts for inflation and the unemployment rate are roughly on the mark ... Fed officials will therefore have to pedal harder and harder to “mimic” the effects of cuts in short-term interest rates via unconventional monetary policy options, and buying longer-term government securities is one of the most conventional of these unconventional options.

Might this have some negative impact down the road? As the saying goes, "We'll jump off that bridge when we get to it." But take note of this recent analysis by currency guru Alex Merk:

After all, the massive stimuli under way should be highly inflationary; but if the Fed helps to engineer that markets cannot price inflation into bond prices, there has to be a valve. This valve, in our view, will be the U.S. dollar; we cannot see the dollar hold up in face of the types of intervention that are under way and that we see play out. Incidentally, a substantially weaker dollar may be exactly what Fed Chairman Bernanke wants. He has repeatedly praised Roosevelt for going off the gold standard during the Great Depression to allow the price level to adjust to the pre-1929 level; this is Fed talk for praising the pursuit of inflationary policies. His only criticism has been that he didn't act fast enough. ... In the U.S., these days, most of the deficit is financed abroad; the U.S. is lucky that at least the debt is U.S. dollar denominated so that it can, at any time, repay its debt by simply printing more money. However, the value that foreigners may place on the U.S. dollar may be substantially less the more inflationary the policies are the U.S. is pursuing.

Does this all have anything to do with the Obama administration's decision to send the national debt soaring with both a giant stimulus package and another bank bailout? Here is what the St. Louis Fed says about debt monetization:

Today, as in the immediate post-World War II period, the phrase “monetizing the debt” means money growth induced by attempts to moderate the effects of rapidly growing gover-nment debt on interest rates.

Some people are going to oppose President Obama's ginormous stimulus package just because they're on a different political team. But when you look at the economic evidence, it sure seems like an economic recovery package that's heavy on government spending and light on tax cuts is just the opposite of what we should be doing right now. Try this closing argument on for size:

1) A 2005 study by Andrew Mountford and Harald Uhlig "analyzed three types of policy shocks: a deficit-financed spending increase, a balanced budget spending increase (financed with higher taxes) and a deficit-financed tax cut, in which revenues increase but government spending stays unchanged. We found that a deficit-spending shock stimulates the economy for the first 4 quarters but only weakly compared to that for a deficit-financed tax cut." In other words, FDR vs. Clinton vs. Reagan, Reagan wins.

2) Harvard economist Robert Barro looked at the multiplier effect of World War II military spending -- supposedly the Mother of All Stimulus Plans and found that "wartime production siphoned off resources from other economic uses — there was a dampener, rather than a multiplier." Barro prefers eliminating the corporate income tax to massive government spending.

3) Alberto Alesina of Harvard and Luigi Zingales of the University of Chicago want to adress the fear and confidence issue by creating "the incentive for people to take more risk and move their savings from government bonds to risky assets. There is no better way to encourage this than a temporary elimination of the capital-gains tax for all the investments begun during 2009 and held for at least two years."

4) An initial CBO analysis found that a mere $26 billion out of $274 billion in infrastructure spending, just 7 percent, would be delivered into the economy by next fall. An update determined that just 64 percent of the stimulus would reach the economy by 2011.

5) University of Chicago economist and Nobel laureate Gary Becker doubts whether all this stimulus spending will do much to lower unemployment: "For one thing, the true value of these government programs may be limited because they will be put together hastily, and are likely to contain a lot of political pork and other inefficiencies. For another thing, with unemployment at 7% to 8% of the labor force, it is impossible to target effective spending programs that primarily utilize unemployed workers, or underemployed capital. Spending on infrastructure, and especially on health, energy, and education, will mainly attract employed persons from other activities to the activities stimulated by the government spending. The net job creation from these and related spending is likely to be rather small. In addition, if the private activities crowded out are more valuable than the activities hastily stimulated by this plan, the value of the increase in employment and GDP could be very small, even negative."

6) Christina Romer, the new head of the Council of Economic Advisers, coauthored a paper in which the following was written about taxes: "Tax increases appear to have a very large, sustained, and highly significant negative impact on output. Since most of our exogenous tax changes are in fact reductions, the more intuitive way to express this result is that tax cuts have very large and persistent positive output effects." And former Bush economic adviser Lawrence Lindsey tack on this addendum: "The macroeconomic benefits of tax cuts can be two to three times larger than common estimates of the benefits related to spending increases. The relative advantage of tax cuts over spending is even clearer when the recession is centered on the household balance sheet."

7) Economists Susan Woodward and Robert Hall find that the multiplier effect from infrastructure spending maybe just 1-for-1, less than that 3-to-1 ratio for tax cuts that Romer found: "We believe that the one-for-one rule derived from wartime increases in military spending would also apply to increases in infrastructure spending in a stimulus package. We should not count on any inducement of higher consumption from the infrastructure stimulus."

8) Economist John Taylor thinks it better to let the Federal Reserve deal with the short-term problems in the economy, while fiscal policy should attend to long-term issues: "In the current context of the U.S. economy, it seems best to let fiscal policy have its main countercyclical impact through the automatic stabilizer ... It seems hard to improve on this performance with a more active discretionary fiscal policy, and an activist discretionary fiscal policy might even make the job of monetary authorities more difficult. It would be appropriate in the present American context, for discretionary fiscal policy to be saved explicitly for longer-term issues, requiring less frequent changes. Examples of such a longer-term focus include fiscal policy proposals to balance the non-Social Security budget over the next ten years, to reduce marginal tax rates for long run economic efficiency, or even to reform the tax system and Social Security."

9) Massive stimulus didn't work in the Great Depression. As this Heritage Foundation study notes: "After the stock market collapse in 1929, the Hoover Administration increased federal spending by 47 percent over the following three years. As a result, federal spending increased from 3.4 percent of GDP in 1930 to 6.9 percent in 1932 and reached 9.8 percent by 1940. That same year-- 10 years into the Great Depression--America's unemployment rate stood at 14.6 percent." Same goes for Japan and its Great Stagnation of the 1990s.

10) Olivier Blanchard, the chief economist of the International Monetary Fund, coauthored a paper which found "that both increases in taxes and increases in government spending have a strong negative effect on private investment spending."

 Bottom line: There is another model out there. One that worked in 2003, 1997 and 1981. But will America use it?

Sources:

1) http://sfb649.wiwi.hu-berlin.de/papers/pdf/SFB649DP2005-039.pdf

2) http://online.wsj.com/article/SB123258618204604599.html

3) http://online.wsj.com/article/SB123249646698200289.html

4) http://cboblog.cbo.gov/

5)http://www.becker-posner-blog.com/archives/2009/01/on_the_obama_st.htm

6)http://www.econ.berkeley.edu/~cromer/RomerDraft307.pdf

7)http://woodwardhall.wordpress.com/2008/12/11/measuring-the-effect-of-infrastructure-spending-on-gdp/

8)http://www.stanford.edu/~johntayl/Papers/Reassessing+Revised.pdf

9) http://www.heritage.org/research/economy/bg2222.cf

10) http://www.mitpressjournals.org/doi/abs/10.1162/003355302320935043?cookieSet=1&journalCode=qjec

11) http://www.weeklystandard.com/Content/Public/Articles/000/000/015/951hvyxc.asp?pg=