Archive for November, 2011

The strategic deficit

22 November 2011

The Republican “starve the beast” strategy of running up huge deficits (preferably by cutting taxes on the wealthy and raining money on military contractors) and then using them as an excuse to cut social programs is nothing new, but this interview tidbit with iconic conservative economist Friedrich von Hayek was new to me:

‘A 1985 interview with von Hayek in the March 25, 1985 issue of Profil 13, the Austrian journal, was just as revealing. Von Hayek sat for the interview while wearing a set of cuff links Reagan had presented him as a gift. “I really believe Reagan is fundamentally a decent and honest man,” von Hayek told his interviewer. “His politics? When the government of the United States borrows a large part of the savings of the world, the consequence is that capital must become scarce and expensive in the whole world. That’s a problem.” And in reference to [David] Stockman, von Hayek said: “You see, one of Reagan’s advisers told me why the president has permitted that to happen, which makes the matter partly excusable: Reagan thinks it is impossible to persuade Congress that expenditures must be reduced unless one creates deficits so large that absolutely everyone becomes convinced that no more money can be spent.” Thus, he went on, it was up to Reagan to “persuade Congress of the necessity of spending reductions by means of an immense deficit. Unfortunately, he has not succeeded!!!”’

The snippet comes from this article about David Stockman, former Republican Congressman and Reagan Office of Management and Budget Director. Another keeper:

‘The deficits were intentional all along. They were designed to “starve the beast,” meaning intentionally cut revenue as a way of pressuring Congress to cut the New Deal programs Reagan wanted to demolish. “The plan,” Stockman told Sen. Daniel Patrick Moynihan at the time, ” was to have a strategic deficit that would give you an argument for cutting back the programs that weren’t desired. It got out of hand.”’

All of which is worth remembering the next time you’re subjected to the hand-wringing of yet another media or political figure who says the deficit is our biggest problem. (Usually these people don’t bother to mention the 25 million unemployed and underemployed, or the $1 trillion output gap.) Yes, the deficit is a problem, but don’t forget where it came from, and especially don’t trust anyone who says reversing the 2001 tax cuts or cutting military spending can’t be part of the solution.

Epic fail

21 November 2011

The so-called “supercommittee” of six Democrats and six Republicans, charged last summer with drafting a deal for $1.2 trillion in spending cuts over ten years, failed to do so by today’s deadline. The so-called teeth in last summer’s agreement to form a supercommittee was that Congress would either accept their proposal or submit to $1.2 trillion in automatic, across-the-board spending cuts. Is this good news, bad news, or irrelevant?

Good, says Paul Krugman. To be precise, he said that last week. His reasoning was that cutting spending is counterproductive in a time of economic depression, as it will just exacerbate the depression, so it’s best that they didn’t make a deal to cut spending. Today, he’s a bit more nuanced, noting a story about how the supercommittee’s failure is rattling markets but highlighting this aspect of the story (Krugman’s words):

‘. . . what it actually says is that market players fear that the absence of a debt deal means no stimulus. So the actual fear is not that spending won’t be cut enough, it is that it will be cut too much — which actually makes sense, and is consistent with the action in stock and bond markets.

‘But how many readers will get that? The way it’s presented reinforces the false notion that the deficit is the problem.’

Bad, says Kevin Drum. At least if you’re someone like Kevin Drum, Paul Krugman, or me, who thinks it’s foolish to cut social spending in a depression and really isn’t all that keen on slashing the social safety net in general. Unlike Krugman, Drum thinks many if not most of the automatic spending cuts will go into effect. The deal is only good if you’re a Republican who lives to cut social programs. In other words, the Democrats got rolled again, just as in the bogus “debt ceiling authorization” debate. Drum:

‘In any case, this should basically be viewed as a total victory for Republicans. Any alternative plan would have included some tax increases, so failure to come up with an alternative means that we get a big deficit reduction that’s 100% spending cuts, just like they wanted. And the 50-50 split between domestic and defense cuts was always sort of a joke. Republicans never had any intention of allowing the Pentagon’s half of the cuts to materialize, and the domestic spending half of the cuts was about as big as they wanted them to be. Big talk aside, they know bigger cuts would run the risk of seriously pissing off voters.

‘So Republicans got domestic spending cuts that were about as big as they really wanted. They know they’ll never have to implement most of the defense cuts. And there are no tax increases.’

Irrelevant, say the bond markets. The demand for ten-year U.S. Treasury bonds was actually up slightly today, whereas really bad news about the long-term U.S. fiscal position should send demand down and interest rates up. Either the market regards $1.2 trillion over 10 years as no big deal (and it is rather small compared with a national debt of $14 trillion), or they were expecting the supercommittee to fail all along. Or both.

U.S. 10-year 1.959% -0.051

The Occupy movement, seriously

17 November 2011

picture with textI’d been meaning to write about the Occupy Wall Street movement, but now I’m intimidated, having just read Mohammed el-Erian’s eloquent take on the movement. Although el-Erian, as CEO of the PIMCO investment behemoth, is about as high up the 1% tree as one can be, he is more than sympathetic to the movement. Sympathy is easy. It’s also easy to criticize the movement for its lack of unity and seeming cacophony of voices. But El-Erian, unlike many observers, sees beyond the surface and makes out a powerful, “peaceful drive for social justice,” not unlike the protests in Tunisia and his home country of Egypt:

OWS may pale in comparison to these country examples. Yet it would be both foolish and arrogant to dismiss three important similarities:

First, the desire for greater social justice is a natural consequence of a system shown to be blatantly unfair in its operation and, to make things worse, incapable of subsequently holding accountable people and institutions.

In the US, it is about a system that privatized massive gains and then socialized huge losses; allowed bailed-out banks to resume past behavior with seemingly little regulatory and legal consequences; and is paralyzed when it comes to alleviating the suffering of victims, including millions of unemployed (too many of whom are becoming long-term unemployed, slipping into poverty, and losing access to safety nets). The result is a visible and growing gap between the haves and the have-nots in today’s America.

Second, OWS’s followers will grow as our economy continues to experience sluggish growth, persistently high joblessness, and budgetary pressures that curtail spending on basic social services (such as education and health). Other internal and external realities will also play a role.

At home, our elected representatives seem incapable as a group to respond properly to severe economic and social challenges. Continuous (and increasingly nasty) political bickering undermines the required trio of common purpose, joint vision, and acceptance of shared short-term sacrifices for generalized long-term benefits.

Internationally, Europe’s deepening debt crisis amplifies headwinds undermining an already sluggish American economy that, in the absence of better policy responses, is on the brink of another recession, Should the economy slip from treading to taking on water, the social implications would be profound given that we already have high unemployment, a large fiscal deficit and, with policy interest rates already floored at zero, little policy flexibility.

Third, advances in social media help overcome communication and coordination problems that quickly derailed similar protests in the more distant past.

I couldn’t have said it better myself. I can only hope that el-Erian will speak out forcefully for better government policies, namely the type of wholesale changes that we need to tackle these huge problems that he identifies.

How do you do it?

16 November 2011

Count me among the skeptics who believe the Fed has pretty much already done all it can to pull the economy out of the deep hole that it’s in. Zero short-term interest rates, purchases of longer-term bonds to keep long-term rates at historic lows, backstopping various asset markets, emergency loans to banks, etc. It’s helped avert a Second Great Depression, which is nothing to sneeze at. Some economists who I usually agree with are convinced that aggressive new policies could pull us out of the current Little Depression, too. They’re smarter than I am, but they have yet to convince me that these policies could work.

The tonic du jour is nominal GDP targeting, by which the Fed would try to reach a certain level of nominal GDP — say, $16. 3 trillion (the current level of potential GDP assuming that, as I’ve read, current GDP is 7% below its potential. Do the math and that’s a $1.1 trillion gap between current and potential GDP). Christina Romer, Obama’s first head of the Council of Economic Advisors, recently backed this approach in a New York Times op-ed. Scott Sumner has been pushing it all along, and there’s now a whole new school of macroeconomics, “market monetarism,” which revolves around nominal GDP targeting. (Economists: see here for Ed Dolan’s helpful explanation of how nominal GDP targeting is a form of Milton Friedman-style monetarism.)

Now, once the Fed announces this new target, how does it actually get there? Romer provides the clearest answer I’ve seen yet:

‘Though announcing the new framework would help, it probably wouldn’t be enough to close the nominal G.D.P. gap anytime soon. The Fed would need to take additional steps. These might include further quantitative easing, more forceful promises about short-term interest rates, and perhaps moves to lower the exchange rate. . . .’

‘Nominal G.D.P. targeting would make it more likely that the Fed would take these aggressive actions.’

That’s clear, but so is weak tea. None of these actions sound all that different from what the Fed is already doing. Proponents of nominal GDP targeting seem to be counting on a huge “announcement effect,” i.e., that people will hear about the Fed’s commitment to raising GDP and will assume that Fed will make it happen. Yet the Fed’s goals already include maximum sustainable employment, which is the employment rate you’d have at potential GDP, so why should this change the public’s behavior? (Although there is a difference between monetary policy goals, like low unemployment, and targets, which now include interest rates, it’s a rather subtle one. I don’t see why it would move markets.)

Another popular tonic is a higher inflation target. Right now the Fed’s unofficial but almost universally acknowledged inflation target is 2%, and for the past few years the core inflation rate has been below or near 2%. When inflation is very low, real interest rates (nominal interest rates minus inflation) can still be high even when nominal rates are also low. In the U.S. in the early 1930s, for example, nominal rates plunged toward 0%, but deflation was raging, so real interest rates were actually quite high. Economic historian Nick Crafts, in a Financial Times op-ed, says that Britain’s recovery from the Great Depression was greatly aided by a combination of low nominal interest rates and rising inflation rates — i.e., negative real interest rates — which promoted homebuilding. Crafts says targeting a higher inflation rate — say, 4% — could do the trick today.

Again, I just don’t see how you get there. Would I like to see lower real interest rates? Sure. But for 4% inflation to happen, a lot of other things have to happen first. Banks need to loan out their excess reserves, people and businesses need to buy stuff with those loans, the money needs to be redeposited in banks,  more loans need to be made, etc. That’s how monetary policy works — when it works. Right now, the banks have over a trillion dollars in excess reserves that they’re just sitting on. Banks are not eager to lend, and businesses and households are not eager to borrow. Classic liquidity trap.

Nominal GDP targeting and higher inflation targets sound radical, but are they? Chicago Fed President Charles Evans said in a speech this week that he viewed the 2% inflation target as a medium-run target, not a short-run target, saying that as long as inflation averaged out to 2% over a multi-year period, higher inflation rates would be acceptable in the short term. That statement is consistent with either a nominal GDP target (shoot for low inflation when real GDP is high, tolerate higher inflation when real GDP is low) or an inflation target (let inflation rise when unemployment is high), which suggests that neither of those policies is all that new. Both seem to promise much more than they could ever deliver.

We’re caught in a trap

15 November 2011

This just in: The Federal Reserve does not control the universe.

Stated differently: The economy is in a liquidity trap (macroeconomists). Or, monetary policy has shot its wad (Pres. Obama to economic adviser Christina Romer in their first meeting, according to Ron Suskind’s Confidence Men). Krugman has been saying this for three years now, and so have a lot of other economists. But until today, I had yet to hear it from a Fed official. Fed Chairman Ben Bernanke has called for Congress to pursue a more expansionary policy fiscal policy, thus implying but not explicitly saying that the Fed has done just about all it can. But in a speech today, Chicago Fed President and Federal Open Market Committee member Charles Evans had the guts to state the obvious:

I largely agree with economists such as Paul Krugman, Mike Woodford and others who see the economy as being in a liquidity trap: Short-term nominal interest rates are stuck near zero, even while desired saving still exceeds desired investment. This situation is the natural result of the abundance of caution exercised by many households and businesses that still worry that they have inadequate buffers of assets to cushion against unexpected shocks. Such caution holds back spending below the levels of our productive capacity. For example, I regularly hear from business contacts that they do not want to risk hiring new workers until they actually see an uptick in demand for their products. Most businesses do not appear to be cutting back further at the moment, but they would rather sit on cash than take the risk of further expansion.”

Evans went on to suggest a number of measures the Fed should still take, like buying up more mortgage-backed securities to get the housing market going (I’m still on the fence on that one — yes, this is the economy’s weakest sector, but how do you do this without reinflating the housing bubble?), while keeping mum on the subject of whether this would do anything more than just nudge the economy forward, as opposed to bringing us anywhere near full employment. I suppose the question is moot, as long as nobody else is willing to act. Congress is not only unwilling to consider fiscal stimulus but seems to be on the verge of massive budget cuts, either by following the “super committee’s” blueprint or letting an autopilot crash the plane.

Hat tip to Judith Osofsky for today’s video:

Dean Baker on banks, bailouts, and reform

14 November 2011

Naked Capitalism has an excellent two-part interview with Dean Baker, one of the Cassandras who spotted the housing bubble years before it burst and who has been a much-needed gadfly in the ointment of economic news reporting and the economics profession. Baker’s new book, The End of Loser Liberalism: Making Markets Progressive, is available for free download here, including in Kindle and Nook formats. Here are some highlights from the interview, conducted by Philip Pilkington. I’ve highlighted in boldface some lines I found particularly compelling:

PP: Moving on, in the book you make the claim that had the financial system been allowed to melt down we would not actually have ended up in another Great Depression. This is not to say that you don’t recognise that letting the financial system melt down would have caused a lot of problems – for banks, of course, but also for pension funds and the like – but you say that those in charge of the bailouts exaggerated the importance of the financial sector. Could you explain briefly what you mean by this? And what do you think should have been done at the time of the bailouts?

DB: The point here is that we know how to reflate an economy. Massive government spending will do it. It got us out of the Great Depression, although not until World War II created the political consensus for the level of spending that was necessary to actually do the job.

A financial collapse cannot condemn us to a decade of stagnation and high unemployment. That only comes about from a prolonged period of political failure. If we had allowed the banks to collapse in the financial panic of 2008 then we would [still?] have had the opportunity to pick up the pieces and get the economy back on track with a massive stimulus program.

Of course it was best to not let the banks collapse. However the bailout should have come with real conditions that would have ensured the financial system was fundamentally restructured. This would have included breaking up the too big to fail banks (on a clear timetable, not necessarily at that time), serious caps on compensation, a commitment to principal write-downs and other real conditions.

At that time the banks were desperate. Without a big dose of public money they would almost certainly have been insolvent, so they would have had little choice but to accept whatever conditions were imposed. As it was, they almost got President Obama thanking them for taking taxpayer dollars in the bailout.

PP: Any ideas about what could be done with the banks now? Or is the damage already done?

DB: We still need to reform and downsize the financial sector. We don’t have the same leverage over the banks as we did at the peak of the crisis when we could have slapped whatever conditions we wanted on the loans and guarantees they needed to stay alive, but Congress can still pass laws that will rein in the industry.

At the top of the list is a financial speculation tax. A modest tax on financial transactions will do much to reduce the rents in the industry and to eliminate or drastically reduce short-term trading that serves no productive purpose. It will also raise a ton of money.

The second thing is breaking up the too big to fail banks. There is no justification for allowing banks to be able to borrow at below market interest rates because they enjoy an implicit government guarantee.

The third item on my list would be re-instating a Glass-Steagall type separation between commercial and investment banking. The Volcker rule, which limits proprietary trading by banks with insured deposits, was a step in the right direction. However it looks as though the industry is using the rule-making process to turn the law into Swiss cheese. It is likely that most banks will be able to find loopholes that will allow them to do as much proprietary banking as they want.

Anyhow, these would be my top three reforms. Politically, all of them would be very tough sells right now. By contrast, at the peak of the crisis, the industry would have voluntarily agreed to the last two in order to get the money they needed to stay alive.

PP: You write in the book that the idea that the banks repaid all the money from TARP is misleading. Could you explain this, because this myth is very prevalent in the mainstream media?

DB: Yes, this is really kind of a joke. The banks got loans at way below market interest rates from the government, and we are supposed be grateful that they repaid the loans? The difference between the market interest rate and the rate they actually paid amounted to a huge subsidy. This is something that anyone with even a passing familiarity with business or economics would recognize, which is why it is so insulting when political figures go around yapping about how the money was repaid with interest.

To see this point, suppose the government gives me a 30-year mortgage at 1 percent interest. If I make all my payments and pay off the mortgage has the government made money? By the logic of the politicians claiming that we profited by the bailout, the answer is yes.

A serious assessment would look at what the market rate for these loans was at the time they were made. To take one example, just before we lent $5 billion to Goldman through TARP, Warren Buffet lent $5 billion himself. He got twice the interest and a much more generous deal on warrants. Plus he knows that it was likely that the government would bail out Goldman if it got in trouble.

Elizabeth Warren commissioned a study of the implicit subsidies in the bailouts when she was head of the TARP oversight panel. As I recall, it came to over $100 billion on just the first batch of TARP loans to the large banks. This didn’t count the value of later TARP lending, the much larger lending programs from the Fed, nor the extensive set of guarantees provided by the Fed, Treasury, and the FDIC.

All of these commitments involved enormous subsidies. In the business world firms pay huge amounts of money if they want their debt to be guaranteed. And everyone understands that a below market loan is essentially a gift. That is why it is so insulting when they try to imply that the public has profited from these loans.

You can make the argument that it was good policy to subsidize the financial industry to get through the crisis, but to pretend that we did not subsidize them is just dishonest.

Incidentally, the reforms Baker suggests are similar to those recently suggested by Rolling Stone‘s Matt Taibbi as a starting point for the Occupy Wall Street protesters. More on those later.


The world economy’s “Mingya!” moment?

10 November 2011

“Italy Is Now the Biggest Story in the World,” says Kevin Drum. And he’s not talking about Joe Paterno (whose story I confess to having spent a lot more time following lately than Italy’s). But this is bad: another Eurozone country with a high debt/GDP ratio, soaring interest rates on its government debt, and no currency of its own that could depreciate to revive net exports, and no central bank of its own to expand the supply of credit. Just like Greece, except that Italy’s economy is about six times as large. It’s the fourth-largest economy in all of Europe, in fact.

For months people have been nervously watching Europe’s toxic cauldron of economic depression, austerity, sovereign debt crises, and bank funding problems (verging on crisis), and wondering if and when Europe’s problems might lead to a double-dip recession (or, as I’d call it, a recession within a depression, a la 1937). I wonder if someone else has already written the headline “Italy: Waiting for the Other Boot to Drop” yet.

P.S. If you’ve never heard the expression “Mingya!” then you obviously don’t live in Oswego. The Urban Dictionary will set you straight.