Archive for December, 2012

The only downgrade that matters

22 December 2012

Remember these words: “means of extinguishment.” The full quote is “The creation of debt should always be accompanied with the means of extinguishment,” and it’s from Alexander Hamilton, the father of our national debt. Hamilton believed that the federal government could do the nation a big favor by carrying a debt as long as it had sufficient revenue streams to eventually pay it off; such an arrangement, he said, would give the US “immortal credit,” which could come in very handy whenever we had pressing needs or good public investment opportunities that justified borrowing more money.

This has been on my mind because the (yawn) “fiscal cliff” negotiations, whatever their outcome, are really just the latest round in an endless series of self-destructive battles over whether to honor our own budget commitments by raising the debt ceiling so that we can pay for them. I’ve written about Congress’s debt-ceiling looniness before, and how it would be better not to have such votes at all. Think the proposed budget has too big a deficit? Fine, then don’t vote for it. But to vote for it and then refuse to pay for it is not only cynical and hypocritical, but sows suspicion that the government is a deadbeat.

Standard & Poor’s (S&P) famously downgraded the federal government’s debt in August 2011 (from AAA to AA+), and the other two major bond rating agencies (Moody’s, Fitch) are threatening to do the same if Congress can’t reach some kind of agreement to reduce the debt/GDP ratio in the long term. After the subprime scandal, in which the rating agencies routinely rubber-stamped dodgy subprime mortgage-backed securities as AAA, these agencies have zero credibility, but that doesn’t mean they’re always wrong. The S&P said its downgrade “was pretty much motivated by all of the debate about the raising of the debt ceiling. . . . It involved a level of brinksmanship greater than what we had expected earlier in the year.” Yes — if Congress can’t be counted upon to honor its own commitments, which include paying back the principal and interest on previously issued Treasury bonds, then why should bond buyers regard Treasury bonds as completely safe? The more Congress continues to play these games, the more rational it is to conclude that maybe Treasury bonds are not so safe. (more…)

The ZIRP walk

12 December 2012

Today’s news from the Fed is that they will continue their zero interest rate policy (ZIRP) until the unemployment rate falls to 6.5%. To be precise, the Federal Open Market Committee (FOMC) announced that they believe the current 0 – 0.25% range for the federal funds rate “will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”

This replaces the Fed’s statement from six weeks ago, which was that they expected to continue the ZIRP “for a considerable time after the economic recovery strengthens” and said they thought the ZIRP would continue at least through mid-2015.

I think the new policy is better, first of all because it’s specific. Of course they’re going to raise rates when the economy’s better, but how do they define better? They just told us — 6.5% unemployment (it’s now 7.7%).

The new statement also is better because it’s a fairly clear policy rule, tied to an actual, observable number, as opposed to a prediction about when the ZIRP medicine will no longer be needed. Including a date like mid-2015 is problematic partly because predictions have a way of being wrong, but also because they have a way of creating bubbles. “Through mid-2015” was widely reported not as a prediction but as a fixed commitment by the Fed, which it wasn’t. If enough people in the financial community believe the Fed will keep rates low through mid-2015, there could be a problem. Because if they know that short-term interest rates will be low for the next three years, then they may be more likely to borrow massively in the short-term money market and invest it in longer-term risky assets while rolling over their short-term debts for the next three years. (Some people say we’re already in a stock-market bubble right now, thanks to today’s low interest rates.) Granted, “borrowing short and lending long” is what banks do, but usually it’s without the certainty of near-zero interest rates for the next three years. (more…)

Glad tidings?

8 December 2012

The US unemployment rate fell to a four-year low of 7.7% in November, it was reported yesterday. The BLS (Bureau of Labor Statistics) report also noted that the economy added 146,000* jobs in November, a better figure than expected, considering Hurricane Sandy. Yet the report did not get a particularly warm reception. Analysts and cynics instantly threw cold water on these seemingly good numbers by stating that the unemployment rate fell only (or largely) because masses of unemployed people stopped looking for work in November and therefore were no longer counted as unemployed. Were they right? Off to the report’s detailed tables!

First, the non-detailed tables. Table A suggests that more than 100% of the drop in the unemployment rate came from people leaving the labor force, which could mean unemployed people giving up looking and no longer being counted as unemployed or in the labor force. The unemployment rate and labor force participation rates both fell by two-tenths of a percentage point, unemployment from 7.9 to 7.7% and labor force participation from 63.8 to 63.6%. The number of employed fell by 122,000*; the number of unemployed fell almost twice as much (229,000); and “not in labor force” rose by 542,000. So it would seem that a lot of people stopped looking.

(*That’s right — the same report that says the net change in jobs in November was +146,000 also says it was -122,000. The reason is that the BLS conducts two different surveys, one of employers (the “establishment survey” of payrolls), which had the positive figure, and one of households, which had the negative one. Barry Ritholtz had a nice cranky comparison of the two a few years back that’s still worth a look. Unfortunately, even though many economists regard the employer survey as more reliable, it tells us only about things like employment, hours, and wages, not about the people in or out of the labor force. For that we still need the household survey. Back to it.)

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Cliff note

2 December 2012

Recently I was asked to write a blurb about the omnipresent “fiscal cliff,” and here it is:

“Fiscal cliff” is a good metaphor. Like a real cliff, it’s something you shouldn’t jump off and really shouldn’t even be standing near. Austerity policies like big tax increases and spending cuts would only make a weak economy worse. While we do need to reduce our deficit and debt relative to the size of the economy, this is a long-term problem that needs to be tackled when the economy is back to normal.* In the short term, the goal should be to avoid pushing the economy back into recession. Similarly, we should avoid needlessly rattling financial markets by threatening to jump off fiscal cliffs, shut down the government, or not raise the debt ceiling. Some say the fiscal-cliff threat is needed to prod Congress into reaching a long-term, balanced deficit-reduction deal; but it’s a dangerous game, especially if the deficit cutting starts too soon, like now.

* OK, I’d amend that to say that it’s fine and dandy for Congress to tackle our long-term fiscal shortfall now, as long as they can agree that to start chopping after, not during, the long slump we’re in now. It would be lovely if the House, Senate, and President could agree on a Grand Bargain of sensible tax increases, meaningful reductions in medical costs (the biggest driver of spending increases), and various spending cuts, to take effect once the unemployment rate is back down to 6% or so, but it just ain’t gonna happen, not with a Congress that just came off its most unproductive session in decades.

The logic of the fiscal-cliff threat was that Congress won’t act on the deficit unless the alternative is calamity. While I tend to agree with that, it’s not logical when Congress is threatening itself with calamity. It’s an empty threat, like saying that if I can’t lose thirty pounds by diet and exercise then I’ll amputate my own limbs. When the time comes, we’ll both realize it was just a stupid bluff. I’ll put down my axe and Congress will punt the decision into a later month or year. Remember, that’s how we got to the current fiscal-cliff deadline, after the debt-ceiling debacle of summer 2011.

I honestly don’t expect Congress to take serious action on the debt until and unless the bond market’s longtime love for US Treasury bonds turns to hate, a la Greece. I could be wrong — it looked pretty hopeless in the early 1990s, too, and yet we ended the decade with the budget in surplus. But both the budget and the economy are in bigger holes now.