As Fed Chairman Ben Bernanke made clear today in his Jackson Hole speech, policy makers beyond the Fed need to actively participate in stimulating aggregate demand in the economy (i.e., Congress and the White House need to do their fair share with respect to fiscal policy stimulus.) Nobel Prize-winning economist Peter Diamond comments on the need for additional fiscal stimulus, especially in the form of infrastructure investment, to help grow the US economy and reduce unemployment.
Friday, August 26, 2011
Ben Bernanake and Hurricane Irene
Between Fed Chairman Bernanke's upcoming comments this morning and the approach of Hurricane Irene this weekend, I think I'll just stay hundered down for the next few days. I liquidated all equity positions yesterday and find little reason to take any new investment risk until the BB speech and Irene damage can be assessed.
Thursday, August 25, 2011
Approaching Bernanke’s Jackson Hole Speech – 2011 Version
For the past couple of weeks I’ve been engaged in short-term momentum/volatility equity trading (including leveraged ETFs) on a limited basis. This has worked very well as I’ve bought when I thought the market has over-reacted on the downside and sold when the market has recouped the over-reaction on the upside.
Getting ready to fasten my seatbelt for the bumpy ride ahead.
However, as we approach Fed Chairman Ben Bernanke’s speech tomorrow in Jackson Hole , I’m preparing to liquidate at the open of the market today my current equity positions. I’m concerned that the equity markets are expecting BB to say something to further buoy stock prices --- and I’m not sure what he can say to meet those expectations.
It seems to me there is more downside risk than upside potential attaching to the BB speech. There are many who believe the Fed has exhausted the tools in its toolbox and won’t be able to do much more to promote more employment in the economy. It appears fiscal policy will be the best way to create jobs --- and we all know how dysfunctional Congress is at the moment for this to be a realistic short-term result. (For an example of this monetary- vs. fiscal-policy discussion, see http://economix.blogs.nytimes.com/2011/08/24/how-much-more-can-the-fed-help-the-economy/.)
If this is a correct assessment, the markets could again fall to their lows of the past month --- and if not correct, what’s the loss of a few upside points by comparison?
Wednesday, August 24, 2011
Tuesday, August 23, 2011
Why Is The Eurozone So Important?
Here's a lead-in paragraph to a Brookings Institution article by Douglas Elliott that is a good summation as to why we need to be concerned about the Eurozone economy and its effect on the US economy.
"The Euro Crisis has struck again, hammering not just European markets, but doing real damage to U.S. markets and to economic prospects around the world. The U.S. could easily be pushed into another recession if the eurozone collapsed. We export well over $300 billion a year to those 17 countries; virtually all of the rest of our exports go to nations that also export to the eurozone and would feel ripple effects; roughly two-fifths of our overseas assets are invested in the eurozone; and our major financial institutions have large credit exposures to eurozone banks and other businesses."
source: http://www.brookings.edu/papers/2011/0822_euro_crisis_elliott.aspx#note1, Why Can’t Europe Get it Right the First Time… or the Second… or the Third?
"The Euro Crisis has struck again, hammering not just European markets, but doing real damage to U.S. markets and to economic prospects around the world. The U.S. could easily be pushed into another recession if the eurozone collapsed. We export well over $300 billion a year to those 17 countries; virtually all of the rest of our exports go to nations that also export to the eurozone and would feel ripple effects; roughly two-fifths of our overseas assets are invested in the eurozone; and our major financial institutions have large credit exposures to eurozone banks and other businesses."
source: http://www.brookings.edu/papers/2011/0822_euro_crisis_elliott.aspx#note1, Why Can’t Europe Get it Right the First Time… or the Second… or the Third?
Hope You Weren't Looking For A Cheerful Beginning To The Day
Here's an article by Richard Posner which outlines some of the economic challenges we face. For the most part I agree, although you'll note a couple of concepts with which I take exception (see my comments in [...] following pink highlighted text).
Let’s Be Honest: We’re in a Depression, Not a Recession, And There’s No End In Sight
Richard A. Posner
August 23, 2011 | 12:00 am
This article is a contribution to 'Is There Anything That Can Be Done? A TNR Symposium On The Economy.' Click here to read other contributions to the series.
If the notion that we are merely living through the aftereffects of a mere “recession” that ended in 2009 sounds somewhat ridiculous, that’s because it is. If we were being honest with ourselves, we would call this a depression. That would certainly better convey both the severity of our problems, and the fact that those problems have no evident solutions.
The American economy currently has both a short-term problem and a long-term problem. The short-term problem is that the economy is depressed; it is growing more slowly than the population, with the result that per capita income is declining. The high rate of un- and underemployment is a factor, but is itself the product of other factors, having mainly to do with the reluctance of over-indebted consumers (over-indebted in major part because of loss of equity in their houses, the major source of household wealth) to spend, the reluctance of the impaired banking industry to make risky loans, and the reluctance of businesses to invest and to hire, which is due in part to weak consumer spending and in part to profound uncertainty about the nation’s economic future.
The roots of this catastrophic situation [i.e., the short term problem] lie primarily, I think, in the incompetent economic management of the Bush administration and the Federal Reserve. The persistence of the depression, however, is due in part at least to surprising failures of the Obama administration—poor leadership, poor management, the sponsorship of incomprehensibly complex health care and financial regulation laws that have created widespread uncertainty that has discouraged consumption and investment, and the inability to explain the nature of the economy’s problems to the general public. These failures caused the stimulus enacted in February 2009 to be botched in both in its design and its administration, resulting in the discrediting of deficit spending as a response to depression.
So what can be done now? Probably nothing. Anything that involves spending, such as a new stimulus program, would come too late to be effective. Measures that would not involve spending, such as devaluing the currency (which the Federal Reserve could do by buying a great many bonds, thus flooding the world with dollars), could stimulate our exports and hence production and hence employment and reduce imports (which would further help domestic production), but they are too risky given the interdependence of our economy and the economies of the rest of the world. Europe is staggering and would be hurt by our devaluing, and our banks and other financial institutions are heavily involved in those European economies.
The long-term problem should be easier to solve. The problem is not the federal budget deficit per se, huge as it is. The public debt of the United States, which is what the federal government owes to persons who have lent money to the government (mainly purchasers of Treasury securities), and thus excludes debt incurred to finance entitlements and discretionary spending, is currently $9.7 trillion, with 46 percent of it owned by foreign governments and other foreigners. Although $9.7 trillion is big even for the United States, we can roll it over more or less effortlessly and at very low interest rates, at least at present and in the immediate future.
The [long-term] problem is not the level of the debt but its growth. In the seven years between 2000 and 2007 (the last year before the financial crisis that triggered the current depression), the public debt grew in real (that is, inflation-adjusted) terms by 56 percent, the consequence of reckless spending and tax cuts by the Bush administration. Between 2007 and 2012 (the debt in fiscal 2012, which ends September 30 of next year, is of course an estimated number), a shorter period, the nation’s public debt will have grown by another 134 percent. The annual increase from 2009 to 2010 and the (estimated) annual increase from 2010 to 2011 are both 17 percent, and the estimated increase for 2012 is 18 percent. These annual rates of growth vastly exceed the rate of the nation’s economic growth even in prosperous times, and if they continue will bankrupt the federal government.
Unfortunately, even when the economy recovers, and tax revenues increase, the federal deficit will continue to rise because of the rapid growth of entitlement expenditures—primarily Medicare and Social Security and, because of the health-reform law, Medicaid. Leaving politics to one side, the increase in Social Security costs can easily be controlled, by a combination of raising the age of eligibility, revising the formula for calculating cost of living adjustments, and means testing—limiting eligibility to persons who do not have substantial other income. Medicare costs are more difficult to control, but not impossible. Medicare too can be means-tested—there is no reason to subsidize the medical costs of affluent people. Copayments and deductibles can be increased to make people think harder about whether they want expensive treatments of marginal efficacy. Medicare can be transformed, as proposed by Congressman Paul Ryan, from a government- administered heath care program to a subsidy program to enable non-affluent persons to buy private health insurance. [This seems easier said than done, as Posner doesn't address the issue of what companies would provide insurance at a reasonable cost. A voucher system for these medical costs reduces the burden on government, only to place that burden on the more vulnerable in our society -- the aged.] And medical research can be refocused on finding cures for medical conditions such as blindness and dementia, which require protracted, expensive care because they create severe disability in the elderly without killing quickly. [This seems too simple --- why not just cure cancer too?]
Efforts to curb increased entitlement spending can be complemented by closing tax loopholes, some of which are as enormous as they are unjustified, notably the deduction for mortgage interest. Half the adult population, moreover, pays no income tax. Everyone with an income should pay income tax equal to a modest percentage of his income. [This ignores the most regressive tax on income -- the payroll tax.]
So the deficit, politics aside, should be manageable. But it’s worth pointing out that anything that takes money out of the economy, such as reducing federal spending or increasing federal taxes, will exacerbate the current depression. Consumers will have less money to spend, and this will discourage employers from hiring. So the reforms that I have been discussing should be phased in gradually over a period of years.
But it’s not clear that we have enough years. Suppose that the economy recovers by the end of 2012, and in 2013 and subsequent years grows at a 4 percent annual rate. (The long-term growth rate is about 3 percent, but growth is usually more rapid when it starts from a low level.) The public debt won’t continue to grow at 17 or 18 percent a year, but suppose it grows at 7 percent a year. Then the already very large federal deficit will continue to grow, and indeed, to compound: At a 7 percent annual growth rate, our public debt in 2012, estimated at $12.4 trillion, will grow by 40 percent in five years if none of the reforms designed to limit that growth are implemented before the end of that period. Yet if they are implemented while the economy is still struggling, the result may actually be to increase the deficit by driving tax revenues down (because incomes will be depressed) despite the elimination of loopholes, and by increasing transfer payments to the unemployed and others hard hit by the economic crisis.
The result is a quandary. I don’t see a way out of it. I hope others do.
Richard A. Posner is a judge on theU.S. Court of Appeals for the Seventh Circuit and a senior lecturer at the University of Chicago Law School
If the notion that we are merely living through the aftereffects of a mere “recession” that ended in 2009 sounds somewhat ridiculous, that’s because it is. If we were being honest with ourselves, we would call this a depression. That would certainly better convey both the severity of our problems, and the fact that those problems have no evident solutions.
The American economy currently has both a short-term problem and a long-term problem. The short-term problem is that the economy is depressed; it is growing more slowly than the population, with the result that per capita income is declining. The high rate of un- and underemployment is a factor, but is itself the product of other factors, having mainly to do with the reluctance of over-indebted consumers (over-indebted in major part because of loss of equity in their houses, the major source of household wealth) to spend, the reluctance of the impaired banking industry to make risky loans, and the reluctance of businesses to invest and to hire, which is due in part to weak consumer spending and in part to profound uncertainty about the nation’s economic future.
The roots of this catastrophic situation [i.e., the short term problem] lie primarily, I think, in the incompetent economic management of the Bush administration and the Federal Reserve. The persistence of the depression, however, is due in part at least to surprising failures of the Obama administration—poor leadership, poor management, the sponsorship of incomprehensibly complex health care and financial regulation laws that have created widespread uncertainty that has discouraged consumption and investment, and the inability to explain the nature of the economy’s problems to the general public. These failures caused the stimulus enacted in February 2009 to be botched in both in its design and its administration, resulting in the discrediting of deficit spending as a response to depression.
So what can be done now? Probably nothing. Anything that involves spending, such as a new stimulus program, would come too late to be effective. Measures that would not involve spending, such as devaluing the currency (which the Federal Reserve could do by buying a great many bonds, thus flooding the world with dollars), could stimulate our exports and hence production and hence employment and reduce imports (which would further help domestic production), but they are too risky given the interdependence of our economy and the economies of the rest of the world. Europe is staggering and would be hurt by our devaluing, and our banks and other financial institutions are heavily involved in those European economies.
The long-term problem should be easier to solve. The problem is not the federal budget deficit per se, huge as it is. The public debt of the United States, which is what the federal government owes to persons who have lent money to the government (mainly purchasers of Treasury securities), and thus excludes debt incurred to finance entitlements and discretionary spending, is currently $9.7 trillion, with 46 percent of it owned by foreign governments and other foreigners. Although $9.7 trillion is big even for the United States, we can roll it over more or less effortlessly and at very low interest rates, at least at present and in the immediate future.
The [long-term] problem is not the level of the debt but its growth. In the seven years between 2000 and 2007 (the last year before the financial crisis that triggered the current depression), the public debt grew in real (that is, inflation-adjusted) terms by 56 percent, the consequence of reckless spending and tax cuts by the Bush administration. Between 2007 and 2012 (the debt in fiscal 2012, which ends September 30 of next year, is of course an estimated number), a shorter period, the nation’s public debt will have grown by another 134 percent. The annual increase from 2009 to 2010 and the (estimated) annual increase from 2010 to 2011 are both 17 percent, and the estimated increase for 2012 is 18 percent. These annual rates of growth vastly exceed the rate of the nation’s economic growth even in prosperous times, and if they continue will bankrupt the federal government.
Unfortunately, even when the economy recovers, and tax revenues increase, the federal deficit will continue to rise because of the rapid growth of entitlement expenditures—primarily Medicare and Social Security and, because of the health-reform law, Medicaid. Leaving politics to one side, the increase in Social Security costs can easily be controlled, by a combination of raising the age of eligibility, revising the formula for calculating cost of living adjustments, and means testing—limiting eligibility to persons who do not have substantial other income. Medicare costs are more difficult to control, but not impossible. Medicare too can be means-tested—there is no reason to subsidize the medical costs of affluent people. Copayments and deductibles can be increased to make people think harder about whether they want expensive treatments of marginal efficacy. Medicare can be transformed, as proposed by Congressman Paul Ryan, from a government- administered heath care program to a subsidy program to enable non-affluent persons to buy private health insurance. [This seems easier said than done, as Posner doesn't address the issue of what companies would provide insurance at a reasonable cost. A voucher system for these medical costs reduces the burden on government, only to place that burden on the more vulnerable in our society -- the aged.] And medical research can be refocused on finding cures for medical conditions such as blindness and dementia, which require protracted, expensive care because they create severe disability in the elderly without killing quickly. [This seems too simple --- why not just cure cancer too?]
Efforts to curb increased entitlement spending can be complemented by closing tax loopholes, some of which are as enormous as they are unjustified, notably the deduction for mortgage interest. Half the adult population, moreover, pays no income tax. Everyone with an income should pay income tax equal to a modest percentage of his income. [This ignores the most regressive tax on income -- the payroll tax.]
So the deficit, politics aside, should be manageable. But it’s worth pointing out that anything that takes money out of the economy, such as reducing federal spending or increasing federal taxes, will exacerbate the current depression. Consumers will have less money to spend, and this will discourage employers from hiring. So the reforms that I have been discussing should be phased in gradually over a period of years.
But it’s not clear that we have enough years. Suppose that the economy recovers by the end of 2012, and in 2013 and subsequent years grows at a 4 percent annual rate. (The long-term growth rate is about 3 percent, but growth is usually more rapid when it starts from a low level.) The public debt won’t continue to grow at 17 or 18 percent a year, but suppose it grows at 7 percent a year. Then the already very large federal deficit will continue to grow, and indeed, to compound: At a 7 percent annual growth rate, our public debt in 2012, estimated at $12.4 trillion, will grow by 40 percent in five years if none of the reforms designed to limit that growth are implemented before the end of that period. Yet if they are implemented while the economy is still struggling, the result may actually be to increase the deficit by driving tax revenues down (because incomes will be depressed) despite the elimination of loopholes, and by increasing transfer payments to the unemployed and others hard hit by the economic crisis.
The result is a quandary. I don’t see a way out of it. I hope others do.
Richard A. Posner is a judge on the
Monday, August 22, 2011
Saturday, August 20, 2011
Euro Debt Crisis: No Solution in Sight
@CNNMoney August 19, 2011: 10:24 AM ET
Investors were not impressed. Stock markets across Europe fell Friday, extending Thursday's big sell-off. Shares in Frankfurt fell 3%, while the main market indexes in London and Paris were down about 1.5%.
"The market gave Merkel and Sarkozy their chance to stop the Euro crisis," said Clem Chambers, chief executive of European financial market website ADVFN. "Today it is responding to their inaction."
Shares of European banks have been hit particularly hard. Concerns about the banking sector flared Thursday following reports that an unnamed institution borrowed $500 million from one of the European Central Bank's emergency lending facilities.
Will Europe come tumbling down?
Investors were hoping for more concrete measures to stabilize shaky government finances. They want to see a big increase in the size of the EU stability fund and many are calling for the creation of a so-called euro bond.
Sarkozy and Merkel dashed those hopes, saying the 440 billion euro stability fund is sufficient and a bond backed by the euro zone as a group would not solve all the region's debt problems.
The proposals the leaders did put forth -- requiring all 17 euro zone nations to commit to balanced budgets, giving the EU bureaucracy more fiscal authority and imposing some sort of transaction tax -- were widely seen as inadequate.
Analysts said serious questions remain about how effective the proposals would be and whether member nations will agree to them. Jennifer McKeown, an economist at Capital Economics in London, said "decisive steps" towards a more uniform fiscal policy are necessary "if the currency union is going to hold together in its current form."
EU leaders have pledged to do what is necessary to protect the euro. And the latest rhetoric has been about fiscal "integration" and economic "convergence."
So far, the EU has responded to the debt problems in Greece, Portugal and Ireland by throwing billions of bailout euros at them in the hope that harsh austerity measures would do the rest.
As the crisis intensified over the last few weeks, the European Central Bank started buying Spanish and Italian bonds in a bid to prevent a broader debt contagion. But the aggressive moves that investors are looking for would require fundamental changes in the business model, such as it is, of the European Union.
Europe's debt crisis: Expect more trouble
In essence, the larger EU economies will be required to shoulder more of the burden stemming from the fiscal indiscretions of their smaller neighbors. That presents a difficult political problem for Germany and France, where voters must approve such measures.
"In the end," said McKeown, "the euro zone's strongest economies might decide that the potential costs of allowing the euro zone to fail, perhaps in the form of a banking crisis, are even greater than those of supporting it."
"There is no solution to the Euroland's sovereign debt crisis in sight," said Carl Weinberg, an economist at High Frequency Economics. "Markets will continue to be fundamentally unstable and volatile as long as we can think."
French President Nicolas Sarkozy and German Chancellor Angela Merkel gave it their best shot on Tuesday. The leaders of Europe's largest economies announced proposals they said will encourage fiscal discipline and increase economic competitiveness across the euro zone.
Investors were not impressed. Stock markets across Europe fell Friday, extending Thursday's big sell-off. Shares in Frankfurt fell 3%, while the main market indexes in London and Paris were down about 1.5%.
"The market gave Merkel and Sarkozy their chance to stop the Euro crisis," said Clem Chambers, chief executive of European financial market website ADVFN. "Today it is responding to their inaction."
Shares of European banks have been hit particularly hard. Concerns about the banking sector flared Thursday following reports that an unnamed institution borrowed $500 million from one of the European Central Bank's emergency lending facilities.
Will Europe come tumbling down?
Investors were hoping for more concrete measures to stabilize shaky government finances. They want to see a big increase in the size of the EU stability fund and many are calling for the creation of a so-called euro bond.
Sarkozy and Merkel dashed those hopes, saying the 440 billion euro stability fund is sufficient and a bond backed by the euro zone as a group would not solve all the region's debt problems.
The proposals the leaders did put forth -- requiring all 17 euro zone nations to commit to balanced budgets, giving the EU bureaucracy more fiscal authority and imposing some sort of transaction tax -- were widely seen as inadequate.
Analysts said serious questions remain about how effective the proposals would be and whether member nations will agree to them. Jennifer McKeown, an economist at Capital Economics in London, said "decisive steps" towards a more uniform fiscal policy are necessary "if the currency union is going to hold together in its current form."
EU leaders have pledged to do what is necessary to protect the euro. And the latest rhetoric has been about fiscal "integration" and economic "convergence."
So far, the EU has responded to the debt problems in Greece, Portugal and Ireland by throwing billions of bailout euros at them in the hope that harsh austerity measures would do the rest.
As the crisis intensified over the last few weeks, the European Central Bank started buying Spanish and Italian bonds in a bid to prevent a broader debt contagion. But the aggressive moves that investors are looking for would require fundamental changes in the business model, such as it is, of the European Union.
Europe's debt crisis: Expect more trouble
In essence, the larger EU economies will be required to shoulder more of the burden stemming from the fiscal indiscretions of their smaller neighbors. That presents a difficult political problem for Germany and France, where voters must approve such measures.
"In the end," said McKeown, "the euro zone's strongest economies might decide that the potential costs of allowing the euro zone to fail, perhaps in the form of a banking crisis, are even greater than those of supporting it."
Friday, August 19, 2011
Sitting on the Sidelines
For the most part, I've been sitting on the sidelines for the past month with cash reserves in all the investment accounts I manage. The debt ceiling debacle together with the do-nothing-but-stymie-our-economy debt ceiling legislation together with weak US and Eurozone economic numbers together with the Eurozone debt problems together with weak (or non-existent) economic leadership on both sides of the Atlantic have only added to my resolve to wait until there is some light at the end of the global economy tunnel before committing to non-cash investment alternatives.
On the other hand, with 30-year US Treasury yields sitting at 50-year lows, is there an opportunity (albeit longer term) to short the US Treasury market and ride the yield curve up as yields inevitably rise over the next few years? I'm considering this possibility, but there's no rush since the Fed has effectively said they will maintain a low-interest-rate policy for the next two years.
But, for the moment, still sitting on the sidelines ---
On the other hand, with 30-year US Treasury yields sitting at 50-year lows, is there an opportunity (albeit longer term) to short the US Treasury market and ride the yield curve up as yields inevitably rise over the next few years? I'm considering this possibility, but there's no rush since the Fed has effectively said they will maintain a low-interest-rate policy for the next two years.
But, for the moment, still sitting on the sidelines ---
Thursday, August 18, 2011
Will This Roller Coaster Go Up Anytime Soon?
Last week I thought the market bottom was about 1120 on the S&P 500 (the intraday market low last week was actually 1101) --- now, I'm not so sure. The latest economic numbers for the US and Eurozone economies show more weakness than the forecasters expected. In addition, neither the US nor the Eurozone is getting any of the bold leadership that will be required to achieve global economic growth and avoid global recession.
Buckle up and let's hope some in Washington and Europe find the courage to be bold.
Buckle up and let's hope some in Washington and Europe find the courage to be bold.
This Path Leads Us To Global Recession
What is most bothersome about the blah-blah-blah we are now hearing from the Republican Presidential candidates and from President Obama is that none of the blah-blah-blah contains any solutions to the economic malaise we are experiencing in the US. And the same is true of European leaders with respect to the Eurozone's economic problems.
The US economy remains the largest in the world, while the aggregate of the Eurozone country economies is second largest. If these economies falter any further, we are almost certain to be on a path toward global recession.
We need bold leadership on both sides of the Atlantic to move the global economy toward growth and away from recession --- and we aren't getting any kind of leadership at the moment.
The US economy remains the largest in the world, while the aggregate of the Eurozone country economies is second largest. If these economies falter any further, we are almost certain to be on a path toward global recession.
We need bold leadership on both sides of the Atlantic to move the global economy toward growth and away from recession --- and we aren't getting any kind of leadership at the moment.
Tuesday, August 16, 2011
What We Need --- Aggregate Demand
There is lots of talk in Washington (or Iowa or New Hampshire or wherever the presidential wanna-bees are campaigning) about "jobs programs." Unfortunately, many of these ideas are on-the-margin concepts which will not do very much to stimulate massive aggregate demand. And aggregate demand is the best way to turn our economy around and to create jobs and lower the unemployment rate.
Further, private enterprise will not add jobs until there is either demand for their goods and services to warrant creating more jobs, or incentives are legislated that encourage self-interest decisions on their part to create more jobs.
Further, private enterprise will not add jobs until there is either demand for their goods and services to warrant creating more jobs, or incentives are legislated that encourage self-interest decisions on their part to create more jobs.
My own view is "infrastructure, infrastructure, infrastructure." (See my prior post on infrastructure investment --- http://theviewfromthemiddleoftheroad.blogspot.com/2011/08/congress-and-president-are-bankrupt-of.html)
Bruce Barlett opined on "aggregate demand" today. Here is his view --
August 16, 2011, 6:00 am
It’s the Aggregate Demand, Stupid
By BRUCE BARTLETT (Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul.)
With the debt limit debate temporarily set aside, the Obama administration is talking about finding some way to create jobs and stimulate growth. But the truth is that there really isn’t much it can do and it knows it. There may be some small-bore things it can do without Congressional action that may help a little, but the operative word is “little.” The only policy that will really help is an increase in aggregate demand.
Aggregate demand simply means spending — spending by households, businesses and governments for consumption goods and services or investments in structures, machinery and equipment. At the moment, businesses don’t need to invest because their biggest problem is a lack of consumer demand, as a July 21 study by the Federal Reserve Bank of New York
The federal government could increase aggregate spending by directly employing workers or undertaking public works projects. But there is no possibility of that given the political gridlock in Congress and President’s Obama’s desire to appear moderate and fiscally responsible going into next year’s election.
That really leaves just consumers as a potential avenue for increasing spending. But that will be difficult as long as unemployment remains high, thus reducing aggregate income, and households are still saving heavily to rebuild wealth, which was decimated by the collapse in housing prices. Saving is, in a sense, negative spending.
Changes in wealth affect spending because people will spend a percentage of their increased wealth. And they are more likely to raise their spending when the wealth increase is perceived to be permanent rather than transitory.
Historically, people have viewed increases in home equity as more permanent than increases in stock market wealth because they know the latter is more volatile. A recent Federal Reserve Board working paper estimated that the long-run increase in spending from an increase in housing wealth may be as high as 9.1 percent per year.
As home prices increased, many people came to believe they had no real reason to save since they could always tap their home equity — which banks were more than happy to help them do — in the event that they needed funds. Thus the personal saving rate fell from 3.5 percent in the early 2000s to just 1.4 percent in 2005 at the peak of the housing bubble.
Home prices roughly doubled between 2000 and 2006, according to the Case-Shiller index, and many homeowners talked themselves into believing they would continue rising indefinitely. Thus they increased their spending and reduced their saving based not only on actual price increases, but also on expectations of future increases.
A prescient 2007 Congressional Budget Office study explained how this would affect spending and growth in the economy. It said that if people were expecting a 10 percent rise in home prices and instead they fell 10 percent, the impact on spending would be equivalent to a 20 percent fall in prices. The budget office estimated that this might reduce growth of gross domestic product by 2.2 percent per year. Since actual home prices have fallen by about a third, this suggests that G.D.P. may be $500 billion less this year than it would be if home prices had simply remained flat since 2006.
One way that the rise and fall of spending can be visualized is by looking at the velocity of money. This is the speed at which money turns over in the economy. When velocity rises, more G.D.P. is produced per dollar of the money supply. When velocity falls, the economic impact is exactly the same as if the money supply shrank by the same percentage.
The chart below comes from the Federal Reserve Bank of St. Louis
This suggests that the Federal Reserve could have offset the decline in spending and velocity resulting from the fall in home prices with a sufficient increase in the money supply. And it tried. Since 2006, money supply has increased by about $2 trillion. But velocity fell faster than the money supply increased as households reduced spending and increased saving — the saving rate is now over 5 percent — and banks and businesses hoarded cash.
Nonfinancial businesses are now sitting on close to $2 trillion in liquid assets that could be invested immediately if there was an increase in sales, and banks have $1.5 trillion of excess reserves that could be lent as well.
Fiscal policy could raise velocity and growth by getting money moving throughout the economy. But since that is not feasible, the Fed is the only game in town. Joseph Gagnon, a former Fed economist, says that it should immediately increase the money supply by $2 trillion and promise to keep increasing it until the economy has turned around.
But the Fed is already under pressure to tighten monetary policy from its regional bank presidents, three of whom dissented from last week’s Fed decision to keep policy steady. They fear that inflation is right around the corner. But as the Harvard economist Kenneth Rogoff has argued, a short burst of inflation would do more to fix the economy’s problems than any other thing. One reason is that inflation raises spending by encouraging consumers and businesses to buy things they need immediately because prices will be higher in the future.
The right policy can be debated, but the important thing is for policy makers to stop obsessing about debt and focus instead on raising aggregate demand. As Bill Gross of the investment firm Pimco put it recently: “While our debt crisis is real and promises to grow to Frankenstein proportions in future years, debt is not the disease — it is a symptom. Lack of aggregate demand or, to put it simply, insufficient consumption and investment is the disease.”
Monday, August 15, 2011
Shared Sacrifice and the "Super Committee"
In an op-ed piece investor Warren Buffett discusses the concept of shared sacrifice, which should be at the forefront of the dialogue when the "Super Committee" begins its discussions about the ways in which deficit-reduction should occur. We can only hope ---
August 14, 2011
Stop Coddling the Super-Rich
By WARREN E. BUFFETT
Our leaders have asked for “shared sacrifice.” But when they did the asking, they spared me. I checked with my mega-rich friends to learn what pain they were expecting. They, too, were left untouched.
While the poor and middle class fight for us in Afghanistan
These and other blessings are showered upon us by legislators in Washington who feel compelled to protect us, much as if we were spotted owls or some other endangered species. It’s nice to have friends in high places.
Last year my federal tax bill — the income tax I paid, as well as payroll taxes paid by me and on my behalf — was $6,938,744. That sounds like a lot of money. But what I paid was only 17.4 percent of my taxable income — and that’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent.
If you make money with money, as some of my super-rich friends do, your percentage may be a bit lower than mine. But if you earn money from a job, your percentage will surely exceed mine — most likely by a lot.
To understand why, you need to examine the sources of government revenue. Last year about 80 percent of these revenues came from personal income taxes and payroll taxes. The mega-rich pay income taxes at a rate of 15 percent on most of their earnings but pay practically nothing in payroll taxes. It’s a different story for the middle class: typically, they fall into the 15 percent and 25 percent income tax brackets, and then are hit with heavy payroll taxes to boot.
Back in the 1980s and 1990s, tax rates for the rich were far higher, and my percentage rate was in the middle of the pack. According to a theory I sometimes hear, I should have thrown a fit and refused to invest because of the elevated tax rates on capital gains and dividends.
I didn’t refuse, nor did others. I have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 — shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money, and potential taxes have never scared them off. And to those who argue that higher rates hurt job creation, I would note that a net of nearly 40 million jobs were added between 1980 and 2000. You know what’s happened since then: lower tax rates and far lower job creation.
Since 1992, the I.R.S. has compiled data from the returns of the 400 Americans reporting the largest income. In 1992, the top 400 had aggregate taxable income of $16.9 billion and paid federal taxes of 29.2 percent on that sum. In 2008, the aggregate income of the highest 400 had soared to $90.9 billion — a staggering $227.4 million on average — but the rate paid had fallen to 21.5 percent.
The taxes I refer to here include only federal income tax, but you can be sure that any payroll tax for the 400 was inconsequential compared to income. In fact, 88 of the 400 in 2008 reported no wages at all, though every one of them reported capital gains. Some of my brethren may shun work but they all like to invest. (I can relate to that.)
I know well many of the mega-rich and, by and large, they are very decent people. They love America
Twelve members of Congress will soon take on the crucial job of rearranging our country’s finances. They’ve been instructed to devise a plan that reduces the 10-year deficit by at least $1.5 trillion. It’s vital, however, that they achieve far more than that. Americans are rapidly losing faith in the ability of Congress to deal with our country’s fiscal problems. Only action that is immediate, real and very substantial will prevent that doubt from morphing into hopelessness. That feeling can create its own reality.
Job one for the 12 is to pare down some future promises that even a rich America
But for those making more than $1 million — there were 236,883 such households in 2009 — I would raise rates immediately on taxable income in excess of $1 million, including, of course, dividends and capital gains. And for those who make $10 million or more — there were 8,274 in 2009 — I would suggest an additional increase in rate.
My friends and I have been coddled long enough by a billionaire-friendly Congress. It’s time for our government to get serious about shared sacrifice.
Warren E. Buffett is the chairman and chief executive of Berkshire Hathaway.
Thursday, August 11, 2011
Some Thoughts About the “Super Committee” Approach to Deficit Reduction
As the Congressional “super committee” selections are finalized (at the moment only Minority Leader Pelosi remains to name her three House of Representatives Ds to the committee), we can only hope that partisan ideological viewpoints are temporarily set aside and the “super committee” members recognize the need to move beyond the dysfunctional nature of our political system which has existed for much too long.
There are now at least three deficit-reduction frameworks that could be used as the committee’s starting point in its deliberations, which need to be concluded by Thanksgiving under the enacted debt-ceiling legislation.
The first of these was the report of the Presidentially-created bi-partisan Simpson-Bowles deficit-reduction commission which was published in December 2010 (you can find it at http://www.fiscalcommission.gov/sites/fiscalcommission.gov/files/documents/TheMomentofTruth12_1_2010.pdf).
The second was an outline proposal by the Senate’s bi-partisan “Gang of Six”, which was issued in July 2011 during the negotiations preceding the enactment of the debt-ceiling legislation. The executive summary of this proposal can be found at http://assets.nationaljournal.com/pdf/071911ConradBudgetExecutiveSummary.pdf.
The third deficit-reduction framework is one advanced by the Comeback America Initiative in July 2011 (you can find it at www.tcaii.org/UploadedFiles/PlanAandBReport.pdf). The CAI was founded by David Walker (former Comptroller General of the United States ), a former Democrat (until 1976) and now moderate Republican --- so Walker
The bottom line is that the “super committee” doesn’t need to reinvent the wheel --- all it needs to do is choose between the best features of the three wheels that have already been invented and put the better-designed wheel on a bi-partisan vehicle that moves our Country forward toward prudent fiscal policy and economic growth.
Wednesday, August 10, 2011
Prediction: Deficit Reduction "Super Committee" Will Fail to Reach Compromise
Nine of the 12 members of the deficit reduction "super committee" have now been named. All six Rs have staunchly opposed tax revenue increases/tax expenditure reductions (Senators Kyl, Portman and Toomey; Representatives Camp, Hensarling and Upton). On the other hand, the Ds named by Sen Reid (Sens Kerry, Murray and Baucus) suggest that the Senate Ds on the "super committee" may be more willing to advocate a “balanced” approach to deficit reduction that pairs spending cuts with new tax revenue. (Minority Leader Pelosi has yet to name the three Ds from the House of Representatives who will serve on the committee.)
Apparently Sen. McConnell and Speaker Boehner didn't get the message from the S&P downgrade of the US debt rating that now is the time to start moving away from a dysfunctional political environment. Looks to me like the Rs are doubling down on their ideological posturing.
Bottom line --- gridlock continues.
Apparently Sen. McConnell and Speaker Boehner didn't get the message from the S&P downgrade of the US debt rating that now is the time to start moving away from a dysfunctional political environment. Looks to me like the Rs are doubling down on their ideological posturing.
Bottom line --- gridlock continues.
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