A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Monday, December 31, 2007

Forecast Friday comes on a Monday this month: Podcast transcript

Monday December 31, 2007

The Demand Side forecast is far too recent for us to bail on it already. We’ve put it up on the website at Demand.net again. It is the doom and gloom forecast, possibly just shy of John Williams prediction for hyperinflation and depression. We also refer you there to a few of the causal elements, most proposed by Nouriel Roubini of NYU’s Stern School. There’s a link to Roubini’s more detailed versions.

Since there has been no great rush from other economists to this side of the bell curve, we wondered what the hell they were looking at and wandered over. It is a bit intoxicating, as they pass around the bong of confidence in Fed interest rate cuts to apparently monetize us out of peril of every type. But we didn’t inhale.

Many were looking at the Conference Board’s (registered trade mark) U.S. Business Cycle Indicators (service mark) which were released on December (copyright – just kidding) twentieth. The leading index, the press release says, “decreased sharply for the second consecutive month in November, and it has been down four of the past six months.”

It was down 0.6 points in November after being off 0.7 points in October. But really, if you look at past charts, that is not so sharp. Also, yes down four of the past six months, but also three of the past four and the only exception being a tiny rise in September which followed a big drop in August.

Leading economic indicators as trademarked, service marked, but not yet copyrighted by the Conference Board. How good are they? What’s up with them?

First of all, they are not and they do not pretend to be causal. They are either forward seismic sensors on the supply side, such as new orders and building permits, indicators of demand to come like unemployment claims, or assessments of economic actors, like stock prices, interest rate spreads and consumer confidence.

Specifically, the leading indicators are ten:
  1. average workweek for manufacturing production workers
  2. average weekly initial unemployment claims,
  3. manufacturers new orders for consumer goods,
  4. vendor performance,
  5. manufacturers new orders for nondefense capital goods,
  6. building permits
  7. stock prices,
  8. M2 money supply,
  9. the spread between Treasury bonds and federal funds,
  10. and the index of consumer expectations
Let me repeat that .... No?

These seem to be the talking points for most of the economists I’ve heard. The first thing I did was to reach over their shoulders and toss into the drink the money supply M2. With credit cards, Fed willingness to print, and the seizing up of credit markets, it is hard to see what relevance this rather narrow version of money has going forward, or even since the 1980s.

The workweek doesn’t change in manufacturing, they just fire people. Those who are left continue to work the same schedule. There may be three instead of thirteen, but they’re still working a 40-hour week. Or actually a 41.1-hour week.

I grabbed the whole manufacturing sheaf, including the two manufacturers new orders and the vendor performance. Manufacturing used to be one-fifth of the economy. You could argue in the late seventies that it generated another two-fifths in support services. Now it is a tenth of the economy and maybe up to a total of three tenths including support. But it is half the Conference Board’s list of leading indicators. Now it is confusing matters. Manufacturing is up, yes, for the export market, but that will be mitigated if the dollar rebounds, or it will translate into higher prices if it doesn’t, since it is not only imports that will increase in price with a lower dollar, but products where export markets bid up domestic prices – like food.

Then I slipped the stock prices out of the deck. Stocks are strong not on the economic outlook, but on the demand for inflation proofing and their cheapness as a hedge against a rebound in the dollar. So we’re left with consumer expectations, interest rate spreads, building permits, and average weekly initial unemployment claims.

The aggregate of these four were:
  • Down 0.31 in November.
  • Down 1.56 since July.
With only two positive numbers among the sixteen: a microscopic 0.01 rise in consumer expectations in September (following August’s 0.22 drop) and a bump in the index for unemployment claims, also in September. (Notice these are index numbers, not percentages.)

Looking over at the graph of the indicators since 1960. The leading indicators, and really all the indicators, were much more emphatic predictors prior to 1980. The strength of movement has declined steadily since then. The jagged teeth of the line graph have been rounded off and softened. Yes, E.B., I realize it is a log scale. If it weren’t a log scale they would all look like a ski jump or a J curve.

This softening is no doubt related to the declining importance of manufacturing in the real economy not reflected in the trademarked leading indicators. BUT the turns are pretty close to the mark, and the turn has occurred. This is referencing the Conference Board’s full list of ten. There was one spot in the 1966-67 Guns and Butter era when a false signal was given, but that was back in the days of a strong middle class.

Other than that, no. Flattening and decline have always meant recession, as defined by the official arbiters, the Conference – trademark not for redistribution or public posting without express permission – Board.

[Thank you, E.B.]

Housing Bust Shatters State Migration Patterns

William H. Frey has put up a stark reminder that economic dislocation is not all about your statement of net worth.

Frey is a senior fellow at Brookings in the Metropolitan Policy Program. The link is here.
Analysis of the new Census Bureau annual estimates of state population changes for 2006-7 shows that the sinking housing market has yanked back high-flying states like Nevada and Arizona. An even bigger tug in growth occurred in Florida, another housing-boom driven state. With credit harder to get and the disappearance of housing deals, the allure of these states appears to have dimmed.

Meanwhile, the up-scale states—California, New York, New Jersey, and Massachusetts—are seeing fewer residents leave for a lower cost of living elsewhere. And those states benefiting from the previous flight to affordability—Nevada and Arizona in the west; Florida in the south; and Pennsylvania and New Hampshire in the east—have shown slower migration gains or greater declines.

Even the states surrounding Washington, D.C., another hot market, have attracted fewer migrants. Potential home buyers in the outer suburbs of Virginia and Maryland face trouble getting credit and recent buyers in the District and inner suburbs are stuck because they cannot sell.

The D.C. region has, in short, become a microcosm of the nation’s reaction to the housing bust. Like in Nevada and Arizona, the market for the region’s suburban buyers is drying up due to the credit crunch, and construction and in-migration is stalling. But the District and inner suburbs are more like coastal California, where housing-rich residents are waiting to sell in order to move to opportunities elsewhere.

In sum, there appears to be a migration correction going on. We’re at the beginning of a leveling off of migration between unaffordable and affordable America. As with the broader economy, we don’t know how much longer it will last.

Sunday, December 30, 2007

Thursday, December 27, 2007

Economic Stimulus with Public Works: Podcast Transcript

What to do when deficits are too big already

Wednesday, yesterday, we went over the varieties of possible stimulus and how efficient they were likely to be. These included Fed rate cuts – parenthetically, cuts by the Fed to this point in 2007 have been widely reported as a response to the flagging economy. In fact they were explicitly intended to remedy “turbulence” and the threat to the economy from credit markets, not from falling demand; that is bail out the bankers. Not stimulate the economy.

Okay – no more detours – Stimulus options we mentioned included those Fed rate cuts, more tax cuts for the rich, across-the-board tax cuts, tax incentives for business investment, and government spending on public works. Oh yes, when we found none of these particularly inviting, we proposed direct support to state and local governments to stabilize them in a period of falling revenues. Without such support, federal expansion will be more than offset by state and local contraction. Further, spending on consumer discretionaries will substitute for spending on schools, police and other state and municipal services.


We have a problem. The federal government under George W. Bush has been running deficits and big ones ever since the tax cuts for the rich. They are rising again. If we borrow further to stimulate the economy, there will be additional upward pressure on interest rates. Higher interest rates could undo any stimulus with increased credit costs.

That’s a bit more than I said yesterday. A week ago Wednesday Senator and chair of the Joint Economic Committee Charles Schumer said this in response to a question following a talk at the Brookings Institute.

We have huge infrastructure needs over the next twenty-five to thirty years. Most of our fundamental infrastructure – roads, sewer, water – was done fifty to a hundred years ago and has to be redone.

When I go around New York State, the number one – in suburban, smaller cities and rural areas – number one, two or three on the list of the local governments is, “How are you going to help us with our need, not for roads, which is more federally oriented and state oriented, but for water and sewer.

So this is a serious problem. School buildings. I greatly worry that overall since 1980 that the federal government has a much more restricted role and the next twenty-five years we’re going to pay a price. We’d better figure out a way to adapt to that in terms of infrastructure and in terms of education.

We have a great system. And we energize people, no matter what their background and what their economic level, the way China doesn’t, Europe doesn’t, Europe doesn’t. Its great. So we have all of this going for us. And the anxiety I have is, as somebody who loves this country, I think we have let things lag, rather significantly, over the last twenty-five years, but particularly over the last six or seven. And we better figure out ways to deal with it.

The substance of the Senator’s talk – as I’ve mentioned before – was the housing and credit market mess and it will be up on the podcast this Saturday. Schumer knows the way out of this mess. He can explain it. And we should be following him, not the scarecrows at the Fed or the ostriches in the White House.

So, the set-up is nearly complete. One more piece. Public Goods v. Private Goods.

Public Goods

Demand Side makes a special point of Public Goods. Public Goods account for an immense portion of the well-being of our citizenry, and at the same time generate immense wealth to private economic actors.

A brief definition: Private goods – those which our society creates and consumes in such abundance – are marked by two primary characteristics. They are excludable and they are depletable.
Excludable means that to a greater or lesser degree the use or enjoyment can be limited to a person, household, or group. This is important. My use excludes your use of the item. Autos, houses, durable goods, food, electronics, air travel, and on and on.

Depletable means the benefit of the product can be limited, focused, monopolized. The entire economic benefit is consumed, or can be consumed by the buyer, wearer, user, and so on.
Public Goods, by contrast, are to a greater or lesser degree not depletable and not excludable. For example, a road is not depletable: No matter how many cars use a road today (and recognizing that there are limits to everything) cars will be using it tomorrow as well. It is not excludable. Who will be able to collect a toll for every road, or collect the cost of the service if the road is plowed free of snow?

Not being depletable means in their own way Public Goods are the goose that lays the golden egg. Not being excludable means the private market is unable to isolate the benefit sufficiently to be an efficient producer of Public Goods. The private market requires payment in an amount approximating value. Such a payment will not be forthcoming if one party does not monopolize the benefit and enjoy the predominant value of the good.

When one party does not monopolize the benefit, it is difficult for the private market to exist. Remember, the market itself consists of nothing more or less than the moment of purchase and sale. This leads into the cul-de-sac for the market known by the technical term “the free rider problem.” The classic example is national defense. If the nation is defended from attack, I am defended, even if I do not choose to pay for the service. I am defended because my neighbor is defended. This is the downside of not being excludable, and it is the major reason that we have a universal coercive means of financing – taxation. There ought to be no free riders on Public Goods. The cost of the road, national defense and education ought to be shared by all, since their benefits are shared by all.

Public Goods as exemplified by roads are obviously a good deal for private actors. MacDonald’s founder Ray Kroc once asked his protégé, “What business am I in?” The unsurprising answer was, “The restaurant business.” “No. The Real estate business.” The success of his fast-food outlets depended on their locations. The value of a location depended on the access from streets and roads. A new highway or bridge may increase property values immensely. In rare instances part of the gain may be captured for public use. Most often it becomes wealth to private landowners.

The same sort of benefit attends all public goods, education, national defense, etc., etc. The total return is far greater than the cost or than the benefit returned to the individual, but it is impossible to isolate and capture that larger return in a transaction. The market requires a relatively simple transaction to operate efficiently. It cannot deal well with multiple beneficiaries or variable benefits or extended or uncertain periods of time. A good which returns enormous benefits over costs will not be produced by the market unless the purchaser commands enough of the benefit to match the seller’s price.

Taxes are simply the means of purchasing or financing Public Goods, in the same way mortgages finance houses. The great success of the anti-government Right Wing in the United States has arisen from their ability to separate taxes from the goods they purchase in the minds of the electorate. In fact, taxes are the source of funding for Public Goods. Public Goods which have a high multiplier at the front end, being expenditures of government, and so stimulate economic activity. They often produce immense value over their cost. And they create wealth for many private economic actors.

Now, for those of you – approximately three of the faithful thirty-nine – who like sports metaphors – we’ve driven the ball down the field. Time is running out. We can’t afford to risk another run, so we’re going to pass for the score.

Wednesday we established that Public Works would be by fr the best stimulus if it could only be implemented more quickly. Here we establish that public works create growth in and of themselves over time.

Let’s just admit that the Bush tax cuts for the rich have been a bust, recapture that money for the operating budget, and use the debt space for bonds for the public works this country needs. This is a sustainable growth path.

Again, thank you E.B. for this transcript of the podcast for Thursday, December 27

Wednesday, December 26, 2007

Stimulus Options: Podcast transcript

We thank E.B. for producing the following transcript of the podcast for Wednesday, December 26, 2007.

Last Wednesday at the Brookings Institute, former Treasury Secretary Larry Summers proposed fiscal stimulus for what he saw as a dangerously slowing economy. This in addition to continued Fed interest rate reductions.

Note: E.B. has done a great deal of work in editing that talk, and by eliminating Summers repetitive measured pauses, his liberal use of caveats and some secondary points, the speech has been reduced from over forty-five minutes to sixteen.

We’ll put that up on the Saturday Special in two weeks. This week remember is Chuck Schumer speaking at the same Brookings event.

Here, let’s listen to the pith of Summers, then I’ll come back with some description of the mechanics of stimulus and at least one good idea I haven’t heard so far.

Now here is Lawrence Summers:
If economic data come in as I fear they will, with increasing signs of recession, policy response should include fiscal as well as monetary measures. Fiscal policy can work more rapidly than monetary policy, which has a lag of about a year between a change in the Federal Funds rate and its maximum impact.

Moreover, the efficacy of monetary policy may well be diminished by capital constraints that limit the ability of banks to lend, or creditworthiness constraints that limit the ability of businesses to borrow. As important, the extent to which monetary policy can prudently be used in the current environment is limited by concerns about the dollar as well as about the bubble-creating effect of very low interest rates.

Certain problems, such as the impact of mass foreclosures on affected communities, are not easily amenable to monetary policy.

Fiscal stimulus is therefore potentially critical. But it can be counterproductive if it is not timely, targeted, and temporary. Gene Sperling’s Bloomberg column this week makes these points strongly.

Fiscal policy has to have its impacts in a timely manner.

It has to be targeted to assure that increased government borrowing translates directly into increased spending and demand.

And critically, it has to be temporary, so that its effects are not offset by higher long-term interest rates.

From the point of view of stimulus, the optimal package is one that raises spending and the deficit in the short run while reducing the deficit in the long run, therefore bringing down long-term interest rates.

Stimulus approaching fifty to seventy-five billion dollars, roughly in the range of one-half of one percent of GNP is likely to be appropriate.
Summers specifically supported stimulus in the amount of one-half of one percent of GDP that was quote timely, targeted and temporary unquote and composed of tax cuts, food stamps and unemployment benefit extension.

Republicans are circling any talk of tax cuts for a flagging economy, ready to enlist recession fears in their continuing demands to bring tax rates to zero. Tax cuts are their favorite remedy for all ills.

George W. Bush recommended tax cuts during his first campaign as the correct response to a healthy economy and a surplus in the budget. “After all, it’s your money,” was the campaign slogan. Bush later promoted tax cuts as the necessary medicine for economic weakness. To admit the obvious, the long campaign against taxes has borne fruit. Today taxes are not considered the necessary means of financing public goods, but the teeth of a vampire government. This is a subject for another day, perhaps one day soon. To continue, when the tax cuts of 2001 did not work Bush – along with the compliant Congress – asserted it was because there were not enough of them, and another round came down in 2003. The slogan was not, I should note, “After all, it’s your children’s money.”


All valid stimulus theory follows from the theory of the multiplier, developed by R.F. Kahn in the 1930s and developed and promoted by John Maynard Keynes. The multiplier is at the heart of Keynesian demand side stimulus.

The idea of the multiplier is that an exogenous (outside) spending stimulus will generate much more economic activity than the simple dollar value of the stimulus, because it will echo through the economy. The laborer will buy bread from the baker who will use the money to buy wheat from the farmer who will use the money to buy machinery from the tractor dealer who will use the money to buy meat from the butcher and so on. There is leakage into savings and out of the economy at each step, so the multiplier is not infinite, and may be between two and five, depending on the situation.

Keynes himself proposed public works financed by government deficits as the preferred way of stimulating demand and starting the cycle of jobs and investment. Some time later, Keynesians under John Kennedy proposed a very modest tax cut for the middle class to stimulate the economy of the 1960s. That is, they kept the deficit, but passed the spending along to private households, who bought things and produced some activity. Kennedy’s has been the model for all stimulus programs since.

The multiplier, then, suggests that an exogenous infusion of spending will multiply through the economy and get the providers of goods and services back into forward gear.

Let’s look at five possible stimulus methods.


Reduction of interest rates. This is the monetary version of stimulus The Fed can make money, at least in the short term, cheaper. This encourages investment and spending in theory, which would engage the multiplier, but the idea that it creates strong business investment action is not well supported by evidence. The last time it was tried we got a housing bubble. Business did not invest. Now we have a huge inventory of energy-inefficient houses, millions of people in financial distress, a credit market dysfunction and a huge debt overhang. This suggests that now, even if money were free, the tendency would be to hold onto it rather than invest.


Tax cuts for the rich.

This has been tried a couple of times. Once under Ronald Reagan and more recently, of course, under George W. Bush. In both instances the economy was not stimulated, as the wealthy simply added the bonus cuts to their wealth and continued to spend as before. This suggests the second of Larry Summers trinity TARGETED, where the tax cuts go to those who will spend, and thus at least start the multiplier.


Tax cuts for the poor or across the board.

The lower the income, the higher the tendency to spend. So if tax cuts are stimulus policy, the lower on the income ladder, the more effective at least for the first round. An interesting parallel exists with inflation. Just as the multiplier differs for different income classes and goes up as you go down the income scale, the same is true of recent inflation. Food and fuel comprise a higher proportion of purchases at the lower end. When you throw in the double digit rises in health care you find that in times such as ours, the effective inflation rate is much higher at the bottom.


Tax cuts for targeted business investment

A way to leverage a higher exogenous stimulus would be to offer tax cuts to business investment. If business moved investment forward or made a yes rather than a no decision on an investment decision as a result of tax incentives, a greater initial boost would follow creating a greater total stimulus. There is, please note, no essential difference between government deficit spending and business investment whether financed by investment or debt. They are both exogenous and stimulative.

The major problem with this scheme is it doesn’t work very well. Businesses may move around investment decisions, but their basic calculus is not changed. They invest when they see an opportunity for profit, not because money is cheap or costs are less. In a flagging economy, profit opportunities may not be very clear.


Public spending on public works.

This was the method preferred by Keynes. Producing public works means you hire somebody up front. His or her paycheck is the means of getting the spending into the private economy. One big advantage is that there is no leakage in the first round, thus the multiplier is greater for the same spending. That is, one hundred percent of the initial spending goes to employment, whereas in tax cuts the recipients may save some portion and will very likely spend at least a little of the rest on goods that generate overseas employment rather than American.

The second major advantage of public works spending is you have the public work when you are done. A road or sewer will yield benefits far into the future for the society that the purchase of a lawn mower will not.


How do these rate on efficacy? And how do Summers Timely, Targeted and Temporary criteria apply?

But first, notice that the multiplier works with negative numbers, too. If for some reason spending is subtracted from the economy, the effect is far more dire than the simple dollar value of the initial subtraction. Ask any community faced with the closure of a plant or military base.

But second, Let us see what goods comprise the initial round of spending. With tax cuts, many people get a relatively small bonus to spend, and that which is not saved goes for consumer goods, discretionaries or necessities at the margin, depending on the income level. With tax cuts for business investment, providing new investment is leveraged, it goes for the range of plant and equipment or R&D and this includes many payroll jobs. Public works is a similar mix.

But third, just be aware that any stimulus, by definition, must be deficit financed. If we rob Peter to pay Paul, the community which includes them both is no better off. So with stimulus we are indeed intending to add to the deficit, all other things equal.

So efficacy?

Interest rate reductions?

Are we really going to restart a housing boom? Is business going to invest in this economy, particularly considering the seizing up of the credit markets we are currently witnessing? Low rates are better than high rates, but the financial markets have a lot of self-repair to do before there is any help from that direction.

Timely? Even aside from the problematic nature of the financial sector, interest rate reductions take twelve to eighteen months to be effective. Knowing how much is enough is very difficult when the results are that far out.

Targeted? As mentioned, last time interest rates were used as the primary stimulus method, housing boomed. It is hard to think that this was the intention, since business investment is always on the front of every policy presentation.

Temporary? Who knows? Interest rates also double as the main inflation-fighting mechanism. That promotes ... well, volatility.

Tax Cuts


Tax cuts can be instituted very quickly by reducing withholding rates. So something, perhaps not a great amount, could be done almost immediately.


Across the board cuts as would likely be used disproportionately benefit the wealthier. According to the Congressional Budget Office, roughly 85 percent of income from all sources goes to the top half of Americans. This is the wrong target. A cut in payroll taxes is not appreciably less biased, with about 80 percent in the upper half. Tax cuts would thus produce more spending on consumer discretionaries after an initial round of leakage (which would be significant, since savings are encouraged in the present consideration).


As Summers has noted, the tax cuts of 2001 and 2003 have been very sticky.

Business Tax Cuts to Stimulate Investment


New business investment does not respond very quickly or directly to tax cuts. As before, prospects of profit far outweigh tax considerations. Evidence is strong that investment decisions already made can be moved forward, but this may not bode well for later time periods, even if the cuts are NOT temporary.


The target is clear. The question is whether tax cuts for business ever reach that clear target. Evidence is not good except in extreme cases, such as some of the Reagan tax incentives of the early 1980s which at times actually made investment cost less than nothing. Note that this tended to promote investments into the favored types, decisions that may have been out of step with overall strategy and so less useful to the business and to the economy.

In the first round, the composition would be more or less productive investments and jobs. This is significantly different than consumer discretionaries. Jobs provide more income to less people than individual tax breaks, but the next round of spending is not focused on discretionaries or at the margin, but across the board, to housing, utilities and the rest of personal consumption.


These sorts of tax cuts have also been somewhat sticky, tending to outlast their original intention, and drawing businesses to depend on them.

Public Works


New public works projects would likely not start until after the need for stimulus was past, considering the need for design and site preparation and so on. Public works already underway could be accelerated, perhaps, or those on the shelf implemented somewhat more quickly. When Keynes developed the theory, the recession in question was a matter of years, not a few quarters.


Again, as with business investment, in addition to the actual public work and materials for it, the target would be the range of personal consumption expenditures, as it would produce jobs, not bonuses to existing workers.


Public works, once completed, provide ongoing public benefit with no ongoing cost. Any particular project, however, could extend into years before completion.

This discussion shows that none of the alternatives is very efficient, but the context of recession on the ground suggests another course. Tax receipts for state and local governments fall during recession, often because they are dependent on sales taxes, but in the current case also because property values are falling.

Since these levels of government do not have the luxury of deficit spending, reducing their revenue reduces their expenditure, and the situation of negative numbers referenced above occurs. That is, the multiplier is employed in reverse. A federal stimulus program might simply offset this contraction.

An alternative would be for the federal level to provide stability to the economy by supporting the state and local levels, mitigating their contraction. Further, this is a direct conduit to public works, since most public works are managed by these lower levels. Support through this channel has a better chance of finding useful projects that can be accelerated, implemented quickly, or just not shelved.


This would be immediate


Public services, public works. These are jobs, thus the range of personal consumption expenditures is wide. Notably the number of employees in the upper quintile would be fairly small.


As property tax and other revenue recovers, the need for federal assistance would be reduced. This would be relatively easy to see and document.

We apologize for the length of this podcast. Providing stimulus in the context of an ongoing and deepening federal deficit has its own dangers we did not mention. Thursday we’ll take a more direct look at this question and possibly another benefit for public works.

Sunday, December 23, 2007

The curse of growth

It’s time to examine the benefits of Growth.
First a couple of notes. I see that many of the faithful thirty-nine have been forwarding the piece on income-based farm support for farmers as an alternative to the current price-based supports for farm commodities. That was a particularly esoteric (although well-timed, considering the Farm Bill was up) issue. We were surprised at the interest. So we’re going to put together an extended treatment of that. It originally aired on December 5 as Market Failure III right after Market Failure II: Immigration. The two are corollaries. If you have specific questions or points of view, you can e-mail us at blog@demandside.net. Be nice.

Also, on the last Saturday Special of the year we will hear from Chuck Schumer – Senator Charles Schumer of New York, speaking at the same Brookings event as Larry Summers, noted later in this podcast.
Schumer is right on top of the subprime meltdown and banking and financial sector mess. If we could plug in his ideas today, we’d eliminate a lot of suffering and error over the next several years. Schumer will be ticking off the problems and the real solutions available as well as revealing in a straightforward manner the dangerous incompetence currently running the show in the Administration and at the Fed.

And we’ll have an extra podcast this week. The fourth Friday of the month is Forecast Friday. Well see how we’re doing and whether we need to make any adjustments to our calls, such as introduce the ambiguity and equivocation we’ve heard from the cattle who comprise the consensus. The answer is No.

Now. The Curse of Growth

It is entirely appropriate to blame Alan Greenspan for the housing bubble. His fiercely low interest rates and complete absence from the scene in terms of structuring and regulating the mortgage market make him the proximate cause of untenable housing price increases. His total disinterest in overseeing or even knowing anything about the Enron-style off balance sheet SIVs or the peculiar securities called collateralized debt obligations and exponential leveraging schemes make him the chief enabler of the binge that has left most banks badly overextended.

But if you’re going to blame him for the bust, you’ve got to credit him for the boom. It was the boom that remade Greenspan’s reputation after his mishandling of the dot.com bust. Not that it was much of a boom. But it was growth and we love our growth.

Similarly, the immense growth of China that is the toast of the free market world has come at an enormous cost. The economies of competitors have suffered and trading partners have been at a disadvantage with the exchange rate manipulation, but far more worrisome than any economic impact on competitors or partners is the environmental impact on the common environment.

The massive use of coal and the employment of worst practices mining and extraction at home and abroad have exported pollution and environmental degradation along with the cheap manufactured goods. Inside the borders of China, the situation is even worse. We have called China the first environmentally failed state because its own tipping points have been passed and the wholesale degradation of its water, its atmosphere and its arable land are now assured.

Growth and slavish adoration of growth as measured by GDP in these two instances have been the sugar for poisonous events. GDP, you will remember, is no measure of well-being, but a measure of monetized activity. GDP-wise, wars are better than peace, prisons the equal of Ivy League campuses, and the depletion or destruction of resources are invisible.

What we need is a good recession.


At least in the great avalanche of consumer goods.

We need a recession that reduces frivolous discretionaries, forces us to tightly structure financial institutions and markets, and compels investment in public works and public goods such as energy-saving infrastructure and health care.

I was listening to Tom Keene interviewing a retail analyst the other day. It was with some shock and awe that I heard her repeat over and over again redundantly that the keys to retail success with respect to fashion was awareness and exclusivity. Awareness and exclusivity. Perhaps it could be said awareness of exclusivity. But awareness of a product seems to me to be somewhat exclusive of exclusivity.

But no! By the magic of marketing, Chan4el hangs its handbag on an actress in a magazine and tens of thousands of target-aged women make the purchase for $185, or probably more, for all I know. Manipulation of consumer demand by the supplier is one of the most egregious sins in the co-called free market.

Enough said about that.

To achieve planetary survival, consumption has to be reduced. That means growth has to be negative. Yes?

No. Of course, we can grow rail transport, green energy, education, health care, third world survival, and so on. Just not SUVs, ATVs or RIPs.

Let’s look at it from the perspective of the current argument of what to do about impending recession. Former Clinton economic adviser and Treasury Secretary Larry Summers made a presentation at the Brookings Institute on Wednesday calling for strong early action that includes fiscal stimulus, by which he meant across the board tax cuts that were “targeted, timely, and temporary.” He also called on the Fed to move more aggressively on interest rates, while admitting that interest rates at best have a one-year lag to effectiveness.

Underlying both tax cuts and interest rates are more private goods, more discretionary spending that may or may not build American jobs. Better stimulus came from the Congress last week with its spending bill complete with lots of earmarks.

The mechanics of stimulus are not difficult. There is a reason the Bush tax cuts were not useful stimulus. The techniques of lowering short-term rates, fiscal deficits to finance tax cuts, fiscal deficits to finance public works, and fiscal deficits to finance other sorts of strategies will be the subject of tomorrow’s post

But this will come down to a battle between public goods and private goods. On Thursday we will look at public goods directly, why they need to be financed through government, and why they are in themselves stimulative, irrespective of whether they are revenue or deficit financed. We will end that podcast with the absurd suggestion that effective stimulus need not increase deficits, and no, not on account of the well-named Laffer Curve.

Today, however, we are talking about the God of Growth of GDP. GDP measures monetized activity, as we said. Well-being be damned. Perhaps a consumer recession is not such a bad idea.

Thursday, December 20, 2007

Market Failure V: The Great Financial Sector Crash of 2007

No time and place and situation in postwar America has fallen more completely under the sway of the free market than the first decade of the Twenty-First Century in the banking and financial sector. We may soon see that no financial crisis will cost America more than that composed and orchestrated and performed by this unregulated, unsupervised, predacious sector.

Of course, the financial sector is not by itself in being outside the pale of even rudimentary structure, although because the central bank was under the control of a self-described Libertarian Republican Alan Greenspan, it could be argued that banks and brokers had special access to government largesse. But with George W. Bush in the White House and his handler Dick Cheney never far away, the corporate oligarchy has written the laws that governed their sectors not only in finance, but in energy, health care, media, and more.

The roots of the financial crash.

In the financial sector during the Greenspan/Bush era, innovation was the word of the day. Special accounts or entities called Structured Investment Vehicles (SIVs) were created by banks off the balance sheet to take advantage of special securities called collateralized debt obligations (CDOs). Imaginative modeling was applied to mortgages to take advantage of a housing expansion built on cheap interest. The extra few beeps from these accounting functions found a ready audience in investor capital. The voracious demand for these securities drove ever more predacious mortgage brokers and ever riskier mortgage loans.

All of it was sanitized by an absent Securities and Exchange Commission, by a diffident Fed and by rating agencies – Standard and Poors and Moodys – in thrall to those they rated. Mortgage-backed securities were stamped Triple A whatever their worth and treated as near money for further leveraging. The demand for it drove the whole sorry circus. Meanwhile, hedge funds operated as usual, in a dark shadow. Mortgage brokers were not licensed, nor were their products examined.

Whatever there is to say about the expansion of the financial sector under Bush/Greenspan, government interference is not part of it. Loud and detailed complaints about government arose only after the collapse. They come from all offices on Wall Street and amount to variations on the theme that government was not, and is not, doing enough to clean up the mess. The banking sector is vital. It needs ever more and ever cheaper money. No time to look at the past.

The common name for this financial sector collapse is the Subprime Mortgage Meltdown, as if it were authored solely by those individuals who obtained inappropriate loans. Lenders, in fact, bear the responsibility and ought to bear the costs. As we see less than six months later, lenders can be very discerning in their choices of mortgage buyers.

Facing the nation and the world today is a solvency problem, no matter what brave face the banks may paint on it. And solvency will be assured by you and me. These banks are – and they realize it – too big to faily. You and I are the deep pockets. Debt leveraged by debt was not a very good idea. Every write-down or equity stake sold to a Mideast potentate is accompanied by assurances, not from the corporate offices, please note, but from analysts and fellow travelers, that banks are facing the music, taking their lumps, clearing their books. Bull. Accounting is opaque. Losses are dribbled out over time as slowly as possible with moves designed only to maintain as long as possible a facade of integrity.

Now, as the Fed moseys into the mortgage corral like a self-conscious Barney Fife to finally close the gate, laughably late, with the fences broken and the tumbleweeds rolling across the scene. The horses are gone. Barney's new, weak subprime lending protections are announced to empty stalls. Deputy Fife retires to his offices, knowing as we all do that even before the charade, the subprime mortgage market was forever a thing of the past.

But the bank examiners have still failed to report for duty. So deep in the pockets of the banks is the Fed that it colludes without a second thought. Its role is not to wonder at causes, but to listen and respond to whispers from the big houses. As much as possible the extent of the damage must be kept from the prying eyes of the public. It was an explicit feature of last week's special auction facility that nobody would know who was using it.

It is still our contention that the overall damage will reach toward one point three trillion dollars, with eight hundred to nine hundred billion resting in the American financial sector and the rest lying mostly in Europe. While write-offs, downgrades and bankruptcies will eliminate some of the overhang, on one hand. On the other the government and taxpayer may be on the hook for the biggest bailout of all time. This in addition to the ever broader gusher of liquidity focused on the sector.

There can be no doubt this is a market failure through and through. The government, particularly the Fed under Greenspan did nothing but abet the private financial sector actors.

It will surprise nobody that we propose some real remedies and responses beyond the, Oh well, it is little more than the normal cycle.

But first, a few notes.
  1. One, the authors of this fiasco are the highest paid professionals in the country. These are the brilliant minds of the A list business schools. They are getting millions and hundreds of millions of dollars. This on the premise that they are providing value. Instead they are costing us – hundreds of billions and rocking the foundation of credit for the whole economy. Aside from a few sacrificial lambs who left with nine figure severance packages, nobody has been held accountable.

  2. Two, the problem is not the unraveling and collapse. The problem was the growth on false pretenses, the bubble itself promoted by cheap money and no structure. The collapse was simply the final act.

  3. Three, the best thing the credit markets can do is every day provision of a reliable supply of capital at the lowest rates possible for the productive industries. Slicing and dicing securities and buying and reorganizing and selling companies is very close to a shell game. At best it spruces up the bottom line and makes the stock more attractive. But the economy is not measured in stock prices, it is measured in jobs, security, continuity and maybe a bit of moral integrity. Whatever incentives make this financial gymnastics activity attractive have to be reversed.

So the remedies.
  • Out the securities for the public to examine. These are not so much complicated as they are preposterous.

  • Realign the mortgage seller with the mortgage buyer. Do not allow secondary markets in mortgages. If people want to invest in mortgages, let them invest in the mortgage providers.

  • Institute a financial transactions tax of five one-hundredths of one percent to recoup the immense costs of these bailouts. A standard, minute tax will generate a great deal of revenue and at the same time discourage the day trading and hyperactivity in what amounts to a casino.

  • Establish a marginal income tax rate of at least 50 percent on income above a couple of million per year, all sources. This event is evidence enough that people are paid enormous sums not for value delivered, but for value extracted.

  • If there is going to be a bailout, aside from the cheap money, get a stake in the companies. Why should Dubai have a stake in Citigroup and the USA not? Providing there is a similar investment.

  • And structure this market. Let's not have financial vehicles or securities that are simply some Wharton grad's senior project. Let's get things vetted. Markets can work, but unstructured markets don't work.

Tuesday, December 18, 2007

Market Failure IV: Russia

The fall of the Soviet Union was a tremendous opportunity. That was squandered when the advice of free market zealots overrode rational transition schemes. Ronald Reagan's grandstanding aside, most historians will say that the West won on the basis of economic might. The democratic mixed economy of the United States produced enormous prosperity for its citizens, replicated in Western Europe. The Soviet Union and that part of Europe under Soviet-style command economies fell further and further behind. Finally Russia acceded to the inevitable.

As we will see, under Western sponsored "shock therapy" Russia was not transformed or invigorated, but brought to its knees economically. Today, largely on the basis of its oil resource, that nation is rising from decline. But the Russia of Vladimir Putin bears more resemblance to the bureaucratic dictatorship of the Soviet era than it does to a European-style democratic mixed economy.

Now. What happened? Why is this market failure IV? Following we offer a very quick description, a skimming of the events taken largely from Stiglitz excellent book Globalization and Its Discontents, the 2003 version.

The debate between gradualists and the free market fundamentalists in the IMF and US Treasury was won by the latter. Their prescription of wholesale liberalization of the economy was accepted by the Russians.

The first mistakes occurred almost immediately upon the decision to institute the shock therapy. Most prices were freed overnight in 1992. Since many prices had been kept artificially low under the communist regime, freeing them – or liberalizing – set in motion an inflation, a hyperinflation of double digits per month, that wiped out savings and moved price stability to the top of the agenda.

The second round of shock therapy thus began – raising interest rates to stem price increases.

The third round of shock therapy was rapid privatization.

When the smoke cleared, a few dozen oligarchs were in control of former state-owned industries. A more broad-based ownership was frustrated by the inflation, which wiped out the savings of the broad population and prevented them from becoming stakeholders in the new economy.

Between 1990 and 1998, Russian industrial production fell 42.9 percent. GDP fell 45 percent. This was nearly twice the damage experienced by the nation's economy during World War II.

The oligarchs got wealthy not by developing industry, but by buying oil at its still restricted prices and selling it overseas. They exploited the newly opened capital markets – a fourth element of shock therapy – to send a flood of money out of the country, quite the opposite of the intention to draw outside capital in.

The IMF kept promising recovery was just around the corner. In 1997 a combination of high interest rates, a collapse in oil prices and insistent borrowing – at IMF direction – to prop up the ruble, eroded the base of the economy completely, and it collapsed.

As Stiglitz says, page 146
An overvalued exchange rate – combined with the other macroeconmic policies foisted on the country by the IMF – had crushed the economy.
Although unemployment was disguised, it was no less traumatic. Workers were kept on payrolls; there was little production. As Stiglitz says,
While workers only pretended to work, the firms only pretended to pay. Wage payments fell into massive arrears, and when workers were paid it was often with bartered goods rather than rubles.
In July 1997 a "rescue" quote unquote was organized by the IMF with participation by the World Bank and was primarily intended to keep the value of the ruble high. Tens of billions of dollars in loans were organized to support the exchange rate.

The rescue failed. An inevitable devaluation did not lead to the doomsday predictions promised by the IMF. But the debt was in place. The oligarchs and Western bankers took what they could.

This is the history, or the froth of the history. What was the root of the failure?

The shock therapy. While markets work, they only work in the context of strong government institutions and mitigation of excesses by social programs. Western societies have hundreds of years of institutional development. Regulatory agencies, courts to enforce contracts, well-developed supply chains and intermediate markets, controls against monopoly exploitation and patent corruption. Russia did not have these. The Soviet economy, in fact, had relied on back alley arrangements to circumvent the official red tape, and was thus practiced in corruption.

Free market fundamentalists believed that the magic of the market itself would organize the society. No less blind than religious zealots, they pushed an idealized liberalization ahead of institutional development and oversight. Most notably, democracy itself was left to follow the market rather than lead it.

Sunday, December 16, 2007

Hire the Third World to develop low carbon sustainable agriculture

What are the two major problems on the globe today? No, Tiffany, it's not finding parking for your Escalade. No, Buzz, it's not getting rid of the coach.

Global warming and global poverty.

The UN climate change conference in Bali ended in acrimony. The world produced a barely adequate so-called road map forward, a process for beginning a process that needed to be in its second decade last year. Obstruction and obfuscation are generated primarily by the United States and its chief supplier China, who refuse to alter their mode of self-interest from greed to simple survival. As we noted in an earlier podcast, it is an enormous market failure when clear information is available to all parties -- that is, the demise of the Earth as an environment suitable for human life -- and the response of the most market-driven economies is to insist on burning more fossil fuels and creating an ever higher tower of cards.

Let us look for a moment at two parts of this issue. First the abstract issue of the motivation of economic actors. The second being the way to connect the undeveloped world to a successful growth path, which by the definition of successful, means a path that is not carbon-intensive.


In economic science, or at least in the primitive form currently in vogue, the world is made up of billions of little units operating on the basis of a kind of primal automatic response to material self-interest. Sometimes economists will introduce institutions as a collective form of this self-interest. The simplistic and oft-repeated magic of the market is then proposed, a catalyst that organizes these billions of self-interested atoms into a perfect crystal of optimal outcome. The invisible hand molds the best destiny, unless of course, government interferes.

Among the many unexamined contradictions and assumptions needed to support this leap of faith are the mass of evidence to the contrary, the patent absence of free markets in the real world, the many anecdotal examples -- say the current financial sector chaos -- where markets that are relatively free produce not optimal outcomes, but crisis and dysfunction. Along with this are the billions who actually act on a basis not exclusively rooted in personal material self-interest. Family, community, nation, race, and many other non-individual, dare we call them social, elements compose the individual's motivation in any particular incident.

To the point relative to Bali and the UN's roadmap. The survival of the planet also entails at least a modicum of self-interest. But this form is not the personal greed of the free market that is supposedly cleansed by the invisible hand. It is a survival where all must survive if one is to survive. The optimal survival of one means the survival of all. This is a powerful shift in motivation and is felt deeply by many of our society. The good of the whole is very much in direct concert with the good of the individual. This creates the opposite perspective on many economic actions, but one still impelled by self-interest. (Leaving aside the Game Theory discussion for the moment.)

I leave that for your reflection with only one additional note. The self-interest of survival ought to engender no less ruthlessness on our parts than that exhibited by the self-interest of those whose world ends at the edge of their skin.

Second point from Bali.

The dispute in Bali seemed to center on equal opportunity to stone our children to death. The U.S. demands its historical rights to foul the common nest. The developing world insists it has not had its full opportunity to pollute.

Pretend for a moment that we need a low carbon replacement for carbon-intensive agriculture and that we need the planting and maintenance of billions of carbon consuming planet regenerator units, aka trees. Suppose we see that we need to replace the current food production method within, say, thirty or forty years with an entirely new method. Not new acreage or sites or substitute fuels for the current method. And entirely new, carbonless method.

If that method were labor-intensive instead of capital intensive, and needed two or three or four decades lead time to come into full production, you would have a compelling rationale for supporting the agrarian economies of the undeveloped world with schools, roads, libraries, intensive R&D in green technology and assistance of all other kinds. A self-interested motive for cooperation.

These conditions exist in exactly this way. Therefore the way to address poverty is exactly the way to support the end of carbon, which is to generate this next agricultural system.

It is a misreading of history to say that the great industrialization of the world drew people from farms to better lives in the city. The great industrialization began on the farms and evicted and continues to evict those working there out over time. The tractors, combines, chemical fertilizers. It was the mechanization and technological alteration of the farm that expelled the population into the cities. If we now find that mechanization, chemicalization and technical complexity is damaging to the planet, then a reversion to technology that is simpler, though more sophisticated in its appreciation of the interrelation of systems, will do nothing but reinvigorate a healthy, prosperous life for billions of people.

Labor market numbers are not credible

It has been a theme of ours that the numbers coming out of the Bush administration do not reflect life on the ground for Americans, particularly the 20% of consumers occupying the bottom half of the population.

The November job numbers came out last week, demonstrating a growth of a much trumpeted 94,000 payroll jobs. This was accompanied by adjectives such as "solid," strong," sometimes "surprisingly strong or solid," and at least "better than expected."

94,000 when the economy needs 150,000 just to tread water is better labeled "tepid" or "weak" and at BEST "better than expected."

But 94,000 jobs were not created.

Dismay has been voiced by, among others, Paul Kasriel, chief economist at the Northern Trust Company of Chicago, who points out that 76 percent of all job growth over the past twelve months has been found in the so-called Birth Death adjustment which attempts to account for 1-5 person businesses going in and out of existence. This corresponds to 36 percent of job growth from these sources in the previous 12-month period.

Similar distrust has been voiced for some time by Michael Shedlock, or Mish, whose blog Mish's Global Economic Trend Analysis is one of the best observers of current economics on the web or anywhere.
For 9 consecutive months the BLS assumed that new unaccounted construction businesses were created in this environment where business spending has been weak, housing has been horrid, and close to 200 lenders have gone out of business or stopped writing loans according to Implode-O-Meter. There is still a lot of catching up to do on those construction assumptions. Eventually we will see higher negative revisions in the months to come. However, I am still struggling with 11 consecutive months of birth death additions to financial services in light of imploded lending. Even though "imploded" does not imply out of business, the number of small 1-5 person shops that have ceased doing mortgage related business has to be staggering. Those numbers are not reflected in Implode-O-Meter stats or in the birth/death model revisions. All things considered, the Birth Death revisions continue to remain in Bizarro World with the model adding 1,239,000 jobs to the economy since February. I do not believe it and neither does the treasury market.
Then we add the commentary. Job growth has been "trending up." Oops, watch the language "Nonfarm payroll employment continued to trend up." If "trend up" means the number got bigger, that is possibly true. As above, possibly not. But if "trend up" means growth is improving, that is demonstrably false.

An EPI report put out on the same day as the BLS numbers demonstrates that growth -- even by official numbers is trending down from over 2 percent in February 06 to 1.4 percent in March 07 and now to approaching 1 percent in November 07. Private payroll growth has trended down even more sharply and is nowless than half its March '06 level.

Underlying this discussion is the question, not of transparency, but of veracity. Clearly the statistical arms of the government are clearing their verbiage with the political arms. The question is whether they are manufacturing the numbers. Private market and public policy analysts have no alternative to official federal numbers. We cannot turn to another provider. Our only choice is to believe or not to believe.

We have seen this administration play fast and loose with national security intelligence to sway public opinion. If the same spin is being applied to the economy, the results could be very bad.

Not being able to believe the data coming out of the BLS and BEA is similar to not being able to believe the accounts of a private corporation. The lost of trust can be an enormous downside risk.

Saturday, December 15, 2007

Text of Bali Road Map - 15 December 2007

Decision -/CP.13
Bali Action Plan
The Conference of the Parties,

Resolving to urgently enhance implementation of the Convention in order to achieve its ultimate objective in full accordance with its principles and commitments, Reaffirming that economic and social development and poverty eradication are global priorities,

Responding to the findings of the Fourth Assessment Report of the Intergovernmental Panel on Climate Change that warming of the climate system is unequivocal, and that delay in reducing emissions significantly constrains opportunities to achieve lower stabilization levels and increases the risk of more severe climate change impacts,

Recognizing that deep cuts in global emissions will be required to achieve the ultimate objective of the Convention and emphasizing the urgency1 to address climate change as indicated in the Fourth Assessment Report of the Intergovernmental Panel on Climate Change,
  1. Decides to launch a comprehensive process to enable the full, effective and sustained implementation of the Convention through long-term cooperative action, now, up to and beyond 2012, in order to reach an agreed outcome and adopt a decision at its fifteenth session, by addressing, inter alia:

    (a) A shared vision for long-term cooperative action, including a long-term global goal for emission reductions, to achieve the ultimate objective of the Convention, in accordance with the provisions and principles of the Convention, in particular the principle of common but differentiated responsibilities and respective capabilities, and taking into account social and economic conditions and other relevant factors;

    (b) Enhanced national and international action on mitigation of climate change, including, inter alia, consideration of:
    (i) Measurable, reportable and verifiable nationally appropriate mitigation
    commitments or actions, including quantified emission limitation and reduction objectives, by all developed country Parties, while ensuring the comparability of efforts among them, taking into account differences in their national circumstances;

    (ii) Measurable, reportable and verifiable nationally appropriate mitigation actions by developing country Parties in the context of sustainable development, supported by technology and enabled by financing and capacity-building;

    (iii) Policy approaches and positive incentives on issues relating to reducing
    emissions from deforestation and forest degradation in developing countries; and the role of conservation, sustainable management of forests and enhancement of forest carbon stocks in developing countries;

    (iv) Cooperative sectoral approaches and sector-specific actions, in order to enhance implementation of Article 4, paragraph 1(c), of the Convention;

    (v) Various approaches, including opportunities for using markets, to enhance the cost-effectiveness of, and to promote, mitigation actions, bearing in mind different circumstances of developed and developing countries;

    (vi) Economic and social consequences of response measures;

    (vii) Ways to strengthen the catalytic role of the Convention in encouraging
    multilateral bodies, the public and private sectors and civil society, building on synergies among activities and processes, as a means to support mitigation in a coherent and integrated manner;
    (c) Enhanced action on adaptation, including, inter alia, consideration of:
    (i) International cooperation to support urgent implementation of adaptation actions, including through vulnerability assessments, prioritization of actions, financial needs assessments, capacity-building and response strategies, integration of adaptation actions into sectoral and national planning, specific projects and programmes, means to incentivize the implementation of adaptation actions, and other ways to enable climate-resilient development and reduce vulnerability of all Parties, taking into account the urgent and immediate needs of developing countries that are particularly vulnerable to the adverse effects of climate change, especially the least developed countries and small island developing States, and further taking into account the needs of countries in Africa affected by drought, desertification and floods;

    (ii) Risk management and risk reduction strategies, including risk sharing and
    transfer mechanisms such as insurance;

    (iii) Disaster reduction strategies and means to address loss and damage associated with climate change impacts in developing countries that are particularly vulnerable to the adverse effects of climate change;

    (iv) Economic diversification to build resilience;

    (v) Ways to strengthen the catalytic role of the Convention in encouraging
    multilateral bodies, the public and private sectors and civil society, building on synergies among activities and processes, as a means to support adaptation in a coherent and integrated manner;
    (d) Enhanced action on technology development and transfer to support action on mitigation and adaptation, including, inter alia, consideration of:
    (i) Effective mechanisms and enhanced means for the removal of obstacles to, and provision of financial and other incentives for, scaling up of the development and transfer of technology to developing country Parties in order to promote access to affordable environmentally sound technologies;

    (ii) Ways to accelerate deployment, diffusion and transfer of affordable
    environmentally sound technologies;

    (iii) Cooperation on research and development of current, new and innovative
    technology, including win-win solutions;

    (iv) The effectiveness of mechanisms and tools for technology cooperation in specific sectors;
    (e) Enhanced action on the provision of financial resources and investment to support action on mitigation and adaptation and technology cooperation, including, inter alia, consideration of:
    (i) Improved access to adequate, predictable and sustainable financial resources and financial and technical support, and the provision of new and additional resources, including official and concessional funding for developing country Parties;

    (ii) Positive incentives for developing country Parties for the enhanced
    implementation of national mitigation strategies and adaptation action;

    (iii) Innovative means of funding to assist developing country Parties that are particularly vulnerable to the adverse impacts of climate change in meeting the cost of adaptation;

    (iv) Means to incentivize the implementation of adaptation actions on the basis of sustainable development policies;

    (v) Mobilization of public- and private-sector funding and investment, including facilitation of carbon-friendly investment choices;

    (vi) Financial and technical support for capacity-building in the assessment of the costs of adaptation in developing countries, in particular the most vulnerable ones, to aid in determining their financial needs;
  2. Decides that the process shall be conducted under a subsidiary body under the Convention, hereby established and known as the Ad Hoc Working Group on Long-term Cooperative Action under the Convention, that shall complete its work in 2009 and present the outcome of its work to the Conference of the Parties for adoption at its fifteenth session;

  3. Agrees that the process shall begin without delay, that the sessions of the group will be scheduled as often as is feasible and necessary to complete the work of the group, where possible in conjunction with sessions of other bodies established under the Convention, and that its sessions may be complemented by workshops and other activities, as required;

  4. Decides that the first session of the group shall be held as soon as is feasible and not later than April 2008;

  5. Decides that the Chair and Vice-Chair of the group, with one being from a Party included in Annex I to the Convention (Annex I Party) and the other being from a Party not included in Annex I to the Convention (non-Annex I Party), shall alternate annually between an Annex I Party and a non-Annex I Party;

  6. Takes note of the proposed schedule of meetings contained in the annex;

  7. Instructs the group to develop its work programme at its first session in a coherent and integrated manner;

  8. Invites Parties to submit to the secretariat, by 22 February 2008, their views regarding the work programme, taking into account the elements referred to in paragraph 1 above, to be compiled by the secretariat for consideration by the group at its first meeting;

  9. Requests the group to report to the Conference of the Parties at its fourteenth session on progress made;

  10. Agrees to take stock of the progress made, at its fourteenth session, on the basis of the report by the group;

  11. Agrees that the process shall be informed by, inter alia, the best available scientific information, experience in implementation of the Convention and its Kyoto Protocol, and processes thereunder, outputs from other relevant intergovernmental processes and insights from the business and research communities and civil society;

  12. Notes that the organization of work of the group will require a significant amount of additional resources to provide for the participation of delegates from Parties eligible to be funded and to provide conference services and substantive support;

  13. Strongly urges Parties in a position to do so, in order to facilitate the work of the group, to provide contributions to the Trust Fund for Participation in the UNFCCC Process and the Trust Fund for Supplementary Activities for the purposes referred to in paragraph 12 above and to provide other forms of in kind support such as hosting a session of the group.

Bush team tries "signing statement" strategy after Bali accord

The Bush administration is attempting a "signing statement" after the Bali agreement. The Telegraph reports
The White House has declared it has "serious concerns" about a historic deal to negotiate a new climate change treaty struck in Bali.

After a sleepless night and a day of high drama in Bali, the United States agreed to a compromise with the European Union to avoid mentioning any target figures for slashing greenhouse gas emissions.

But the country, which reneged on the Kyoto Protocol six years ago, has since issued a statement questioning the role of developing countries involved in the deal.

The White House, while recognising that there were positive conclusions from the conference, said the "United States does have serious concerns about other aspects of the decision as we begin the negotiations.

"The negotiations must proceed on the view that the problem of climate change cannot be adequately addressed through commitments for emissions cuts by developed countries alone," it said.

"We must give sufficient emphasis to the important and appropriate role that the larger emitting developing countries should play in a global effort to address climate change."
Signing statements are, of course, one of the extra-legal measures this administration has taken to legislation the president actually signs. Signing statements have no standing in law, and are simply an assertion, a fig leaf to cover the policy of doing what it wants no matter what.

The international community may not recognize the ploy, but it ought to be concerned, since it is emblematic of the absence of integrity in force in Washington. Negotiate a deal, then walk away with a statement of what you will do. Dishonest? Yes. And in full view of the world.

Thursday, December 13, 2007

Budget and Prospects in Pictures

From the newly released CBO Budget Outlook

Wasn't this supposed to come in under $50 billion, and I think Iraqi oil was going to pay for it

On-budget costs for Iraq from the CBO will top $1 trillion by 2017. Never mind the ruined lives, ruined reputations, ruined countries and completely missed objectives. CBO Director Peter Orzag told Congress also that:
  • CBO’s projections find that under DoD’s current plans, defense resources will average about $521 billion annually (in 2008 dollars) from 2014 to 2025 — or about 8 percent more than the total obligational authority for defense requested by the Administration for 2008.
  • Considering potential unbudgeted costs increases the projected long-term demand for defense funding to an annual average of about $621 billion through 2025, or 29 percent more than the Administration’s 2008 request of about $482 billion (excluding funding for war-related activities).

  • CBO’s analysis of unbudgeted costs included several possibilities: that the costs of weapon systems now under development would exceed early estimates, as they have in the past; that medical costs might rise more rapidly than DoD has assumed; and that DoD would continue to conduct contingency military operations overseas as part of the war on terrorism, albeit at reduced levels relative to current operations in Iraq and Afghanistan.

Tuesday, December 11, 2007

Housing bubble counter factual

What would the economy look like without the debt bubble and financial dysfunction?

Only two years ago, those of us who refused to buy a house and actually turned down the free money of guaranteed house appreciation were viewed as sad relics of a bygone age. We didn't understand. What was it that we didn't understand?. That house prices always went up.

If we pointed out the historical fact that house prices did not always go up, or suggested that prices were going up now as a function of a bubble, the reply was seldom verbalized. Instead it was expressed with a simple and sad shaking of the head from side to side. The gesture used for those doomed to be eternally poor on account of addiction or stupidity.

Now it is not quite the same. But close. The shaking of the head is peremptory. How can we presume to have seen something that nobody saw or could have seen? Do we not realize the criminal culpability of [pick one] blind bankers, predatory mortgage brokers, incompetent rating agencies, lax regulators or -- the favorite -- borrowers consumed by greed-lust for houses?

It is not generally acknowledged today that the outcome was predictable in general if not specific form. It is all, to quote the noxious, a "perfect storm." Even fewer accept that there is any value in hashing over old and now very painful history.

Today we are going to look at what happened, try out a counter factual of what did not happen, and hope the result displays some targets for the future.

1. What happened.

Record low interest rates came out of the dot.com bust. They were held low for a long time and created a housing bubble, as investors professional and amateur saw the prices appreciating and money being made in solid equity year after year. The industry was sold on growth. The investment community came to rely on the gains. A corruption in the form of predatory lending to create paper for near fraudulent securities extended the bubble. Finally perpetual rises could not be sustained. The paper melted. It will continue to melt over the next five years. There is nothing to do about it, barring an impossible ignition of price appreciation in real estate. Not stabilization. Appreciation.

We are left with burdened households and a financial marketplace that insists on ever more and cheaper money, hoping that paper will turn to water and make the worthless into valuable.

2. What did not happen


A counter factual argument has to begin with acknowledging the fact that without cheap money from Alan Greenspan and the housing bubble, the recession of 2001-02 would have been much longer and deeper. Business investment over this period has been tepid and shallow and would have been no less so absent the household demand created by the bubble.


The bubble economy might have been shorter in the presence of a valid regulatory regime such as exists, for example, in all other countries in the world. Hedge funds, SIVs, CDOs, adjustable rate and low-doc mortgages are financial innovations only in the sense they figured a way past traditional and well-understood business practices and into a realm of free market that was free from legal, ethical and professional compass.


Mortgage payments would have been about the same for those who took them out. Lower interest was quickly translated to higher price.


George Bush would not have been reelected. His hallmark tax cuts would not have had the smoke of low interest rates to disguise their ineffectuality. Gaping budget deficits in precisely the amounts of the tax cuts would have exposed the scam as a simple shift of taxation from the rich of today to the children of the middle class tomorrow.

3. Targets

If a low-interest bubble economy was all that separated us from recession, What do we have to look forward to? We have the financial ruin of millions of would-be homeowners to deal with, along with a dysfunctional financial sector, and now a falling dollar. Soon we will have inflation.

The first and most obvious thing is to return integrity to the financial sector itself. A one-page summary of terms is available that could have covered every mortgage let and eliminated a large fraction of the predation that is now exposed. Prosecution of predatory lenders ought to be undertaken wherever it can be shown they violated their implied fiduciary responsibility to help people get the best deal.

The lending activity of banks. Healthy economic growth needs transparent, stable financial structures. Innovation is too often a word for illusion. Regulators need to know what is going on. Investors need to know what is going. Risk needs to be explicit, not masked. How can we run around the world preaching against corruption and allow this sort of business to go on right in the heart of the financial system?

Second, we need to find the demand that is going to pull the economy forward. When recession occurs, everybody becomes a demand sider. That is the genesis of the hullabaloo about lower rates. It is presumed that lower interest will stimulate demand.

(Ben Bernanke and the Fed may be less attuned to this. Their policy statements have focused on the "turbulence" quote unquote in the financial markets. As we noted in our last podcast, this turbulence is caused by the collapse of the house of cards, running from usurious subprime loans through shady SIVs and into portfolios around the world as bogus collateralized debt obligations.)

IF LOWER RATES ARE SUPPOSED TO REKINDLE DEMAND, EXACTLY HOW? The Fed's short-term rates have lost connection with long-term rates. Even if they were still connected, do we expect businesses to begin to invest, even at zero percent. Or perhaps another housing boom?

Obviously not.

Government deficit spending, then? We have a war. That's spending. And costing.

I will just posit two parts to a successful stimulus.

Part One: Tax financed. Taking the froth off the top will do nothing but help rebuild a sound economy.

Part Two: Transportation infrastructure, energy R&D, products that mitigate global warming -- we need these. Creating demand for them through government can be the demand engine. Please note there's a lot of work for corporations here.

Monetary policy has foundered in a chaos of its own making. If we expect a carriage out of the Fed's magic wand of short-term interest rates, we'll end up spending a lot of time looking at rotting pumpkins.

Interpreting the fall of the dollar from the demand side

The decline of the dollar as a speculative bubble

As mentioned in somewhat cruder form on the blog last week, it is our contention that the current decline in the dollar is more appropriately seen as a speculative bubble in commodities and the euro.

The possibility that the dollar will continue to decline on its own merit, or demerit, certainly exists – in face of decades of trade deficits – but the current steeper slope of fall should not be seen exclusively in that light.

Let me explain in seven parts.


The dollar has been declining against the euro for five or six years, not coincidentally beginning with the cheap money policies of then Fed chair Alan Greenspan. Parenthetically if you had listened to George Soros back then, you would have shorted the dollar and made thirty percent just on the currency. Much better than the stock market.


The recent so-called turbulence in credit markets was a house of cards. The suites were:
  • Hearts - subprime mortgages
  • Diamonds - near fraudulent securities rated at triple A
  • Spades - dodgy Enron-style off-balance sheet vehicles known as SIVs
  • Clubs - whatever the transitive form of the term lax regulation is, as in the SEC and Fed not only failed to structure or monitor the market, but actually cheered on the players as they neared the cliff.
The cheap money that created the housing bubble is the same cheap money that reduced the value of the currency, but the salient feature of this whole mess is that the financial market hijinks led to the flight of investors to safety – to T bills, stocks, foreign securities and significantly to the apparent concreteness of commodities

Two B

Said another way, investors of all nationalities have to be wary now of US financial markets, self-described as the strongest and deepest in the world, because they have just burped forth hundreds or thousands of billions of dollars in bad paper after their most recent binge. Very poor regulation and poor structure to the markets should make the US markets toxic in themselves, and they are only palatable for the wrong reason, the implicit risklessness of risk now being exposed with the various bailouts.


Many nations around the world have a dominant commodity as an export, and the value of that commodity determines the value of the currency. Domestic problems with this condition are known as the Dutch Disease, after the effects of oil prices on the currency of the Netherlands. Other nations relevant to the current discussion are Canada with oil and natural gas, any of a number of Latin American and African countries with metals and petroleum, Australia with metal ore, and even New Zealand with dairy.


The bidding up of commodity prices by investors, a process known by the technical term “speculation,” also bids up these currencies relative to the dollar and leads to the inverse and more visceral experience of decline.

That is, for example, higher oil prices and lower dollar values are two sides of the same coin. It is our contention that it was the attractiveness of oil – and commodities in general – as a secure investment play, not the extra weakness of the dollar that began the slide. Most experts in oil will tell you that fundamentals call for a price of sixty, not one hundred.


A special case exists with the euro, because of the aforementioned slide of the past six years, because of the perception of a shift to the euro as a reserve currency, and because of current strength in the Eurozone economies attracting investor dollars into euro-priced investments. This has created a speculative bubble in the euro itself.


Other nations that are big in trade – Japan, Britain, China, India have not appreciated against the dollar. Of course, China and India have less than fluid exchange rate regimes. But the point is taken.


The resulting speculative bubble in commodities threatens to ignite inflation and call down the wrath of the charcoal-suited Myopes of central banks.

The bubble also threatens to ignite a fire sale on dollars that has not yet occurred, further fueling inflation and bringing crisis to the Globe.

Already food inflation is rampant. Fuel inflation is rampant. This hits demand very hard, particularly at the low end, where fuel and food are larger components of household spending.

Admittedly, the architecture in seven parts just constructed is an interpretation, and no more or less verifiable than any of a hundred or more other interpretations.

But, as some might say, we’ve got the arrow in the chest. Perhaps we’d better get it out now and worry about where it came from later. I agree – though if some of the archers were taken down it might make our task easier.

We do need to find a source of demand and soon that is not infected by the financial market dysfunction. Clearly we cannot simply go back to cheap credit, McMansions and consumer baubles as a driver.

Saturday, December 8, 2007

Job streangth is implausible

While an increase of 94,000 jobs is nothing really to celebrate, it is "better than expected," and really better than likely.

EPI is never happy with an economy that is unfriendly to its workers, so it hasn't been happy for several years. They were up and running with a chart showing the gradual decline over the past two years. Still, the more radical weakness in the labor markets since the subprime meltdown has not shown up in the official statistics.

Here's an intro to EPI's note:
Another unexpectedly positive month for jobs, but with clear signs of weakness

by Jared Bernstein with research assistance from James Lin

Employers added 94,000 jobs last month, and unemployment held steady at 4.7%, as the nation's job market remains healthier than expected, according to today's report from the Bureau of Labor Statistics.

Employment growth has clearly slowed in recent months (see Figure 1), reflecting fall out from the meltdown in the housing market. Revisions in today's report subtracted 48,000 jobs from the prior two months' gains, bringing the average monthly increase for the past three months to 103,000, compared to 168,000 in the comparable three month period last year.

Figure 1

Yet, for the second month in a row, payroll job gains exceeded economists' lowered expectations, suggesting the labor market has yet to consistently reflect the sharply slower growth thought to be occurring in the overall economy. The Household Survey data were particularly strong last month, posting an implausibly large jobs increase of just under 700,000, after falling 250,000 in October. For those who doubt the volatility of this variable, Figure 2 shows the extremely large monthly swings in the Household Survey employment data.


Be clear that EPI is not casting aspersions on the data being purveyed by the administration. That is my job.

AMT needs its PAYGO, both economically and politically

Why is the Senate turning its back on even rudimentary good economic sense? They were sent an alternative minimum tax (AMT) patch several weeks ago by the House and its Ways and Means chair Charles Rangel that patched the AMT for a year and paid for it by closing gaping loopholes for billionaire hedge fund managers.

Aviva Aron-Dine at CBPP correctly points out that tax increases on this class of citizen is in no way contractionary. Can the presidential candidates have hung the economy in the loft by its ... waiting for the campaign to be over?

This is the perfect populist tax -- on the class of folks who have brought us financial sector chaos, who have earned their money outsourcing and downsizing, and have done it all with an eye to short-term gains for themselves. I say this not entirely with the simplistic voice of Middle America in mind.

By Aviva Aron-Dine

Several weeks ago, the House of Representatives passed legislation that would provide Alternative Minimum Tax relief for 2007, extend other expiring tax provisions, and offset the cost with various revenue-raising measures. Some have argued that Congress should instead waive its Pay-As-You-Go (PAYGO) rules and deficit finance the cost of the AMT package. Recently, some advocates of this view have offered a new justification for their position. Including offsetting revenue measures, they claim, would dampen AMT relief's positive, stimulus impact on a possibly weakening economy.

Even if this were a valid concern with respect to some types of revenue-raising provisions, it does not apply to the revenue raisers included in the House-passed AMT patch bill. These provisions have three important characteristics.

  • They would have little impact on tax bills or the economy in the short term. While the AMT patch and other provisions of the House bill would together provide $56 billion in tax cuts in fiscal year 2008, the measures that offset them would raise less than $5 billion in 2008; the bill would recoup the rest of the revenue over the following nine years. This means that any short-run stimulus that would result from the AMT bill would not be materially reduced by the offsets. (See Figure 1.)[1]

At times when Congress has reason to be concerned both about the health of the economy and about the nation’s fiscal health, this approach — providing tax cuts or expenditure increases up front and offsetting their cost over ten years — has much to recommend it. In 2001, this approach was explicitly endorsed by the Chairmen and Ranking Members of both the House and Senate Budget Committees. Laying out principles for economic stimulus, they wrote, “outyear offsets should make up over time for the cost of near-term economic stimulus.”

  • The most significant revenue raisers in the House AMT bill raise considerable revenue when the affected industries are faring well but little revenue when they are doing poorly. To the extent that the health of these industries tracks the overall state of the economy, this means that these provisions will raise little revenue — and have little impact on tax levels — if the economy goes into a recession. They will raise revenue later, when the economy recovers.


  • The House offsets raise revenue primarily from high-income individuals, further dampening their short-term economic impact. Economic stimulus measures have the greatest impact when they put money in the hands of individuals who will spend rather than save it. For this reason, tax-side stimulus is generally more effective when it is targeted to low- and moderate-income, rather than high-income, households. As a 2002 Congressional Budget Office report concluded, “higher-income households save more of their income than do lower-income households… Consequently, tax cuts that are targeted toward lower-income households are likely to generate more stimulus dollar for dollar of revenue loss — that is, be more cost-effective and have more bang for the buck — than those concentrated among higher-income households.”

Conversely, revenue raising measures will have less impact on the economy in the short run when they take money out of the hands of those who are likely to save rather than spend it: that is, when they raise revenue from high-income individuals. The major offsets in the House AMT bill would do exactly that since they would close tax loopholes that primarily affect private equity and hedge fund managers, two very high-income groups.