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, November 30, 2009

Obama team undercounts jobs from Recovery Act, according to CBPP

The Center on Budget and Policy Priorities revealed last week that because of omissions and faulty reporting requirements, the impact of Obama stimulus program, the American Recovery and Redevelopment Act, was significantly underreported in its October 30 data. While a countervailing negative stimulus from states and municipalities closing down shop and no help from private investment will wash away any positive effect from the Recovery Act, it is important to recognize that there is a positive effect.

Release on Jobs Created by the Economic Recovery Law: What it Told Us and What it Didn’t

The Obama Administration’s October 30 release of data on jobs created and saved by the American Recovery and Reinvestment Act (ARRA), which the Administration and Congress enacted early this year, captured only a portion of the jobs created and saved due to ARRA’s limited reporting requirements.

According to the Government Accountability Office, ARRA’s reporting system covered only 27 percent of ARRA expenditures through September 30.  Most of ARRA’s distributed dollars to date have gone directly to individuals (including greater jobless benefits and food stamps) and states (including greater federal support for Medicaid). Although these dollars are likely protecting or creating many jobs, none of the aid for individuals or the Medicaid support are reflected in the October 30 jobs data release.

Moreover, the release did not even capture all of the jobs created by the 27 percent of ARRA funds for which the government reported. Recipients of ARRA grants and loans, for instance, reported on the jobs that they created or retained, but such reporting did not capture the jobs that were indirectly generated by the projects in question, such as by suppliers of goods and services to the projects.

Separate from the October 30 jobs data release, ARRA requires the President’s Council of Economic Advisers (CEA) to report each quarter on the law’s full impact in protecting or creating jobs. The CEA’s next quarterly report, to be released late this year or early next year, will incorporate the jobs data released on October 30. That report will provide a better measure of ARRA’s jobs impact than what the Administration reported on October 30.

Most Recovery Act Spending Is Not Included in the October 30 Jobs Data Release

Some 73 percent of the Recovery Act’s spending through September 30 is outside of the jobs reporting requirements in the Act. But there is substantial reason to believe that it includes some of the most effective job-creation and job-protection measures, even though it would have been meaningless to mandate that the specific jobs created by these programs be tracked.

  • Jobs generated by federal aid going directly to individuals will not be reported. These provisions, totaling more than $30 billion as of the end of August, include a boost in unemployment insurance benefits for laid-off workers and an increase in food stamp benefits for vulnerable families (see Appendix). The tens of millions of individuals receiving these benefits spend them at grocery stores and other businesses, making it easier for these businesses to retain their existing employees or hire more workers. The employees of those businesses consequently have more income than they would have otherwise, allowing them to spend more, which props up the revenue of other businesses. Economist Mark Zandi of Moody’s Economy.com estimates that every dollar spent on extending unemployment insurance benefits produces $1.63 in economic activity, and every dollar spent on temporarily increasing food stamp benefits produces $1.73 in economic activity. [2] Although this increased economic activity produces and sustains jobs, the Recovery Act exempts individual recipients of Recovery Act aid from the jobs reporting requirements because it is impractical for individuals to track how their spending affects jobs after it leaves their hands.

  • * Jobs generated by additional Medicaid funds to states will not be reported. As of the end of September, states had spent $31 billion in extra Medicaid support provided through the Recovery Act (see Appendix). According to the Government Accountability Office, states have used these funds in part to pay hospitals, doctors, and others to provide health care to the rising number of families that have lost jobs and income and therefore are eligible for public insurance. [3] As a result, health care providers have more income and hence are more able to sustain or increase the number of doctors, nurses, and other staff they employ. The GAO reports that states have also used the extra Medicaid support to avoid cuts in other areas of state government (such as education and human services) and to minimize tax increases that otherwise would be necessitated by state balanced budget requirements. Such actions have bolstered income for state residents, jobs for state employees, and profits for private firms contracting with the government.
  • Despite the value of this spending for sustaining and creating jobs, the Recovery Act exempts states from reporting jobs created with the Medicaid funds. The technical reason for this exemption is that generally the Act covers jobs created with “appropriations,” and Medicaid is not considered an “appropriation” under federal budget rules. But there is also a practical reason: Medicaid spending occurs through a very large number of individual transactions between states and primarily private sector health care providers. For states to track the jobs produced and sustained in the private sector by these myriad transactions would be impractical and overly burdensome on states.

  • Jobs generated by tax cuts will not be reported. As of the end of August, Recovery Act tax cuts had delivered about $66 billion to hundreds of millions of individual and business taxpayers. Although taxpayers have saved some of this money, they have also spent much of it at businesses in their communities and other parts of the United States. This spending has produced income for U.S. businesses, allowing these firms to keep current employees and in some cases hire more. But it is impractical to expect individuals and businesses receiving tax breaks to determine the impact of their tax break spending on U.S. jobs. As a result, the Recovery Act exempts recipients of tax breaks from the jobs reporting requirements.

Even Among Spending Included in the Jobs Report, a Significant Share of Jobs Are Missed

While most recipients of Recovery Act funds this year are exempted from reporting on jobs they created or sustained, some recipients are required to submit quarterly reports. The first quarterly reports were due October 10. The Obama Administration released preliminary data from some of these reports — those submitted by recipients of federal contracts — on October 15. The Administration released the remaining jobs data — those submitted by recipients of grants and loans — on October 30, along with finalized jobs figures for contract recipients.

In their reports, recipients were required to list the number of jobs they created or retained with Recovery Act funds. Recipients of grants and loans were required to list the number of jobs created or retained by direct sub-recipients that helped complete the project.

Despite these requirements, a significant share of jobs generated by these projects was not included in the reports. That is in part because no recipients were required to report on jobs indirectly generated by the project. Hence, no jobs saved or produced by the Recovery Act in firms that serve as suppliers to Recovery Act projects were included, though clearly these suppliers benefited from the Act. In addition, recipients were not required to estimate the number of jobs induced in the economy as a result of the workers on Recovery Act projects spending the wages they received. The Council of Economic Advisers estimates that these “induced” jobs will account for 36 percent of all “job-years” produced by the Recovery Act. The Council defines a “job-year” as one job for one year.

Sunday, November 29, 2009

Brad DeLong defends the deficit

Here is a spirited center-left discussion of why expanding the deficit is good, is favored by the market, and is the appropriate public policy. Demand Side am not convinced the market knows what it needs nor that revenue is not an appropriate financing mechanism for necessary government expansion, in which case the deficit would not need to rise. But we are alone out here, and thought you might like to hear the favored line.
Why Are Good Policies Bad Politics?
J. Bradford DeLong
Project Syndicate
November 28, 2009

From the day after the collapse of Lehman Brothers last year, the policies followed by the United States Treasury, the US Federal Reserve, and the administrations of Presidents George W. Bush and Barack Obama have been sound and helpful. The alternative – standing back and letting the markets handle things – would have brought America and the world higher unemployment than now exists. Credit easing and support of the banking system helped significantly by preventing much worse.

The fact that investment bankers did not go bankrupt last December and are profiting immensely this year is a side issue. Every extra percentage point of unemployment lasting for two years costs $400 billion. A recession twice as deep as the one we have had would have cost the US roughly $2 trillion – and cost the world as a whole four times as much.

In comparison, the bonuses at Goldman Sachs are a rounding error. And any attempt to make investment bankers suffer more last fall and winter would have put the entire support operation at risk. As Fed Vice Chairman Don Kohn said, ensuring that a few thousand investment bankers receive their just financial punishment is a non-starter when attempts to do so put the jobs of millions of Americans – and tens of millions outside the US – at risk.

The Obama administration’s fiscal stimulus has also significantly helped the economy. Though the jury is still out on the effect of the tax cuts in the stimulus, aid to states has been a job-saving success, and the flow of government spending on a whole variety of relatively useful projects is set to boost production and employment in the same way that consumer spending boosts production and employment.

And the cost of carrying the extra debt incurred is extraordinarily low: $12 billion a year of extra taxes would be enough to finance the fiscal-stimulus program at current interest rates. For that price, American taxpayers will get an extra $1 trillion of goods and services, and employment will be higher by about ten million job-years.

The valid complaints about fiscal policy over the past 14 months are not that it has run up the national debt and rewarded the princes of Wall Street, but rather that it has been too limited – that we ought to have done more. Yet these policies are political losers now: nobody is proposing more stimulus.

This is strange, because usually when something works the natural impulse is to do it again. Good policies that are boosting production and employment without causing inflation ought to be politically popular, right?

With respect to Obama’s stimulus package, it seems to me that there has been extraordinary intellectual and political dishonesty on the American right, which the press refuses to see.

For two and a half centuries, economists have believed that the flow of spending in an economy goes up whenever groups of people decide to spend more. Sometimes spending rises because there is more disposable cash in the economy, and sometimes because changes in opportunity costs – the cost of forgoing some other action, such as saving – make people want to spend the cash they have more rapidly. Sometimes and to some degree these increases show up as increases in prices, and sometimes and to some degree as increases in production and employment.

But, whatever the cause or effect, spending always goes up whenever groups decide to spend more – and government decisions to spend more are as good as anybody else’s. They are as good as the decisions of mortgage companies and new homebuyers to spend more on new houses during the housing bubble of the mid-2000’s, or of the princes of Silicon Valley to spend more building new companies during the dot-com bubble of the late 1990’s.

Obama’s Republican opponents, who claim that fiscal stimulus cannot work, rely on arguments that are incoherent at best, and usually simply wrong, if not mendacious. Remember that back in 1993, when the Clinton administration’s analyses led it to seek to spend less and reduce the deficit, the Republicans said that that would destroy the economy, too.

Such claims were as wrong then as they are now. But how many media reports make even a cursory effort to evaluate them?

A stronger argument, though not by much, is that the fiscal stimulus is boosting employment and production, but at too great a long-run cost because it has produced too large a boost in America's national debt. If interest rates on US Treasury securities were high and rising rapidly as the debt grew, I would agree with this argument. But interest rates on US Treasury securities are very low and are not rising. Every single Treasury auction, at which the market gobbles up huge new tranches of US Treasury debt at high prices, belies the argument that the economy has too much debt.

Those who claim that America has a debt problem, and that a debt problem cannot be cured with more debt, ignore (sometimes deliberately) that private debt and US Treasury debt have been very different animals – moving in different directions and behaving in different ways – since the start of the financial crisis.

What the market is saying is not that the economy has too much debt, but that it has too much private debt, which is why prices of corporate bonds are low and firms find financing expensive. The market is also saying – clearly and repeatedly – that the economy has too little public US government debt, which is why everyone wants to hold it.

Copyright: Project Syndicate, 2009.

Saturday, November 28, 2009

Relay: Keen on Debt

Listen to this episode

Economist Steve Keen speaks on the outlook for the financial crisis

Bill Black and the rest of us wonder why Obama is rewarding the wrecking crew

Pragmatism was the catchword of the Obama administration's ascent to power.  Do things until something worked.  Unfortunately, things haven't worked.  Even more unfortunately the authors of the mess have been rewarded with re-upping.   Continuity may have had its place in the darkest days of crisis, which the interregnum was, but now it is only continuing the crisis.  Black offers ten steps.  #1:  Can the wrecking crew.
Why is Obama Championing Bush’s Financial Wrecking Crew?
Bill Black
New Deal 2.0
November 23, 2009

Tom Frank’s book, The Wrecking Crew explains how the Bush administration destroyed effective government and damaged our social fabric and our economy. The Obama administration has chosen to reward two of the worst leaders of Bush’s crew — Geithner and Bernanke - with promotion and reappointment. Embracing the Wrecking Crew’s most destructive members has further damaged the economy and caused increasing political and moral injury to the administration.

Last week was a bad one for Geithner and Bernanke. Senator Dodd said that Bernanke’s confirmation was no longer a done deal. The House Financial Services Committee revolted against the administration, the Fed, and Chairman Barney Frank. It voted for a strong bill to audit the Fed. Senate Banking Chairman Schumer went to a conference at Columbia University — where a generation of students salivated at the prospects of Wall Street wealth — and was overwhelmed by an audience denouncing the continuing stranglehold of the finance industry over successive administrations and the Congress. Neither Barney’s blarney nor Schumer’s schmooze was any avail before an outraged public.

The administration promptly secured a column in the Washington Post claiming that the effort to fire Geithner “buoy[ed]” him because, as the subtitle to the article explained: “Even ex-Bush aides sympathetic, sources say.” The article didn’t note that Geithner is an “ex-Bush” senior official who, with his fellow “ex-Bush aides” (particularly Bernanke and Paulson) produced a chain of disasters: the bubble, an “epidemic of mortgage fraud” by lenders, the Great Recession, and the scandalous TARP and AIG bailouts. Of course they’re “sympathetic” to a fellow member of the Wrecking Crew that destroyed effective regulation and turned the nation over to Wall Street. The craziest part of the story is that the anonymous Obama administration flack that spread this anecdote believes that we should support Geithner because his fellow members of the Bush Wrecking Crew empathize with him because they, too, have been criticized for wrecking the economy.

The Washington Post article then offers a metaphor that serves as an apology for the Bush Wrecking Crew. The metaphor is driving over a cliff: “‘Secretary Geithner has helped steer the American economy back from the brink, and is now leading the effort on financial reform,’ White House spokeswoman Jen Psaki said.” Geithner pushed back against Republicans who questioned his performance, telling them, “you gave this president an economy falling off the cliff.”

You? How about we? Bush’s financial Wrecking Crew “gave this president an economy falling off the cliff.” Geithner was President of the Federal Reserve Bank of New York from October 23, 2003 until President Obama chose him as his Treasury Secretary. He was supposed to be the lead regulator of many of the largest bank holding companies. His failures as a regulator were a major cause of the “economy falling off the cliff.” Bernanke held prominent positions in the Bush administration from 2002 to the end of the administration and failed as a regulator an economist. Geithner and Bernanke failed to regulate even after the FBI publicly warned in September 2004 that (1) there was an “epidemic” of mortgage fraud and (2) it would lead to a financial crisis if it were not contained. Their refusal to take responsibility for the harm they inflicted on our nation as leaders of Bush’s financial Wrecking Crew adds to their unsuitability. Rewarding their perennial failures with a promotion and reappointment represents a dereliction of duty by the Obama administration.

The administration apologists praise Geithner and Bernanke for “steer[ing] the American economy back from the brink.” Greenspan, Paulson, Bernanke, and Geithner were the leaders of Bush’s financial Wrecking Crew. They were the guys blinded by their pro-Wall Street ideology that drove the car 120 mph down an icy mountain road and lost control of it. They took us to the “brink” of running “off the cliff” and creating the Second Great Depression. The bizarre claim is that we should praise them because they, and Wall Street, only wrecked the economy — they haven’t (yet) utterly destroyed it. Under their metaphor, we’re supposed to cheer Geithner and Bernanke because once they finally figured out that they were careening toward the cliff, they decided to sideswipe a row of trees in order to avoid going over the edge. They wrecked the car but they walked away from the crash without a scratch. If your teenager gets drunk, speeds, crashes into a school bus (injuring dozens of kids), and flips the Ford Focus — but walks away from the crash — you don’t praise him, give him the keys to the family minivan, and have him drive the soccer team to practices. You take all the keys away from him and ground him.

The Obama administration promoted Bush’s architects of the financial disaster and demands that we hail them as heroes. President Bush was ridiculed for saying: “Brownie, you’re doing a heck of a job.” FEMA administrator Michael Brown stood by while Hurricane Katrina reduced a single large city to ruin. Geithner and Bernanke stood by while scores of large cities were devastated.

I suggest that we will build on the momentum we’ve achieved on the Fed audit by making the following issues our near term financial priorities:

1. Can the Wrecking Crew. Fire the senior leaders of Bush’s and Clinton’s financial Wrecking Crews and stopping treating them as financial experts. President Obama should not reappoint Bernanke as Fed Chairman. He should dismiss Geithner and Summers and cease to take any advise from Rubin. Replace them with the Reconstruction Crew — people with a track record of getting things right and being effective economists, regulators, and prosecutors. Members of Bush’s financial Wrecking Crew run far too many regulatory agencies, often as “Actings.” They can, and should, be replaced promptly.

2. End “too big to fail.” These banks are “systemically dangerous institutions” (SDIs). They should not be allowed to grow. They should be shrunk to the point that they no longer pose systemic risk, and they should be subject to vigorous regulation while shrinking. They are too big to manage and too big to regulate. They are ticking time bombs that will cause recurrent global crises as long as they are SDIs.

3. More white-collar watchdogs. Adopt Representative Kaptur’s proposal to provide the FBI with at least 1000 additional white-collar specialists. Senator Durbin and (then) Senator Obama made a similar proposal several years ago.

4. No more executive compensation looting. End the perverse executive compensation systems that reward failure and fraud. The private sector has made compensation worse since the crisis. Modern executive compensation creates a virtually perfect crime — “accounting control fraud” (looting a company for personal profit).  Until we fix the perverse incentives of executive compensation we will have recurrent epidemics of fraud and global financial crises.

5. Kill TARP and PPIP. Use the funds to help honest homeowners that would otherwise lose their homes because of predatory loan terms.

6. Make the Federal Reserve System public. It is a largely private structure that creates intense conflicts of interest and ensures that it is controlled by the systemically dangerous institutions. We have already decided that such a structure is inherently improper. The Federal Home Loan Bank System was set up along the same institutional lines and suffered from the same conflicts of interest. Congress ordered an end to these conflicts in the 1989 FIRREA legislation. It should end private control of the Fed.

7. Defeat any proposal to make the Fed the “Uberregulator.” The Fed, for inherent institutional reasons, is unsuited to be the “systemic risk regulator.” The Fed has never cared about regulation. The Fed cares about monetary policy and (theoclassical) economic theory and research. Regulation is, at best, a tertiary concern. Its economists wrote frequently about systemic risk — but missed the obvious, massive systemic risk of the financial bubble and the epidemic of accounting control fraud. Its policies intensified rather than restricting systemic risk. Theoclassical economists have no effective theories (or policies) to deal with bubbles or epidemics of accounting control fraud. Greenspan, Bernanke, and Geithner epitomize the Fed’s inability to recognize or reduce systemic risk. Their policies consistently increased systemic risk. Greenspan didn’t believe that the Fed should act against fraud. Geithner testified before Congress that he had never been a regulator (a true statement - but one that should have gotten him fired rather than promoted). Bernanke praised the subprime loans that caused the crisis and were so often fraudulent.

8. Ensure a robust CFPA. Sever the Consumer Financial Product Agency portion from the broader (and deeply flawed) regulatory reform bills in the House and Senate and adopt it into law. Revise the broader bill to strip out its many anti-reform provisions.

9. End the waste of long-term unemployment. Anyone able and willing to work should be employed by the government as an employer of last resort and should help repair our crumbling infrastructure. Paying people to do nothing or allowing them to become homeless (the status quo) is an insane system.

10. Adopt a $250 billion revenue sharing program. American state and local governments are in economic crisis. They are slashing spending at the worst possible time when their services are most vital and when cutting spending is pro-cyclical and will delay our recovery from the Great Recession. Revenue sharing was a Republican initiative. Republicans and “Blue Dog” Democrats killed the revenue sharing provisions of the administration’s proposed Stimulus bill. That was an enormous mistake. The federal government is not like a state government (or a household). It is a sovereign government with its own currency and a central bank. It can - and should - run large deficits during deep recessions, but the states and local governments cannot. Revenue sharing is the ideal answer to the crisis and it is an answer with an impeccable conservative pedigree. State and local governments should come together and demand a program to offset the state and local cutbacks - roughly $250 billion. (The Obama administration’s claim that reducing the deficit should be a priority - at a time when unemployment has reached tragic levels - is economically illiterate. It repeats the error that FDR made when he listened to conservative economic advisors and slashed the budget deficit during the Great Depression - causing a surge in unemployment and the extension of the depression. The large federal deficits of World War II reversed the policies of his conservative economic advisors and ended the Great Depression.)

Friday, November 27, 2009

Taxing financial bads is economically efficient, Paul Krugman agrees

The deficit hawks are exposed in the headlights when revenue options get a fair hearing. The multiplicity of financial transactions, from hot money currency speculation to the trading games from the ex-Enron operatives on Wall Street, have nothing to do with financial stability or financial health, except in the negative sense. Taxing them, in fact, is a good way to get some of the bailout money back in the hands of the taxpayer. Here, Paul Krugman lays it out nicely for us.
Taxing the Speculators
New York Times
November 26, 2009

Should we use taxes to deter financial speculation? Yes, say top British officials, who oversee the City of London, one of the world’s two great banking centers. Other European governments agree — and they’re right.

Unfortunately, United States officials — especially Timothy Geithner, the Treasury secretary — are dead set against the proposal. Let’s hope they reconsider: a financial transactions tax is an idea whose time has come.

The dispute began back in August, when Adair Turner, Britain’s top financial regulator, called for a tax on financial transactions as a way to discourage “socially useless” activities. Gordon Brown, the British prime minister, picked up on his proposal, which he presented at the Group of 20 meeting of leading economies this month.

Why is this a good idea? The Turner-Brown proposal is a modern version of an idea originally floated in 1972 by the late James Tobin, the Nobel-winning Yale economist. Tobin argued that currency speculation — money moving internationally to bet on fluctuations in exchange rates — was having a disruptive effect on the world economy. To reduce these disruptions, he called for a small tax on every exchange of currencies.

Such a tax would be a trivial expense for people engaged in foreign trade or long-term investment; but it would be a major disincentive for people trying to make a fast buck (or euro, or yen) by outguessing the markets over the course of a few days or weeks. It would, as Tobin said, “throw some sand in the well-greased wheels” of speculation.

Tobin’s idea went nowhere at the time. Later, much to his dismay, it became a favorite hobbyhorse of the anti-globalization left. But the Turner-Brown proposal, which would apply a “Tobin tax” to all financial transactions — not just those involving foreign currency — is very much in Tobin’s spirit. It would be a trivial expense for long-term investors, but it would deter much of the churning that now takes place in our hyperactive financial markets.

This would be a bad thing if financial hyperactivity were productive. But after the debacle of the past two years, there’s broad agreement — I’m tempted to say, agreement on the part of almost everyone not on the financial industry’s payroll — with Mr. Turner’s assertion that a lot of what Wall Street and the City do is “socially useless.” And a transactions tax could generate substantial revenue, helping alleviate fears about government deficits. What’s not to like?

The main argument made by opponents of a financial transactions tax is that it would be unworkable, because traders would find ways to avoid it. Some also argue that it wouldn’t do anything to deter the socially damaging behavior that caused our current crisis. But neither claim stands up to scrutiny.

On the claim that financial transactions can’t be taxed: modern trading is a highly centralized affair. Take, for example, Tobin’s original proposal to tax foreign exchange trades. How can you do this, when currency traders are located all over the world? The answer is, while traders are all over the place, a majority of their transactions are settled — i.e., payment is made — at a single London-based institution. This centralization keeps the cost of transactions low, which is what makes the huge volume of wheeling and dealing possible. It also, however, makes these transactions relatively easy to identify and tax.

What about the claim that a financial transactions tax doesn’t address the real problem? It’s true that a transactions tax wouldn’t have stopped lenders from making bad loans, or gullible investors from buying toxic waste backed by those loans.

But bad investments aren’t the whole story of the crisis. What turned those bad investments into catastrophe was the financial system’s excessive reliance on short-term money.

As Gary Gorton and Andrew Metrick of Yale have shown, by 2007 the United States banking system had become crucially dependent on “repo” transactions, in which financial institutions sell assets to investors while promising to buy them back after a short period — often a single day. Losses in subprime and other assets triggered a banking crisis because they undermined this system — there was a “run on repo.”

And a financial transactions tax, by discouraging reliance on ultra-short-run financing, would have made such a run much less likely. So contrary to what the skeptics say, such a tax would have helped prevent the current crisis — and could help us avoid a future replay.

Would a Tobin tax solve all our problems? Of course not. But it could be part of the process of shrinking our bloated financial sector. On this, as on other issues, the Obama administration needs to free its mind from Wall Street’s thrall.

Transcript Demand Side 325: Forecast continued inflation

Listen to this episode
Plus Steve Keen and Hyman Minsky on debt deflation
nd a comment on the Fed's fanciful independence.

Today's forecast defends our call at Demand Side that the Great Recession has not ended.  Growth in Q3 and possibly Q4 is noise from record government subsidy, not a turn in the business cycle.

The Conference Board said Thursday that its index of leading economic indicators rose 0.3 percent last month. Economists polled by Thomson Reuters had expected an 0.5 percent gain.  The index of leading indicators has been a major positive for recovery fans, who remark on its seven months of positive showings, forgetting how poorly the index performed at the turn of 2007-08 and failed to predict the Great Recession, largely on the effect of stock prices then.  You'll remember the peak.  October 2007.

Taking a look at the details of the leading indicators, we see that the vast majority of the upside push is provided by three items:  the interest rate spread, the money supply and stock prices.   Absent the continuing effects of these, the negative effects of supplier deliveries, building permits and consumer expectations would have pushed leading indicators negative.

Answer for yourself whether stocks and monetary aggregates are rebounding as a result of business cycle recovery or as a result of policy manipulation.

Elsewhere David Rosenberg cites sources saying the 3.5 percent 3rd quarter number is already being retracted to 2.5 percent.  Our oft-quoted Steve Keen has pointed out the absurdly high contribution of 1.66% of the growth was due to increased motor vehicle output, which was primarily driven by the government’s “Cash for Clunkers” program. Another 0.48% was due to the growth in government expenditure and investment rising an improbable 11.5%, due primarily to a whopping 23.4% in residential investment.  How likely is that?

Meredith Whitney, noted Wall Street analyst who called the collapse, in fact calls it her major worry that the entire housing market is being supported by the Fed, which holds 1.25 trillion dollars of decreasingly valuable mortgage-related paper on its balance sheet.  Who will buy it?  And who will step in when the Fed steps out?  Many analysts are predicting another ten percent leg down in housing. 

Demand Side asks you to consider what effect $1.25 trillion in direct aid to debtors would have had.  Next week's forecast will estimate the impact of not following the Home Owners Loan Corporation model, but rather ratifying as much as possible the claims of the lenders and giving the borrowers more time.

Rosenberg notes also the consensus forecast believes that the unemployment rate will peak this quarter at 10.2%. That is remarkable, he says, because we know that in a garden-variety manufacturing recession, the jobless rate lags by 2-3 months. But in a credit and asset cycle, it lags by 12-18 months.


"As for Q4, it looks like restocking in the automotive sector is the big story and likely to underpin growth. We could see a 3.5% on headline GDP, but only 0.5% on real final sales, which is key."

At Demand Side, we're sticking with our claim that the recession has not ended.  We see twelve percent unemployment already baked in, and twenty percent in the all-in U-6 measure. 

Debt Deflation

We see that Minsky's debt deflation is not well explained in tomorrow's relay of a Steve Keen talk, as we promised, so we'll borrow from Mr. Keen's book Debunking Economics to outline what exactly debt deflation is.

After liability structures have gotten out of hand in a boom, and a reversal in the growth of asset values is visited on the Ponzi financiers and other actors, increasing debt to equity ratios affect the viability of business activities.  Cash flows cannot finance debt service.   Liquidity is suddenly much more highly prized, holders of illiquid assets attempt to sell them. The asset market becomes flooded and the euphoria becomes a panic, the boom becomes a slump.

Investment collapses, leaving only two forces that can bring asset prices and cash flows back into harmony: asset price deflation, or current price inflation. This dilemma is the foundation of Minsky’s iconoclastic perception of the role of inflation, and his explanation for the stagflation of the 1970s and early 1980s. Minsky argues that if the rate of inflation is high at the time of the crisis, then though the collapse of the boom causes investment to slump and economic growth to falter, rising cash flows rapidly enable the repayment of debt incurred during the boom.

The economy can thus emerge from the crisis with diminished growth and high inflation, but few bankruptcies and a sustained decrease in liquidity. Thus though this course involves the twin ‘bads’ of inflation and initially low growth, it is a self-correcting mechanism in that a prolonged slump is avoided. However, the conditions are soon re-established for the cycle to repeat itself.

If the rate of inflation is low at the time of the crisis, then cash flows will remain inadequate relative to the debt structures. Firms whose interest bills exceed their cash flows will be forced to undertake extreme measures: sell assets, increase their cash flows at the expense of their competitors, or go bankrupt. All three classes of action tend to further depress the current price level.

If assets are sold as going concerns, then those who buy them face a lower cost of capital, and can undercut their rivals in the current goods market. If firms attempt to increase cash flows by reducing their markups, they can instigate a race to the bottom.  If firms go bankrupt, their stocks and assets will be sold into depressed markets, thus further reducing current prices.

The asset price deflation route is therefore not self-correcting but rather self-reinforcing, and is Minsky’s explanation of a depression. Thus while Minsky still sees inflation as a problem during stable periods, he perceives it in quite a different light during a time of crisis. The fundamental problem during a financial crisis is the imbalance between the debts incurred to purchase assets, and the cash flows those assets generate. A high rate of inflation during a crisis enables debts that were based on unrealistic expectations to be nonetheless validated, albeit over a longer period than planned and with far less real gain to the investors. A low rate of inflation will mean that those debts cannot be met, with consequent domino effects even for investments that were not unrealistic.


Listening to Steve Keen reminds us that it was not just the Chicago School who missed the crisis, but the great swath of mainstream economists of all stripes.  We at Demand Side hit the call on the housing bubble, but we did not see the financial crisis until we were alerted by the likes of Nouriel Roubini in late 2007.  We are reminded again that it is not only conservative economists who need to revisit their assumptions and revise their views.

Today's example is Alan Blinder and Mark Thoma who support the illusion of Fed independence.  This is even more fatuous than the belief in economic stability in the midst of the housing bubble.

Blinder recently wrote, and Thoma seconded:

"In academia and in the financial markets, the overwhelming attitude is: Hurrah, and thank goodness, for Ben Bernanke, who gets kudos for his boldness, creativity and smarts."

Calling on the good sense of Academia and Wall Street is a bit strange.  I have a vision of somebody blindsided by a bus raising a broken hand and bleating "Good thing the driver is keeping the speed up."  The Fed didn't see it coming, when it came they couldn't manage to avoid the worst, and after the fact they are now denying the obvious remedies, plus ignoring their residue of $1.25 trillion in rapidly devaluating mortgage backed securities on the Fed's balance sheet. Great.  Clever.  Creative.

Bernanke's "save the big banks first" strategy is increasingly flimsy, a "keep the bonuses flowing while one-quarter of children go hungry" strategy.  It shows how little he knew about the Great Depression and how much he was willing to risk on his unproven hypothesis.  Then as now it is income flows that have to be restarted, not balance sheet flows.

And who gave the Fed this independence? Was there a law or Constitutional amendment that created a fourth branch of government? After they bungled the Great Depression, there was little appetite in the country for giving them more power.  They waited until in the middle of the night in 1951 when Truman was preoccupied and politically impaired by the MacArthur in Korea fiasco.  Then they broke free to make interest rate policy on their own. The so-called "Treasury Accord."

It wouldn't be a problem if the Fed was independent like the SEC or FDA or every other "independent" government agency. But they are independent like they can spend trillions of dollars with no control. They are independent of everybody but their owner banks.  Whether Academia and Wall Street approve, history will not.

Thursday, November 26, 2009

Maria Cantwell gets the nod from Robert Kuttner

We've featured the junior senator from Washington State on the podcast recently, and we agree with Kuttner that she is progressive, intelligent, determined and effective.  Another dozen like her and we could have our country back again.  Only the first part of the piece is reproduced, because we'd like you to visit the American Prospect site where the rest is resting.
Wall Street Meets Its Match    If Congress ends up with effective financial regulation, Sen. Maria Cantwell will deserve a lot of the credit.   
Robert Kuttner
American Prospect
November 23, 2009   

In the showdown over the regulation of potentially toxic securities like credit-default swaps, the savviest and toughest battler for effective legislation turns out to be not Barney Frank or Chris Dodd, who chair the key House and Senate financial committees. Surprisingly, the best informed and most relentless crusader is a back-bench senator from Washington state, Maria Cantwell. If you want to see how one determined junior legislator can make a difference, Cantwell is your woman.

Cantwell, a big booster of Barack Obama, is determined to push his administration to deliver on fundamental reforms to the financial system -- and dismayed by what she's seen to date from Obama's staff. "If there are people at the Treasury and the White House who think that the way to get the economy going again is not to close these loopholes," she told me in an interview, "that's disgusting."

Cantwell, who just turned 51, is a former tech executive who won a squeaker of an election in 2000 by less than one-tenth of 1 percent of the vote. She is the kind of senator who is even better informed on the details of a complex issue than her highly competent staff. Washingtonian magazine once dubbed her a "Hill hottie," but in her efforts to reform the black holes of the financial system, and in her little-known but critical role in health reform, her undeniable charm is far less important than her tenacity and brains.

She tends to win arguments not with bluster or horse-trading but with deep knowledge of her subject and a refusal to be bluffed or to back down. For example, during the October markup of health-reform legislation in the Senate Finance Committee, Cantwell crafted an amendment, modeled on a Washington state program, that would allow states to negotiate with insurance companies on the terms of coverage for those eligible for subsidies and for other citizens buying in. By giving the government bargaining power, her amendment salvages some of the cost-containment goals of the more contentious "public option." And the committee adopted it by consent. "Senator Cantwell has done amazing work," her colleague Sen. Charles Schumer of New York told the committee. "The unsung hero of this bill is her amendment on costs." Moves like this are the hallmark of the truly effective legislator.

But the most lasting impact of her diligent approach to public policy is likely to come from her crusade for financial reform, particularly the fight over regulation of derivatives. Derivatives are securities at one or more layers of abstraction from real economic transactions. A mortgage loan, for example, is a real transaction. A bond backed by a sub-prime mortgage loan is a derivative. A package of such bonds is an even more abstract derivative. And a credit-default swap, which is an insurance policy against such packages of bonds going bad, is four levels removed from financial reality. At each stage of abstraction, derivatives invite pyramids of leverage and huge speculative profits for insiders -- as long as the bubble keeps inflating. When the bubble bursts, the losses can be as infinite as the capital is infinitesimal.
continue at American Prospect

Wednesday, November 25, 2009

What if recovery is all in the economists' heads?

Barry Ritholz takes issue with the proposition from Robert Shiller that the recovery is over because people are feeling better, and it is time for the recovery to be over. He is much more polite than we are at Demand Side.
How Overrated is Sentiment in Economics?
from The Big Picture
by Barry Ritholtz
November 22, 2009

There is a small cadre of Economists — original thinkers, contrarians, out of the box theorists — I respect a great deal. It is a modest list ranging from Richard Thaler to David Rosenberg to Robert Shiller, with lots of econ wonks in between.

This morning, however, I find myself somewhat disagreeing with the main premise of Professor Shiller’s NYT column. For those of you who are unaware, the Sunday Times Business section (now that Ben Stein is gone) is a veritable Murderers’ Row, the 1927 Yankees of economic thought and insight. Its one high percentage power hitter after another, with very little weakness in the line up. Shiller is one of the star batters.

It is with some trepidation that I point out what I find to be flaws in Shiller’s discussion about the recovery, titled “What if a Recovery Is All in Your Head?.” Its a thought provoking but unpersuasive argument, as we shall soon see. To be fair, he uses the column to provoke a debate, rather than defend the position that the recovery is “all mental.”

I found numerous things worth challenging in the column. Let’s start with the basic premise:

“Beyond fiscal stimulus and government bailouts, the economic recovery that appears under way may be based on little more than self-fulfilling prophecy.

Consider this possibility: after all these months, people start to think it’s time for the recession to end. The very thought begins to renew confidence, and some people start spending again — in turn, generating visible signs of recovery. This may seem absurd, and is rarely mentioned as an explanation for mass behavior late in a recession, but economic theorists have long been fascinated by such a possibility.

The notion isn’t as farfetched as it may appear. As we all know, recessions generally last no more than a couple of years. The current recession began in December 2007, according to the National Bureau of Economic Research, so it is almost two years old. According to the standard schedule, we’re due for recovery. Given this knowledge, the mere passage of time may spur our confidence, though no formal statistical analysis can prove it.”

Here are 10 items that challenge the column’s main premise:

1. Time: The typical Recession lasts 8 months; We are now in month 23. If people started to spend because they sensed it was “Late in the recession” or that it was time for the contraction to end, well then, that would have been somewhere around August 2008.

2. Not Totally Irrational: One of my complaints about economics is it over-emphasizes people as rational, unemotional actors. However, when it comes to sentiment, economics seems to make the same mistake in the opposite direction — it assumes that people are foolish, unthinking creatures unable to engage in ANY rational thought whatsoever. All sentiment, no rationality at all.

The reality is quite different: Sometimes, people behave the way they do because they have figured out a problem and are responding to it intelligently.

3. Healthy Fear of Job Loss: Employed people began to spend their money more carefully when they saw coworkers getting laid off in increasing numbers. That is a rational act in the face of an increasing possibility of a loss of income. This is unlikely to change in the near future, so long as large public layoffs remain a news item.

4. Asset Deflation: Consumers cut back their spending when they saw their biggest assets (Homes, Stocks) lose a significant value. Again, a rational response to a change in personal financial conditions.

5. False Belief System: Earlier this year, the Dow had dropped over 5,000 points in 6 months. One of the collective fallacies our culture operates under is the delusion that the market is some kind of astute forecasting machine. It is not — it represents the collective wisdom of 10 million panicked monkeys. This is not a sentiment error, but is actually a faulty belief system. That millions of slightly clever, pants wearing primates can combine their collective ignorance, their intellectual foibles, biases and false beliefs somehow into something resembling intelligence was one of the false beliefs of the era. Unfortunately, this is a condition the monkeys are prone towards.

6. Doom Warnings Began Making Sense: Many of the doomsayers have been warning of the coming apocalypse for years. Jeremy Grantham, James Grant, Steve Roach, Nouriel Roubini, Robert Prechter, David Rosenberg, Mark Faber (and your own humble blogger). Why did this group suddenly gain traction in 2008? Maybe it was because the population is not as stupid as the politicians believe, and saw with their own eyes the decay in the economy. Suddenly, the warnings were not as far fetched as they previously seemed.

7. Reacting to Flat Income: Families have recognized their incomes have remained flat to negative over the past decade, while their expenses have increased. What should be the rational reaction to this realization? (Hint: a new car, a bigger house, a new vacation are not on the list of options).

8. Time to Exit the Bunkers: Ten months ago, people were betting the economic world was coming to an end. The economy was in freefall, and people had dramatically reduced spending. The freefall is now over, and while its arguable whether the recession is over (by some measures it is, others not) we can all agree the Great Recession ended in the Spring og ‘09. The US consumer is no longer frozen like deer in headlights.

9. The Cheerleaders Now Look Like Fools: At the onset of a recession, we often see cheerleaders, OpEd writers, and money losing fund managers make the argument that there is no economic slowdown — that the weakness is only in people’s minds. I call these people the Pervasive Pollyannas of Prosperity. (Think Phil Gramm, Amity Shlaes, Don Luskin). Some are partisans, others are dumb, others still merely incompetent — a few are all three. yet despite their best efforts of the cheerleaders, the economy still went into freefall.

10. Deleveraging: We know why this recession was so deep and long — the wanton use of leverage by people and financial institutions. The deleveraging that is taking place is a long slow process. It is rational, it is intelligent, and it will be how families will restore their balance sheets — the paradox of thrift be damned . . .

What if a Recovery Is All in Your Head?
NYT, November 21, 2009

Tuesday, November 24, 2009

Transcript: Demand Side 324 Steve Keen on Minsky

Listen to this episode
plus Idiot of the Week with William Dunkleberg

First a note, we are rehabilitating the old Demand Side format.  The consensus of listeners is that the podcast is too long.  Too much Demand, as it were.  We're going back to the twice weekly 10-12 minute format, but keeping the Saturday relays.  Friday will be forecast day.

That means there will be a lot left on the cutting room floor.  If you are really hungry, you can keep up to speed with the Demand Side Group of blogs and sites.  Access that at Demand Side Blog dot blogspot dot com.

Now today, Steve Keen on Minsky and seeing it coming, plus idiot of the week with William Dunkleberg.

What a find is Steve Keen.  An Australian economist who as you will hear is in the direct lineage of Keynes through Minsky. 


Steve Keen.  We'll have him back on Saturday with a full description of the Minsky view and debt deflation.  Don't miss that.  It is essential to understanding where we are and where we're going.  His blog is at debtdeflation.com.  

Next.  Idiot of the Week, with William Dunkleberg

Dunkleberg is chief economist of the NFIB, National Federation of Independent Businesses.  Here he is reporting to Tom Keen and a doorpost on the outcome of the NFIB's most recent survey.


It is no surprise to Demand Side that demand is the problem.  "How's business?" usually means how is demand, do you have any customers, and so on.  You would think this is exactly where Dunkleberg is going.  Stimulating incomes and demand and getting customers back in the store might be important. 


Yes.  The gutting of federal revenues by the Bush tax cuts had little to do with federal deficits, the housing bubble and debt deflation don't warrant a mention as causes of the current collapse, it is uncertainty about what congress is going to do.  Mr. Dunkleberg reliably informs us also that sun spots cause global warming and Elvis has returned to Memphis.

But there is a good reason beneath the vigorous pointing to Washington.  Mr. Dunkleberg is himself a banker, head of Liberty Bell Bank, a small bank in southern New Jersey.  But a bank which pumped home equity loans to people who are now under water, who wrote $300,000 mortgages on $200,000 houses, who resists every possible reduction of principle on these loans, and who is now sad for small business having no demand because Washington is worried about health care.

William Dunkleberg.  Idiot of the Week.

I suppose we could be more polite.

It is only when we get incomes going, debt burdens down and demand up that we will get any real forward movement in this economy.

Looking over the precipice with Niall Ferguson

The V-shaped recovery seems to have been about a two-day thing. Economic historian Niall Ferguson does a good job of suggesting why. Demand Side suggests that since the policy actions of the Fed and Treasury have done nothing to address the root problems, we might expect another flowering of those problems. Soon.

Interview with Niall Ferguson
Brian Milner
Globe and Mail
Nov. 23, 2009

Does the recovery we've seen in fits and starts have any legs at all, outside of the major emerging markets? Or is it a mirage?

I don't think it's possible to infer from the stock market rally anything resembling a sustained recovery. The third quarter GDP number of 3.5% growth [subsequently revised down to 2.8%] was at least half due to one-off government measures. In any case, the U.S. consumer is constrained by horrible balance sheet problems – excessive leverage and severely reduced real estate values on the assets side. The stock market rally has been largely due to near-zero interest rates and a weaker dollar. In foreign currency terms there's been no rally.

What's your assessment of how the economic and financial crisis has played out this past year? Worse or better than you thought? Are markets headed for another big fall, or are they correctly predicting that the frail recovery will be sustainable?

I feared all summer that we might have another big banking crisis in Europe just as happened in 1931. Well, the European governments turned a blind eye to their big banks' problems and we avoided a repeat of Creditanstalt. So things are better than they might have been. But I don't think you can have any faith in markets ‘predicting' anything. First, the bond market isn't predicting anything resembling what you might infer from the stock market, where the price/trailing earnings ratio is now pretty high. Secondly, how well did markets predict the crisis? Enough said.

Let's address your famous “Blood in the streets” comment to The Globe and Mail last February. Still feel that way?

I wasn't saying there would be blood in the streets of Toronto, remember. My first point was that the crisis would likely destabilize about a dozen relatively weak states and that this ‘axis of upheaval' would become more violent. That's happening already – just look at the escalation of violence in Afghanistan and Pakistan, and the signs of a deterioration of security in Iraq, not to mention Somalia.

The other point I had in mind was that, after previous big financial crises, insecure governments have been tempted to rattle sabres for the sake of promoting their own domestic legitimacy. My prime suspect here is Russia, which of all the big powers stands to gain the most from geopolitical instability, since [for example] a major attack on Iranian nuclear installations would double the price of oil and greatly enrich the denizens of the Kremlin. The probability of such a war is currently being underestimated by many people.

You have said projections about the economy are wrong because they're based on models that don't correspond to real life. Do you feel they have by now been well and truly discredited, along with the efficient market theory and other dearly held views of so many academic economists?

No, I think they are putting up a heroic resistance. And I don't want to caricature the process whereby economists try to model the complex thing that is the economy. These exercises have their uses. And the efficient market hypothesis is not all wrong. Most of the time, stock prices do seem to follow a random walk, as the theory states. But the key phrase is ‘most of the time.' We need to use history and psychology to understand what makes seemingly irrational manias and panics happen so frequently in financial markets. Too many economists thought they didn't need to stoop to incorporate such lowly disciplines. The discipline succumbed to hubris, because mathematical elegance took precedence over the real world.

Please give your outlook for the U.S. dollar, inflation and long-term interest rates?

My outlook? After what I just said about models? The most we can say, drawing on what we know about past financial crises, is that over a five-year time frame, the dollar is likely to weaken some more, inflation is likely to pick up after another year or two of pretty low prices and long-term interest rates could move up sooner than that, in anticipation of a revival of inflation. Add, say, 50 to150 basis points to the U.S. federal government's 10-year Treasury yield and the effect could be quite painful for the economy as a whole.

What are the biggest surprises in the unfolding story so far? Would the quick response by central banks be one? And have they done the right thing by turning on the taps and bringing rates down to record low levels?

I was truly surprised by some of the things Ben Bernanke did, especially in late 2008. He was buying up securities that previously would have been considered totally unacceptable on a central bank balance sheet. Full marks to him, however, for realizing the gravity of the crisis and moving to avert a second ‘great contraction.'

But what surprised me even more was the readiness of Treasury officials to accept the nakedly self-interested arguments of the ‘Too Big To Fail' institutions.

Any concern about the lack of a clear exit strategy for the fiscal stimulus programs? Will we be looking at higher taxes soon, despite the protestations of the politicians?

I am very alarmed by the prospect of trillion-dollar deficits as far as the eye can see – though for this year and next year they make sense. My bet is that Obama will eventually be forced to introduce a value-added tax on the European model.

You've been lumped in with Nouriel Roubini and some others with strongly bearish sentiments as doom-spreaders making a lot of hay out of the crisis. Is that an unfair criticism?

Well, I like Nouriel a great deal and admire what he's achieved. But we've approached this in very different ways. Nouriel was predicting collapse from as early as 2002, if not before, and his focus was on the current account and the dollar more than the banks. I first raised the spectre of a massive liquidity crisis for highly leveraged U.S. financial institutions in 2006, so I think my timing and focus were a little better. But I was wrong in one respect: I thought a geopolitical event would be the trigger for a massive repricing of risk. Wrong. It happened all by itself, caused by endogenous forces within the financial system.

What's your outlook for 2010 for both the U.S. and global economies?

U.S. growth will likely be lower than the 3.2 per cent forecast by the administration earlier this year. Growth in the big Asian economies and their trading partners may beat expectations. But this is pure guesswork. Remember: The models used to make forecasts of this sort by the IMF have been largely discredited by the crisis, just like the ‘predictions' of the stock market.

What's the risk of new asset bubbles forming and what threat would they pose, if any, to global recovery?

Excessively loose monetary policy causes asset bubbles and excessively loose monetary policy is what we have now. It's a little early to start pointing figures and calling things ‘bubbles,' however. Many prices are simply returning to their trend growth line after the collapse that occurred a year ago.

You have said: “Default is not a scenario we can rule out.” Do you believe the U.S. government would ever renege on it obligations to foreign investors? What are the risks that the government would cut off funding domestically for programmed spending on Medicare et al?

At some point it is absolutely inevitable that the U.S. will have to ‘default' on part of its existing liabilities, since the long-run trajectory of government borrowing is clearly unsustainable. With the unfunded liabilities of the Social Security and Medicare systems now around $100-trillion, these look like the most vulnerable budget headings.

You said recently the biggest problem that anybody faces today is that their lifetime experience is no longer a reliable guide to the future. But some economists, including your Harvard colleague, Ken Rogoff, have been saying that we have seen this movie before.

Ken and I are of one mind. His book [ This Time is Different: Eight Centuries of Financial Folly ] goes back eight centuries, mine goes back four millennia. We need financial history to free us from the trap of our own personal experience which (unless you're Paul Volcker) is just too short to offer a reliable guide to the range of possible crises we may face.

You have talked about the “Chimerican era” coming to a close and that the 10/10 rule of 10 per cent Chinese growth and 10 per cent U.S. unemployment can't be maintained. Any time frame for the end of the Chinese-U.S. financial marriage?

I think Chimerica is a marriage on the rocks. The Chinese feel they have more than enough U.S. Treasury bills and bonds. They also know our consumer isn't coming back any time soon. But for the short run they gain from their currency's peg to the [U.S.] dollar. As the dollar weakens, do does the renminbi. So this has a few more years to run, after which the Chinese may allow their currency to appreciate.

Are you concerned about rising U.S. protectionism?

Protectionist measures by Congress don't worry me. I am more worried about a game of competitive devaluations.

In The Ascent of Money and subsequently in public comments, you have talked about the crippling U.S. debt and the lack of political will to fix it. Do Obama's comments [last week] in China that urgent steps must be taken to rein in public finances give you any hope that the government will be serious about tackling the problem?

I was very glad to hear him say that. The administration urgently needs to get serious about medium- to long-term fiscal stability, or the U.S. risks losing credibility as a borrower – and that generally translates into higher interest rates.

This is another debt-related question. You have argued that the only way out of this mess is to get the U.S. off its addiction to debt and for China to end its role as chief enabler, which you see already occurring. But foreign demand for U.S. bonds remains relatively strong and domestic purchases by financial institutions and institutional investors is picking up some of the slack. Do you see this changing any time soon?

I think it's much too early to conclude that the U.S. can count on foreigners to finance a cumulative $9-trillion of new bond issuance at the current low rates over a nine or 10-year time horizon. At some point, especially with the dollar weakening, the U.S. will need to offer higher real returns to sell all this stuff.

Does being an historian give you a better perspective on the future?

I think it has taught me that there is no such thing as the future, only multiple futures of varying degrees of probability.

How does it colour your advice to hedge fund investors?

‘History' is mostly what the statisticians call the ‘fat tails of the distribution.' I advise my financial friends to keep trying to imagine big ‘tail events' like wars, revolutions and of course financial crises.

How have the events of the past year affected your personal investment decisions?

I am out of U.S. stocks and currently have a modest cash pile. The commodity and stock market rally since March looks to me to be coming to an end. I am genuinely not sure what happens next. Having narrowly avoided a Great Depression by using massive fiscal and monetary stimulus, we are now in uncharted waters.

Monday, November 23, 2009

Steve Keen suggests recovery patch-up may fail

Demand Side has rejected the nearly universal call by economists that the recession is over and recovery has begun.  In doing so, we observed that a jobless recovery is now the norm, this time we have the investment-less recovery, and soon we'll have the recovery-less recovery.  But there WAS investment in the data after all, as Steve Keen points out here.  Yes.  A 23.4 percent bump in residential investment.  This following declines of -23, -38 and -23 in the previous three quarters.  Why we still are not jumping on the bandwagon, I wonder.

Check out the link for some illustrative charts.

Have we dodged the Iceberg?
Debtwatch No. 40 November 2009 
by Steve Keen

The most recent “unexpectedly good” growth figures for the USA appear to indicate that what will still be the worst downturn since the Great Depression is finally over. However this is not your usual downturn. Not only is it acknowledged as the most severe since the Great Depression, it has also evoked the most remarkable government economic stimulus ever seen. It would be bizarre if this had not had an effect on the data.

Whether a recovery is truly underway in the private sector therefore depends on how the economy is likely to perform after the stimulus is withdrawn.

The “recession is over” reaction could be valid under two circumstances. Either:
  • The figures are very high even when the government stimulus is taken into account; or
  • If the economy could be expected to continue growing endogenously after the stimulus were withdrawn, even if the aggregate numbers for this quarter were good only because the government stimulus was so large.
Let’s consider the first option. The growth rate on an annualised basis for the last quarter was 3.5%. The BEA’s decomposition of this notes that 1.66% of the growth was due to increased motor vehicle output, which was primarily driven by the government’s “Cash for Clunkers” program. Another 0.48% was due to the growth in government expenditure.

There are also some elements of the figures that simply seem, in the original sense of the word, incredible. For example, rising investment levels—up 11.5%—were a major reason for the positive reading. But all components of this measure were either tepid or negative—except for residential investment, which was up a whopping 23.4%.  That just doesn’t tally with the most depressed real estate market in history; possibly this huge contribution to aggregate investment could be the result of a large movement from a very small base, whereas the sector’s weight in the overall calculations of investment hasn’t been revised downwards to reflect its true contribution today. Or it could be a problem with the data sample that will be revised substantially downwards in later estimates of GDP.

Either way, the prospect that a serious recession, which was caused by the bursting of a housing bubble, which left an unprecedented stock of unsold existing houses on the market, and which has led to an unprecedented unsold over-supply of existing housing stock, has been ended by a revival in housing investment… is simply incredible.

That leaves the second option—that even though the positive figure was the product of the government stimulus, when this is withdrawn the economy can be expected to continue growing on its own.  Here trends in consumer income and non-residential investment are the important issues. These would both need to be positive (or at least turning from lows) for the private sector to resume growth in the next quarter without the need for stimulus.

Consumer disposable income fell at a substantial 3.4% annualised rate in the quarter, while fixed investment expenditure rose by an anaemic 2.3% and investment in structures fell by 2.5%.    It is thus likely that if the government stimulus were withdrawn, both these private sector areas would show even more negative figures over this quarter.


[T]here is another factor that hasn’t yet been considered—the role of credit. During post-War recession, credit growth has dropped well below trend, and the recovery has involved rising debt levels. This is not the sign of a healthy economy—far from it—but this is how the US economy has “recovered” from every previous post-WWII recession.  Not this time it appears.  If this is a recovery, then it’s a highly unusual one because credit growth is still well below trend—and, in fact, negative: America is deleveraging.

We therefore have the strange combination that one accepted “leading indicator” of recovery—a turnaround in investment—appears to have occurred, while another less favoured indicator—the trend in credit growth—is still pointing at recession.


[T]he data favours debt growth as the leading indicator to watch. Investment is strongly correlated with GDP, but that’s hardly surprising since it constitutes a major and volatile component of GDP. Just as with consumption—the larger but less volatile major component—its correlation is highest when coincident with GDP. It is not a leading indicator.

The two best leading indicators are debt, and government spending—with the former stronger than the latter. Government spending a year ahead of GDP is a good indicator of which way GDP will go—something which supports the Chartalist approach to macroeconomics and undermines conventional “neoclassical” economic thinking. But changes in debt are a stronger indicator still, and have a stronger effect closer to the actual movements in GDP.

I don’t believe that this quarter of growth for the USA implies it has dodged the iceberg. Instead a patch-up job has been done on the damage, but the USS is still taking on water as the private sector deleverages.

Sunday, November 22, 2009

Australia and Brazil not happy to be Wall Street's target of speculation

The most successful economies in the current calamity are not in China or Europe, but in Brazil and Australia. Now the cheap chips minted for the big banks by the Fed are being carried into these markets and are producing trouble. Here from a leading journalist is what's up Down Under.

Foreign speculation on our currency is a bubble set to burst
Kenneth Davidson
The Age (Australia)
October 26, 2009

The pooh-bahs running US and British hedge funds and the banks supporting them are more than capable of reading the minutes of the Reserve Bank of Australia board meetings and coming to the conclusion that RBA Governor Glenn Stevens is committed to pushing up the cash rate from the present 3.25 per cent to 4 to 5 per cent if necessary.

And they are already betting tens of billions of dollars on what has so far been a sure bet. These foreign financial institutions are up to their old tricks. After getting trillions of dollars out of their respective governments to avoid GFC-induced bankruptcy - which was largely engineered by their criminal greed - because they are ''too big to fail'', they are already using their influence to maintain ''business as usual''.

Why funnel the money gouged out of American and British taxpayers into lending to their national economies to maintain employment when there are richer pickings elsewhere? Two of those destinations are Brazil and Australia. Their resource-rich economies are still doing well compared with most other countries because they are riding in the slipstream of the strong demand for commodities from China and India.

Cash is pouring into these economies, not for development, but to speculate on the local currency and the sharemarket. The rising value of the Brazilian real and the Australian dollar against the US dollar has had a disastrous impact on both countries' non-commodity export and import competing industries. Brazil's popular and largely economically successful left-wing Government led by President Lula da Silva is meeting the problem head on. It has decided to impose a 2 per cent tax on all capital inflows to stop the real appreciating further.

Arguably, the monetary strategy adopted by Stevens has compounded Australia's lack of international competitiveness for our manufacturing and service industries, especially tourism. Since the end of 2008 our dollar has appreciated 27 per cent (as of last week). This means that financial institutions that invested money at the beginning of January are enjoying an annual rate of return on their investments of 35 per cent.

US and British commercial banks can borrow from their central banks at a rate less than 1 per cent. The equivalent RBA rate is 3.25 per cent and many pundits are forecasting the rate could go to 3.75 per cent before the end of 2009. This will increase the differential between Australian and British and US interest rates and make the scope for speculative profits even higher.

Since the beginning of the year, $64 billion has poured into Australia in the form of direct and portfolio (share) investment and foreign lenders have switched $80 billion of foreign debt payable in foreign currencies to Australian currency. Most of the portfolio investment ($41 billion) has gone into bank shares. Banks now represent 40 per cent of the value of shares traded on the stock exchange, and while shares in the big four bank shares have increased by about 80 per cent (as measured by CBA shares), the Australian Stock Exchange Index has risen by only 30 per cent.

Foreigners have shifted out of Australian fixed interest debt and into equities because as interest rates go up, the capital value of fixed debt declines. By driving up interest rates to curb inflationary expectations and the prospect of a housing price bubble the RBA is in far greater danger of creating a stock exchange asset price bubble as well as an Australian dollar bubble. Once foreigners believe interest rates have peaked, the bubbles are likely to be pricked as financial speculators attempt to realise their gains. This could lead to a stampede out of Australian denominated securities.

With unemployment expected to continue to rise, and the level of unemployment disguised by growing numbers of workers being forced to work part-time, there is little chance of the underlying inflation rate, already below 2 per cent, increasing as a result of a wages break-out. The last wages breakout (leaving aside the explosive growth in executive salaries in the past three decades) occurred in 1979.

The world has moved on but the obsessive debate about wage inflation and union powers hasn't. Since the beginning of the '80s, the problem has been periodic bouts of asset price inflation. It is the biggest danger now.

Instead of controlling the unions, there should be control of financial institutions. The Australian dollar bubble and the incipient housing bubble should be micro-managed. Capital inflow could be dampened by a compulsory deposit of 1 to 2 per cent to be redeemed after a year to stop speculative inflow. Home ownership has become a tax shelter. The steam could be taken out of the rise in house prices if negative gearing was limited to new housing. This would obviate the need for higher interest rates that affect everyone.

Kenneth Davidson is an Age senior columnist.

Saturday, November 21, 2009

Look Out Above! Forecasters predict falling inflation

The Philadelphia Fed's survey of professional forecasters is out.  We want to put them on record along with their universal faith in an expanding economy and a recession being over.  As we've said, GDP can expand with continued federal subsidy, but the economy is not expanding, and the major risks are still to the downside.

One of these days we'll put up the consensus's record for the past couple of years.  Karl Popper is reported to have said, "Explanations and forecasts are symmetrical and reversible."  Only by reversing their forecasts can these guys get to symmetrical with actual results.

Fourth Quarter 2009 Survey of Professional Forecasters

Forecasters See the Expansion Continuing

The U.S. economy will grow over each of the next five quarters, according to 41 forecasters surveyed by the Federal Reserve Bank of Philadelphia. The forecasters see real GDP growing at an annual rate of 2.7 percent this quarter. On an annual-average over annual-average basis, forecasters see real GDP falling 2.5 percent in 2009 before rebounding in each of the following three years. Real GDP will grow 2.4 percent in 2010, 3.1 percent in 2011, and 3.3 percent in 2012. As the table below shows, these estimates are a bit higher than those the forecasters projected in last quarter's survey.

The labor market looks weaker now than it did three months ago. Unemployment is now seen at an annual average of 9.3 percent in 2009 and 10 percent in 2010, before falling to 9.2 percent in 2011 and 8.3 percent in 2012. These estimates mark upward revisions from the forecasters' previous projection. Likewise, growth in jobs looks weaker. The forecasters see nonfarm payroll employment falling at a rate of 160,000 jobs per month this quarter and 35,000 jobs per month next quarter. Both estimates mark downward revisions from the previous survey. The forecasters see jobs beginning to grow in the second quarter of 2010. Over the second half of the year, jobs will grow at a rate of 150,000 per month.

The forecasters' projections for the annual average level of nonfarm payroll employment suggest job losses at a monthly rate of 427,000 in 2009 and a further loss of 70,000 per month in 2010. (These annual-average estimates are computed as the year-to-year change in the annual-average level of nonfarm payroll employment, converted to a monthly rate.)

Real GDP (%)
Rate (%)
Quarterly data:2009:Q4

Annual average data:

Reduced Expectations for Inflation at (Almost) All Horizons

The forecasters have cut their expectations for inflation at all but the shortest horizons. This covers the survey's headline and core measures of CPI and PCE inflation. Most notably, the forecasters see lower inflation at the 10-year annual-average horizon than they predicted in last quarter's survey, as shown in the table below.

Headline CPI
Core CPI
Headline PCE
Core PCE
Q4/Q4 Annual Averages
Long-Term Annual Averages

The lower estimates for five- and 10-year annual-average headline CPI and PCE inflation are of particular interest. For CPI inflation, the projections were cut from 2.15 percent in the last survey to 1.89 percent currently (2009-2013) and from 2.50 percent to 2.26 percent (2009-2018). For PCE inflation, the estimates fell from 2.00 percent in the last survey to 1.83 percent currently (2009-2013) and 2.15 percent to 2.10 percent (2009-2018).

Demand Side Relay 323: Nouriel Roubini and the pessimistic path forward, plus the mother of all carry trades

Listen to this episode
Today two pieces from Nouriel Roubini. The first, his presentation at an AEI conference outlining his very pessimistic view of the prospect for the U.S. and global economy. The second is part of a somewhat contentious interview on CNBC describing his position on the mother of all carry trades.

Nouriel Roubini

The mother of all carry trades is Roubini's necessary explanation of the stock market surge that he missed in March, when he described it as a sucker's rally. We will remind you that we did not miss the rally because we see cheap Fed chips having to blow up some bubble somewhere.

But now Roubini is back ahead of us.

note: podcast upload is delayed for technical reasons

Friday, November 20, 2009

Robert Kuttner seconds the Obama jobs summit

Jobs need to lead the recovery. They are not a lagging indicator, at least according to Demand Side. Jobs need to lead stability and aggregate demand. The easy money zero interest policy has not worked, although tepid and doubtful growth in Q3 has given the professional economists another opportunity to make a mistake.  Although Larry Summers, quoted by Kuttner here, is good at taking credit, he was slow and reluctant to the party.
A Wake Up Call on Jobs
by Robert Kuttner
November 15, 2009

President Obama has announced a White House Jobs Summit for next month. At least that's the beginning of recognition that the unemployment rate is unacceptable. The measured rate is now 10.2 percent, but if you count people who have given up or who are involuntarily working part time, the real rate is over 17 percent.

This spells political catastrophe for Democrats in the 2010 mid-term election, as foreshadowed by the recent losses in the New Jersey and Virginia governors' races. But Obama's top economic advisers, such as Larry Summers, don't seem to get it. They continue to resist the idea of a second stimulus package.

"I think we got the Recovery Act right," Summers recently told the Washington Post's Alec MacGillis, adding, "We always recognized that America's problems were not created in a week or a month or a year and that they were not going to be solved quickly. We designed the Recovery Act to ramp up over time, through 2010, and to make sure that the investments we made were important for the country's future."

And other senior Obama officials such as White House Chief of Staff Rahm Emanuel and Office of Management and Budget Chief Peter Orszag are more concerned with cutting the deficit than spending more money to reduce joblessness. According to the Wall Street Journal, Orszag is sympathetic to the idea of a commission to cap government spending and Emanuel is floating the idea of spending some of the money that has been repaid from TARP bank bailouts on deficit reduction.

But this is putting the cart before the horse. We need larger deficits now, in order to get a real recovery going, so that a healthy economy will allow us to pay down public debt later. Specifically, we need to focus on three big things:

State and Local Fiscal Relief. You often hear that outlays on public infrastructure are not a good source of stimulus because they take too long to plan. But emergency revenue sharing to states and localities takes effect almost instantly because it prevents cuts in existing programs and layoffs of existing workers. Today, states and localities are not only cutting back outlays because their constitutions require balanced budgets; they are raising taxes, usually regressive taxes. According to the Center on Budget and Policy Priorities, the three year state fiscal gap 2010-2012, will be at least $470 billion. So more than half of the federal stimulus is undermined by state and local belt tightening.

Accelerated Spending on Public Works. The Roosevelt administration, in an era before computers, got a lot of public works spending going in less than a year. There are massive unmet needs in public infrastructure. The Obama administration needs a short term and a long term strategy. Projects such as school repair and expansion, which can get underway in a few months, should get fast-tracked funding commitments right away. Longer term needs, such as smart electrical grids and modernization of water and sewer systems, expanded mass transit, and green energy, should be targeted for funding in 2011, so that plans can get on the drawing boards now.

Wage Subsidies. It is fashionable among American conservatives to make fun of the "rigidity" of European labor markets. But Germany today has a flexible and creative program of wage subsidies. The result is that the German unemployment rate has pealed at around 8 percent while ours has crashed through 10 percent. German companies suffering a downturn because of recession can get wage subsidies for their workers. Workers can also be put on reduced working time (kurzarbeit) and the German unemployment office will make up most of the loss in their take-home pay. According to the German government, a worker cut to 40 percent of his or her normal hours will end up with about 85 percent of usual take-home pay. Today, some 1.4 million German workers have been able to keep their jobs and most of their earnings thanks to the kurzarbeit plan. German firms keep their workers connected to the company, workers hold on to their jobs, and there are also incentives for workers on reduced time to use their spare hours to get additional training.

All told, we need additional federal spending in the range of at least $500 billion. But won't this increase the deficit? Yes it will, and that is the whole point. We are in a classic downward spiral of reduced household income and wealth, and a weakened financial sector. Many businesses face reduced consumer demand, compounded by a reluctance of banks to advance to any but the most blue chip borrowers.

In this climate, GDP growth can turn positive but companies are reluctant to hire. Full recovery will not resume spontaneously based on household or business demand, and the only source of increased demand to break the cycle is the government.

One of the most widespread and mistaken assumptions is that this bleak future is just baked into the cake. Because of the legacy of the financial collapse, and the limits of deficit spending, supposedly, we are just stuck with it. You hear that in testimony from Federal Reserve Chairman Bernanke, and it is repeated mindlessly by the media.

This fatalism is just plain wrong, and history's great counter-example is World War II. In 1939, unemployment was stuck around 16 percent. GDP growth after 1933 was solid -- 6 to 10 percent a year with the exception of 1937 -- but the wounded economy was just not generating net jobs. Many expert commentators of that era concluded that there was something about the maturity of capitalism, or the replacement of human workers by machines, that consigned the economy to a chronic structurally high, rate of unemployment.

Then World War II broke out. The US government borrowed huge sums to recapitalize US industry and re-employ and retrain US worker in war production, to employ 12 million men and women in the armed forces, and to invest massively in science and technology to develop advanced weapons and substitutes for materials in short supply. The unemployment rate dropped to 2 percent by 1943. Deficits were enormous, as high as 29 percent of GDP in 1942 (this year they will be about 10 percent) but the economy grew at 12 percent a year for the four years of the war, and the high unemployment of the 1930s never returned.

The deficit hawks of that era worried that the very large national debt would be a millstone around the economy. At the end of 1945, the debt was 122 percent of GDP, compared to about 55 percent today, but of course the end of 1945 was the beginning of the 25 year postwar boom -- the longest sustained boom in US history. GDP grew at 3.8 percent a year. The average deficit was about 1.1 percent, and with the economy growing much faster than the debt, the debt to GDP ratio declined to about 30 percent by the 1970s. So, we can grow our way out of debt -- but we need to get a real recovery going first.

If past Obama White House Summits are any guide, this one will invite a broad cross section of people: trade unionists and deficit hawks, investment bankers and labor economists, industrialists and Republicans; and everyone will speak of the importance of their pet project for job creation. That's not good enough. This is not a moment for another White House gab fest. It's a time for progressive leadership.